Axon Enterprise, Inc.

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Axon is a leading provider of law enforcement technology solutions, primarily known for its TASER devices and software platforms.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: Axon’s business revolves around providing a suite of hardware and software solutions to law enforcement agencies. Their primary hardware product is the TASER, a less-lethal weapon used by law enforcement officers. The company also offers body-worn cameras, in-car camera systems, and a digital evidence management platform called Evidence.com. Their revenue streams are diversified and include product sales, cloud services subscriptions, and training.

TASER Devices (Professional): This is the core product which generates the most revenue.
Sensors: This segment includes Body Cameras and associated equipment
Software & Services: This segment includes Evidence.com subscription sales. This is also growing exponentially.

The company operates a dual-revenue business model: hardware sales and recurring software subscriptions.

Trends in the Industry

The law enforcement market is facing increased scrutiny, with emphasis on accountability and transparency. This is driving adoption of body cameras and digital evidence management systems, where Axon is very well-positioned to benefit.
Rising adoption of data analytics and data management tools within law enforcement agencies
Increasing demand for non-lethal weapons in policing to reduce civilian harm
Growing preference for integrated systems that combine software, hardware, and training
A trend of digitalization of law enforcement operations, including evidence management, case reporting and administrative duties.

Competitive Landscape

Axon operates in a competitive landscape, facing rivals in the various segments. However, Axon’s unique product portfolio allows it to be the only one-stop-shop solution to provide multiple needs of the police department.

Taser Devices: The market for less-lethal weapons is dominated by Axon. However, other smaller companies may compete with niche offerings.
Body Cameras: This market faces significant competition from various hardware manufacturers.
Software and Cloud Services: This market also faces strong competition from other providers that specialize in data management or security.
There’s also competition from tech giants like Microsoft and Axon and their cloud offerings.

What Makes Axon Different?

Integration: The company’s ability to integrate hardware, software, and data analytics sets it apart from competitors.
Established Market Presence: Axon has a well-established track record, particularly in the TASER and body-worn camera space.
Proprietary Technology: While some components can be replicated, their technological dominance in TASER and integrated systems gives them an edge.
Ecosystem Approach: Axon is not just selling products but rather an ecosystem to serve its customer’s needs.

Moat Rating: 3 / 5

I have rated Axon with a moat score of 3 out of 5. Here’s my justification in detail:

Switching Costs: Axon’s subscription-based services in Evidence.com create a high degree of customer lock-in. Once a law enforcement agency is using Evidence.com to store its video and digital evidence, it is costly, time-consuming, and disruptive to migrate to a competitor. The integration of Axon’s hardware and software creates a sticky ecosystem. The integration makes it hard to change the company or its product as the financial, legal, and training aspects are heavily reliant on Axon’s platform.
Intangible Assets: Axon benefits from its brand recognition and reputational value, especially when it comes to TASER devices. Their patents also provide some protection against competition. But many of their products are not patent protected.
Network Effect: A network effect is present on the Evidence.com side. The more users join the platform and upload and share the data, the more valuable the platform is to other agencies.
Cost Advantages: Axon does not have huge cost advantages from the supply side, but they’re not completely a commodity either because of the research they do.
However, despite having some competitive advantages, their products are in some way replicable, even though other companies have not achieved the same level of execution and dominance as AXON, the company is still at risk of competition especially in the newer sectors they are moving into.

Overall, Axon possesses a narrow moat, which could prove sustainable for the medium term.

Risks To Moat and Business Resilience

Competition: Rising competition in the body camera and software sectors poses a risk to the company’s profitability and growth. New entrants and aggressive pricing strategies by competitors could erode market share and pressure margins.
Technological Disruption: Rapid changes in technology could render Axon’s products obsolete, requiring continuous innovation to remain competitive. Specifically, more efficient or cheaper alternatives to current technology could threaten margins.
Regulatory Changes: Changes in legal or regulatory frameworks related to law enforcement, data security, and privacy could negatively impact the business, affecting contract terms and demand.
Economic Downturn: Since government agencies are a big customer for Axon, economic downturn might put some strain on their financials. But since the safety and functioning of police department is paramount, cuts in their budget might be limited.
Reputational Risk Negative news events and controversy about certain technology such as TASER might result in lower demand of their product.
Acquisitions: As AXON is pursuing rapid growth strategy through both organic and inorganic means (acquisitions), they should be very careful that the acquisitions are not priced too high and whether their integration actually leads to higher value. There have been a large number of acquisitions that never worked out well. So AXON’s risk management should be careful about acquisitions.

Business Resilience: Overall, I would say Axon has good resilience since it provides core products to its customers and it also has a diversified revenue stream. Their products have been tested and proven to work. However, competition might still affect the profit margins over the long term.

Financials:

Here’s a deep dive into Axon’s financials:

General Performance

Axon had a very high revenue growth rate of 34% from $861 million to $1.16 billion from 2021 to 2022.
Adjusted EBITDA also grew rapidly 20% from $196 million to $237 million in the same period.
Total cash from operating activities has been growing rapidly in past few years.
They have also been heavily investing in the business with their CapEx which they are accounting in the line item of “Investments in property, plant and equipment”.
They have around $150 million in debt in total liabilities and over $300 million in cash and short-term investments.
Their equity is very high, and they have retained almost all their earnings in the business.

Their financial growth is not just reliant on revenues, but it also depends on the profits they can make, and also the cash-generation potential of the company. They’ve been performing exceedingly well in all three sectors.

Revenue Segments

TASER: The TASER segment continues to be the cornerstone of Axon’s revenue. In 2022 it generated $541.7 million in revenue a very large portion of their total revenue.
Sensors: This division, which is mainly responsible for the body cameras, generates $421.7 million
Software and Services: The subscriptions for the Evidence.com cloud platform generated $196 million in 2022 and it is also the fastest growing segment of the company.

Profitability Analysis

Axon’s gross profit margin for their business has seen little change in last three years, which is somewhere around 62-63%. This implies a consistent cost structure for their production.
They do have a decent operating profit of 20% in 2022, which is a very healthy margin.
Their net income has been highly volatile in the past two years from 0.74 dollars in 2021 to -0.39 dollars in 2022, to 0.11 dollars in latest filings. This has to do with a lot of non-recurring expenses as discussed previously, such as stock-based compensations, litigation expenses and so on.

Cash Flow Analysis

Axon generates a lot of cash. Free cash flow for 2022 is $100 million.
Their cash conversion is not 100%, but since the core business is a software as a service company, they reinvest cash in other parts of business like research and development, and for building new capabilities.

Capital Allocation

Axon uses much of its cash flows in capital expenditures (CapEx), which is basically the investment they are making to support future growth. This does include investing in technology, as well as for building up the necessary equipment.
The remaining cash has been invested back into the business for R&D and share buybacks.
They had over $300 million in cash and short term investments at the time of writing.
They seem to be conservative about issuing shares, as the dilution is minimal.

Debt & Liabilities

They have total debt (including long term debt, capital lease, and current debt) of around $150 million. Most of their debt seems to be long term, having 5-10 years of repayment window.
They have a lot of intangible assets on the balance sheet, so they need to be careful that they do not end up overvalued.

Understandability: 2 / 5

Axon’s business model, in theory, is easy to understand, as they are supplying essential goods to law enforcement organizations. But in reality, it has several complexities due to their various product segments, which are mostly interdependent.

Here’s the detailed breakdown of why this has a rating of 2/5:

Dual Revenue Stream: The business has two very different revenue drivers:
1. hardware sales (TASERs and cameras) that face intense competition
2. SaaS subscription revenues with more recurring nature and lock-in. Valuing a business with these two different characteristics becomes difficult.
Technological Advancements: Since a significant portion of their revenues are from technology products, it is hard to foresee how technological advancements will change their competitive landscape. This can be tricky to understand as technology changes rapidly.
Complex Customer Base: Axon’s customers are mainly governmental organizations. Their spending habits and budget allocations can differ significantly from region to region and have a strong reliance on regulation and political environment of a specific country or region.
Accounting Practices: It is important to keep a close eye on different accounting practices that impact reporting of revenue and cost. For example, it is important to understand how share-based compensation effects earnings and the treatment of goodwill and intangibles which can be tricky.
Inter-relatedness of Product Segments: Their different segments (Taser, Cameras, Software) are interconnected, and the health of one segment might affect another.

Balance Sheet Health: 4 / 5

I would say that the Axon has a healthy balance sheet:

They have a very good current ratio of about 1.7, meaning it has about $1.7 of assets for every $1 of liability. This indicates good liquidity in the company.
Total debt (including long-term debt, capital lease and short-term debt) is about $150 million, which is minimal compared to the equity of the company, which is over $1 billion. This implies low financial risks for the company.
They also have a high amount of cash reserves in hand to cover any short-term emergencies. They have over $300 million in cash.
Though they have a high amount of intangible assets and goodwill, they’ve been consistently increasing their revenues and profits which is a good sign of the growth prospects of the company.
Their reliance on operating lease is high which should be closely monitored.

Conclusion:

Axon Enterprise is a growing company operating in a very important field that affects the lives of ordinary people. Their business involves a mix of different aspects, including hardware, software, recurring revenues, and specialized distribution which makes it difficult to fully grasp the business. The company does enjoy a narrow moat with good financial backing and revenue potential.

Overall, Axon can be a good long term investment for an intelligent investor who understands the economics of the business and can analyze how sustainable the moat is.