Axon Enterprise Inc (AXON) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the TASER International Inc. Fourth Quarter 2016 Earnings Conference Call.

(Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to our host for today, Luke Larson, President. You may begin.

Thank you, and good afternoon to everyone. Welcome to TASER International's Fourth Quarter 2016 Earnings Conference Call. Before we get started, I'm going to turn the call over to Arvind Bobra, our Director of Finance, to read the safe harbor statement.

Thank you, Luke. This call is being broadcast on the Internet and is available on the Investor Relations section of the TASER International website. Please note that the earnings press release as well as supplemental materials, including our key operating metrics, are available on our website. Today, we will open the call with prepared remarks. We will follow the prepared remarks with our standard live question-and-answer session.

Statements made on today's call will include forward-looking statements, including statements regarding our expectations, beliefs, intentions or strategies regarding the forward-looking statements around projected spending. We intend that such forward-looking statements be subject to the safe harbor provided by the Private Securities Litigation Reform Act of 1995.

The forward-looking information is based upon current information and expectations regarding TASER International. These estimates and statements speak only as of the date on which they are made, are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. All forward-looking statements that are made on today's call are subject to the risks and uncertainties that could cause our actual results to differ materially. These risks are discussed in our press release we issued today and in greater detail on our annual reports on Form 10-K and quarterly reports on Form 10-Q under the caption, Risk Factors. You may find these filings as well as our other SEC filings on our website at www.taser.com.

With that, I will now hand the call over to Rick Smith, our CEO and founder.

Great. Thank you, Arvind, and good afternoon to everyone. Before we begin, I'd like to share some news on the TASER team. As we announced last quarter, Dan Behrendt, our CFO, will be transitioning out of TASER after filing the company's 10-K for 2016. On January 31, Dan was hit by a vehicle while he was cycling. And following the accident, he was hospitalized for an extended period of time. Since the event, Dan has not been able to act in his CFO capacity and he will likely not be returning. We are thankful that he has now been released from the hospital, and he is now recuperating at home and is expected to make a full recovery. Dan has been a colleague and a friend for 12 years, and we wish him a speedy recovery and success in his future endeavors.

We are in active negotiations with a strong candidate and look forward to announcing the appointment of a new CFO in the coming weeks. In the interim, [Marie Masenga], our Controller, has been acting as Principal Financial Officer. Marie and Arvind, along with the entire finance team, are doing a wonderful job in ensuring a seamless transition. And that's in reference to Arvind Bobra, our Director of Finance.

And now turning to our business. Our fourth quarter represented a really strong finish to a tremendous year. In 2016, we booked $254 million on our Axon platform, an increase of 88% over the prior year. We now have over half of the major U.S. city police departments on the Axon network. We grew our Weapons business by 25% over 2015, shipping nearly 130,000 weapons and 2 million cartridges to our customers. We launched two new industry-leading cameras, the Axon Body 2 and the Axon Flex 2.

We also began rolling out our in-car camera, Axon Fleet. Fleet trials are currently underway with several agencies, and we have already received notice we've been awarded several contracts. Customer feedback has been very positive particularly around the simple cloud-based workflows and instantaneous upload of critical incident videos. In the past few months, we have won major body camera contracts with our first three state patrols, which we believe was enabled knowing that we have a compatible in-car solution coming to market. We have multiple state patrol field trials going on currently, and we expect accelerating momentum in this important market segment in 2017.

In addition to our extended market share gains in the U.S., in 2016, we expanded our presence in our Tier 1 international markets. We announced significant Axon bookings in the U.K., including the London Met, South Wales and West Mercia; and in Australia, including Queensland and the Northern Territory. We're excited to end the year with record quarterly revenue for our international business, and international accounted for 23% of total revenue in the recent period.

Our focus throughout 2016 was on continuing to scale the Axon platform and enhance the industry-leading ecosystem, as evidenced by our new product and future releases. We are continuing that momentum in 2017. We just announced the new Signal Sidearm yesterday, the first wireless sensor to alert Axon cameras when a firearm is removed from an officer's holster.

Signal Sidearm is a seamless add-on that works with the majority of holsters in use today and offers high reliability and maintainability with a battery life of around one and a half years. It is a strategic addition to our ecosystem, adding an important capability to sense firearm draws. And we do expect Axon Signal to have a high attachment rate with our cameras and to have solid gross margin contribution. We will continue to develop and launch new sensors and devices to round out our offering and drive adoption and usage of the Axon platform applications.

Earlier this month, we announced the acquisition of two industry-leading teams in artificial intelligence, Dextro and Misfit's computer vision group. In doing so, we are moving forward aggressively with the implementation of AI technology to help our customers make use of all the data that they are recording while significantly reducing their workload.

As many of you know, our Axon platform was based on the concept of a network of people, devices and apps that collect, analyze and put data to use. AI represents the next step in harnessing the power of this data.

To build a world-class AI platform in a specific space, you need three elements, one, access to lots of data for your specific problem; two, access to users for training the system on how to interpret the data; and three, the right machine learning expertise to research tailored deep-learning models and engineer the machine learning infrastructure. All three are critical, and we now have achieved a uniquely powerful combination of these three elements. We have the largest community of users in public safety with over half the major cities and over 100,000 users.

Evidence.com now secures over 6 million gigabytes -- or 6 petabytes of law enforcement video data, and it's growing along an exponential curve. And now through the acquisitions of Misfit and Dextro, we now have state-of-the-art machine learning pipelines and a world-class team of experts dedicated to acquiring artificial intelligence in law enforcement. These two strategic investments will highly differentiate our offering in a way that no one else can deliver and can create a highly defensible platform that will continue to pull further ahead of our competition. Additionally, we do expect AI-related services will create entirely new lines of revenue-generating business.

Our company's advantages in AI aren't just somewhat better than our competitors. It's structurally superior. All systematic incentives for progress in AI, for us, are aligned towards deepening our market lead in users, which means deepening our market dominance in data, which means deepening our market lead in AI.

Our initial focus will be around redaction in video, which is a very repetitive and time-consuming process for officers today. With our existing Axon capabilities, we have been able to reduce the time it takes to redact one hour of video in half, from eight hours using other solutions to four hours using our solution today. We expect to reduce that time from four hours down to just 90 minutes by the end of this year with our new AI feed and capabilities. This will represent a huge savings in time and resources. And within the next five years, we believe that number could drop to zero as AI does all of the work without requiring any human interaction.

It's application of technology like this through our Axon platform that will automate data gathering and records management, freeing up officers to focus on the human element of policing so that they can spend their time interacting with the community. We're really quite excited about AI -- how AI fits in with this vision, and we look forward to updating you on our progress.

We will hold our second annual User Conference in June, where we help our customers learn how to better utilize and deploy the cutting-edge technologies available on the Axon platform. At the conference, we will also unveil our records management product and share more on the value our RMS product would bring to customers compared to the current options.

Today, officers around the world spend about two-thirds of their time on data entry and paperwork and only one-third of their time doing actual police work. We now know based on the extensive field experience we have that body cameras record far richer and far better information than the handwritten forms of yesterday. All the information needed for police reports can be easily captured in the audio/video record from our ecosystem of cameras and sensors. The only information not captured are the perceptions of the individual officer, which frankly can be more easily dictated to the video after the incident than being painstakingly typed on a keyboard.

The remaining challenge for us is to extract this information into a searchable format that can be utilized to transform the business processes, reviews and the prosecution and litigation processes that currently run on text data. This is where our ecosystem of devices, software and users, now powered by AI, will be a game changer. Our AI tools will extract the information for the police record system. And in the future that we are building, records will be recorded, not written.

The value proposition for our customers is enormous. We can free up to two-thirds of their time their officers spend on tedious data entry. This will be akin to tripling their force of police officers on the street. And all the while, the back-end data will be far richer, qualitatively, similar to the archive of televised sporting events, as compared to the newspaper accounts that predated televised recordings. As you can tell, we are incredibly excited about the market opportunity for RMS in conjunction with our sensors, cloud and AI capabilities.

In summary, the long-term outlook for the business is stronger than it's ever been. In the fourth quarter, we booked orders of over $130 million across both our Axon and our Weapons business segments. Continuing to execute at this pace would drive GAAP revenue over $500 million per year in the next three to five years, roughly doubling the business. However, the investments that we have made and are making are not intended to simply maintain our current revenue bookings rate. We see opportunities for significant continued growth from here.

As one example, we've looked at some of the early Axon Fleet orders, and the revenue per user over contract term roughly doubles when agencies add Fleet to their body camera program. Now that's for agencies that have a vehicle for every officer. We're just now starting to see our international investments really contribute to Axon bookings, which we believe can scale to a size similar to our U.S. business, if not larger. With Fleet, international growth, plus the Records Management System and Axon AI, we now have visibility to a $1 billion annual run rate business, predicated, of course, on continuing our strong execution.

After we've onboarded our new CFO, we plan to hold an investor event and provide you all with an update on our long-term business model, financial outlook and strategic vision. We're on a truly exciting trajectory from 2016 going into 2017, executing across the organization and adding the right people and resources. We will maintain discipline in our investments and our quest to transform public safety through technology while building a highly defensible and profitable business for our shareholders.

I'll now hand over to Luke to take us through an operational update.

Thanks, Rick. We had an exceptionally strong fourth quarter and full year 2016, and I am proud to share the highlights of our accomplishment. Revenues came in very strong at $82.1 million with international sales contributing $18.6 million to the total. Our other key metrics also showed continued strength within the quarter. Bookings on our Axon platform were a record $72.5 million in the fourth quarter, an increase of 62% compared to the fourth quarter of 2015 and up 26% sequentially from the third quarter. It is important to note this number exceeded the bookings of Q2, which included the very large LAPD order, yet without any similar singular large event. We see the achievement of this milestone without any outliers as strong evidence of the general momentum of this business unit.

Annual recurring revenue in the fourth quarter was $40.2 million, an increase of 26% from the third quarter as we converted over 17,000 seats to paid seats. In the fourth quarter, we booked approximately 21,400 incremental new seats on our Axon platform. That brings our cumulative total booked seats to 132,000 since inception and represents 19% growth sequentially.

Operating income in the TASER Weapons segment was 36.1% in the fourth quarter of 2016, down from 38% in the third quarter. The slight decrease was driven by higher research and development expense as well as end of the year physical inventory adjustments.

The last metric, the ratio of lifetime value of a customer to the customer acquisition cost in the third quarter, was 6x, up from 4.9x in the prior quarter on higher bookings. We view this ratio as one of the key operating metrics used by management to evaluate the effectiveness and validation of our strategy as we invest in the customer acquisition. It should be noted that this ratio is calculated only including current product at current price level. We believe the true value of each customer will be significantly higher as we are able to add premium service tiers and new products, such as our RMS, Fleet in-car systems and AI-based offerings. Together, we see these offerings more than doubling the potential value of each customer seat.

We had several notable bookings in Q4 as we continue to consolidate the market. Louisiana State Police went with full deployment on the Axon platform on our unlimited plan for all officers. Other notable Q4 wins included Seattle, Winston-Salem, Garland and Chattanooga PDs.

We're excited with the pace of innovation at TASER. We're not satisfied with just maintaining our position as the leading provider. Instead, we are pushing the bounds of technology applications for our law enforcement to truly deliver on our vision of an end-to-end experience. As Rick noted, we're extending product lines and developing future revenue streams, including Fleet, RMS and artificial intelligence offering.

With nearly two patrol cars for every three officers and the increasingly positive feedback from our trials, we see the Axon Fleet in-car camera as a tremendous opportunity to extend our capabilities. Investment in Records Management System, the central technology hub of public safety, we believe, is the best way to expand our current offerings from the Axon platform.

As we mentioned on our last call, we estimate the addressable market for RMS is nearly double the size of our current offerings on the Axon platform. We expect to start shipping full Fleet deployments beginning in the second quarter of 2017, and we will unveil our RMS product at our Axon Accelerate User Conference in June.

I'll now move on to the discussion of financial results, which I will be reviewing this quarter. Revenue in the fourth quarter was $82.1 million, a 46% increase from the prior year and our third consecutive quarter of record revenue. The increase was driven by a 154% increase in the Axon segment revenue and a 25% increase in Weapons segment revenue. The $14.4 million year-over-year increase in Axon segment revenue was driven by a 167% increase in hardware revenue as we shipped over 28,000 cameras in the quarter, a 140% increase on our Axon service revenue. We continue to add users to the Axon platform and ended the year with almost 95,000 active paid licenses on our Axon platform. The fourth quarter also included $1.5 million in catch-up service revenue previously held due to the delay in meeting contractual terms or milestones.

The $11.6 million year-over-year increase in Weapons segment revenue was nearly evenly split between international and domestic revenue growth. Internationally, Weapons segment revenue growth was driven primarily by our focus on our Tier 1 markets. Domestic growth was driven by our TASER 60 and officer safety payment plan, the continued success of our telesales team servicing the long tail of the market and demand for a full deployment into existing customers. TASER 60 continues to resonate well with customers, representing approximately 20% of unit volume in Q4, and we expect this percentage to increase in 2017. We continue to drive customers to our TASER 60 and officer safety payment plan to help drive full deployment and shorten the upgrade cycle.

Total international revenues in the fourth quarter increased 53% from the prior year to a record $18.6 million. The growth was primarily driven by an increase in TASER Weapons and cartridges, with approximately 80% of international revenue coming from our TASER Weapons segment. We continue to have strong momentum in the Axon bookings in our target international markets.

As we've discussed previously, due to the seasonal procurement patterns and the typical size of international orders, we expect to see some revenue lumpiness from quarter to quarter in the international part of our business. For the full year, total revenue increased 35.6% to a record $268.2 million, driven by a 25% increase in our Weapons segment and an 85% increase in our Axon segment. This growth rate significantly exceeded our internal expectations, and we're really proud of these results.

Annual recurring revenue, which excludes the impact of a onetime catch-up revenue at the end of fourth quarter, was $40.2 million, representing a 26% or $8.2 million growth sequentially. We expect to see relatively consistent growth in ARR through 2017 as we add users to the Axon platform.

We are experiencing some initial backlog on our new Axon Flex 2 camera as we ramp up capacity to meet demand. Our backlog on the Flex 2 is currently approximately 9,000 units. As a reminder, we began recognition of service revenue in the month following the shipment of the camera. We are actively working through this backlog and expect to clear it in Q2.

Bookings of $72.5 million were also record for the company, up 62% from the prior year and 26% from the third quarter. This exceeds our prior record of $72 million in Q2, which included $20.5 million in the LAPD booking. The largest booking this quarter was $5.3 million, showing broader body camera adoption across all agencies. International bookings were still less than 10% of total bookings but are expected to contribute more meaningfully to bookings in 2017. Domestically, our bookings pipeline remains very strong, and we expect Fleet bookings to begin to contribute incrementally as well.

Total deferred revenue increased by $7.9 million sequentially to $85.2 million. As a reminder, over 80% of our Axon contracts include the TASER Assurance Plan feature, under which customers prepay for their future camera upgrades. Axon hardware deferred revenue, or customer prepayments for future camera and dock upgrades, represent $21.1 million of the total deferred revenue balance. These future hardware upgrades will have a lower implied discount than the initial camera purchase and, as such, will flow through the P&L at a higher average selling price.

Gross margins in the fourth quarter were 60.6% on a consolidated basis due primarily to a significant decrease in Axon segment hardware gross margin. This decrease was driven largely by nonrecurring items, including inventory write-downs related to the end of life of Flex 1 and year-end inventory adjustment. We expect Axon hardware gross margins to increase back to the 25% level we first -- we saw in the first half of 2016, but we can still have some quarterly fluctuations based on the customer mix. Longer term, we see the opportunity for the Axon segment hardware margins in the 50% range as service plan upgrades start to kick in.

Sales, general and administrative expenses increased to $30.7 million compared to $21.9 million in the prior year period. This increase was due primarily to increased headcount, variable compensation, legal expense and professional fees. In the fourth quarter, we also had $600,000 of CFO severance cost, and we will have another $900,000 of CFO severance cost in the first quarter of 2017. R&D expenses increased to $9.6 million compared to $6.6 million in the prior year. The increase is driven primarily by increased headcount in our Axon segment and higher professional fees.

Due to the strong momentum in our business, we elected to increase spend in areas where we expect to generate superior levels of return. As a result, our 2016 full year operating expense was $138.7 million. This was above our target range for the full year of $130 million to $132 million, which excluded nonrecurring expenses in Q3 of approximately $2 million and the Q4 severance expense of $600,000. As previously noted, we continue to ramp investment levels as we saw the opportunity to drive revenue and bookings levels higher.

Income tax expense in the fourth quarter was $3.2 million for an effective tax rate of 33%. We recognize some favorable R&D tax credit adjustments, which were partially offset by losses in foreign entities which do -- we do not currently expect to receive a tax benefit from. We expect the first quarter effective tax rate to be in the 41% to 44% range.

Turning to 2017. We expect first quarter revenue growth of approximately 25% year-over-year. However, we expect Q1 to be down sequentially due to seasonality around municipal budget cycles. For the full year 2017, we expect year-over-year revenue growth consistent with our stated objective of 15% to 20% growth. We anticipate 4% to 6% sequential increase in operating expenses in 2017 first quarter as we continue to add customer-facing roles, invest in R&D initiatives and expand into new international markets.

Our two areas of R&D investment in 2017 consist of new hardware technology, including the Signal holster we announced yesterday, next-generation Axon Body cameras, Axon Fleet, Records Management System, Axon Artificial Intelligence and continued feature enhancements to our Axon digital evidence management platform.

We are confident that our investments will continue to drive revenue and bookings growth and expand our addressable market over time. We will continue to calibrate our expense level relative to bookings and revenue and carefully assess the return on our spend. We expect to see margin pressure in Q1 2017 with margin improvement sequentially through 2017 as we add users to our Axon platform and continue to make inroads internationally.

Please note that the anticipated sequential increase in Q1 operating expenses is in addition to the expenses relating to our two recent artificial intelligence acquisitions. The combined impact of the two transactions is expected to approximate $6.5 million of incremental R&D expense for the full year, of which $2 million will be noncash amortization expense.

We are now going to move to the Q&A portion of the call.

(Operator Instructions) And our first question comes from Mark Strouse of JPMorgan. Your line is now open.

Dan, if you're listening, best of luck. I wish you a speedy recovery. So guys, I just wanted to talk about the time line for new offerings here. I understand Fleet in 2Q and you'll -- you're going to introduce RMS at the User Conference, but when can we expect RMS and a bigger presence of the AI to be commercially available?

I think those will be -- AI would be late 2017, and RMS would really be 2018 revenue.

Okay, okay. And then with the OpEx, I understand all the color there. Just long term, though, are we still expecting -- I think in the past, you've said that you expect bookings to outpace the growth in OpEx. Is that still your target?

Yes. Just to add a little more color there, specifically, I think it's important to add a little context around the fourth quarter. Majority of the increases relate to our cost structure to support the accelerated growth. So in Q1, we expect a 4% to 6% sequential increase in operating expenses. We're not providing guidance past Q1. And I would just want to reiterate the largest drivers of these costs are going to be towards quota-carrying sales reps as well as engineers developing net new revenue streams for our business.

And I would just add, in general, we believe bookings can continue to outpace or at least match the spend rate. Now again, that may bounce around a little bit quarter to quarter, but we're really keeping a close eye on how we're spending -- how we're investing. So we're building something that, long term, will be very profitable and defensible.

Got it, okay. And then just one more quick one, if I can. Just pricing of EVIDENCE.com, are you seeing any shifts either towards the low end or towards the high end of your pricing scheme? What are we seeing over the last quarter?

Mark, that's a great question. And I think coming out of Q4, there is a lot of questions around pricing pressure in regards to the NYPD deal. And we really pointed analysts to the Seattle deal as a good proxy. I would say the other large deals that we announced on the call today would be kind of in that similar vein as Seattle, and we still feel really confident in the price structure that we have.

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

On the Weapons side, based on the units and the revenue, the implied ASP appears to be very high or -- either that or there was a onetime sort of other piece of revenue that fell in that. Any -- or maybe it's just the way that TASER 60 is recognized. But any sort of commentary on that? It looked like about $6 million of upside either came from higher ASPs or something onetime in nature.

Yes, I would say -- I will just talk to two items there. Approximately 20% of the Q4 deals came in from TASER 60 program, and then we also had a strong international quarter, which is going to have a slightly different ASP than the domestic deal.

Okay. And just to kind of refresh, the TASER 60 revenue is recognized upfront, and it's the cash flows that come ratably over the five years. Is that right?

That's correct except for the warranty. So we recognize the TASER handle and the cartridges that are delivered, and then we spread the warranty out over time, but cash flows do come in like you said.

Okay. On the Axon side, gross margin, as you noted on the hardware side, was basically zero. If you backed out, I guess, if -- could give us a little more color on the onetime issues, whether it's end-of-life inventory adjustments, et cetera? If you back that stuff out, what would gross margin have been sort of versus previous quarters?

That's a great question, Steve. I don't know that I have the number off the top of my head. I would say the biggest two reasons for this kind of deal mix in combination with some inventory write-offs for Flex 1 as well as end-of-year inventory adjustment. We do feel pretty confident that we're going to see margin expansion there, especially the original cameras that are sold in are often discounted and the next camera that comes through will see a higher ASP. So we think that's going to drive up the margin.

Okay. And then we're probably far enough along into the cycle that you're starting to have some Axon deals come up for renewal. Any color around, I guess, renewal rates or sort of the tone you get when you go back sort of for the second -- or for the renewal of that contract?

It's still not a big enough sample size where we're going to give the exact data on it, but that's a great question, Steve, and I would say we feel really, really confident with having a very low churn rate. And actually, we're seeing just a lot of momentum in these kind of bundle deals, with things like OSP and tightening the integration with our TASER line of products with offerings like Signal. And so we feel really, really confident on a low churn rate.

Okay. And then I just want to make sure that I'm clear on the OpEx increase here. It was $40.3 million in the quarter, but that included some severance. And then subsequently, you made a couple of acquisitions. So do -- I mean, should we just think about the $40 million and add 4% to 6% sequentially?

Yes, that's correct.

Okay. And then presumably, that will grow at some level sequentially after that? Or do you feel like you're getting to the point where most of that fast growth is behind you?

Yes, we're not really going to provide annual guidance at this point. We're -- as Rick said, we're still putting together the plans to monetize these acquisitions. And so I think as more information comes to light, we'll communicate that at our User Conference in June and have more information at our investor event that we're going to hold once the CFO joins.

Yes, I would add on that as well. Last year, we provided some expense guidance, but then the business, frankly, grew significantly faster every quarter. The bookings numbers, in particular, were well above what we were expecting. And we were calibrating every quarter to the bookings opportunities in front of us. So we ended up making so many adjustments to the annual number that I think at this point, we felt the most productive approach was to give you some guidance on Q1 and just let you guys know that if we see the opportunity to keep growing the business, we're going to keep making those investments.

But we'll give a -- we'll tend to give a little more color, I think, quarter to quarter based on how we're seeing the business continue to grow. How Fleet gets accepted is going to be really a significant opportunity for us. And that's where some of the investment in the fourth quarter came in, adding the right roles and people to be able to support the whole new implementation of rolling out in-car video and then the international space. So we will continue to calibrate relative to the bookings level.

Okay. One last question from me and I'll hop back in the queue. Inventory was up pretty meaningfully sequentially, almost doubled year-over-year. Anything to read into that? Is that just Gen 2 Axon backlog? Or was there any sort of year-end push or pull around that?

Yes. I'll take that one. We've really been in -- at this point, we think it's most important that we're able to satisfy orders quickly as the bookings have continued to grow. And frankly, earlier in the year, we had some times where we felt we were not providing the right customer experience. And so we strategically made the decision that it made sense for us to ramp up some of our finished goods inventory to make sure that we were able to fulfill demand in a really timely fashion.

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

Two quick questions on my end, the first one being is if you take a look at international bookings, there's still a relatively small part of the total bookings. So what do you need to do on your end to make sure that international bookings become a much larger percentage of the total bookings?

Yes. So we see international as a really big opportunity, and what we really see the opportunity is to have markets where we can sell our full product suite with both TASER, Axon and the service. Today, we see really, really big opportunities in the U.K., Canada and Australia, where I would say we've become kind of the market leader in terms of capturing significant footholds. And we'll continue to drive out full deployments and add offerings there. And then our next big focus is on Continental Europe, and we're in key discussions. Rick has actually spent a lot of time in Europe and might be able to add a little more color on that.

Yes. So again, I think we've now gotten to the point we've got really good momentum in our Tier 1 countries. So some of that required investing ahead, acquiring our former distributor in the U.K. and some of these beachhead accounts. We found sometimes getting into a market that we've got to be more aggressive on pricing to get a foothold, and then we tend to see pricing return to more normal levels as we start to scale up in each market.

So really at this point, what we need to do is just continue to execute really well. We feel great about the team we've got on the field. We spent the last two years really revamping our whole structure, going much more with a direct sales force internationally. Now long term, that can lead to better margins and a more reliable customer relationship. [Now the] downside, what we've seen over the past couple of years, is that you've got to invest in teams of people probably two years ahead of when you start to see meaningful revenue, but we should start to see some -- we think that the Tier 1 markets will become more significant this year, that the bookings are going to really start to become material. And then we should start to see some of what we consider Tier 2 markets start to place some initial orders and start to get some footholds.

Great. And the other question I had was previously, you've talked about the Tier 2 markets. That market opportunity, roughly about $1 billion or so with, I think, over 800,000 officers that you guys talked about previously. From the conversations that you've had with your country managers, particularly in France, what feedback are they giving you right now regarding either the competition from low-price providers that are out there or other reasons why they think that either 2018 or 2019 there could be other things outside of low price solution providers that could serve as headwinds as opposed to what they previously thought?

Yes. I'd say the main thing we've learned globally is we've got to help our customers get to field trials so that they're actually deploying the products in the field. That is where the game changes. When you're buying it off of a -- some arcane bureaucratic purchasing process, that's where you get things -- like late last year, we had a large U.S. order that didn't go our way, and there was no field trial.

So we're really trying to be, frankly, aggressive in educating our customers. You can't buy sophisticated technology with procurement processes that were built 20, 30 years ago for buying belts and holsters and that sort of stuff. So we're really working proactively with our customers to enable field trials both in the U.S. and internationally. I think that's our most powerful weapon. As our head of sales likes to say, our best advocate is a well-educated customer. And we're starting to see some real momentum around that, where we're starting to see a shift in perspective where agencies are starting to do some more field trials.

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

Congratulations on the terrific year and quarter. I wanted to ask a couple of questions about the Weapons side of the business for 2017. You saw 25% growth year-over-year. Can we safely assume that you expect that business, that segment, I should say, to grow in 2017?

We are still expecting growth. 2016 was really a banner year. I think we're still prognosticating double-digit growth. We do see some opportunities where we could see some upside to that, but I would model it or plan on sort of double-digit -- low double-digit growth, not -- it's not clear that we'd be able to replicate the same level of growth we had this year.

No, understood. And just embedded within that, you saw significant acceleration in the second half of the year on your single cartridge sales. In terms of why -- what is driving that, is that really attributable to TASER 60? Is that partly attributable to field usage increasing because you simply have more officers carrying the product?

Yes, Jeremy. That's a great question. I would say it's attributable to three things. You've got our service plans that include TASER 60 and the Officer Safety Program. Overall, the strength in the business, as we're selling more TASERs, we're going to be selling more cartridges. And then we've actually introduced an unlimited cartridge plan as well, where officers can sign up to pay for their cartridges with a predictable line item. And so those kind of three key drivers are why we're seeing the strength.

Okay. And then in terms of just a follow-up on that on the international side, you've obviously seen some success on body cameras. But in terms of the Weapons side of your business, the profitability that you're getting overseas on your Weapons segment, how is that comparing to what you've seen in your U.S. markets in terms of kind of your margin profile?

This is Rick. I'll take that one. I would say generally, international is somewhat favorable to the U.S. in general.

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

A question, I guess, for Luke. The 9,000-unit backlog, I believe it was in the Video segment. Is that -- can you talk about how that's going to flow through as the year progresses?

Yes. So as we mentioned, Glenn, good to talk to you, there is a backlog of 9,000 seats today due to us just launching Flex 2 and making sure we have good quality. In Q1, we expect to clear some of that, but the bulk of it is going to be cleared in Q2.

Okay. So I'm just trying to think about the guidance for 25% sequential revenue growth. Was that -- that was the number, correct? Sorry, 25% year-over-year, right?

Yes. We committed to 15% to 20% for year-over-year for the whole business.

And that's for the whole year. In the first quarter, I think we're projecting 25% revenue growth for Q1. That's over Q1 of 2016.

Right. I guess in order to get there, I mean, Weapons has been so strong in part, I'm guessing, due to the TASER 60 program. You have that kind of a significant down quarter in Weapons, assuming that video is -- I imagine the service business is not going to be down sequentially. Maybe hardware fluctuates a little bit. But I wonder what's the thought process behind the drivers of the Weapons being down so significantly sequentially.

Yes, yes, yes. So seasonality in our business. Q4 is always very, very strong quarter with us. So we believe, year-over-year, Q1 is going to be up from the previous Q1 but not sequentially to Q4, and that's just normal business conditions for our market.

Okay. It just seems a little more severe than in previous years, the sequential -- I mean, perhaps you're being just cautious or maybe there was some driver in Q4 that was stronger than expected.

Yes, Glenn, international in Q4 was a record for us. And so that's also going to drive some of our thinking around what we're communicating for Q1.

Okay, great. And then the -- on the free cash flow, affected this year by the changes in working capital, is that -- are those changes expected to continue to affect free cash flow in 2017? Or do they stabilize here? I'm talking about like inventory and receivables growing.

Arvind, I don't if you want to comment to that.

Well, I would expect free cash flow to be relatively stable. We don't expect working capital to be a significant tie-up in free cash flow for 2017. Of course, we have some long-term receivables driven by our TASER 60 program, which you may see a continued increase in 2017.

And our next question comes from Andrew Uerkwitz of Oppenheimer. Your line is now open.

I'm not sure if you addressed this in the comments before. When you do the dash cameras, you start selling those commercially, what's going to be the accounting treatment for those? Will those be similar to like an Officer Safety Plan? Will it be more TASER 60-like? Could you walk us through the different pieces there? And then additionally, will you package dash camera with Officer Safety or with weapons and introduce a new program?

Yes. So on the accounting, it's going to be very similar to the body cameras, upfront hardware and service, storage, license and then any kind of warranty will spread out over the deal.

And then implementation time for dash cameras, is it -- is that long like the body cameras where we could see an implementation over multiple quarters? Or is it a pretty quick introduction?

No. I think it's going to be similar to the body cameras, where you'll have an agency and they might buy, just for example, several hundreds, but they might roll out that over a couple of quarters.

Got it. And then on RMS, I think, Rick, you mentioned to see that sometime in 2018. Could we start to see like a new product offering overall and how you tackle rolling that out, either discount some of these other programs to get RMS in there? Or how do you see selling that into the end markets once it gets close to being ready?

Yes. At this point, I'd say strategically, we haven't announced anything and probably wouldn't want to give too much color. We're operating in some pretty competitive spaces already with cameras. And certainly RMS, we're a new entrant. So we are certainly looking -- one of these that -- I think if you look at all the new products and services we're talking about, they share two characteristics, one, they increase the value of the ecosystem. They're more valuable as a part of the ecosystem we've already built, and they make the ecosystem what we have more valuable by adding the new service. And each of them are new, profitable -- highly profitable product opportunities. So none of these things are big loss leaders. Each of them will be able to stand on their own from a profitability perspective.

Now in terms of how we end up selling RMS in terms of bundling and what we do with Fleet and the body camera programs, we tend to be very customer-driven, looking at what are the -- what are the hot buttons, frankly, that matter to our customers that make the offers most compelling to them. And one of the examples, if I just sort of look back at history, with body cameras, what we have found in a lot of cases is that customers really appreciate discounts on the hardware upfront. And we've been very successful gaining market share. And I think we're now going to see the benefits of that as we start to get into -- I think in 2018 -- I'm sorry, 2017, we'll start to see the kick in, where customers have gone on this replacement plan. And you're going to see those second and third cameras -- as the hardware goes in, it's going to be much more profitable on the back end because the way we structured our program is really catered to the way our customers -- what they were focused on.

So I guess it's a long-winded way of saying we're not going to give any more color on that right now other than I can tell you we will apply a lot of creativity based on where our customer see values in bundling them together.

Sure, understood, and I appreciate that answer. Last question, as -- you guys have done a great job of kind of penetrating Tier 1 cities. How do you see your sales force size? Is it sized appropriately as you approach Tier 2, Tier 3 and maybe even Tier 4 cities going forward to kind of drive the bookings growth?

Yes, I think overall, we've -- go ahead, Luke.

Yes. I think domestically, we've really built out a strong sales channel where we've got great coverage in all segments of the market. So I would say our sales channel is going to be relatively flat, where we may continue to add additional SG&A cost. It would be on kind of post sales support and implementation, specifically around products like Fleet and RMS. But in terms of our domestic sales force, we feel like we've built just a really strong channel there today, and that should remain relatively flat.

And our final question comes from George Godfrey of C.L. King. Your line is now open.

Just two questions. Arvind, I wasn't clear on the free cash flow from working capital impact in '17. Historically, working capital has been a net contributor. Do you expect it to be a net contributor or a drag on free cash flow?

Working capital in general?

Yes.

It's tough to tell, but it generally should be relatively flat going into '17. We have two kind of offsetting factors that we haven't had historically. We primarily had the prepayments for the hardware upgrade being as a source of cash, but we have that little bit offset by the TASER 60 payment plan. So it really depends on the level of TASER 60 uptake in 2017 that will drive how much working capital we generated.

And then my other question, on the Fleet camera, is the pricing of the service component similar to the body camera? Or is there anything different, depending upon the tier that's chosen?

George, great question. It's going to be similar to the body camera.

Okay. And then just a follow-up on that. You said you already have some orders. So a two-part question. One is, I guess, there -- for some departments, there isn't a concern of overlapping services or cost as such an issue that they still feel the body camera on the officer as well as in the car is something they want. And then the flip side of that is, are you still -- are you having to educate departments on the value of having two cameras? Or are departments continuing to push back, saying, "No, we'll choose one or the other but not both?" Thank you for taking the question.

Yes, let me take that one. I would say a few years ago, I was under the impression that body cameras would obsolete the need for in-car cameras. And it turns out we're dead wrong, particularly for the state patrols. We had zero uptake in the state patrols until this last quarter, and now we won three of them. And we've got a bunch that are going into testing. And the rationale was really that state patrols felt that they really needed the in-car camera.

Frankly, I think some of it -- it's just become so much a part of their operating use case. So this is a qualitative statement. But I would say, in general, what we're finding it's not just the state patrols. Once agencies have gotten used to dash cams, I'd say the vast majority of them want to maintain dash cams even if they add body cameras. And they typically already have pre-existing budgets where they've built it into when they buy a patrol car, they've got budget money there to outfit the car with an in-car camera and to allocate money towards the back end.

And so we -- we certainly aren't having to educate them on the need for both. I would actually say our customers educated us more on their need for both, mainly if they've already had in-car.

Thank you. And ladies and gentlemen, this does conclude our question-and-answer session. I would now like to turn the call back over to Rick Smith for any further remarks.

Great. Well, thanks, everybody. I know it's been a little bit of a long call. We had a lot to talk about. And man, what an exciting year was in 2016. As we've told you, we've been very focused on consolidating the market. I think we made a ton of progress there, and we're really excited to continue that momentum this year and -- with some of the new service offerings, we're bringing out to start to launch some additional revenue streams.

So it's really exciting time to be at TASER. We're delighted to have you as shareholders, and we look forward to seeing you all at our shareholder meeting coming up in May. And with that, I'll wish everyone a good day, and we'll see you all soon.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.