Axon Enterprise Inc (AXON) 2013 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the TASER International Incorporated quarter one 2013 earnings conference call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session with instructions to follow at that time. (Operator Instructions) As a reminder, this conference is being recorded.

I'd now like to turn the conference over to your host for today, Mr. Rick Smith, CEO. Sir, you may begin.

Thank you. Before we get started this morning, I'm going to have Dan Behrendt to read the Safe Harbor statement and then we'll get started.

Hey, good morning. Safe Harbor statement. Statements made on today's call include forward-looking statements, including statements regarding our expectations, beliefs, intentions or strategies regarding the future. We intend such forward-looking statements be subject to the Safe Harbor provided by the Private Securities Litigation Reform Act of 1995.

The forward-looking information is based upon current information and expectations regarding TASER International Incorporated. These estimates and statements speak only as of the date, in which they are made are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. All forward-looking statements that are made on today's call are subject to risks and uncertainties that could cause our actual results to differ materially. These risks are discussed in our press release we issued today and in greater detail in our Annual report on Form 10-K for the year ended December 31, 2012 under the caption Risk Factors. You may find both of these filings as well as our other SEC filings on our website at www.taser.com.

With that, I'll turn the call back over to Rick Smith.

Great. Thanks, Dan. All right. So surely have all seen the press release this morning. The team here has been working hard. And again, I think turned in some great results. First quarter revenues were up 19% from $25.6 million last year to $30.4 million this year. Most of that is driven by law enforcement agencies purchasing and upgrading to our new Smart TASER Weapon platforms, namely the X2 and the X26P.

You're all familiar with the X2 which we've been selling for several years; the X26P is a new product where we integrated many of the new smarter features and upgraded it to an all-digital platform in a device that does not require changes in user training or behavior, so it's a very seamless upgrade for agencies that have already deployed the X26. And we've received extremely positive feedback from the market. For those agencies that are looking to be increasing their capability, the X2 has been widely adopted and is widely selected. But for a lot of agencies that are dealing with a tougher budgetary environment and reduced training staff that we just really want to keep things simple, yet still upgrade to some of that new technology. The X26P has been frankly a home run, those agencies see at has been very responsive to the voice the customer, that really meet their needs, in particular which is simplifying their deployment process.

And one example of that is that less than 90 days after its launch, by March, the X26P in the month of March outsold the X26. Now, it's certainly too early to call out the trend or it depend on that going forward, but that's pretty remarkable for a new weapon to have that happen that quickly. So we are seeing the intended features of the X26p making it easy to adopt, do seem to be resonating well in the market. The CE Weapon -- I'm sorry, the CEW or the Weapon segment revenues were up 13% over the prior year to $28 million. In the Video segment, we saw an increase of $1.5 million or 175% up to $2.4 million in the first quarter of 2013, up from a small base the year prior. But sequentially, Video segment revenues grew $0.6 million or 32% from the fourth quarter.

Also important, we saw net operating losses, we've pared those by 50% over last year, down from 3 million to 1.5 million in the first quarter. Obviously, part of that is due to the increasing revenues and part of that is due to continued optimization in that business unit.

Gross margins overall were up 61% from 59% in the year-ago period. Our SG&A expenses were down sequentially 10% from the fourth quarter, although up 27% from the prior year, as we've talked about increasing our investments in customer-facing roles as we transitioned from a company that's traditionally just sold weapons or products in a box, to a more solution sales company. We've created a whole-new customer-facing functions in order to do that. We believe those investments are paying off.

We also did see some increase in litigation activities, about $0.5 million compared to last year. And before I [go] to Dan, let me comment briefly on litigation. We're seeing a very promising trend in our litigation. Many of you know that we've taken a number of steps, including revision of our warnings in 2009 and 2010. And since that time, given that most of our cases are related to warnings, not actually to any product defects, we've seen our rate of litigation drop significantly over the past year. One example of that is two years ago, we had 60 active cases and today, we have only 25.

So we've cut the number of active cases by more than half, because the rate of dismissals is significantly greater than the rate of new addition. I should caution for modeling purposes, we don't expect to see financial benefits from this decreasing trend for probably at least another year to 18 months due to the lag time between when cases are found, either adjudicated. We're still working through the backlog of cases from prior to those days. But for the long term, obviously, this is a very promising trend in the business. And with that, I'm going to turn over to our Chief Financial Officer, Dan Behrendt, to go through the financial details.

Thanks, Rick. As Rick mentioned, revenue for the first quarter was $30.4 million, which is up approximately $4.8 million or 18.7% from the prior year. The increase in sales versus the prior year is mostly driven by the continued adoption of the X2 Conducted Electrical Weapons as well as the adoption of new X26P CEW that was announced in January 2013. The North American Law Enforcement business continues to be strong, mostly driven by the upgrade cycle of the X2 and X26P CEWs. We actually sold $8.1 million of the X26P and X2 CEW handhelds in Q1 and North American Law Enforcement sales were actually up 31% over the first quarter of 2012. The upgrade opportunity in North America remains one of our growth drivers and one that we're excited about as we continue into 2013.

Gross margin was $18.5 million or 60.6% of revenues, which is up slightly from 59.4% of the prior year. We continue to see the benefit of higher operating leverage in the business as the fixed and semi-fixed expenses in our manufacturing overhead are levered up as we see increased sales. We also had a high percentage of dropped shipments and other direct sales to customers in the quarter, which increases our average selling price and the high average selling price in that business has a partial offset and that for some of the dropped shipments, we actually have higher variable selling expenses because we paid distributors their commission in SG&A when we dropped ship on their behalf.

Cost of service delivered actually decreased $417,000, as we continue to realize the lower cost structure that we benefit from, from moving to a public cloud web services from our own data center that we made that move, completed that in about midway through last year and started seeing the full benefit of that in the fourth quarter and that continues into the first quarter here.

SG&A expenses of $11.2 million for the first quarter of 2013 compared to $8.9 million in the first quarter of 2012. As a percentage of sales, SG&A was 36.8% of net sales in Q1 of 2013 versus 34.5% in 2012. The comparable levels overall, the primary driver for the increase was personnel cost, which increased $1.1 million due to the making of additional strategic hires as part of our ongoing commitment to enhance our customer-facing capabilities. Variable selling expenses also increased in the quarter when compared to the prior quarters, again, we mentioned, that's due to paying distributors their overages as well as paying higher commissions for our inside salespeople when they make some of these direct sales. We also saw increase to trade show expense in the first quarter due to the technology summit we conducted for our Video segment and then legal-related expenses, as Rick mentioned, increased approximately $0.5 million when compared to the first quarter of 2012.

SG&A expenses in the Video segment overall increased $341,000 when compared to the first quarter of 2012 as a result of investments in customer-facing roles as well as technology summit. We also had an additional $210,000 of increases in SG&A to support the growth of our international business.

The research and development costs of $2 million for the quarter, which are pretty much flat compared to the 2012 and really are in line with sort of the run rate. We're seeing efficiencies in consulting and the decline in appreciation expense offset by some higher payroll-related expenses. We do expect R&D expenses to trend up over the year, especially in the Video business as we saw some critical open positions and reinvest in those.

When you look at the segment results, you'll see the Video business R&D came down during the quarter, that's really mostly as a result of hardware R&D, there's folks that are in the Scottsdale headquarters office to support the hardware development Flex and TASER CAM. Those expenses have come down in the first quarter as those products have matured up to the point where they don't need as much work.

Moving onto adjusted EBITDA, which includes the add-backs for depreciation, stock compensation, among other items, was $7.7 million in the first quarter of 2013, compared to $6.9 million in the first quarter of 2012, with improvement being driven mostly by the higher sales levels. We have a table that reconciles adjusted EBITDA to net income in the earnings release you can refer to.

Income from operations for the quarter was $5.3 million and we saw net income in the first quarter of $3.3 million, or $0.06 a share on both basic and diluted basis. This compares to $3.8 million or $0.07 a share on basic and diluted basis in the first quarter of 2012 although the prior year, you remember benefited from the $2.2 million reduction in accrual on the term case, so more of a normalized basis, results this year were better.

As we move on to the balance sheet for assets, we finished the quarter with $38.6 million of cash. We're able to offset the $5.4 million that we spent repurchasing stock bought back through the quarter as part of the $25 million buyback approved on February 25, 2013, with operating cash flow and cash flow from the tax shield provided by employee stock option exercises. We actually bought back 702,866 shares during the quarter for $5.4 million with an average purchase price of $7.61 per share. Accounts receivable of $16.8 million are down $1.3 million from year-end due to the timing of collections that occurred during the quarter.

Inventory of $11.8 million is up about $800,000 from the year-end balance, mostly attributed to buildup of X2 and X26P inventory just anticipation of the sales transferred to 2013.

We saw the investment in property equipment of $21.2 million is actually down $800,000 when compared to the prior year-end. The net decrease includes approximately $949,000 depreciation expense offset by some capital expenditures about $609,000 of CapEx in the quarter; most of that was for production equipment with some purchases of computer equipment as well made in the first quarter. And the total assets as of March 31, 2013 were $117.1 million.

Moving onto liability and equity section of the balance sheet, accounts payable were $4.8 million is actually down $1.4 million from year-end due to the timing of some check-runs and processing the invoices, accrued liabilities of $6.8 million decreased $0.3 million, primarily as a result of the timing of bonus payments accrued in Q4, which are paid out in Q1. Total deferred revenue of [$13.8] million has actually increased $1.7 million from year-end, primarily due to the increased sales of X26P and X2, both of those being sold with training programs that included extended warranties that we're seeing higher warranty purchases because we're selling more of those products with the warranty bundled in as well as the deferral revenue EVIDENCE.com service which actually grew deferred revenue of $767,000 over the fourth quarter of 2012 due to increased sales of the Video segment.

As people probably remember, we're the seller of AXON Flex video products. We're deferring revenue related to EVIDENCE.com service, so the revenue for that will be -- for the service piece will be recognized over the service period of between one and five years depending on the contract that customer is signing with us. And of the $13.8 million of deferred revenue on the balance sheet, $2 million of that is actually related to EVIDENCE.com service and that continues to grow pretty sharply from the fourth quarter balances which I think is a good trend.

Total liabilities of $28.9 million and the Company finished the quarter with $88.2 million of stockholders' equity. Again, we have no long-term debt on the balance sheet other than a small capital lease and continue to have plenty of liquidity and strong cash flow engine in our core business to fund our R&D efforts and operations as we move into the future. We're looking at the cash flow information. We did have a cash flow provided from operations of $4.5 million during the first quarter of 2013. We also had some net cash provided from investing activities in the first quarter of 2013, mostly driven by some maturing short-term investments of $1.7 million during the quarter. They weren't reinvested in the quarter because we made a decision to change investment advisors in early Q2, so it just made a very cleaner transition to those short-term investments matured late March and we just waited to invest them in April.

Cash used in finance activities, just $3.3 million, again, that's driven mostly by the stock buyback of $5.4 million executed in Q1 partially offset by 1.9 million tax benefit from employee stock option exercises. We finished the quarter with 38.6 million of cash, very confident liquidity position business, really the strong cash generation in the business is what gave the confidence to continue to stock buy back in 2013 and we feel good about where we sit right now.

One thing I want to just talk about briefly on the call today. I've gotten a couple of questions from investments. This is just sort of the press release strategy for the business. You probably noticed that the Company has been making press releases more often talking about new orders that were booked throughout the quarter. We just think it's important for a customer's many of who look to each other for guidance on technology shift to see which of the peers have deployed our new video technology or upgrading to the new CEW platforms, but it's not something we want to [talk from our investors] perspective, we don't want investors to read too much into it, one way or the other, it's just something really more for commercial purposes that just have that weekly cadence of press releases each week just talking about our customers that are either upgrading to the new CEW platforms or deploying the video. We think it's important commercially, but you should expect to continue to see sort of that cadence of weekly press releases.

And finally, I want to cover just the tail statistics for the quarter. We actually sold 9,024 X26 units in the quarter. As Rick said, the X26P was actually off to a strong start. We sold 4,345 X26Ps in Q1. X2s were 4,946. We sold 628 M26 CEWs; we sold 200 of the X3 that's mostly in the consumer segment of the business, so that continues to sell slowly, but we are happy with where that sits right now. C2, we sold 2,295 C2 units in Q1.

TASER CAMs were 2,313 units. We sold 363,515 cartridges. So again, cartridge sales continue to be strong, partially driven by the X2 because it uses a different cartridge design than the X26 that is replacing a lot of cases. [Just forcing] customers have to buy sort of a new arsenal of cartridges, so that's part of what's driving that. And we sold 788 of the Flex video cameras.

So with that, I'd like to turn the call back over to Rick Smith.

Great, thanks, Dan. One thing you'd like to notice in the quarter, well, a couple of things. First, a significant number of X26P orders, including some of the larger agencies, New Orleans with 400, New York State Police with 334, Sunnyvale with 210, and then, of course, the X2 continues strong as well with Atlanta buying 200 more, Louisville Police Department, Buncombe County, Garfield and a bunch of others.

What you don't see this quarter is there were no particularly large orders of the magnitude like a Phoenix PD. In fact, San Diego Sheriffs was on our pipeline we expect in the first quarter and it slipped into the second quarter and yet we were still able to meet an impressive sales result this quarter largely to the continued success in growth of the telesales team that brought in $3.3 million in business from the smaller agencies in the market. That's again I'll attribute that largely to the [arrear] that Jeff Kukowski has brought to our -- go to our sales team and our operations, our [program is life style] and the other things we are doing.

We also had a bit of a soft spot internationally in the quarter. International sales came in at about 10%, down from our historical levels. We attribute that largely to just the -- international tends to be lumpy, they tend to be some larger orders. As you know, we've been investing in international sales offices that really started in earnest about nine months ago. We are expecting to see those results take some time to kind of find the pump, but we are certainly of the belief that, that same regulator that's working in the US is going to help us internationally.

Let me shift now to talking about AXON Flex and EVIDENCE.com. Again, continued to see momentum in new adoptions on the marketplace. Bookings were up 300% over the first quarter of 2012, although down 17% sequentially. We attribute that to a couple of things; number one, the fourth quarter does tend to be a stronger quarter than the first, in general. The other is, if you look at the dynamics of the longer sales cycle in the Video segment, many of the agencies we were closing up through the end of the year were actually agencies which started working with, with our first-generation AXON Pro system before.

So they are sort of in the sales cycle, agencies like Havasu that we closed right around the end of the year. We've been working with them for about 18 months. So we are now getting into the point where we are really able the focus on many new agencies as we are scaling up the AXON Flex that really became commercially available last summer.

Another thing that we see is really quite reassuring in that part of business is the number of renewals and expansions. We talked about like Havasu has gone now to a full patrol deployment, Salt Lake City and the Valley Police Alliance [up there] deploying cameras simultaneously across 14 agencies. Chesapeake, Virginia, they just expanded their program to now full deployment of all their field officers.

Albuquerque, another big win. Albuquerque actually was the first major city I believe in the United States to put on-officer video on all of their offices with somewhere between 700 and 1,000 cameras. They had originally done this with consumer cameras at a much lower price point and we have been able to work with Albuquerque to understand the significant logistics costs associated with handling the video as well as the utility and durability of those consumer cameras and having them now come across as a customer we see as an important validation that the investments we've made in really building an end-to-end system that is both robust and really manages that work flow through this total cost of ownership is able to go in and displace agencies that had previous products that they were using.

Also, Cook County, another interesting one to talk about, Cook County has deployed 250 of the AXON Flex video systems. What's important about Cook County is there, we've found that they really wanted to save the data locally within their own networks. They had large investments in infrastructure around fixed cameras and other sorts of video. So our Flex system has been designed so that we could accommodate that. So customers can now use our gear and point it to store the files in their local system; of course, we also believe it gives us an advantage over time as the cloud deployment model with all of its advantages around cost and speed of innovation, et cetera, that at any point, an agency like this wants to [make] a transition back, of course, our gear can seamlessly move from storing stuff on-site to allow them to deploy EVIDENCE.com in the cloud.

I'm going to conclude by talking a little bit about our Analyst Day that we hosted in New York. I assume some of you, I know some of the analysts on the call were there, many of you were not. What we really talked about there is how we have identified that you are really one of our greatest assets, greater than our IP, greater than our tooling or any individual product is the relationship, the unique relationship we have with 16,000 plus US law enforcement agencies, [any of the] agencies around the globe. These agencies are spending between $10 billion and $20 billion a year on technology.

We believe we have one of the strongest brands. We're seen as a company that takes advanced technology and combines them with training to provide simple, easy to use, reliable systems end to end solutions that our customers can deploy and so we're developing new products to back in to that same market and frankly enable us to win much larger share of their dollar spend on technology. And of course, the first major expansion is what we're doing with on office video Flex and with EVIDENCE.com with the cloud-based digital evidence management system.

Many of you saw recently the New York Times article showing the first really academically rigorous study of the impact of AXON Flex in the field, that is out of Rialto, California in combination with the Cambridge University in the UK. We're using a randomized study design. They were able to show a direct correlation from the deployment of the cameras to an almost 90% reduction in complaints against police. This is significant. Perhaps even more significant based on almost 60% reduction in the use of force, meaning that when cameras were deployed, the de-escalated behaviors in these tense situations frequently even the suspects would de-escalate when they knew they are being recorded.

We've had several major agencies that have told us that that data alone empowers them to go to their risk managers and make a case for reallocating risk management funds to fund AXON Flex and EVIDENCE.com systems and Rialto, while it is the first major academic study, they are not alone in terms of the results that they are reporting. Lake Havasu reported complaints down about 60%, Pittsburgh relatively 4%, Tonganoxie reported a 100% decrease in complaints. In terms of use of force, we have seen others like Tonganoxie actually report a 90% decrease or Sikeston Police Department down 40% or Oviedo down 30%. So we believe these early validations are supercritical, both in terms of proving the value of the system quantitatively as well as qualitatively by seeing customers come back to renew and expand their programs.

Our best estimates right now based on a report from the AP is the US law enforcement agencies spend around $2,500 a year settling claims against the agency, so $2,500 per officer per year is an average payout for claims -- or complaint cost. The aggregate that over the US, that works out to well over $2 billion, so it's a significant problem that we're helping them solve and we are now seeing some real similarities to the early days when we were first launching TASER devices here in North America.

Those were the two big factors early on that helped the TASER to gain traction. The first was the emergence of the statistics showing the deployment of the TASER M26 led to significant reductions in deaths and in injuries. And then, that actually was more qualitative, that was the personal experience of officers in the field, many of whom were skeptical. They talked to many officers who said, I've been doing the job for 20 years, why do I need this new TASER thing, and yet those same people after having them in the field for a while would come back to us and share stories about how they saved somebody's life with it.

We are now seeing similarities in AXON Flex and EVIDENCE.com where we are seeing the statistical results and we are now having officers come back as well, some of which saying, I do not want to go on patrol without this, particularly officers who have had complaints filed against them where the video has clearly exonerated them.

If you go to our website at taser.com and go to the AXON video page, there is a compendium of many of the testimonials from individual officers. So at the end of the day, the strategy that we are employing here with this public safety platform strategy is to really come to an understanding even our TASER weapons are connected devices, they are smart devices, they are collecting information about how they are used, they've got sophisticated firmware, they need to be periodically connected and updated, we're using EVIDENCE.com as the network to make that happen, many times we have some like 60,000 or 70,000 TASER CAMs in the field.

We are helping our customers deal with all that information and of course expanding that network to include things like EVIDENCE.com -- I am sorry, the AXON Flex wearable cameras. So we believe that we are proud of what we've done historically. Many of our customers will tell us that TASER has been the biggest revolution in law enforcement certainly in this century. And we believe we are positioned to do it again. The digital video and multimedia is the opportunity to become the centerpiece of law enforcement records of the future, so this goes even beyond just defending against complaints. We see video moving to the center of all law enforcement work flows and that will create a number of extension opportunities for us as we continue to scale this business.

At the Investor Day, we talked about we actually shared some models. Obviously, when you're dealing with disruptive technology, it's very difficult to make short-term models or even long-term models with much accuracy because creating market that don't yet exist, but we believe with some conservative assumptions that we can grow TASER to between $166 million to over $300 million in revenue over the next three years to five years.

And I'll reiterate that none of these models assume the kind of rapid adoption we saw with TASER weapons nearly 2000. So if we should be fortunate enough to see a TASER like adoption there is upside in these models. However, again, I caution you, we are seeing longer sales cycles and these more complex solution sales. That's why we are being a little more conservative.

So I'd conclude by just again reiterating that we are solving big, important problems for our customers and when you solve big problems, you create significant value for all of our stakeholders. So it includes our customers, our employees and certainly our shareholders, as well as society at large. When we make communities safer, I think that's something we can all feel good about. Solving big problems is not quick and it's not easy. We've done this before in creating the global market for TASER Conducted Energy Weapons and we've done it in this market facing similar challenges with these same customers and we're intent on doing it again. I think we're making a lot of progress.

So with that, I will open it up and we will take a few questions.

(Operator Instructions) Our first question comes from the line of Steve Dyer of Craig-Hallum. Your line is open. Please go ahead.

Thanks. Good morning. Nice quarter, guys.

Thank you.

Just a housekeeping question to begin with, do you -- is the X26P a subcategory or subgroup of the X26 numbers that you give or are those in addition?

Those are in addition. So we sold 9,024 X26s; and in addition to that, we sold another 4,345 X26Ps.

Okay. That's helpful. And then, with respect to the new bookings, I realize it's very early and this isn't going to be a linear progression, et cetera. But in general, what are you kind of seeing there that number was off slightly quarter-over-quarter, how do you sort of think that plays out from a cadence standpoint?

Well, one of the things that's interesting from a market dynamic perspective is we're seeing the larger agencies move faster than we have historically. The TASER growth early on was driven really a lot more by the smaller agencies moving more quickly. We've been surprised frankly at the level of interest in the big agencies, so there is a plus and a minus to that. We've actually put a lot of focus seeing the opportunity there. We see to really win this market long term, the more the big agencies we can get, the more influential they will be. So we're putting a lot of our focus -- when a Salt Lake City or a Fort Worth puts their hands up or a Pittsburgh, we really put a lot of focus on those.

If we can win over a sizeable percentage or even a majority of the major cities and begin to work with those customers to identify what sorts of information they will want to share, but those network effects you can really kick in like we saw in Salt Lake City with the local agencies, the smaller agencies tending to follow the large. So there is some real advantages to that dynamic. One disadvantage is relying on big agencies means it's going to be more lumpy. In the quarter, we certainly -- we had some pipeline that had it come in in the quarter, we would have seen significant growth over the fourth quarter some of those deals pushed out, it happens with larger agencies.

So I would say probably for the balance of this year, we're going to continue to see some lumpier, large orders that will sort of determine some of that quarter-to-quarter sequential noise, whether it's up or down, but I can tell you qualitatively, we've seen a major shift in the response to the market. People are no longer saying -- I actually presented at a Chief's Course in Louisiana about two weeks ago, where we get about 110 chiefs and senior administrators. And at the beginning of my presentation, I asked how many of them saw their agencies moving major systems to the cloud and I would say 80% of the hands went up. Two years ago, I think we might have seen 10% of the hands go up. So we're seeing a lot of those good, qualitative responses. Obviously, we'd like to see sequential growth every quarter, but the large agencies are going to make it a bit lumpy.

And we expect the trend line will continue to be [up here] with that lumpiness. So that's kind of what we're focused on sort of the overall trend. Although, as Rick said, we like to sort of see sequential growth, but I think as long as you're sort of seeing that trend line continue to be up and to the right, we feel like we're on the right track.

Sure, understood. And then, just, I guess, sequentially, from a revenue perspective, I know you don't give a lot of guidance. I had expected maybe a little bit of a -- you talked about little pause as people, agencies evaluate the X26P versus the X2. Certainly, it didn't seem like you saw much of [one] if any. Sequentially, does it feel like kind of things get better from this level throughout the year?

I think, obviously, we felt very good about first quarter. We expected to see agencies sort of evaluating X2 sort of weight. We still saw some of that in the quarter and I think that's still probably something we could see in Q2, but we feel very good to be able to put up these kinds of numbers with that backdrop of a new product being launched. So I think we're sitting in a good position. I think, as Rick said, we've had a couple of deals get pushed from Q1 into Q2. So I think that [hussle over] Q2, but as you know, this is a difficult business to forecast, but we feel very good about sort of we're sitting overall with a large amount of the North American business has not having upgraded yet, but we're certainly seeing continued traction there.

Sure, okay. Thank you.

Thank you. Our next question comes from the line of Paul Coster of JPMorgan. Your line is open. Please go ahead.

Thanks very much for taking my question. Rick, can you talk a little bit about the penetration of large accounts in North America with your video solutions? Where do we stand not just in terms of the percentage of large accounts that have even adopted it, but within those large accounts what's the sort of penetration level and where do you expect to ultimately to go?

Okay, great question. Most of the large agencies, I would say, are in early deployment, so if we look at the major -- the MCC or the major cities, we've got Pittsburgh, well, I think around 50 units, Mesa around 50, Fort Worth is around 50 to 100. We've got a number of others that are testing or that have made smaller purchases that we have not yet announced as we work through. Some of these have paid in trials; I guess there's probably another 5 to 10 agencies that are actively testing of the major cities which again is top 65 or around 70 agencies in the country.

We have seen some of the mid-size agencies like BART [amidst that], so and now Chesapeake that have gone to full deployment. Obviously, we're excited and working hard to help get some of these major cities to really expand their programs. We do expect that to happen in several of those cities to have significant expansions by the end of this year. We're also learning that one of the things that we're working hard at to help that happen is doing some integrations with some of their existing IT systems to be able to pass some information back and forth logistically.

So, for example, one of these agencies, they want the officers to be able to just record on and off all day and not have to tag any videos, and we could then match on the back end based on the time and date of who made the recording, we could pull tables from their record management system and have the [evenues.com] automatically do that tagging. That would remove any incremental work up to those officers which have seen as a huge benefit. So we are working very closely with these customers, warning what are the next enhancements, and again being in the cloud model it's great that we can roll out enhancements about every 90 days, and those types of things we think will help keep these agencies from the 100-ish range up to much larger deployments.

I would also point out that perhaps new this quarter, we knew how major agency is beginning field trials in Brazil, the UK, Australasia, and elsewhere in Europe. So I don't want to give too many details until we are further into these tests, but we've been able to turn on instances through our cloud partner, so we do have the ability to store data internationally. That increases the comfort level of our international customers, and so we are -- work into the sales process now globally.

And where are you seeing competition in this space and from whom?

Great question. There's a lot of guys making cameras out there. In Albuquerque, we saw they had bought the -- those little cameras you can buy in Sky Mall for $150. Now, they found that we are replacing some of those. I don't know if it was the exact one from Sky Mall, but similar category. They found that we are replacing those one or two times a year out in the field. So for us to be able to upgrade them from a $150 price point obviously to a $800 or $900 price point I think shows that again the industrialization we've done really pays off and really the work flow as we worked with Albuquerque they were burning, and officers had to download their own devices and burn them to CDs or DVDs and I think they had hundreds of thousands of disks they were dealing with. So untangling that has another big advantage for us.

Internationally, there are some local players in different countries. I know in Australasia, there's at least one on-body camera maker; in France, we believe there's one. There's a couple in the UK. Some of them are doing software backend. Typically, we are still seeing most of the business models are facing or at least all of them that I am aware of currently are primarily the hardware vendors where the software is like a free app sort of approach. I don't know that we've seen somebody at really make the heavy investment in building out the enterprise class software that comes with the core and over time that's where again we see the real value out of the business.

There are some in the media you probably saw in one [area] really asked us about Google Glass and how we see that coming. We've been selected as one of the early glass explorers. We look at that as when that technology is commercialized, we are building our system the same way that we frankly partnered with Looxcie to make AXON Flex taking right commercial technology and [dab it into] our marketplace. We see our strategy is building that ecosystem that partners with world-class devices like iPhones and Android devices. So we are less focused on the hardware over time certainly will become commodity. We see the opportunity to solve the big data problem as the big one, and we have not yet seen I would say a major competitor go there, although I would expect within the next year we will probably see some of the car vendors that have done on-premise digital evidence management solutions probably also start to make moves into the cloud. So we've got to continue to press our first-mover advantage hard.

Oh, you could actually capture there [later] I imagine. But my last question is what percentage of revenue today is recurring, and then looking out over your forecasting horizons, how do you see that evolving for the Company?

Is your question about the percentage of revenue that's recurring in the video business or across the whole business?

Well, it's really both, but obviously, the video is very much recurring, but I'm really keen to understand how your business is working for the whole Company over the sort of five-year period that you've talked about?

This is Dan. Yes, we do expect the recurring piece of video will grow over time and as I mentioned we've got $2 million of deferred revenue on the balance sheet right now, just for the video business. In this quarter, the service piece of the revenue was about 10% of the total and we expect that that percentage will increase over time. The overall business we still sort of benefit from sort of the razor-blade model on that roughly 30% of our sales are cartridges and other accessories and that's been pretty predictable to [make that] part of the business and we expect the video as the service business. Some of these early customers come back and now move to trial the deeper adoptions and buying the service. We expect that service revenue will grow over time.

Okay, got it. But do you also anticipate hardware leasing to grow?

Yes, I mean we didn't have a lot of the TTP deals this quarter but it continues to generate a lot of interest from our customers. I think the good news is we continue to see cases where customers evaluate our TTP program and do a cash deal that's perfect for us. I mean part of it is just another tool for our salespeople to use and continue the conversation and make sure that the conversation doesn't stop with, hey, we are not sure we have enough budget to deploy this and in some cases, they have been able to actually find budget dollars and just make cash purchases which is great.

Got it. Thank you.

Thanks.

Thank you. Our next question comes from the line of Glen Mattson of Sidoti & Company. Your line is open. Please go ahead.

Hi. Good afternoon, gentlemen. A real quick. Housekeeping first. SG&A jumped this quarter. Is that -- first off, do you still have same expectations for SG&A this year and also more conceptually on the Video business, between the Rialto study and the attack in Boston and what a key role Video played there, it almost feels like have we turned this a corner? Are we starting to see a lot more interest and it seems like you have a lot more deal flow in the Video business even in this second quarter? So basically those two points.

Dan, why don't you start with SG&A?

Yes, on the SG&A side, we do saw [the same] expectations that we'll see SG&A expenses go up about 10% year-over-year. So not any -- really not a change in strategy there. This quarter we saw about half a million of incremental legal expenses in the quarter but overall we still feel comfortable that we will be in the 10% growth with a lot of that growth being in customer base and we also grow both the video segment as well as the international part of the business.

On the other front, it's too early to say about the role of video in Boston. I don't know that we have a good feel on whether that has an impact. Certainly, we also, we've been sharing that study liberally. It actually the first place we had an opportunity to gauge customer reactions was we held what we call a Tech Summit here in Scottsdale about 60 days ago where the Chief of Rialto came and presented his results before they were public.

At that event, we had roughly 100 law enforcement officials from various agencies around the country and many of them we have actually helped cover the travel cost because of budgets aren't allowing them to travel. So just to be able to make sure we had good attendance we provided some grants to cover the travel cost. What we found was all the folks that came in including some major agencies that I would say were skeptical the night before the conference at our welcome reception by the evening after the conference we saw market changes and their receptiveness, I'd say almost everyone I interacted with that was leaving the conference was of the tone that they were going to go back to their agencies and begin the process to deploy this technology.

We are now looking how we can scale that by moving those summit events around the country by scheduling them around other events where senior law enforcement officials will be other major conferences, so that it doesn't have the incremental travel cost or significant incremental travel costs, that's probably one of the biggest things we can do from a thought leadership perspective is getting the chief to these events, where they hear, chiefs like the Christopher Bank, the Chief of Salt Lake, was a speaker talking about other deploying multi-agency models in Salt Lake, Chief from Rialto, Chief Halstead from Fort Worth talking about the benefits of that they are seeing.

So yeah, it feels to me like we crossed a tipping point intellectually. Again, we need to be conservative about we just don't know as they point out in the study the innovators of the Limo, one of the challenges in modeling or analyzing or forecasting disruptive technologies is it's really hard if not impossible to do, we just don't know where we see that economic tipping point, but I think we're starting to see some evidence in the numbers that we are certainly on an upward slope, now the question is what that ramp looks like.

Okay. Great. I think that's it from me. Thanks guys.

Thanks, Glen.

Thank you. Our next question is from the line of Peter Mahon from Dougherty & Company. Your line is open. Please go ahead.

Yes. Good morning, guys. Just had one question. Looking at the CEW segment, Dan, actually gross margins declined almost 200 basis point year-over-year. I was hoping that you might can elaborate on that, especially after you guys talked about having more direct sales and things like that that increased ASP?

Yes, I think that's a good question. I think it's really driven a little bit by the mix. Also, as we saw more of the X26P units, we are offering trading credits to encourage our customers to do that, so while we see like maybe a higher ASP for cartridges and things like that for those parts of the business, we are offering trading credits, so that does have an impact on gross margin, although we think that the trading credits, we've seen those as being a very successful way to drive the business. So I think that small decrease in gross margin is really just driven by the trading credits we've run through the income statement.

And most of the trading credits are again packages that include extended warranties, so part of this is probably relating to a higher percentage of deferred revenue associated with a higher percentage of units being purchase, warranty, et cetera.

And we are seeing -- as I mentioned, we are seeing that deferred revenue line of balance sheet continue to grow pretty sharply, so which is again I think to Paul's questions earlier, I think again that's because more and more predictable part of the business, it's going to run in every quarter because we know we're going to see that deferred revenue for warranties as well as the service on EVIDENCE.com come through each quarter.

Got it. And just to clarify, you guys have a training program on both the X2 and X26P, is that correct?

That is correct.

Okay. And would you mind letting us know what those credits are at this point in time?

Yes, I believe it's $135 per handle for the second quarter.

Okay, great. Thanks a lot, guys.

All right. Thank you.

Thank you. And ladies and gentlemen, that does conclude our Q&A session. I would like to turn the conference back over to Mr. Smith for any closing remarks.

Great, thank you very much. Well, we appreciate those of you who stuck with us through the whole call here and have stuck with us, the shareholders over here. I think we are seeing the return on investments that we make as we start to scale new parts of the business. I would also invite all of you to join us for our Annual Shareholder Meeting, which will be May 23 at our headquarters here in Scottsdale in Sunny Arizona. So come around and join us then, we will have more updates on the business and we look forward, if you can't make it then, to talking to you on our next quarterly results call which should be in July. So thanks and have a great day.

Ladies and gentlemen, thank you for your participation in today's call. This does conclude the program and you may all disconnect. Have a great rest of the day.