Axon Enterprise Inc (AXON) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first-quarter TASER International, Inc.

earnings conference call.

My name is Jennifer and I'll be your operator for today.

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

Later we will conduct a question-and-answer session.

(Operator Instructions).

I would now like to turn the conference over to your host for today, Mr.

Rick Smith, Chief Executive Officer.

Please proceed.

Thank you very much.

Welcome, everybody.

Before we get started here I'll have Dan read our Safe Harbor statement and we'll get started.

Okay, thank you.

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.

TASER International intends that such forward-looking statement 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 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 or 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 of the markets in which we compete and accompanying demand for our products; potential for delays of international domestic orders; implementation risk of manufacturing automation; risks associated with rapid technological change; execution and implementation risks of new technology; new product introduction risk; ramping manufacturing production to meet demand; litigation resulting from alleged product-related injuries and deaths; media publicity concerning product uses and allegations of injury and death and the negative impact this could have on sales; product quality risk; potential fluctuations in the 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 governmental investigations and regulations; TASER product sets and reports; dependence upon key employees; employee retention risk and other factors detailed in the Company's filings with the Securities and Exchange Commission.

With that I'll turn it back over to Rick Smith.

Great, thanks, Dan.

So as everybody has no doubt seen in our press release, we came in at a little over $23 million in revenue in the first quarter and generated over $4 million in cash off that revenue base -- something we're proud of and enthusiastic -- continue to see the core business generating cash on a quarterly basis.

So we were able to execute a stock buyback for a little over $5 million and yet our net cash change was not too significant from the end of the year due to cash generation.

Similarly in this quarter we saw product gross margins improve by a little over 1% of revenue compared to last year, that's on the product only gross margin.

The net gross margin did decrease because we're now selling EVIDENCE.COM in what used to be under the R&D line is now (inaudible) sold for operating our data center.

SG&A also dropped over last year by about $1 million, and yet I think we are accomplishing more with less.

You may have noticed if you go to TASER.com we've launched a brand-new website that's been redesigned from the ground up, optimized for search engine results.

And we believe is going to help to make our website into the best salesperson for the Company and a valuable resource for our distributors.

A couple other things to talk about.

Probably the big one happened just this week and that was the announcement of the new TASER X2.

The X2 is basically our middle option now in ECDs.

We've got our entry level with the X26, which has been our workhorse since 2003.

At the high-end we have the X3.

The X2 we believe is the optimal balance of features, price and size.

It's almost as small as the X26, has a second shot, as a second laser so you know where both darts are going to go.

Has an invented fire control system so that you can arc the device for warning purposes while it's still loaded.

We've improved the weatherproofing, has a battery system that can now support over 500 discharges and we're offering this at a price under $1000.

Our market research indicates that -- at least based on various survey results -- we believe the X2 has the option of providing very compelling upgrade opportunity for our installed base.

As we look at it, there are around 250,000 weapons that are over five years old that have surpassed the typical useful life for electronic devices.

It's been somewhat challenging to have a compelling message to our customers to upgrade the device to get the same fundamental weapon they've had, just a newer one.

We believe the X2 is a game changer and we've talked to a number of customers and received very positive feedback and indeed this creates a compelling need for upgrade, particularly the backup shot.

We've (inaudible) a number of marketing materials and our training materials pointing out there have been a number of cases over the years where when an operator misses -- which happens; we're all human -- cases have escalated to lethal force levels.

We believe having that second shot can save a lot of lives, prevent injuries and make TASER devices all that much more effective.

Running the simple math, if this is compelling enough to upgrade just 10% of our installed base, that would lead to an incremental $25 million in revenue, in round numbers.

Obviously if the conversion rate goes up so does the incremental revenue.

So X2 is something we're quite excited about.

There is some risk, particularly in the current quarter, of revenue disruption.

Meaning it does take agencies some time to digest new information, to test new equipment.

And so the only real downside potential with the X2 is if agencies stall purchases while they look at it we could see short-term disruption.

But we believe that the results are pretty compelling about the device and that agencies should be able to make decisions relatively quickly.

And at the end of the day the upgrade opportunity is very significant.

The next thing to talk about also happened after the end of the quarter and that was the launch of POLICE POV, which is a television show that we developed in partnership with BASE Productions, which is on truTV on Sunday nights, one of their prime TV slots.

They launched this past Sunday with dual back-to-back episodes of the show.

We're quite excited about this.

It's pretty rare that a company launching an entirely new product category ends up having a prime time television show built around that capability and that product.

So we believe this will do a lot to educate the public, as well as police, about the benefits of on-officer video.

And frankly that it will create a compelling positive urge for law enforcement when they see the benefits of the cameras being used on -- by the agencies in the show.

Also over the past quarter we did bring on five new agencies that have purchased TASER AXON and EVIDENCE.COM, including one trading college in Wisconsin.

We continue to get excellent feedback on the system and on the capability.

It is a longer sales cycles than has been with our traditional weapons; there are a lot more decision makers involved when you're not only selling hardware but back-end IT systems and services.

We've been meeting with numbers of experts in the software as a service business from some of the leading companies that you've heard about out there.

I probably shouldn't name the firms, but people that are involved in the sales and growth of leading staff providers.

And we've been learning a lot along the way, that they're not surprised to see that the adoption curve on the front end for these types of businesses takes a while to ramp, but once they do, they can really hockey stick in an interesting way.

So the most important factor I'm looking at it that we see consistently that chiefs and leaders in law enforcement, they all see video coming.

They see that as a trend; there's no dispute it's on its way.

They see that moving video on to the officer is also something that's coming; it's just a natural progression.

It's just going to take some time for it to happen.

We believe we're in a first mover position and we're well positioned to take advantage of that trend and we'll continue to put a lot of focus and resources on AXON and EVIDENCE.COM in the future.

And again, we believe that having a TV show about AXON and EVIDENCE.COM is an invaluable resource.

As I also mentioned, we launched the new TASER.com, our new website.

I'd encourage you to all go on and take a look at it.

We think that it's easier to digest, obviously the importance of a strong Web presence can't be understated in the world today that we live in.

And what you're seeing today is just the first iteration.

We've gone (inaudible) management platform as a far more user friendly and particularly marketing friendly site that our people can change and adapt much more easily than the prior infrastructure.

And again, we've accomplished these things all while reducing costs.

The last thing I would talk about before I head over to Dan is we've implemented a number of key operating improvements within the Company that have allowed us to become more efficient.

And one of them is the implementation of a phase gated product development process and the creation of a world-class voice to the customer program.

And the first product you're seeing come out of these refined systems is the TASER X2.

We literally involved thousands of officers directly and indirectly through surveys who helped us compile what the key features of a new weapon platform would be in terms of selecting the right price points and product segmentation between our product line to create a compelling upgrade program.

And then we fed that feedback into a much more structured product development process that included a much longer planning phase on the front end of development.

And the benefit of doing that with the X2 is what we have actually seen is we were able to develop that platform at a significantly lower cost and the overall development time was quite a bit faster than it was for previous weapon systems that we've done it because we had the rigor to spend a lot of time on the front end on the planning and validation of new technologies before they went into the design.

And as a result our quality tests have been pretty unbelievable on the X2.

It is already surpassing by significant margins the design margins of the X26.

Basically we can put the X2 through tests and count on this thing in ways that none of our prior weapon systems could have withstood.

And we believe that goes back to a rigorous process.

And of course that's important for our shareholders in that we believe this gives us the ability to scale and bring ever more products to market more consistently with better cost controls and better quality and that's key to driving revenue over the long-term.

So with that let me turn it over to Dan to give you some more detail about the quarter.

Okay, thank you.

So as Rick indicated, revenues for Q1 were $23.1 million, this is down approximately $700,000 or 2.9% from the prior year.

The decrease in sales versus the prior year quarter is primarily driven by a few individually significant orders to international customers and a small reduction in the domestic law enforcement spending in Q1.

Last year in Q1 we kind of saw the tail end of the stimulus funding benefiting us.

We just saw that in the beginning of last year -- by the time we kind of completed the year that was done and we saw a little bit of that impact here in Q1 for 2011.

Gross margins of $12.2 billion or 52.8% of revenues are down 3.8% as a percentage of sales.

Again following commercial launch of our EVIDENCE.COM platform we're now putting as cost of service delivered the cost of the data center, amortization costs of our E.COM software, development efforts in the cost of sales line.

That has about a 5% impact on cost of sales in the quarter.

So when you exclude that actually our margins are actually up versus the prior years when we look at the -- on kind of a similar basis.

So excluding the SaaS costs our gross margins for the quarter would have been 57.8% of sales, which is an improvement of 1.2%.

Again, our long-term margin targets for just the product side of the business remained at 60%.

So we're getting closer to that and feel good about the work we're doing.

The improvements in our product side of the business were really driven by the efficiencies from the automated cartridge assembly production that we put in place last year, reduced scrap and reworked expenses as well as a more favorable sales mix here in this quarter versus the same quarter last year.

SG&A expenses for the quarter were $9.3 million versus $10.3 million in the prior year.

Again, that represents about 40.4% of net sales versus 43.2% last year.

So on a leveraged basis we're gaining a little more leverage out of our SG&A as well which is certainly part of our plan here to get the cost structure in line in order to get the leverage back in the business model here.

The reduction in the SG&A expenses versus the Q1 of the prior year were really driven by lower salaries, benefits and stock compensation, as well as sales and marketing expenses, including outside commissions.

Again, we continue to see the impact of cost control measures that we implemented during 2010.

Research and development expenses were $2.8 million for the first quarter which is a decrease of $2.2 million compared to 2010.

The decrease is driven by the reclassification of EVIDENCE.COM, data center software-related costs previously included in R&D, so that's now moved up into the cost of sales, as well as decreases in salaries due to headcount reductions, reductions in consultant costs as the heavy lift of the development of AXON and EVIDENCE.COM scaled back and reduced scrap expenses.

This is offset by expenses incurred to develop the new X2 electronic control device which we just launched here, as Rick spoke about earlier, as well as some costs of capitalized software development that we included last year that this year now all that money is sitting up in cost of sales.

We did reap -- those costs benefited the cost control during the quarter by generating income from operations of $110,000.

I'm going to continue to work on getting the leverage in the model here and making sure that we manage our expenses efficiently and effectively.

With the ramp-up of our software development in California and the resulting 123R compensation and just the fact of the amount of the non-cash charges we have for things like depreciation, we do look at the business both on a GAAP basis and also a cash basis.

So when we look at the cash basis P&L actually for the quarter, our adjusted operating income was $3.1 million.

When we add back depreciation and amortization and stock compensation this is almost a doubling of last year's cash earnings of 2.1 -- I'm sorry $1.6 million and on a GAAP basis we had, again, operating income of $110,000 and net of tax income of $20,000 or zero cents per share on both a basic and diluted basis.

You may notice that the tax -- income tax expense for the quarter looks high.

At the end of March the Arizona Legislature actually approved a phased reduction in Arizona's corporate income tax rate that starts in 2014 with the full impact being in 2017.

As a result we had to do a -- look at our long-term deferred tax assets for Arizona and look at what the value is going to be of those tax assets as they roll through our tax returns in future years.

So we've booked an estimated reduction in the value of those tax assets because the lower income tax rate actually reduces the value of those tax assets.

We did book a $100,000 estimate in Q1, so that's why the income tax expense is so high for the quarter.

We'll get back to more normalized income tax rates as we move later in the year.

I'm not going to really cover the balance sheet in detail, I think most of those changes are pretty straightforward.

So I'm going to move to the cash flow information; I think that's probably more beneficial.

So as we go to the (inaudible) information from the statement of cash flows, we did have cash provided from operations of $4.3 million during the first quarter of 2011.

This compares to cash used in operations of $6.7 million in the prior years -- very happy with that swing in cash generation.

The cash generation for the quarter was really driven by the cash earnings of $3.1 million.

We had accounts receivable actually drop $1.9 million, inventory decreased $1.2 million, and then we had a couple offsets, prepaid expenses, prepaid assets went up $1.2 million and accounts payable actually came down a little bit -- came down $0.9 million for the quarter.

Again, we used a lot of cash last year, that was really driven by lower operating income on a cash basis, really specific to last year, we really had a large impact, inventory grew $2.9 million last year and prepaid assets grew $[1.6] million, and then accounts payable, because we had some of the final payments on the automation, actually decreased $4 million.

So big swing cash generation wise in the business, feel good about generating $4.3 million from operations.

You'll see that cash used from investing activity in the first quarter was $10.2 million compared to $2.3 million last year.

The largest use of that cash is actually we purchased $9.8 million of short-term investments.

As we looked at the yield we're getting on our cash we saw the opportunity to actually increase our interest income by buying some high-grade corporate short-term investments all left in the year.

So that's actually going to help with the interest income.

We actually saw a decrease in property, plant and equipment versus the year-end balance; it's just really driven by the fact that we had very low purchases of CapEx in Q1, so the depreciation expense is actually higher than the CapEx in the quarter.

We did have cash used in the finance activities of $5.1 million, this was really driven by the stock buyback.

As Rick indicated, we did purchase 1.25 million shares in the quarter at a cost of just a little under $5.1 million.

That leaves us $7.4 million left on the $12.5 million buy back that the Board of Directors approved here in March of 2011.

We did finish the quarter with $31.8 million of cash and another $9.8 million in short-term investments for a total of $41.6 million of cash and investments.

Very confident that we've got a strong liquidity position that allows us the means to manage our business during these challenging times.

And it's also allowed us to focus on growing our business throughout 2011.

So with that I'll turn the call back over to Rick Smith.

Okay, thanks, Dan.

As we look forward to the rest of 2011 there are five key areas where you'll see the Company focused.

Number one is upgrading our installed base of customers to our latest technology.

We believe the X2 is the central thrust of that theme.

As I mentioned, we believe it provides a compelling feature set to drive an upgrade cycle.

The second area is to continue to drive adoption of AXON and EVIDENCE.COM.

We've made significant investments in this space.

We get excellent feedback on the overall capability; the folks who are deploying it are reporting significant drops in complaints against officers, significant improvements in the efficiency of their investigations.

We've been told of criminals entering guilty pleas as soon as they realize the incidents were caught on video, things that otherwise would have spent valuable time and resources for the agency and the prosecutor's office to have to take through trials.

Just can't tell you -- it feels like the early days of TASER back in the late '90s and early 2000's.

I think we're on to something significant there.

The third area is growing our penetration in the international market.

We continue to believe that TASER devices have made such a big impact in North America, can do so internationally and they have been.

We continue to see new countries coming on board with TASER devices and our penetration in the international markets is much, much lower than it is here in the US, it's certainly been in the single digits.

So lots of room for growth internationally.

The fourth area is continuing to improve our in efficiency and profitability.

I can tell you it feels good to see some black ink at the bottom of the income statement for the last quarter.

We're very much focused on continuing to improve profitability.

We're coming out of a heavy investment cycle.

I believe we're still making the right investments in innovation, we're doing it better, we're doing it more efficiently and we think we're starting to do it profitably.

And the fifth is continuing our progress towards a world-class human capital system.

Over the past year or so we've put a lot of focus on our recruiting, interviewing and selection processes on on-boarding, on leadership training, on making sure that we retain the best folks in the world and develop them within TASER.

We believe that that's the key to long-term success is having the best and most motivated people in the world.

And we believe we've got that and our systems are getting better each quarter.

And finally I'll talk a bit about if you haven't yet received your annual report, when you do if you look inside the last -- the back cover you'll see a new intellectual device for us called TASER's Mission Pyramid.

Or you can go to our website at TASER.com and click the About TASER in the upper right-hand corner and there you can see our mission pyramid.

And basically what we've done is over the past six months or so we've led a number of exercises within the Company, one of them is based around Jim Collins' Good to Great principles, another around [Durand's] [Quality Tones] and we're continuing that through this year.

With the concept of driving towards a simple set of values, our mission, our core values and the key success factors that can be used day to day by our individual employees who drive decisions and speed execution throughout the organization.

So hiring the best people and giving them a clear mission and then giving them the freedom to execute and the principles against which to measure success we believe are the keys for this Company to continue in its mission to transform the world, which we've done it once at least in North America with TASER and we've had impacts in Europe and other places, lots of room for us to continue to change the world in our mission.

And now with AXON and EVIDENCE.COM to expand it not just from the incidents when police are actually on the street dealing with a bad guy, but all of the things that proceed and come after those effects that we believe we can have a major impact on improving public safety, officer safety, reducing injuries, saving lives.

And at the end of the day improving the relationship between law enforcement and the communities they work in through greater transparency and protecting the truth of what happened in these incidents through world-class on-officer video and evidence management systems for really optimized sharing, storage and retrieval of digital evidence.

So with that we'll wrap up the call and we'll take a few questions.

(Operator Instructions).

Eric Wold.

Good morning.

I guess first of all, Dan, just real quick to get it out of the way, can you run through the unit numbers?

Yes, (inaudible) to do that.

So X26 we sold 12,940 for the quarter; we sold 3,719 M26s, so most of that's an international market; X3 we sold 165 in the quarter; C2s we sold 4,440 for the quarter, so nice quarter for the C2s; TASER CAMs we sold 1,789; and then we sold 350,345 cartridges, so real strong cartridge sales for the quarter which actually contributed to the sales as well.

Perfect.

And then, I know we're kind of in the midst of this upgrade cycle just in general and then obviously a replacement cycle possibly for those devices past their useful lives and now it's that combined with an upgrade cycle with the new launches of X3 and X2.

I guess can you quantify what you've seen in this past quarter in terms of -- I know you can't tell necessarily what unit sales are a replacement, but can you maybe give a sense of what percentage of your sales were to new customers versus existing customers?

The bulk of our sales at this point are going to be to existing customers.

But that could be anywhere from just a replacement of units to just further penetration within the agency.

We've got a much deeper penetration at the agency level than we do at the officer level.

So it's tough to tell exactly how much is replacement versus further penetration, but most of our sales are still going to be to the existing customers, especially in the North American market.

Internationally I think we still have the opportunity, although maybe we've sold to a country before.

There are a lot of countries which are sort of in the very early -- in procurement cycle.

So I think there are still a lot of opportunities to get what would really be kind of a new customer too, they haven't bought yet in any kind of quantities.

Now if an existing customer or existing department is actually replacing tasers that are beyond use of life or upgrading, do they typically alert you to that fact that they are doing that?

And do they do that to try to get -- I guess, one, do they just alert you in general?

And two, do they do that to try to get some kind of trade-in value as well?

Yes, we've seen some of that.

Last year we saw it -- it's a little easier for 2010.

We saw a lot of that when we end-of-life'd the M26 for the North American market last year we saw a lot of those M26 customers come to us and upgrade to X26 or X3 at that point.

So we think we've got roughly I'd say between $5 million and maybe $7 million of our sales last year with those upgrades around that M26 program.

So we do offer some trade-in credits in some cases to try to drive that cycle, even getting a small value for what they have sometimes would be enough to drive that sale.

So we are seeing that cycle start, we think the X2 is actually a more compelling upgrade [task], especially since most of the install base is X26s at this point.

So having something compelling to upgrade to I think will actually help drive that.

And then with the budget -- most departments are still under a budget crunch.

I mean is there any difference between a department trying to get budget dollars for new tasers they've never had before versus trying to argue that they need to replace tasers that are on their force now that are end of life or is it basically the same tough situation?

No, I think the optimist in me says that it's maybe in some respect easier to upgrade because they've seen the benefit of the product.

Some of our customers that we've seen successfully get budget dollars for upgrades have really made that argument that hey this is a product that saved the department a lot of money in worker's comp and suspect injury savings, saved avoidance of lethal force situations.

So the product has proven itself to be valuable for the city, so in some respects hopefully that upgrade cycle is easier because they've already made that step to purchase the technology and they've seen the benefit, so hopefully the upgrade is -- that path is smoother.

But it's still a tough budget climate, my view is they're still spending some money, we just need to be at the top of that list of what they're spending their capital dollars on.

We think that second shot is a real valuable -- very much a life-saving, officer protecting capability.

And hopefully our customers find that compelling.

And then last question, I guess, is it budgets or as the economy does come back and budgets do kind of pick back up, are most departments for this year -- and you'll know kind of like what percentage of them tend to be on a September versus December fiscal year.

But is it pretty much if you're on a September fiscal year, even if things improve is there a chance of getting more dollars in this budget or once the budget set is done, basically if you want to buy stuff you need to use kind of the confiscated kind of found dollars, if you will?

Yes, that's still a major funding source for us.

Really in a good budget climate those (inaudible) forfeiture moneys and grants are still a big funding source for us even in a better economy.

It's still tough municipal budgets, but I think we're starting to see some indications that that's improving.

At least in some places we're seeing sales tax revenues increase as the economy improves.

So hopefully over time we'll be in a better climate, certainly having -- we think having a good line up of products as the economy improves really puts us in a good position.

I just want to make sure I understand the dynamics though.

So if sales tax trends and everything gets much, much better over the next few quarters -- or next few months, does it matter though if a company is on a September budget year, can they change it this year?

Or is it really -- they'll get some dollars in for the next year's budget?

It's probably more of a next year budget for that, but I guess my first point was that a lot of the dollars that to go to buying tasers aren't always budgeted.

There are some of those asset forfeiture moneys and other things you pointed out as well.

And I think that's going to be just -- that doesn't really change.

I think better budget climate, probably where it helps us is that money doesn't get swept to other places, it stays with the police and maybe they use it for equipment at that point.

Perfect.

Thank you, guys.

Peter Mahon, Dougherty.

Good morning, guys.

Say, I just wanted to dig into the X2 product a little bit.

How does that product from a margin perspective impact the X26?

You said you were pricing it a little bit south of $1000 a handle and the X26 right now is running probably in the ballpark of somewhere between $700 and $800.

Have you elected to lower the price of your X26 with the launch of the X2?

No.

Okay, so essentially from the X26 perspective the margin makeup will remain the same.

Is the X2 margin makeup very similar to that?

Yes, it's similar on a percentage basis.

Obviously with a higher price point, the dollar margins per unit will actually be a little better for us.

Right, okay, got it.

And then, Dan, I just wanted to confirm a couple housekeeping questions with you.

You said that the Arizona tax, that was a $100,000 item, correct?

That's correct.

Okay.

Now in terms of SG&A, you guys -- it was relatively flat sequentially at $9.3 million.

Is there anything that you guys can do -- should we see a dramatic change in that SG&A number throughout the year or have we kind of reached a bottom in kind of our cost savings?

How should we think about that as the year unfolds?

Yes, I think the heavy lift on the cost savings is really behind us.

We did make some really pretty significant structural changes last year to headcount.

Certainly we're going to look for the ability to be as efficient, effective and we're not -- we haven't stopped those efforts.

But I think the big dramatic improvement is behind us.

I think at this point I'd like to look at SG&A as sort of another leverageable line of the P&L that as we -- if we're effective in growing the business that we'll see that SG&A as a percentage of sales come down and see the operating income as a percentage of sales go up.

Okay, got it.

Great, thank you.

And from the December quarter to the March quarter here we saw R&D go up modestly.

I assume that has a lot to do with the X2 development.

As the year progresses do you think that we'll see that number decline?

What do we have in the hopper right now that would warrant a $2.5 million to $3 million R&D P&L hit on a quarterly basis?

And is that level we're going to see it stay at or how is that going to unfold as the year progresses?

Yes, I'd say that's a good question.

I think we're going to kind of stay at that range for the rest of this year.

I think certainly even with the launch of the products you continue to do value engineering on the products you've launched.

There's still a fair amount of investment still happening on the video side of the business and also EVIDENCE.COM.

The software piece of the business that you -- sort of that part never sleeps.

Even if the (inaudible) launch the product you're going to continue to work on new features and capabilities in that SaaS model.

So I think that, again, that will probably stay relative at these levels for the rest of this year.

But again, it's something that -- I expect it to leverage.

R&D as a percentage of sales, if we're successful in growing the top-line, do they expect to come down as a percentage basis.

Okay, great.

Thanks a lot, guys.

Steve Dyer, Craig-Hallum.

Thank you, good morning.

A real quick question and I hopped on -- I had another call, so I hopped on about halfway through.

The X2 -- how do you see that adoption taking place?

The move from the M to the X back a few years ago was pretty rapid, actually.

Do you see a similar move this time or do you think it will be more muted or sort of how do you think that transition takes place?

That's a great question.

There are factors on both sides of that.

We did see the X26 flip; in its first full quarter of production it was outselling the M26.

Of course at that point in time we were in a little stronger economic environment and they both use the same cartridges.

So people that had a stock in cartridges could easily deploy some of the new devices, they could keep the X26 and the M26.

The X2 we believe provides an even more compelling upgrade in terms of its capabilities and the fact that we were able to engineer it into something that's fundamentally within an ounce or two of the X26 that from the officer's perspective is a very compelling upgrade.

It's been probably the strongest positive reaction we've had to products in focus groups and market testing certainly since the X26 introduction.

So on the plus side, a lot of old weapons out there that are past their useful life, customers are looking for a compelling reason to upgrade, that's in our favor.

The only thing that could slow it down is just it does require a transition of their inventory and expendables as well.

We are putting programs together, we've not announced them yet, that will create I think a compelling trade-in value with a full conversion program to be able to take their inventory of cartridges and get some credit for that as well as they roll out the X2.

So at this point we've really just started showing it to customers on a private basis in the last few weeks, we (inaudible) yesterday so it's a little early to say.

Although qualitatively we've been getting very positive feedback.

So I think we'll -- unfortunately we're not going to know what the future holds until it gets here in terms of the actual conversion rate, but I'm pretty optimistic.

And then as far as the X3, are you going to I guess kind of keep that around and I guess still offer that kind of now I guess making the assumption that that's not the answer for the upgrade cycle for everybody anyway.

Are you going to keep that around or is there more cost associated with doing that than just scrapping it?

Oh, no, we'll absolutely keep the X3 around.

It is our top of the line product, particularly for like SWAT operators where the Arizona Highway Patrol bought them because their guys tend to operate out in remote areas in the state by themselves.

And having not just one backup but two backup shots is particularly important when your next officer might be half an hour away.

We also, just purely from a marketing perspective, that having a three product lineup tends to help people with their decision-making.

When you've got three products people tend to pick the one in the middle.

And having a higher priced full-featured product like the X3 on the top end and the relative price scale between the X26, the X2 and the X3 -- does that really help position the X2 as a --.

For most people it's going to be the (inaudible), the right combination of size, price and features.

And we believe that actually keeping the X3, even though it's probably going to sell in smaller unit volumes and to a more specialized unit, that the net effect is that it should help drive overall sales adoption of the X2.

Okay.

What's the progress of some of the other ancillary products, the XREP and some of those types of things?

Anything worth talking about there?

The XREP, we are seeing some decent interest internationally.

The overall impact in the munitions space is considerably smaller than the hand-held ACDs; i.e., the number of cases where police will roll up and use a shotgun launch, an extended range projectile is really pretty small compared to the average patrol use.

So one thing that we are doing within the business is trying to focus our resources on doing fewer projects, so you will probably see -- well, you will see from us in the future less of the specialized applications of our technology and we're more focused on projects that have a higher utility across the broadest base of law enforcement.

So we'll keep the XREP around in our product lineup.

We're not investing overly heavily in it or into, for example, a next-generation of the XREP.

We think our resources are better focused.

The two big things that can move us from a product perspective are a compelling upgrade cycle that is compelling for the mass patrol officers and we think we've got that right with X2.

And then the on-officer video and digital evidence management.

And so we're -- the mission pyramid I talked about in our annual report, we're going through the exercise of asking okay, what we can be best in the world at, what are the few things that this Company should focus on and just doing it in a world class way has led to I think the right business decisions about focusing on doing fewer things and doing them better.

For whatever my opinion is worth, I think that's the right way to go.

Well, thank you.

How would you categorize kind of the tempo or the climate internationally?

Historically it's been kind of fits and starts and there for a while France was going to put one on everybody and their brother.

How would you -- and I know they have some of the same budget issues that we have, but how would you categorize their receptiveness to the product now versus a couple years ago or what are the thoughts there?

Well, I think some of the controversy is dying down a bit.

To be honest, Amnesty International is not as vigorous as they were a few years ago when there was all the controversy in the US and then there was all the controversy in Canada.

I think the negativity has sort of run its course to some degree where even the people that were really critical in 2005 are now saying, yes, these devices have a place in modern policing and the studies are just beyond compelling about the injury reduction potential.

It's been a little frustrating that we haven't seen countries take that next step to go to full deployment on all their officers.

We're continuing to have inquiries and conversations on those levels.

We're continuing to have more countries come on and we just had a significant international order in the last couple weeks here.

Over the long haul we think we're in an even better position in that the international customer base seems to be a bit more risk averse.

Anytime you're dealing with national level politics, all it takes is one thing to derail you for a bit.

Frankly in the UK last year there was a lot of controversy over the use of the XREP projectile in an unauthorized use in -- I think the guys name was [Raul Mote].

And that led to a lot of consternation in the media and we actually saw that -- I believe that kind of disrupted the normal sales process.

I think we're kind of past that now.

We've gotten things sorted back out and onto a steady plane.

So I think we're actually in a better position than we were several years ago just because time has passed, the data continues to really support the technology.

In the X2 we've even built in some pretty compelling safety features that further reduce the already remote risks of adverse events and we think that can also be compelling as well.

I wish I could give you a more direct answer and say we've got a couple countries lined up that are buying for every officer.

But until we get the orders that -- we've had countries talking about it for years and I share your frustration with the France situation.

We weren't quite able to get that ball across the goal line.

But we believe we will in the next 12 to 18 months see some significant, very significant international orders on a scale perhaps that we haven't seen before.

Okay.

And then one last question.

We talked about the SG&A line.

The R&D line, is that, Dan, is this kind of the level that you guys are looking at?

Is there any ramp for anything or does it ramp down for anything or how should we think about that?

I think I feel pretty confident about these levels.

I think of this as kind of the range you're going to see for at least the rest of this year.

There's still some value engineering to do on some of the new products, we still have our investments in EVIDENCE.COM and our on-officer video products that we're making.

So I think this is kind of a reasonable level at least for the rest of 2011.

All right, perfect.

Thanks, guys.

Okay, well we've run almost an hour here.

I'd like to thank everybody for your time.

We've still got a large list that stayed through all the Q&A.

It's an exciting time for us, we look forward to our next call in July when we'll be able to talk about some of the initial adoption of the X2 and we'll know the answers to some of the questions that were asked today about the future.

It's an exciting year ahead.

So thanks for your support of shareholders; we appreciate the opportunity you've given us to work with some of the finest customers in the world and we'd encourage you all to come out for our shareholder meeting here on May 26.

Come see the building, see some of the automation equipment we've got, some of the new stuff we're in production is really world-class.

And we look forward to meeting ever more of our shareholders.

So thank you all and have a great day.

Ladies and gentlemen, that concludes today's conference.

Thank you for your participation.

You may now disconnect.

Have a great day.