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 June 30, 2022, and results of operations for the three and six months ended June 30, 2022 and 2021, should be read in conjunction with the condensed consolidated financial statements and related notes included in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and related notes in our 2021 Annual Report on Form 10-K filed with the SEC on February 25, 2022. 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 2021 Annual Report on Form 10-K. See also "Special Note Regarding Forward-Looking Statements" on page ii of this Quarterly Report on Form 10-Q.

Overview

Axon is the global leader in connected public safety technologies. We are a mission-driven company whose overarching goal is to protect life. Our vision is a world where bullets are obsolete, where social conflict is dramatically reduced, where everyone has access to a fair and effective justice system and where racial equity, diversity and inclusion is centered in all of our work. Axon is also a leading provider of body cameras for US public safety, providing more transparency and accountability to communities than ever before.

Our revenues for the three months ended June 30, 2022 were $285.6 million, an increase of $66.8 million, or 30.5%, from the comparable period in the prior year. We had income from operations of $21.4 million compared to a loss from operations of $93.7 million for the same period in the prior year. Gross margin dollars increased $36.0 million but decreased as a percentage of revenue compared to the three months ended June 30, 2021, reflecting higher freight and labor costs. Operating expenses decreased $79.1 million, reflecting a decrease of $115.6 million in stock-based compensation expense primarily related to the CEO Performance Award and XSPP, partially offset by an increase in salaries, benefits, and bonus expense, and increases in sales, marketing, and professional and consulting expense. Net income of $51.0 million included net unrealized gains of $59.7 million related to observable price changes for our existing investments and related warrants and an unrealized loss of $11.7 million on marketable securities related to our investment in CLBT, compared to net loss of $47.1 million for the comparable period in the prior year.

Our revenues for the six months ended June 30, 2022 were $542.0 million, an increase of $128.2 million, or 31.0%, from the comparable period in the prior year. We had income from operations of $38.6 million compared to a loss from operations of $143.9 million for the same period in the prior year. Gross margin dollars increased $68.4 million but decreased as a percentage of revenue compared to the six months ended June 30, 2021. Operating expenses decreased $114.1 million, reflecting a decrease of $179.8 million in stock-based compensation expense primarily related to the CEO Performance Award and XSPP, partially offset by an increase in salaries, benefits, and bonus expense, and increases in travel and commissions expense. For the six months ended June 30, 2022, we recorded net income of $105.8 million, which reflected net unrealized gains of $130.1 million related to observable price changes for our existing investments and related warrants and an unrealized loss of $26.3 million on marketable securities related to our investment in CLBT, compared to net loss of $95.0 million for the comparable period in the prior year.

Outlook

For the year ending December 31, 2022, we revised our full year revenue expectations to approximately $1.07 billion to $1.12 billion. We are revising our expected 2022 capital expenditures to approximately $80 million to $90 million, which includes up to $25 million for development of our manufacturing facility and campus in Scottsdale, Arizona, approximately $40 million to support capacity expansion and automation of TASER devices, and the remainder on additional investments to support our continued growth.

Results of Operations

Three Months Ended June 30, 2022 Compared to the Three Months Ended June 31, 2021

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 June 30,
	2022				2021
Net sales from products	$	200,051	70.0	%	$	156,427	71.5	%
Net sales from services		85,562	30.0			62,368	28.5
Net sales		285,613	100.0			218,795	100.0
Cost of product sales		87,502	30.6			65,301	29.8
Cost of service sales		24,148	8.5			15,565	7.1
Cost of sales		111,650	39.1			80,866	36.9
Gross margin		173,963	60.9			137,929	63.0
Operating expenses:
Sales, general and administrative		95,005	33.3			177,662	81.2
Research and development		57,547	20.2			53,952	24.7
Total operating expenses		152,552	53.5			231,614	105.9
Income (loss) from operations		21,411	7.4			(93,685)	(42.9)
Interest and other income, net		47,026	16.5			41,841	19.1
Income (loss) before provision for income taxes		68,437	23.9			(51,844)	(23.7)
Provision for (benefit from) income taxes		17,475	6.1			(4,727)	(2.2)
Net income (loss)	$	50,962	17.8	%	$	(47,117)	(21.5)	%

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


	Three Months Ended June 30,
	2022				2021
United States	$	228,446	80	%	$	164,908	75	%
Other countries		57,167	20			53,887	25
Total	$	285,613	100	%	$	218,795	100	%

International revenue increased compared to the prior year comparable period, driven primarily by increased sales in our Asia-Pacific (“APAC”) region.

Net Sales

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


	Three Months Ended June 30,								Dollar		Percent
	2022				2021				Change		Change
TASER segment:
TASER 7	$	53,440	18.7	%	$	28,128	12.9	%	$	25,312	90.0	%
TASER X26P		12,339	4.3			9,569	4.4			2,770	28.9
TASER X2		4,534	1.6			16,145	7.4			(11,611)	(71.9)
TASER Consumer devices		1,687	0.6			1,701	0.8			(14)	(0.8)
Cartridges		49,845	17.5			46,678	21.3			3,167	6.8
Axon Evidence and cloud services		3,720	1.3			1,702	0.8			2,018	118.6
Extended warranties		7,459	2.6			5,857	2.7			1,602	27.4
Other		2,562	0.9			2,748	1.2			(186)	(6.8)
Total TASER segment		135,586	47.5			112,528	51.5			23,058	20.5
Software and Sensors segment:
Axon Body		27,468	9.6			19,927	9.1			7,541	37.8
Axon Flex		621	0.2			1,088	0.5			(467)	(42.9)
Axon Fleet		15,881	5.6			5,247	2.4			10,634	202.7
Axon Dock		5,849	2.0			5,509	2.5			340	6.2
Axon Evidence and cloud services		81,911	28.7			60,367	27.6			21,544	35.7
Extended warranties		12,498	4.4			8,149	3.7			4,349	53.4
Other		5,799	2.0			5,980	2.7			(181)	(3.0)
Total Software and Sensors segment		150,027	52.5			106,267	48.5			43,760	41.2
Total net sales	$	285,613	100.0	%	$	218,795	100.0	%	$	66,818	30.5	%

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



	Three Months Ended June 30,		Unit	Percent
	2022	2021	Change	Change
TASER 7	32,790	17,711	15,079	85.1
TASER X26P	8,831	7,012	1,819	25.9
TASER X2	2,745	9,788	(7,043)	(72.0)
TASER Consumer devices	5,157	6,307	(1,150)	(18.2)
Cartridges	1,536,332	1,413,329	123,003	8.7
Axon Body	59,851	45,572	14,279	31.3
Axon Flex	1,136	1,846	(710)	(38.5)
Axon Fleet	6,146	2,462	3,684	149.6
Axon Dock	5,314	5,283	31	0.6

Net sales for the TASER segment increased 20.5% primarily due to an increase of $25.3 million in TASER 7 devices that was partially offset by a decrease of sales in TASER X2 devices by $11.6 million. We continue to see a shift to purchases of our latest generation device, TASER 7, from legacy devices. TASER 7 revenue was impacted by higher average selling prices and an increase in unit sales. The increase in revenue from Axon Evidence and cloud services was driven by an increase in the number of TASER 7 devices in the field and VR training. Cartridge revenue was impacted by an increase in unit sales and by lower average selling prices. Offsetting the increases were decreased unit sales for our TASER X2 devices.

Net sales for the Software and Sensors segment increased 41.2% year over year for the three months ended June 30, 2022 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 $21.5 million. The $10.6 million increase in Axon Fleet revenue was primarily driven by higher unit sales and higher average selling prices. Our newest Fleet product, Axon

Fleet 3, which includes automated license plate reader technology, began shipping on June 30, 2021. Increased unit sales of our Axon Body 3 camera drove the $7.9 million increase in Axon Body and Axon Dock revenue. Increases in Axon Body and Axon dock revenue drove the $4.3 million increase in extended warranties, as most of those devices are sold with extended warranties.

We consider total company future contracted revenues a forward-looking performance indicator. As of June 30, 2022, we had approximately $3.33 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 ten 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 $48.5 million for the three months ended June 30, 2022 from $37.8 million for the same period in 2021, primarily related to higher unit sales. Cost as a percentage of sales increased to 35.7% from 33.6%. The increase was primarily attributable to higher freight and labor costs as well as increased manufacturing overhead costs due to expanding our manufacturing footprint. While we continue to adjust strategic inventory levels based on areas of risk to mitigate potential supply disruptions, global supply conditions and local closures related to the COVID-19 pandemic could further impact our margins.

Within the Software and Sensors segment, cost of product and service sales increased to $63.2 million for the three months ended June 30, 2022 from $43.0 million for the same period in 2021. Cost as a percentage of sales increased to 42.1% from 40.5%. The increase was primarily driven by product mix. We expect to realize cost savings related to the new cloud hosting contract of approximately $2.5 million per quarter as compared to our current spend level; however, overall cloud hosting costs will continue to increase as we continue to add users to the Axon network.

Gross Margin

As a percentage of net sales, gross margin for the TASER segment decreased to 64.3% from 66.4% for the three months ended June 30, 2022 and 2021, respectively. The decrease was a result of higher labor costs and increased freight. We expect to increase operational spend as we are investing for scale and increased production capacity.

As a percentage of net sales, gross margin for the Software and Sensors segment decreased to 57.9% from 59.5% for the three months ended June 30, 2022 and 2021, respectively. Within the Software and Sensors segment, hardware gross margin increased to 42.9% for the three months ended June 30, 2022 compared to 39.7% for the same period in 2021 due to increased unit sales of Axon Body 3 and higher average selling prices. Service margins decreased to 70.4% for the three months ended June 30, 2022 from 74.5% for the same period in 2021 due to the mix of services provided.

Sales, General and Administrative Expenses

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


	Three Months Ended June 30,						Dollar		Percent
	2022			2021			Change		Change
Total sales, general and administrative expenses	$	95,005		$	177,662		$	(82,657)	(46.5)
Sales, general, and administrative as a percentage of net sales		33.3	%		81.2	%

Stock-based compensation expense decreased $105.5 million in comparison to the prior year comparable period, which was primarily attributable to a decrease of $69.0 million in expense related to the CEO Performance Award and a decrease of $42.0 million related to our XSPP. The decrease was attributable to the vesting of ten tranches of the CEO Performance Award and nine tranches of the XSPP in 2021, which have no remaining unrecognized expense for the vested tranches. Total SG&A stock-based compensation expense of $8.6 million included $3.3 million of expense reversal related

to employee forfeitures. The decrease was partially offset by increased stock-based compensation expense due to increased headcount.

Salaries, benefits, and bonus expense increased $8.1 million primarily due to an increase in headcount and an increase in bonus expense of $2.6 million, primarily as a result of higher bonuses paid to employees at the senior director level and below. Partially offsetting the increase was a decrease of $2.0 million in payroll taxes related to the vesting of two tranches of our XSPP in May 2021; as no tranches of the XSPP have vested in 2022, we have not recognized payroll tax expense related to the program this year.

Sales and marketing and travel expenses increased $7.6 million. The increase was partially attributable to a $3.5 million increase related to trade shows and seminars as we hosted our annual user conference, Axon Accelerate, in May 2022. The increase was also driven by a $3.7 million increase in travel expenses, reflecting a return to pre-pandemic levels as travel restrictions have eased and in-person customer meetings have resumed. Also impacting higher travel expense was increased travel costs per trip.

Professional and consulting expenses increased $3.8 million in comparison to the prior year comparable period, driven primarily by increased legal and consulting expense.

Research and Development Expenses

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



	Three Months Ended June 30,						Dollar		Percent
	2022			2021			Change		Change
Total research and development expenses	$	57,547		$	53,952		$	3,595	6.7
Research and development as a percentage of net sales		20.2	%		24.7	%

Within the TASER segment, R&D expense increased $1.0 million. An increase of $2.6 million in salaries, benefits and bonus expense reflected higher headcount. Additionally, indirect manufacturing costs and supplies increased $1.2 million related to the development of next generation products. Fully offsetting these increases was a decrease in stock-based compensation expense of $3.5 million, due to the vesting of nine XSPP tranches during 2021, for which there is no remaining unamortized expense for the vested tranches.

R&D expense for the Software and Sensors segment increased $2.6 million, reflecting an increase of $8.1 million in salaries, benefits and bonus expense due to higher headcount, higher bonuses paid to employees at the senior director level and below, and higher anticipated attainment on our annual bonus. Partially offsetting the increase was a decrease in stock-based compensation expense of $6.7 million, due to the vesting of nine XSPP tranches during 2021, for which there is no remaining unamortized expense for the vested 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, Net

Interest and other income, net was $47.0 million for the three months ended June 30, 2022, compared to income of $41.8 million for the same period in 2021. During the second quarter of 2022, we recorded a net unrealized gain of $59.7 million related to the exercise of warrants in one of our strategic investees and observable price changes for our existing investments and related warrants. Additionally, we recorded an $11.7 million unrealized loss on marketable securities related to our investment in CLBT. During the three months ended June 30, 2021, we recorded a gain of $40.9 million related to observable price changes for our investmests 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.

Provision for Income Taxes

The provision for income taxes was an expense of $17.5 million for the three months ended June 30, 2022, which was an effective tax rate of 25.5%. Our estimated full year effective income tax rate for 2022, before discrete period adjustments, is 26.0%, which differs from the federal statutory rate primarily due to the impact of R&D tax credits offset by the executive compensation limitation under Internal Revenue Code ("IRC") Section 162(m) and an increase in valuation allowance and unrecognized tax benefits, on projected pre-tax income for the year. The effective tax rate was favorably impacted by a $0.5 million discrete tax benefit primarily associated with windfalls related to stock-based compensation for RSUs and PSUs that vested during the three months ended June 30, 2022.

Net Income

We recorded net income of $51.0 million for the three months ended June 30, 2022 compared to net loss of $47.1 million for the same period in 2021. Net income per basic share was $0.72 for the three months ended June 30, 2022 compared to $0.72 net loss per basic share for the same period in 2021. Net income per diluted share was $0.71 for the three months ended June 30, 2022 compared to $0.72 net loss per diluted share for the same period in 2021.

Three Months Ended June 30, 2022 Compared to the Three Months Ended March 31, 2022

Net Sales

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


	Three Months Ended				Three Months Ended				Dollar		Percent
	June 30, 2022				March 31, 2022				Change		Change
TASER segment:
TASER 7	$	53,440	18.7	%	$	50,066	19.5	%	$	3,374	6.7	%
TASER X26P		12,339	4.3			9,479	3.7			2,860	30.2
TASER X2		4,534	1.6			3,619	1.4			915	25.3
TASER Consumer devices		1,687	0.6			1,696	0.7			(9)	(0.5)
Cartridges		49,845	17.5			37,825	14.7			12,020	31.8
Axon Evidence and cloud services		3,720	1.3			3,017	1.2			703	23.3
Extended warranties		7,459	2.6			6,679	2.6			780	11.7
Other		2,562	0.9			1,979	0.8			583	29.5
TASER segment		135,586	47.5			114,360	44.6			21,226	18.6
Software and Sensors segment:
Axon Body		27,468	9.6			29,708	11.6			(2,240)	(7.5)
Axon Flex		621	0.2			1,329	0.5			(708)	(53.3)
Axon Fleet		15,881	5.6			13,820	5.4			2,061	14.9
Axon Dock		5,849	2.0			7,480	2.9			(1,631)	(21.8)
Axon Evidence and cloud services		81,911	28.7			79,939	31.2			1,972	2.5
Extended warranties		12,498	4.4			9,061	3.5			3,437	37.9
Other		5,799	2.0			729	0.3			5,070	695.5
Software and Sensors segment		150,027	52.5			142,066	55.4			7,961	5.6
Total net sales	$	285,613	100.0	%	$	256,426	100.0	%	$	29,187	11.4	%

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


	Three Months Ended
			Unit	Percent
	June 30, 2022	March 31, 2022	Change	Change
TASER 7	32,790	31,395	1,395	4.4	%
TASER X26P	8,831	6,338	2,493	39.3	%
TASER X2	2,745	2,006	739	36.8	%
TASER Consumer devices	5,157	6,201	(1,044)	(16.8)	%
Cartridges	1,536,332	1,089,939	446,393	41.0	%
Axon Body	59,851	62,562	(2,711)	(4.3)	%
Axon Flex	1,136	3,127	(1,991)	(63.7)	%
Axon Fleet	6,146	5,747	399	6.9	%
Axon Dock	5,314	8,064	(2,750)	(34.1)	%

Net sales within the TASER segment increased by approximately $21.2 million or 18.6% as compared to the prior quarter, primarily due to an increase of $12.0 million in Cartridge revenue due to increased units sold, partially offset by lower average selling prices. Net sales for our TASER legacy devices increased $3.8 million due to increased units sold, partially offset by lower average selling prices. TASER 7 revenue increased $3.4 million due to increased units sold and higher average selling prices.

Within the Software and Sensors segment, net sales increased $8.0 million or 5.6% during the three months ended June 30, 2022 compared to the prior quarter. Other revenue increased $5.1 million as a result of $2.1 million of contra-revenue during the prior quarter related to a free trial program of third party products which did not recur, as well as a $1.9 million increase in sales of signal sidearm. Axon Fleet revenue increased $2.1 million due to increased units sold and higher average selling prices. The increase in the aggregate number of users resulted in increased Axon Evidence revenue of $2.0 million. Partially offsetting the increases in segment revenue, Axon Body, Flex, and Dock revenue decreased $4.6 million as a result of decreased units sold, as well as lower average selling prices.

Six Months Ended June 30, 2022 Compared to the Six Months Ended June 30, 2021


	Six Months Ended June 30,
	2022				2021
Net sales from products	$	376,255	69.4	%	$	297,313	71.8	%
Net sales from services		165,784	30.6			116,501	28.2
Net sales		542,039	100.0			413,814	100.0
Cost of product sales		166,854	30.8			123,917	29.9
Cost of service sales		45,483	8.4			28,615	6.9
Cost of sales		212,337	39.2			152,532	36.9
Gross margin		329,702	60.8			261,282	63.1
Operating expenses:
Sales, general and administrative		185,134	34.2			304,259	73.5
Research and development		105,963	19.5			100,970	24.4
Total operating expenses		291,097	53.7			405,229	97.9
Income (loss) from operations		38,605	7.1			(143,947)	(34.8)
Interest and other income, net		102,325	18.9			42,426	10.3
Income (loss) before provision for income taxes		140,930	26.0			(101,521)	(24.5)
Provision for (benefit from) income taxes		35,097	6.5			(6,487)	(1.6)
Net income (loss)	$	105,833	19.5	%	$	(95,034)	(23.0)	%

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


	Six Months Ended June 30,
	2022				2021
United States	$	442,660	82	%	$	325,294	79	%
Other Countries		99,379	18			88,520	21
Total	$	542,039	100	%	$	413,814	100	%

International revenue increased compared to the prior year comparable period, driven primarily by increased sales in our Asia-Pacific (“APAC”) region.

Net Sales

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


	Six Months Ended June 30,								Dollar		Percent
	2022				2021				Change		Change
TASER segment:
TASER 7	$	103,506	19.1	%	$	62,119	15.0	%	$	41,387	66.6	%
TASER X26P		21,818	4.0			19,532	4.7			2,286	11.7
TASER X2		8,153	1.5			28,923	7.0			(20,770)	(71.8)
TASER Pulse		3,383	0.6			3,906	0.9			(523)	(13.4)
Cartridges		87,670	16.2			77,096	18.6			10,574	13.7
Axon Evidence and cloud services		6,737	1.2			3,098	0.7			3,639	117.5
Extended warranties		14,138	2.6			11,503	2.8			2,635	22.9
Other		4,541	0.9			5,350	1.4			(809)	(15.1)
TASER segment		249,946	46.1			211,527	51.1			38,419	18.2
Software and Sensors segment:
Axon Body		57,176	10.5			39,683	9.6			17,493	44.1
Axon Flex		1,950	0.3			1,993	0.5			(43)	(2.2)
Axon Fleet		29,701	5.5			9,010	2.2			20,691	229.6
Axon Dock		13,329	2.5			12,429	3.0			900	7.2
Axon Evidence and cloud services		161,850	29.9			112,661	27.2			49,189	43.7
Extended warranties		21,559	4.0			15,649	3.8			5,910	37.8
Other		6,528	1.2			10,862	2.6			(4,334)	(39.9)
Software and Sensors segment		292,093	53.9			202,287	48.9			89,806	44.4
Total net sales	$	542,039	100.0	%	$	413,814	100.0	%	$	128,225	31.0	%

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


	Six Months Ended June 30,		Unit	Percent
	2022	2021	Change	Change
TASER 7	64,185	41,071	23,114	56.3	%
TASER X26P	15,169	15,241	(72)	(0.5)	%
TASER X2	4,751	18,626	(13,875)	(74.5)	%
TASER Consumer devices	11,358	14,993	(3,635)	(24.2)	%
Cartridges	2,626,271	2,423,089	203,182	8.4	%
Axon Body	122,413	91,666	30,747	33.5	%
Axon Flex	4,263	3,411	852	25.0	%
Axon Fleet	11,893	3,902	7,991	204.8	%
Axon Dock	13,378	12,069	1,309	10.8	%

Net sales for the TASER segment increased 18.2% primarily due to an increase of $41.4 million in TASER 7 devices and $10.6 million in cartridge revenue. We continue to see a shift to purchases of our latest generation device, TASER 7, from legacy devices. TASER 7 revenue was impacted by higher average selling prices and an increase in unit sales. The increase in revenue from Axon Evidence and cloud services was driven by an increase in the number of TASER 7 devices in the field and VR training. Cartridge revenue was impacted by an increase in unit sales and by higher average selling prices. Offsetting the increases were decreased unit sales for our legacy TASER devices and our consumer devices. During the six months ended June 30, 2022, we recognized $33.1 million in TASER 7 revenue for orders that were scheduled to ship prior to December 31, 2021, but could not be fulfilled due to the delayed receipt of a manufacturing component for our TASER 7 devices.

Net sales for the Software and Sensors segment increased 44.4%, or $89.8 million during the six months ended June 30, 2022 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 $49.2 million. The $20.7 million increase in Axon Fleet revenue was primarily driven by higher unit sales, partially offset by lower average selling prices. Our newest Fleet product, Axon Fleet 3, which includes automated license plate reader technology, began shipping on June 30, 2021. Increased unit sales of our Axon Body 3 camera drove the $18.4 million increase in Axon Body and Axon Dock revenue and were partially offset by a decrease in Axon Dock average selling prices. Other revenue in the Software and Sensors segment decreased $4.3 million, driven primarily by $2.4 million of contra-revenue during the period related to a free trial program of third party products. During the six months ended June 30, 2022, we recognized $13.0 million for orders that were scheduled to ship prior to December 31, 2021, but could not be fulfilled due to supply chain constraints for our Axon Body 3 devices.

Cost of Product and Service Sales

Within the TASER segment, cost of product and service sales increased to $89.1 million for the six months ended June 30, 2022 from $70.8 million for the same period in 2021, primarily related to higher unit sales. Cost as a percentage of sales increased to 35.6% from 33.5%. The increase was primarily attributable to higher freight and labor costs as well as increased manufacturing overhead costs due to expanding our manufacturing footprint. While we continue to adjust strategic inventory levels based on areas of risk to mitigate potential supply disruptions, global supply conditions and local closures related to the COVID-19 pandemic could further impact our margins.

Within the Software and Sensors segment, cost of product and service sales increased to $123.2 million for the six months ended June 30, 2022 from $81.7 million for the same period in 2021. Cost as a percentage of sales increased to 42.2% from 40.4%. The increase was primarily driven by product mix. We expect to realize cost savings related to the new cloud hosting contract of approximately $2.5 million per quarter as compared to our current spend level; however, overall cloud hosting costs will continue to increase as we continue to add users to the Axon network.

Gross Margin

As a percentage of net sales, gross margin for the TASER segment decreased to 64.4% from 66.5% for the six months ended June 30, 2022 and 2021, respectively. The decrease was a result of higher labor costs and increased freight. We expect to increase operational spend as we are investing for scale increased production capacity.

As a percentage of net sales, gross margin for the Software and Sensors segment decreased to 57.8% from 59.6% for the six months ended June 30, 2022 and 2021, respectively. Within the Software and Sensors segment, hardware gross margin was 41.7% for the six months ended June 30, 2022 compared to 40.4% for the same period in 2021, while the service margins were 71.3% and 74.8% during those same periods, respectively.

Sales, General and Administrative Expenses

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


	Six Months Ended June 30,						Dollar		Percent
	2022			2021			Change		Change
Total sales, general and administrative expenses	$	185,134		$	304,259		$	(119,125)	(39.2)	%
SG&A expenses as a percentage of net sales		34.2	%		73.5	%

Stock-based compensation expense decreased $163.5 million in comparison to the prior year comparable period, which was primarily attributable to a decrease of $104.6 million in expense related to the CEO Performance Award and a decrease of $67.2 million related to our XSPP. The decrease related to the vesting of ten tranches of the CEO Performance Award and nine tranches of the XSPP in 2021, which have no remaining unrecognized expense for the vested tranches. The decrease was partially offset by increased stock-based compensation expense due to increased headcount.

Salaries, benefits, and bonus expense increased $14.3 million. Of the total increase, $11.9 million is attributable to an increase in salaries and related primarily to increased headcount. An increase in bonus expense of $3.8 million reflected higher bonuses paid to employees at the senior director level and below as well as higher anticipated attainment on our annual bonus. Partially offsetting the increase was a decrease of $3.3 million in payroll taxes related to the vesting of three tranches of the XSPP in March and May 2021; as no tranches have vested in 2022, we have not recognized payroll tax expense related to the program this year.

Sales and marketing and travel expenses increased $15.5 million. The increase was primarily driven by a $7.1 million increase in travel expenses, which reflected a return to pre-pandemic spending levels as travel restrictions have eased and in-person customer meetings have resumed. Also impacting higher travel expense were increased travel costs per trip. The increase was also driven by $4.8 million increase in commissions expense tied to higher revenue, and a $4.1 million increase related to trade shows and seminars as we hosted in-person events including our annual user conference, Axon Accelerate, in 2022.

Professional and consulting expenses increased $6.8 million in comparison to the prior year comparable period, driven primarily by increased legal and consulting expense.

Research and Development Expenses

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


	Six Months Ended June 30,						Dollar		Percent
	2022			2021			Change		Change
Total research and development expenses	$	105,963		$	100,970		$	4,993	4.9	%
R&D expenses as a percentage of net sales		19.5	%		24.4	%

Within the TASER segment, R&D expense increased $1.7 million. An increase of $4.0 million in salaries, benefits and bonus expense reflected higher headcount. Additionally, indirect manufacturing costs and supplies increased $2.3 million related to the development of next generation products. Fully offsetting these increases was a decrease in stock-based compensation expense of $6.1 million, due to the vesting of nine XSPP tranches during 2021, for which there is no remaining unamortized expense.

R&D expense for the Software and Sensors segment increased $3.3 million, reflecting an increase of $12.7 million in salaries, benefits, and bonus expense due to higher headcount, higher bonuses paid to employees at the senior director level and below, and higher anticipated attainment on our annual bonus. Partially offsetting the increase was a decrease in stock-based compensation expense of $10.1 million, due to the vesting of nine XSPP tranches during 2021, for which there is no remaining unamortized expense for the vested tranches.

Interest and Other Income, Net

Interest and other income, net was $102.3 million for the six months ended June 30, 2022, compared to income of $42.4 million for the same period in 2021. During the first half of 2022, we recorded an unrealized gain of $130.1

million related to observable price changes for our existing investments and related warrants and the exercise of warrants in one of our strategic investees, which was partially offset in part by a $26.3 million unrealized loss on marketable securities related to our investment in CLBT. For the six months ended June 30, 2021, we recorded a gain of $40.9 million related to observable price changes for our investmests 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.

Provision for Income Taxes

The provision for income taxes was an expense of $35.1 million for the six months ended June 30, 2022, which was an effective tax rate of 24.9%. Our estimated full year effective income tax rate for 2022, before discrete period adjustments, is 26.0%, which differs from the federal statutory rate primarily due to the impact of R&D tax credits offset by the executive compensation limitation under IRC Section 162(m) and an increase in valuation allowance and unrecognized tax benefits, on projected pre-tax income for the year. The effective tax rate was favorably impacted by a $1.6 million discrete tax benefit primarily associated with windfalls related to stock-based compensation for RSUs and PSUs that vested during the six months ended June 30, 2022.

Net Income

We recorded net income of $105.8 million for the six months ended June 30, 2022 compared to net loss of $95.0 million for the same period in 2021. Net income per basic share was $1.49 for the six months ended June 30, 2022 compared to $1.47 net loss per basic share for the same period in 2021. Net income per diluted share was $1.46 for the six months ended June 30, 2022 compared to $1.47 net loss per diluted share for the same period in 2021.

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						Six Months Ended
	June 30,		March 31,		June 30,		June 30,		June 30,
	2022		2022		2021		2022		2021
Net income (loss)	$	50,962	$	54,871	$	(47,117)	$	105,833	$	(95,034)
Depreciation and amortization		6,210		5,755		4,291		11,965		8,582
Interest expense		3		8		17		11		22
Investment interest (income) loss		584		346		(502)		930		(1,035)
Provision for (benefit from) income taxes		17,475		17,622		(4,727)		35,097		(6,487)
EBITDA	$	75,234	$	78,602	$	(48,038)	$	153,836	$	(93,952)

Adjustments:
Stock-based compensation expense		21,162		25,088		137,549		46,250		227,159
Adjusted EBITDA (CEO Performance Award)	$	96,396	$	103,690	$	89,511	$	200,086	$	133,207

Liquidity and Capital Resources

Summary

As of June 30, 2022, we had $212.8 million of cash and cash equivalents, a decrease of $143.5 million as compared to December 31, 2021. Cash and cash equivalents and investments totaled $356.3 million, representing a decrease of $45.8 million from December 31, 2021.

Our ongoing sources of cash include cash on hand, investments, and cash flows from operations. Restricted cash balance of $1.9 million primarily related to funds held in an international bank account securing a guarantee and 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 long-term 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 June 30, 2022, we had letters of credit outstanding of $6.5 million, leaving the net amount available for borrowing of $43.5 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 June 30, 2022 and December 31, 2021, there were no borrowings under the line other than the outstanding letters of credit.

Based on our strong balance sheet and the fact that we do not have long-term debt at June 30, 2022, 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):


	Six Months Ended June 30,
	2022		2021
Operating activities	$	63,340	$	95,115
Investing activities		(198,786)		26,446
Financing activities		(2,393)		(10,312)
Effect of exchange rate changes on cash and cash equivalents		(3,910)		(319)
Net increase (decrease) in cash and cash equivalents and restricted cash	$	(141,749)	$	110,930

Operating activities

Net cash provided by operating activities in the first six months of 2022 of $63.3 million reflects net income of $105.8 million, non-cash income statement items totaling $11.6 million, and a decrease of $30.9 million for the net change in operating assets and liabilities. Included in the non-cash items were $46.3 million in stock-based compensation expense, a decrease of $26.1 million in deferred income taxes, net, $12.0 million in depreciation and amortization expense, and a $130.1 million gain on the change in fair value of strategic investments, offset by an unrealized loss of $26.3 million on marketable securities. Cash provided by operations was favorably impacted by increased deferred revenue of $74.6 million, which was primarily attributable to increased sales. Additionally, accounts payable, accrued and other liabilities increased $24.6 million due to an increase in accounts payable due to the timing of invoice payments. Offsetting this activity was an increase of accounts and notes receivables and contract assets of $80.2 million, an increase of $47.1 million in inventory, and an increase in prepaid expenses and other assets of $2.7 million. The increase in accounts and notes receivable and contract assets is due to increased sales and timing of satisfied performance obligations compared to customer payments of accounts receivable. The increase of inventory was primarily driven by the proactive buildup of raw materials required to meet future demand and an increased revenue forecast. The increase in prepaid expenses and other assets was driven by an increase of deferred commissions related to increased bookings.

Net cash provided by operating activities in the first six months of 2021 of $95.1 million reflects $95.0 million in net loss, non-cash income statement items totaling $194.0 million, and a decrease of $3.9 million for the net change in operating assets and liabilities. Included in the non-cash items were $8.6 million in depreciation and amortization expense, $227.2 million in stock-based compensation expense and $40.9 million gain on the change in fair value of strategic investments. Cash provided by operations was primarily driven by increased deferred revenue of $25.6 million. The increase in deferred revenue is primarily attributable to increased sales. This increase was partially offset by increased prepaid expenses and other current assets of $13.3 million and decreased accounts payable, accrued liabilities and other liabilities of $10.4 million. The increase in prepaid expenses and other current assets was driven by an increase in prepaid commissions related to higher bookings not yet recognized as revenue, an increase in capitalized cloud computing costs related to an enterprise resource planning system conversion, an increase in right-of-use lease assets, and an increase in income tax receivable as compared to the end of fiscal 2020. The decrease in accounts payable, accrued liabilities and other liabilities related primarily to the timing of invoice payments at the end of the 2021 second quarter.

Investing activities

We used $198.8 million in investing activities during the first six months of 2022. Cash outflows from investing activities included $61.5 million for new strategic minority investments, $6.6 million for the exercise price of warrants related to our strategic investments, and $2.1 million for a business acquisition. The outflows also included $98.8 million for available-for-sale investments, net of proceeds. Property and equipment purchases totaled $29.8 million, net of proceeds

Net cash provided by investing activities was $26.4 million during the first six months of 2021. Cash inflows from investing activities included proceeds from held-to-maturity investments of $56.5 million, net of purchases, 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 $24.2 million for the purchase of property and equipment and intangible assets.

Financing activities

Net cash used in financing activities was $2.4 million during the first three months of 2022 and was primarily attributable to the payment of income and payroll taxes on behalf of employees who net-settled stock awards during the period.

Net cash used in financing activities was $10.3 million during the first six 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.

Off-Balance Sheet Arrangements

The discussion under the heading off-balance sheet arrangements in Note 12 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

Our management’s discussion and analysis of our financial condition and results of operation is based on our condensed consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosures. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances, and we evaluate our estimates and assumptions on an ongoing basis. Due to the ongoing COVID-19 pandemic, there is ongoing uncertainty and significant disruption in the global economy and financial markets. We are not aware of any specific event or circumstance that would require an update to our estimates or assumptions or a revision of the carrying value of assets or liabilities as of August 9, 2022, the date of issuance of this Quarterly Report on Form 10-Q. These estimates and assumptions may change in the future, however, as new events occur and additional information is obtained. Our actual results could differ from these estimates.

Our significant accounting policies are discussed in Note 1 to our consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021. There have been no significant changes to these policies for the six months ended June 30, 2022.

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