Axon Enterprise, Inc.

Mr. Josh Isner and Chief Product Officer Jeff Cunnins, and we feel great bringing you guys the whole team. First, we're going to give prepared remarks, and then we'll bring our analysts on camera for questions. Analysts, your lines should be muted and try to keep them muted until it's time to ask a question and a follow-up. If you have a third question, you can let us know via the chat window. We'll circle back around depending on time. Axon's moderators, Mark, Doug, and Angel will be unmuting your lines or you can mute them yourselves when we call on you. If you get into trouble, type your question in the chat window and we'll read it aloud. Hope everyone has had a chance to read the shareholder letter, which we released after the market closed. You can find it at investor.axon.com. Our remarks today are meant to build upon the information in that letter, which is very robust. If for some reason there's an internet outage beyond our control or we lose Zoom connectivity, We'll make every effort to post a copy of our prepared remarks to investor.axon.com this evening. 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, are not guarantees of future performance. All forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. These risks are discussed in our SEC filings. Okay, please go ahead, Rick.

Thank you, Andrea, and thank you everyone for joining us today. During our last quarterly update in May, one of the biggest issues we addressed was how we were managing our business through a pandemic. One quarter later, we have so much more to talk about because we've all watched Thousands of people take to the streets demanding police and public safety reform. Our company's reason to exist, our mission, is for exactly moments like right now. Protect life. We are on a mission to make energy weapons so safe and so effective that we make bullets obsolete. We preserve truth. Body cameras protect officers from bad claims and citizens from bad behavior, increasing transparency and reducing social conflict. We accelerate justice with advanced cloud software and AI that have potential to make the entire justice system more fair and more effective. When you think of gun violence, social conflict, and a fair justice system, most people don't think of these as technology problems, but as political problems. We frame them as problems where technology can play a transformative role. Now look, technology is no panacea and it cannot solve these problems for us. However, Almost any problem can be solved faster and more effectively with the right technology tools to help people solve them. So as we look at all the pain and anger today, we ask ourselves, what can we do to help promote equity? Our superpower is creating technology to address social problems that many others see as intractable. So we have added a fourth mission to inspire our work. Centering racial equity, inclusion, and diversity. which might make you wonder, how can you build technology to promote equity? If you want to hear specific examples of how we are using technology to support this new mission, you'll have to wait and come join us at our conference Accelerate later this month. We at Axon can't change the policies and cultural norms in policing, but we can build the tech tools to help our customers do it. We're hearing consistent and emphatic calls for change from the most prominent leaders of law enforcement, and we are excited to build the tools to help them. Back when we began investing in body cameras in 2008, we faced innumerable skeptics. But we knew that body cameras were the future. And body cameras started gaining traction after a wave of protests began in Ferguson, Missouri in 2014, which was really the birth of the Black Lives Matter movement. At the time, we were delivering the right capabilities at the right time, and our investments in cloud software made body cameras suddenly feasible and affordable for all agencies. We invested in body cameras when nobody believed they were possible. And as the investment community well knows, our core body camera and software business lost money from 2008 to 2019 when it began to turn a profit. Those 11 years of continuous investment in R&D To prove out the feasibility and sustainability of body cameras are now the foundation for our next leg of growth. In 2020, we're humbled to be developing solutions that once again find themselves relevant to a national conversation about policing. We do not shy away from these hard discussions, and we see the pain and the nuance behind demands to defund police. This is really all about reforming and reshaping the justice system. And these are issues that we engage with daily. They're not new to us. We invite input from a broad spectrum of voices. We have the industry's most relevant and productive ethics board. With renewed calls for reform, we can leverage technology and policy changes to improve public safety. We believe that our product moment fit is why our pipeline continues to strengthen as communities see the power of our platform to drive positive change. And now with that, I'm going to turn it over to our president, Luke Larson.

Thanks, Rick. In a few weeks, on August 25th, as Rick mentioned, we'll be hosting our annual technology summit, Axon Accelerate. Due to COVID, we've shifted this to a virtual event, which has allowed us to grow the event to reach a much bigger scale of our audience and customers. We're also able to offer a cutting-edge virtual reality track. If you'd like to attend, go to axon.com and register. We're very excited to share some key customer updates and product announcements on how Axon can help officers and the communities they serve ensure everyone makes it home safe. Our strategic priorities in 2020 are to continue to execute in our core market while accelerating our path to market in new product categories. Our engineering and product teams are solving some of the most difficult problems at the intersection of the physical and digital worlds to advance our mission. This is also a year where we have walked beside our customers in one of the most challenging environments they have ever faced. Our customer-facing teams have built amazing relationships with our customers, not by selling devices or software, but by becoming trusted advisors on how we can help customers with the important problems they are facing. We are helping them to source mission-critical technology amid greater public budget scrutiny, helping them to access federal dollars where available, and we aspire to be true partners to our customers. We are emphasizing the mission-critical importance of our OSP7 Plus offering. De-escalation, transparency, and productivity have never been more critical to police and community relations during this watershed moment, and our offerings address these exact situations. This emphasis drove our Q2 results, with revenue up 26% year over year. This is a strong performance in the context of one of the toughest macros we've faced, a global pandemic and massive economic uncertainty. Our strong results were also driven by a stellar quarter for international, up 80% year-over-year to $34 million. This was on top of 38% international revenue growth in Q1. We were just getting started in large markets such as Brazil and India and three countries top $1 million in revenue for the first time in the quarter, Indonesia, Panama, and Thailand. Turning to the bottom line, GAAP income was affected by stock-based compensation and tax expense. Adjusted EBITDA was $28 million, reflecting a 20% margin, which showcases our cost discipline and some travel savings related to COVID. Turning to operations, you will see the inventory build on our balance sheet. This was very intentional. We have adapted well to an ongoing supply chain environment that we've never seen. Recall that last year, we diversified our supply chain and global manufacturing footprint due to tariffs. And it turns out that those initiatives positioned us well to handle COVID-19. Even so, given the number of unforeseen challenges that could lay ahead and the fact that 2020 is full of curveballs, we've elevated our inventory build in the first half. This safety stock helps minimize shipping disruptions and also prepares us for some key Axon Body 3 shipments to major customers in Q3 and Taser orders we are expected to fulfill in the back half of the year. Currently, we expect Q3 inventory levels to remain about the same, and by the end of the year, they could come down by as much as 10%. And with that, I'll turn it over to our Chief Financial Officer, Jawad.

Thanks, Luke. Our second quarter performance was a testament to our ability to deliver sharp execution in a challenging environment. Although demand remained robust, domestic customers were often banned with constraint, dealing with COVID-19, personnel outages, employee restraint, dealing with COVID-19, personnel outages, employee safety concerns, and caution about uncertain budgets. Even with these challenges, Q2 revenue is generally in line with our pre-pandemic expectations. Domestic body camera bookings remain strong and our international expansion continues to accelerate. Our results in the quarter speak to our resilience as a company and the critical importance of our products in our customers' lives. A few years ago, we set out on a journey to transform into an enterprise software company that also sells devices, and our performance this past quarter further solidifies that path. High-margin annual recurring revenue grew 42% to $183 million, Software revenue was a record 30% of total sales, and we sustained a SAS net revenue retention of 119%. Turning to our outlook, we're watching to see whether states shut down in the fall, which could bring renewed caution on budgeting. There is just enough outside of our control regarding COVID-19 that we did not reinstate formal full-year guidance. We did provide a range that we are managing toward for Q3. There are two factors to keep in mind when considering our interim Q3 guidance. The first is that we made a strategic and intentional decision to prioritize growing our cloud user base and adding nodes to our network in the early days of our software and sensors business. As a result, we have contracts with strategically important agencies, both domestically and internationally, that have served as beachhead accounts but come with a lower margin than average. The second factor is that the majority of our multi-year contracts come with hardware refreshes at periodic intervals, which come at a lower margin than the SAS portion of these contracts. The confluence of these two factors will conspire in Q3 to be a headwind on our gross margins, which we expect will normalize by Q4. Anticipating a question we often receive these days, we are not seeing changes in buying activity due to police defunding concerns. In fact, We've seen some anecdotal acceleration of body camera buying decisions due to agencies wishing to provide transparency to their communities. We remain confident in our long-term, multi-year outlook. We're privileged to be working on solutions to some of society's most entrenched challenges. We're just getting started in several new markets internationally and in several new software product lines. Importantly, the addition of capital from our recent follow-on offering further strengthened our balance sheet, and provides us with even greater flexibility to continue investing for growth. At quarter end, we had $675 million of cash and investments and zero debt. Before we move to Q&A, I'd like to share some insight with you as to how we view the company relative to the investments we're making and where we're headed. The first phase of the company's growth, let's call it Axon 1.0, saw us establishing the Taser business and building an unparalleled sales channel with law enforcement. The second phase of our growth, Axon 2.0, saw us continuing to innovate with the introduction of smart devices, including body-worn and in-car cameras, which integrated seamlessly with our customer-focused cloud network. Now we're entering the next phase of our growth, Axon 3.0. We're building a rapidly evolving public safety ecosystem with both connected devices and intuitive workflows powered by AI with the increasingly powerful Axon Cloud as our centerpiece. Our mission with this ecosystem is to protect life, capture truth, and accelerate justice. Now more than ever, society is driving towards these outcomes, and Axon is uniquely positioned to partner with our customers and deliver on all three. And with that, Andrea, let's move to questions.

Thank you, Joad and team. Thanks so much. Moderators, can we bring everyone up into gallery view? Okay, thank you. We'll take our first question from James Fawcett with Morgan Stanley. Go ahead, James.

Great, thank you very much. I wanted to ask the team, Rick, Luke, obviously there's a lot of pressure on police departments at the very least to improve efficiencies, et cetera. Where are we now in terms of some of the software products like records, dispatch, et cetera, to really effectively reduce time that officers have to spend on paperwork, et cetera. And so they can spend more time in the field and gain efficiencies that way. And how well are you being able to communicate the current capabilities to the customers?

Well, I would say the best answer to that question will be if you tune in to Accelerate. We have some pretty significant new announcements, and we'll be showcasing some new capabilities that will have a big impact on efficiency, one of which we've been in field trials that will go – it's going into full release. And I can tell you that one agency in Canada was testing one of those capabilities that was absolutely transformative. They had two homicides happen in a short period of time. And for a small agency, these create tremendous levels of workload. And one of our new AI products actually helped them handle two simultaneously that they said without us, they would have been at risk actually potentially having those cases at risk of getting disqualified because they would not have been able to process all the paperwork and evidentiary data and meet the judicial deadlines. So stay tuned to Accelerate for more, but both records and dispatch are live in the field, and we're now beginning to start really linking some of the AI capabilities to power the creation of the structured data in those systems from the unstructured data we capture with our body cameras.

Got it. And as a follow-up, you mentioned Canada, but it was interesting, at least to us, to see the big jump in international revenues. Where are you and how should we be thinking about the ability that you have in other international markets to take the success of Taser and take it over to body cameras and some of the other software products in those markets?

Josh, why don't you start answering that as the head of sales?

Thanks very much, James, for the question. Ultimately, I think we see a lot of similarities regarding where international is now versus where domestic was four or five years ago. And we're very much following the same playbook. We're going to be focused on international. fewer markets than the entire world. And we're going to continue to build out, you know, a few markets at a time over the next few years. I think the investments we made in our tier one markets a couple of years ago, building really talented teams, they're focusing on expanding both Taser, And getting our early body camera and Dems customers there are why you're starting to receive the revenue results now. And as we continue to build bookings up internationally, we expect revenue to follow in future years. And so our focus is to build very, very talented teams in the markets that we see as potential movers. And we'll start to introduce. some of our newer products into those markets that are already showing great results. And as more and more markets kind of come up to speed, we'll introduce our newer and newer products as those markets become, you know, larger markets and deployments of body cams and tasers.

Thanks, James. We'll take the next question from Keith Husam at North Coast. Go ahead, Keith.

Thanks. Good afternoon, guys. Rick, in terms of the budget relief, which the government is considering, is there any impact to your guidance if budget relief is offered to the state and local agencies over the next several months?

Yeah, I think it would just be pretty speculative for us to speculate on what might go in there. Obviously, if there's a lot of money specifically earmarked to state and local agencies, we suspect in this environment that it would end up being focused specifically towards a lot of the transparency tools, things we're doing with body cameras, et cetera. We've also seen a lot of interest in corrections growing around the taser weapons because COVID-19 still remains a big issue, and particularly in confined environments. So there's more focus on maintaining safe distances. You know, traditionally in corrections, if you have an inmate that decides that they're going to become resistant to following you know, the procedures they have to, that has meant correctional officers suiting up and having to go hands-on in a very close, personal, you're, you know, covered in each other's sweat and other things you'd really worry about. So our plan does not account for any additional federal funding. If it comes in, I think there could be a little bit of upside, but I wouldn't, you know, I don't want to speculate too much.

Fair enough. July, just a little bit of housekeeping here. In terms of the EBITDA margins for the next quarter, what's the impact of your large contracts on your EBITDA margins?

Yeah, that was part of what we signaled with our Q3 guidance, Keith. We have some large international customers. We have a couple of domestic customers that we consider to be strategic BCHAT accounts where the margins are lower than on the camera contracts. And as those customers get the refreshes on their contracts in the quarters that we ship, which Q3 happens to be one, we're going to see lower margins, which is why we gave that specific guidance for Q3. Right. But would it be fair to say the impact of those largest shipments can be 2% on the EBITDA margins? Is that a fair assumption? Well, we are anticipating the EBITDA margins to be 12% on our Q3 revenues. We don't have formal guidance for the year, so I can't officially say what that impact is going to be. All right. Fair enough. Thank you. Yeah, Keith.

And if you dive into the segment commentary in the shareholder letter, we're even more specific on the gross margin thoughts by segment. Great. Thank you. We'll take our next question from Joe Osha at JMP. Go ahead, Joe.

Hi. Thank you for taking my question. One of the questions that's come up around this notion of police funding is the idea that some functions might be taken over by non-sworn officers. I'm wondering about how Axon sees the opportunity to address those types of people. Thank you.

Yeah, let me take that one on. So First of all, I had a really interesting call with a major city police chief where we were talking about the defunding phenomenon and what happened. And what he related to me was actually they did reassign portions of his budget to other portions of the city. So basically they just shifted some resources out of police to other city agencies. And then his net budget was actually increased fairly significantly for body cameras and transparency tools. So in that respect, he was pleasantly surprised that the whole defunding discussion actually led for their agency to a better place. It allowed them to focus in on their function a bit more, relying on some partner agencies within the city to take a little more of the load and ultimately give them a little more budget for tech. Now, ultimately, you know, we'll see how this plays out in other agencies. But we believe that this idea that right now, law enforcement, they're doing a lot of social services. They're dealing with homeless people and mental health issues because you pick up the phone and you dial 911 for a lot of things that maybe don't need a cop. And so as we think about our dispatch software, what a great time to be introducing a new cloud-based dispatch capability where we can obviously shift our roadmap and be looking at introducing new features. things that would allow agencies to perhaps integrate better with other city agencies that might not traditionally need dispatch-oriented type folks to use some of our communication tools in ways that would allow the dispatchers to dispatch non-sworn officers to different types of events. So we tend to love change as an organization, and times are changing rapidly here, and we view that our DNA sets us up well to move quickly to new opportunities.

That's right. And Joe, I think, you know, how we talked about when we last spoke about, you know, when you think about something like dispatch and you think about something like Axon Aware and building, you know, geolocation and live streaming into our cameras, really being part of a bigger mission for agencies around real-time operations and broadening that lens, this is exactly the perfect scenario for which that is purpose-built. And so even right out of the box, The integration of, you know, Axon Dispatch and Axon Aware bringing together the ability to bring other kinds of resources into an incident in real time is a capability that is just native to our, you know, cloud-borne approach to all of these categories.

Thank you. And just following on that, if I may, is it possible perhaps that we might see an opportunity to deploy Axon Body alongside some of this new dispatch technology with non-sworn community officers or whatever we're going to call them?

Absolutely. We're seeing also not only the ability for non-sworn officers to be able to use cameras, but for sworn officers to be able to live screen with folks like mental health experts that can be helping them in real time dealing with complex situations where those officers might need more expertise. But we actually think this could open up some adjacent areas, particularly if you have unarmed, non-sworn people, your ability to identify emerging dangers becomes even more important because you may have to rapidly route, you know, armed officers to the scene to help out. Thank you.

Great. Thanks so much, Joe. We'll take our next question from Scott Berg at Needham. Go ahead, Scott.

Hi, everyone. Congrats on a great quarter. Thanks for taking a couple questions here. I guess first, I don't know if this is a question for Luke or for Rick, but Rick, in your newsletter, you talk about OSP pipelines in particular strong, including the components for RMS. Now, you just signed a really large contract with Baltimore that includes records. But I guess, what are you seeing on the records level out there, maybe from a demand perspective, that would suggest those OSP7 contracts with records will actually be implemented and utilized? Because that seems really given the commentary, but obviously great if that's the case. Sure. I'll take that.

Josh. No, no.

Or Jeff, if you want to start us off. I'll go ahead and take that. So I love that question. And so again, like we talked about last quarter, we're thrilled that well more than a dozen agencies are already live signed or being actively deployed on records using one or more modules of the product. And we're incredibly confident of the trajectory, as you've seen with the Baltimore announcement. both committed adoptions among OSP customers, as well as continuing interest with the pipeline beyond that, continue to accelerate well ahead of even our expectations. And I think the two key things at play there, like we talked about before, the first is the power of the bundle makes it an easy choice for them to take advantage of that benefit at a perceived value point that goes hand in hand with what they're already paying for because it's effectively, it's already included with the money that they've already committed to. And then second is this key notion that we've talked about of Axon standards, which is this use of force reporting module. And what's beautiful about standards is that it just so happens in records that every agency has to do use of force reporting but they typically use a third-party module for it. They don't actually use their historical RMS. But because standards is built right into Axon Records, it's the perfect first experience that they can use it as an and rather than an or with their legacy RMS to begin getting value out of it right away with incredible easy deployment. And then from there, decide when they're ready to migrate their entire RMS. And that's exactly what happened with Cincinnati and we're seeing that same pattern play out as we go forward because it's incredibly easy to deploy. It works side by side with what they've already got. And then as they come to Lovett, whenever they're ready, they can quickly decide to adopt full records for their entire RMS needs.

Yeah, and specifically on the pipeline, I would say, you know, we are seeing more and more agencies interested in OSP7 plus and we're seeing some acceleration from the agencies that bought OSP 7 Plus last year in adopting our standards module of records, as well as a lot of the other key modules like reporting and so forth. So I'm very confident in our team to be able to convert some of those OSP 7 Plus opportunities into RMS deployments. We're very focused on and we're very focused on making sure that customers are valuing and adopting all of the benefits in OSP 7 Plus. And this is a place where I think certainly the combination of having a very, very strong product organization with a very, very strong channel should lead to outsized results down the road.

Super helpful. Thanks, guys. Then I guess just as a quick follow-up, Jawad, companies posted four straight quarters of greater than 25% revenue growth, which is a nice acceleration from the 12-month period before that. Your guidance calls for 15% revenue growth in the third quarter. Is that just some, you know, being conservative in the current lights and macro environment, or are you seeing anything else that's maybe tempering that guidance just a little bit? Thank you.

Yeah, I'll tag team this, Josh, with you if that's all right. But we have a a plan and operating plan for the year that had informed our guidance. And that's still pretty much informs what we're managing to. We outperformed in Q1 and Q2. We were very happy with the performance of our business and our sales team. The investments we've been making in international has been really paying off some of these new markets, new products, but we don't obviously bank on that. And so, you know, we feel that it's prudent to, stick relatively close to what our operating plan is, which informed the 15% guidance.

Yeah, ultimately there are going to be some quarters that have higher, you know, revenue growth rates than others. And, you know, we feel good about full year. We feel good about kind of our long-term trajectory, but, you know, we do view this year as being back half weighted compared to the front half. And it just might be an issue between what comes in in Q3 and what comes in in Q4.

of our kind of large CW deal pipeline.

Thanks, Tim. And also in the back half, just on a comparables, the percentages are lower, but the nominal dollars much higher. On a comparables, the percentages are lower, but the nominal dollars much higher is what Josh means on that.

Thanks, Scott, for your questions. Okay, we'll turn to Charlie Anderson at Dory. Go ahead, Charlie.

Thanks. So I wanted to ask about bookings. It was very interesting to see the The bookings transit very much reflects what we're seeing in the business in terms of international strong, domestic not as strong. I wonder, is that just a snapshot in time, or is that the way we should think about the trajectory of the business in terms of international continuing to put up the big performance and domestic maybe trailing the performance on a year-over-year basis? And then, secondly, you made a comment in bookings about the first few weeks of the quarter better than April. I wonder if you could just layer in some context in terms of what that means from your standpoint and what's going on there. And then I've got follow-up.

Yeah, thanks. Thanks, Charlie. We've got a lot of domestic salespeople and leaders on the call here that hopefully are motivated by that question. And we certainly expect a great back half from our domestic and international teams. I think there was, you know, if you look back at it, we lost about half the Q2 due to the pandemic shutdown. Everyone was trying to figure out how to conduct like city council meetings and really conduct business on Zoom for the first time. And that certainly slowed down you know, some of our momentum in the first half of Q2. And then really in June, we lost about two weeks due to the kind of civil unrest and the events that followed the killing of George Floyd. So, you know, I would look at Q2 more as just kind of a unique point in time due to some external factors that slowed us down a little domestically. But, you know, we have high expectations of our team and they're very motivated to turn that trend around. in Q2, or I'm sorry, in Q3, both domestically and internationally.

Okay, great. And then a question about the fleet product. There were some points in the shareholder letter about the importance of that product in the back half. So I wonder, you know, we can see what the run rate has been the past few quarters of the existing product. I'm curious if you can maybe help us with expectations for how much of a contributor that is. Does it lift to a meaningfully higher level than we've seen historically. Just any context around that launch would be helpful. Thanks.

So I think from a bookings perspective, we do expect Fleet 3 to be a contributor in the back half of the year. I think there's still some question about shipping Fleet 3 and shipments, depending on how well the T&Es go, might end up in the front half of 2021 as opposed to the back half of 2020. We don't expect that to have much of an impact on revenue. And bookings, like I said, given the fact that we'll be doing T&Es, it'll contribute to bookings that we feel great about. You know, fleet two has really stabilized in the last couple of quarters in terms of, you know, customer satisfaction and so forth. And we're excited to build on that momentum as we launch fleet three, certainly the ALPR and modular capabilities of fleet three, where we can do 360 degree recording around the car and so forth are things our customers are excited about. And we absolutely are confident that, we're going to get a great customer reaction from this product and be followed by bookings and revenue associated with it.

And just to add one clarifying comment there. So we're going to be in some pretty in-depth trials in the back half of this year, but we don't expect to be in full production ramp of fleet three until 2021. And that's where we'll see the real growth contribution.

And the key, you know, Josh mentioned this, you know, with Fleet 3, in addition to it being our best ever in-vehicle camera system, straight up as a camera system, it will also be the launch, as we've said before, of our approach, our pretty disruptive and novel approach to the automatic license plate recognition category in mobile, where fundamentally it's different than the way it's done today in the market by being disruptively more affordable and better designed. more cost effective for better performance and results by making it a thing that departments can put in every single police vehicle, as opposed to a small number of very expensive purpose-built cameras. And of course, no matter how good any one camera is, it can only be in one place. And then you combine that with it being built from the ground up with ethics and privacy in mind, and our strategic partnership with Flock Safety for a similar approach for fixed ALPR cameras, We really think it's a watershed change in the way ALPR as a category will work.

Great. Thank you so much.

Thank you, Charlie. Okay, we'll move to Mark Strauss from J.P. Morgan. Go ahead, Mark.

Thanks, everybody. Thanks for taking our questions. Pretty impressive international growth the last couple quarters. Just kind of curious, what trends you're seeing as far as those customers signing up for recurring payment plans, or are these really just kind of one-off purchases?

Hey, Mark, great to see you again, and thanks for the questions. Hey, Mark, great to see you again, and thanks for the questions. So ultimately, I think it's a combination of a few things. Certainly, as we open up new international markets, those first-time orders are probably not going to be on recurring payment plans. That's due to You know, we want to make sure we have the ability to collect on all these plans. And when we enter markets for the first time, we'd like to see some payment history there first. So those will be kind of one-time contributors to revenue. And we expect those to continue from newer markets as well as markets making their second and third buys in their taser programs. The teams have done an awesome job, especially in the U.K., And in Canada, driving most of our new deals towards subscriptions. In the UK, I believe almost every or every department is already on a taser payment plan as opposed to one-time purchases. I think we'll see more of that in Australia over the next 12 months as T7 starts to get legs there. And same in Canada. And so I think in our more established international markets, we'll definitely see more recurring payments on CWs and video alike. And in our newer kind of first and second time buyer type markets, those will be driven by more one-time revenue transactions there as we ship those new weapons.

Okay. Thanks, Josh. And then Rick, this is the highest cash balance that you've had in a long time, maybe ever. Can you just talk about your plans for that cash? I mean, obviously there's a lot of organic investments that you've been talking about for the last several quarters, but you know, how should we think about M&A? How important is that going to be going forward now with this cash truant that you have?

Yeah, I got it. I can't help but smile. You know, I remember the days when we were struggling to pay the light bill and putting stuff on credit cards, and now we've got almost $700 million in cash. I would also say that Historically, as you know, I'm a skeptic on M&A that I think I'm a Chicago school guy. Markets are pretty efficient. M&A, a lot of times, you know, it always drives up the price of the acquired frequently to the detriment of the acquirer. And we still approach M&A from that position that it has to be unquestionably more valuable as a part of our ecosystem than as a standalone in order for an acquisition to make sense for all the headaches that come with integrating different companies. That being said, I think we are in a unique position where we have built and we now have this fairly ubiquitous cloud software and connected hardware ecosystem that make things like partnerships, flock, safety become essential. you know, pretty, pretty powerful as well as we are really building out our M&A function. It's actually under Andrea James, who's doing a fantastic job. We've been building out a team, but either we get a ton of inbound inquiries and the vast majority of the time we say no, because we are on a mission. We've got a lot of focus, but we are starting to see there are things that will be interesting partnerships, and there are some things that could be interesting acquisitions. And, you know, we have plenty of cash to have the flexibility to do it when it makes sense. But I just want to reassure you, we start from the position of no, and that we have to overcome some pretty skeptical hurdles before we're going to spend the money you, our shareholders, gave us. We're going to treat it very carefully, as if it's the same money I was using to pay those light bills 25 years ago. Good. Thank you.

Thanks, Mark, for the questions. Thanks, Rick. All right. We'll take our next question from Jeremy Hamblin with Craig Hallam now. Thanks, Jeremy. Go ahead.

Thanks, Andrea. So my question is actually a follow-up really on that cash balance and what you potentially could do with it. You know, you've built some inventory here. You have some clients that may be strapped. A little bit in the near term on cash flow, do you use some of that cash to potentially do kind of taser 60 type financing here where we look to bridge the gap in the near term while there may be some budget crunch and that's one of the uses of cash?

Yeah, I'll start with this one. One of the things I love about our cash balance and our position, our balance sheet, is the optionality it provides us. And Jeremy, you've honed in on a couple of things that we've been able to do with that optionality. One is, of course, the inventory bill. It was a material amount of cash in the quarter, and we felt like it was the right thing to do. It positions us really well to be able to deliver the much-needed products for our customers in the back half of the year and beyond. And then on the payment plans for customers in the back half of the year and beyond, And then on the payment plans, which you touched upon, Josh first brought this up when the coronavirus really started becoming problematic for our customers. There were concerns about budgets. And we talked about, hey, look, we're signing up multi-year contracts with our customers. We have longstanding relationships with them. We're going to have relationships with them that will extend far beyond the coronavirus. And so we want to make sure that we're doing right by them. And it's easier for us to get flexible on payment terms to help bridge them to a time when they are no longer, they don't have concerns about budget. And so when you have five, 10 year contracts, you can get creative and that's what we've done. It's been fairly, on a smaller scale, it's been fairly negligible across the entire portfolio of contracts, but it is something that we've offered in select cases.

Yeah, I would just add to that and say like, ultimately, While there have been some data points to suggest individual customers asking for kind of a rework of their accounts receivable, it hasn't been very widespread. I personally attribute this to the fact that we have customers that are paying for value that we are delivering across our product lines. And we haven't seen any of these kind of asks like to push payments out multiple years or to not pay us anything for the next couple of years. I think ultimately our customers are seeing value in what we're delivering, and we're very honored to continue to provide that value to this market. And only in very kind of edge cases have we had to entertain situations like that.

Great. And then just a follow-up question here on your progress on federal contracts. In terms of thinking about the negotiations in those contracts, the tenure of the contracts, are you seeing them extend longer when you're having discussions? You know, it's still somewhat early in the ramp of that channel of business. Are they looking to start shorter contracts and see how it goes and then get into some longer deals? Just any call you can share on progression there.

Sure thing. So a gentleman by the name of Richard Coleman has just done a fantastic job over the last couple of years building up our federal pipeline. And for the first time, we are seeing customers willing to engage in multi-year engagements with us on both body cameras, but also on the taser side. So again, We're very excited. There are you know, it's not always easy to get federal customers to buy hardware in kind of annual phases as opposed to one time purchases. So we're learning a little there. And, you know, there is some of that. But other federal agencies are heavily engaged in these five year projects. plans for both weapons and video. You know, federal takes time. It's a slog, but for the first time in really 10 years here, I feel like we're starting to break through and crack the code of how to work with federal customers, and that's largely due to Richard's contributions, and hopefully we start to see a lot of that growth materialize over the next couple years here. Thanks, guys. Good work.

Good to be back on this one.

Thanks, guys.

Welcome back, Jeremy. Good to see you.

We want to get through to at least, I think, four more analysts, so we'll keep this going here. Jonathan Ho from William Blair. Go ahead, Jonathan.

Can you hear me okay? Great. So just relative to, I guess, the current budget environment, are you seeing traditional RFP processes perhaps start to stall and up some more opportunities for you to disrupt the traditional, I guess, RFP-driven acquisition process for RMSCAT?

Yeah, great question, John. And I think ultimately I haven't seen a huge change in procurement methods. I think some agencies still are issuing RFPs, others are issuing sole sources, and others are issuing more like cooperative procurements or piggybacking off of other contracts that are already in place. And so I'm not sure a ton has changed there. I think the big thing for us is to focus on OSP seven plus adoption, because in that event, the customer is already essentially getting the opportunity to deploy our RMS in that bundle. And so the more we drive up OSP7 plus procurements, the more agencies are exposed to kind of our enterprise software before they make a formal buying decision. And so that's kind of how we're looking at things in terms of CAD and RMS. And I think that strategy is paying off and we're seeing a lot of interest in in those products via that, that purchasing mechanism. And certainly every day that goes by, we're also getting closer to being ready to compete every day that goes by. We're also getting closer to being ready to compete in, you know, RFPs for CAD and RMS to see Baltimore issued an RFI for RMS. And we were victorious over some competitors that we have a lot of respect for in this market. So we're excited about where this business is going.

Got it. And then just one for Jawad, in terms of the decision to increase inventory, can you maybe give us a little bit more color in terms of what types of components you had concerns around and maybe what risks you're seeing around the supply chain? Thank you.

Maybe I'd lead off on that and then Jawad could add some additional context. So as we looked at really our kind of next six to 12 months based on our previous with really adjusting for tariffs, we wanted to make sure that we were going to be able to supply our customers with key products for two major upgrades, AB3 as well as Taser 7. And so we made the decision to add additional inventory to ensure that we would have product on hand for those in addition to making sure that we would have a good buffer for any potential supply chain disruptions due to COVID. We also have a couple really, really big orders coming in Q3 that are kind of outside the context of our normal inventory build. I would let you know the majority of that inventory is going into finished goods, which is something that me and Josh Isner feel really strongly about. If we can build it up into a finished product, we're going to find a home for it.

Yeah, and the only other thing I'd add from a financial standpoint, this doesn't happen often, but there have been times when we've left revenue on the table at the end of a quarter because we didn't have inventory. And that's not a great thing to have happen, especially when you've got the flexibility with our balance sheet to be able to have a bit of an inventory buffer. And so that's what we've committed to. In addition to the factors that Luke mentioned, we never want to be in a position where we leave revenue on the table.

Thanks, guys. Take a question now from Will Power at Baird. Go ahead, Will.

Okay, great. Thanks. You know, Rick, you suggested that it doesn't sound like we're seeing too much of a negative impact from some of the police defunding initiatives today. But I wonder if you could comment, now that we're in the back half of the year, on some of the early discussions with respect to municipal budgets, agency budgets for 2021. You know, what's your sense for, you know, their expectations and how that could potentially flow through the

Yeah, you know, I'm actually going to hand back to Josh because I think Josh is a little closer to the budgeting side of things. Josh, you want to take that one?

Yeah, sure. So I appreciate the question. I think there has been some reaction from some customers in this regard, right? Like if you're a major city that relies heavily on tourism, then certainly that's going to have an impact on how you think about budgeting for the next year. The good news here, though, is that customers are viewing our products as mission-critical products. Customers, there's no willingness to not outfit police with tasers or body cams. And, of course, computer-aided dispatch and RMS are also in that bucket. So I think there is some impact to budgets overall. But when you kind of look at it in terms of is there impact to the budgets that then impacts the products that customers buy from us, I'd say that's a lot less of the case.

Yeah. And I would just add another point there. I think if you look at our business, maybe, you know, 10 years ago or even eight years ago, we were really dependent on, you know, one core market, our domestic market with one core product. And today we've got, you know, a lot of diversification, not only in our product lines, but also in are geographical and even different market segments. And so as we see some puts and takes in different segments or products, we are seeing the evidence with international and some of these early other segments, we still feel really confident there.

Okay, that's good to hear. I guess just a quick follow-up question, maybe circling back to international, given the strength you've had the last couple of quarters, Any comments you can make with respect to, you know, pipeline from here? I'm guessing a lot of those deals you announced this quarter last were the pipeline prior to COVID. How much has COVID impacted your ability to sell there? How does that then look over the next, you know, several quarters?

Yeah, thanks a lot. So, you know, there is going to be some lumpiness in international quarter to quarter, but on a year by year basis, we still expect, you know, very encouraging double digit growth out of our international revenue. COVID, it's impacted our ability to travel, but in most of our key markets now, we've got teams on the ground. So in most of our key markets now, we've got teams on the ground. So it's not like folks are having to travel on planes region to region. We do have teams built out in a lot of key places and distributors supporting us in a lot of key places. So Ultimately, the work that's gone into international started three, four years ago. And so the things that are impacting the quarter results, these are things that teams have been working on for quarters and quarters already. So, you know, I would expect there's going to be some lumpiness, you know, in revenue quarter to quarter internationally. But, you know, I do have a lot of confidence that we're trending in a very, very strong direction, both in terms of bookings and revenue internationally.

Great. Thank you.

Thank you. Will, we were admiring your collection of phones in the background there. We'll take our next question from Brian Jaswali at Raymond James. Go ahead, Brian.

Thanks, Andrea. Just wanted to ask a question on the net retention rate, which was a really good metric up 119% of net dollars. And you maybe provide a little bit of color on how we might think of that between additional seats versus additional functionality that drives incremental R2 and how we might want to think about that mix as we move forward.

Yeah, I'll start with that one. So that's a metric that we wanted to introduce for some time now. It's something we've been tracking for a while and we felt confident that you have enough data and enough sort of history there to be able to start to publish it. And we feel very confident that number will hopefully tick up over time. It's a dollar retention. It's not a user retention. And so as we sign more OSP 7 and 7 Plus contracts, which are, of course, at a much higher ARPU, that number will start to tick up. We, at this point, don't disclose ARPU because there's a lot of noise in that number, certainly between domestic and international. But even within domestic, we have different customers at different stages, so we're not yet ready to disclose the ARPU number Does that help, Brian? Is that what you're looking for?

Yeah, that's perfect. Maybe just to follow up a little bit, I wanted to just kind of revisit the gross margin kind of assumption for the third quarter. And I know you're not going beyond that, but how might we think about the duration of these headwinds that you mentioned? I'm sure they're not all on a similar rhythm, but how might we think they lift over time?

Yeah, our expectation is that the one that we mentioned specifically for Q3 will be resolved within Q3. There may be a little bit of spillover into Q4, but it'll be on an order of magnitude of a couple of weeks. It's not going to materially impact Q4. And so at this point, our best sort of outlook there is that it's going to be resolved within Q3. And then there are other I wouldn't necessarily call them a headwind, but we're still working very hard to get our gross margins up in the hardware business. That's something that, you know, obviously the more software we bring online, that business is printing at 80% plus gross margin. So as more of our business shifts to software, our gross margins will lift there naturally.

Thank you. Thanks, Brian. Okay, Andrew Arkwitz. With Oppenheimer, we'll take your question next.

Great. Thank you, guys. I appreciate the time. Could you help me understand that based on our research, many of your RMS wins are more similar to the module, similar to what I think Jeff mentioned with Baltimore with the use of force. I assume the expectation is this will lead to kind of a rip and replace for the entire system. So, one, am I thinking about this correctly? And then, two, how does the accounting – pricing work over the life of a contract for a city that goes this route. And then lastly, kind of in that context, Baltimore signed an OSP7 contract a year ago, and then they just recently announced that RMS module. Does that contract get reset? Does it get extended when something like that happens? Does ASP go up at that point? Could you talk a little bit about the accounting and dynamics of when that happens? Thank you.

I'll lead off overall and then let the other guys chime in. So first on the product point, like we said, we're seeing a great pipeline of both committed existing commitments as well as the pipeline from here, both for full records deployments, meaning the full replace of their legacy RMS. as well as standards, which is that first module. And so, for example, just Baltimore, since they've already made it public, that's a commitment to move to records in its entirety and to fully replace their legacy RMS. And we're seeing we are ahead of our expectations to see RMS. And we're seeing we are ahead of our expectations on the pipeline there, as well as, of course, a larger number of the standards ones. So we're seeing success on both. And again, ultimately, our goal, and we're confident that this outcome is that we're ultimately going to be on track to become the number one in this category for full records. And standards is just a great part of the path to get there because it's such an easy first step for a given agency to take. And then I'll let Dwight give more color, but fundamentally on the accounting, again, specifically with regard to OSP7+. it is part of this overall, you know, primification of the way that public safety buys this technology, where just like for a subscription service like that, where you are buying a thing that has many benefits to it, you are buying a thing that has many benefits to it, regardless of whether and when you choose to adopt any given benefit.

Yeah, and then as far as how the accounting works, the revenue recognition, so we allocate a portion of the overall bundle to records, and that portion we start recognizing once the customer's gone live. And, you know, let me stop there. Is that what you're looking for?

Yeah, I think so. And does the contract reset then? You know, so like Baltimore signed for OSP7, were they paying $199 a year ago, or were they paying less than that? And now that they're rolling out RMS... Now they're moving up to that full price. And because they kicked that in there, does that reset the contract where now it's five years from now as opposed to five years from a year ago?

So the price they paid last year is the same they paid this year with a couple notable exceptions. The first of which is the professional services to deploy RMS is a separate contract. So once they're ready to deploy, they would pay us for the professional services. The second one is they're going to add or they have added some more users because, you know, the OSP 7 plus often covers sworn officers that are carrying body cams and tasers. But ultimately, they're going to need more users to to, you know, administer a lot of the elements of an RMS system and. see that data and work with reports and so forth. So we do expect some user uptick as agencies start to deploy RMS. The third one is in Baltimore's case, they actually did extend their contract as well to co-turn with some of their other items they have with us and I think they extended out a couple of years as part of that. So those are all dynamics that we expect to see. But I think the most important thing is we're betting on ourselves to be able to upsell additional new features outside of OSP 7 Plus to agencies that are deploying our RMS. So transcription is a great example of this. And Baltimore paid us additional monies per user to deploy transcription as part of their RMS service. For us, you know, I think we do envision some of these kind of value added features on top of the OSP7 deliverables as, you know, upsell opportunities as agencies deploy RMS.

Got it. Thank you guys so much. I appreciate that.

Love the foosball table as well. My favorite.

All right. And we're going to go a little over. Thanks, guys, for your patience. We'll take our next question. It might be our final question from Pawan Kumar from Northland.

Hi, guys. Can you hear me? Yes.

We can hear you. Can't see you, but we can hear you.

Yeah, I disabled my video because I'm having some internet connectivity issue. Thanks for taking my questions. Regarding R&D and SG&A spending as a percentage of revenue in second half and 21, which areas of products would get most focus?

Yeah, I'll start with that, Jeff, if you'd like to weigh in. So right now, the majority of our R&D is being spent on software. We're very excited about what we've got in the pipeline from a software standpoint. As you saw quarter over quarter, our SG&A was actually flat and our R&D grew significantly. And that was very much by design our R&D growth, well-paced revenue growth this year. But at some point, we have long-term targets that we've set of 30% on EBITDA. And the way that we're going to get there is by allowing more of the revenue growth to fall to the bottom line. But overall, the investments we're making in R&D we think are going to help pay off over a long horizon and keep our revenue growth rate above 20%.

Great. And regarding competition, like, who are the competitors we are seeing most on the records team? Who are the competitors we are seeing most on the records team?

Sorry, the question was records competition, if I heard? Yes. Okay. Yeah, I think there are some competitors. Competitors that I would characterize as companies that have been in the records business for a long time, and a lot of them are incumbents, and we have a lot of respect for those companies. We certainly believe kind of our new innovative approach to records will lead to customer adoption in times away from some of those products like we saw in Baltimore. And there are new entrants to the space as well. And ultimately, like, you know, the combination of our channel coupled with the amount of investment and talent we're bringing on on the product side, we think that we're really well positioned for the long term, I think. You know, for the newer competitors, certainly they have more constraints around channel and spend than we might. And for some of the incumbent competitors, they probably have a little more constraint around, you know, servicing existing customers as opposed to really innovating quickly. And so we view ourselves as a really disruptive entrant into this market. And we're very hopeful that we can become the market leader in due time here.

Yeah, that's right. I mean, I think first, you know, we always like to say that we obsess first and foremost about our customers. You know, we're happy to have our competitors obsess about us, but we like to focus on the customer. But exactly as Josh said, you know, overall, both the legacy providers as well as some of the new ones, Axon just has a pretty unique combination of assets that makes us different. both in the legacy incumbents and the newer startups, because the legacy incumbents are simply not cloud-first and born in the cloud, and you fundamentally can't deliver the kinds of results that the departments of today and tomorrow need without being born in the cloud. And on the other hand, the newer startups simply don't have the network of sensors and signals that are connected into the services that can also do the same thing. We're really the only company that has that combination of both, which is why we're so excited about where we're ultimately going to deliver for customers in this category.

Great. Thank you.

I think that's all of our questions. I'm just looking at all of your screens here. Okay. Let's have Rick close us out.

All right, we're a little over, so let's keep it quick. Thank you, everybody, for joining us. We're confident we'll all look back on 2020 as a time that set in motion the next wave of policing reform and the next leg of growth for Axon. We hope you stay safe, healthy, sane during this period of continued disruption, and we look forward to updating you on our progress against our mission in November. And don't forget to come to Axon Accelerate in a couple weeks, and you'll see a lot more detail on our product roadmap. Thanks, and bye-bye.