Axon Enterprise Inc (AXON) 2004 Q3 法說會逐字稿

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  • Operator

  • Good day, ladies and gentlemen, and welcome to the third-quarter 2004 TASER International, Inc. conference call.

  • My name is Alicia and I will be your operator.

  • At this time all participants are in a listen-only mode.

  • We will be facilitating a question-and-answer session towards the end of the conference. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded for replay purposes.

  • I would now like to introduce your host for today's call, Mr. Tom Smith, President for TASER International.

  • Please go ahead, sir.

  • Tom Smith - President

  • Good morning.

  • Welcome to the TASER International conference call.

  • We are obviously very excited, very proud of the quarter we are able to report on this morning; another record quarter from a number of different categories that we will get into during the call.

  • I would like to introduce who we have in the room, Phil Smith, the Chairman of the Board;

  • Doug Klint, our General Counsel;

  • Dan Behrendt, our Chief Financial Officer; and Kathleen Hanrahan our Chief Operating Officer.

  • They are all with me here in Scottsdale.

  • Also participating from Europe is Rick Smith, our CEO and co-founder with me; he is at the NATO Advanced Research workshop where they have been talking about tasers quite a bit, and they also had a presentation given today by Rick from Prague, the Czech Republic.

  • We also will have Rick be attending the Jane’s Defense Non-Lethal Weapons Conference tomorrow in Dublin, Ireland, again giving a presentation to the Europeans on where TASER International is in terms of a lot of the research that we've been able to report on in the last several weeks.

  • And with that, I would like to ask Doug Klint to read our Safe Harbor statement.

  • Doug Klint - General Counsel

  • Certain statements contained in this presentation may be deemed to be forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995.

  • And TASER International intents that such forward-looking statements be subject to the Safe Harbor created thereby.

  • Such forward-looking statements relate to expected revenue and earnings growth, estimations regarding the size of our target markets, successful penetration of the law-enforcement market, expansion of product sales to the private security, military and consumer self-defense market, growth expectations for new and existing accounts, expansion of product capability, new product introductions and our business model.

  • We caution that these statements are qualified by important factors that could cause actual results to differ materially from those reflected by the forward-looking statements herein.

  • Such factors include but are not limited to market acceptance of our products, the establishment and expansion of our direct and indirect distribution channels, attracting and retaining the endorsement of key opinion leaders in law-enforcement communities, the level of product technology and price competition for our products, the degree and rate of growth of the markets in which we compete and the company demand for our products, potential delays in international and domestic orders, implementation and risk of manufacturing automation, risks associated with rapid technological change, execution and implementation risk of new technology, new product introduction risk, ramping manufacturing production to meet demand, litigation resulting from alleged product-related injuries, media publicity concerning allegations of deaths occurring after use of the TASER device, and the negative impact this could have on sales, product quality risks, potential fluctuations in quarterly operating results, competition, financial and budgetary constraints of prospects and customers, dependence on sole limited source suppliers, fluctuations in component pricing, risk to governmental regulations, dependence upon key employees, employee retention risk, and other factors detailed in the Company's filings with the Securities and Exchange Commission.

  • I will now turn the call back to Tom.

  • Tom Smith - President

  • And Doug has successfully passed the reading of small print on our PowerPoint slide test that we open our call with and for those of you that do have Internet access, we will be referencing the change to the next slide on the screen so that you can follow along in the conversation, and we will begin with the first slide.

  • One of the questions that has come up quite a bit, actually, is the definition between the terms that are used in this industry of less-lethal versus non-lethal.

  • This is something when we first got into the consumer marketplace we used the term less-lethal which had been adopted by law-enforcement.

  • And earlier this year we started using and have changed to standardize the term of non-lethal in regards to this technology in this space.

  • And one of the things that we wanted to clarify was the definition under which the term non-lethal is being used.

  • That definition is that the U.S.

  • Department of Defense policy defines non-lethal weapons as weapons systems that are explicitly designed and primarily employed as to incapacitate personnel or materials while minimizing facilities, permanent injury to personnel, minimizing fatalities, permanent injury to personnel and undesired damage to property in the environment.

  • It is important to note that the Department of Defense policy does not require or expect non-lethal weapons to have a zero probability of producing fatalities or permanent injury.

  • Rather, non-lethal weapons are intended to significantly reduce the probability of such fatalities or injuries as compared with traditional military weapons, which achieve their effects through the physical destruction of targets.

  • This is again a question that we wanted to make sure everybody was on the same page in terms of the term that we are using and again risk as inherent, confrontation as inherent risk of potential injury.

  • And the press has portrayed us as saying that the TASER is 100 percent safe.

  • What we are saying is, and we have never said that.

  • We have stated that the TASER in the medical testing that we have done and in the analysis that has been done by medical experts and in looking at the facts have shown the TASER technology to be safe.

  • There is no way in this world that anybody can test 100 percent of every possibility that exists out there today.

  • We have done numerous tests and you're seeing independent reports beginning to come out now that have discussed this topic, and we will continue to advance research in this area as we ongo with further testing, but there is no way you can ever test 100 percent of the probabilities that exist out there today, therefore the risk of the confrontation of the possible injury cannot be 100 percent qualified.

  • So we will use the non-lethal definition as defined by the Department of Defense.

  • We go to the next slide please, let's look at the overview of this quarter.

  • We were very excited to be able to report record revenue of 18.9 million for the quarter.

  • That is also a record with 32 percent earnings after tax.

  • I think you will be challenged to find many small manufacturing companies with these kinds of numbers, and we are very excited to see the continued growth that we've had during this quarter.

  • We withstood at first media coming from both the New York Times and CBS who ran CBS in particular multiple stories that did not shed the best light on our technology.

  • Hamilton County, Indiana has taken the step to remove tasers from their officers, and this is actually an interesting one because I happened to be in Washington, D.C. at the time this story came out.

  • We were able to contact the sheriff and get to meet with him the day after he made this decision, and when the sheriff was presented with the facts of the TASER, and with the facts on the medical information, he and his risk management team realized that they had made a mistake, and he and I sat shoulder to shoulder in a press conference as he put them back and announced to the media that they were going back on the street as quickly as possible, and that he had made a bad decision based on bad information.

  • And again, I think that shows to the fact that the data out there that we are providing law enforcement really does stand on its own and supports the safety of our technology and the fact that we are saving lives every day.

  • We also hired a firm called Public Strategy as crisis management consultants to work with us on our media interaction.

  • I think that has been a very successful program, and we will continue with that going forward in the foreseeable future.

  • We really focused our message now, and focused on the fact that we are in fact saving lives every day and reducing injuries and saving a lot of money and worker comp claims for law enforcement as well as the suspect and the persons that those people interact with on a daily basis.

  • We also have taken our website, which has had a lot of information added to it over the years; we basically did a complete overhaul of the website, and please we encourage everyone to take a look at www.TASER.com and take a look at the new overhauled website that just went live within the last several weeks.

  • Another very exciting announcement during this quarter was the United Kingdom approval for officer, armed officers in the country to carry the tasers.

  • We have had a number of questions about how many officers are armed in the country and the number is roughly 6000.

  • But the bigger issue here is this is the medical equivalent of getting an FDA approval on a blockbuster drug.

  • This is a government that spent almost four years and several million dollars studying this technology from a scientific side, from a medical aspect, from conducting a field trial with forces using this on the ground and evaluating all of that information, all of those results and giving the Minister David Blunkett the opportunity to stand up in Parliament and make the statement that the risk of injury is very low, and that he has authorized all of the forces in the United Kingdom to go forward and use this technology.

  • We've been talking about this for a long time, and yes there were some delays, but ultimately the decision came forward that we were waiting for and wanting, and that was the advancement of taser technology in one of the most conservative policing programs in the world, that is the United Kingdom.

  • And again we believe that will have a tremendous impact and we will talk about that a little later.

  • Next was the legalization in Massachusetts of this technology for law enforcement.

  • Several years ago there were four states that outlawed this technology to law enforcement; after Massachusetts Governor approved this over the summer, we are now down to one state.

  • That is the state of New Jersey.

  • So three out of four states where this had previously been banned to law enforcement have now adopted this technology, again showing the acceptance because of the results that we're seeing on the streets of law enforcement around the world.

  • With that I would like to turn the call over to Phil Smith to talk in more detail about our medical study.

  • Phil Smith - Chairman of Board

  • Thanks, Tom.

  • Good morning.

  • These studies that I'm going to cover basically are the things that we've been talking about;

  • God knows just long enough to get this information out.

  • But it is out, and we will try and cover those.

  • The next slide here shows the independent studies in the Department of Defense, the United Kingdom home office;

  • Canada has an interim report from British Columbia, Orange County independent review that was done recently.

  • And one thing we're very happy about, the TASER X26 safety study has been accepted for a publication in a top medical journal that will be peer-reviewed and that will be published in January of '05.

  • We had this information for a year; we have not been able to disclose it because we wanted to get a peer review and in the journal, it has now been accepted and we hope to see that published in January of '05.

  • And finally, there is a new TASER Scientific and Medical Advisory Board.

  • We have gone out and gotten some top cardiologists and microphysiologists around country, and some ER doctors to form this Board.

  • We will give you more information on that.

  • We have to get their clearance to let their names be public and their institutions.

  • They are names that you will recognize, I assure you.

  • And these people are going to guide us in our future research efforts as we continue to push this technology forward.

  • The conclusions from all the testing today is that TASER is generally safe and not the primary cause of any in custody death.

  • I'm sure that sticks in the craw of the media because they have had a lot of fun with this thing, this thing has caused death.

  • They continue to put it out there, but this thing is now been reviewed and it is not responsible for any in custody death.

  • Continued testing is recommended by these people, and we are moving forward on that under the guidance of our new TASER Scientific and Medical Advisory Board.

  • Let's go to the next slide.

  • Let's talk about the independent conclusions from the British Columbia, Canada.

  • The conclusion was our analysis of the field usages and the medical literature suggests appropriate use of the taser presents an acceptable level of risk to subjects being controlled.

  • You can actually see this report at www.OPCC.CC for British Columbia and .CA for Canada.

  • So if you want to take a look at that report, you can go there yourself.

  • Go to the next slide.

  • This is the independent conclusion of the Orange County medical examiner.

  • From Dr. Gant Caravoglia (ph) who was the Orange (indiscernible) medical examiner, he said "it is my belief that taser is now associated with excited delirium because that is how they are bringing them down.

  • But there's really no evidence that they are causing any of the deaths.

  • I believe these individuals would have died with or without being shot with a taser."

  • That is available at our website www.TASER.com if you want to get more information.

  • Let's go to the next one, the United Kingdom.

  • This is the one that Tom talked about a four-year testing.

  • Their conclusion was the risk of life-threatening or serious injuries in the M26 TASER is very low.

  • Again, that is available on our website www.TASER.com.

  • This is a multiyear study.

  • The (indiscernible) subcommittee of the home office of the British Government.

  • And finally, the granddaddy of them all, in fact, Rick will talk about this in Prague there over there making presentations, the HECOE, the Human Center of Excellence from the Department of Defense is actually making presentations in Prague to the NATO countries about all the fine work they did.

  • This is a huge study, and their conclusions are -- "analyses provided by law-enforcement agencies indicate that increased use of the TASER M26 or the X26 has decreased the overall injury rate of both police officers and suspects in complex situations when compared to alternatives along the use of forced specter (ph).

  • Another conclusion, this report concludes that electromuscular incapacitation i.e. the taser, is likely not the primary cause of factor in reported fatalities.

  • They went and looked at the in custody deaths.

  • This is approximately 20 MDs and PHD research participants and approximately 12 academic, government and private institutions.

  • It doesn't get any more peer reviews than this.

  • It does not get anymore independent than this.

  • And we hope this closes that chapter on the issue of taser safety.

  • Now there is more research needed and we are going to do that.

  • But they have concluded exactly what we said, all the testing and scientific data to date that TASER is a safe technology for all those cases in which it has been tested.

  • So with that, I would like to turn it back over to Tom, and he will cover the next slide.

  • Tom Smith - President

  • One of the things is it is great to have all this scientific data.

  • It has been ongoing; we have been hearing about it for a while.

  • Phil just game the summary of the report, and if you take a look at the next slide one of the things that really drives this point home is where the rubber meets the road, and that is what is happening out there with the users of our technology, the law enforcement communities, the military communities.

  • And on this slide, the next slide here you will see one of our larger customers the Cincinnati 90 Police Department, they went and purchased over 1000 TASER X26s and deployed them in January of this year.

  • And their first six-month results are listed on this slide.

  • And they are very, very impressive.

  • And those are they are reducing officer injuries by over 70 percent.

  • They are also reducing officer assaults by over 70 percent.

  • They are reducing suspect injuries by 40 percent.

  • They are reducing citizen complaints by 50 percent, and other use of force is down by over 50 percent.

  • These numbers again are right in line with information we've seen from other departments around the country that have made the full deployment decision, meaning 1 taser on every officer.

  • I think that is a very key point is that when this technology is available to the front-line officers of the United States and around the world, you are going to see very dramatic results.

  • And Cincinnati has shown that.

  • Phoenix has shown that, Orange County, Florida has shown that.

  • It is not where they are putting the taser with a supervisor that they are having to call it out to the senior (indiscernible) wait for it to show up, it is when it is present with the officer that when the situation is turning for the worst, he is able to use this technology and end that confrontation and again those numbers are being driven home with what you see here as reported by Cincinnati Police Department, and we are obviously very excited for those results.

  • These guys don't get paid to hurt, nor are the citizens.

  • And we are giving them a tool that enables them to reduce injuries both to themselves and the suspect by giving them to front-line officers.

  • We go to the next slide, let's take a look at the sales update.

  • During the quarter we shipped our largest military order, almost $1.8 million that we received in late Q2.

  • That order was shipped complete during the third quarter.

  • We also received a new military contract from a new branch, and that would be the Armory National Guard.

  • So not only are the regular army using it, now the National Guard is deploying the TASERs as well.

  • We also received our first lease from the Indianapolis Police Department.

  • This has been very exciting.

  • We have been talking about leasing for a while because in these tight times of budget restrictions for cities we've offered an alternative for financing where Indianapolis was able to go and get quite a few, plenty of TASERs for all their officers where they might not have been able to do that had they had to rely on their own budget because they were able to spread the payments out over a multiple year plan.

  • We again reported record sales for the third quarter.

  • Also during the quarter, we launched the TASER X26 (indiscernible) of our website.

  • This was a very soft launch.

  • Again, our focus has been and as you have seen in the results has come from the law-enforcement community.

  • We are not focusing on the consumer market at this time.

  • It is a test market.

  • While we are learning what the messages are out there.

  • We've received limited orders and spent virtually no money on advertising.

  • Again, it is a soft launch; we are working through the buzz (ph) of our Web store as well as with the company that is doing our background checks to ensure that we are not selling these any felons or anyone who is under the age of 18.

  • So as we get our call center and our background checks and our Web store up in place and we begin our test marketing, we will roll into that stronger in 2005.

  • There will not be a major focus of this in the remaining part of this year.

  • We are staying focused on sustaining our law-enforcement growth which is going to carry us for the vast majority of our business through the end of this year and well into next year.

  • Let's talk about international.

  • We mentioned the United Kingdom approval.

  • Once that approval came, now we are into the sales cycle.

  • Now these agencies are working with their staff to get law enforcement officers trained.

  • In fact just this past weekend on Saturday and Sunday they held their first training course to start training new officers and the feedback was extremely positive.

  • So the sales are not going to roll in overnight.

  • It is a process that they now received the approval.

  • So now they have to integrate this with their use of force, with their armed officers to get them trained, to get the money allocated so that they can get it sent and get this equipment; you will see some sales come in during the fourth quarter.

  • And well into next year as this program continues to move forward.

  • But again, the larger picture here is that approval that came from the United Kingdom is going to have a much greater impact on foreign countries around the globe.

  • One of the other countries that we talked about for a while is France.

  • And France was -- we were hoping to see a report by this time, but they've had a few delays in producing that.

  • And they have actually now made it into a larger work force so that they are going to be producing three different reports.

  • Those reports will now be out in early December.

  • The results are very impressive.

  • In fact, they've had more uses doing their field trials and was actually conducted in the United Kingdom.

  • We worked very closely with them to train them, to get them up to speed, and those results are coming through loud and strong.

  • So we expect in early December to see reports come from not only the field usage, but from the budgetary office as well as their research arm which is called the (indiscernible).

  • The gentlemen that was in charge of that program recently retired, which is one of the reasons for the delay.

  • But they will be talking about the medical aspects again, and I think they will also be relying and working with the United Kingdom on what they found during their study.

  • This again is going to have a huge influence on countries such as Australia, South Korea and the old Commonwealth countries where they are going to be going forward and we received quite a few inquiries now that the United Kingdom report has been released, and again I think you'll see a bigger impact in 2005.

  • We can go to the next slide.

  • Take a look at new business.

  • We reported 17.1 million, 159 (ph) in new business during this quarter, up from 15.695 (ph) in Q3.

  • But I think if you'll notice and look at the slide here, you'll notice there is a green line on there, and that is comparing the trend between what we saw in Q2 and Q3 of last year.

  • We saw that same trend between Q2 and Q3 of this year.

  • So we were able to report a new record quarter although the third quarter is our typically the slowest in the seasonality of quarters during the year but it is no different than the trend we saw a year ago and previous years that is not as big of an increase as we've seen from quarter to quarter, for example between Q1 and Q2.

  • So again, great new business, but we are just looking at the trends continuing from what we've seen in the past.

  • We go to the next slide, we are going to talk about sales by quarter.

  • We reported 18.948 million for the Q3 of '04, up from 15.3 million in Q2.

  • Again, a great quarter for us and another new record that Dan will get into in more detail a little bit later on.

  • On the next slide, we are looking at TASER weapon sales.

  • And this was another milestone reached for us.

  • The first time in our history that we have shipped over 20,000 TASER weapons, TASER devices during a quarter. 17,793 X's during the quarter and 2440 M's during the quarter and I think you'll notice there was a little drop there in the M's as more and more departments are transitioning to the new technology of the TASER X26.

  • We look at the next slide, we are tracking our cartridge sales.

  • Up by 253,043 cartridges during the quarter from 240,000 in Q2, maintaining the rough ratio of about 13 cartridges per TASER that is going out the door, and that also is indicative of a lot of new orders where new departments are coming online, ordering the handles, more handles than the cartridge in the ratio, but again, 13 to 1 was maintained during the quarter and obviously a positive trend we like to see continued.

  • As we go to the next slide, our TASER full deployments were up 23.8 percent from 930 in Q2 to 1151 in Q3.

  • As I mentioned when I was talking about the Cincinnati Police Department, this is where the departments are seeing the biggest results.

  • Putting that taser on the frontline officer, we now have over 1150 that have permitted or are in the process of doing that, and those departments are seeing the same types of results that we talked about with Cincinnati earlier today.

  • Obviously, we'd love to see that trend up and to the right.

  • And if we look at the next slide, let's look at the U.S. law-enforcement market penetration.

  • We had a 22.8 percent increase in overall penetration from 7.9 percent of law-enforcement officers, up to 9.7 percent in Q3.

  • And again, the total number there is 1.1 million sworn law-enforcement between corrections, sheriffs and police, so we have roughly 9.7 percent of that market penetration now accomplished.

  • Unidentified Company Representative

  • Tom, I think it's worth pointing out, this says that in total, we still have less than 10 percent of U.S. law-enforcement carrying these weapons, so I think that speaks for what the future potential is.

  • They love this product, we have great customer acceptance, and this is the total cumulative penetration, less than 10 percent, even with all the actual numbers we've been able to put out.

  • Tom Smith - President

  • Obviously, we're very pleased and excited with what's gone on in the sales arena.

  • We obviously believe that is going to continue.

  • We believe we are going to see a much larger impact in the international markets, especially in 2005, now that a lot of these independent studies that have been asked for many, many years have now come out from the 3 largest countries using our technology, being Canada, the United Kingdom and the United States.

  • You know, you don't get more independent than a government agency coming out and approving it and the UK reviewing it in Canada and reviewing it in the United States.

  • I think that speaks volumes for the response on the TASER technology and what we've been able to do.

  • With that, I'd like to turn the call over to Kathy to discuss our operations.

  • Kathleen Hanrahan - COO

  • Good morning.

  • As you've heard, we're continuing to improve our operations department, both in terms of the margins generated for the organization and the service to our customer base.

  • During the third quarter, we built more than 26,000 X26's and more than 260,000 cartridges.

  • This resulted in a 28.7 percent increase in finished goods on hand at the end of the quarter.

  • In addition, we also increased our production through sub assemblies by an average of 59 percent during the same period.

  • The increase in finished goods and work in process along with the ramp in raw material purchases resulted in a $1.5 million increase in inventory.

  • This will provide adequate material flow for the fourth quarter build, as well as give us cushion into Q1, should the move require the lines to be down more for more than a few days.

  • During the third quarter, we increased gross margins by 3 percent despite a spike in inline scrap generated by our X26 and high voltage coil line.

  • Our team of R&D engineers with the assistance from our IS department also completed the development and testing of a new software revision for the X26 law-enforcement community in Q3.

  • This version modified the pulse rate on the device and provided additional data interfaces for the user through a new version of the USB download software.

  • Both were fully implemented on the production lines in July and shipping during the quarter.

  • R&D engineers also completed integration of the new software release for the consumer version of our X26 productline.

  • This software allows us to configure the standard TASER X26 with custom software designed specifically for the consumer.

  • Limited quantities were shipped in the third quarter as our logistics team tested and verified our new systems for customer background checks and our sales team initiated their new call center.

  • We also made significant strides toward improved customer service during the third quarter.

  • Since the introduction of the X26, customers have waited up to 12 weeks to receive their orders.

  • At the end of the second quarter we reduced this wait time to one week and by the end of our third quarter we were shipping many orders the same day they were received.

  • We did end the third quarter with a backlog of approximately $960,000.

  • This was the result of a few large orders received on the last day of the quarter, as well as special order items requiring longer prep time.

  • Next slide, please.

  • During the fourth quarter we intend to continue working on ways to improve our throughput from initial receipt of raw materials to delivery of finished product.

  • We will remain focused on reduction of in line scrap on the X26 line so these monies can be used to grow our business.

  • We will be completing the integration of our new ERP system into manufacturing and MRP planning.

  • We will be working with quality assurance to complete a formal library of work instructions for line operators.

  • And we intend to hire a process industrial engineer to champion our efforts toward automation of the cartridge lines and improvements to our existing production processes.

  • And continue growing our R&D department to capitalize on the expansion of taser technology.

  • With that I would like to turn the call over to Dan Behrendt, our Chief Financial Officer.

  • Doug Klint - General Counsel

  • Kathy, one point you might want to point out, is how many we ended up at the end of the quarter on the shelf and whey we have so many on the shelf, because the inventory jumped quite a bit during the third quarter.

  • Kathleen Hanrahan - COO

  • Right, we actually ended the quarter with 9000 extras on the shelf going into our fourth quarter.

  • We also had almost 50,000 cartridges on the shelf to take us into Q4.

  • Unidentified Company Representative

  • And the reason is?

  • Kathleen Hanrahan - COO

  • We are building for fourth quarter because again we expect to see the sales go up and we want to make sure that we plan going into Q1 when we relocate to our new facility.

  • Dan Behrendt - CFO

  • Thank you.

  • First I am going to cover the finance update.

  • The highlights for the quarter include record sales and profitability with sales of 18.9 million for the quarter and net income of 6.1 million.

  • As the Company continues to leverage its fixed costs, with operating income as a percentage of sales, improving over 8 percent from 44.7 percent last quarter to 52.8 percent of sales this quarter or an 18 percent improvement.

  • This was driven by a 3 percent improvement in gross margins over the prior quarter with SG&A expenses as a percentage of sales improving by 5 percent, as timing items from the second quarter such as the cost of the annual shareholders meeting and the Company's user conference do not repeat themselves, and SG&A costs actually went down quarter-over-quarter as a result.

  • We also had 9.2 million of operating cash flow during the quarter and 22.3 million year-to-date.

  • Also I am happy to report that the first stage of the ERP implementation is now complete.

  • We are now using the new ERP system in finance area with the general ledger, accounts receivable and accounts payable areas all converted.

  • Next slide.

  • Next I would like to cover the financial results as we compare the third quarter of this year to the third quarter of the prior year.

  • Sales were up 211 percent from roughly $6.1 million last year to 18.9 million this year.

  • Gross profits increased 277 percent from last year, 3.5 million to 13.2 million this year, and our net income increased 469 percent from 1.1 million last year to 6.1 million this year due to the increased gross margins and better leverage out of our SG&A costs.

  • The punch line here is that we had record sales of 18.9 million, record earnings of 6.1 million and record profitability of 32.3 percent on an after-tax basis.

  • Unidentified Company Representative

  • And that is for a manufacturing company, I would suggest there aren't too many manufacturing companies producing a product that is generating 32 percent after-tax profits.

  • Dan Behrendt - CFO

  • That's right.

  • Thank you.

  • Next slide to cover the quarterly net sales.

  • Sales of 18.9 million for the quarter up 211 percent versus the prior year of 6.1 million and up 16 percent over last quarter, which is a previous record as the Company continues to enjoy strong demand for its product.

  • Next slide.

  • Gross margins for the quarter were $13.2 million.

  • These are up 277 percent over the prior year's gross margin of 3.5 million and up 21.3 percent over the prior quarter's gross margin of 10.9 million.

  • As a percentage of sales, gross margins for the quarter were 69.6 percent.

  • This compares to 57.2 percent of third quarter of '03 and 66.6 percent last quarter.

  • Next slide.

  • Next I would like to cover the breakout of expenses as a percent to sales.

  • Cost of goods sold for the quarter were 30 percent of sales with SG&A expenses decreasing to 16 percent of sales.

  • Our R&D expenses for the quarter were 1 percent of sales and again this is an area we intend to invest more in the future as we expand our product offerings and capitalize on our technology.

  • The result of a this is an operating income of 53 percent.

  • This is a new milestone for the Company which actually exceeds our business model.

  • And really, it is something we hope to continue going forward.

  • On a net income basis, net income for the quarter was $6.1 million up 469 percent over the third quarter of last year and of 1.1 million.

  • And up 36 percent from last quarter's record.

  • Let's put 36 percent improvement in net income in perspective, the Company enjoyed a fall-through of 62 percent on an incremental sales increase over Q2.

  • Put this another way for every dollar increase in sales over the prior quarter the company was able to earn 62 cents in additional net income.

  • Next slide.

  • I know you are all interested to see how this converts into on an EPS basis.

  • The basic EPS for the quarter increased by 5 cents a share to 21 cents, a 31.25 percent improvement over last quarter's 16 cents per share.

  • On a diluted basis, EPS also increased by 5 cents a share over the prior quarter to 19 cents a share for a 35.7 percent improvement over last quarter's 14 cents a share.

  • Next slide.

  • Next I would like to cover the cash flow.

  • Cash flow provided by operations was $9.2 million for the quarter or 22.3 million year-to-date.

  • Because of the Company's deferred income tax asset, the Company is able to convert all of its pretax income to cash each quarter.

  • Accounts receivable only increased by $700,000 for the quarter despite a $2.6 million increase in sales and as Kathleen mentioned before, inventory was up 1.5 million with one million of increase in raw materials and $500,000 in finished goods.

  • But we feel this puts us in a good position to meet demand in the fourth quarter, and then move in the new facility in the first quarter of next year.

  • The Company did spend $4.1 million in CapEx during the quarter primarily on the new headquarters facility and the new ERP system.

  • And finally, options exercised during the quarter generated another $1.8 million of cash during the third quarter.

  • Next slide.

  • On a DSO basic days sales outstanding, the DSO continues to trend downward with a 35.8 of days sales outstanding this quarter compared to 37 days last quarter.

  • It is interesting to note that if we would use the cut-in method actually the DSO would have been less than 30 days as our sales in September were actually higher than our ending AR balance for the quarter.

  • The result of all these positive results is an increase in the Company's cash balance of $6.9 million for the quarter despite having CapEx expenses in excess of $4 million for the quarter.

  • As you can see from this chart cash has been climbing all year but the December 31, 2003 cash balance of 15.9 (ph) million we have seen the cash balances climb by 25.6 million during the year to 41.5 million we have at the end of the third quarter.

  • Finally, I like to cover the Company's balance sheet statistics.

  • The working capital for the quarter is actually up 4.9 million, primarily driven by the increase in AR and inventory.

  • Our cash balances are up $6.9 million for the quarter to 41.5 million for the reasons I discussed earlier.

  • Our total assets are up $10 million for the quarter, the biggest changes there are the increases in our cash balances and the property plant and equipment.

  • Our liabilities are up $1 million to 6.2 million for the quarter, primarily driven by the increased accounts payable.

  • Finally, our owners equity is up $9 million for the quarter.

  • This is driven by the $6.1 million in net income and the exercised employee stock options.

  • Now I would like to turn the presentation over to Doug Klint, our general counsel.

  • Doug Klint - General Counsel

  • The company is involved in several different types of litigation I would like to review real quickly.

  • We have a contract dispute with two former distributors.

  • We are also involved in four training injury cases.

  • It is important to note that these injuries were secondary, exertion-type injuries caused by pre-existing injuries or medical conditions.

  • TASER International did not conduct any of these trainings, and going forward we are now requiring all volunteers to sign a release form which should put a stop to these type of claims.

  • These claims are covered by our insurance.

  • We are also involved in litigation from 3 unexpected and unforeseeable deaths while in police custody.

  • The TASER device was not the approximate cause of death in any of these cases.

  • It was listed as a contributing factor in one case which is being contested by medical experts and by the way was covered extensively by CBS News.

  • We now have the independent HECOE study connected by the U.S.

  • Government which concluded that the TASER device is likely not the primary causative factor and reportedly (indiscernible).

  • This report will play a very important role in this litigation and will provide additional evidence to support our motions for a summary judgment.

  • These claims are also covered by insurance.

  • We have been named a party in an absurd, frivolous excessive use of force case alleged against police.

  • This claim is also covered by insurance.

  • We do not believe that any of these lawsuits have merit and none should have any material financial impact on the Company.

  • Rick will now talk about competition on the next slide.

  • Rick Smith - CEO

  • Thank you, Doug.

  • I think it bears noting again that some of those in custody deaths while very tragic and unfortunate for the families involved, it’s pretty similar to the case we had dismissed just last quarter, successfully.

  • Now let's talk about the competition slide.

  • You will see the subheading here "bulletin boards and vaporware."

  • I have to kind of chuckle, it seems like the latest get rich scheme in the U.S. is to get a bulletin board company announce a product that doesn't exist and that you’re going to compete with TASER.

  • And the valuation just goes through the roof.

  • If imitation is flattery, we're certainly flattered.

  • We've seen a number of companies out there again with no substantive product, and when you take the time to go out and actually look up their filings, which is somewhat a challenge for bulletin board companies, you find that these companies now have over $100 million market caps just based on the fact that they say they're going to compete with us.

  • Now some of the companies are based on misinformed assumptions.

  • And the reason we want to talk about this is we got lots of calls from shareholders who see some of the press releases and things being set out in the marketplace, and they are calling us concerned to ask what our take is on this.

  • And I should first say it's really hard for us to comment on vaporware and things that don't exist.

  • We really can't comment a whole lot until we see something.

  • But let's take one of these devices out there, one of these companies.

  • Their key assumption, their business plan apparently is that they believe that tasers are ineffective at short range.

  • But if you refer to the study just released in British Columbia, the taser success rate in short range of less than 3 feet is 94.2 percent.

  • That is basically the same as our overall success rate.

  • So we think that is a fallacious assumption, and certainly would not be a good cornerstone of a business model to try and compete with us.

  • But now let's look at the barriers to entry of getting into this space.

  • We at TASER International have 11 patents plus 17 more applications pending.

  • So we have been very busy turning out new ideas and new intellectual property.

  • Some of those are wonderful applications and in my estimation, particularly the ones that cover our electrical waveforms.

  • I think we should also point out that last quarter we filed lawsuits against three companies, three little-known private companies that had announced that they are going to sell products that look like they infringed our patents.

  • We had all three of those cases -- I think successfully, came to a successful conclusion in that all three companies admitted in the court documents that those products did not exist, and the lawsuits were dismissed.

  • Although we're keeping a very close eye on those and our shareholders should know we will defend our intellectual property very aggressively.

  • And next here we talk about trade secrets and know-how.

  • There are a lot of proprietary processes that go into not only the manufacture of our products, but the design, the development in knowing how to test, to safely incapacitate through this neuromuscular or electromuscular disruption mechanism without leaving lasting effects.

  • We have been at this now for a dozen years, and we think those trade secrets are every bit as powerful as our patents.

  • And again, the production processes alone are daunting.

  • There is a whole lot that goes into this to making these devices work.

  • In terms of execution risks, certainly as you will see at the bottom of the page we say saying it is one thing, doing it is another.

  • There is a lot of ground to cover from saying you are going to compete with TASER International to actually doing it.

  • I will give you one example.

  • Two years ago one company announced that they were going to launch a competing system to the M26.

  • It is two years later we still have not seen a product in the marketplace, in fact that was one of the companies that we sued last quarter and admitted that the product did not exist.

  • Now if you look at large switching costs, if you think about it for police agency, buying the equipment is the easy part.

  • From there they have to develop policies, training, implementation, they then have to go forth and train all their officers.

  • In some cases those training costs are higher than the equipment acquisition costs.

  • And because of this particularly in the larger agencies, we've been told by some of the top agencies in this country they won't look at a weapon changeover for another five or ten years because that is just their policy.

  • Once they decide on a platform it takes them so much time, effort and money to implement it.

  • They just can't afford to go looking to change weapon platforms in a year.

  • So even if a competitor did somehow come up with a new product to compete with us that didn't infringed our patents, they would have huge switching costs to overcome and a lot of resistance in the marketplace.

  • As we now have 6000 agencies deploying the taser, more than 6000 in fact, all of the top five agencies are deploying the taser with 15,000 instructors and over 100,000 users.

  • And we continue to see momentum building in the marketplace.

  • As I'm sure you can imagine, it would be very difficult for a new entrant to come in and sell a police department when all of the top police departments are using TASER equipment, it just strikes me as a very risky thing for a small agency to go with an unproven source.

  • I think our strongest barrier to entry is the fact our excellent relationships with our customers.

  • I think that is true in any business.

  • We've stubbed our toe along the way.

  • We've had issues where we've had weapon breakage in the field or we've had certain batches where we had quality problems, but the one thing we heard consistently from our customers is we give them "the best customer service they've ever had."

  • We go out of our way to correct any issues that have happened out there, and that makes our relationships all the better with our customers.

  • And that we believe is our best defense, serving the customers' need beyond their expectations.

  • And finally, independent safety tests.

  • Certainly this is a great example of what doesn't kill you makes you stronger.

  • In the past six to nine months we've seen all of these allegations regarded to product safety and requests for independent tests.

  • While with TASER we now have independent tests from the U.S.

  • Department of Defense, UK, Canada, Australia and other countries.

  • And each one of these tests are multi hundred thousand dollars expended if not more, in some cases in the millions of dollars.

  • Now that we have those independent tests, anybody else looking to get into the space is either going to A, violate our patents on our waveforms because that is specifically what has been tested or they would have to come up with something new.

  • Now we are very skeptical that anyone can come up with a way to incapacitate a human subject through an electromuscular disruption without violating one of our patents.

  • We don't think that can be done.

  • Let's assume they can.

  • Now you have got a new waveform that has to go forth and be tested independently by all these other agencies.

  • And again, the impetus for them to do so, there is a lot of time, cost and effort -- I remind you we've been at this for almost four years in the United Kingdom.

  • So again these first (indiscernible) advantages are significant and I end again with the concept that saying it is one thing, doing it is another.

  • Any potential competitors that get into the space will find a highly focused company in TASER International.

  • This is all we do.

  • We've got a very talented team of people; a lot of expertise, and we are certainly well funded and we are very focused on this marketplace.

  • Now I should also point out for our shareholders that don't think we don't take these threats seriously.

  • We did feel the need to set the record straight that we have not seen these products out in the marketplace.

  • And frankly, our technical evaluations of them leave us skeptical that these products, many of them at least, that they would pose serious competition even if they did exist.

  • But we don't want you to think that we are not watching this very carefully, very closely and continuing to push innovation as fast as we can.

  • That is our best defense.

  • Take the best products out there and service the customers, and in a superior fashion.

  • So we have our eye on the ball.

  • And you will continue to see more great things coming from TASER International.

  • If I move to the next slide, you'll see that we've now increased our 2004 guidance from 150 percent revenue growth to 175 percent revenue growth.

  • To save you a trip to the calculator that's approximately $67 million at the top line for the year.

  • You'll recall we started the year with 100 percent revenue growth guidance, we increased it to 150 and now 175 percent.

  • You will also notice that this is around 25 percent increments.

  • And I think it's important to note this is a difficult business to predict given the nature of the growth and the lumpiness of the business.

  • So this is not a very precise science, and we don't mean to imply that it is.

  • We do feel comfortable though that as an order of magnitude the 175 percent revenue growth is now achievable, and we are comfortable that we will hit that by the end of the year knowing what we know today.

  • Moving to the next slide, talking about our new headquarters, we've got a picture there, this was taken a few days ago.

  • Of the new headquarters.

  • We're very excited about this.

  • The program has gone swimmingly well.

  • This is the first building I have been involved in, and our contract, Orion Construction has done a fantastic job.

  • We are still slated for a first-quarter move in sometime around the first of February.

  • If you go to the next slide, you will actually see a computer rendering of what the project will look like when it is completed.

  • With the three-story atrium, it allows us to keep a very high energy level in the organization, the steel entry tower in front, which will have a really imposing entry feel, and I should also point out that we are using advanced biometric access controls throughout the facility.

  • Basically, we are using iris scanning equipment, so there will be no keys, no employee access cards.

  • We take a snapshot of the iris of your eye, and that will control all key access points, including the most sensitive places such as engineering.

  • We believe this will be a cutting-edge facility in many respects, again including its security.

  • And it will also house in its 100,000 plus square feet not only our headquarters staff, but our warehouse and our production.

  • And with that I will turn it back over to Phil and Tom, back in Scottsdale, again greetings everybody from Prague.

  • We have an exciting day here and I'm off to Dublin tomorrow.

  • I can tell you the interest in TASER in Europe is remarkably higher than it has been in the past.

  • This technology now has a degree of credibility that just wasn't there a few years ago.

  • They are seeing that this is for real; it is having a real impact on law enforcement, and I think the future in Europe is bright.

  • Phil Smith - Chairman of Board

  • Let me just -- one minor point -- this is going to be my last conference call.

  • At the end of the year I am just going to move to Chairman of the Board.

  • We are going to get someone else to do Investor Relations, so I will be available next year.

  • I will be on the Board, be active on the Board, be available by phone for either the boys or anybody in the Company.

  • I've been here for 11, 12 years, enjoyed it, been a lot of fun, made some money.

  • It has been the most fun thing I have done.

  • In all I have done 7 startups in my life.

  • This is by far the most exciting most successful and to get to do it with your two sons is an extra thrill.

  • But it is time, I am going to be 67 in December -- in January 1, I will have been in business 36 years.

  • So with that I am going to take some time off, enjoy life and again be available on the Board and always be available by phone for the boys.

  • With that, I will turn it back to Tom.

  • Tom Smith - President

  • Obviously we will continue to be working with Phil because he's our dad.

  • So he is not going to be going too far away for those of you that are out there who have any questions about that.

  • Rick Smith - CEO

  • Congratulations too, and by the way, Tom, I think it's important that we couldn't have done this without dad's involvement all along.

  • We call him Phil in business settings, but dad, we will miss you around the office on a daily basis, and I'm really glad you're taking some time off to spend with Mom.

  • You deserve it.

  • Tom Smith - President

  • We're obviously very excited about the numbers we report.

  • We continue to believe we're going to be able to set records as we go forward.

  • We are very pleased with the results we've been able to provide, and there is quite a bit of pride and ownership in what we do from all the employees here at TASER.

  • With that, we would like to ask our operator to come back, and we will take a few phone calls to wrap up our conference call.

  • Operator

  • (OPERATOR INSTRUCTIONS) Eric Medal with Sprott Asset Management.

  • Eric Medal - Analyst

  • Congratulations on a truly excellent quarter.

  • I wanted to talk a moment more about the X26-C and its potential.

  • As you may know, we commissioned (indiscernible) to conduct a survey for us about a month ago looking at the willingness of U.S. citizens to buy the X26-C and we polled 819 people and had a vote, about 5 percent of people responded they definitely would purchase it.

  • And just realizing that the market potential could be enormous even if you get a small percentage of U.S. households.

  • I am wondering if you could just give us a bit more color as far as marketing or testing the market or expected sales for 2005.

  • Rick Smith - CEO

  • This past quarter, to be honest what happened with the New York Times and the adverse publicity switched us a little bit from playing offense to defense, and the magnitude of the accomplishment our people were able to pull together in delivering a record quarter under those circumstances really did require an extraordinary effort going out and going back and solidifying our law enforcement customer base.

  • And given the growth in our existing business that is where we're going to be focused for at least the next quarter or two.

  • In the consumer business we agree there's a huge opportunity there, but we're going to take it slowly.

  • We don't think the way to introduce this is through a massive marketing blitz out of the gate.

  • The way we were successful in law enforcement was by methodically focusing on training and getting to know our customers, and slowly building the sort of the word-of-mouth advertising, went from agency to agency about how effective our taser weapons were.

  • And in order to help with that, we've signed up over 1000 X26-C instructors or police officers that will be assisting with consumer training.

  • We will be trying some limited test markets in the fourth quarter and first quarter of next year.

  • But we really want to be careful, the growth rate of 175 percent growth rate, that is almost tripling the Company since last year.

  • Implementing new ERP systems, moving into a new facility, all the things that go with that are really straining on an organization.

  • If there's one thing I learned from Phil early in this is no company ever went out of business from over-focus.

  • And we are going to stay focused on the opportunity in front of us, which is the real law enforcement marketplace.

  • The consumer market again right now I will just tell you we are getting our feet wet, we are taking it slowly.

  • We're implementing new controls to make sure we keep these out of the wrong hands.

  • I wouldn't look for anything exciting out of the consumer market in the next quarter or two, that is our time to get up and learn about this, and as we get our messages refined and we move into latter half of next year that is when I think that we will then armed with good data, good marketing test studies, then we will be ready to make decisions about how to do a wide-scale rollout.

  • Meanwhile, in that time we think we can sustain a very high growth rate in U.S. and now of course, the new markets coming up overseas in law enforcement.

  • Eric Medal - Analyst

  • Rick, can we talk then more about those international markets?

  • I know we've been hearing information on France for a number of quarters and we've heard South Korea and Australia.

  • Can you list other countries that TASER is in either negotiations or talks with?

  • Tom Smith - President

  • We've been in conversations and actually sold and shipped test evaluation equipment to over 40 different countries, so there is really not one region of the globe that we don't have something going on.

  • You know, there is 200, roughly countries in the world and we got about 40 of them looking at this technology.

  • Some are the bigger names out there that are currently looking at this, you know South Korea, Australia, obviously in the European market there is quite a few countries there.

  • But those are the big movers, and those are the ones that obviously we expect to see in the next several years to adapt and start to use this technology.

  • Unidentified Company Representative

  • We may actually see our first order out of Latin America, a good sized order in the fourth quarter.

  • We are hearing rumbling, but we haven't seen the order and that's why we don't put them in the forecast, but we may start to see our very first order out of Latin America in the fourth quarter.

  • Eric Medal - Analyst

  • And probably now for the toughest question of all, for all those countries that you're chatting with is there any possible ballpark number you could put on as far as what the market potential is in dollar terms?

  • Unidentified Company Representative

  • Not really.

  • Again, trying to predict -- the UK has taken four years to get them to this point.

  • Again here in the United States we have 18,000 agencies and each makes their own buying decisions and oversees it is one person that makes the decision, and they are going to go very, very slow in that decision.

  • Like we have seen in the UK, France is going at what we would consider lightning speed for a country having really just started the project in February or March of this year.

  • And being at the point where their infield testing, getting results on the street and still going to put those reports out in December.

  • I still think we're excited about where those opportunities are and we have very large quotes out there, but really what that potential is, its much larger than the United States if they all start to go, but we don't really put a ballpark number on it.

  • Unidentified Company Representative

  • Just to give you a scope though the European Union market we estimated 2 to 3 times the size of the U.S.

  • If you take the global market its 10 to 12 times the size of U.S.

  • Again we like to give you more precision, but these agencies are so hard to predict, these international countries.

  • We think we would be giving you a false sense of security if we started giving you real precise numbers in any country.

  • Because not only do we have to consider the number of officers, but the rollout time, like the UK where it's going to go to a subset of officers first and then rolling out beyond that hopefully.

  • So wish we could give you better answers other than it is a big opportunity, we think we got the right people focused on it, and it's not just with TASER, just historically the international police markets take a lot of time to develop but when they do, the orders are big.

  • Tom Smith - President

  • What we did this year, just to remind everybody we uses the U.S. as a proxy and said we will get our growth in the U.S. which by the way the U.S. is 98 percent of our business this year -- international is fallen to 2 percent so there is really a lot of room for improvement next year as these start to come online.

  • But the problem is as Tom points out is trying to project these guys is particularly difficult.

  • So probably when we come out with our guidance for '05 and we have our Q4 conference call, I won't be here then, but it will probably be based on U.S. again pretty much with upside coming from the rest of the world because it is just too hard to predict.

  • And the UK's a perfect example; we expected that over a year ago, they finished their test in April.

  • It took them to October to make the decision.

  • So it's really very hard to predict these governmental things.

  • But let it be said that they are big, we are after them, we are focused on them and as soon as we can close them, we will.

  • You can be assured.

  • Operator

  • Brian Ruttenbur from Morgan Keegan.

  • Brian Ruttenbur - Analyst

  • Great quarter.

  • A couple questions.

  • First of all, in the third quarter revenue from the new consumer X series in the quarter, do you have any kind of estimate on -- is it 100,000, 5000?

  • Can you give us any kind of color on how you did on that launch?

  • Tom Smith - President

  • Because we were setting up all of our systems and spent virtually no advertising, we didn't ship hardly any during the quarter.

  • We were focused on law enforcement, making sure we serviced those guys while we got the call center up.

  • Kathy mentioned the logistics and setting up, it was just a handful of orders that were really shipped in test shipments to make sure they went through the process okay.

  • For all intent and purposes it was a very small number during the third quarter.

  • Brian Ruttenbur - Analyst

  • Okay, so it is less than $50,000?

  • Tom Smith - President

  • Less than 10.

  • Brian Ruttenbur - Analyst

  • In the fourth quarter you anticipate that number will grow?

  • Rick Smith - CEO

  • The total orders taken was greater than 50.

  • I think it was around 75 or 80, $90,000 in that range in consumer products.

  • The only thing we did was put it on our website and 1 press release.

  • We will be doing some advertising and marketing in select test markets.

  • I would say as far as your modeling assumptions, I would assume zero revenue, let's be conservative.

  • And until we've got a proven model that is significant and will impact our revenues from a financial perspective, I just encourage you to be conservative and focus your numbers on law enforcement until next year.

  • Brian Ruttenbur - Analyst

  • Okay, and moving on over to bookings in the quarter, you did as I understand it 17.1 million.

  • Is that correct in the quarter?

  • Tom Smith - President

  • That's correct.

  • Brian Ruttenbur - Analyst

  • And that is for 16.2 in the second quarter.

  • The guidance you’re giving going forward is for roughly 19 million in total revenue in the fourth quarter, as I understand it.

  • Is that correct?

  • Tom Smith - President

  • That is about correct.

  • Brian Ruttenbur - Analyst

  • Should I assume that you're going to burn off all your backlog then in the fourth quarter and end the year with essentially zero backlog so your bookings will only have to be 18 million?

  • Is that the assumption that we should be going by?

  • Rick Smith - CEO

  • I think that is probably higher resolution, Brian, and we are really whether it is 18 or 19 million, it is certainly within our window of resolution.

  • Unidentified Company Representative

  • And as Kathy mentioned, we only had 900,000 in backlog at the end of the quarter and that's because we get a lot of -- or not a lot, we get orders at the end of the quarter that have some special requests that manufacturing has to take a week or two to process. '04 (ph) is just a large order that we can't get out -- it's too late in the quarter for that to happen just in terms of sheer volume.

  • So obviously we're striving to zero in terms of being under $1 million, we think that's pretty good.

  • Unidentified Company Representative

  • Let me just say one thing.

  • We can all put the numbers up there.

  • Brian this is our strongest quarter of the year; we're going into our strongest quarter, it looks to the our strongest quarter and I think that says it all.

  • What we put out, we always put out conservative numbers.

  • Brian Ruttenbur - Analyst

  • Yes, because right now it is just looking like single digit bookings growth, so that seems to be relatively conservative given historical.

  • Unidentified Company Representative

  • Isn’t going to happen.

  • Brian Ruttenbur - Analyst

  • Moving on to another question, SG&A.

  • It was down as a dollar amount.

  • Should we expect that going forward, or was there some anomaly?

  • Dan Behrendt - CFO

  • We did have some anomalies during the quarter.

  • As I mentioned, on the call we had some expenses relating to our annual shareholders meeting and also our tactical conference we have with our users each year.

  • Both of those happened in the second quarter, obviously they didn't repeat themselves in the third quarter.

  • So we expect SG&A to maybe creep up slightly into the fourth quarter.

  • We've got some expenses for our PR firm which we hired at the end of the third quarter, which will be in the fourth quarter numbers, but I don't expect a dramatic increase going forward.

  • Brian Ruttenbur - Analyst

  • Okay, and then on R&D, you had R&D drop in half.

  • I didn't know what was going on there.

  • Was that just ending of projects or what?

  • In the third quarter you went down to only spending 100,000 and you had been spending 2 to 300.

  • Dan Behrendt - CFO

  • That is just a bit of a timing difference for the quarter, we expect the spending for R&D to increase as we move forward.

  • Brian Ruttenbur - Analyst

  • Back to kind of historical levels first, second quarter?

  • Dan Behrendt - CFO

  • That's right.

  • Rick Smith - CEO

  • This is Rick chiming in on that as well; some of our Government contracts ramped up in the first half of the year.

  • So some of the things that get allocated towards research and development, particularly outside consulting etc. we are kind of a holding pattern as we look at the next stages on some of those contracts.

  • I would also point out that of our engineering department, they both do R&D and manufacturing support.

  • So most of those salaries actually get sucked into SG&A.

  • So we are probably -- we are spending more in R&D in terms of time effort and energy than is reflected in the numbers.

  • But I think as we move into next year, one of my directives as CEO at this point is not to be as focused on the absolute bottom line performance as on growing the top line and continuing to own this marketplace through continued innovation.

  • So I am giving directive to your R&D folks to really beef up the staff and start to separate so we have a dedicated R&D staff and a dedicated manufacturing support engineering staff that will be more productive by doing that and bringing more products out faster.

  • R&D is definitely lower this quarter than you should see in the future.

  • Brian Ruttenbur - Analyst

  • Okay, and then finally on gross margins, they were up at astronomical levels.

  • The highest we've seen.

  • Is that sustainable, or is that having to do with anything with the inventory build?

  • Is this a onetime thing, or can gross margins be maintained here?

  • Dan Behrendt - CFO

  • We do feel the gross margins can be maintained going forward.

  • We had fairly high scrap rate in the quarter which gives us an opportunity to maintain the gross margin going forward if we can continue to make improvements in that area.

  • So we do feel part of the improvement in gross margin is also driven by just increased leverage.

  • We saw our indirect cost stay relatively flat with the increase in sale.

  • So that is something that as we continue to try and keep costs under control here as we grow, we hope to see that leverage moving forward as well.

  • Brian Ruttenbur - Analyst

  • Did it have anything to do with shipping a higher percentage of Xs versus Ms, or I didn't know if there was anything with the business mix that I could look to?

  • Dan Behrendt - CFO

  • Absolutely if you look at the mix of the X versus the Ms, there is definitely a higher percentage of Xs shipped this quarter versus last quarter which did help our gross margins.

  • We also saw a slight improvement in the average selling price during the quarter as well.

  • Brian Ruttenbur - Analyst

  • Where did that move to?

  • The average selling price?

  • It went up 1 percent, $5?

  • I didn't know if you can give me something tangible to grab on to --.

  • Dan Behrendt - CFO

  • Up about 3 percent.

  • Brian Ruttenbur - Analyst

  • Up about 3 percent, from second quarter?

  • Dan Behrendt - CFO

  • That's right.

  • Unidentified Company Representative

  • We actually shipped less cartridges too.

  • If you look at the cartridge ratio they dropped about 12.8 to 13.2, and remember cartridge margins are lower than X margins.

  • So by shipping more weapons and less cartridges we actually helped the gross margins as well as both the mix, in that category, as well.

  • Brian Ruttenbur - Analyst

  • So it had nothing to do with inventory?

  • Dan Behrendt - CFO

  • No, no.

  • Brian Ruttenbur - Analyst

  • And the final question, on big potentials that we should be looking for in the fourth quarter.

  • Obviously everybody has been talking about Houston, that's been in the press a lot.

  • Detroit has been in the press a little bit.

  • The UK, what are the big ones out there beyond Houston?

  • Is it Detroit, is it something else?

  • Unidentified Company Representative

  • To be honest we have heard about Detroit as well.

  • We have done several meetings up there, I don't see that going into the end of the year.

  • Houston, obviously everybody has seen it, it is on the agenda tomorrow for the city council, they may or may not vote on it.

  • They have the opportunity for a council member to tag it, which means they would push it out to the next meeting, which is a couple of weeks if they want more information.

  • Obviously we will be in attendance, but that is obviously at the top of the list in terms of agencies, number four in the country.

  • We do have several other large cities that we've been working with.

  • And again, trying to nail down whether it will happen in Q4 or early next year we are not sure, but we do see and obviously feel confident in the increased guidance that we are giving that we will be able to get several of these to come on board.

  • Brian Ruttenbur - Analyst

  • I said that was the last one, but is your goal going forward to have zero in backlog?

  • Unidentified Company Representative

  • Yes.

  • Brian Ruttenbur - Analyst

  • Okay.

  • Unidentified Company Representative

  • As close as we can get barring any special requests at the end of the quarter, any large orders that we just physically don't have the time to get it put together and get out.

  • Brian Ruttenbur - Analyst

  • Okay, great.

  • Thank you.

  • Operator

  • Unidentified Company Representative

  • Literally the last couple of weeks, Kathy and Operations, they were shipping orders the same day they were coming in the door.

  • Brian Ruttenbur - Analyst

  • Great.

  • Thanks.

  • Operator

  • James Baker.

  • James Baker - Analyst

  • Congratulations to all of you people on a continuing great job.

  • When do you move, Tom into the new space, into your new facility?

  • Tom Smith - President

  • The scheduled completion date is the end of January, and our move would be sometime in the mid February timeframe, mid to late February.

  • James Baker - Analyst

  • Good, so that never has been delayed.

  • That is just right on schedule, right?

  • Tom Smith - President

  • It was originally scheduled at the end of this year.

  • We did have a little bit of a delay.

  • But like Rick said, our contractor has done an outstanding job in tracking this project and moving it forward.

  • And it does look like it's going to be first quarter -- it may slip a week or two in there, but we do anticipate the move happening in the first quarter.

  • James Baker - Analyst

  • Yes, well, in my opinion for what it's worth the "pinko" liberal media people up there have been trying to help some of their friends or contacts through friends or whatever to help the people who are short of stock in the major way they are is (indiscernible) all of us know.

  • And personally, again for what it's worth, I believe anyone who's short the stock is going to die a financially agonizing death and they deserve it.

  • Unidentified Company Representative

  • Well, we appreciate the support and obviously our numbers continue to speak for themselves and we're focused on the business and expect to continue to see it grow and we appreciate all the support the (indiscernible) institutions have with us.

  • Unidentified Company Representative

  • One thing I've got to say, Jim, and I have to agree with you, is we've got 9.5 percent penetration -- I mean, it doesn't take a great leap of faith to see that growing.

  • I mean, my God, that's less than 10 percent.

  • And you can see it's accelerating, all you have to do is go out and talk to our customers about what they think of this product and you'll get a pretty good feel for what the potential is for the rest of the 91 percent that we don't get have covered in the U.S. law-enforcement, not to mention Europe, Latin America and the rest of the world.

  • So with that, next question.

  • James Baker - Analyst

  • Let me say finally, Phil, you've been a tower of strength for stockholders.

  • Anyone who will answer a call from a stockholder while he's barreling down the highway in a motor home pulling a Suburban at 80 miles an hour, that's dedication, Buddy.

  • Unidentified Company Representative

  • It's a threat to public safety, too.

  • James Baker - Analyst

  • Yes, I don't think you dad ever worried about that.

  • But I'm still going to get a Corvette that will outrun that 911 Turbo, Phil.

  • Congratulations, Phil.

  • Phil Smith - Chairman of Board

  • You live out here now, Jim, bring it on over.

  • James Baker - Analyst

  • Okay, buddy.

  • Congratulations to all of you.

  • And Phil, fantastic, buddy, you can retire with the knowledge that you've been on top all the way.

  • What a great family, what a great management team and great product.

  • We really appreciate all of you.

  • And Phil, you've just been great.

  • Thank you.

  • Phil Smith - Chairman of Board

  • Thanks, Jim.

  • We all appreciate it.

  • Operator

  • Sada Parick (ph), the Robbins Group.

  • Sada Parick - Analyst

  • Good morning, gentlemen.

  • Can you just elaborate a bit on the scrap issue as to how much of an impact it had on gross margins?

  • Kathleen Hanrahan - COO

  • Sure.

  • The scrap actually increased by about 1.5 percent of sales in Q3.

  • That was a result of some new methods that were introduced on the floor to keep the finished product quality at its highest for the customer.

  • We also put some new testing procedures in place.

  • On our M26 product, they completely redesigned how we put the coil, which is the high voltage portion of the weapon, into place.

  • So we scrapped existing inventory that we had and went forward with a new process.

  • We've made a lot of improvements.

  • We set of some quality improvement teams to actually address the issues on a going forward basis.

  • In the first 3 weeks of the quality team we actually eliminated the number one cause of fallout on the X26-Coil.

  • So I'm really excited about the team we have and the work that we are doing.

  • Sada Parick - Analyst

  • So just going forward they'd probably be lower (multiple speakers)?

  • Kathleen Hanrahan - COO

  • Absolutely.

  • That's our objective in operations is to get that scrap number down.

  • Unidentified Company Representative

  • And there is an inherent scrap that we do as part of testing our cartridges.

  • We do test fire those regularly.

  • So obviously we aren't going to see that the to zero because there is an inherent scrap number built into the process of putting these together to further validate our quality.

  • So we do expect another to go down in total, but we do expect that we will continue to see scrap just because of it's part of the process.

  • Kathleen Hanrahan - COO

  • Right?

  • The other thing that gets the scrap number on a quarterly basis is at the end of each quarter we take a look at how many products we have in the field, how many units we've shipped and our return rate.

  • And the accounting department also does an accrual for reserve.

  • That hits the scrap as well.

  • And that's a conservative way of protecting the company and its shareholders from any big returns in the future.

  • Sada Parick - Analyst

  • Okay.

  • I'm just going to head out to -- you said that 1150 are the (indiscernible) full deployment.

  • And you are penetrating about 6,000 different departments at this point.

  • Do you have any indication as to when these remaining departments will probably go ahead and buy one for every officer?

  • And what potential size is this?

  • Tom Smith - President

  • Well, it ranges across the board, and it ranges in time frame.

  • We do have 1,150 out of 6,000 that are on full deployment, and you saw it went up almost 25 percent during the quarter because the departments usually start with a pilot program, they start with test and evaluation, they see the results for themselves and those tests can range from 30 days to the larger agencies like NYPD where it's 3, 4 years.

  • So to really nail down when they're going to do it is a factor of seeing the results of their command staff making a decision of working with the city government to get the budget approved for it.

  • So there's a variety of factors in there.

  • So obviously we believe that more and more of these will continue to go full deployment and it ranges from the one and two man departments to the larger departments.

  • Again, as Rick said, we've got all the top five agencies at some point in the use of this and, to put a number on it, we just -- again, we have to look at the totality of the circumstance.

  • So, we're going forward and believe we'll see continued acceptance of full deployment with our current users and new users.

  • Unidentified Company Representative

  • I think the questions that was asked was what's the penetration of those other departments you don't have, not the ones you have.

  • So that question is we have about two-thirds of the departments that still don't have the weapons.

  • And answering that is just the old question, I think we've got the early visionaries, the early adopters and the luminaries -- the visionaries have the product.

  • I think now we're going to start to get into the main market out there.

  • We really haven't penetrated two-thirds of the departments.

  • We have roughly 6,000 and they're still 12,000 out there.

  • And I think it's a long, slow process to get the information.

  • But I think it is starting to get out there, and I think we will start to see that pick up in 2005.

  • Sada Parick - Analyst

  • What do you think is a factor that's -- I mean, address change the remaining departments from at least trying out the weapon initially?

  • Why is there this delay?

  • Unidentified Company Representative

  • A lot of people don't like change.

  • That's the simple fact.

  • People don't like change and they're slow to move.

  • I mean, this thing has been out there for 4 years now, and look, we still have -- or 5 years.

  • We started in December of '99, and the next couple months we'll be 5 years at this, and we've gotten -- that long.

  • But the acceleration rate is picking up, the word is getting around, they're going to conferences, they're hearing guys.

  • If we get Houston, that's number four in the country.

  • We have Phoenix is number six.

  • That word starts to spread pretty quick, and I think you'll see more acceleration in 2005.

  • But other -- lack of information, lack of money.

  • I think doing big deployments is probably lack of money, getting them to start with the deployment is just resistance to change.

  • That's all I can attribute it to.

  • I can't tell you anything else.

  • Sada Parick - Analyst

  • Okay.

  • And just a quick question on the consumer -- the X26C.

  • As far as I understand, you do not mandate training for customers to buy this.

  • I was just wondering what is the Company doing to prevent unintended use in the sense -- I mean, apart from obviously checking the background?

  • Is there any other way that you're going to try and show that it's not used in a manner it's not supposed to be?

  • Rick Smith - CEO

  • Let me take that one, Phil.

  • This is Rick from Prague.

  • A couple things.

  • First of all, every unit that is shipped comes with a DVD that has a 40 minute training program on it, and it comes with a voucher that's good for a free 1-hour training class in your home with a police officer provided you don't live in the Aleutian Islands or someplace out where we don't have an instructor.

  • And we pay those instructors out of a voucher that's in the box to come and train you in your home.

  • So we do believe very much in training.

  • But we don't think that making it mandatory was feasible, again, just because that would be a real disadvantage to people in remote locations who may not be able to make it to a training.

  • And the device is easy enough to use that we thought a DVD was sufficient, although we prefer that they get trained with an officer.

  • In terms of what we're doing to prevent criminal misuse, again, I think this is something that sets our company apart from anybody else out there.

  • Not only do we run background checks that are not required by law, both Social Security number and background checks that validate not only against felony checks but also against the terrorist watchlist through one of the largest law-enforcement information providers, CheckPoint.

  • We also register the device to the end-user and when they fire it, it disperses ID tags printed with the serial number of that cartridge.

  • So we can track down -- if it is misused we can track down the registered owner of that device.

  • In fact, I have a letter that just came in from Florida this past month where an agency down there had a crime that was committed against an elderly person with an M18 TASER.

  • And they were able to use the tags, work with us, track the subjects down, arrest them and put them away because of the things that we do, none of which are required by law.

  • And I know of no other company in the self-defense industry that does anything like what we do.

  • But we pride ourselves on being ahead of the curve and doing the right things to be as responsible as we can.

  • And we're always open to more input and more feedback about innovative ways to keep these out of the hands of the bad guys.

  • Sada Parick - Analyst

  • And one final question.

  • The Company (indiscernible) significant amount of cash.

  • What is it going to be used for?

  • I mean, what is the intention?

  • Rick Smith - CEO

  • Again, I'll take that one.

  • This is Rick again.

  • At this point we're in I think what could fairly be characterized as an explosive growth market.

  • And right now we don't know for sure where that cash is going to be used.

  • We've been using it for building a new building, we've been paying cash and yet cash still tends to accumulate on our balance sheet.

  • I think it would be imprudent for us to do something like disbursing the cash to our shareholders because the nature of the business with the growth cycle we're in makes it very hard for us to predict the future.

  • And that cash -- it certainly belongs to our shareholders, we're being good custodians of it.

  • I think you can see in our spending patterns, we're very careful with a dollar.

  • But we feel it's best to keep that on hand because strategic opportunities may arise.

  • If the consumer market does start to take off and we need to plow a lot of money into promotions there or for other strategic investments either in new technologies or bringing new things into production.

  • I mean, there's lots of things you can imagine, and we think it would just be unwise of us to do anything but sit on the cash right now.

  • We look at that as an option for us to execute very quickly on opportunities as they arise.

  • Sada Parick - Analyst

  • All right.

  • Thank you very much.

  • Operator

  • Dick Ryan, Feltl & Co.

  • Dick Ryan - Analyst

  • Dan, I'm not sure if I caught it, but did you give a revenue breakdown between cartridges and units?

  • Dan Behrendt - CFO

  • No, I didn't.

  • The cartridge revenue for the quarter was about $4.3 million.

  • Dick Ryan - Analyst

  • Okay.

  • Dan Behrendt - CFO

  • Perhaps it would be the unit itself.

  • Dick Ryan - Analyst

  • Sure.

  • Do you have the number of orders and order size for the quarter at this point?

  • Kathleen Hanrahan - COO

  • Dick, we had 2,988 orders and it was roughly -- and I don't have the number in front of me -- roughly 6,000 per order.

  • We saw a lot of big agency orders come through in Q3.

  • Dick Ryan - Analyst

  • Yes, if I recall that's up pretty significantly from Q2.

  • Kathleen Hanrahan - COO

  • Yes, it is.

  • We were averaging right around 3,000 and it did jump.

  • The military orders also had an impact on that.

  • Dick Ryan - Analyst

  • Sure.

  • Kathy, what's the production capacity now?

  • Kathleen Hanrahan - COO

  • What we did in Q3 was an average of 400 X's a day.

  • We had several days where we actually produced 700 to 800, which is sustainable as long as I've got the material flow moving down the line.

  • Cartridges are about 4,000 a day, and are M26's, we build roughly 100 a day just to stay up with the sales.

  • Dick Ryan - Analyst

  • Okay.

  • So Rick, you mentioned an independent study out of Australia yet I didn't see that in the slides as you were talking about.

  • What are you expecting there?

  • Rick Smith - CEO

  • Well, we've actually seen the independent studies that were done for the Australian government.

  • We have not put them on our website because -- Tom, you were actually going to check on that as to whether that study could be publicly released.

  • Tom Smith - President

  • Yes, we have not gotten an answer back yet.

  • The initial report that came out had confidential on it, so until we get the clearance we can't make it publicly available.

  • Dick Ryan - Analyst

  • Great.

  • That takes care of it.

  • Thanks.

  • Operator

  • Chris Best (ph), SAC Capital.

  • Chris Best - Analyst

  • First congratulations to Phil.

  • You made a great bet on your two sons and have a great time in retirement.

  • Phil Smith - Chairman of Board

  • Thank you.

  • Chris Best - Analyst

  • Secondly, just a clarification.

  • I believe it was Rick who was talking about -- you talked about investing in the business and I'm looking to model your company going out.

  • What targets -- I know you don't want to talk about the revenue side for '05, but what targets should we be thinking about in terms of operating expenses?

  • Obviously you're going to have the new building.

  • You have the opportunities in Europe.

  • What should I be thinking about in terms of operating expenses over the next several quarters?

  • Unidentified Company Representative

  • Dan's actually taking a look at that in terms of the new building.

  • You might share that with Chris.

  • Dan Behrendt - CFO

  • Taking a look at the new building, I really don't expect the new building to really change our cost structure.

  • We've got actually four different facilities we're running right now.

  • So we're going to be eliminating a fair amount of rent as we move into the new facility.

  • So I think long-term the cost structure is not going to really change appreciably because of the new building.

  • Chris Best - Analyst

  • And then in terms of investment, in terms of capturing European opportunity, is there an operating margin target we should be looking at longer-term, or longer-term margin target that you are focused on?

  • Rick Smith - CEO

  • At this point the honest answer is no.

  • We are going to be working in the next few weeks here putting together our planning and budgets for next year.

  • We've really been focused on delivering the growth this year, getting new ERP in place.

  • We're very tactically focused.

  • I would say on our next quarterly conference call we will be able to give you some better numbers for next year but I would say certainly you would expect to see a big increase in R&D as an absolute value.

  • I don't know that it is going to be more than a couple percent of sales just with the sales growth rate that it is at.

  • Chris Best - Analyst

  • In order to capture the European opportunity, you think you will have to -- I mean should I assume a rampant SG&A in my model?

  • Or do you think that you can leverage your current infrastructure?

  • Rick Smith - CEO

  • At this point I would not expect an increase as a percentage of sales, but the sales on absolute terms I think, Tom would you agree with that?

  • Tom Smith - President

  • Yes, I would, I was going to say the same thing.

  • I think we will be able to leverage it off our growth.

  • Unidentified Company Representative

  • That will wrap up our quarterly conference call.

  • Again we appreciate all the participants.

  • We are very proud that we were able to present this to you today, and we will talk to you early next year when we wrap up of 2004.

  • Operator

  • Ladies and gentlemen, thank you for joining today's conference.

  • This concludes the presentation.

  • You may now disconnect.

  • Good day.