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Executives

Patrick W. Smith – Chief Executive Officer and Director

Daniel Marc Behrendt – Chief Financial Officer and Investor Relations Contact

TASER International, Inc. (TASR) Q1 2012 Earnings Call April 26, 2012 11:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to Q1 2012 TASER International, Inc., earnings conference call. My name is Sandra and I will be your operator for today.

At the time all participants will be on a listen-only mode. We will conduct a question-and-answer session towards the end of the conference. (Operator Instructions). As a reminder, this call is being recorded for replay purposes.

I would now like to hand the call over to Mr. Rick Smith, CEO. Please go ahead, sir.

Patrick W. Smith

Great. Thank you. Welcome, everyone. Thank you for spending part of your morning with us. Before we get started I’m going to have Dan Behrendt, our CFO, read the Safe Harbor.

Daniel Marc Behrendt

Thank you, Rick. Our Safe Harbor statement. 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.TASER International intends that such forward-looking such forward-looking statements to be subject to the Safe Harbor created thereby. Such forward-looking statements relate to expected revenue and earnings growth, estimations regarding the size of our target markets, successful penetration of law enforcement markets, expansion of product sales through the private security, military and consumer self-defense markets, growth expectations for new and existing accounts, expansion of production capabilities, 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 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 in the markets for 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 risk 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 concerns, potential fluctuations in quarterly operating results, competition, negative reports concerning TASER device uses, financial and budgetary constraints in prospects and customers, dependence upon sole and limited source suppliers, fluctuations in component pricing, risks of governmental 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.

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

Patrick W. Smith

Thanks, Dan. I think we’re all proud to be having a call like one we’re having today. I think the results reflect a lot of hard work by a lot of great people. As you all are probably aware, first quarter revenues came in at $25.6 million, an increase of $2.5 million or 10.9% over the first quarter a year ago.

Sequentially revenues grew by about 20%. This increase was driven primarily by our third consecutive quarter of growth in North American law enforcement, which grew by over 25% as well as by a large order from the United States Army. These increases were partially offset by a 51% decrease in international sales from a year ago period, although we did see a slight sequential increase over the fourth quarter.

There were two particularly bright spots, I’d like to highlight in first quarter revenues, and then I will hand you over to Dan to go through the details. Gross margin across the business grew from 52.8% from a year ago period to 59.4%. Even more impressive, if you look at gross margin in our core ECD business, they were at 65.2%.

Operating income of $6.4 million, $6.456 million, I guess round up to $6.5 million, came in over 25% of revenues, driven by a combination of strong operating results and a partial reversal of the Turner verdict, which caused us to reduce our litigation reserve by $2.2 million.

And with that, I will hand over to Dan to go into more detail through the results.

Daniel Marc Behrendt

Thanks, Rick. So as Rick said, revenue for Q1 was $25.6 million, which is up approximately $2.5 million or 10.9% from the prior year first quarter amount. The increase in sales versus prior year were driven by the continued adoption of the X2 electronic control device as well as a significant order from the United States Army for 3500 X26 ECDs, following the DOD's Type Classification of the X26.

Gross margin for the first quarter was $15.2 million or 59.4% of revenue which is 6.6% as a percent of sales better than the 52.8% in the prior year. The improvements in margins were mostly driven by the increased leverage of indirect manufacturing cost due to the higher sales and a favorable product mix.

When we look at the ECD segment gross margin, it was 65.2% in Q1 of 2012 versus 59.3% in Q1 of 2011. We’re encouraged by the gross margin performance. We’ll likely see a slight degradation in gross margin as we increase the sale of video products, as these carry lower gross margin than the ECD products. But that should be partially offset over time with profitable recurring revenue from EVIDENCE.com as the video business scales up.

The SG&A expenses for the quarter were $8.9 million versus $9.3 million in the prior year. SG&A was 34.5% of net sales in Q1 of 2012 compared to 40.4% of net sales in 2011. The improvement was mostly driven by lower consulting and lobbying fees, about $240,000 and we continue to encourage by the lower SG&A levels, although some of the improvements in the quarter were really driven by some timing difference, so we expect the ongoing SG&A rate to be closer to the sort of the 2011 SG&A levels on a go forward basis.

Research and development expenses were $2.1 million for the first quarter, which were favorable by $0.6 million when compared to 2011. Again, the decrease was mostly driven by the continued decline in consulting costs, as well as implementing some head count reductions. And then similar to SG&A, R&D expenses were favorable even to our budgets. So again we expect our ongoing R&D expenses to be closer to sort of the run rate you saw in the later part of 2011.

The litigation judgment expense is driven by the reversal of the part of our accrual on the Turner case. The judgment allowed us to reverse $2.2 million of the $3.3 million we had on the balance sheet. We still have that $1.1 million reserved, which is the amount of the judgment which is in excess of our insurance limits for that year.

Our adjusted operating income, which excludes the impact of stock-based compensation charges, depreciation and amortization and losses on write-down disposal of property and equipment, was $6.7 million for the first quarter of 2012. This is a $3.5 million or 113% increase from adjusted operating income of $3.1 million in the first quarter of 2011.

We also backed out the benefit of the partial reversal of litigation judgment on Turner out of that normalized adjusted operating income, just so people would see on a go-forward basis without that one-time benefit in the results.

The GAAP income from operations for the quarter was $6.5 million for the first quarter, compared to income of operations of $100,000 for the first quarter of 2011. Net income for the first quarter was $3.8 million or $0.07 per share on both basic and diluted basis, compared to net income of $19,000 or $0.00 per share on a basic and diluted basis in the first quarter of 2011.

The tax provision for the first quarter is $2.6 million compared to $0.1 million in the first quarter of last year. We continue to show the results of both the video and the ECD segments of the business. Increased sales and reductions in the cost structure drove an increase in operating income from the ECD business in the first quarter of 2012 to $9.4 million versus $2.9 million in the first quarter of 2011. When we back out the one-time benefit of the reduction of the judgment accrual on the Turner case and normalize the results, income from operations for ECD remains at $7.2 million or 29% of ECD sales, very strong results in that segment of the business.

We do continue to invest heavily in the video segment. The loss from operations for the video business was $3 million in the first quarter of 2012 versus $2.9 million in the first quarter of 2011. We are beginning to see more traction in the video business with launch of the AXON Flex product and expect to see results improve over the year.

Moving on to the balance sheet, we did finish the quarter with $29.7 million worth of cash, cash equivalents, and short-term investments. The increase of $3.3 million from the year-end balance was due to the $3.6 million provided from operating activities. So the net cash flow from operations was $2.6 million, which drove that increase in the cash balance.

Accounts receivable of $14.3 million are up $2.5 million from the prior year end due to the increased sales in the first quarter of 2012 versus the fourth quarter of 2011. Inventory of $11.1 million is down about $200,000 from the prior year end balance. The decrease is attributed to just general reductions in inventory balances and the increased sales figures. We do expect to see a short-term surge in the inventory balances as we ramp up the production of the AXON Flex product lines.

The investment in property and equipment is $25.6 million, down $1.2 million compared to the prior year. Decrease is mostly a result of $1.6 million of depreciation expense, which was partially offset by investments in property and equipment for TASER X2 electronic control device product line and the AXON Flex video product line. Total assets were $107.4 million at the end of the quarter.

Moving on the liability side of the balance sheet, accounts payable of $3.8 million is down $700,000 from the prior end due to timing differences in AP check runs at the year end versus the quarter end. Accrued liabilities of $5.8 million decreased $3.5 million primarily due to the litigation judgment expense reversal of $2.2 million on the Turner case.

Deferred revenue of 8.2 million at March 31 increased $225,000 from the year end balance was due to new increased sales of the X2 trade-in program which includes an extended warranty. So that extended warranty deferral went up in the first quarter. And continue to have no long-term debt and plenty of liquidity to operate the business here. As we move on to the cash flow information, the company had cash provided from operations of $3.6 million during the first quarter of 2012 versus $4.4 million in the same quarter of last year. Again, the biggest difference versus the cash generation last year is the $2.5 million of AR. It’s more of a just driven by the sales growth in the first quarter.

We did have cash used in investing activities. For the first quarter it was $0.6 million compared to $10.2 million in the prior year. The use of cash in 2011 was mostly driven by the net purchasing activity and short-term investments last year. Cash used in financing activities was only $14,000 for the three months ended March 31, 2012 compared to $5.1 million used in the same period in 2011.

The cash usage in 2011 was driven by the stock buyback. And as we announced on the release here, the Board of Directors did approve another $20 million buyback for the company. So you will see that cash used in financing activities go up as we move into 2012. The company did end the quarter with $24.3 million of cash and $5.3 million in short-term investments for a total of $29.7 million of cash, cash equivalents and short-term investments. Again, very confident in the strong liquidity position we’re in and ability for the business to generate cash, which gives us a lot of confidence in the business.

Also I’d like to just cover the unit sales before I turn the call back over to Rick just for the analyst, so they can model this. We had, for X26s we sold 13,415 units in Q1 of 2012. We sold 3,778 X2 units, 834 M26 units, 8 of the X3 units. We sold 3,054 of the C2s. TASER CAM we actually had a strong quarter for TASER CAMs 1631. TASER CAM sold in the quarter, and we sold 362,785 cartridges.

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

Patrick W. Smith

Thanks, Dan. First I’d like to highlight the U.S. Army order. Certainly I am sure folks are asking whether we should think about it as a one-time event or is this something that can impact the future of the business. The important part there is this purchase comes at the end of the Type Classification process, which, the military has a fairly involved approval process for products to be Type Classified, which means that all the acquisition, methodologies, procedures, safeguards, et cetera are in place. And the product is officially approved for use by the department of defense.

So this milestone does set the way to streamline future procurement by the Army. So of course we still have selling to do for those orders to come in. But that now drastically simplifies their ability to purchase and deploy as it’s now an officially approved platform. So a significant milestone. Great work to our federal and military team in completing that long process.

As we initiated last quarter, we have begun to break out our P&L by business unit, so that our investors will be able to see how we’re doing in the electronic control device business, our historical core business, as well as the new video and cloud business unit. What you continue to see is that we have a solidly profitable, very cash, very positive cash generating machine and our core business. And the profits and cash flow from this core business have been funding the major development efforts in AXON and Evidence.com, where we believe we are well positioned as the first major mover in cloud computing for law enforcement.

We believe we are close to the inflection point for the rapid adoption of officer-based video, and we believe that our solution is best-in-class with the Flex that will begin shipping next month. So we believe the investments we’ve made are the right move for TASER. It has been a good use of our cash and positions us to be a dominant player in a major new market.

As I mentioned in our last call, in 2012 we are focused on rigorous execution. I believe that is part of what you are seeing in the numbers. Our organization is aligned towards three key goals. First is driving an upgrade cycle in our core ECD business in North America. Second is driving international sales adoption of our products globally, and third is driving adoption of AXON and Evidence.com in our cloud and video business unit.

Progress on any one of these three initiatives can create significant growth and profitability for the company in 2012. Therefore we are limiting our scope of efforts to focus like a laser on these three areas. The upgrade opportunity will represent roughly 327,000 units by the end of this year that will be more than five years old, which is roughly a $350 million potential market for us to upgrade, just users that have devices that are past there expected useful life.

In the first quarter, upgrades only accounted for roughly 1000 of the X2 sales. The reason for this is on December 31 our trade-in program expired, so for most of the first quarter we did not have an active trade-in program in place. Now, we felt it was important to maintain credibility by sunsetting the program at the (inaudible). We felt it was also important to test whether the upgrade program was making a difference, which we validated it was making a difference. And therefore we looked at how we could construct a new trade-in program after a six day period we introduced our 2012 trade-in program which we obviously had to take a hard look at how to make it consistent with what we had sunset in 2011 and yet meet our corporate objectives for 2012.

So the new program whereas in 2011 the trade-in was a $300 credit. In 2012 the trade-in will start at $250 per unit for the first half of the year, and then it will decline to $160 per unit by year end. We believe this program will help agencies continue to transition for the new X2 over the course of the year.

As of March 30, we’ve fully upgraded 3.3% of ECD's that are greater than five years old, although we do have a significant pipeline of agencies that are looking to upgrade and obviously with 96.7% of the market available, it's an opportunity we just need to execute well on.

In our video could business, the core effort has been on the dramatic product improvements with the AXON Flex. As we have talked about before the primary barrier to sale with our first-generation AXON was the size, wires, and comfort. It was quite interesting; I recall some amusing conversations with our general manager of EVIDENCE.com. He related to me it's the first time he is aware of a cloud business whose growth has been somewhat throttled by something like size, wires, and comfort of the physical gear. But that is what happens when you are launching a truly integrated system for our customers and we feel very confident, based on customer feedback and the fact we’ve been able to reduce the size and weight by 85% of that system, as well as partnering with Oakley on the sunglass integration, and then multiple new mounting options. And then of course, partnering, getting out of the business of building man-portable computers and instead leveraging the fast-moving technology of the iPhone, Apple solution as well as the Android universe of new devices.

So, at the end of the day we continue to get excellent feedback from customers that we have got the product right. We are taking our time in bringing it to market to make sure it has gone through full validation. In the first quarter, we did see sales bookings for AXON and EVIDENCE.com decline slightly to $402,000 in Q1 for $537,000 in Q4. The primary driver was our decision to stop selling new orders for our first-generation hardware. In the fourth quarter of last year we showed select customers the new Flex system, and we used an upgrade offer to drive purchases of the Gen 1 system.

However, we determined that the cost to deliver, install, and support the first-generation hardware was diverting our precious sales and engineering resources away from focusing on getting the Flex unit launched properly and expeditiously. So while we're able to close several important Flex orders, including Mesa PD and BART, because we have been working with those agencies for an extended time period, in fact, they were able to see the product and Mesa was involved with the early design of the product.

So those agencies were able to go ahead and make a purchasing decision. Most agencies that have expressed interest are waiting to get units they can test before making a purchase decision. Dan mentioned we also did begin shipping the new TASER CAM HD in the first quarter which help to I'll drive TASER CAM product line sales well over $680,000 in the quarter.

We do anticipate, we will begin commercial shipments of Flex in May. We are currently in the late stages of product validation and testing. Now, speaking of our product validation and development processes, we had another significant milestone this quarter. One year into the X2 sales we validated a return rate of less than 1%. This is dramatically lower than our historic product launches, and I believe solid evidence that our revised systems are performing extremely well.

Accordingly, part of the profitability in Q1 resulted from a reduction in warranty reserves based on the one-year data that we now have. On the international sales front, we saw a slight increase from the $2.3 million in the fourth quarter to $2.6 million in Q1.

I would say were in the midst of this transition in our international sales strategy. We are preparing to launch two teams from TASER International to launch into our global markets. The first team is a marketing oriented team that will be joining our sales office; that’s already on the ground in Europe. We have launched a French website and have several other internationalized sites in progress that will be launching in the coming months.

This marketing team will be providing in-market progress based on what has worked in the U.S. but of course working with the local market and our local sales team to learn and localize our approach within the European market. We feel this immersion in the customer environment is critical to our success, and we are preparing a second team that we will launch to Brazil this summer.

We believe this approach is highly cost effective and best leverages our talent, culture, and systems we have built to take known players from within our TASER environment and use them as elements to go out and build the international market, of course with the long-term goal that they will be helping us to hire and develop a team of local people that really know the market. But it’s our way to seed the TASER culture and processes into those markets.

We are very excited to bring Flex to market after several years of heavy investment. We believe we have the right solution. Evidence.com is stable, ready to scale, ready for the content explosion that would come with scaling Flex sales. We will all be watching closely how the positive market reception to the concept translates into revenue over the coming quarters.

So I will end by just reiterating that the Board shares our confidence in the cash generation ability of the business. It has authorized us to use up $20 million to buyback shares in the marketplace. And with that, we will open it up to take a few questions.

Question-and-Answer Session

Operator

(Operator Instructions) [E.C.], your line is live. Please go ahead.

Unidentified Analyst

Hello. Guys can you hear me?

Patrick W. Smith

Yes, we can.

Unidentified Analyst

Oh! I’m sorry. Just as a couple of follow-up question. Can you mention that or actually I might have been Rick, you mentioned the North American law enforcement sales were up in the first quarter, I didn’t catch that percentage. I was wondering if you could give that to us again.

Patrick W. Smith

Yeah, let me take a look at my notes. I believe it was 25%.

Unidentified Analyst

25% and does that include the U.S. Army order?

Patrick W. Smith

No

Unidentified Analyst

No. Okay, got it. And really that’s pretty significant improvement and certainly exceeded my expectations. What is really driving that? Have you guys seen kind of inflection point in municipal budgets or has something as the landscape changed that gives these agencies much more confidence in purchasing the product, and the funding to make the purchase.

Patrick W. Smith

You know I would actually tell you the users using about the first quarter sales is that X2 the new product was not the primary driver of the growth relative into the prior quarters. In the first quarter, the primary driver was, I believe, just a more rigorous execution of our sales team. We’ve been very focused on developing new rigorous pipeline system using salesforce.com and really bringing best practices in to drive results. So I would actually tell you first quarter more than market dynamic was driven more by just operational excellence of our sales and marketing teams.

Unidentified Analyst

Got it. So you'd characterize it as really just hammering the product home with these agencies and helping them across the finish line in purchasing them.

Patrick W. Smith

Yeah, we have actually launched a telesales initiative we’re looking to augment our field sales group having a dedicated outbound team in addition we’ve had a great customer service team. And then I think we’ve got a great people over the years I think we are giving them better systems now to be able to track leads, and follow up on them, and make sure that we are reaching out to the market and closing every opportunity that comes our way.

So it's mostly rigorous execution although I would say we are also feedback from the law enforcement market is the major layoffs they were going three years ago but mostly behind them. And I say the market is somewhat stabilizing we do expect that in the next couple of years and we should see a drive to replace capital equipment law enforcement just across the board over the last few years they were really delaying their refresh of capital equipment in the budget environment to try to avoid the layoffs so they come out of that now, TASERs, cars, computers, pretty much across the board, I think the market is seeing that they’ve not been keeping up with their capital equipment needs. And we think that is obviously a good trend for us.

Unidentified Analyst

Got it. Great, and then internationally you mentioned that sales declined 51% year-over-year, are there any – can you maybe revisit some of the bigger fish that you are going after right now or you see as really reasonable opportunities. I know we’ve talked about some Australian opportunities and France opportunities and things like that. Could you maybe rehash a couple of those bigger fish that you are going after?

Patrick W. Smith

Yeah. We typically don’t get into a lot of detail on their international sales from a sort of competitive space analysis. And frankly as we mentioned historically, this can be politically sensitive for some of those agencies that may not want to, it’s a security issue in terms of us, necessarily talking about what agencies are looking at expanding. But once we talk about historically that remain significant opportunities, there is certainly Australia, France, Brazil. Those are areas where we are putting some teams in-market, in Brazil and in France. We’ve got a very strong distributor in the United Kingdom, it continues to do well. I think its I would say some of what we’ve seen is with the introduction of the X2 the international markets do tend to take a little longer cycle to evaluate new technology.

So we are expecting to see some more significant X2 orders begin to develop, we are hearing from our sales pipeline that some of those evaluations are now complete, and perhaps some of the agencies that were looking at buying X26 once the X2 came available may have taken a step back to evaluate the new technology so we remain confident that we are going to see the pipeline at least sort of returns up towards the more historic levels. And we believe the things that we are doing now to actually put teams in market and begin to invest in more scalable systems internationally, will set the basis for long-term growth.

Unidentified Analyst

Great, and last one for me. Looking at ECD segment margins 65.2% was just a really nice performance follow-through. Was there anything because I mean I would even looking back historically that’s probably on the higher end of what you guys have done. Was there anything in the quarter that really stood out from a margin perspective? And Dan, I think you mentioned that we should probably expected to move back towards more historical levels would you think more in that 60% range. Is that probably a fair way to think about it?

Daniel Marc Behrendt

Yeah Peter, yes it is certainly a fair way to think about, we benefited from the number of things as Rick said we did see some fair goal sort of news on the warranty side of things with – when we launch new product we typically just record a higher warranty percentage, because we don't have an actual return rate to go against and then we adjusted once that product has been in the market for a year. And with really the rock-solid quality of X2 we had a pretty significant reduction in warranty reserve which certainly help things. The mix helped as well. We had a lot of handle sales in the quarter those are higher margin business for us, which certainly help. So I think yeah we feel good about the margins. I think as the video business scales will certainly contribute. But, the margins on the video businesses are quite healthy as the ECD handle profitability. So you will just see a little bit of a negative mix impact but, we feel good certainly the leverage on the indirect cost were solid for the quarter, when we see those higher sales it certainly helps to bring down that indirect manufacturing cost as a percentage of sales, which improves the margin as well.

Unidentified Analyst

Perfect, great, thanks a lot guys.

Patrick W. Smith

Well, thank you.

Operator

Thank you. We have no more questions. I’ve now like to turn the call back over to Rick Smith. Please go ahead.

Patrick W. Smith

Great. All right, well, again thanks everyone for tuning in. We do have our shareholder meeting coming up here at this headquarters May 31st. So we certainly invited to come down, come see the new flex unit for yourself. You had an opportunity to test-fire on X2 and see our latest ECDs. So we will be talking to you either in the shareholder meeting or I guess our next call. Our conference call will be in July looking at Q2 results. And by then we should hopefully have some interesting early indicators on Flex market attraction. Thanks for joining us today. We will see you all soon.

Operator

Thank you ladies and gentlemen, that concludes your conference call for today. You may now disconnect. Thank you for joining. And enjoy the rest of your day.

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