Good day, ladies and gentlemen, and welcome to the Q1 2018 Axon Enterprise, Incorporated Earnings Conference Call. [Operator Instructions] I would now like to introduce your host for today's conference, Mr. Luke Larson, President of Axon. Sir, you may begin.

Thanks. Good afternoon to everyone. I'm Luke Larson, the President of Axon. Welcome to Axon's first quarter 2018 earnings conference call. Joining today are CEO and Founder, Rick Smith; and CFO, Jawad Ahsan. Before we get started, Andrea James, our V.P. of Investor Relations, will read the safe harbor statement.

Good afternoon. This call is being broadcast on the internet and is available on the Investor Relations section of the Axon Enterprise website. During our call, we'll be making references to our reported results, which you can find by reading our quarterly shareholder letter and the supplemental materials, both of which are available at investor.axon.com and on the SEC website. We'll start today with prepared remarks, and then we'll move to a live question-and-answer session. Statements made on today's call will include forward-looking statements, including statements regarding our expectations, beliefs, intentions or strategies regarding the future, including statements around projected spending. We intend that such forward-looking statements be subject to the safe harbor provided by the Private Securities Litigation Reform Act of 1995. This forward-looking information is based upon current information and expectations regarding Axon Enterprise. These estimates and statements speak only as of the date on which they are made, which is today, are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. All forward-looking statements that are made on today's call are subject to risks and uncertainties that could cause our actual results to differ materially. These risks are discussed in greater detail in our annual report on the Form 10-K and our quarterly reports on the Form 10-Q under the caption Risk Factors. You may find these filings, as well as our other SEC filings at investor.axon.com or at sec.gov by searching for filings under the Axon ticker, AAXN. Okay, turning the call over to Rick.

Thanks, Andrea. Welcome, everyone. First and foremost, I want to commend our employees throughout the organization for helping us achieve outstanding first quarter performance. Our results reflect strength across the board, in our Weapons and Software & Sensors, domestically and internationally. The team has been working really hard to execute, and they deserve a lot of praise. In Q1, we delivered record revenue and solid gross margins, while continuing to execute against our cost control initiatives. This drove first quarter GAAP earnings per share of $0.24. We're incredibly excited about the opportunity in front of us and continue to position the business to deliver growth and increase shareholder value. The strategic tuck-in acquisition of VIEVU we announced last week is a great example of this. The deal adds a solid team that shares our mission of saving lives. Our new holster partner, Safariland, produces high-quality products and, most importantly, has history and credibility with the law enforcement community. Those of you who aren't in law enforcement might not notice, but Safariland is a very well-regarded holster supplier and has a lot of fans in law enforcement, and it's very exciting to work with them in developing a holster for the next generation of TASER weapons. Also, VIEVU technology is used by hundreds of police agencies and the acquisition adds 5 major U.S. cities to our customer portfolio. Internationally, the acquisition adds Mexico City and Mexico's federal police. We believe this deal is great for customers because Axon has made an outsized investment in software, which will give these customers access to new features sooner than they otherwise would have had. Also, serendipitously, VIEVU is based in Seattle and so we plan on integrating that team into our existing Seattle office. This next part is really important, especially for the employees…

Thanks, Rick. We're moving pretty fast at Axon, and it's an exciting time to be part of the company that is executing on such a large and important mission. We've come a long way since 2010, when Axon's stock was trading at just under $4 per share and we were under a lot of pressure to exit the body camera business, and instead of exiting, we doubled down on body cameras and more importantly the software ecosystem, Evidence.com. One particular moment I'd like to call out is at a company meeting about five years ago when we did a survey, and 90% of the company wanted to exit the Axon business, and Rick Smith showed a picture of General Patton from World War II with a quote that said, "The road home goes through Berlin." I call that out because this has been a big investment cycle, and I want to thank the investors that have supported Rick and Axon's vision. We are realizing the benefits of those investments today, and at the same time, we are investing for the next stage of growth. We're all working very hard to accelerate the speed at which we bring the leading public safety technology to police forces around the globe. We want to equip every officer with a body camera, a TASER and a seat on the Axon network. You have the shareholder letter in front of you that does the heavy lifting, talking about many of the ways we are executing. I'll pull back the curtain a little bit more and then turnover the call to Jawad. Over the next few quarters, there are three execution items that are most relevant to the investment community. The first and newest is the successful integration of VIEVU into Axon. I've appointed Bryan Wheeler,…

Thanks, Luke. We're pleased to report another strong quarter of execution. Record revenue, strong gross margins, and good cost control enabled us to bring $0.24 to the bottom line. I'm going to first talk about the VIEVU acquisition, then I'll unpack the guidance for you. After that, I'll touch upon a few housekeeping items, and then we'll go right to Q&A. So first, the VIEVU acquisition. As you can see in our shareholder letter, we paid $7.1 million upfront in cash and stock, with contingent consideration in the form of a stock-based earn-out over the next two years. This is a great deal for Axon shareholders and most importantly for the customers, who can now access the Axon network and the software features we're investing in. This deal turns a competitor into a partner and supplier and is synergistic for both companies. We only recently closed on the deal and are still working to quantify the extent of these synergies but expect there to be significant opportunities to rationalize expenses by eliminating duplicate sales efforts and combining certain aspects of our teams, both of which are based in Seattle. I’m particularly excited that this deal gives us five U.S. major city customers at about a 20% lower customer acquisition cost than we'd normally realize organically. Many people on both sides worked hard to get this deal done, and we're very pleased with the result. Next, I'd like to unpack our guidance and how we're thinking about the full-year. We're raising our revenue guidance by 2 percentage points, which reflects both the strength of Q1 and the VIEVU acquisition. In Q1, we had very strong international weapons revenue, which we do not expect to benefit from in Q2. We expect Q2 weapons revenue to grow about 7% to 10% year-over-year. So,…

[Operator Instructions] And our first question comes from the line of Mark Strouse from JPMorgan. Your line is now open.

Yeah, good evening. Thanks for taking our questions and congrats on another solid quarter. So, my first question is for Jawad. I'm sorry if I missed this in the prepared remarks, but I'm just trying to kind of back into what the organic guidance is for the year. Did that change? Or is everything just because of VIEVU?

No. The organic guidance for the year, we're sticking to 300 basis points to 400 basis points of improvement.

Okay. But it sounded like though – right. It sounded though that it – maybe my impression was that you had a good start to the year and you got these lower-margin VIEVU contracts coming on. So, is it fair to assume that the organic operating margin might have been a bit stronger, if it hadn't been for this acquisition?

That's correct.

Okay, okay. And then, Rick, I know it's still early, but with VIEVU, can you share any kind of initial feedback that you've gotten from VIEVU's customers? And technically speaking, is there any kind of a change-of-control clause or anything in those contracts that could be a potential risk?

Yes. So, we've reviewed the contracts. There's no legal risk from a change-of-control provision. And I would say, generally, the feedback from customers has been positive, in that some of them, their procurement ended up going to VIEVU largely for price. And so, some of the commentary I've heard back is that they're actually rather excited that they're now getting on to the Axon platform and that we're going to honor those contracts. So, we intend to make this a very positive experience for every one of those customers.

Got it. Okay. That’s it from me. I’ll hop back in queue. Congrats again.

Thank you.

And our next question comes from the line of Steve Dyer from Craig-Hallum. Your line is now open.

Thanks. Good afternoon and congratulations as well. Just following up on Mark's question around organic, how the organic growth is tweaked in the guidance. On the revenue side, sort of the new revenue guidance would sort of imply that Q1 was flowed through, and maybe not a lot was added or expected for VIEVU. I just wondered if you're willing to sort of break out, ballpark, what you're sort of anticipating from VIEVU over the balance of the year versus what was already in the numbers.

Yes, so we took up our revenue guidance, as you pointed out, Steve, and we were, as Mark pointed out, on track to exceed our initial guidance. And the operating expenses in VIEVU, that business is dilutive to our Software & Sensors business. And so, what we feel comfortable is that we're going to be able to absorb that and stick to the original guidance we gave around operating margins.

Yes. I'm talking, I guess, revenue. If, very rough numbers, you'd be by about $10 million in the revenue line this quarter, and the raise on the revenue line would sort of imply about that kind of an uptick. So, just wondering if maybe the last three quarters of the year organically were a little softer given the big first quarter, or if there's just not a lot of VIEVU revenue you're assuming.

Well, we don't expect generally VIEVU to be all that material for the year. We did, as you mentioned, have some onetime items in Q1 from the international Weapons segment that we don't expect to recur.

Got it. Okay. And so, I guess, along those lines, Weapons grew by 10% in the first quarter, and I think you had said 7% to 10% for the second quarter. Are you seeing sort of, I guess, a broader downtick in growth? Or is that sort of a, I guess, a sequential anomaly? I'm trying to figure out at some point, if TASER 60 has gone on long enough to where, potentially, you just see an organic slowdown a little bit.

Yes, great question. We're still seeing our Weapons business grow lower double digits organically. What you're seeing is really the sequential anomaly.

Got it. Okay. And then, I guess, lastly for me, staying with Weapons. The operating margin there ticked below 30% this quarter. Historically, that used to be sort of a mid- to high-30% operating margin business. I'm just wondering if mix has suddenly shifted there a little bit over time, or maybe what I'm missing, if there's more R&D expensed for new products or what have you.

Yes, so this is Rick. I would say, I think the majority of what you're seeing there is we're seeing more and more of the TASER deals are going in as part of the Officer Safety Plan, OSP. And so, when you bundle the TASER Weapons together with cameras and software, some of it is just a little bit of just revenue allocation, but some of the discount on – like the Software & Sensors business tends to see more discounting than the TASER business, so on those bundled deals, by the time you end up with the revenue allocation, that ends up perhaps allocating some revenue away from the TASER hardware, which would obviously impact the margins.

Got it. Okay. Thanks very much.

Thank you.

And our next question comes from the line of Saliq Khan from Imperial Capital. Your line is now open.

Great. Thank you. Hi, Rick, Luke and Jawad.

Good afternoon.

Guys, a couple of real quick questions on my end, the first one being is, if you take a look at the outlook, what are your thoughts on the percentage of the trial users that are becoming full-paying customers?

Got you. So, let me take that one. It's a little bit hard to give exact numbers, because in many cases, people have contacted us about the trials. We're in the midst of – they might have already been procuring weapons, they may have gone into a field trial. I can tell you this, and I'm just going to look at Luke and Jawad, make sure you guys agree with this, of the major customers that moved into a trial, if they completed the trial, pretty well universally, we won the deal. I mean, we still have some of them where there's contracts – those trials are still ongoing. But we're very happy that it was strategically a very successful project, in that we saw the vast majority of procurements moving towards trials, which is what we wanted to see, right? Put the stuff in the hands of the users, not in the hands of some bureaucratic purchasing committee, and let the users evaluate what does the job for them. And I think we've moved the ball materially in that direction, and when it moves that direction, we do really well. And of those deals that have closed, a very high percentage have gone our way. And I can't think of any that went away from us.

Yes. Any time we see a trial of over 100 units, we have a very high success rate. I can't think of a deal we've ever lost where we have a 100-unit trial.

Well, we had one or two, and that's particularly if it went on-premise because of a, sort of an institutional belief within IT, where they said, "Hey, we're going to run this on-premise." And frankly, our assessment on that is that we believe the tides of history are kind of on our side here, that the world is moving towards an internet-enabled, connected cloud world, and so we believe we've got a very good shot to win those customers in the future.

[Indiscernible] what really kind of surprised me is you had Kanders that, for years, was talking about how great VIEVU, was and he had a real good market opportunity there. So, what do you think motivated Kanders to sell Safariland's VIEVU over to you guys?

So yes, he's a very smart guy. I mean, it's a well-run company. We actually were talking about this internally, and to be honest, I was expecting the phone call. Because I remember, when we first launched into the software space many years ago, we were surprised at how expensive it turned out to be to build the team, to build the support infrastructure. To basically build the platform cost far more than we expected. Now in our case, we pressed through that because, ultimately, we saw the opportunity that we were the first mover and that we were creating the space, and we felt we could create a very valuable business. If I put myself in the Safariland position, basically realizing the importance of the software and the cost of doing it, it's hard to make the economics work when there's already a really strong market leader. So, if I were in their position, I likely would have come to the same conclusion, that just the level of investment simply couldn't be justified, given that Axon already had such a strong lead in the marketplace. And I really respect that Safariland reached out to us, and ultimately, we found a way to leverage everybody's strengths and help them to continue to build a strong and growing business. And frankly, I'm delighted we can work with them now because they're really good at things around support gear and holstering that is going to make our solutions more valuable and allows them to focus on continuing to run where their core competencies are really strong.

Well, I agree. I've just had a pretty nice switch over there into the marketplace. And just one last question, Rick. If you take a look at the product portfolio versus your – and if you map one over the other, how do I start thinking about the margin potential opportunities that you have once the integration happens? And what could that product portfolio look like when you really tighten it up?

Yes. So, I think part of what – as the Safariland team looked at this, they would have had to spend a lot of time, energy and effort building a system to be competitive with what we had already built. So, from just a global economics perspective, this is much more efficient for us to acquire VIEVU and be able to leverage what we've built. So, I would say, over the next 6 to 12 months, the team at VIEVU is going to be really helping figure out how we integrate the best of what they've got into our platform, and then everybody can shift their focus to moving the ball further down the field, building new exciting features that are solving new problems for our customers. And at this point, it's really an exciting time to be at Axon because this, having the major cloud platform in public safety and running one of the largest datasets in the world, opens up just virtually unlimited opportunities for us to leverage that into additional capabilities and additional expansion opportunities. So, for us, one of the challenges is making sure my partner Jawad here keeps us focused on sequencing those investments so that we're making the investments the right way to add maximum value for customers, while also managing the company with some financial rigor.

Fantastic. Thank you.

Thank you.

And our next question comes from the line of Jeremy Hamblin from Dougherty & Company. Your line is now open.

Hi, thanks for taking the questions and congratulations on the deal and the strong results. I wanted to jump into thinking about this kind of intermediate-term plan that you have on your Software & Sensors business on breakeven. You mentioned that – overall to the Axon business that revenues may not be material, but I imagine, as it pertains to Software & Sensors, it is more material. Are you still on track to see that business break even, given the contracts that you've inherited, kind of in the next three years?

Yes, we're not making any changes to our long-term model. Every day, Jawad and I get up and think about how do we turn the Software & Sensors business into a profitable business, and we've got really good plans in place to execute on that plan.

Okay, great. And then I wanted to also ask, you had some great updates here on progress in Europe. And just thinking about the sales cycle that you saw play out in the U.K., maybe in Australia, how has the evolution of the length of the sales cycle played out in the U.K. where it is today, and how we might expect that to play out in some of these newer frontiers in Germany or Italy. Have we gone from a kind of 36-month sales cycle to now, in the U.K, we're at 12 months to 18 months? Can you provide any color on that, Rick?

Yes, so I don't know that it has changed the sales cycle. We're just a few years into this sales cycle, where we're now seeing the approvals in Italy, we're seeing field trials happening in other continental European countries. I think there are some differences, where the U.K. and Australia still tend to have regional police units. So, there's 44 constabularies in the U.K. and around 10 in Australia, whereas in Italy and France, for example, we're dealing with more major national police forces. So, larger institutions tend to have longer decision cycle times. So, I don't know that I've seen it changing, but we're a few years into it now, and I'm glad to see that we're starting to see some progress. Luke, do you have anything to add?

Yes. I mean, I think, when we look across the table at our international customers, we've done a really good job building out a direct sales channel where we've hired local nationals. And we now, I think, are gaining access to key stakeholders that we just didn't have before. And this isn't just in the last few months. This is really a culmination of two to three years of hard work. This last quarter was a record international quarter at $23 million. Again, when I was over there at the end of March, they were preparing for Mayday events. Every major city in Europe has protests, and they're looking for effective use-of-force options to deescalate those types of situations. And so, we're seeing all the right signs in markets like Germany and Italy in addition to expansions in the U.K. So, we feel really good about our international progress.

Yes. Just to expand on the question, or maybe clarify, the sales cycle that you have in the U.K., where you're now an established player, has that shortened? That's really the base of the question.

I think it'll likely shortened a bit. Yes, I think there's growing confidence versus when we were new in that business, in the body camera business, in the U.K. and the cloud was a brand-new concept when we first started, whereas now the largest agencies in the U.K. are customers. I think we're seeing more and more customers starting to convert over onto our platform. And the buzz between them is sort of validating that, this whole business model of using the cloud and internet-enabled docks is some real advantages. So, I'd say that it's accelerating the decision cycles in the U.K.

Okay, great. And then last one here is on the Axon Fleet. And just thinking about that business, you've really made very quick progress on gaining market share there. I wanted to understand, in terms of the reporting of that revenue and the way that you're selling that service, clearly disruptive to the current player and market structure. Is that going to be reported under software services revenues moving forward? Or how is that business going to be reported?

Yes, it is under Software & Sensors, Jeremy. And at this point, we don't have any plans to break that out separately. At some point in the future, we may revisit that, but for the foreseeable future, we're going to include that in Software & Sensors.

Okay. So, but is that going to be included, right now, in net sales from products or net sales from services?

Yes, it's actually both. So, the software portion will be under Axon Cloud, as I said the new nomenclature for our software revenues, and then the hardware around Fleet will be under the Sensors and Other.

Okay great. Thanks for taking the questions guys. Best of luck.

Thank you. And by the way, I would add in there, we, last year, mentioned we had acquired a team in Finland. Juha and his team over there are just doing a fantastic job. I'm really excited at the vision of bringing, particularly around where the Fleet product line's going to evolve in the future. So, we're – I think that's one of the exciting areas of the business for me.

And our next question comes of the line of Glenn Mattson from Ladenburg. Your line is now open.

Hi, thanks for taking the questions. Just a couple. On the acquisition, can you give us a sense of how many years are left on those contracts, for instance? Like, take the NYPD. Was it a three-year or five-year deal at the time that they signed with VIEVU? And the reason I'm curious is just, like I know they were significantly underbidding you in a lot of situations, which you've mentioned. But how do you feel about the confidence of getting those contracts up to more standard – your more standard pricing structure upon renewal?

Yes, so at this time, we're not going to talk about any specific customers. But I would say, the way we're thinking about this is, there'll be a natural kind of upgrade cycle where those customers, the average life of the hardware is anywhere from 2.5 to 3 years, and we're going to go out and work with those customers and really earn their trust and show them the benefits of the Axon network. And in early discussions with several key customers, we feel really good about their willingness to move over to the Axon network.

Yes, and I would add that, we're – part of the value of building the Axon network is that it gives us the ability to offer future products and services that are extremely valuable. So, I've already had some discussions with some of these customers where they're validating that these future products and services that we're building are going to be really valuable. So, I don't think we have – we're not thinking of those in terms of like how do we increase like the prices at some renewal in the future. We're thinking about this; how do we delight those customers with new services and new capabilities that are going to be really valuable for them that they'll want to purchase some of the new things we're building? And I'm very confident that we'll be able to earn the additional business with these customers over time.

Yes. And actually, just to build on that, the proof point of what Rick just spoke about is that many of our contracts, even though they're on average 4.5 to 5 years in length, don't end up running their full term because we're introducing new products and new solutions at such a rapid pace, some of these contracts get rewritten in upsell situations. And we would expect the same to continue in the future.

Great, that's helpful. Jawad, how about service margins? They were up, I think, 10 percentage points sequentially and maybe 8 year-over-year. Is there anything going on there beyond just getting better scale, I guess?

So, part of it was we've completed our migration costs from AWS to Azure. So, there were some duplicate costs, there were migration costs in there. So, some of that, we just benefited from having that complete and behind us. Jawad, do you have anything else to add?

That's exactly it, and also the fact that we continue to add users to the network, and we're getting scale there.

Great. And last thing, just curious on the – seems like the TASER Cam and – I mean, the dock ebbs and flows, I guess. Dock was kind of – TASER – the Dock was a little weaker maybe last quarter, so maybe there was some catch-up, but TASER Cam was oddly strong this quarter. Was that just a few random orders maybe in the international orders?

Yes, we had a really, really strong international quarter. It was actually a record quarter, and we're still selling some TASER Cams internationally.

I can think of one major U.S. order as well. Probably – our U.S. customers typically don't like us talking about them with specificity, but there was at least one that I know who went with TASER Cams that was pretty significant.

Okay. Great thanks guys. Congrats.

Thank you.

[Operator Instructions] And our next question comes from the line of Bill Baker from GARP Research. Your line is now open.

Hi. My question is about artificial intelligence. I greatly appreciated you having some folks from that part of your business in the Analyst Day several months back. And just wanted to hear your thoughts about developing this internally, you've placed a lot of emphasis on that, and strategically how you're thinking about that. Because I see you passed on Avigilon, and a lot of my colleagues out here in The Street really were a little fearful of Motorola a year or two ago, and to see them do this deal, are you seeing this as a signal that there's a divergence in strategic thinking here among the two companies, and you're not going to be in that adjacent market? Or do you think internally you're going to be morphing beyond the straight police kind of applications over time?

Hopefully, for sure. We're very focused on building our [indiscernible] as a core asset. I would say there is a bit of a difference. Some of our competitors are growing through like a heavy acquisition approach. And interestingly I was talking with some of our technical leaders, and the risk of that is you end up acquiring a bunch of technical debt because you're buying a bunch of things that weren't necessarily designed to play well together. And doing that integration, it's really hard to buy a lot of different things and then end up with an Apple-esque user experience where things really work well together. So, our approach is much more focused on building things in a highly integrated way. So, from an AI perspective, we're not doing foundational AI research on the scale of like a Google or Facebook. Our team is really focused on leveraging the best-in-class AI tools and algorithms, and we're building the data models based on this wonderful, you know we have one of the largest datasets in the world at 22 petabytes and growing exponentially. Now, that's our customers' data. We'll be very clear. It is not ours. But our customers can now opt in to be able to have that data used to train our AI algorithms. They can then automate many of the mundane and boring and tedious tasks that law enforcement has to do with this data and, ultimately, to unlock the value that's inside that data. So, we believe having more data and a focused AI team allows us to build better features so we win more customers, which gets more data, which we can feed to our team to build better features and so forth, and the flywheel continues. So, we're feeling very confident about our approach. We do know that we're up against some people with deep pockets that are competing with us, and we're enjoying the competition. We feel really good that our strategy is one that, over the long haul – I'm just saying, let's just say we're confident in our approach, and we're excited to see how the future unfolds.

Well, thank you, and again I appreciate having to have a chance to speak with some of your engineers. So, it is a really fascinating area.

Great. Thank you.

You’re welcome.

And our next question comes from the line of George Godfrey from CL King. Your line is now open.

Thank you. Thanks for taking the questions and congratulations on the great quarter. I just wanted to start with VIEVU. From – Rick, from the comments, it wasn't clear to me whether you were leaving the customers on VIEVU hardware and then moving them over to Evidence.com or do you plan to migrate them to the full Axon solution immediately. How does – and what is the time frame for moving the existing customers to your solution?

Yes, those are issues that we're working through right now in consultation with our customers. So, we don't – we don't have a firm time line on that. So, that's going to be determined, again, in close consultation with our customers to make sure that they have input on the path that we choose forward.

Got it. And then, secondly, New York City and Boston, I think, are two Northeast cities that have been really slow to adopt the body camera solution. Given that New York signed a contract for 5,000 cameras with VIEVU, has their thinking around that changed? Have you been able to ascertain that?

So, the biggest agencies in particular have asked us not to comment or hypothecate [ph] about what their plans are, although I do know that the mayor of New York has made public statements earlier this year about accelerating the cameras to full deployment. And if you – we'll have our IR team send you references to some of those statements, but we will be really careful not to speak on behalf of our customers.

Understood. Okay, thank you. Nice quarter.

Thank you. We are pretty excited about it.

Thank you. And at this time, I'm showing no further questions. I'd like to turn the call back over to Rick for any closing remarks.

Okay. Well, hey, everybody. It's hard not to smile when you see the fruits of the labor and the hard work that all of our people have done over the past few quarters to just pitch in on a quarter like this one. So, thanks for sticking with us, and we're really excited to have you all come out to our shareholder meeting and tune in for our calls in the rest of the year.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.