Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition as of September 30, 2021, and results of operations for the three and nine months ended September 30, 2021 and 2020, should be read in conjunction with the condensed consolidated financial statements and related notes included in this Report on Form 10-Q and the audited consolidated financial statements and related notes in our 2020 Annual Report on Form 10-K filed with the SEC on February 26, 2021. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in such forward-looking statements as a result of certain factors, including but not limited to those described under “Risk Factors” in our 2020 Annual Report on Form 10-K. See also "Special Note Regarding Forward-Looking Statements" on page ii of this Report on Form 10-Q.

Overview

Axon is a global network of devices, apps and people that helps public safety personnel become smarter and safer. With a mission of protecting life, our technologies give law enforcement the confidence, focus and time they need to protect their communities. Our products impact every aspect of a public safety officer’s day-to-day experience with the goal of helping everyone get home safe.

Our revenues for the three months ended September 30, 2021 were $232.0 million, an increase of $65.5 million, or 39.4%, from the comparable period in the prior year. We had income from operations of $2.9 million compared to a loss of $5.4 million for the same period in the prior year. Gross margin improved compared to the three months ended September 30, 2020, reflecting strong demand for our premium TASER offerings and manufacturing cost improvement. Operating expenses increased $38.0 million, reflecting an increase of $8.0 million in stock-based compensation expense related to the CEO Performance Award and XSPP and an increase of $20.9 million in salaries, benefits and bonus expense. For the three months ended September 30, 2021, we recorded net income of $48.5 million, which reflected an income tax benefit of $51.2 million and an unrealized loss of $6.7 million on marketable securities related to our investment in CLBT, compared to net loss of $0.9 million for the comparable period in the prior year.

Our revenues for the nine months ended September 30, 2021 were $645.8 million, an increase of $190.9 million, or 42.0%, from the comparable period in the prior year. We had a loss from operations of $141.1 million compared to $19.9 million for the same period in the prior year. Gross margin improved compared to the nine months ended September 30, 2020 as a result of product mix, reflecting strong demand for our premium TASER offerings and manufacturing cost improvement. Operating expenses increased $252.0 million, reflecting an increase of $170.1 million in stock-based compensation expense related to the CEO Performance Award and XSPP and an increase of $53.2 million in salaries, benefits, and bonus expense. For the nine months ended September 30, 2021, we recorded a net loss of $46.5 million, which reflected an income tax benefit of $57.7 million and a gain of $40.9 million related to observable price changes for our investments in certain unconsolidated affiliates and related warrants, partially offset by an unrealized loss of $6.7 million on marketable securities related to our investment in CLBT, compared to net loss of $27.6 million for the comparable period in the prior year.

Outlook

For the year ending December 31, 2021, we expect revenue in the range of $840 million to $850 million. This guidance reflects our expectation that approximately $30 million in TASER segment revenue previously expected to be recorded in the three months ending December 31, 2021 will shift into the first half of 2022 due to the delayed receipt of a manufacturing component for our TASER 7 devices. Our expectation for capital expenditures of approximately $65 million to $70 million in 2021 remains unchanged.

Total Addressable Market

Axon has raised our total addressable market (TAM) projections from $27.0 billion to $51.6 billion, reflecting a 91.1% increase. This update is largely based on introducing new products, selling into new customer segments and adding sales channels to new geographic regions. Specifically, our two newest drivers of TAM growth are justice software and consumer safety.

Justice: Axon’s expansion into justice software is a natural evolution of our market-leading cloud-hosted digital evidence management software category. Specifically, we are developing software to help prosecutors and defense attorneys streamline the discovery process. Not only is our goal to save attorneys time, but also to shorten the time people are jailed awaiting trial. We expect to share more in the coming months around product launch and customer announcements.

Consumer: We see opportunity to create more effective and reliable personal protection for private individuals, and, thus, our consumer business is a growing area of investment. Our current market penetration in consumer is virtually nil. Historically, our law enforcement and consumer devices have relied upon separate platforms. To drive greater efficiency and reliability, our next generation consumer and law enforcement devices will leverage much of the same core technology. We also plan to offer personal safety solutions, including a consumer-focused smartphone app, and expect to share more details over the coming quarters.

COVID-19

The COVID-19 pandemic has adversely affected workforces, economies, and financial markets globally, leading to an economic downturn. As an essential provider of products and services for law enforcement and other first responders, we remain focused on protecting the health and wellbeing of our employees while assuring the continuity of our business operations.

We have taken a number of actions in response to the pandemic, as described in our Annual Report on Form 10-K. In April and May 2021, we hosted several onsite vaccination clinics for our employees and their family members. In September 2021, the U.S. federal government issued guidance on previously announced COVID-19 vaccination requirements for large U.S. employers. Consistent with this guidance, we announced in October 2021 that the federal vaccine mandate would require all of our U.S.-based employees and contractors to be vaccinated, without the provision of a regular testing alternative. Employees may request a reasonable accommodation for medical or religious reasons.

We elected to participate in the social security deferral program offered under the Coronavirus Aid, Relief, and Economic Security Act, whereby we deferred payment of the employer portion of all social security taxes that would otherwise have been payable from March 27, 2020 through December 31, 2020. Payment of the deferred amount is due 50% on December 31, 2021 and 50% on December 31, 2022.

Results of Operations

Three Months Ended September 30, 2021 Compared to the Three Months Ended September 30, 2020

The following table presents data from our condensed consolidated statements of operations as well as the percentage relationship to total net sales of items included in our statements of operations (dollars in thousands):


	Three Months Ended September 30,
	2021				2020
Net sales from products	$	165,803	71.5	%	$	120,091	72.2	%
Net sales from services		66,186	28.5			46,351	27.8
Net sales		231,989	100.0			166,442	100.0
Cost of product sales		71,336	30.7			57,798	34.7
Cost of service sales		16,086	6.9			10,404	6.3
Cost of sales		87,422	37.6			68,202	41.0
Gross margin		144,567	62.4			98,240	59.0
Operating expenses:
Sales, general and administrative		99,295	42.8			74,443	44.7
Research and development		42,382	18.3			29,246	17.6
Total operating expenses		141,677	61.1			103,689	62.3
Income (loss) from operations		2,890	1.3			(5,449)	(3.3)
Interest and other income (expense), net		(5,530)	(2.4)			2,040	1.3
Loss before provision for income taxes		(2,640)	(1.1)			(3,409)	(2.0)
Provision for (benefit from) income taxes		(51,164)	(22.0)			(2,536)	(1.5)
Net income (loss)	$	48,524	20.9	%	$	(873)	(0.5)	%

The following table presents our revenues disaggregated by geography (in thousands):


	Three Months Ended September 30,
	2021				2020
United States	$	192,756	83	%	$	143,380	86	%
Other countries		39,233	17			23,062	14
Total	$	231,989	100	%	$	166,442	100	%

International revenue increased compared to the prior year comparable period, driven primarily by increased sales in the Americas and Europe, the Middle East, and Africa (“EMEA”) regions.

Net Sales

Net sales by product line were as follows (dollars in thousands):


	Three Months Ended September 30,								Dollar		Percent
	2021				2020				Change		Change
TASER segment:
TASER 7	$	50,641	21.8	%	$	21,702	13.0	%	$	28,939	133.3	%
TASER X26P		9,086	3.9			9,766	5.9			(680)	(7.0)
TASER X2		10,078	4.3			14,494	8.7			(4,416)	(30.5)
TASER Pulse		967	0.4			2,981	1.8			(2,014)	(67.6)
Cartridges		39,313	16.9			26,335	15.8			12,978	49.3
Axon Evidence and cloud services		2,711	1.2			692	0.4			2,019	291.8
Extended warranties		6,099	2.6			5,265	3.2			834	15.8
Other		2,596	1.3			3,171	1.9			(575)	(18.1)
Total TASER segment		121,491	52.4			84,406	50.7			37,085	43.9
Software and Sensors segment:
Axon Body		20,862	9.0			15,978	9.6			4,884	30.6
Axon Flex		1,488	0.6			1,589	1.0			(101)	(6.4)
Axon Fleet		6,063	2.6			4,215	2.5			1,848	43.8
Axon Dock		6,460	2.8			5,708	3.4			752	13.2
Axon Evidence and cloud services		63,272	27.3			45,450	27.3			17,822	39.2
Extended warranties		8,983	3.9			6,514	3.9			2,469	37.9
Other		3,370	1.4			2,582	1.6			788	30.5
Total Software and Sensors segment		110,498	47.6			82,036	49.3			28,462	34.7
Total net sales	$	231,989	100.0	%	$	166,442	100.0	%	$	65,547	39.4	%

Net unit sales for TASER segment products and Software and Sensors segment products were as follows:



	Three Months Ended September 30,		Unit	Percent
	2021	2020	Change	Change
TASER 7	36,350	15,908	20,442	128.5
TASER X26P	6,596	8,119	(1,523)	(18.8)
TASER X2	5,562	10,078	(4,516)	(44.8)
TASER Pulse	3,232	12,811	(9,579)	(74.8)
Cartridges	1,327,971	852,980	474,991	55.7
Axon Body	58,248	62,873	(4,625)	(7.4)
Axon Flex	3,390	3,175	215	6.8
Axon Fleet	2,753	2,396	357	14.9
Axon Dock	8,556	9,165	(609)	(6.6)

Net sales for the TASER segment increased 43.9% primarily due to an increase of $28.9 million in TASER 7 devices and $13.0 million in cartridge revenue. We continue to see a shift to purchases of our latest generation device, TASER 7, from legacy devices. The increases in TASER 7 revenue and cartridge revenue were due to increased unit sales. Revenue was also impacted by higher average selling prices for TASER devices other than TASER 7, for which the average selling price remained stable. Offsetting the increases were decreased unit sales for our legacy TASER devices. In May, we began taking orders for our new wireless Virtual Reality (VR) Simulator Training. While revenues for this product were less than $0.2 million during the period, future contracted revenues for VR products grew to over $20.0 million.

Net sales for the Software and Sensors segment increased 34.7% during the three months ended September 30, 2021 as we continued to add users and associated devices to our network. The increase in the aggregate number of users drove the majority of the increase in Axon Evidence revenue of $17.8 million. Increases in the average selling price of our

Axon Body 3 camera drove the $5.6 million increase in Axon Body and Axon Dock revenue and were partially offset by a decrease in total Axon Body units. The increase in the aggregate number of users and devices also resulted in increased extended warranty revenues of $2.5 million. The $1.8 million increase in Axon Fleet revenue was primarily driven by higher unit sales, as well as an increase in average selling price. Our newest Fleet product, Axon Fleet 3, which includes automated license plate reader technology, began shipping on June 30, 2021.

We consider total company future contracted revenues a forward-looking performance indicator. As of September 30, 2021, we had approximately $2.39 billion of total company future contracted revenue, which included both recognized contract liabilities as well as amounts that will be invoiced and recognized in future periods. We expect to recognize between 15% - 20% of this balance over the next twelve months, and expect the remainder to be recognized over the following five to seven years, subject to risks related to delayed deployments, budget appropriation or other contract cancellation clauses.

Cost of Product and Service Sales

Within the TASER segment, cost of product and service sales increased to $41.6 million for the three months ended September 30, 2021 from $31.3 million for the same period in 2020, primarily related to higher unit sales. Cost as a percentage of sales decreased to 34.2% from 37.1%. The improvement was mainly attributable to a combination of manufacturing cost improvement and strong demand for our premium TASER offerings. We are building manufacturing capacity to support our TASER device and cartridge manufacturing lines in response to growing international and federal demand and an increased install base.

Investments in manufacturing capacity so far in 2021 have resulted in an approximately 40% capacity increase in TASER 7 propulsion module and cartridge line production capacity, combined with greater per-person efficiency that will generate over $1.0 million in gross cost annual run rate savings on the TASER 7. Across all products, manufacturing improvements have contributed over $4.0 million in gross cost savings in 2021. Segment gross margins may continue to fluctuate based on customer and product mix. Additionally, we expect lower output during the three months ending December 31, 2021 due to the TASER 7 component supply chain constraints discussed above.

Within the Software and Sensors segment, cost of product and service sales increased to $45.9 million for the three months ended September 30, 2021 from $36.9 million for the same period in 2020. Cost as a percentage of sales decreased to 41.5% from 45.0%. The increase was driven by the fulfillment of several large shipments of lower-margin body camera hardware to our largest customers during the prior year comparable period.

Although we have experienced supply chain disruptions relating to port constraints along with some increases in raw materials costs, we have remained focused on closely managing our supply chain to keep our gross margins predictable and our inventory levels steady while managing some short term raw materials impacts. We have also worked to mitigate some raw materials costs increases through supplier alignment, alternate sources, and product design changes. We continue to bolster our strategic relationships in our supply chain, identifying secondary/alternate sourcing, adjusting build plans accordingly, and building in logistic modes in support of our increasing demand while working to minimize disruptions to our customers. Supply remains dynamic and our supply chain is focused on mitigating risk and managing constraints within our control.

Gross Margin

As a percentage of net sales, gross margin for the TASER segment increased to 65.8% from 62.9% for the three months ended September 30, 2021 and 2020, respectively. The increase was a result of manufacturing cost improvement and product mix, as discussed above.

As a percentage of net sales, gross margin for the Software and Sensors segment increased to 58.5% from 55.0% for the three months ended September 30, 2021 and 2020, respectively. Within the Software and Sensors segment, hardware gross margin was 36.9% for the three months ended September 30, 2021 compared to 27.5% for the same period in 2020, while the service margins were 74.6% and 77.1% during those same periods, respectively.

Sales, General and Administrative Expenses

Sales, general and administrative ("SG&A") expenses were comprised as follows (dollars in thousands):


	Three Months Ended September 30,						Dollar		Percent
	2021			2020			Change		Change
Total sales, general and administrative expenses	$	99,295		$	74,443		$	24,852	33.4
Sales, general, and administrative as a percentage of net sales		42.8	%		44.7	%

Stock-based compensation expense increased $6.9 million in comparison to the prior year comparable period, which was attributable to an increase of $6.2 million in expense related to the CEO Performance Award and an increase of $1.2 million related to our XSPP. Acceleration in the anticipated timing of attainment for the unvested probable tranches resulted in a $14.9 million increase to stock-based compensation expense. The increase was partially offset by a decrease of $4.2 million, for tranches that have vested and have no remaining unrecognized expense, primarily related to the CEO Performance Award.

Salaries, benefits and bonus expense increased $14.7 million primarily due to an increase in headcount and an increase in payroll taxes on a higher base of salaries and bonus expense. Included in this increase was $5.9 million in employer payroll taxes related to the vesting of the fourth through eighth tranches of our XSPP in September 2021.

Sales and marketing expenses increased $4.9 million, primarily driven by a $2.3 million increase in commissions expense tied to higher revenues and by higher spending on content development, promotional videos, spending for new product launches, and advertising. Included in this increase was $1.2 million related to trade shows and seminars, reflecting increased spending related to our VR roadshow, which began in June 2021, and other events which took place during the quarter.

Travel expenses increased $2.4 million, reflecting a return to pre-pandemic travel levels for certain of our employees.

Professional and consulting expenses decreased $6.6 million in comparison to the prior year comparable period. This included a decrease of $8.3 million in legal expenses relating to the FTC litigation; as discussed in Note 13 of the notes to our condensed consolidated financial statements within this Report on Form 10-Q, we sued the FTC in the District of Arizona, and the FTC filed an enforcement action regarding our May 2018 acquisition of Vievu LLC. Offsetting the decrease in legal expenses was an increase in other professional and consulting expenses of $1.1 million, including professional and consulting costs related to the implementation of several phases of our enterprise resource planning and related systems.

Research and Development Expenses

Research and development ("R&D") expenses were comprised as follows (dollars in thousands):



	Three Months Ended September 30,						Dollar		Percent
	2021			2020			Change		Change
Total research and development expenses	$	42,382		$	29,246		$	13,136	44.9
Research and development as a percentage of net sales		18.3	%		17.6	%

Within the TASER segment, R&D expense increased $7.1 million, reflecting increased stock-based compensation expense, professional and consulting expenses and salaries, benefits and bonus expense in the current period. An increase of $2.4 million in salaries, benefits and bonus expense reflects higher headcount. Professional and consulting expenses increased $1.8 million related to the development of next generation products. Stock-based compensation expense increased $1.3 million, due partially to updated attainment estimates for the unvested probable tranches.

R&D expense for the Software and Sensors segment increased $6.0 million, reflecting an increase of $3.9 million in salaries, benefits and bonus expense due to higher headcount. Professional and consulting expenses increased $1.0

million related to the development of next generation products. Stock-based compensation expense increased $0.5 million, due partially to updated attainment estimates for the unvested probable tranches.

We expect R&D expense to continue to increase in absolute dollars as we focus on growing the Software and Sensors segment as we add headcount and additional resources to develop new products and services to further advance our scalable cloud-connected device platform. We are investing in technologies that include our CEDs, body cameras, in-car cameras and other sensors, artificial intelligence, digital evidence management, productivity software, communications software, and technologies that enable real-time situational awareness for public safety.

Interest and Other Income (Expense), Net

Interest and other income (expense), net was an expense of $5.5 million for the three months ended September 30, 2021 compared to income of $2.0 million for the same period in 2020. During the third quarter of 2021, we recorded a $6.7 million unrealized loss on marketable securities related to our investment in CLBT. The unrealized loss was partially offset by income of $0.8 million from a government grant.

Provision for Income Taxes

The provision for income taxes was a benefit of $51.2 million for the three months ended September 30, 2021, which was an effective tax rate of 1,938.4%. Our estimated full year effective income tax rate for 2021, before discrete period adjustments, is (11.8%), which differs from the federal statutory rate primarily due to the impact of the executive compensation limitation under Internal Revenue Code ("IRC") Section 162(m), partially offset by R&D tax credits, on a projected pre-tax loss for the year. The effective tax rate was favorably impacted by a $44.3 million discrete tax benefit primarily associated with windfalls related to stock-based compensation for RSUs and PSUs that vested during the three months ended September 30, 2021.

Net Income

We recorded net income of $48.5 million for the three months ended September 30, 2021 compared to net loss of $0.9 million for the same period in 2020. Net income per share was $0.73 per basic share and $0.67 per diluted share for the three months ended September 30, 2021 compared to $0.01 net loss per basic and diluted share for the same period in 2020.

Three Months Ended September 30, 2021 Compared to the Three Months Ended June 30, 2021

Net Sales

Net sales by product line were as follows (dollars in thousands):


	Three Months Ended				Three Months Ended				Dollar		Percent
	September 30, 2021				June 30, 2021				Change		Change
TASER segment:
TASER 7	$	50,641	21.8	%	$	28,128	12.9	%	$	22,513	80.0	%
TASER X26P		9,086	3.9			9,569	4.4			(483)	(5.0)
TASER X2		10,078	4.3			16,145	7.4			(6,067)	(37.6)
TASER Pulse		967	0.4			1,701	0.8			(734)	(43.2)
Cartridges		39,313	16.9			46,678	21.3			(7,365)	(15.8)
Axon Evidence and cloud services		2,711	1.2			1,702	0.8			1,009	59.3
Extended warranties		6,099	2.6			5,857	2.7			242	4.1
Other		2,596	1.1			2,748	1.2			(152)	(5.5)
TASER segment		121,491	52.2			112,528	51.5			8,963	8.0
Software and Sensors segment:
Axon Body		20,862	9.0			19,927	9.1			935	4.7
Axon Flex		1,488	0.6			1,088	0.5			400	36.8
Axon Fleet		6,063	2.6			5,247	2.4			816	15.6
Axon Dock		6,460	2.8			5,509	2.5			951	17.3
Axon Evidence and cloud services		63,272	27.3			60,367	27.6			2,905	4.8
Extended warranties		8,983	3.9			8,149	3.7			834	10.2
Other		3,370	1.6			5,980	2.7			(2,610)	(43.6)
Software and Sensors segment		110,498	47.8			106,267	48.5			4,231	4.0
Total net sales	$	231,989	100.0	%	$	218,795	100.0	%	$	13,194	6.0	%

Net unit sales for TASER segment products and Software and Sensors segment products were as follows:


	Three Months Ended
			Unit	Percent
	September 30, 2021	June 30, 2021	Change	Change
TASER 7	36,350	17,711	18,639	105.2	%
TASER X26P	6,596	7,012	(416)	(5.9)	%
TASER X2	5,562	9,788	(4,226)	(43.2)	%
TASER Pulse	3,232	6,307	(3,075)	(48.8)	%
Cartridges	1,327,971	1,413,329	(85,358)	(6.0)	%
Axon Body	58,248	45,572	12,676	27.8	%
Axon Flex	3,390	1,846	1,544	83.6	%
Axon Fleet	2,753	2,462	291	11.8	%
Axon Dock	8,556	5,283	3,273	62.0	%

Net sales within the TASER segment increased by approximately $9.0 million or 8.0% as compared to the prior quarter, primarily due to an increase of $22.5 million in TASER 7 revenue, and partially offset by a net decrease in revenue from other TASER devices of $7.3 million as a result of lower units sold. Cartridge revenue also decreased on both lower units sold and lower average selling prices due to the mix of cartridge types sold during the period. The increase in TASER 7 units was partially offset by lower average selling prices.

Within the Software and Sensors segment, net sales increased $4.2 million or 4.0% during the three months ended September 30, 2021 compared to the prior quarter. The increase in the aggregate number of users resulted in increased Axon Evidence revenue of $2.9 million. Axon Dock revenue increased $1.0 million, while Axon Fleet revenue increased $0.8 million, both primarily driven by an increase in the number of units sold. Partially offsetting the increases was a

decrease of $2.7 million in other revenues, attributable to decreased sales of TASER Cam, Interview Room, and Signal Sidearm.

Nine Months Ended September 30, 2021 Compared to the Nine Months Ended September 30, 2020


	Nine Months Ended September 30,
	2021				2020
Net sales from products	$	463,116	71.7	%	$	326,134	71.7	%
Net sales from services		182,687	28.3			128,729	28.3
Net sales		645,803	100.0			454,863	100.0
Cost of product sales		195,253	30.2			150,507	33.1
Cost of service sales		44,701	6.9			29,331	6.4
Cost of sales		239,954	37.1			179,838	39.5
Gross margin		405,849	62.9			275,025	60.5
Operating expenses:
Sales, general and administrative		403,554	62.5			209,763	46.1
Research and development		143,352	22.2			85,187	18.7
Total operating expenses		546,906	84.7			294,950	64.8
Loss from operations		(141,057)	(21.8)			(19,925)	(4.3)
Interest and other income, net		36,896	5.7			4,594	1.0
Loss before provision for income taxes		(104,161)	(16.1)			(15,331)	(3.4)
Provision for (benefit from) income taxes		(57,651)	(8.9)			12,227	2.7
Net loss	$	(46,510)	(7.2)	%	$	(27,558)	(6.1)	%

The following table presents our revenues disaggregated by geography (in thousands):


	Nine Months Ended September 30,
	2021				2020
United States	$	518,050	80	%	$	368,390	81	%
Other Countries		127,753	20			86,473	19
Total	$	645,803	100	%	$	454,863	100	%

International revenue increased compared to the prior year comparable period, driven primarily by increased sales in the Americas and EMEA regions.

Net Sales

Net sales by product line were as follows (dollars in thousands):


	Nine Months Ended September 30,								Dollar		Percent
	2021				2020				Change		Change
TASER segment:
TASER 7	$	112,760	17.5	%	$	48,616	10.7	%	$	64,144	131.9	%
TASER X26P		28,618	4.4			30,338	6.7			(1,720)	(5.7)
TASER X2		39,001	6.0			45,401	10.0			(6,400)	(14.1)
TASER Pulse		4,873	0.8			6,374	1.4			(1,501)	(23.5)
Cartridges		116,409	18.0			76,732	16.8			39,677	51.7
Axon Evidence and cloud services		5,809	0.9			1,776	0.4			4,033	227.1
Extended warranties		17,602	2.7			15,340	3.4			2,262	14.7
Other		7,946	1.3			6,214	1.3			1,732	27.9
TASER segment		333,018	51.6			230,791	50.7			102,227	44.3
Software and Sensors segment:
Axon Body		60,545	9.4			40,645	8.9			19,900	49.0
Axon Flex		3,481	0.5			3,452	0.8			29	0.8
Axon Fleet		15,073	2.3			13,088	2.9			1,985	15.2
Axon Dock		18,889	2.9			14,714	3.2			4,175	28.4
Axon Evidence and cloud services		175,933	27.2			126,495	27.8			49,438	39.1
Extended warranties		24,632	3.8			17,707	3.9			6,925	39.1
Other		14,232	2.3			7,971	1.8			6,261	78.5
Software and Sensors segment		312,785	48.4			224,072	49.3			88,713	39.6
Total net sales	$	645,803	100.0	%	$	454,863	100.0	%	$	190,940	42.0	%

Net unit sales for TASER segment products and Software and Sensors segment products were as follows:


	Nine Months Ended September 30,		Unit	Percent
	2021	2020	Change	Change
TASER 7	77,421	36,352	41,069	113.0	%
TASER X26P	21,837	26,780	(4,943)	(18.5)	%
TASER X2	24,188	33,656	(9,468)	(28.1)	%
TASER Pulse	18,225	21,501	(3,276)	(15.2)	%
Cartridges	3,751,060	2,441,612	1,309,448	53.6	%
Axon Body	149,914	137,803	12,111	8.8	%
Axon Flex	6,801	8,213	(1,412)	(17.2)	%
Axon Fleet	6,655	7,399	(744)	(10.1)	%
Axon Dock	20,625	19,096	1,529	8.0	%

Net sales for the TASER segment increased $102.3 million, or 44.3%, primarily due to a net increase of $54.5 million in TASER device sales and an increase of $39.7 million in cartridge revenue. We continue to see a shift to purchases of our latest generation device, TASER 7, from legacy devices. Revenue was also impacted by higher average selling prices for TASER devices other than TASER Pulse. The increase in cartridge revenue was primarily due to increased unit sales. The increase in Axon Evidence revenue of $4.0 million was primarily attributable to an increase in the aggregate number of TASER 7 users.

Net sales for the Software and Sensors segment increased $88.7 million, or 39.6%, during the nine months ended September 30, 2021 as we continued to add users and associated devices to our network. The increase in the aggregate

number of users resulted in increased Axon Evidence revenue of $49.4 million. Sales of our Axon Body 3 camera drove most of the $19.9 million increase in Axon Body revenue and the $4.2 million increase in Axon Dock revenue. The increase in the aggregate number of users and devices also resulted in increased extended warranty revenues of $6.9 million. The increase of $6.2 million in other revenue was primarily driven by higher sales of Signal Sidearm, TASER Cam, and Interview Room.

Cost of Product and Service Sales

Within the TASER segment, cost of product sales increased to $112.3 million for the nine months ended September 30, 2021 from $88.8 million for the same period in 2020. Cost as a percentage of sales decreased to 33.7% from 38.5%. The improvement was primarily attributable to a combination of manufacturing cost improvement and strong demand for our premium TASER offerings, which resulted in a favorable product mix. We are building manufacturing capacity to support our TASER device and cartridge manufacturing lines in response to growing international and federal demand and an increased install base.

Within the Software and Sensors segment, cost of product and service sales increased to $127.6 million for the nine months ended September 30, 2021 from $91.1 million for the same period in 2020. Cost as a percentage of sales increased to 40.8% from 40.6%. Cost of product sales increased $21.3 million, however decreased as a percentage of sales primarily as a result of product mix. Cost of service sales increased $15.2 million, and increased as a percentage of sales. We are investing in scaling our cloud business, which includes standing up new cloud environments, cloud applications, and Long-Term Evolution (“LTE”) costs, which can result in some margin compression in advance of anticipated revenue, as well as low-to-no margin professional services that support new installations for software customers.

Gross Margin

As a percentage of net sales, gross margin for the TASER segment increased to 66.3% from 61.5% for the nine months ended September 30, 2021 and 2020, respectively. The increase was a result of manufacturing cost improvement and product mix, as discussed above.

As a percentage of net sales, gross margin for the Software and Sensors segment decreased slightly to 59.2% from 59.4% for the nine months ended September 30, 2021 and 2020, respectively. Within the Software and Sensors segment, hardware gross margin was 39.2% for the nine months ended September 30, 2021 compared to 36.7% for the same period in 2020, while the service margins were 74.7% and 76.8% during those same periods, respectively.

Sales, General and Administrative Expenses

Sales, general and administrative ("SG&A") expenses were comprised as follows (dollars in thousands):


	Nine Months Ended September 30,						Dollar		Percent
	2021			2020			Change		Change
Total sales, general and administrative expenses	$	403,554		$	209,763		$	193,791	92.4	%
SG&A expenses as a percentage of net sales		62.5	%		46.1	%

Stock-based compensation expense increased $150.2 million in comparison to the prior year comparable period, which was attributable to an increase of $93.5 million in expense related to the CEO Performance Award and an increase of $59.5 million related to our XSPP, which were primarily attributable to acceleration in the anticipated timing of attainment for the remaining probable tranches. Stock-based compensation expense also increased over the prior year comparable period due to an increase in headcount.

Salaries, benefits and bonus expense increased $36.2 million primarily due to an increase in headcount. Included in this increase was $9.2 million in employer payroll taxes related to the vesting of eight tranches of our XSPP in March, May, and September 2021.

Sales and marketing expenses increased $14.3 million, driven by a $8.7 million increase in commissions expense tied to higher revenues and by higher spending on content development, promotional videos, new product launches, and advertising.

Professional, consulting and lobbying expenses decreased $13.6 million, driven by a $17.9 million decrease in expenses relating to the FTC litigation. Offsetting the decrease in legal expenses was an increase in other professional and consulting expenses for costs related to the implementation of several phases of our enterprise resource planning and related systems.

Research and Development Expenses

Research and development ("R&D") expenses were comprised as follows (dollars in thousands):


	Nine Months Ended September 30,						Dollar		Percent
	2021			2020			Change		Change
Total research and development expenses	$	143,352		$	85,187		$	58,165	68.3	%
R&D expenses as a percentage of net sales		22.2	%		18.7	%

Within the TASER segment, R&D expense increased $21.9 million, reflecting increased stock-based compensation expense, salaries, benefits and bonus expense, and professional and consulting expenses in the current period. The increase of $9.6 million in stock-based compensation expense related primarily to acceleration in the anticipated timing of attainment for the remaining probable tranches of our XSPP and to attainment of other PSU awards. Salaries, benefits and bonus expense increased $5.0 million on higher headcount, and professional and consulting expenses increased $5.2 million related to the development of next generation products.

R&D expense for the Software and Sensors segment increased $36.3 million, reflecting an increase of $20.0 million in stock-based compensation expense, an increase of $12.0 million in salaries, benefits and bonus expense, and an increase of $2.5 million in professional and consulting expenses. The majority of the increase in stock-based compensation expense was attributable to our XSPP and was due to acceleration in the anticipated timing of attainment for the remaining probable tranches. Stock-based compensation expense also increased over the prior year comparable period due to an increase in headcount. The increase in salaries, benefits and bonus was primarily a result of increased headcount. The increase in professional and consulting expenses was attributable to development of next generation products.

Interest and Other Income (Expense), Net

Interest and other income, net was $36.9 million for the nine months ended September 30, 2021 compared to $4.6 million for the same period in 2020. We recorded a gain of $40.9 million related to observable price changes for our investments in certain unconsolidated affiliates and related warrants; $12.3 million of this gain was realized during the period on the sale of a portion of our existing investment. The increase in other income was partially offset by a decrease in interest income attributable to decreased interest rates on investments during the current period.

We recorded a $6.7 million unrealized loss on marketable securities related to our investment in CLBT. The unrealized loss was partially offset by income of $0.8 million from a government grant.

Provision for Income Taxes

The provision for income taxes was a benefit of $57.7 million for the nine months ended September 30, 2021, which was an effective tax rate of 55.3%. Our estimated full year effective income tax rate for 2021, before discrete period

adjustments, is (11.8%), which differs from the federal statutory rate primarily due to the impact of the executive compensation limitation under IRC Section 162(m), partially offset by R&D tax credits, on a projected pre-tax loss for the year. The effective tax rate was favorably impacted by a $70.0 million discrete tax benefit primarily associated with windfalls related to stock-based compensation for RSUs and PSUs that vested during the nine months ended September 30, 2021.

Net Income

Our net income decreased by $19.0 million to a net loss of $46.5 million for the nine months ended September 30, 2021 compared to net loss of $27.6 million for the same period in 2020. Net loss per basic and diluted share was $0.71 for the nine months ended September 30, 2021 compared to $0.45 net loss per basic and diluted share for the same period in 2020.

Non-GAAP Measures

To supplement our financial results presented in accordance with GAAP, we present the non-GAAP financial measures of EBITDA and Adjusted EBITDA (CEO Performance Award). Our management uses these non-GAAP financial measures in evaluating our performance in comparison to prior periods. We believe that both management and investors benefit from referring to these non-GAAP financial measures in assessing our performance, and when planning and forecasting our future periods. A reconciliation of GAAP to the non-GAAP financial measures is presented below.

	●	EBITDA (Most comparable GAAP Measure: Net income) - Earnings before interest expense, investment interest income, taxes, depreciation and amortization.

	●	Adjusted EBITDA (CEO Performance Award) (Most comparable GAAP Measure: Net income) - Earnings before interest expense, investment interest income, taxes, depreciation, amortization and non-cash stock-based compensation expense.

Although these non-GAAP financial measures are not consistent with GAAP, management believes investors will benefit by referring to these non-GAAP financial measures when assessing our operating results, as well as when forecasting and analyzing future periods. However, management recognizes that:

	●	these non-GAAP financial measures are limited in their usefulness and should be considered only as a supplement to our GAAP financial measures;

	●	these non-GAAP financial measures should not be considered in isolation from, or as a substitute for, our GAAP financial measures;

	●	these non-GAAP financial measures should not be considered to be superior to our GAAP financial measures; and

	●	these non-GAAP financial measures were not prepared in accordance with GAAP and investors should not assume that the non-GAAP financial measures presented in this Quarterly Report on Form 10-Q were prepared under a comprehensive set of rules or principles.

EBITDA and Adjusted EBITDA (CEO Performance Award) reconciles to net income (loss) as follows (in thousands):


	Three Months Ended						Nine Months Ended
	September 30,		June 30,		September 30,		September 30,		September 30,
	2021		2021		2020		2021		2020
Net income (loss)	$	48,524	$	(47,117)	$	(873)	$	(46,510)	$	(27,558)
Depreciation and amortization		4,838		4,291		3,133		13,420		8,944
Interest expense		5		17		32		27		44
Investment interest income		(123)		(502)		(965)		(1,158)		(3,157)
Provision for (benefit from) income taxes		(51,164)		(4,727)		(2,536)		(57,651)		12,227
EBITDA	$	2,080	$	(48,038)	$	(1,209)	$	(91,872)	$	(9,500)

Adjustments:
Stock-based compensation expense		35,062		137,549		26,094		262,221		80,124
Adjusted EBITDA (CEO Performance Award)	$	37,142	$	89,511	$	24,885	$	170,349	$	70,624

Liquidity and Capital Resources

Summary

As of September 30, 2021, we had $281.7 million of cash and cash equivalents, an increase of $126.3 million as compared to December 31, 2020. Cash and cash equivalents and investments totaled $631.0 million, representing a decrease of $21.6 million from December 31, 2020.

Our ongoing sources of cash include cash on hand, investments, and cash flows from operations. Restricted cash balance of $0.1 primarily consists of funds held in an international bank account for a country in which we are required to maintain a minimum balance to operate. This balance is included in prepaid expenses and other current assets, as well as other assets on our condensed consolidated balance sheet. In addition, our $50.0 million revolving credit facility is available for additional working capital needs or investment opportunities. Under the terms of the line of credit, available borrowings are reduced by outstanding letters of credit. Advances under the line of credit bear interest at LIBOR plus 1.0 to 1.5% per year determined in accordance with a pricing grid based on our funded debt to earnings before interest, taxes, depreciation and amortization ("EBITDA") ratio.

As of September 30, 2021, we had letters of credit outstanding of $6.1 million, leaving the net amount available for borrowing of $43.9 million. The facility matures on December 31, 2023, and has an accordion feature which allows for an increase in the total line of credit up to $100.0 million, subject to certain conditions, including the availability of additional bank commitments. There can be no assurance that we will continue to generate cash flows at or above current levels or that we will be able to maintain our ability to borrow under our revolving credit facility. At September 30, 2021 and December 31, 2020, there were no borrowings under the line other than the outstanding letters of credit.

Our agreement with the bank requires us to comply with a maximum funded debt to EBITDA ratio, as defined, of no greater than 2.50 to 1.00 based upon a trailing four fiscal quarter period. At September 30, 2021, our funded debt to EBITDA ratio was 0.00 to 1.00.

TASER subscription and installment purchase arrangements typically involve amounts invoiced in five equal installments at the beginning of each year of the five-year term. This is in contrast to a traditional CED sale in which the entire amount being charged for the hardware is invoiced upon shipment. This impacts liquidity in a commensurate fashion, with the cash for the subscription or installment purchase received in five annual installments rather than up front. It is our strategic intent to shift an increasing amount of our business to a subscription model, to better match the municipal budgeting process of our customers as well as to allow for multiple product offerings to be bundled into existing subscriptions. We carefully considered the cash flow impacts of this strategic shift and regularly revisit our cash flow forecast with the goal of maintaining a comfortable level of liquidity as we introduce commercial offerings in which we incur upfront cash costs to produce and fulfill hardware sales ahead of the cash inflows from our customers.

Based on our strong balance sheet and the fact that we do not have long-term debt at September 30, 2021, we believe financing will be available, both through our existing credit line and possible additional financing. However, there is no assurance that such funding will be available on terms acceptable to us, or at all. We believe that our sources of funding will be sufficient to satisfy our currently anticipated cash requirements including capital expenditures, working capital requirements, potential acquisitions or investments, income and payroll tax payments for net-settled stock awards, and other liquidity requirements through at least the next 12 months. We and our Board of Directors may consider repurchases of our common stock from time to time pursuant to our stock repurchase plan. Further repurchases of our common stock would take place on the open market, would be financed with available cash and are subject to market and business conditions.

Cash Flows

The following table summarizes our cash flows from operating, investing and financing activities (in thousands):


	Nine Months Ended September 30,
	2021		2020
Operating activities	$	111,564	$	4,163
Investing activities		93,412		(300,294)
Financing activities		(76,902)		300,188
Effect of exchange rate changes on cash and cash equivalents		(1,827)		(303)
Net increase in cash and cash equivalents and restricted cash	$	126,247	$	3,754

Operating activities

Net cash provided by operating activities in the first nine months of 2021 of $111.6 million reflects $46.5 million in net loss, non-cash income statement items totaling $192.1 million, and a use of cash of $34.1 million for the net change in operating assets and liabilities. Included in the non-cash items were $13.4 million in depreciation and amortization expense, $262.2 million in stock-based compensation expense and a $40.9 million gain on the change in fair value of strategic investments, offset by an unrealized loss of $6.7 million on marketable securities. Cash provided by operations was impacted by increased deferred revenue of $87.6 million, which was primarily attributable to increased sales. This increase was offset by increased accounts and notes receivable and contract assets of $118.1 million and increased prepaid expenses and other assets of $28.9 million. The increase in accounts and notes receivable and contract assets was primarily driven by increased sales. The increase in prepaid expenses and other assets was driven by increases in deferred commissions for bookings not yet recognized as revenue, an increase in prepaid licenses, an increase in right-of-use lease assets, and an increase in income tax receivable as compared to the prior year end.

Net cash provided by operating activities in the first nine months of 2020 of $4.2 million reflects $27.6 million in net loss, non-cash income statement items totaling $85.0 million, and a use of cash of $53.3 million for the net change in operating assets and liabilities. Included in the non-cash items were $8.9 million in depreciation and amortization expense, $80.1 million in stock-based compensation expense, and a $11.7 million increase in deferred tax assets, net. Cash used in operations was primarily driven by increased inventory of $59.4 million, as we proactively built up a safety stock of inventory to help meet strong product demand while also preparing us to stagger factory work schedules. Also contributing to the use of cash were increased accounts and notes receivable and contract assets of $48.6 million, which was attributable to increased sales over the last several quarters, primarily sales made under subscription plans. Partially offsetting the uses of cash were increases in accounts payable, accrued liabilities and other liabilities of $25.4 million, and in deferred revenue of $34.1 million. The increase in accounts payable, accrued liabilities and other liabilities was primarily attributable to accruals for professional services, inventory in transit, and taxes. The increase in deferred revenue was primarily attributable to increased hardware deferred revenue from TASER subscription sales, partially offset by a decrease in prepayments for Software and Sensors services.

Investing activities

Net cash provided by investing activities was $93.4 million during the first nine months of 2021. Cash inflows from investing activities included proceeds, net of purchases, from held-to-maturity investments and marketable securities

of $136.7 million, and $14.5 million of proceeds from the sale of a portion of one of our existing strategic investments. The inflows were partially offset by outflows of $20.5 million for new or incremental strategic minority investments and $36.7 million for the purchase of property and equipment and intangible assets.

We used $300.3 million in investing activities during the first nine months of 2020, which was comprised of $229.5 million for the purchase of investments, net of proceeds, $66.0 million for the purchase of property and equipment and intangible assets, and $4.7 million for an equity investment in an unconsolidated affiliate.

Financing activities

Net cash used in financing activities was $76.9 million during the first nine months of 2021 and was attributable to the payment of income and payroll taxes on behalf of employees who net-settled stock awards during the period, net of proceeds received from our ATM offering. Net-settled stock awards included five tranches of our XSPP which vested during the three months ended September 30, 2021.

Net cash provided by financing activities was $300.2 million during the first nine months of 2020. During the first nine months of 2020, we completed an equity offering that generated net proceeds of $306.8 million and received proceeds from options exercised of $0.3 million; the proceeds were partially offset by payments of income and payroll taxes of $6.9 million on behalf of employees who net-settled stock awards during the period.

Off-Balance Sheet Arrangements

The discussion under the heading off-balance sheet arrangements in Note 13 of the notes to our condensed consolidated financial statements within this Quarterly Report on Form 10-Q is incorporated by reference herein.

Critical Accounting Estimates

We have identified the following accounting estimates as critical to our business operations and the understanding of our results of operations. The preparation of financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, the disclosure of contingent assets and liabilities at the date of our unaudited condensed consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. While we do not believe that a change in these estimates is reasonably likely, there can be no assurance that our actual results will not differ from these estimates. The effect of these estimates on our business operations are discussed below.

Stock-Based Compensation

We have historically granted stock-based compensation to key employees and non-employee directors as a means of attracting and retaining highly qualified personnel. Stock-based compensation awards primarily consist of service-based RSUs, performance-based RSUs, and performance-based options. Our stock-based compensation awards are classified as equity and measured at the fair market value of the underlying stock at the grant date. For service-based awards, we recognize RSU expense using the straight-line attribution method over the requisite service period. Vesting of performance-based RSUs and options is contingent upon the achievement of certain performance criteria related to our operating performance, successful and timely development and market acceptance of future product introductions, and market capitalization conditions. For performance-based RSUs containing only performance conditions, compensation cost is recognized using the graded attribution model over the explicit or implicit service period. For awards containing multiple service, performance or market capitalization conditions, where all conditions must be satisfied prior to vesting, compensation expense is recognized over the requisite service period, which is defined as the longest explicit, implicit, or derived service period, based on management’s estimate of the probability of the performance criteria being satisfied, adjusted at each balance sheet date. For both service-based and performance-based RSUs, we account for forfeitures as they occur as a reduction to stock-based compensation expense and additional paid-in-capital.

For performance-based awards, stock-based compensation expense is recognized over the expected performance achievement period of individual performance goals when the achievement of each individual performance goal becomes

probable. For performance-based awards with a vesting schedule based on the attainment of both performance and market capitalization conditions, stock-based compensation expense is recognized over the longer of the expected achievement period of the performance and market capitalization conditions, beginning at the point in time that the relevant performance condition is considered probable of achievement. The fair value of such awards is estimated on the grant date using Monte Carlo simulations. Refer to Note 11 of the notes to our condensed consolidated financial statements within this Report on Form 10-Q.

Stock-based compensation expense associated with the CEO Performance Award and XSPP is recognized over the requisite service period, which is defined as the longest explicit, implicit or derived service period, based on management’s estimate of the probability and timing of the performance criteria being satisfied, adjusted at each balance sheet date. Expense recognition begins at the point in time when the relevant operational goal is considered probable of being met. The probability of attaining an operational goal and the expected attainment date for meeting a probable operational goal are based on a subjective assessment of our forward-looking financial projections, taking into consideration statistical analysis when considered appropriate. The statistical model and the assessment that determine the estimated attainment dates are subject to a number of estimated inputs, including expected volatility rates, management’s forward-looking financial projections, in particular for operational goals that are anticipated to be attained in the near future, and adjustment of other estimates based on the passage of time.

Beginning with the three months ended June 30, 2021, management discontinued consideration of the statistical model based on actual and anticipated attainment of the remaining operational goals. During the nine months ended September 30, 2021, we recorded an additional $172.6 million in stock-based compensation expense as a result of updated estimates for the CEO Performance Award and XSPP.

As a result of attaining the ninth market capitalization goal in October 2021, we expect to record an incremental $8.0 million in expense during the three months ending December 31, 2021 related to our XSPP, as the related operational goal was attained as of September 30, 2021.

We have granted a total of 15.0 million performance-based awards (options and restricted stock units) of which 8.2 million are outstanding as of September 30, 2021, the vesting of which is contingent upon the achievement of certain performance criteria including the successful development and market acceptance of future product introductions as well as our future sales targets and operating performance and market capitalization. Compensation expense for performance awards will be recognized based on management’s best estimate of the probability of the performance criteria being satisfied using the most currently available projections of future product adoption and operating performance, adjusted at each balance sheet date. Changes in the subjective and probability-based assumptions can materially affect the estimate of the fair value of the awards and timing of recognition of stock-based compensation and consequently, the related amount recognized in our condensed consolidated statements of operations and comprehensive income (loss).

Reserve for Expected Credit Losses

We are exposed to the risk of credit losses primarily through sales of products and services. Our expected loss allowance for accounts receivable, notes receivable, and contract assets represents management’s best estimate and application of judgment considering a number of factors, including historical collection experience, published or estimated credit default rates for entities that represent our customer base, current and future economic and market conditions and a review of the current status of customers' trade accounts receivables. Additionally, specific allowance amounts are established to record the appropriate provision for customers that have a higher probability of default. Our monitoring activities include account reconciliation, dispute resolution, payment confirmation, consideration of customers' financial condition and macroeconomic conditions. Balances are written off when determined to be uncollectible.

We review receivables for U.S. and international customers separately to better reflect different published credit default rates and economic and market conditions.

A majority of our customers are governmental agencies. Due to municipal government funding rules, certain of our contracts are subject to appropriation, termination for convenience, or similar cancellation clauses, which could allow our customers to cancel or not exercise options to renew contracts in the future. Economic slowdowns that negatively

affect municipal tax collections and put pressure on law enforcement may increase this risk and negatively impact the realizability of our accounts and notes receivable and contract assets. We considered the current and expected future economic and market conditions surrounding the COVID-19 pandemic and recorded an additional credit loss reserve of approximately $1.2 million as of September 30, 2021.

Based on the balances of our financial instruments as of September 30, 2021, a hypothetical 25 percent increase in expected credit loss rates across all pools would result in a $1.0 million increase in the allowance for expected credit losses.

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