Axon Enterprise Inc (AXON) 2007 Q3 法說會逐字稿

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  • Operator

  • Good day, ladies and gentlemen, and welcome to the third-quarter 2007 TASER International earnings conference call. My name is Carmen; I will be your coordinator for today. We will be facilitating a question-and-answer session towards the end of this conference. As a reminder ladies and gentlemen, all lines are in a listen-only mode. (OPERATOR INSTRUCTIONS). I would now like to turn your presentation over to your host for today, Mr. Rick Smith, CEO of TASER International. Please proceed.

  • Rick Smith - CEO and Director

  • Good morning, everyone. Before we get started here, let me turn it over to our General Counsel, Doug Klint, for the formalities.

  • Doug Klint - VP and General Counsel

  • Certain statements contained in this presentation may be deemed to be forward-looking statements as defined by the Private Securities Litigation and Reform Act of 1995, and TASER International intends 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 markets, growth expectations for new and existing accounts, expansion of production capability, new product introductions, product safety 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. Such factors include, but are not limited to, market acceptance of our products, establishment and expansion of our direct and indirect distribution channels, attracting and retaining the endorsement of key opinion leaders in the law-enforcement community, the level of product technology and price competition for our products, the degree and rate of growth in the markets in which we compete and accompanied 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 and risk of new technology, new product introduction risk, ramping manufacturing production to meet demand, litigation resulting from alleged product-related injuries and death, media publicity concerning product uses and allegations of injuries and deaths and the negative impact this could have on sales, product quality risk, potential fluctuations and quarterly operating results, competition, negative reports concerning TASER device uses, financial and budgetary constraints of prospects and customers, dependence upon sole and limited source suppliers, fluctuations in component pricing, risks of government investigations and regulations, TASER product tests and reports, dependence upon key employees, employee retention risk, and other factors detailed in the Company's filings with the SEC.

  • Rick Smith - CEO and Director

  • Before we get into the numbers, I'm proud to report to all our shareholders that our chairman, my brother, Tom Smith, was on squawk box this morning. And I think we saw a real rapport with Tom and the anchors there as they talked about TASER entering the popular lexicon, and even going back and forth a little but about "Don't tase me, bro" and just how powerful frankly our brand has become over the past several years.

  • We're now at over 90% brand awareness of the TASER name, which really positions us well for our continuing launch into the consumer market space. And of course, we're very proud to have delivered yet another record quarter in terms of revenue at $28.5 million, which beat our previous record by 10%. It showed a 56% increase over the prior year. Also turning in $6.9 million in operating income, or 24% operating income and $6.2 million of net income; that's $0.10 per basic or $0.09 diluted earnings per share.

  • Now the reason that the net income was so close to the operating income was that Dan and his group had a nice win with net income being positively affected by a research and development tax credit study that they completed this quarter. And as a result of the study, the Company recognized $1.8 million in the current quarter and year-to-date as a reduction in income tax expense.

  • Let's talk about some of the achievements we saw in the third quarter before we get too far into the numbers. We continued to see growth in our base business as well as significant sales orders which included Miami Dade County, the Police Department there, Kern County Sheriffs, San Diego; Brevard County, Onondaga County Sheriff's Office in Syracuse, New York, which is good. We've seen real growth and strength in the Northeast, which has not been one of the early adopters for us. We're seeing that part of the country starting to come on strong.

  • And we also ended the quarter with a big order from the California Highway Patrol, which is exciting in two regards. First, they're clearly seen as [fog] leader among agencies and among state patrol, and also the fact that (inaudible) use of demand and our production capacity expansion, that order actually pushed into the fourth quarter, along with some other orders. That gives us a good base of revenue to start from, leaving us very excited about the fourth quarter.

  • In the international sales area, international sales contributed 15% of our total sales in the quarter. Again that was sort of a positive surprise for us. Q3 tends to be particularly weak, as many of our European customers sort of go on hiatus during the month of August and early September. It included an order from the French ministry, for 1249 X26s.

  • We also did have orders from some other countries and just to reiterate we generally do not relates the names of new countries coming online for a variety of security reasons, for our customers as well as to minimize some potential controversies as they get started. But with the French being pretty mature in the process, we will continue to update folks on France and the UK.

  • Also, in addition to the international markets, we saw several federal agencies coming on board with significant orders from the US Forest Service, the US Marshall Service, and an unnamed federal law-enforcement agency opening a new market space for us. We commenced shipments of the TASER C2 personal protector. We shipped around 7000 units in the quarter, and we ended the quarter with a significant backlog, and Kathleen and her crew are continuing to ramp production there.

  • And we also introduced two new product lines, two sort of radical new product concepts at our conference in Chicago. The TASER Shockwave was the first, and that is a command-activated area-denial system; a modular six-shot TASER device that covers a 22-arc area with a range of 25 feet. This device was designed largely with input from our military advisory board, advising us about some of the challenges our men and women are facing in Iraq and the need for the ability to have area denial system that can very quickly and non-lethally incapacitate people that encroach on certain areas, such as areas around checkpoints where you might have suicide bombers or other people coming in where today our military is faced with the choice of using lethal force or no force at all.

  • There is a real need for this intermediate force option as they escalate for us in the face of uncertainty. We've received tremendously positive feedback on the Shockwave, and expect that to be a real new market opportunity for us in 2008.

  • We also introduced the eXtended Range Electronic Projectile. We've been working on this for some period of time. As our shareholders well know this has been a long and very exhaustive technology development program. We're getting to the end of the road there, and buttoning up all of our prereleased (inaudible). We expect to begin the field testing on the 1-gauge wireless XREP projectile in early 2008; the same with the Shockwave.

  • We would say from a financial modeling perspective, the earliest we would see significant revenues would be the second half of 2008, and that will depend on what we learned in field testing. Given that these are both pretty radically new technologies we're being very careful at how fast we roll it out and making sure the design is performing in the field the way it has in the lab.

  • Also, Doug and his crew continued their achievements with six more product liability suits being dismissed, for a total of 58 wrongful death or injury suits that have been dismissed or judgment entered in favor of the Company. Overall it seems significant rate reduction in our new litigation that Doug will talk about.

  • We also saw ten new medical and scientific studies announced in the quarter, including the one from the National Institute of Justice by Dr. Bosman, that looked at the comparative injuries of TASER and other devices, and found that the TASER has an extremely low injury and I believe it was about three out of 1000. And of those three I think the only two of which were potentially attributable directly to TASER, and those were injuries primarily related to falls, as I recall.

  • So it a very supportive study that was picked up around the world. We saw a lot of publicity in the UK and elsewhere looking at that study, as the sciences continue to basically support the general safety of TASER devices. And I think Doug will explain that's one of the reasons we have been so successful court, that the science is really pretty compelling.

  • And as we mentioned before, Dan and his group with the research and development tax credit generated another $1.8 million in earnings by reducing our income tax expense. So on that note I'm going to turn over to Kathy Hanahan, our President, to talk about the Company's operations and performance.

  • Kathy Hanrahan - President

  • Good morning. As Rick discussed, Q3 was a record quarter for TASER in terms of revenue growth and market expansion. But we also set a record for our production facility. During the quarter we shipped $28.5 million in revenue which included the first deliveries of our new TASER C2. In total we shipped nearly 7000 C2s to our retail partners, Web customers and existing TASER dealers, ending the period with 5900 units in backlog to be shipped in the fourth quarter.

  • During the third quarter we also converted $8.7 million of inventory into either finished assemblies for shipment or subassemblies to be incorporated into future product. This represents an increase of approximately $3 million over the prior quarter. Much of the increase was in C2 product line but we also saw significant production increases in our X26 and cartridge line assembly operations.

  • The full-scale launch of our C2 did not come without a short-term sacrifice to margins. As with prior product introductions of the new TASER technology we saw that even our best operational plans have assembly complications in the first few months of full scale production especially when you're integrating cutting-edge technology into assembly operations. Although the C2 product has proven to be robust through all aspects of production, it was challenging for our operators to master both the handling and board assembly techniques and build in volumes greater than the initial marketing and test requirement without creating significant line scrap. In addition, we added multiple layers of final testing and quality control screening on our line and in our final kitting operations to ensure that no unit left our facility that did not meet our final quality control specifications though many fully functional units were rejected for minor cosmetic blemishes.

  • To address our yields long-term and ease the manufacturing process going forward, our engineering team modified our production tooling and also slightly modified the printed circuit board designed for better fit and more durable assembly both of which are now in process. But during the quarter to meet market demand, these assembly modifications had to be incorporated into the current inventory through manual rework operations. These operations added significant time to the assembly of each C2 produced in the period and we lost more than 2000 finished assemblies, as well as hundreds of these piece parts to scrap during the rework training and development process.

  • Although the design challenges resulted in excessive cost in Q3, the design changes will significantly improve the manufacturing operations going forward. In fact, we believe we will see a 1.5 to 2% improvement to overall gross margins in the fourth quarter 2007 as a result of the modifications we made late in September.

  • The C2 was not operation's only challenge in the third quarter of the year. We also continued to see product cost rising as a result of increases in raw materials and transportation costs as well as scrap generated by the expansion of our existing line. We believe the labor and scrap cost will be reduced in the fourth quarter as our new shipped operators become more proficient in the assembly operation.

  • And to offset the material increases going forward our materials team took an aggressive stance with leading suppliers for the X26 cartridge and C2 assemblies and worked to reduce the [bill] and material cost, which should result in additional savings going forward. These costs decreases will transition into inventory beginning in the fourth quarter, but will be fully realized in 2008 as our pipeline is replaced with lower-priced assemblies and components. We anticipate based on our forecast sales mix these changes will result in approximate material savings of 2% of sales during fiscal 2008.

  • In closing I want to reiterate that our entire operations team is focused on improving gross margins for the fourth quarter this year and into 2008. We're reviewing our pricing and sales strategies, we've implemented cost reduction with key suppliers, implemented pilot programs to better measure and report on labor efficiency and utilization, and we're conducting studies to further expand automated equipment to perform key processes in our product assembly and further reduce our total labor cost. Our future looks bright and we're excited about the further introduction of new products and services for our customers and the expanded market acceptance of our new TASER C2. With that I'd like to turn the call over to Dan Barron, our CFO.

  • Dan Behrendt - CFO

  • Let me just go through the income statement first for the quarter. Sales for the third quarter, as Rick indicated, are $28.5 million which does set a new record for the highest quarterly sales in the Company's history with our sales up 55.8% over the prior year; our gross margins for the quarter of $16 million or 56.1% of sales.

  • As Kathy indicated, the degradation in gross margins were caused by lower labor efficiencies, higher scrap expenses and material costs as well as change of mix from the prior year as more our sales are coming from cartridges, the C2 handles and TASER CAMs which carry a lower gross margin than our TASER law-enforcement devices. We have 33.9% of our sales from those lines versus 24.8% of sales in the third quarter of 2006 on the same product lines.

  • The Company did experience higher direct labor costs during the quarter due to some of the inefficiencies associated with the new production employed as well as higher temporary labor and overtime costs incurred as we expanded our labor workforce to meet growing demand for existing products and launch the TASER C2. These items contributed to a 2.6% increase in direct labor as a percentage of sales versus the same quarter in 2006. We do expect that labor efficiencies will improve as we move into the fourth-quarter 2007, and our staff is fully trained.

  • The $2 million increase in indirect manufacturing expenses are mostly driven by higher scrap during the quarter due to costs associated with the initial production builds of the C2, as well as higher X26 scrap. We also incurred higher indirect wages due to increased headcount and quality, manufacturing and engineering and materials areas to ensure that we can adequately support the ramp of production for our products as we added a second shift in many of our lines during the quarter. As our new products come to market, we expect to get better leverage out of these costs.

  • We do expect to see sequential gross margin improvements in Q4 as the higher levels of scrap associated with initial production of C2 dissipate, and material labor savings and progress initiated earlier in the year began to bear fruit. SG&A expenses were $8.1 million for the quarter versus $7.1 million in the prior year. The variances were driven by higher salaries and benefits of $418,000 as we increased our headcount, increased bonus expense of $195,000 due to the improved operating performance, and $495,000 of higher travel and meals expenses which are mostly driven by our annual user conference which took place this year in July versus June in the prior year. These unfavorable variances were offset by lower legal fees of $704,000 due to lower activity in the quarter and two cases hitting the Company's (inaudible) protection so we're no longer having to fund those cases.

  • Research and development expenses were $979,000 for the quarter which is an increase of $206,000 over the prior year, mostly driven by higher salaries and increased tooling costs. The Company intends to continue to invest heavily in R&D spending going forward and we'll -- but we are seeing a lot of new products come to market. So we're definitely getting pay off for those investments.

  • Income from operations were $6.9 million and the Company had pretax income for the quarter of $7.4 million. The pretax income is up $3.2 million or 75% versus the prior year, due to the follow-through on the higher sales. Net income for the quarter was $6.2 million or $0.10 per share basic and $0.09 per share diluted basis.

  • Year-to-date our sales were $69.7 million; this is up $21.3 million or roughly 44% over the prior year. It's good to note that our year-to-date sales through September actually exceeded our total sales in 2006. Gross margins are $40.4 million or 58% of sales are down versus prior year, again due to some of the material costs on the components as well as the Company selling a higher proportion of cartridges and TASER CAMs which carry a higher percentage of material content. The cartridges and TASER CAMs constituted 29.5% of the sales year-to-date this year versus 24.7% of sales in 2006.

  • We did also experience higher direct labor costs due to some of the inefficiencies associated with the new production [employed], costs associated with initial builds of the C2 and the XREP as well as higher temporary labor and overtime costs in the quarter. Direct labor actually increased by 1.6% of sales in 2007 versus 2006 but again we expect we will see improvements in direct labor as we move into the fourth quarter and then into 2008.

  • The $3.8 million increase in indirect manufacturing expenses were mostly driven by higher scrap, higher indirect wages due to increased headcount to support the higher sales levels, increased supplies to support the production of the C2 as well as higher warranty reserve related to the higher sales levels. On the SG&A line, SG&A expenses are $24.1 million year-to-date versus $21.9 million in the prior year. The variances are driven mostly by higher salaries and benefits of $1.1 million, higher travel and meal costs of $495,000, higher bonus expense of $446,000 due to improved operating performance, and higher consulting costs of $356,000. These unfavorable variances are partially offset by lower legal fees which are $941,000 lower in 2007 than 2006.

  • Research and development costs of $3.2 million year-to-date, which is an increase of $1.2 million again, driven mostly by salaries, $552,000 and increased supply and tooling cost of $467,000. Year-to-date income from operations were $13.1 million, and we had a year-to-date pretax income of 14.6. Pretax income is up $24 million over the prior year due to the [fall through] on increased sales as well as the shareholder lawsuit which was recorded in 2006. Net income for the year is $10.3 million or $0.17 per share basic and $0.16 per share on a diluted basis.

  • To move onto the balance sheet we finished the quarter with actually $53 million of cash investments. This is an increase of $5.2 million over the prior year. Accounts receivable of $13 million is up $2.9 million from the prior year-end balance of $10.1 million due to the significantly higher sales levels in the third quarter of 2007 versus the fourth quarter of 2006.

  • The DSO is actually 41.1 days, which is down approximately seven days from the year end total. Inventory of $10.9 million is up $1.6 million from the prior year due to an increased work and process inventory built to support the higher sales levels. Prepaid and other assets of $2.4 million are up roughly $200,000 from the year end levels, just due to increase in prepaid advertising relating to the production of an infomercial to support the new C2 product.

  • Deferred tax asset is down sharply, but that's just a re-class for the long-term deferred tax asset that you see further down to the balance sheet. Current assets of $62.1 million; this is up $6 million from the prior year mostly driven by increased accounts receivable and cash.

  • The [property plant] equipment of $22.8 million is up $1.9 million for the prior year. This is driven by the initial payments on the new automated production equipment of $1.5 million, purchases of C2 production equipment of $632,000, and the cost associated with the Company's new website of $335,000.

  • Total assets finished the period at $128.7 million, up $8.9 million over the prior year's total assets of $119.8 million. On the liability side of the balance sheet, accounts payable and accrued liabilities of 7.5, roughly $733,000 for the prior year due to the increased purchasing activity.

  • The deferred revenue of $1.5 million is up from the prior year balance of $1 million due to the sale of more extended warranties in 2007. The customer deposits are up versus the prior year due to prepayments on orders. And litigation settlement liability is now zero as we made the final payment via the issuance of stock at Q2 to settle the last of the shareholder driven lawsuits.

  • The current liabilities are $9.9 million. This is a reduction of $8.4 million, again driven by the shareholder and (inaudible) lawsuit settlement payments. Deferred revenue net of the current provision increased by $1.1 million to $3 million due to the sales of extended warranties. In total liabilities ended the period at $13.7 million, and we finished the quarter with $115 million of shareholder equity.

  • So we move onto cash flow. The Company had operating cash flow of $6.7 million for the year compared to our cash generation last year of $9.5 million. The cash generated actually in the third quarter from operations was actually $9.6 million. So we had a very strong quarter for cash generation of 9.6. We did use $1 million of cash and investing activities. Basically this is mostly made up of the property plant equipment additions we talked about before offset by some maturing short-term investments.

  • We generated $2.5 million (technical difficulty) this is mostly driven by stock option exercise during the year. And the Company ended the period $27 million in cash, which is up $11.1 million from the prior year, again due to the cash flow from operations and the maturing short-term investment. So we ended the period with again $53 million of cash and investments.

  • With that I'd like to turn it over to Doug Klint, our General Counsel.

  • Doug Klint - VP and General Counsel

  • I'd like to give you a brief update on the product liability litigation. We've had a total of 58 lawsuits dismissed, zero lawsuits lost. This number does include a small number of police officer training injury lawsuits that were settled and dismissed in cases where the settlement economics of TASER were significantly less than the cost of litigation. It should be noted that we do not settle suspect injury death cases.

  • We're very pleased to see a significant decrease in the rate of litigation from 2007 to -- from 2006 to 2007 we have seen a 66% reduction in litigation filed against the Company. For example, a year ago we had 13 lawsuits filed against TASER in third quarter. This third quarter we've had only three lawsuits filed.

  • In fact, in 2007 we have had more dismissals and TASER judgments than lawsuits filed, and this appears to be a positive trend going forward. Year-to-date we've had 29 lawsuits dismissed, only 11 lawsuits filed, a net reduction of 18 lawsuits.

  • In addition we have four lawsuits that we filed as plaintiffs. We have two lawsuits that we filed against medical examiners. And it should be noted that we filed these lawsuits to hold these medical examiners accountable for mistakes they made and refused to correct when they were provided with medical studies showing them wrong.

  • We also have a patent infringement lawsuit pending against Stinger. In addition we just filed a lawsuit against two former employees for breach of duty of loyalty, breach of contract, breach of fiduciary duty and conversion. This does not involve our core business and we don't expect this to have a material impact on our financial results.

  • Our litigation strategy is to send such a strong message to our adversaries by overwhelming them with our aggressive defense and resolve not to settle that they conclude that filing litigation against TASER is not a profitable venture. It should be noted that our strategy is not dependent upon winning every lawsuit. Juries are unpredictable. We may very well lose a lawsuit in the future, but if that were to happen we have adequate insurance coverage to cover any anticipated financial loss.

  • We're winning our litigation because plaintiffs have been unable to prove that the TASER device was defective or was the cause of any suspect injury or death. The driving force behind our litigation success is the overwhelming medical and scientific evidence confirming that general safety of TASER technology.

  • Our litigation strategy is beginning to show results, since we have had nine lawsuits that were voluntarily dismissed by plaintiffs in second and third quarter, when it became apparent to them that we would not settle and they realized that the medical and scientific evidence was overwhelmingly in favor of TASER. More importantly we're aware of at least eight instances where litigation was not filed against TASER at all.

  • It should be noted that product liability litigation is not a risk to our customers. Our customers place a very high value on the TASER device in reducing their excessive force litigation and it is an important economic benefit for TASER deployment.

  • Statistics from our customers show marked decrease in excessive use of force claims when the TASER devices have been deployed. Courts have also routinely held that the use of the TASER device does not constitute excessive force, since it has the lowest risk profile for any use of force tool.

  • We're also continuing our efforts to reduce legal expenses. Third quarter outside attorneys fees were reduced by over 50% from second quarter 2007. I would now like to turn the call back to Rick.

  • Rick Smith - CEO and Director

  • Let's talk a little bit about some of the sales numbers. I'm going to start again with international, which turned in 15% of our quarter sales and 17% year-to-date. Again, reiterate third quarter tends to be quite weak internationally so we're very happy with those numbers.

  • I'll take the report back. We really did upgrade the organization when we added our new VP of International Sales, Scott Munson. Scott joined us just before the last conference call, and in the past 90 days he has visited 20 countries. He has spent a lot of time on airplanes, and it's been very encouraging what he is found.

  • Scott comes from a significant international sales background and he has reported back to make that he has never seen distributors so dedicated to a product line as ours. Frankly, when you bring in somebody with a fresh perspective to look at distribution, sometimes you wonder what they're going to find in your existing distribution. Scott thinks we've got people that are as evangelical about our mission of protecting life as we are, and that's very good news for our business and for our shareholders.

  • In fact, Scott said he is far more excited now even than he was when he joined the Company. He sees opportunities for major sales in many countries all around the globe. And while we don't know at what point in time those countries are going to start to pop, his feeling is that there will be Domino effect as we start to see major deployments occurring in the international markets where again, they buy on a national basis generally rather than regional; so longer lead times but big orders. So we look forward to continuing to see good things out of Scott and the international markets.

  • Here in the US we added 578 new agencies for a total of 12,047 agencies deploying or testing TASER technology. We had 294 full deployments for a total of 4075 full deployments. I should point out there the way our sales department categories as full employment is that they've got TASERs available to each patrolman on each shift. It doesn't necessarily mean that they've bought TASERs for every individual officer. In many cases they may still be sharing across shifts.

  • So there are still opportunities for expansion and sales back into those same agencies as they move from what we call full deployment to individual officer issue, where every officer gets a TASER as part of their standard equipment. Again, we're continuing to see a trend where TASER is becoming routine equipment for patrol officers.

  • This quarter in terms of sales and shipments, we shipped 22,651 of the X26 series. We shipped 1530 of the M26 series. We shipped 6932 TASER C2s. Kudos to Kathy and the operations team; you're scaling up from zero and getting those units rolling out the door.

  • Air cartridges, we shipped 374,062 air cartridges. That's a ratio of 16 cartridges per TASER sold. I think it's important point out that is higher than the average that we see historically. We believe that's primarily due to -- we had a military order came in late in Q2, the cartridge portions of that in particular rolled over into the third quarter, and orders from the United Kingdom where they tend to buy a lot of cartridges for training. During the quarter we also shipped 3473 TASER CAMs.

  • On the qualitative front, we saw other achievements during the quarter notably a resolution from NOBLE, which is the national organization of black law-enforcement executives issuing in resolution and support of TASER devices. This continues the political support that we've seen historically from the major City Chiefs, the major County Sheriffs, I believe the National Sherrifs Association as well as the National League of Cities, representing city councils across the country and LULAC, the League of United Latin American Citizens, all coming out and supporting TASER devices as improving community safety.

  • So I mentioned we continue to be very excited about the fourth quarter, with some significant orders sent to the California Highway Patrol rolling over in backlog from the third quarter, giving us a good revenue base to launch into Q4. Also late in the fourth quarter we expect to launch the infomercial for the C2 and that could well be the sleeping giant in this business in that the infomercial will be a highly replicable sales channel for us if it succeeds, and we won't know until the infomercial is running. That gives us the ability to scale up a direct-to-consumer distribution channel that is basically just a factor of our expenditures in advertising.

  • So basically if we see a good return on advertising we can scale that channel up very quickly. We also believe that the infomercial will really drive sales at retail during the educational components. We've of got a host we're very excited about on the infomercial. I think some things are better left unsaid, and we'll keep that one in our hip pocket until we launch. I think you'll all be excited to see who we've got introducing the world to the TASER C2.

  • This quarter as well we continue to see other qualitative things develop that really are what drives the motivators to the business. And those are the incidents where our products are used to protect life. We've seen innumerable attempted suicides, mentally disturbed persons interacting with police, cases where without TASER, lethal force would've been used and lives would've been taken.

  • But with our technology and the professionalism of the men and women of law-enforcement, we are continuing to play a part in saving lives and protecting life and making communities safer. And we believe the new products that you'll see in 2008 will extend our reach, into extended range wireless projectiles in area denial. And there are more systems in development. The black box is busy. You will continue to see innovative new products as we move forward on our core mission again, which is to protect life.

  • So with that, we will wrap up the conference call. I'd like to congratulate everybody on the operations team again for an outstanding job. And let's go ahead and open it up for some Q&A.

  • Operator

  • (OPERATOR INSTRUCTIONS). Eric Wold, Merriman Curhan Ford.

  • Eric Wold - Analyst

  • Good morning. A couple questions on the C2. How much detail can you give in terms of maybe what you saw in terms of sell-through from the retailers? And then of that 6900 units that were shipped in the quarter, what was the mix between directly to consumers through your website and then sell into the retail channel?

  • Rick Smith - CEO and Director

  • Let me first start -- I'll take the question about sell-through. We saw mixed results in sell-through, depending on the amount of in-store training and support. We were doing a number of events across the country where we would go in and we would provide training to the salespeople. And we would do some events, basically where we would have a person there promoting the unit in the store.

  • Where we did that, we saw some fantastic sell-through numbers, frankly. In one case I know we sold almost 20 units out of one retail outlet in one weekend. In other places, where the product was just coming in, and perhaps was not being displayed very well or at least in a prominent location where consumers weren't seeing that it was there, we didn't have the in-store promotions, consumers didn't know it was there, they weren't buying it.

  • So the really encouraging part is in our Company's history we've never had a product where we've seen anything remotely like 18 unit sales out of one store in a weekend. We're now -- and I would also mention during the quarter our focus is primarily on meeting a lot of the backlog and starting to test what types of promotional activities lead to sell-through.

  • We will in the fourth quarter began scaling those activities up. We've just recently shipped out a series of in-store promotional materials that include counter cards, posters, hanging displays that you hang from the ceiling, in-store DVDs. You'll see the infomercial coming in the fourth quarter. As a direct response on television, we believe that will drive a lot of retail interest. You'll see our print ad campaign, which really started in late September, where we have print ads going out in a number of periodicals. You'll see us also looking to replicate some of the in-store promotional activities by offering things like in-store training classes periodically on the TASER and using some of our instructor base to provide that training.

  • So the qualitative answer is, when it's promoted well, the sell-through is very good. Where it wasn't as well promoted or we didn't have salespeople trained in the store, it didn't perform as well. So we've got our work cut out, but when we do it right, the product sells through well.

  • Kathy Hanrahan - President

  • In terms of the shipments and the mix out, it was probably between 10 and 15% that was direct sales for Web orders that had come in from the time we launched in CES to current. And the rest went out to the three new retail partners in our current distribution.

  • Eric Wold - Analyst

  • I know it will be in the 10-Q, but do you have the revenue from the C2 in the quarter?

  • Kathy Hanrahan - President

  • It's approximately $1.7 million.

  • Eric Wold - Analyst

  • To continue on that, obviously you increased production significantly towards quarter end, into this quarter. By going into infomercials towards quarter end, and obviously if that drives more demand from the consumer side directly, does that impact your ability to add new retailers during the quarter, or can they both be done?

  • Rick Smith - CEO and Director

  • We really don't see adding many new retailers in the quarter, because it is the Christmas season. Any major retailers at this point are focused on sell-through. The feedback we're getting from our sales reps in the channels, and it make sense, is that nobody of any significance is really adding product during the fourth quarter. They're all about executing during the holiday season.

  • So we wouldn't expect any major new retail partners until after the first of the year. Of course we'll have a big present at the consumer electronics show again (inaudible) sellthrough being proven at retail which will make it a much stronger case for us, with some of the retailers expand on the sidelines.

  • And of course with the infomercial, which I would also caution -- we may not see a significant revenue impact from the infomercial this quarter because the earliest we think the production will be done and we will be ready to air would be the second week of December. So we might get a couple weeks under our belt in terms of testing. But our infomercial partners who advised us that once you get past about the 16 of December, direct response sales tend to drop off as people are not watching as much TV. They tend to be shopping at retail, they don't want to take the risk if they're buying a gift that it may not arrive in time for Christmas.

  • So in terms of us being able to hit much this year in revenue from the infomercial I wouldn't look at it that way. I would say that that's really a springboard for us into the first quarter of 2008.

  • Eric Wold - Analyst

  • Lastly, you mentioned that a number of the orders that were announced in Q3 or received in Q3 will be shipping in Q4. Do you have a sense of how much of what with kind of the law enforcement orders that were announced in Q3 regarding Q3 actually will ship in Q4, what that cushion was?

  • Rick Smith - CEO and Director

  • We're probably not going to get into a specific backlog, but the CHP was a significant order. It did get pushed and a couple of the other smaller orders we announced also got pushed into Q4. So we've got a good base of business to move into Q4 with. But we're not going to disclose the exact backlog going into the fourth quarter.

  • Eric Wold - Analyst

  • I had to try. I appreciate it, thank you.

  • Operator

  • Steve Dyer, Craig Hallum.

  • Steve Dyer - Analyst

  • Good morning, thanks for taking my call, nice quarter. A couple of mine have been answered. But just kind of to dive back into the C2, how much of the Web backlog -- I think Kathy said 10 to 15% of this initial quarter shipments was Web ordered, if I understood it correctly. How much of that have you worked through, either in quantity or through what month?

  • Kathy Hanrahan - President

  • In terms of the consumer, we should have all of them out the door in the next couple weeks. That was a priority as we got into higher volumes to make sure that we got those customers satisfied along with the new retail partners.

  • Steve Dyer - Analyst

  • Okay, great. And relating to the marketing efforts, is there going to be -- I guess of course there's going to be, but what -- can you quantify the cost associated with sort of upping the marketing there for the C2?

  • Rick Smith - CEO and Director

  • I believe the print campaign on the order about $400,000. The infomercial production costs alone will probably be a little over $500,000 and most likely we will recognize that impact as soon as we run the infomercial. So we would recognize the expense for the full production cost.

  • In terms of the media buys on the infomercial, I would suspect our initial runs will be between $100,000 and $200,000 in media. And then from there, if we're getting a good return on investment, we will [steal] that media [by us] very quickly. We will have a number of different offers we will be testing. The great thing about direct response is, you run the show, and by the next day, you know what the response was. So we will be able to test different types of offers to see what really drives the business.

  • And we'll also look at doing that with some of our retail outlets where we will be drawing different messaging in different media in different markets to -- and then measure the response. I believe that's the most important thing we can accomplish in the next two quarters is to really dial in the recipe of what is effective in moving the C2 so we can really expand it next year.

  • Steve Dyer - Analyst

  • So is that -- just by my math, is it safe to say, $1 million kind of an incremental cost this quarter for that?

  • Rick Smith - CEO and Director

  • That would be right.

  • Steve Dyer - Analyst

  • And Dan, you had said that you expect some improvement here in gross margins as a lot of your C2 difficulties, you work through them. Any idea, can you quantify -- does it bounce kind of back up to that 60% level, or do we not quite get there this quarter?

  • Dan Behrendt - CFO

  • Certainly I think the scrap and some of the initial production cost of the C2 costs is roughly 2% this quarter. So certainly we would expect much of that to reverse itself, and then we will see better labor efficiencies and some of the material cost savings that Kathy and her group have been working on. So I would expect we will be into the upper 50s or 60% certainly by end of fourth quarter.

  • Steve Dyer - Analyst

  • Great. I'll jump back in the queue, thanks.

  • Operator

  • Greg McKinley, Dougherty.

  • Greg McKinley - Analyst

  • Thank you. On the C2, I noticed you had indicated about 7000 units shipped. Does that mean those are essentially revenue recognition on those full 7000 as well, or is there a difference between shipment and revenue?

  • Rick Smith - CEO and Director

  • Pretty much our shipments with the initial retailers, there's no rights to return so we're recognizing revenue on the [sell-in].

  • Greg McKinley - Analyst

  • Okay. And I have recently been visiting some Cabela's and Gander Mountain stores in the area. A couple of them have had the product, several have not. And I was curious, with the 7000 I noticed 10 to 15% are going to the e-commerce channel. But what portion of that is going to these three main retail partners versus maybe just a broad range of smaller distributors, one [of our] firearms dealers, that type of thing? Can you give us a sense for that mix?

  • Rick Smith - CEO and Director

  • Roughly, to the retail partners we had in the 35 to 40% range of -- the initial shipments went to those retail partners. And we've got a lot of two-step distributors we're selling into as well. It's a more efficient way for us to go to market through that traditional gun channel, that's been a good channel for us for our products.

  • So we're going through a number of two-step distributors as well. So we're seeing kind of roughly 35 to 40% with the retail partners, you're aware of, and other -- a comparable amount in the two-step distributors and the rest is going to a direct sales channel.

  • Greg McKinley - Analyst

  • Okay. And could you give us a sense for what type of production run rate you're on now with the C2? I think you said you entered the quarter with 5900 units in backlog into Q4. Is 7000 a reasonable run rate for us to expect on a quarterly basis, or should we naturally assume that escalates meaningfully, now that some of those production hurdles were crossed late in the September quarter?

  • Kathy Hanrahan - President

  • Well we gave the target on the last conference call as 500 a day by the end of Q3, which we hit. And that number is being ramped up now for Q4 to meet demand that we think is coming, both in Q4 and Q1. So you will continue to see the C2 grow in production as well as the X26 and our cartridge line.

  • Greg McKinley - Analyst

  • Okay, thank you.

  • Operator

  • Matthew McKay, Jefferies & Company.

  • Jason O'Connell - Analyst

  • Good morning. This is Jason O'Connell at Jefferies calling in on behalf of Matt. Thanks for taking our questions and congratulations on a great quarter. First question, back to the C2 is, where are you in terms of the ramp up of the second shift?

  • Kathy Hanrahan - President

  • We started the second shift about the last week of the quarter and we're running right now at about 125 people on that shift. So it's coming up very quickly. Again, when you bring new people, you have some temporary hiccups, both in labor efficiency and scrap. But they're coming up nicely.

  • Jason O'Connell - Analyst

  • Has that led to any discussion of potentially expanding to additional X26 shifts as a function of potentially low additional overhead?

  • Kathy Hanrahan - President

  • We also put a second shift on the X26. Right now it's a partial shift, both for the high-voltage assembly which is a subassembly to the X and X itself. We also brought on two more cartridge lines on our second shift.

  • Jason O'Connell - Analyst

  • Okay. I know you've talked a lot about bringing on additional retailers, and how it's not going to happen in this ensuing quarter. Do you have a bead on when you expect to make those additions? Could it potentially be in Q1?

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  • Operator

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