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TASER International, Inc. (NASDAQ:TASR)

Q2 2008 Earnings Call Transcript

July 24, 2008 10:00 am ET

Executives

Rick Smith – CEO and Co-Founder

Dan Behrendt – CFO

Analysts

Paul Coster – JP Morgan

Steve Dyer – Craig Hallum

Eric Wold – Merriman Curhan Ford

Operator

Good day, ladies and gentlemen, and welcome to the TASER International second quarter 2008 earnings conference call. My name is Jane, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of today’s conference. (Operator instructions) I will now like to turn the presentation over to Mr. Rick Smith, CEO. Please proceed, sir.

Rick Smith

Thank you and welcome everyone. Before we get started, I am going to turn over to our Chief Financial Officer, Dan Behrendt to read the Safe Harbor statements, and then we’ll get started.

Dan Behrendt

Okay. Thank you. Safe Harbor statements: Certain statements contained in this presentation maybe deemed to be forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. And TASER International intent is 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, expansions of private 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 the 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 or 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 the accompanying demand for our products; potential delays in the international and domestic orders, implementation risks of manufacturing automation, risks associated with rapid technological change; execution and implementation risks of new technology; new product introduction risks; ramping manufacturing production to meet demand; litigation resulting from alleged product-related injuries and death; media publicity concerning product uses and allegations of injury and deaths and the negative impact which could have on sales; product quality risks; potential fluctuations and 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 government investigations and regulations; TASER product tests and reports; dependence on key employees; employee retention risks; and other factors detailed in the company's filings with the Securities and Exchange Commission.

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

Rick Smith

Thank you, Dan. Certainly it’s been a challenging economic environment across the board during here in the US. But I would like to start by highlighting one of the real bright spots in our operations, and that is despite the decrease in revenues, our gross margins improved to 64.5% this quarter compared to 60% in the second quarter of 2007. So, we told you a couple of quarters ago, we are putting a renewed, vigorous focus on our internal operations cost control, the margins and those efforts are paying off as we are seeing improvements in our operations.

Now, revenues for the quarter were $21.1 million, which is $4.8 million or 18% decrease over the same quarter last year. It’s primarily the result of lower municipal spending in the US resulted from two factors, lower tax income for state and municipal governments primarily associated with decreased property tax revenues given what’s going on in the real estate markets, and you couple that with rising fuel costs, as I’m sure everyone is aware, fuel is a major consumable for law enforcement in their patrol cars using it 24 hours a day, and with (inaudible) from agencies that the unanticipated and significant rise in fuel costs has not only consumed most of their unallocated budgets but has cost them to shift otherwise allocated funds over to fuel, and even then they’ve gotten to a point where many agencies are curtailing patrol shifts.

This translated into a decrease particularly in the last two weeks of the quarter, where traditionally TASER International in the last two weeks of the quarter are strongest and we see significant upticks as budgetary dollars flush through again with the quarter. In fact we were tracking to 2007 revenues right until the last two weeks of this last quarter. It was in the last two weeks that we did not see the increase in sales that we saw in 2007, and we can account for more than the entire revenue decline by the decline in sales in the last weeks of the quarter, which again bears out the lack of a budgetary flush due to lower municipal spending and tightened budgets.

Now, after this quarter, we saw expected research and development expenses increase by $1.8 million, or 139% as we continue to invest in our future. We did also incur a one-time extraordinary charge of $5.2 million in the second quarter as a reserve for an adverse litigation verdict in the Hasting trial. Now the – I’ll come back and talk more about that later. At this point judgment has not been entered, but we have reserved for the verdict and for damages.

So, the net loss for the quarter was $4.3 million and the net loss and basic and diluted loss per share for the second quarter were $1.6 million or that’s $0.02 a share respectively. Now, metric that I’m using and Dan to keep our eye on operations, when you’ve got things like significant increase in R&D, which is really we believe the right call for this business to be investing in our future, want to make sure that those expenses don’t mask the rest of the performance of the operations. So, Dan and I are tracking in non-GAAP items basically operating income before R&D in extraordinary expenses which allows to keep our eye on the core running of the business to make sure that we are running efficiently. So, this quarter given with the revenue decrease we are running at about 18.2% operating income again before research and development and the extraordinary expenses associated with litigation reserve.

Now, during this last quarter, the company also repurchased approximately 1.8 shares of our common stock for $12.5 million. So, we ended the quarter with cash and cash equivalents of $33 million.

Now, let me turn to talk about some of the significant events in the quarter. First I would like to talk about the management team. I personally have been very focused over the last six months on building out our management team to grow us from $100 million to the next level. Obviously, the types of systems you need to have in place to handle that kind of growth are different than it took to get us from zero to $100 million. So, I’m very proud of the team that we have assembled are not only of the historic TASER employees who continue to help us build this company, but some of the new talents that we brought to take it – help us go to the next level.

Most recently we hired a new Vice President of Sales, Mark Fidelman. Mark comes from a very strong background where he’s had his initial sales training at Autodesk in the text [ph] sector. He was involved in software services business, that was a startup and they grew significant revenues. So, he has grown sales teams from zero, from scratch and built sales teams. Then he spent a lot of time in consulting, where he worked with Fortune 500 and other companies. He has been exposed to sales in many different type of different sizes of organizations as well as actually setting up sales operations in international markets particularly India and China. So, Mark brings a lot of talent to the team. We are excited to have him on Board and focusing on giving our sales programs lives.

Next, previous – before that was Nick Pappas our new Vice President of Marketing. We talked to Nick a little bit on the last call. Nick has a very strong commerce background. He was the Gateway and was primarily responsible for setting up gateway.com, their e-commerce portal and was with the team. He grew that over to $1 billion in sales and he went to Best Buy, where he was involved with the team that setup Best Buy.com, where his primary responsibility for computers and digital cameras, and they grew that to over $0.5 billion. He then went to – back to Gateway, Circuit City and Luxottica. So, a very strong consumer and e-commerce background. Nick’s been on Board now for about 3 months. He’s been doing a great job, he actually handled the entire TASER tactical conferences here as well as the launch announcement activities associated with the AXON, I’ll talk about it shortly. And now Nick has turned into e-commerce efforts between now and the end of the year I think you’ll see some significant improvement there.

And then thirdly, I will talk about our VP of Operations. He is Steve Mercier, who joined us in the first quarter out of Intel. Steve’s got very strong operational background. He was with Intel from the early 1980s through their wild growth days, and he got to see the systems took their place to grow that company. And I would say the investment in folks like Steve are paying off. We are seeing it in the gross margin numbers that have improved pretty significantly in the last two quarters.

So, in addition to rounding out our management team, we’ve also had some other significant events including a RAND Study from the RAND Corporation, a rather well-known think-tank. He was hired by the New York City Police Department, and Rand came back with the findings that NYPD should implement upon a program for expanded use of conducted energy devices. Now some folks have asked me if we received the order yet from NYPD, and the answer is “no, we did not.” But RAND Study is a very bullish long-term indicator. We think it’s important we think other agencies as well as NYPD will look at it. However, it’s close to (inaudible) the NYPD. It’s somewhat like turning a battle ship to the New York City Police Department. It takes time to implementing the programs. So, I think we are bullish on the long term there, but it’s hard to predict when we’ll see any particular orders associated with those findings.

(inaudible) we had a number of important wins in the court room. Most importantly the judge in Ohio in the trial that where we are plaintiff, they are challenging the findings of in three autopsy reports after a short trial the judge found that the evidence was compelling and overwhelming and ruled in our favor that those certificate to be changed and that the TASER device be removed because there is absolutely no evidence associated with TASER with those tasks. Also in the US Patent and Trademark Office denied a reexamination request assailing one of our tans [ph] so obviously, we are happy to see our patent standing up the PCO. We have a very robust patent intellectual property portfolio that continues to grow every quarter as we continue filing new patents.

Stock was about sales this quarter. We saw a number of significant orders including the New South Wales Police Department in Australia. Since that time we’ve – there’s has been much talk in the media about expanding the programs throughout Australia in Queensland and other states. So, we believe Australia is getting ready to significantly expand their TASER programs. We’ve also again seen some bullish indicators not necessarily major orders yet. The Home Office Secretary in United Kingdom has now on several occasions consistently repeated the message point that she can envision the day when UK offices are routinely armed with TASER devices something that would have been unthinkable just 5 or 6 years ago.

Now, again in our shareholders’ (inaudible) I talked to them, they get frustrated that we’ve talked about international sales for a number of years, and they ask when are they going to develop into major sales. Now, just to give you an example. Our distributor in Australia has been with us now for 9 years, and it took him 8 years to get orders of any significance. The international market takes a long time. We have seen significant movement in those markets at the policy level and we are starting to see that translate into sales.

Here in the US Harris County Sheriff's Department in Tomball, Texas; the Kentucky State Patrol, the Lexington Division of Police in Kentucky, Honolulu, the Tulare County Sheriff's Department, Corpus Christi Police Department, the St. Paul Police Department all placed recently significant orders this quarter as we continue to see them expanding their TASER programs. This quarter we had 318 new agencies. So, we are now over 13,000 testing and deploying our products. We’ve added 196 new full deployments, those are agencies are making TASER’s available to their frontline patrol officers, added 133 new TASER CAM agencies. So, now we have 1800 agencies testing and deploying the TASER Cam.

In international book sales for the quarter came in at about $2.4 million. On the consumer front, we partnered with the Sports Authority to begin carrying the TASER C2 Personal Protectors, and on the military front we have awarded a multi-year Science and Technology Award from the Joint Non-Lethal Weapons Directorate of the Department of Defense to develop specific TASER technologies to meet their requirements. It’s an initial one year contract with renewal options and the total contract over 24 months would be a little under $2.6 million. Again that will help fund some of our R&D as well as to develop some new technology, which we believe will have both commercial and military applications.

This quarter we also unveiled three new innovative products. First is the TASER AXON, the Autonomous eXtended on-Officer Network. Now the AXON builds off of our base in the TASER Cam. Again some folks ask why is TASER getting into on-Officer video. The answer is we’ve been there for a number of years, in fact TASER is the world leader over 25,000 TASER Cams in the field. We have more on-Officer video recording systems than anyone. And in fact we know that this is a growth market, and if you look at the historic market and segment of In-Car Video from several different sources we have actually attained that over $300 million a year business for In-Car Video and we see on-Officer video growing in a important segment. So, we are going to build off of our lead in launching the TASER AXON, which will be in field trials by the end of this year, and we expect deployments to begin in 2009, and from a shareholder perspective, revenue impact we would expect in the second half of 2009.

We also launched the TASER Controlled Digital Power Magazine. Now this an accessory for the TASER devices where there is a lange [ph] on the device, and if it disconnects it disables the TASER and in fact even if you plug the magnetic key back in, the device will not react when you enter an activation code. We believe this will be an important item to help open up the Corrections market, with that at least one stage Correction all agency mandate this device before they would deploy TASER because the risk in Corrections is that officers who are outnumbered by the inmates and if they get overpowered they don’t allow the inmates to be able to use their weapon systems. So, the CDPM gives a strong answer and should enable us to make more headwind in Correctional market. We expect that CDPM to be shipping in the fourth quarter this year.

We also announced the TASER Shield Conversion Kit. And many of our customers have been asking for TASER to produce neuro-muscular incapacitation shield. There had been some electrical stun shields in the market historically. We believe our technology is far superior, particularly and they will provide TASER level incapacitation as well as by going with a Conversion Kit, agencies can buy any shield they want or they up-convert their existing shields, so it minimizes their capital outlaid on their shield equipment and by applying the laminate of the TASER REPEL Laminate Film Technology, we can now apply the TASER electrical discharge to the point of any shield or not even shields to other types of devices or barriers could be used with this system. We are expecting that system to be shipping in the first half of 2009.

Now, let me follow-up on a couple of previously products, and I’ll start with the XREP eXtended Range Electronic Projectile. We have over 1000 units in the field now in field trials, and in fact we recently had our first field deployment of the XREP where we successfully used to subdue a – I believe is fleeing (inaudible). Now the XREP we believe or we are preparing for full scale production, we expect to commercialize the product in the first quarter of 2009. We have learned some things in field trial. We’ve gone back and made some modifications to the design and particularly we’ve now upgraded it for a full environmental ceiling, which will meet in our most standard conditions, and we’ve improved the manufacture ability of the device, and we’ve actually added a larger battery capacity for better cold weather performance. So, we are taking feedback that we’ve learnt in both our validations and field trials, and we’ve made modifications and again we are now starting to scale up for full scale production.

On the Shockwave system, the Shockwave Area Denial System as we announced last year, we’ve done field demonstrations at a number of different events. We have manufacturing units for the field trial that we expect to be in this field with a number of different agencies this quarter, and we would expect Shockwave to be commercialized end of the fourth quarter from a revenue impact perspective we would say at first quarter 2009. We’ve got a number of initiatives coming together at that time.

Next, we had abstracts of five human studies examining the safety of TASER devices presenting at the Heart Rhythm Society's 29th Annual Scientific Sessions and two presentations in Europe. All five studies found that TASER ECD's have no effect on the human heart or on pacemakers, again further authenticating the general safety of the devices. We have five more product liability suits dismissed, although we did have the jury verdict in the Heston case for which we recorded $5.2 million charge in the second quarter of 2008 for that jury verdict. Even though they only found that the TASER device and (inaudible) contributed 15% to death of Robert C. Heston and it was 85% responsible for his own demise. Of course this was a tragedy for the Heston family no matter how you look at it, if they – one couldn’t help but have tremendous sympathy for everything his family has been through, and we think that’s sympathy ended up expressing itself in the jury verdict.

Just for one to understand, the theory in that case was that Mr. Heston was – had exercised himself to the point of death, that he died from metabolic acidosis as a result of the muscular activity in his body, which was significant for many hours leading up to this event. And that the jury found that the muscle contractions associated with the TASER at the end contributed somewhat. So, there’s not some new theory about TASER cardiac effects or otherwise it was purely that the stress and exercise they found to be contributory. Now, we are filing a number of post-trial motions, the judgment has been entered in that case. Once judgment is finally entered which we anticipate will be sometime around the end of this year. Then will be appropriate time for us to file appeals and you can rest assured that we will pursue all channels. We don’t believe that the – certainly the amount of the damages awarded stand up to the Supreme Court guideline on punitive damages, and we believe there is a number of issues in the case that are subject to appeal.

I think it’s also important to point out that in the Heston case, the officers involved were not found liable, and that’s a very important finding that our customers in using TASER devices even in adverse and very difficult case like this are not being found liable. With that I’m going to ahead and I’m going to turn over to Dan to talk a little more about the financial results for the quarter, and then I’ll be back to wrap up.

Dan Behrendt

Thanks, Rick.

Rick Smith

There’s one other point that I forgot to make there, which is, in most states this exact same verdict would have resulted in no liability for TASER. If a person is found to be greater than 50% responsible for their own death or injury in the vast majority of states, in a significant majority of states and then there can be no award in a case like this. Unfortunately California is not one those states. So, I think that’s an important point to make. And back to Dan.

Dan Behrendt

Thanks, Rick. I’ll start with the income statement for the quarter. As Rick indicated, sales for Q2 were $21.1 million, which is down $4.7 million from the prior year, and sequentially we saw our sales drop $1.4 million from Q1 as we did not see the budget (inaudible) and budgets that we really enjoy in the second quarter each year. The unanticipated increase in fuel cost coupled with shrinking municipal budgets cost lower amounts of budgets has been in the quarter which unfavorably impacted our sales during the second quarter.

Gross margins of $13.6 million or 64.5% of sales are up 4.4% for the prior year, the increase in margin was caused by several factors including elimination of most cash and distributed discounts, lower overtime expenses and better productivity and improvements in scarp expense during the quarter. This is the second quarter in a row where we saw margins improve sequentially and margins are up actually 7.7% from the first quarter of this year, and the sequential improvement was driven by much – a lot of the same factors including the curtailed distributed cash discounts, improvements in direct labor efficiency, scarp, material costs and product mix had a favorable impact this quarter with a higher percentage or sales coming from the X26 product.

The $1.5 million decrease in indirect manufacturing versus the prior were mostly driven by the lower scarp and greater manufacturing efficiencies during the quarter. SG&A expenses of $9.7 million for the quarter versus $8.3 million in the prior year. The increase again was driven mostly by higher salaries and benefits of $548,000 mostly due to increased headcount, advertising cost mostly relate to the infomercial increased by about $365,000, higher travel expense of $291,000 and higher tradeshow cost of $170,000 were mostly related to the company’s annual tactical conference, which Rick mentioned. That conference takes place typically in the second or third quarter of the year, this year it was in the second quarter. Obviously, last year in the third quarter, so when you compare versus the prior year, that’s one of the reasons for the increase. We also had recruiting and relocation expenses of $100,000 in the quarter due to some of the executive adds that Rick mentioned before.

Research and development expenses of $3 million for the quarter were up actually $1.8 million from the prior year, again this is mostly driven by the outside development costs at $1.1 million that relates to the AXON product. We did have higher salaries at $243,000 due to increased headcount and increased supply cost. As we communicated in the last conference call, we are going to continue to ramp up the R&D expenses during 2008 in order to accelerate the introduction of the new products in the pipeline. We did record the $5.2 million charge related to the litigation charge in the Heston case this quarter as we’ll continue to explore all our probable legal channels including (inaudible) we have reported that judgment expense in the quarter’s results.

Funds from operations were $4.3 million and the pre-tax loss is $3.6 million. The net loss for the quarter was $1.6 million which translates into $0.02 loss per share in both the basic and diluted basis. On the – for the six months ended June 30, sales for the first half were $43.6 million, which are actually up by about 5.9% or $2.4 million from the prior year. And while we are starting it up and optimistic about our long-term ability to grow the top line, at this point, our expectation is that absence in margin in international orders which has been historically difficult to predict that the second half sales will be roughly in line with the first half at this point.

Gross margin is at $26.4 million or 60.5% of sales are up 1.1% from the prior year. Again the increase is mostly driven by the elimination of cash and distributed discounts, lower labor expenses and improvements in the scarp expense.

SG&A expenses of $18.9 million are up $2.9 million over the prior year, mostly driven by increased salaries and benefits of $170,000 due to increases in headcount, higher advertising costs, again mostly relates to the infomercial of roughly $900,000 on a year-to-date basis, and higher travel and trade show expenses driven by the company’s annual tactical conference.

R&D expenses were $5.1 million are up $2.9 million over the prior year due to an increase of outside development cost, mostly associated with AXON product of $1.5 million so far, higher salaries and benefits of $76,000 and higher supply cost of $287,000.

The loss from operations on a year head [ph] basis is $2.8 million and a pre-tax loss is $1.6 million both impacted by the $5.2 million charge in the Heston case. The net loss for the year is $337,000 which translates into a loss of $0.01 per share on both basic and diluted basis.

As I move on to the balance sheet, the highlights for the assets. We did finish the quarter with $43.5 million in cash and investments, this is a decrease to $16.8 million from the prior year end. The biggest driver is the stock buyback of $12.5 million which we announced and completed in the second quarter. We also made investments in inventory and property, plant and equipment, which were partially offset by lower cash receivable and lower prepaid asset values. It’s worth noting again that TASER doesn’t have any exposure on its balance sheet to auction [ph] nor securities.

Accounts receivable of $10.8 million are down roughly nine-tenths of $1 million from the prior year’s balancing the $11.7 million due to the lower sales in the second quarter of ’08 versus the fourth quarter of ’07. Our day sales outstanding for the quarter were 45.6 days which helps – is up about approximately 10 days from the prior year end. This is expected. We eliminated the cash discount, so we’ve seen increase in the day sales outstanding (inaudible) remains very strong.

Inventory of $20.6 million is up $7 million from the prior year-end balance of $13.5 million. As the company has invested in more inventory support they anticipate a higher sales level. We increased raw materials and finished good to support both the C2 and X26 product lines and we will continue to evaluate our inventory mix and inventory levels as we move forward in the year.

Prepaid assets were $1.5 million are down $2.8 million this year due to the receipt of the insurance receivables and expensive prepaid production cost in infomercial and amortization of prepaid insurance.

Property, plant, and equipment $26.2 million is up $2.6 million over the prior balance, mostly related to progress payments on the automated production equipments, this point we have invested about $4.6 million in that equipment. We do expect that we’ll see that equipment installed late this year, and I believe we are going to have some positive impact on margins as we move into the 2009 year.

Total assets finished with $128.4 million, compared to $137.8 million at year end. On liabilities side of the balance sheet, the accounts payable in accrued liabilities of $12.3 million are up $2.2 million from the prior year, mostly relates to the Heston litigation judgment accrual of $5.2 million, offset by some timing differences in accounts payable and some purchasing activity with the lower sales levels. The current deferred revenue of $2 million is up from the prior year balance due to the extended warranties and total liabilities are $19.6 million. The company finished the quarter with $108.8 million stockholders’ equity.

Moving on to the cash flow information. The company had operating cash usage of $321,000 year to date versus a cash usage of $2.9 million in the prior year. The cash usage was mostly driven by the increase of (inaudible) and inventory, partially offset by the lower prepaid expenses I mentioned earlier.

Net cash provided by investing activities was $2.8 million as the company realized $7 million from maturing and called investments, which were partially offset by the $4 million investment in new property and equipment purchases. The company used $12.2 million in financing activities, again driven by the stock buyback at $12.5 million, which was approved and executed in the second quarter. The company did purchase $1.8 million –1.8 shares or approximately 2.9% of the company’s outstanding stock during the second quarter. And the company ended the period with $33 million in cash, which is up $9.8 million from the year end.

And with that, I will turn the call back over Rick Smith.

Rick Smith

Thank you. Couple of items to wrap up with, one on the C2 infomercial. We continue to run the infomercial throughout the quarter. It continues to run rate around breakeven. So, we have not yet scaled it up into a national by – in terms of media we are continuing to (inaudible) with the infomercial, and also one of the challenges given the nature of our product that has somewhat difficult for us to obtain network appearances on some of the major networks, although we’ve had some recent success where some of them are coming around and now giving us some approvals.

So, we continue to test would be in infomercial looking at different modalities of deployment. We are looking at 30 second and 60 second stocks with a DVD follow-up technique we’ve not yet tried in conjunction with the straight 30-minute time purchases on air. We will be bringing up a more robust e-commerce in online promotional program using the infomercial content. We’ll also be reformatting it to test deploying in-store video using our infomercial at point of sale in different retail environments. So, we’ll continue to focus on that as we move into the latter half of the year, and hopefully a strong retail season.

Okay, to wrap up, I’m going to talk a little bit about the ad time again and some of the different product initiatives with TASER. We are very focused on broadening and diversifying our revenue base both by markets by bringing new products up like the C2 that allow us to sell in the consumer market as well as law enforcement, the military markets with products like XREP and Shockwave and the new systems that we are working on in the R&D pipeline that have been funded by the DoD as well as in the international markets.

If you look at AXON, it really expands our mission to providing an end-to-end solution for safer and more accountable conflict management. But if you look at the issue from our customers’ perspective, historically TASER has – we’ve made devices like the M26, the X26 that we can give to a police officer to think about pretty dangerous subject. But that’s not the whole problem that our customers face. Our customers are generally pleased, the agencies they often manage thousands of cases of – officers go with suspects every year. And so the information technology that they can use to deal a conflict is very important. In fact dating back to 1999, we were the first company in the world to issue to take handheld weapon that would download in the interface to a computer network.

With the X26 we added a USB serial port enhancing its communication capabilities. In 2006, we introduced the concept of the TASER CAM adding infrared audio and video recording capability to these handheld devices. And so as we look at it, we come to realize that we are not just selling a baton or some simple unintelligent device, all these devices are microprocessor controlled, communication capable network notes and they really enable our customers to gain the true value of these systems. We are going to start haying these devices together with advanced wireless communication capabilities and at the center of that effort is the AXON system. We can now begin to command, control, data gathering both real time and after the fact, so that our customers can take advantage of that information to make better decisions, better command and control decisions.

There’s an analogy in the military markets, where if you look at what it made the US military so effective, it’s not the speed of our airplanes or the diameter of our artillery, it’s really the information abilities. So, for example if you look back to Gulf War 1, when the United States and its allies and the coalition were facing the fourth largest army in the world that has some fairly advanced individual equipment. We saw the results primarily because the coalition forces had much better real time information technology. We see that same sort of trend developing in the law enforcement markets and for non-lethal weapons in general where these devices become capable weakening, enhance the effectiveness and safety of their use.

So, TASER International is now really broadening our mission and becoming a 21st century normally for a weapons company. If you look at the major defense contractors whether it’s Boeing, Northrop Grumman, Lockheed Martin, Raytheon, they all have significant IT system components to make their hardware more intelligent and more useful to their customers. We are doing the same thing, we are now integrating more tightly with our customers to give them advanced capabilities and deepen our relationship with our customers so that not only we are providing them tools to incapacitate but the tools to make sure that they are doing their – that the incapacitating the right way, that tactics policies, procedures are being followed and giving information tools to management to really optimize and make sure that they are doing the best that they can do for safe and effective resolution of dangerous situations.

So, in this markets phase, again we’ve talked about there is a significant market already developed for In-Car Video. In the United Kingdom, they’ve done some experiments with on-Officer video with some pretty striking results. Now the UK experiment was done with – certain hardware that was not as well integrated is what we are talking about with ad time. And we had a field trial in the United Kingdom with 300 officers participating with TASER CAM, they found improvement in convictions rates when they had video. They found decreases in officer complaints or complaints against police officers because of the incidents we believe were well documented.

We believe that video when it is being used in altercations is likely to deescalate the situation because when people realize that the situation is being videotaped they are less likely to for example lock up and strike an officer if they know they are being recorded. Similarly officers hold themselves to a higher standard of care when they know that they are actions as well are being recorded. So, we see this as a real de-escalation tool for conflict management.

Now, also in the UK, they found that the TASER CAM significantly improved officer efficiency as they spent less time writing reports because the level of documentation was provided by the video. In fact it was something like 10% or 15% if I remember correctly, reduction in work load for paper work, which is the equivalent of an officer getting an extra hour of patrol time on a typical shift. So, it’s like putting a lot more cops in the street for the police agency without extra budgetary dollars to do so. So, there’s a couple of reasons we think that TASER can be very successful in this markets base. First is our channel, we have 14,000 active certified TASER instructors, those are the same folks that the police chief generally rely on when they look at tool tactics and procedures for doing their jobs and particularly for evaluating on-Officer police equipments. And then we believe the hardware integration is unique and it is in core confidence.

We typically make devices that are developed from component level up specifically integrated for the task at hand. In the case of the AXON, we are developing a dual microprocessor global computing device effectively with a dedicated HD video capable video compression chip as well as another microprocessor to run the communication and control functions. We have developed the operating system, we are using the same unique operating system to detect this instruments uses on its tools, on its chipset. We partnered with ModaVista [ph] the software development firm, it’s one of the leaders in Linux development for embedded software globally. In fact they maintain the Linux operating system that’s used by TASER’s instruments. So, we believe we’ve got world class hardware in this space. We are building out a team in-house as well to drive the AXON system. So, we are investing heavily but we see a significant return on investment for AXON as well as XREP, Shockwave, the shield and the Controlled Digital Power Magazine.

So, yes we believe that now is the time for us to invest in extending our lead. Dan and I continue with rest of management to look at our operating income, independent of the investments we are making in R&D, make sure we keep our eye on the core business, but build out for the future. The analogy IQ sometimes is (inaudible) are pretty tough on the weak, but they are not too bad for the strong. The species that survive ice ages tend to flourish in the periods after as the environment comes back, they tend to take over many more niches. We believe that’s a good analogy for us now and the rest of the world and potential competitors are financially constrained and are pulling back, it’s the time for us to invest and extend our lead and as economic times return you’ll see us flourish in more market niches both here in the United States and internationally, and you’ll see new technology that will be bringing to barricading you revenue streams, that the hands are depth of relationship with our current customers as well as broadening in the new markets.

And so with that, we will conclude this conference call, and we’ll open it up for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) Our first question is from Paul Coster with JP Morgan.

Paul Coster – JP Morgan

Thank you and good morning.

Rick Smith

Good morning.

Paul Coster – JP Morgan

The improvement in gross margins of course is much welcome. And first question really is do you feel that this is sustainable particularly in the context of so many new products coming to market. Traditionally no new products attract lower absorption rates initially instead of way for a while. What’s the outlook say looking out six months and beyond?

Dan Behrendt

Yes, that’s a good question, Paul. This is Dan. Obviously as we look to the new products we are making sure that we have set prices appropriately and make sure that the manufacture ability of the products as they come into commercial production so that the short-term impact is minimized. Certainly our target is to keep gross margins above that 60% level and yes, we feel that we’ve got the right team in place in making the right steps now to continue to drive those efficiencies to offsetting the startups you have in new products but one of the things I think we’ve learned from some of the new products is there it is over the last couple of years is that the criticality of making sure that manufacturability is built in the products from day one and that as we ramp up production there’s not any hiccups and we can go right to commercial production without having any significant impacts to margins.

Rick Smith

I don’t know whether we continue to see margins in proving some of their (inaudible) or some product mix since some other things in that as well. That is where Dan is saying we are pretty confident that we'll be able to sustain on the 60% margin levels in our plan.

Paul Coster – JP Morgan

The R&D that you are putting into AXON, once you've got AXON ready, assuming at that point that you haven’t got more new products in the pipeline which of course is unrealistic hypothesis, but would R&D then come down in a sort of all things being equaled?

Rick Smith

Yes, we are – a lot of that research and development money is being spent on external resources like ModaVista, that’s a significant software element to this. We are also using external design resources mechanically and then there’s of course the PC network software which we are using both outside resources and we are building some internal capabilities as well. So, the short answer is if AXON ended up not being a success, we’ll not build a huge infrastructure that would be an ongoing expense. So, there is the ability to basically push – R&D expenses background at historic levels. Now of course if it takes off like we think it will, then we see that that platform will provide a interesting and exciting platform for us to deliver other types of software services and communication services to our customers. So, on a success basis, we’d probably continue to see R&D levels closer to the new levels that we are at, but it’s not that we’ve invested in internal infrastructure to where it cannot be downwardly adjusted for some reason it didn’t workout.

Paul Coster – JP Morgan

Dan, I may have missed it. But can you share any of the unit shipment dates by products?

Dan Behrendt

Sure, sure. On the law enforcement side, the X26 we shipped 14,307 X26s and 447 M26s. We shipped 249,361 cartridges during the quarter, and we shipped 7611 C2s, which is roughly flat with the first quarter. We are hoping as we expand our retailer base there that we could see some improvement over time, but we are roughly flat on the C2 side during Q2.

Paul Coster – JP Morgan

Okay. And then finally on AXON, Rick, it just sounds tremendously interesting – I’m curious just to see the – but the UK experiment, what did they actually use to do it, and is that essentially a competitive solution?

Rick Smith

Yes. There are some companies in the UK that they’ve been providing both the hardware and then the digital asset management tool set. Again our read on is that there is a more of a system integration type of play we didn’t see a full up tightly integrated component level up-system and was more cameras that appear to be adapted to digital video recorders that appear to be adapted for the application. But yes, it’s certainly not a space where we will be without competition, there will be competition in this space. But we believe that we have between our channel and the engineering between the product as well as some of these capabilities in integration into the radio communications, will provide us some significant competitive advantages.

Paul Coster – JP Morgan

Which brings me to my last point, what is the anticipated price point for the AXON solution?

Rick Smith

We have announced that system prices will start around $1000 mark. We’ve been – we’ve been trying to – the customers actually with significant positive reaction. We’ve met with the some of the major city police chief’s here in the United States. We have met some of our international customers, and they clearly see the benefits of this technology. We have been also doing research on advanced feature sets that they would like to see incorporated into the device. So, we view that $1000 is probably the starting the point. We anticipate average sales prices would probably be somewhere in that $1000 to $2000 range, over $1000 that we start to integrate more advance features like for example GPS and some other things customers have told us they would if you want to have a premium port.

Paul Coster – JP Morgan

Thank you.

Rick Smith

Thank you.

Operator

The next question is from Steve Dyer with Craig Hallum.

Steve Dyer – Craig Hallum

Thanks and good morning guys. Dan, I didn’t hear that TASER CAM number, do you have that?

Dan Behrendt

I’m sorry, yes, TASER CAM, we had 2391 TASER CAMs during the quarter.

Steve Dyer – Craig Hallum

Okay. And then the real doubter to me looks like cartridges is lowest number in quite a number of quarters. Is there anything specifically that you guys can chalk that up to?

Dan Behrendt

I think there are a couple of things, one is the budget that we talked about. A lot of times those year end budget monies are used for some other consumables, something they feel pretty comfortable buying. They just put them in their armories, so they are coming back to us with those budget monies for that. Last year in the second quarter, we saw a significant military order that simply cartridge metrics, so actually we shipped a number of cartridges to military customer in Q2 and Q3 of last year. So, that was certainly a driver in the prior year. We had not seen that repeat order thus far this year. But I think the budget flush is probably the biggest reasons especially for this sequential decrease.

Steve Dyer – Craig Hallum

Okay. And then if I’m hearing you correctly, gross margin is probably a bit too much to ask, may be to say at current levels but 60% plus seems reasonable?

Dan Behrendt

Yes. I think 60% is reasonable target at this point. As we talked about last quarter, product mix has a big impact as well. They are fairly wide range and all our products are pretty healthy margins especially for manufacturing company. There is a range of almost 20 point between our lowest margin price and our highest margin price. This quarter we did see a larger percentage of sales coming from the X26 product which is one of our better margin price. So, that’s really benefitted us but even with the mix that we’ve seen in the last few quarters, we expect that 60% is a reasonable target.

Steve Dyer – Craig Hallum

Okay. And then R&D, you had said in the past $13 million to $15 million, is that still a target for this year?

Dan Behrendt

Absolutely. And we ran about $3 million for this quarter, so that’s still we are comfortable that we’ll be certainly within those constraints.

Steve Dyer – Craig Hallum

Okay. And then I guess lastly, I’m curious to see if you seen any kind of anecdotal change in legal activity since the adverse ruling against you guys, if you seen an uptick at all in cases brought or anything out of the ordinary?

Dan Behrendt

We have seen a moderate increase in some of the legal activity. I think we’ve had a total of four cases filed, a couple I think were not related to Heston, one of two of them are (inaudible) best judgments. While we seen a couple of comments I think we are clearly associated with that. So, it’s still balanced significantly from the highs that we saw in the 2005 time frame, but it’s up a little bit over. We are really trending down. We are down about one case, one per quarter. We saw a handful in the second quarter, again not a dramatic number but we did see a little bit of uptick, and we’ll obviously will monitor that closely. I think that depending on where the appeal process goes to stop I think that may drive the future litigation. As we look at it, our case record is still very strong here and the vast majority of these cases is not that very profitable to – So, certainly we think that that long-term trend is still positive.

Steve Dyer – Craig Hallum

Okay. Thanks.

Operator

The next question is from Eric Wold with Merriman Curhan Ford.

Eric Wold – Merriman Curhan Ford

Hi, good morning. Question on the international front. (inaudible) about 11% in the quarter. One, was there any significant weakness you saw from normal customers, in the national it was just question of large orders are now flowing and then two, in the comment related to the back half of the year, you lost any large international orders which are tough to predict, looks like it’s of flat, can you may be walk us – name – but what is going to be the likely level of near term when that you could see in the international front, you got your eye on what may be a high in the sky in the 12 months to 18 months. If you could give us a sense how significant do you think you could move from the national standpoint?

Dan Behrendt

This is Dan. In international I think it’s really more of a sort of a timing difference. We don’t really see, obviously the US economy is certainly challenging a lot more than some of the international economies at this point. I think the sales being little bit of a lower percentage of our total sales this quarter versus maybe some of historic levels. This is really more, I think the timing difference and also to your point that – absence of the large orders. We continue to be very enthused about the long-term prospects for the international part of our business. We see that as a real potential catalyst for growth in the future. I think the tough thing for us is that it’s difficult to predict. We think that several markets are sorted in that early procurement phase including the UK and France, Australia, Singapore, South Korea, all these countries are – we think rounding out their trial phase and getting really into those current phases. The total addressable market in those markets combined is certainly something that is very significant. There is upwards of 500,000 officers in those countries on a combined basis. So, we do expect that we will see some business from those countries over the next 6 to 12 months, but it’s very difficult to predict exactly when we’ll see that. But we are working hard, and we are also working to expand the number of countries we are talking about. We see that – we look at (inaudible) has been very similar around the world, these guys face similar issues and we don’t see that there’s any reason why we can’t broaden the number of countries that we are selling into.

Eric Wold – Merriman Curhan Ford

Did you look at where international has been, you have trailing 12 months time, couple of years time in the mid-teenish that kind of range. Would you expect ’09 to be a larger percentage than that?

Dan Behrendt

Yes. I think there’s certainly got potential for that. Again I think – when I look at the business and where, I think the near term opportunities for growth are I think it’s both in the international part of the business and also the consumer part of the business. Both are large addressable markets where fairly low penetration today. So, certainly I think there’s potential for the international to become a bigger part of the business over time. I think that’s – next year obviously we’ll have the AXON product, we’ll start seeing the revenues in the second part of the year. Probably out of the gate that will be probably more of a US product that certainly has some international potential in that product as well.

Eric Wold – Merriman Curhan Ford

And then lastly, on AXON and XREP and Shockwave and all those, if you just think about – and I’m looking for guidance if you think about in ’09 once they start to commercialize, I know AXON is kind of a back half product. How significant could those be to ’09 numbers if you could ballpark a percentage of revenues?

Rick Smith

This is Rick. Let me start with it. Shockwave is probably the most difficult one to predict because the nature of Shockwave will see some limited deployments with law enforcements swat teams. We could see some deployment in the Correctional environments, where they are using along defense lines or high-risk areas where they may need to incapacitate number of people trying to break out of a facility etcetera. But the really big opportunity for Shockwave is the US military, and traditionally they take a very long time to deploy new products and new technologies. Now there is some exceptions which for example the counter IED, they are spending billions of dollars in rapidly moving devices to the field. So, Shockwave the way I think about it is sort of a proof of concept. There’s been PowerPoint presentations for a decade on non-lethal area denial systems, and we felt it was important to get it out of the PowerPoint and into reality, and start giving out in disforcing [ph] with customers, get it into their hands let them play with it, let them see how powerful capability could be for example to check point in Iraq to be able to have a safe result where they could drop people that are approaching the check point to become soft, where us right now they have to deploy lethal force. But I’m sure, and that is if we get some units in the right hand to the military and they get them in (inaudible) and they determine that this an important part to counter a suicide bomber, that’s an equipment we could see enormous may be I shouldn’t use this types of terms, we could see some very big orders. But it’s a long shot. So, I would think if the Shockwave from a modeling perspective is sort of binary. You see there, may be $1 million year, kind of small niche business or it’s something far more significant if the military get behind it. The XREP we see as being a little more – it can have broader market if you will in all the different markets segments for a wireless engagement capability. So, it’s – you don’t have a really good feel yet, we are doing some market analysis and market study but because of the nature of the product being so different from anything out there, it again makes it very hard to predict. So, I would say, at least it’s closer to a bell curve in terms of predictability when these binary go, no-go that we see with the Shockwave. But we sees a lot of interest across the board from law enforcement agencies on the XREP, although we are probably going to sell a lot more practice rounds on the XREP, which needs much lower dollar value than the live round, which just faced out any of the (inaudible). The vast majority are used in training. And then the AXON is back half of the year. The good news about the AXON is that we are going into a more established market for incident recording video is a fairly large installed annual budget are currently, and we think that this will help create a new market segment. And it really does right it in our core sweet spot of law enforcement agencies that would be deploying it as an On-office. So, that I think could have similar adoption curves to what we saw with the M20, with the X26 where it will take time but I see that is having a very significant revenue opportunities over the next couple of years.

Eric Wold – Merriman Curhan Ford

Okay. Thank you, guys. Appreciate it.

Rick Smith

Thanks Eric.

Operator

I will now hand the call back to Mr. Rick Smith for closing remarks.

Rick Smith

Okay. We appreciate everybody giving us an overview morning. Obviously, we wish we could have produced better results with the top line, but I’m proud what the team was able to accomplish operationally. Very proud of what they are accomplishing in R&D. I think we are setting a firm base to take this company to the next level. Many of you have been with us from when we went public, and we where in the $6 million revenue range, we have done a lot over the last several years, taking it to $100 million is been exciting, and I think when you see the full picture of what we are doing which we have not for strategic reasons been able to share with everybody, everything that we have going on in R&D in our full product strategy, but as you see it unfold over the next couple of years, I’m confident we are doing the right things to take TASER from the very exciting new tech company to a very established dominant market player in a variety of market segments in the security industry. So, thanks everybody and we look forward to talking to you again in about 90 days.

Operator

Ladies and gentlemen, we thank you for your participation in today’s conference call. This concludes your presentation, and you may now disconnect. Have a good day.

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Source: TASER International, Inc. Q2 2008 Earnings Call Transcript
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