Earnings Call Transcript - AXON Q4 2023

Operator, Operator

All right. Hello, everyone. Thank you for joining Axon's executive team today. I hope you've all had a chance to read our shareholder letter, which was released after the market closed. You can find it at investor.axon.com. Our prepared remarks today are meant to build upon the information and the financial tables in that letter. During this call, we will discuss our business outlook and make forward-looking statements. Any forward-looking statements made today are pursuant to and within the meaning of the safe harbor provision of the Private Securities Litigation Reform Act of 1995. These comments are based on our predictions and expectations as of today and are not guarantees of future performance. All forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. We discuss these risks in our SEC filings. We will also discuss certain non-GAAP financial measures. A description of each non-GAAP measure and a reconciliation of each non-GAAP measure to the most directly comparable GAAP measure can be found in our shareholder letter as well as in the Investor Relation section on our website. All right, every quarter we play a video to kick off our call. We love how this helps you get a closer view and feel for our business. To start us off today, we're going to play a video we put together that hits on a bit of what we talk about when we tell you about our moonshot. It's a little under three minutes. Let's pull up the video.

Rick Smith, CEO

All right. Thank you, Erik, and thanks all of you for joining us today. Welcome everyone to our fourth quarter 2023 earnings. It's great to come back to you with another incredible year in the books for Axon. We kick off these calls with those videos to help you understand what we do. Sometimes seeing these kinds of scenes brings out different emotions. But that's what our customers face every day. And making those complex situations safer for everyone involved is what energizes us in our work. I've talked about my abhorrence for violence many times in the past. We envision a world where violence is just a far-out thought, but we are constantly trying to find new forms of technology to make this a reality, and we're really proud of the progress we've made over the last year. First, with seemingly small things like adding a warning sound to TASER 10 to help communicate to someone on the other end that something unpleasant is impending with the hopes that that person will rethink their decisions and alleviate the need for a use of force action at all. And adding a watch me button to our body camera so that an officer can proactively request a second set of eyes during their most high-risk situations. Next, we thought a bit more outside the box, introducing individually targeted probes, enabling far more effective range on TASER 10 and making our innovative TASER technology more effective in more situations. And we reimagined real-time operations, introducing two modern communication capabilities with two-way voice communication through our body cameras to help complex decision trees in real time. As we look ahead, we're solving for higher-level challenges like enabling better decision-making in potentially life-threatening encounters, or effectively expanding a police force by reducing the extensive time that they spend on paperwork. And we envision accelerating the speed of the entire justice system. We're innovating in diverse areas from robotic security to Generative AI to virtual reality. And there’s really so much more that's still left for us to do. When I think back to the video we just showed you, think about what would happen in those situations if an officer didn't have one of our TASER devices or was not wearing one of our body cameras so we could all understand what unfolded and why. It excites me that we made huge strides and that our technology is driving better outcomes. I think a lot of what we're working on now has the opportunity to become so pervasive in the future that it will be hard for us to remember life without it. Highly disruptive technology, that's the beauty of it. When you get it right, it quickly becomes difficult to imagine what things were like beforehand. But we're not always going to get it right by ourselves. We rely heavily on feedback from our customers, their challenges in the long term, rather than what's simply in demand today. While present needs do matter too, I spend most of my time with our customers on the vision beyond tomorrow, which is what I believe will drive our growth for not just the next one to five years, but the next decades. What energizes me in my time with customers is they provide us with the best and most actionable feedback on our roadmap, the snags and problems we may run into, and they help us think through the way to overcome those challenges and the best avenues for us to deliver them what they need. Most critical for us is making sure we have the right people to help us deliver for our customers. When I look at our team, I know we have attracted some of the best and brightest to come and work here. If it's not me meeting with a customer about a new product we have in development, it's somebody from our team. Our team works together, relays feedback, and understands our common goal. We don't accomplish what we're doing in silos. We join forces across the company and together with our customers. This goes beyond our current team and extends into key partners like Fusus, who we're thrilled is now part of Axon. Our partnership with Fusus began a few years ago and we've really been impressed with their people and the product they've built. I'm traveling with their founder as we speak today. Together, we're taking our real-time operations to the next level and opening our ecosystem to an even larger network of sensors and devices which will unlock entirely new solutions for our customers over time. Before I hand it over, I'd like to say that I'm grateful that I've been trusted to lead this company for the past 30 years and that we've been able to maintain the same drive and energy we had when we started. I might be a little atypical as a CEO as my day-to-day responsibilities align more with my background as a Founder than as a Senior Manager. I'm focusing on what's next. What's always important in driving any enterprise from a startup to a $20 billion public company is that we need to encourage people to be the best versions of themselves, but also to challenge each other, just as our customers will challenge us, and to share in a common mission with a culture that encourages us to do our best work. I'd like to provide one last comment on something near and dear to me. We've talked about our intent to invest in our new headquarters over the past few years. And we mentioned last quarter, we were revisiting those plans after we had paused work in September. Part of revisiting that has been working to bring our vision of a corporate campus to life. We would like Axon to remain headquartered in Scottsdale where we own a piece of land and where we have built this business. I love Scottsdale. However, it's not clear that Scottsdale wants Axon as we're seeing the political environment become more challenging and frankly, anti-development. It's unclear if we will get the approvals we need to execute our project. So we're exploring several geographies and other options. As a result, it may take some time before we have a definitive decision on our next steps. We will keep you updated in the coming quarters as we resolve our plans and we make progress. Now, I know we're not a startup anymore, and that also means we need people focused on execution, making sure that what we do is viable and is executed to world-class standards. And I am beyond fortunate that Josh and Brittany and their teams are here to help me in our execution. And with that, I'll turn it over to them now.

Josh Isner, CRO

Thanks a lot, Rick. And good afternoon to everybody. I continue to believe there is no better place to be than at Axon. We are building the most talented, outcomes-oriented team in tech, knowing that that's what it will take to deliver on our moonshot of protecting life and reducing the number of deaths in civilian police encounters by 50% over a 10-year period. 2023 marked another promising step in that direction. We just recorded our fifth consecutive year of greater than 25% revenue growth, and we beat that by a good amount, coming in at 31% year-over-year. Looking ahead to 2024 and beyond, the opportunity is right there in front of us. We're steeply ramping TASER 10 and Axon Body 4, we are building transformative new products and we've added Fusus and Sky-Hero, which together grow our estimated TAM by over $13 billion to a total of $63 billion. And I'd just like to say welcome to the Fusus team. This is your first earnings call as part of Axon and we're thrilled to have everybody on board. In the past, I've shared my vision on Axon's priorities over the next three to five years. We are focused on delivering the technology ecosystem of public safety globally. This approach supports our growth in two powerful ways. Number one, through new product introductions, which expand our ecosystem and deliver new value to our existing customers. And number two, through expansion into our new customer verticals, where our existing products empower new users to deliver safer outcomes and drive a clearer ROI. This framework has led us to invest in opportunities with federal and international governments, justice, corrections, and in the enterprise space. We finished the year with record federal bookings as we continue to see rapid adoption of both hardware and software within the federal civilian market. Likewise, the new Axon Body Workforce camera, or ABW as we call it, has driven strong pipeline in several segments within enterprise, such as retail and healthcare. One shining use case within the healthcare space is Fairview Health where they are trialing ABW with nurses as part of their commitment to patient and staff safety. A key to our success is that we continue to lead the market in innovation. It's no surprise when you listen to Rick that we believe our ability to innovate is a competitive advantage for Axon. Jeff's leadership in our product org combined with Rick's visionary thinking and foresight is an unmatched combination that gives us the luxury of doing two things in parallel: building the next wave of world-class products for public safety and identifying the most synergistic partners in the market, such as Fusus and Sky-Hero. Our standards are high and yet year in and year out, our product team sets a new bar. Before I turn it over to Brittany to go through our operations and financials in more detail, I'd like to congratulate several of our teams on some substantial recent achievements. First, the TASER 10 lead team led by Pat Madden. We are now four quarters in, and our order rate is pacing at more than four times what we saw with TASER 7. And then secondly, with Axon Body 4 product line led by Jason Hartford and David Mesri, we shipped more than 100,000 units in the second half of 2023, only two months after announcing the product. While these products started in R&D, they end in the hands of our brave customers. A lot of collaboration among functions, or as we call it, #JoinForces, happens in between. Our teams deliver outsized societal outcomes together. As you can see, we're not slowing down. We are incredibly humbled by the trust our customers and shareholders continue to place in us, and we remain committed to holding up our end of that bargain. 2023 was a record year and we are so proud of the team. But we are equally proud that that same team moved on from 2023 58 days ago. As we like to say, we're on to the next play. Over to you, Brittany.

Brittany Bagley, CFO

Thank you, Josh. As Josh mentioned, 2023 was another great year for us with revenue growth of 31% year-over-year and Q4 revenue growth of 29%. We continue to be incredibly pleased with all segments of our business and continue to see enormous opportunities in front of us. In addition to continued strong top-line growth, we expanded our profitability with a 21% adjusted EBITDA margin for the fourth quarter and full year. This represents 160 basis points of improvement versus 2022, largely driven by leverage in our SG&A function. As we've talked about before, we continue to focus on expanding gross margins and expect improvement over the course of 2024 as we see the benefit from enhanced efficiencies with TASER 10 from manufacturing automation and cost initiatives as well as continued benefits from software growth. We're also going to continue investing in our R&D to support the opportunities we see in front of us and to make sure we can keep delivering strong growth for years to come. You've heard today and read in the shareholder letter the significant growth opportunities we see in federal, international, and enterprise, as well as for Axon Air, real-time operations, and new software capabilities to name just a few. We think we're hitting a nice balance of investing for the future while also increasing profitability and driving towards operational excellence. While we have leveraged SG&A, we have also continued to invest in expanding our sales and marketing teams to address new markets, improving our internal technology capabilities, and bolstering our financial strengths, including the fact we remediated our material weakness this quarter. This positions the business well to continue growing and scaling. Now, as I turn to our guidance, we expect 20% to 24% total revenue growth, or $1.88 billion to $1.94 billion for 2024. This is quite strong guidance for us and is the result of increased visibility for 2024. The strong visibility is driven by TASER 10 demand, as well as the continued strengths in our future contracted bookings, which has reached $7.1 billion as of the end of Q4, growing 54% year-over-year. Our software, which provides us with strong visibility, recurring revenue, and attractive gross margins, also contributes to the strength of our guide. In Q4, our ARR was $697 million, which grew 47% year-over-year. We continue to have a 122% net retention rate and strong customer satisfaction. We expect adjusted EBITDA of $410 million to $430 million, which implies an adjusted EBITDA margin of approximately 22%, up another 100 basis points from this year, on moderate gross margin improvement as well as continued SG&A leverage. This guidance includes the impact of Sky-Hero and Fusus, though we aren't going to comment specifically on either of their financials. Finally, last year we put out a 2025 target model of $2 billion in revenue and 25% adjusted EBITDA margin. As you can see from our 2024 guidance, we're pacing to well exceed our revenue target in 2025 and tracking nicely to our adjusted EBITDA margin target. As we look to 2025 and beyond, we expect to continue targeting a 20% annual revenue CAGR and a 25% adjusted EBITDA margin. We think this is achievable and represents a very healthy, sustainable, and attractive long-term model. We're comfortable in maintaining this long-term growth rate based on the opportunities we've discussed and think this is the right balance of investing back into the business and generating attractive profitability. Also, while we have fantastic organic growth opportunities, we're very excited to be able to strategically make acquisitions in markets that will continue to support and grow our TAM like we have just done with Fusus. Finally, we are also continuing to target 60% free cash flow conversion on adjusted EBITDA and approximately 3% average annual dilution from stock compensation expense for 2025 and beyond. As you can tell, we're all incredibly excited about what we can deliver in 2024 to both our customers and our shareholders. We're looking forward to another great year. And with that, I would like to open it up to questions.

Trevor Walsh, Analyst

Thank you, Erik, and thanks everyone for the question. I appreciated the TAM outline in the shareholder letter regarding its expansion and the roles of Sky-Hero and Fusus. However, I didn't see any details about the Axon Body 4 Workforce component or its contribution to that. Can you provide an overview of how you see that opportunity developing? I'm particularly interested in the adoption rate, considering it's a new vertical or user experience. Does the adoption rate resemble that of body cameras in law enforcement, or does it feel different?

Rick Smith, CEO

Yeah, Trevor, thanks a lot for the question. I appreciate it. The first thing just to clarify is within the enterprise section of our TAM. That's where the Axon Body Workforce would roll up. And we could certainly talk through that more offline. And in terms of just interest in the camera, we had a launch event. We had some customers in town for it and some trial partners in town. I think this year is truly about, hey, how do we make our early customers really successful on this product and then build from there. It's not much different than the playbook we ran in public safety. And so much of it comes down to just having these early maven type customers that will help us not only build our brand in that space but also help us build the next iterations of the products. And so that's really what we're focused on. We really do believe the future is bright in enterprise. We're seeing that early on in the bookings results. We're not quite ready to share anything more on those at this point, but over the coming years, we do believe enterprise will become a bigger and bigger part of our business.

Brittany Bagley, CFO

And just to jump on a little bit, so we gave enterprise a $15 billion TAM in our update, so that's where we see that playing in. And a lot of the Body Workforce camera really came because we were getting feedback from our customers as we were trialing it, largely in retail and in healthcare, about sort of the size and the weight and how they wanted to wear it and how they wanted to use it. And so we really took that feedback and we reflected it in the updated product. And that's what you see, We announced Fairview Health as an early customer there but we're really looking to be able to provide this solution into the retail and the nursing part of the market where they're facing a lot of challenges today around associates and nurses feeling safe in their work environment.

Joe Cardoso, Analyst

Good afternoon everyone. I want to congratulate you on the results and thank you for the question. It's encouraging to see that TASER 10 momentum is continuing from last quarter. I would like to know your thoughts on how you're projecting the margins for this product. The TASER gross margins appear stable over the past two quarters, so should we view this as the lowest point for the segment? Additionally, how should we expect the margins to evolve as we move through 2024, especially considering your ongoing discussions about implementing automation and cost efficiencies? I'm interested in your insights on the margin trajectory. Thank you.

Brittany Bagley, CFO

Yeah, great question. Thank you. We had a one-time event in TASER in Q4 where we had a bit of a manufacturing issue largely related to a batch in March of last year. And so that is impacting our growth margins in this quarter in TASER by about 420 basis points. So absent that one-time impact, they would still be down slightly on mix, but they would look much more stable sort of quarter to quarter. And so as we go into next year, that one-time impact comes out and that's where you start to get the commentary about how the TASER gross margins, overall we expect them to improve and they really are improving around our efforts for TASER 10. As TASER 10 mixes in, that's an impact, but then we're offsetting that by the fact that we're getting benefits from automating the line and doing cost-down initiatives as we go through the year.

Rick Smith, CEO

Yeah, and just to jump in and reiterate there, the issue was on TASER 7, not TASER 10 that led to this warranty reserve. And one thing I would point out is TASER 7 was developed prior to the current regime under Hans Moritz that's leading our whole hardware engineering group and we've seen substantially more rigorous free market validation and as a result with AB4 and the Fleet 3 and so far with TASER 10 we've actually seen more robust field reliability, lower return rates. So just want to make sure we didn't conflate that warranty issue was T7, previous design, not the current T10.

Joe Cardoso, Analyst

Got it. Totally makes sense. And then maybe just quick clarification on that front just in terms of the TASER 10 improvement, not to harp on it, but maybe just in terms of the improvement you're expecting through the year, is the expectation that it happens more linearly or is it more back-end loaded? Just curious just in terms of like, as you bring on this automation equipment, is that more subject to being in the back half or is it more first half? Just curious how we should think about linearity through the year?

Brittany Bagley, CFO

Yeah I think there's a number of different initiatives going on including the automation and then cost-down initiatives. And so I would expect you see that starting to roll in as we go through the year. So it won't be all back-half weighted, but obviously you'll see the cumulative impact of that more in the back half as we get all of those executed.

Keith Housum, Analyst

Yeah, thanks guys. Appreciate it. Can you guys unpack international a little bit more? Perhaps I missed this in the release. Perhaps talk about, if you don't mind, some trends that you're seeing with international. Obviously, I know there's a very strong bookings trend for your last quarter. But how did it look this quarter both in bookings and are we starting to see some of that revenue that you booked last year come to fruition?

Josh Isner, CRO

Thank you, Keith, that's a great question. We're very excited about last quarter's bookings, which were a record for us. The team has been successful in generating orders and building momentum in the market. However, there's some uncertainty regarding when revenue recognition will happen. I expect this to vary more than it does in the US due to factors like country-specific approval for TASER 10. Even if a customer wants it and has purchased it, they must wait until all testing is completed before they can receive it. In the video business, implementation times are longer because we're often deploying to a national government rather than just a city. This means there is a significant amount of work and clearances needed. Consequently, we anticipate that revenue will be inconsistent from quarter to quarter, influenced by shipment times and implementations. However, we believe that as long as bookings continue to rise, the revenue will accumulate and positively impact EBITDA. We're excited as the team has gained momentum after working hard to establish a presence in continental Europe, and we are beginning to see the results of that effort. The outlook for international remains positive, but we do expect some fluctuations in revenue recognition throughout the year.

Meta Marshall, Analyst

Thank you. You mentioned earlier that the drone business may not make a significant contribution this year. I would like to know more about the feedback from customers regarding the challenges to wider drone adoption and an update on how the integration of Sky-Hero is progressing and any initial results you might have. Additionally, it seems there are developments happening with headquarters decisions. Is there a specific deadline by which you aim to decide on the city for the expansion? Thank you.

Rick Smith, CEO

Let me discuss the drones. We see a significant long-term opportunity in this area. In the short term, there are a few challenges that we believe are pre-inflection points. Regarding outdoor drones, there is increasing interest in using drones as first responders. Currently, the process involves police arriving at a scene, retrieving a drone from their patrol car, and deploying it from there. This approach has limitations, as officers must be present on scene to utilize the drone, and it poses safety concerns for those monitoring the drone from the ground. The ideal scenario is to have drones deployed from fixed locations to arrive at the scene before the officers do. This concept was pioneered in Chula Vista, California, thanks to Chief Roxana Kennedy. We are witnessing early signs of rapid growth, with the number of agencies adopting drone as a first responder doubling each year, rising from single digits to the tens. For this expansion to continue, we need clearer guidance from the FAA regarding flying beyond visual line of sight to ensure safe drone operation. Currently, first responder drone flights often require a police officer on-site to monitor the drone, which limits effectiveness. Through our partnership with Dedrone, a leader in drone tracking and counter-drone solutions, we are able to enhance this capability. Dedrone helps track drones in various high-traffic areas, including NFL stadiums, and is being utilized in conflict zones such as Ukraine. We are also conducting pilots that combine Dedrone's technology with drone as a first responder, enabling us to track drones effectively in the airspace without human oversight. This integrated solution could be crucial in allowing drones to grow in practice. I should also note that the growth rate this year was more than just a doubling, albeit starting from a small base, indicating early exponential growth in drone first responder operations. As for indoor drones, we encountered some compliance challenges following our acquisition of Sky-Hero. We found that the RF transmission bands they were using for indoor flying were outside the acceptable limits set by the FCC in the United States. Consequently, we temporarily halted sales while seeking FCC approval and an exemption for selling those drones to state and local agencies in the U.S. However, our acquisition of Sky-Hero was not primarily for immediate revenue. We value the relationships they have with leading SWAT teams and tactical users, which we believe will support the development of innovative capabilities. As Sky-Hero integrates into our larger organization, we are focusing on enhancing legal compliance while benefiting from their agile approach to innovation. They successfully established a profitable drone business with a small team, which is commendable. Exciting developments are underway as they collaborate with our design team, and over the next two to five years, we anticipate groundbreaking advancements in both our indoor tactical drones and outdoor first responder drones. The two main goals are to enable outdoor drones to operate without human presence and to use drones in challenging indoor environments.

Josh Isner, CRO

That's right. And there's also a really exciting hybrid between the sort of drone in a trunk thing Rick talked about and full DFR as the whole industry tries to sort of find their way forward as fast as they can. And this is a thing that actually, Adam Bry, the CEO of one of our other partners, Skydio, and he and I talked together about it, their keynote of their launch a few months ago of their newest drone, where you combine the physical drone being with a patrol officer who can go to scene, but then the instant that they need it, you have that remote pilot who's able to manage it on scene in a DFR style. And so what you're seeing is innovation and experimentation to try to move as fast as possible while navigating around these various short-term constraints. And so it's just a keep watching the space.

Keith Housum, Analyst

Yeah, thanks guys. Appreciate it. Can you guys unpack international a little bit more. Perhaps I missed this in the release. Perhaps talk about, if you don't mind, some trends that you're seeing with international. Obviously, I know there's a very strong bookings trend for your last quarter. But how did it look this quarter both in bookings and are we starting to see some of that revenue that you booked last year come to fruition?

Josh Isner, CRO

Thank you for the question, Keith. We are very enthusiastic about the previous quarter, which saw a record in bookings. The team is effectively securing orders and generating significant market momentum. However, there is some uncertainty regarding when revenue will be recognized, which I anticipate will vary more than in the US due to factors like country-specific approval of TASER 10. Even if a customer orders the product, they must wait until all testing is completed before taking delivery. In our video business, implementation times are longer since we often deal with national governments rather than cities, requiring extensive site work and clearances. Therefore, revenue will likely fluctuate from quarter to quarter depending on shipment schedules and implementation processes. Nevertheless, as long as bookings continue to grow, we expect that revenue will accumulate and positively impact EBITDA. We are optimistic, as the team is seeing the benefits of their efforts in continental Europe after several years of building a stronger presence there. Our outlook for international remains positive, although we do expect some variability in revenue recognition throughout the year.

Rick Smith, CEO

I hope to have a decision by this summer to make the call. This has taken a while, so we would like to get moving on it.