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  • Brett Schafer

Not So Deep Dive: Axon Enterprise Stock

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Show Notes

(Ryan) What they do: I’m stealing this from their 10-K, “Axon’s mission is to protect life. We fulfill this mission through developing hardware and software products that advance our long-term strategic goals of a) obsoleting the bullet, b) reducing social conflict, c) enabling a fair and effective justice system, and d) building for racial equity, diversity, and inclusion.”

So they sell various across basically 3 product categories: (1) Tasers: They have various versions that they sell, but their most recent is a cloud-connected taser. Then they pair it by selling the cartridges as well. (2) Sensors: Body cameras one of which includes their Axon flex sunglasses, in-car cameras, and Axon Air which is data capturing drone devices.

The last product category is software. This is a complete suite of SaaS solutions that connects with the tasers and sensors. They group these into 3 different segments. (1) Digital Evidence Management: These software solutions make it easy to store, manage, redact, and share evidence on one platform. This includes their site, Axon Performance, and Redaction Assistant which I’ll talk about in a bit. (2) Productivity: Includes Axon Records, a records management system. Axon Standards, a use-of-force reporting module. And Auto-transcribe, AI that helps quickly and accurately transcribe video. (3) Real-time Operations – these are decision-making and communication tools for real-time situational awareness. And right now it consists of two products. Respond for Devices, which alerts agencies with GPS locations and live stream video of what their officers are doing and Respond for Dispatch, this is a dispatch system which alerts every party that’s involved in incident response.

So it’s really a blend of hardware and software meant to help law enforcement agencies reduce harm and better de-escalate situations. They have customer relationships with 95% of all law enforcement agencies in the US.

(Ryan) History: Axon was founded in 1993 in Arizona by two brothers, Rick and Tom Smith apparently after 2 of their friends were killed due to gun violence. The goal at the start was basically to bring Tasers into mainstream usage for law enforcement. The taser was invented by Jack Cover in the mid-1970’s and really brought to market by Axon, which used to be known as Taser International.

In the late 90’s they added cameras to the bottom of their tasers to capture video, but quickly realized that capturing video wasn’t the big problem. It was the managing video on the back end that was tough. This led Axon to create Axon evidence in 2009. Since then, Axon has added a bunch of different sensor devices and software solutions that all come together to make up the Axon Network. The company IPO’d in 2001 so it’s been around for a while, and Rick Smith is still in charge.

(Brett) Industry/Landscape/Competition:

  • We’re going to use Axon’s own TAM estimates which should be taken with a grain of salt

  • They are a very TAM-happy company

  • Estimate total TAM of $52 billion

  • Axon sells to law enforcement, federal agencies, and consumers

  • Largest product markets are consumer safety ($17.8 billion), digital evidence management ($13.4 billion), Devices ($6.5 billion), and TASER ($4.7 billion)

  • This highlights why they talk about software as the long term growth driver for the business

  • The only categories where they have double-digit penetration are Taser and body cameras and that is only in English speaking countries

  • According to an executive a congressman called them and said they want body cameras on every cop in America

(Brad) Management and Ownership:

The team seems extremely sharp based on some interviews I listened to and then obviously credentials:

  • Founder and CEO since 1993 is Rick Smith

  • Basically graduated from Harvard and then started Axon (TASER at the time)

  • 87% GlassDoor rating is solid

  • Former Ernst and Young Entrepreneur of the Year

  • Phoenix Business Journal’s list of Most Admired CEOs

  • President is Like Larson since 2008 (sounds like he’s really the COO at this point too

  • Decorated Marine Corps Infantry Officer

  • He climbed the ladder from product manager to EVP to CMO to President over his 14 years with the company

  • CFO is Jawad Ahsan

  • With the company in the role since 2017

  • Former CFO of a SaaS company that sold to Vista Equity

  • Former CFO of GE Healthcare’s HER and enterprise software businesses

  • Chief Revenue Officer is Josh Isner

  • Another guy who has been with the company since 2008 climbing all the way up from an associate to a VP EVP and now CRO

  • Another Harvard Grad

Ownership doesn’t look the way I expected it to look:

  • Smith owns about 1.5% of the outstanding common shares but looks like he has another 9ish % in CEO option awards with the rest of the executives and directors owning another 0.8% outright and having about 1% each in awards to vest

  • BlackRock owns 9.4%; Vanguard 8.7% and Ballie Gifford 6.7%

  • 80% of the overall float is owned by institutions

(Brett) Valuation:

  • Market cap of $8.77 billion, ticker AXON

  • EV of $8.17 billion

  • EV/s of 9.4

  • EV/gp 14.9

  • EV/OCF of 56

  • 7.5 million dilutive securities vs. 68 million shares outstanding

  • Expect 3% - 4% dilution a year

(Ryan) Earnings:

  • The 3rd quarter was really strong for them. $488M in bookings in Q3, up 54% YoY

  • ARR grew 42% to $289M.

  • Blended gross margin 62.3%

  • Highest margin product is Axon Cloud at 75%. That saw strong growth as well.

  • Taser gross margins are surprisingly high. 66%.

  • Adj. EBITDA margin for the last nine months has been 23%.

  • Operating margins are -22%

  • And they report about $75M in FCF for the first 9 months

(Brad) Balance sheet and liquidity:

Has $280 million in cash and equivalents and another $300 million in marketable securities and other short-term investments

$150 million in total credit revolver borrowings that’s mostly untapped ($6.1 million drawn at a rate of LIBOR + 1-1.5% based on liquidity ratios)

Essentially no debt with a hefty cash balance and profitable

Anecdotal Evidence:

  • (Ryan)

  • (Brett) Hard to have anecdotal evidence personally but cops I have talked to say it is the top company for that industry. Departments are spending tons of money with the company

  • (Brad)

Future growth opportunities:

  • (Ryan) In general, cross-selling their software products. But to highlight one specifically, Axon recently updated their video redaction tools. The way I understand it, when a video gets shared to or automatically shared to Axon Cloud there are people or data in those videos that deserve privacy. So, law enforcement has to go in there and edit out things like bystanders’ faces, and that process is known as manual redaction. With Axon’s redaction assistant, agencies can quickly redact their videos using AI.

  • (Brett) I gotta go with Axon Cloud/ This is the software backbone that is helping them sell the bundle and according to them has small market penetration. Plus, they expect this segment to hit 80% gross margins over time. Can it grow sales at a double-digit rate for the next decade? I think that is likely.

  • (Brad) Maybe start marketing more heavily to single women? I’m reaching here not really sure what to say other than sell more tasers

Highlights and lowlights:

  • (Ryan) Highlights: Massive installed base of law enforcement agencies. Strong ARR growth and net revenue retention rate. Lowlights: Compensation structure. Performance awards for CEO and other execs is based primarily on Adj. EBITDA. They’ve generated $212M in adj. EBITDA over the LTM, and paid $315M in SBC over that time. Which they adjust out in their next incentive.

  • (Brett) Highlights: durable grower, incredible moat, and large market opportunity. What more is there to say? Lowlights: The only lowlight I can find is share dilution and the incentives around the stock performance plans

  • (Brad) The management tenures are awesome. The CEO/Founder seems super bright and capable and has been with the company for longer than most public CEOs and with a great track record of success

Bull Case:

  • (Ryan) Net revenue retention rate stays above 110%. They’re able to expand customers internationally

  • (Brett) sustained double-digit revenue growth and steady margins counteracts 3% - 4% dilution per year.

  • (Brad) this is the evolution of public safety beyond deadly weapons to something that finds the right balance between debilitating yet not deadly. Its products are used to create a safer society and maybe it even leverages this positive perception to try and expand globally

Bear Case:

  • (Ryan) Dilution and exec comp bogs down FCF/share growth. Other than that, I don’t how Axon doesn’t grow.

  • (Brett) Multiple compression and share dilution really hurt returns here. I struggle to see how they don’t grow revenue but maybe margins are not as strong as we assume.

  • (Brad) -- this is part of the process of evolving from deadly weapons to something that is 100% temporarily debilitating but does not inflict pain. That’s the perfect scenario. So a little bit of they do to tasers what Axon is doing to some gun use cases

Chit Chat Money is sponsored by 7investing. Use our link or enter promo code “CCM” at check-out to get $10 off your first month of the service.

Disclosure: The author and podcast guests are not your financial advisors. Ryan Henderson and Brett Schafer are general partners and portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this show.

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