Axon Enterprise Inc (AXON) 2007 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q4 2007 Taser International Earnings Conference Call.

My name is Tony and I'll be your coordinator for today.

At this time, all participants are in a listen-only mode, and we will conduct a question and answer session towards the end of this conference.

(Operator Instructions).

I'd now like to turn the call over to your host of today's conference, Mr.

Tom Smith, Chairman and Founder.

Please proceed, sir.

Thank you and good morning.

This morning, I'm joined by Kathy Hanrahan, our President, and Dan Behrendt, our CFO.

And I'm going to start with the all-exciting Safe Harbor statement.

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 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 markets, 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 innovations, 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 herein.

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, a 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 accompanying demand for our products, potential delays in international and domestic orders, implementation risks of manufacturing automation, risks associated with rapid technology change, execution and implementation risks of new technology, and new product introduction risks, ramping manufacturing production to meet demand, litigation resulting from alleged product-related injuries and death, media publicity concerning product issues and allegation of injury and death and the negative impact this could have on sales, product quality risks, potential fluctuations in quarter operating results, competition negative reports concerning Taser device uses, financial and budgetary constraints of prospects and customers, dependence upon limited source suppliers, fluctuations in component pricing, risks of governmental investigations and regulations, Taser product tests and reports, dependence upon key employees, employee retention risks, and other factors detailed in the company's filings with the Securities and Exchange Commission.

So, 2007, we ticked $100 million milestone; we're obviously very proud of that.

That's a 49% increase over 2006.

For the fourth quarter 2007, we were $31 million, up 61% from the same quarter the prior year.

Obviously, we're very proud of those results, especially despite the ongoing controversies that are shown by our critics in the media out there.

Some of the significant events included during the fourth quarter were shipments that were announced and made to the Houston Police Department, Jacksonville Sheriff's Office, the City of Cleveland, the Kansas City Highway Patrol, Knott's County Sheriff in Tennessee, San Bernardino Police Department and the San Jose Police Department.

We continue to see growth within the law enforcement community because of the successful use of the products in reducing risks and injuries to both officers and suspects.

We also saw continued sales in our international markets, doing $15 million for the year, or accounting for about 15% of our revenue, and approximately $3 million or 10% of that was in the fourth quarter.

We also -- medical studies continue to be a big focus for us, and those continue to come out and get published.

Again, I want to remind everybody that the medical studies that as they get completed, usually take anywhere between 6 and 18 months for them to go through a peer review process prior to publication.

So a lot of the studies and the work that had been done in the past, we have to wait and cannot comment on until they have gone through that peer review process.

And most recently, almost 75 - 80% of the studies that are being published these days are completely independent of Taser, and I think that's one of the big impacts that it is having when people are evaluating Taser technology.

The United Kingdom Defense Science and Technical Labs published a study that they had reported previously, which again showed the significant safety margin that they determined and very minimal cardiac risk for any dysarrythmias; that was again, a ground-breaking study and that was done in the United Kingdom, completely independent of Taser, and really, again, goes to the safety of the device.

That medical science has also continued to support our legal department with three more product liability suits dismissed during the fourth quarter, bringing a total of 61 wrongful death or injury suits that have been dismissed or judgment entered in the favor of the company.

Our legal staff obviously has been able to continue to do impressive work as they have driven forward, and it is based on the science behind the technology, and a lot of that now is carrying over to what we're seeing overseas, in addition to our critics becoming more active.

And we're still focusing on a product education campaign as they continue to come out with bad and misinformation.

And we'll take those on any day, and talk about them any time, because again, the science is why we're win in the court, the science is what's protecting the officers in the department and that's why we're seeing those uses continue with our products.

So with that, I would like to turn it over to Kathy Hanrahan, our President, to go though our operations.

Good morning.

As Tom explained, we're extremely pleased with the sales growth -- both in the United States, as well as the foreign markets during 2007.

Our sales team worked hard to achieve the $100 million milestone, but also to lay the foundation to further grow the sales pipeline in 2008.

Despite the strong revenue growth seen in 2007, our margins did not demonstrate the same forward growth.

Therefore, I'm dedicating my commentary on this call to the comparison from 2007 to 2006 and the corrective processes already implemented to improve our margin performance going forward.

Fourth-quarter results were similar, and will be detailed in full by Dan.

As I stated on my previous calls in 2007, there are four key factors that have impacted our margin performance throughout the year.

First is the sales mix, in that we're selling a greater amount of lower-margin products during the year, such as some of our peripheral products like the cartridges and the Taser Cam.

Second, we have been impacted by a change in average selling prices due to the distribution mix and cash discounts taken by our customers.

Third, our products utilize certain raw materials that have seen substantial increases in price during the year, which impacts our bill of material structures.

And finally, labor and efficiencies caused by the ramp up of new product introductions, the implementation of a second shift, and a short term decline in production yield.

We have thoroughly analyzed the impact that each sector has on our margin progression, and we have taken very specific action to address each of these target areas.

We began implementing many of these steps late in the third quarter, and at the time of our last call, had hoped to see the cost reductions materialize in our fourth quarter.

While the material reductions did begin to reduce our costs during the fourth quarter, they were overshadowed by the loss of efficiency associated with bringing on our second shift to support the expanded C2 and X26 sales.

The following is a summary of our corrective actions.

First, we have rewritten our annual contracts with our distribution base, to eliminate cash discounts and reduce distributor commission programs, increasing our average sales price on products sold.

These will be eliminated effective March 1 of this year and collectively accounted for 1.2% decline in 2007 margins.

Second, materials increased by 2% of sales during 2007 as a result of significant increases in raw materials.

To address the rising cost and further eliminate future price pressure, we negotiated material price reductions with our supply chain in the third quarter of 2007.

This has already impacted inventory.

We expect to see these decreases roll-through to our cost of sales late in the first quarter of 2008, and estimate the impact on our specific bill of material to vary depending upon the product line.

With respect to our direct labor, we experienced a 1% decline in margin due to the increase in average hourly rate paid to our employees.

This increase was the result of higher volume of overtime hours charged at a premium, and a higher burden temporary labor used to meet the growing demand for our products.

We have now level loaded or two shifts, eliminated overtime, and have transferred the required temporaries to our payroll.

In addition to the higher rate paid, we also lost 0.9% in margin due to a reduction in parts per man hour processed.

This was caused by an influx of new employees and training losses.

In summary, we believe the culmination of these actions taken to address our average sales price, materials and labor, will be incrementally realized over the next four quarters, leading to an improved gross margin by year end.

Finally, it is important to understand the impact of our sales mix on gross margins for the Company.

In previous years, we have enjoyed higher product margins resulting from higher proportion of X26 and M26 product sales.

As the Company continues to see a shift in these sales to lower margin cartridge and Taser accessories, as well as lower cost consumer products, we will see an impact to our overall margins.

We believe we can offset a significant portion of this impact through programs like automation and expanded focus on sustaining engineering to reduce man hours and improve on manufacturing design.

In closing, we are excited about our market expansion and the introduction of our new Taser C2.

We also believe the short-term decline in margins is the investment made to ensure success in an aggressively growing company.

Therefore, we want our investors to understand we remain just as focused on the bottom line in 2008 as we do on growing the top line.

This has led us to examine our help operating efficiency so we can maximize our margin performance in the years to come and better prepare for further growth spurts.

While we're disappointed by the decline in margins caused by our labor and material efficiencies in 2007, we have taken appropriate corrective action to address the issue.

We have realigned our operations structure to ensure we keep a constant focus on our operating results while we drive new innovation.

We are also establishing a new product development team in operations, whose focus will be on streamlining new products like the XREP and Shockwave into full-scale production, without jeopardizing our existing manufacturing operations.

Finally, I want to share with you our excitement in having Steve Mercier join our operations team at Taser.

We are looking to his experience and his leadership skills to help Taser achieve the same level of success he shared with his teams at Intel.

We believe that his focus on operations, coupled with an expanded focus in manufacturing engineering under our VP of Engineering, Joe Paolo, will give us a dual path to success.

With that, I'd like to turn the call over to Dan Behrendt, our CFO.

Thank you.

First, I will go through the results for the quarter.

As Tom indicated, sales for the third quarter were $31 million, which sets a new record for the highest quarterly sales in the Company's history, with sales for the quarter up 60.9% from the prior year.

Sequentially, the Q4 sales were up $2.5 million from the third quarter sales, as the company increased its sequential sales for the third quarter in a row.

Gross margins of $17.2 million or 55.4% of sales are down from the prior year, as Kathy indicated, the degradation of margins was caused by lower labor efficiencies, higher strap expenses and material costs, as well as the change in mix as more of our sales are coming from cartridges, C2 handles, and Taser cams, which carry a lower margin than our Taser X-26 products.

The Company continued to experience higher direct labor costs due to some of the inefficiencies associated with the new production employees, as well as the higher temporary labor and overtime costs incurred as we expanded the direct labor workforce to meet the growing demand for the existing products and the new C2 product.

These items contributed to a 3.1% increase in direct labor as a percent of sales versus the same quarter in 2006.

The $1.5 million increase in indirect manufacturing expenses were mostly driven by the higher strap during the quarter due to higher production levels and lower yields.

We also incurred higher indirect wages due to increased headcount in the quality, manufacturing engineering, and materials departments to ensure that we can adequately support the ramp in production for our products.

As Kathy indicated, there are number of initiatives that have been put in place to improve margins in 2008.

SG&A expenses were $8.7 million for the quarter versus $7.7 million in the prior year.

The variances were driven mostly by higher salaries and benefits of $290,000 due to increased headcount to support the growth of the business.

We had increased bonus expenses of $145,000 due to the improved operating performance and higher advertising commission expenses related to the new C2 product.

Research and development expenses of $1.2 million for the quarter, which were $505,000 over the prior, mostly driven by higher salaries and wages of $258,000.

Due to increased headcount, we had increased supply costs of $138,000 related to new products in development.

Income from operations was $7.2 million for the quarter, and the Company had pre-tax income for the quarter of $7.9 million.

Pre-tax income is up $3.5 million or 80% from the prior year due to the fall through on the higher sales levels.

Net income for the quarter was $4.7 million, or $0.07 per share on both a basic and diluted basis.

Moving on to the total year results, as Tom indicated, the total sales for the year were $100.7 million, this is up $33 million or 48.7% from the prior year.

Gross margins of $57.6 million or 57.2% of sales are down versus the prior year due to the increased labor and material costs, as Kathy talked about.

SG&A expenses for the year were $32.8 million, versus $29.7 million in the prior year.

The variances were mostly driven by higher salaries and benefits of 1.4 million due to the higher headcount, increased bonus expense of $591,000 due to the improved operating performance and higher travel and meal costs of $469,000.

R&D costs were $4.4 million for the year, which is an increase of $1.7 million, again, mostly driven by higher salaries and benefits of $809,000 due to the increased headcount.

We also had increased supply and tooling costs of $626,000 related to soft tools and other supplies to support the XREP and C2 product lines and increased consulting costs of $95,000 over the prior year.

For the year, income from operations were $20.4 million and the Company had year-to-date pre-tax income of $22.5 million.

Pretax income was up $27.5 million over the prior year due to the fall through on the increased sales, as well as the shareholder lawsuit settlement of 17.65 million recorded in the second quarter of 2006.

Net income for the year was $15 million or $0.24 basic and $0.23 on a diluted basis.

Moving on to the balance sheet, we did finish the year with $60.3 million of cash and investments; this is an increase of $12.5 million over the prior year end.

As you look at the balance sheet today, you'll see that there is a large increase in the cash balance.

Part of this is a change in the Company's investment philosophy, as more of the maturing and called investments were invested in cash equivalents due to the current yield curves, so we have actually shortened up our portfolio due to the yield curve that is currently out in the market.

So we got a lot more of the cash, but it'd still be actively invested in cash equivalents.

The accounts receivable of $11.7 million is up $1.6 million from the prior year and a balance of $10.1 million due to the significantly higher sales in the fourth quarter of 2007 versus the fourth quarter of 2006.

Our days sales outstanding is actually 35 days, which is down 13 days from the prior year end.

As Kathy indicated, we have eliminated our cash discount as of March 1.

We will likely see the DSO climb slightly in 2008, as we no longer have distributors paying at the ten day mark.

Inventory of $13.5 million is up $4.2 million from the prior year end balance of $9.3 million as the company has invested more inventory to support the higher sales levels.

The overall inventory turns have actually improved over the 2006 levels; even with larger investment in inventory and turns at the end of the year were 3.5 turns.

Prepaid and other assets of $4.3 million are up $2.1 million from the year end 2006 levels due to other receivables from our insurance carrier and increases to prepaid advertising and prepaid liability insurance.

At the end of the year here, we had current assets of $96.4 million.

This is up $40.3 million from the prior year end, mostly driven by the increases to cash.

Property, plant and equipment of $23.6 million is up $2.8 million from the prior year end mostly due to the initial payments for the new automated production equipment at $2.7 million; purchases of C2 production equipment of $720,000; as well as costs associated with the Company's new website of $350,000.

All these were partially offset by the depreciation expense incurred during the year.

Total assets finished the year at $137.4 million; this is up $17.6 million over the prior year end.

Total assets of $119.8 million.

On the liability and stockholders' equity side of the balance sheet, accounts payable and accrued liabilities of $10 million are up $3.1 million from the prior year end due to increased purchasing activity as well as an accrual for the second installment of automated equipment of $1.2 million.

Current deferred revenue of $1.7 million is up from the prior year end balance of $1 million due to the sale of more extended warranties.

You also see that impact down below in the long term section -- long term liabilities.

Litigation settlement liability is now zero.

We did make the final payments via the issuance of stock in the second quarter so that liabilities have been eliminated in 2007.

Current liabilities of $12.4 million.

This is a reduction of $5.9 million from the 2006 levels.

The deferred revenue [note] of the current provision increased $1.6 million to $3.5 million, again, due to the sale of more extended warranties in 2007.

And total liabilities of $16.7 million and the Company finished the quarter with $120.7 million of stockholders' equity.

Regarding the cash flow, the company had operating cash generation of $13.9 million for the year compared to a cash generation of $7.5 million in the prior year.

This increase was driven mostly by higher net income, and a reduction in the company's tax assets because of the higher income we've been able to utilize from the tax assets on the balance sheet.

Net cash provided by investment activities netted to $13 million, as the company realized $17.5 million from maturing and called investments which were partially offset by $4.1 million of new property and equipment purchases.

The company generated another $3.1 million in financing activities, mostly driven by stock option exercises during the year.

The company ended the period with $48.8 million of cash, which is up $30 million from the prior year, partly due to maturing and called investments of $17.5 million as well as the operating cash flow.

Total cash and investments were $60.3 million at 12/31.

And with that, I'd like to turn the call back over to Tom Smith, our Chairman.

Thanks, Dan.

I'm going to touch briefly on some of our sales accomplishments; starting in the fourth quarter of 2007, we added 365 new agencies taking the total number of agencies that are testing or deploying Taser products at the end of the year to a little over 12,400.

We also, during the quarter, added 285 new full deployments, meaning there are 4,360 agencies carrying a Taser on every officer.

We also, on the Taser Cam side, added 157 new agencies for a total of 1,585 testing or deploying the Taser Cam products.

During the quarter, we shipped over 23,000 X26 handles, that's up from 22,500 in the previous quarter, and that also is bringing our ratio of handles to cartridges of roughly 17.7 to 1 for the year.

Again, that is showing the continued growth we're seeing within the law enforcement market.

And again, I think 2007, it was a landmark year for Taser International, ticking the $100 million number was a huge goal of ours, and we were able to achieve that goal.

Being in a growth company, obviously, we have -- had to bring in over 150 employees and that is a challenge to get people in and get them up to speed and trained.

But I think I'm very proud of the accomplishments that we as a manufacturing company and a technology company were able to do during the course of the year.

2007 started with the launch of the C2 at CTF.

It was obviously very well-received, was one of the top picks of the show.

We were able to also attract higher caliber individuals such as Dr.

Richard Carmona to join our Board of Directors.

During the summer, we had our annual tactical conference, announced several new product initiatives, which I'll talk about here in just a minute.

Let's start with first, the XREP, the eXtended Range Electronic Projectile, we actually did have some material delays getting that started late in '07, and that field trial is scheduled to begin prior to the first quarter 2008 with revenue shipments beginning this year.

And again, depending on the field results, from the field trials, will depend on how quickly we roll into the actual manufacture of the final product.

The Shockwave which was also announced during the year is going to expect to begin field trials in the second quarter of 2008 and sales again scheduled to begin prior to the end of the year.

So we are continuing to push forward with new products.

We are continuing to invest in research and development, and expand Taser technology and we're also seeing that in recent studies.

In 2007, the National Institute of Justice funded Dr.

William Boseman at Wake Forest University to commission a study where they looked at 1,000 uses and showed literally that it was only been a few people had some scrapes and cuts from falling, but it was less than 3 people out of 1,000 or over 99.7% of the people hit by the Taser in real field world use applications, did not suffer any injuries.

And again, that bodes well for us, not only in the legal side but also for our users, that they can continue to have confidence that this is a field-proven product, it has been tested and challenged over and over again and it continues to come back and provide a safety margin that is unmatched by any other system carried by an officer today.

Coming in to this year, we obviously kicked off 2008 with a very exciting consumer electronics show, our new fashion leopard print Taser as well as our red-hot red and fashion pink for some new color schemes that were brought on board.

That's obviously stimulated a whole round again of interest at the dealer and retail level of people that saw us announce it a year ago.

We got into production in the third quarter.

Obviously, they wanted to see how that was received, and now, we're back into getting some of those meetings again with people that we had talked to and started with a year ago.

We also attended the SHOT Show earlier this year, which we also announced our partnership with Mossberg, where we're coming out with a dedicated less lethal launcher with a radio key system that will be used primarily with our XREP system and as well, we will be incorporating in other platforms.

We're obviously very excited about that as they are one of the leaders in that industry.

And that's going to be a good partnership for us as we go forward.

And then again, when it comes to the rubber meeting the road, San Diego County just recently put out data that they went all of 2007 without a single lethal shooting by law enforcement, and the first time that they have done that in over 10 years.

And it's again, I think they attribute a lot of that to improved training, improved policy and really specifically, the use of the Taser.

And as I continue to travel on around and talk to people, they have seen the success of the product and I think a lot of the focus now is really turned to how these are being used and the command staff and the local law enforcement agencies are stepping up.

They're putting their policies out there; they're reviewing them, they're tweaking them, the training is solid.

And I think that's why we're going to continue to see the growth in the use of Taser technology as we go into 2008.

Obviously, we get a lot of questions about the international markets.

Those continue to still move forward.

We recently announced a 3,000 unit order of our M26 product line, which again is field-proven.

The thing that was most exciting about that particular order for me was the fact that they went straight to a deployment.

They talked to the other countries that have been using it, such as France, the UK, some of those other countries, and they just became a user right out of the gate based on the success of the study without having to reinvent the wheel.

And I think that bodes well for us as we look forward.

And obviously, you all have seen a lot of media coming out of Australia with Sarcoxie and France still continuing to press forward; and the United Kingdom, starting in December, to use Tasers with non-fire arm officers.

We're obviously very excited about our international opportunities.

And then obviously, the C2, we're excited about those opportunities, the military opportunity.

We signed a big contract last summer, and have shipped against that.

We expect we'll have some more shipments against that this year.

So we're very excited about where we're going as a company, continuing to invest in research and development.

Kathy and Steve Mercier is going to be focused on getting our operations in line and it's something we're very excited to present for 2008.

And with that, I'd like to open the call to questions and ask Tony to come back and help us with that.

Tony?

No problem, sir.

(Operator Instructions).

Your first question does come from the line of Eric Wold with Merriman Curhan Ford.

Please proceed.

Hey, good morning.

Hey, Eric.

Before I get into a couple of questions, do you mind just giving the actual numbers in the quarter for X26 and M26, Cams and cartridges?

The X26 in the quarter was 23,065, on the M26, it was 777, and on the Cameras was a little over 3,000.

And the C2s were 8,830.

And the cartridges?

439,252.

Perfect.

So going to the C2, update us on where we are there, when we could start seeing additional retailers being announced, what retailers are saying to you either -- that they excited about it or they are still possibly hesitant about carrying the C2.

And then on the infomercial, when that starts rolling out kind of full force and kind of where the cost for that has been placed, how much of the infomercial was in Q4, if any, and if it's all going to be falling into Q1?

Well, let me start backwards and I appreciate you bringing up the infomercial, I skipped that in my comment.

Our actual roll out begins this coming weekend.

We're going to be going with -- start in 10 cities, and all of the costs will be borne for that in Q1 of this year, but it will start running this weekend.

We're going to be, again, working with a company that they manage how you test those and get the response and then tweak what the messaging is within the infomercial and the call to action and we'll be starting, for example, in Phoenix, Atlanta, Denver, Los Angeles, just to name 4 of the 10 cities, I don't have them all in front of me, that they'll be doing some tests this weekend and monitoring those results.

But we will be taking all the expense for that in Q1.

We put a lot of effort into it, you can see a full version of the infomercial on our website.

And as far as the C2 goes, so far, the response has been very good.

I can tell you our biggest hurdle has still been the interest in what our critics are throwing out there about the potential for injury.

And when we're able to get in front of these people, we're able to convince them of that.

And I'm hoping to make some announcements with some retailers by the end of the second quarter at the latest.

But a lot of the people that we've started conversations with a year ago, we have renewed those conversations.

They have now seen six months of some sales out there; we have seen good response.

The holiday season quite frankly, we were late to at the end of the year.

A lot of times, the people are doing their buying for that in the first half of the year.

So at the end of the year, it was a lot of the direct sales and a lot of the guys that had come on line, but they're talking now about those types of applications.

So the response has been very positive.

I think we're seeing a positive response from the consumers that are buying and that are coming back to us.

I just ran into some folks a few weeks ago that went out and bought five for some family and friends that they just believe it's a good product and it's really demonstrated well for them.

And they actually had -- not a huge, but they're seeing the law enforcements use it; its mere presence is deterring people.

And I think that's again, with the reputation that we have out there, that's the best use of all we can have for our users.

And just two quick follow ups on that.

One, what is the cost of the infomercial, specifically that will fall in Q1, and what do you expect throughout all of this year that you could spend on marketing around the C2.

Well, we don't have the final comps run down, but it's not going to be cheap, but I can tell you on the advertising side, we're dipping our toe into the pool very, very slowly.

It's depending on how that response goes, that's something that we can react to very quickly.

If we're seeing a good response, we can lever that up very quickly; if we're not, we'll slow that down, we'll tweak it, go run some more tests.

So we could spend anywhere between $1 million at a minimum.

If it's running very well, Dan will probably choke me for this, but we could spend 10-20 if we're getting the responses that we see.

Again, that is something that we do get direct response, we get direct feedback.

On the infomercial itself and in the channel, they usually are telling the stats are 7 to 1.

So whatever we're going to see on the direct response, you'll see 7 times that out in the marketplace.

But we're going to be measuring specifically what we're doing this weekend, what is the call response and what is the response in those particular markets, we're running different tests in different markets, on the call to see what's working and what's not.

As far as the cost of the commercial, it'll be about $520,000 we will recognize, just for the commercial itself, and then the advertising on top of that.

As Tom said, we'll spend at least $1 million on the advertising and depending on what we see, it's very scalable, that's one of the things that is great about the infomercial.

Okay, and then final question, before, when you were having some commodity price pressure, you raised prices on the cartridges last year; you took them up a buck.

Any thoughts on doing the same with the X26, as you are still getting pressure there, pushing that up, $50 or so or something?

I don't think so, not right now.

We're still pretty confident that we can -- we've hit the bottom on the margin side that we're going to be able to get that turned around without having to go out there and raise the cost or the price.

Okay, perfect, thanks guys.

Thank you.

With Dougherty, your next question comes from Greg McKinley.

Please proceed.

Yeah, thank you.

In terms of the international sales that occurred this quarter, I know you mentioned $3 million; how many customers did that come from?

Could you share that?

I can't give you that, we had -- literally, we've got 45 countries now using the product and it did come from all over.

And obviously, there was a lot of attention during that quarter from Canada and we still did have sales from Canada during the quarter, but it's not one single customer per se during the quarter, it's pretty spread out.

Okay.

Looking at operating costs, Dan, it looks like it was, for the full year, it was maybe up about 15% in terms of total operating expenses.

As you said you had 150 new employees in '07.

Can you give us a sense for where you are in terms of infrastructure build out at corporate and the manufacturing facility and how we can expect that impact '08 trends.

Well I think it's one of those things, I think one of the things I've been pretty proud of is I think we have done a real good job in 2007 on keeping a handle on the cost structure.

The rallies -- we grew the sales by close to 50%, and as you pointed out, there's a much smaller growth in the indirect expenses.

I think as we move into '08, we are definitely going to have to make some investments in the business in order to continue our growth.

And I think it's a bit of a step function for the Company, where we're able to keep the costs down in 2006 and 2007.

But as we grow the business, I think we find that there are certain areas we need to invest in.

And I think we'll see investments -- you've seen some of that already with the hiring of Steve Mercier.

In the manufacturing area, we'll be -- we've got open searches right now for a VP of marketing, VP of consumer sales.

So we're adding to the infrastructure, but, we think we need to do that in order to make sure we can execute and grow the business profitably.

Okay, very good.

And then, just a follow up on the advertising and media, you mentioned $500,000 for the commercial; I'm assuming -- is that the expensing of the capitalized production costs?

That's correct.

Okay, and then what was the amount you indicated for advertising?

It'll be at least $1 million over the year and then we'll lever that up, but that's not all going in one chunk.

Like I said, we're starting in 10 cities this weekend.

By midweek next week, we ought to have some initial results from that and then we can determine what do we do, what do we tweak, what worked, what didn't.

So again, that's kind of a budget that we have set for the beginning of the year at a minimum.

But again, according, like Dan said, that's something we can respond and lever very quickly.

Okay, thank you.

Thanks, Greg.

Your next question comes from Steve Dyer with Craig Hallum.

Please proceed.

Good morning, guys.

Good morning.

A couple of quick questions, just to clarify, Tom, on what you just said, $1 million base line in advertising, over the year, not per quarter, I mean it certainly could be per quarter, but what you're referring to is sort of spread out throughout the year?

That's correct.

We spent $500,000 to produce the commercial; we want to dedicate at least $1 million over the course of the year, at a minimum to go out and run that.

And again, it's going to be done in very small bites and spread in numerous cities in all different areas of the country so we can find out, is it regional, is it the message.

We're going to be -- we've hired an outside firm, that that's what they do, is test these things.

They have a pattern that they follow, and then they can come back to us with very specific results on what we need to tweak or not tweak or areas of the country that are working.

Okay.

You won't see all that hit in Q1 unless the thing is running bananas on it for us.

So, the way to think about it would be about $500,000 to make the commercial, and then an extra $1 million to run it?

Correct, that's what we have in the budget, and that's assuming we really have to tweak it and it's taking a long time to really find the right lever and we're not getting any big hits with it.

Okay, and then how much for additional advertising and what channels would you be looking at?

Again, I think that's going to be a direct message as to how successful it is.

If it's -- if we're getting three to one on the investment, I don't think we'd have any problems going and twisting Dan's arm to throw $3 million, $4 million, $5 million at it in a quarter.

But if it is not doing that or we're not seeing the results we want to see, again, we're not going to go and blow money just for the sake of doing it.

We want to be very scientific about how we do this, look at the stats, look at the results, and then sit down and be very methodical about our approach to it.

The infomercial is being coupled with a lot of marketing materials that are being developed at the retail point as well.

So as we drive people in, we have the same kind of promotional materials being supported at the retailers and the stores that carry it.

And if you have watched the infomercial, we have really spent a lot of time going through the script for many months on making sure we're communicating the testing, the science, that it's police-proven, a lot -- there is a lot of education in the infomercial that we're looking at it to help us in that aspect as well, that it's going to educate people as well as just get them interested in where to get it.

Right, I thought that was very well done.

The C2, just in general, where are you seeing maybe pockets of surprising growth or weakness, what are your best channels, what's working, what's not thus far?

Well, obviously, with the announcements of [Cabella, Gainer Mountain and Academy] we were very excited to see those guys.

Because traditionally, the firearms dealers have been selling our products over the last 14 years, the sporting goods chains, they are new to us.

So I was surprised how quickly they came on and they've been very happy with the performance so far.

So I think they obviously, the weak side for us was the consumer electronic retailers not getting any of those guys right out of the gate, but again, we're still in conversation, so I think the surprise would really be the sporting good guys.

Okay, and then just shifting channels here a little bit, we had gone last year sometime without really a dust stop in the press so to speak, until kind of the Canada situation sort of late in the third or fourth quarter.

Did you see anything you can identify in terms of people that maybe got cold feet or stepped away given that and just kind of let the dust settle?

Obviously, we got a lot of inquiries around it.

If you have followed the media up there at all, I was in Toronto doing a presentation to the public.

Again, it's about public education, it's about public information, and giving people the facts.

I testified in Ottawa about it.

So certainly Canada has taken a slowdown, they're still buying, as I said; we received orders from them even after the incident occurred.

But I think it was more a lot of questions than what was our response to a lot of the hype.

Again, people have to remember, we went through this in the United States in 2005, so this time, I think especially in the US, they're like oh, "We've heard that story; we know the science is there." And internationally, they were just reconfirming that.

Where it is still a dust up in Canada.

There is still a great deal of interest in it.

I'm sure I'm going to be up there some more.

But it's about presenting the science and the facts, and it's very hard for people to argue with that.

If you'll remember, you probably saw pictures of me sitting with a great big blue book of all of our over 120 studies and 1,300 pages of science, and I think that was the biggest surprise when I went and talked to these individuals and to the committee up there was how much science really is there.

Because the critics obviously are trying to present that there isn't any, and the reality is they're just full of it.

Okay, and then I guess, finally circling back to gross margins, how -- can you give us any color on sort of how you see that ramp back progressing?

Sort of what do we get to, how does that ramp over the year, just with these improvements you're making.

You'll see a steady improvement as we go from Q1 to Q4.

As I explained a little bit in the material reductions, we saw those come into our inventory in the fourth quarter and we're still starting to see those reductions come into play.

So you'll see them roll out probably late in March in terms of cost of goods sold.

The labor reduction is in place now, so we should see a decline in the labor for the first quarter and we'll continue to manage that as we go forward.

The other thing that was impacted by the cost of our materials was our scrap, because we took a really hard look at the production scrap versus the prior year.

And a lot of that increase also had to do with the component costs.

So that really should make an improvement in a couple of places.

But again, I think the biggest thing we did is to step back and restructured and realigned that organization to really be successful.

We've got one group focused on the sustaining engineering, so how do we make our products better and for less money?

They are working very diligently and have some great ideas moving forward on our existing products like the X26.

I think Steve is focused on putting systems in place and improving the things that we need to grow the business so we don't incur the kinds of things we did with the C2 last year, are all going to have improvements.

So you will see it in Q1; you will see it continue to improve all the way into Q4.

And I think that is one of the things, Dan touched on.

We grew our revenue at a pretty substantial rate but our SG&A was pretty tight.

We are coming back now; we've been pretty tight, and we are coming back now.

We've been pretty sensitive over the last couple of years to make sure that we didn't grow too much there, but at the same time, we do see a lot of opportunities out there and we're going to make the investments to get the right people in here to help us grow and go into these different markets.

The R&D, obviously, we're going to continue to invest in that to expand our technology.

And Kathy and Steve are going to be really focused internally on making sure that we're efficient where we stumbled in the fourth quarter trying to get all the product out the door because we wanted to hit our growth numbers, which we did.

And now, we're going to really make sure that in addition to hitting our growth numbers, on the revenue side, we're going to hit them on the margin side.

Okay, so then just finally, I guess in terms of numbers, would you expect gross margin in Q1 to be up over Q4 and then steadily progress higher throughout the year?

Yes.

Okay, thank you.

Yes.

Thank you.

With Jefferies and Company, your next question comes from Matthew McKay, please proceed.

Good morning, guys.

Good morning, Matt.

Just on the production side, I'm assuming that you guys are still running two shifts at this point?

We are running two shifts, yes.

Okay, and what capacity are the two shifts being run at?

The first shift is running at 100%, and we ramped back that second shift.

Effectively, we did not do a great job when we brought the second shift on in terms of bringing the labor in and making sure that was efficient.

When we took a look at it, we actually had more headcount than we needed so we pulled that back and we will continue to track that with our sales forecast and the demand for the product as we bring people in, but we will do a much better job bringing them in.

We're running at 100% of bodies, maybe not efficiency, but we're going to get that improved too.

Okay.

Because when I look at the number of units in the quarter, kind of -- on the X26, a little over 23,000, C2, only just about 9,000, it would seem like, although while you're coming close to capacity on the X26, that those type of capacity levels can be met with just kind of one shift.

We do, but we've also got the cartridges.

The other things that we're working on in addition to our current production are the new products, things like the XREP that are going into field trials are also being built now by production employees.

So we're trying to make sure that as we bring those on, we do a much better job moving forward than we did last year.

Okay, and then just kind of a curiosity why you run one shift at 100% and another shift at considerably below that as opposed to maybe trying to go 60/60 or something like that, just to try and -- just to kind of some of the logic behind it would be helpful.

One of the reasons we run a first shift full capacity is it is when we've also got all of the engineering resources here.

So we're also taking a look at some of the sustaining engineering and how we can improve those products.

And the second shift right now is really used to offset what cannot be produced on one shift, like the cartridge lines, for example.

Because the demand for the cartridges, and you can see from that 17 to 1 ratio, is climbing.

And we build -- the majority of our cartridges are actually -- that's where the overflow is being built, is on the second shift.

Okay, and then there was a recent article where one of your distributors basically highlighted that he sold $1 million of C2 in the past 4 months, which given how many you sold in the fourth quarter, would either he is completely dominating what you're selling or it would seem like things have sort of heated up a little bit in January in the first quarter.

So I'm just curious, like any color you can give on the C2 in the first quarter?

I saw that article and that's a guy down in Florida and obviously Florida and California tend to be the leading areas of product adoption.

So we're again, we're seeing continued success of the product, but we aren't able to say any big numbers, what we can give for the first quarter, we'll be able to give you that in about two months, but again, with the response we got out of the Consumer Electronics show and then that followed promptly with the SHOT show, that product was in the media, very, very successfully.

So, obviously, that was very positive for us to see that guy come out and make that statement.

And again, that is on the retail side.

We sell at obviously a discount from that for the dealer's distributors.

But obviously, that was a very positive note for us to see as well on the C2.

Yeah, and then I just wondered if the build in inventory, Dan, I know you said it was a reflection of the growing sales, but I am wondering if anticipation of CES, but also return on advertising, everything else if you guys have been building up a C2 inventory; and if so, if you could quantify just how many units are in there?

Yeah, we definitely built inventory, both of the C2 product and also the X26 product.

And that was one of the ways we're able to meet the demand for the quarter.

So, I think unlike some of the prior quarters where we finished the quarter with very little in finished goods, we have really built some inventory there, which I think puts us in a good position to be able to satisfy the demand as we move forward and really service our customers better from that perspective.

We've got -- we did put about 19,000 C2s on the shelf in the quarter, which is really, as you pointed out, an anticipation of the CES show, and also the infomercial starting.

And once we've got the production employees ramped up and working efficiently, it did make sense to scale them back, and it made more sense to go ahead an put some inventory on the shelf in order to be in a position to satisfy what we hope to be growing demand for the C2 as we move into 2008.

And there was a conscious thought to do that, as you mentioned, CES, SHOT are our biggest consumer shows of the year, they're right out of the gate and the infomercial.

The biggest lever for us on that infomercial is being able to deliver very quickly.

The last thing somebody wants to do is see something, order it and then get it in six weeks.

So we wanted to make sure that as that infomercial starts to run, that we are able to ship within a 48-hour period and get that out to the customer very quickly.

Okay, and then relative to when you made the decision to allow the inventory to build up to what you've seen over the past month and a half, has it kind of met expectations?

We made the decision last year obviously, because in looking at the timing of the trade shows, knowing we were spending the money on the infomercials, we obviously made the decision to give manufacturing a heads up that hey, we wanted to not only build the demand, to ship everything we've gotten out, but we want to put X thousand units on the shelf, which we came pretty close to getting right on where we were going to be on the manufacturing side.

So I would say on the manufacturing side, yeah, we did what we wanted to do.

We didn't miss by any big number.

In other words, we weren't saying let's build 2,000 and then we built 20.

We were pretty close to what we wanted on the shelf coming into the first quarter this year.

And then again on the sale side, we've got the infomercial just starting to hit, and the interest out at CES was great, it really was.

But on the other side, Matt, you've been following us for a while and there's a lot of exciting things in the future.

So the other decision was made not just on the C2, but we wanted to make sure that we started to put X26s on the shelf as well as cartridges for some of the lumpier sales that hit our business to make sure that those were not an interruption to the regular pipeline as well.

Okay, that's all, because that's actually one of my other questions.

Sort of as we move through here and you've got a lot of agencies that are still at partial deployment, does the X26 side of the business, does it become more lumpier as maybe you get some larger departments that go to full deployment or does it actually become smoother just because you've got a larger install base and therefore, you just start getting kind of more predictable reorder flow?

Domestically, it's definitely smoother.

It's the consistent, they're adding units to grow it out.

The lumpy side comes internationally.

Obviously, let's use the one we just put out, the 3,000 M26s in a single order; obviously, I've been working on that for a few months here.

But we did 777 in all of Q4 of that particular product line, so that is right there a demonstration of the lumpiness that we expect to get this year on the X26.

So we do want to have products on the shelf to be able to meet that.

I mean, I don't want to get an order and then have to wait two quarters to ship it, because a lot of times too, these are fill or kill type deals, they won't take partials for the order.

So obviously, some of the bigger ones, such as France or things like that come in, we are telling them we aren't going to be able to -- we want to space those out because they're also going to have to time that with training.

But the international is really where we're going to see the lumpiness I think on the X26.

So do you expect more like a recent order than kind of what the UK did, which was a very methodical multiyear study -- test and sort of roll out.

Do you think that like France, for example, could be a larger near-term order I guess.

Correct.

And they'll have to go back out and bid that so they'll do it in a larger number.

The UK is the UK; I don't expect them to change.

I think we'll continue to see them steady slow progress.

I mean, for them, this was -- I can't even put it, this is a monumental step for them to take this and give it to non-firearms guys.

I mean these are guys that have never touched a firearm in their life, they have no experience in it, they don't cover it even in their training, and now they're giving them this device to carry.

And there was a lot of trepidation as they moved forward with that, but they did it; it's being received very, very successfully in the initial results that we're seeing and hearing them from the media over there, but there again, they are a little over 2.5 months into that program.

But I expect to see that one to go continually, I expect to see some of the other countries to take some larger numbers.

And then again, going back to that order we just announced, I do think that's going to be a direct result of some of the countries that don't have the dedicated study resources.

They're going to look at somebody like the UK and France, Australia, Singapore, those types of countries that have done the due diligence that have really spent the time on the resources and hopefully, we're going to see more of those guys come on line where they're just going to go right to the deployment out of the gate.

Yeah, how many countries now have some type of a Taser program going?

45.

45.

And you still expect kind of about half a dozen of them to enter into more of a procurement phase this year?

We do.

Obviously, the one that's garnered our attention recently, as I'm sure most people that watch it is Australia.

They've been having a lot of media and a lot of press come out of there from all the seven states with the police ministers talking about broader expansion.

And again, I think that goes back to, they've been doing a field test for several years, they've done the studies, last year, Western Australia moved forward with a big order, and that is now resonating through the rest of the country.

So again, I think that's kind of a microcosm of what we see on the international market stage.

Okay, great.

And then just one last question, as the cash builds up, you guys are going to think more about share repurchase or anything like that?

We've had some discussions at the board level about what we're going to do, no decisions were made; I can tell you both those items were -- there were a bunch of items that we looked at.

At the same time, there was a lot of discussion.

We are going to continue to invest in research and development, advance our technology and we are going to keep a sizeable war chest to be able to take on the folks and grow the business.

But there are a lot of discussions going on at the board level.

Okay, great, thanks a lot.

Good job, guys.

Thank you.

Your next question comes from Paul Costa with JP Morgan, please proceed.

Thank you, good morning.

Good morning, Paul.

I've got a few questions; first off, for Dan, in the press release, it hints at the possibility that legal activity is are going to start tapering off soon; is that true?

What -- how much of your expense is going towards legal activities on a quarterly basis and do you expect it to decline in '08?

I think as far as the -- we definitely have seen a number of active cases in front of us decline.

We've had more dismissals in 2007 than new cases so I think that decline in active cases facing the company certainly helps to keep a handle on legal.

I would not -- legal expenses for the fourth quarter were about $750,000; that's down about $100,000 from last year.

So we definitely have seen that come down year-over-year.

It is higher than the third quarter but I think the third quarter, as we talked about, was a bit of an anomaly as we had a number of cases hit the retention in the third quarter, and also, just where cases were in their life cycles.

So I think it's one of those sort of ebb and flow type items.

I think that our focus as a company is to work on ways to try to reduce that amount of litigation that we're facing and I think it will come down over time, it is tough to predict.

I would kind of model it at comparable levels for 2008, and hopefully, we can improve on that.

But I don't think we're going to see a dramatic reduction in the near term.

I was talking to our legal department too; and one of the things that we're going to be facing in 2008 is a couple of these cases that were previously dragging a little bit, they're really getting pretty heavy into the discovery phase this year and I think we've got a couple scheduled for going to trial at the tail end of the year, and obviously, we will be ready for those.

We're not going to skimp there on our defense side.

If I could just revisit the international side of the business for a second; Kathy, how are you pricing the products and is the weak dollar giving you some leeway to increase your pricing there?

Well, we sell in US dollars to all of our customers, we sell to the distributors who are then turning it around and selling it there, so I think it is making it a little bit more affordable there on their side.

But quite frankly because we're turning it and selling into the distributor and always dealing in US dollars, we don't get into any of the currency valuations in affecting our international.

I can tell you our cost is obviously a little bit higher in the international side, so our prices are a little bit higher.

But the currency I think is more going to affect the distributor in that particular country than really us.

As you scale up internationally, is there the opportunity to move to direct sales in certain countries and will it have impact on margin?

I think the -- I don't know that we'll go to direct sales, because a lot of times, the foreign countries want to work with somebody that's right -- located in that country to provide service, to provide response, to provide training.

One of the things actually that they've asked us in the past is will we be setting up an operation to manufacture there.

And again, because of Department of Commerce export rules, we will not be doing that.

But I think that -- by keeping somebody there locally, keeps somebody gainfully employed in that country and that helps us more than it would hurt us.

And the other piece of that is typically, our distributors establish all of the importing, and they're also pretty well connected with the Departments of Ministry and the other agencies that are involved with bringing the product in.

So they're incredibly helpful.

Our folks, like in the UK and France, were instrumental in that product expanding the way it has.

It would just be hard to sit here in Scottsdale and be able to provide service to France or the UK with the time change and the cultural differences and just the language barriers and all those things that factor into it.

Lastly, I'm intrigued by what's happening in the military at the moment; there's a move towards unmanned ground vehicles.

I think they're talking about 30% of them being unmanned by 2015.

You've had this early success with iRobot.

Can you give us any data points on the iRobot partnership, but also your sense of this unmanned ground vehicle opportunity and is it something you're actively involved in here?

The iRobot has been the slowest of the three because we've been working so hard on the other areas.

And again, really what that was more intended to do was to be a proof of concept, to prove whether there was interest there, and I can tell you there was.

We've received from a number of different areas within the military, interest, not just domestically but internationally of incorporating Taser technology with the unmanned vehicles.

I can't give any real specifics on it, but I can tell you that we felt that that was a successful launch, that there was a lot of interest in terms of that integration.

Our partnership with iRobot still is going to move forward.

But it did prompt a lot of the other branches of the military to think and look at our technology being integrated with the unmanned vehicles, again, especially in the European theater with some of our partners over there.

Okay, great.

Thanks very much.

Thank you.

Sorry I can't be more specific on that, but a lot of times, when you're working with the military, they don't want a whole lot of that information out as do our customers.

That order that we announced earlier, unless the country, they'll, a lot of times, want to do their PR, and if they don't want to, we won't.

And that's why you will see it go as an unnamed country.

Got it.

Thanks, Paul.

Your final question is a follow up question from the line of Eric Wold with Merriman Curhan Ford.

Please proceed.

A couple of follow up questions on the C2; I don't know if you want to give it.

In the past, you gave the backlog going into next quarter; do you have that for the end of Q4?

It was minimal.

Okay.

We really did [hum] to get it all out by the end of the year.

That's good.

And secondly, saw an article as well, where the C2 is being sold over in France direct to the distributor there, and the article talked about having 2,000 units already in backlog; that was I think a couple of weeks ago, and being shipped this month.

Any update on kind of how that's being sold there, kind of any thoughts there?

That one is -- it is going very slow and we're doing that for a reason, because we really are focusing on -- we've got a huge opportunity with the law enforcement side of this.

And we're quite frankly, he and us are putting just the effort into the law enforcement side, not spending a lot of time on the C2 side over there.

There has been obviously, demand.

He talked about that in the article, but it's not been a focus for us and probably won't be till the latter half of the year.

Okay, and any other countries besides France that would be getting the C2?

There's a handful, but it's 3-5; it's not very many.

Most of the countries like the UK, like Canada, it's a prohibited item, so it's a very small handful of number of countries that will even allow their citizens to have that type of a technology.

And for the most part, those will be done through distributors or will you ever do those direct?

Those will all be done through distributors because then again, we hear when we sell these in here, we do a background check and we do a registration.

So we're asking our distributors, when they're doing the same thing, which also is taking time for them to set up that they -- when they're selling, they need to do some kind of a check on who it's going to, where it's going and a registration system, so that our AFID system has integrity that not just here domestically but internationally as well.

So if someone from France logs onto your US website and tries to order one, it'd either just deny them or does it kind of relocate them to the France site, or how does that flow?

We cannot ship there; we deny them that because the export licensing requirements from the US.

So we would be sending those over to our distributor in that country.

And what happens on the web if they try to put it into a location we can't ship, it tells them to call the 1-800 number and our customer service folks walk them through that.

Perfect, thanks, guys.

Thank you.

Thank you so much, Eric.

And Tony, thank you very much for hosting the call.

For everyone on the call, thank you so much for listening in.

Obviously, stay tuned, we're very excited, and we'll talk to you in April after Q1 2008.

Good morning.

Ladies and gentlemen, once again, thank you for your attendance in today's conference.

This concludes your presentation.

You may now disconnect.

Good day.