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, 2022, and results of operations for the three and nine months ended September 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 a technology leader in global public safety. Our moonshot goal is to cut gun-related deaths between police and the public by 50% before 2033. Axon is building the public safety operating system of the future by integrating a suite of hardware devices and cloud software solutions that lead modern policing. Axon’s suite includes TASER energy devices, body-worn cameras, in-car cameras, cloud-hosted digital evidence management solutions, productivity software and real-time operations capabilities. Axon’s growing global customer base includes first responders across international, federal, state, and local law enforcement, fire, corrections, and emergency medical services, as well as the justice sector, commercial enterprises, and consumers.

Our revenues for the three months ended September 30, 2022 were $311.8 million, an increase of $79.8 million, or 34.4%, from the comparable period in the prior year. We had income from operations of $32.1 million compared to $2.9 million for the same period in the prior year. Gross margin dollars increased $48.7 million but decreased slightly as a percentage of revenue compared to the three months ended September 30, 2021, reflecting higher labor and freight costs. Operating expenses increased $19.5 million, reflecting an increase in salaries, benefits, and bonus expense and increases in sales, marketing, and commissions expense, partially offset by a decrease of $6.9 million in stock-based compensation expense primarily related to the CEO Performance Award and XSPP. Net income of $12.1 million included unrealized losses of $11.3 million related to observable price changes for our existing strategic investments and marketable securities related to our investment in CLBT, compared to net income of $48.5 million for the comparable period in the prior year.

Our revenues for the nine months ended September 30, 2022 were $853.8 million, an increase of $208.0 million, or 32.2%, from the comparable period in the prior year. We had income from operations of $70.7 million compared to a loss from operations of $141.1 million for the same period in the prior year. Gross margin dollars increased $117.1 million but decreased as a percentage of revenue compared to the nine months ended September 30, 2021, primarily reflecting higher labor and freight costs. Operating expenses decreased $94.7 million, reflecting a decrease of $186.7 million in stock-based compensation expense primarily related to the CEO Performance Award and XSPP, partially offset by an increase in salaries and bonus expense, and increases in travel and commissions expense. For the nine months ended September 30, 2022, we recorded net income of $118.0 million, which reflected net unrealized gains of $129.4 million related to observable price changes for our existing investments and related warrants and an unrealized loss of $36.9 million on marketable securities related to our investment in CLBT, compared to net loss of $46.5 million for the comparable period in the prior year.

Results of Operations

Three Months Ended September 30, 2022 Compared to the Three Months Ended September 30, 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 September 30,
	2022				2021
Net sales from products	$	210,398	67.5	%	$	165,803	71.5	%
Net sales from services		101,356	32.5			66,186	28.5
Net sales		311,754	100.0			231,989	100.0
Cost of product sales		93,724	30.1			71,336	30.7
Cost of service sales		24,773	7.9			16,086	6.9
Cost of sales		118,497	38.0			87,422	37.6
Gross margin		193,257	62.0			144,567	62.4
Operating expenses:
Sales, general and administrative		102,023	32.7			99,295	42.8
Research and development		59,127	19.0			42,382	18.3
Total operating expenses		161,150	51.7			141,677	61.1
Income (loss) from operations		32,107	10.3			2,890	1.3
Interest and other income (expense), net		(11,249)	(3.6)			(5,530)	(2.4)
Income (loss) before provision for income taxes		20,858	6.7			(2,640)	(1.1)
Provision for (benefit from) income taxes		8,727	2.8			(51,164)	(22.0)
Net income	$	12,131	3.9	%	$	48,524	20.9	%

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


	Three Months Ended September 30,
	2022				2021
United States	$	264,644	85	%	$	192,756	83	%
Other countries		47,110	15			39,233	17
Total	$	311,754	100	%	$	231,989	100	%

International revenue increased compared to the prior year comparable period, but decreased as a percentage of total revenue. The increase in domestic revenue was driven by demand for the premium versions of our products and bundles, as well as increases in our federal business.

Net Sales

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


	Three Months Ended September 30,								Dollar		Percent
	2022				2021				Change		Change
TASER segment:
TASER 7	$	65,951	21.2	%	$	50,641	21.8	%	$	15,310	30.2	%
TASER X26P		5,897	1.9			9,086	3.9			(3,189)	(35.1)
TASER X2		8,298	2.7			10,078	4.3			(1,780)	(17.7)
TASER Consumer devices		1,702	0.6			967	0.4			735	76.0
Cartridges		46,475	14.9			39,313	16.9			7,162	18.2
Axon Evidence and cloud services		5,125	1.6			2,711	1.2			2,414	89.0
Extended warranties		7,290	2.3			6,099	2.6			1,191	19.5
Other		4,145	1.3			2,596	1.3			1,549	59.7
Total TASER segment		144,883	46.5			121,491	52.4			23,392	19.3
Software and Sensors segment:
Axon Body		35,427	11.4			20,862	9.0			14,565	69.8
Axon Flex		687	0.2			1,488	0.6			(801)	(53.8)
Axon Fleet		10,139	3.3			6,063	2.6			4,076	67.2
Axon Dock		4,830	1.5			6,460	2.8			(1,630)	(25.2)
Axon Evidence and cloud services		96,814	31.1			63,272	27.3			33,542	53.0
Extended warranties		14,511	4.6			8,983	3.9			5,528	61.5
Other		4,463	1.4			3,370	1.4			1,093	32.4
Total Software and Sensors segment		166,871	53.5			110,498	47.6			56,373	51.0
Total net sales	$	311,754	100.0	%	$	231,989	100.0	%	$	79,765	34.4	%

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



	Three Months Ended September 30,		Unit	Percent
	2022	2021	Change	Change
TASER 7	40,502	36,350	4,152	11.4	%
TASER X26P	3,745	6,596	(2,851)	(43.2)
TASER X2	5,120	5,562	(442)	(7.9)
TASER Consumer devices	7,180	3,232	3,948	122.2
Cartridges	1,481,169	1,327,971	153,198	11.5
Axon Body	71,070	58,248	12,822	22.0
Axon Flex	1,188	3,390	(2,202)	(65.0)
Axon Fleet	2,342	2,753	(411)	(14.9)
Axon Dock	3,822	8,556	(4,734)	(55.3)

Net sales for the TASER segment increased 19.3% primarily due to an increase of $15.3 million in TASER 7 devices that was partially offset by a decrease of sales in our legacy devices of $5.0 million. We continue to see a shift to purchases of our latest generation device, TASER 7, from legacy devices. TASER 7 revenue was favorably 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, in particular for TASER 7 cartridges, and by higher average selling prices.

Net sales for the Software and Sensors segment increased 51.0% for the three months ended September 30, 2022 as compared to the prior year quarter 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 $33.5 million. The $14.6 million increase in Axon Body revenue was primarily driven by higher unit sales and higher average selling prices. An increase in cameras and docks in the field drove the $5.5 million increase in extended warranties, as most of those devices

are sold with extended warranties. Higher average selling prices drove the $4.1 million increase in Axon Fleet revenue, partially offset by decreased unit sales.

We consider total company future contracted revenues a forward-looking performance indicator. As of September 30, 2022, we had approximately $3.73 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 $53.4 million for the three months ended September 30, 2022 from $41.6 million for the same period in 2021, primarily related to higher unit sales and increased cost of raw materials. Cost as a percentage of sales increased to 36.9% from 34.2%. The increase was primarily attributable to higher labor and freight costs as well as increased manufacturing overhead costs due to expanding our manufacturing capabilities. While we continue to adjust strategic inventory levels based on areas of risk to mitigate potential supply disruptions, global supply conditions could further impact our margins.

Within the Software and Sensors segment, cost of product and service sales increased to $65.1 million for the three months ended September 30, 2022 from $45.9 million for the same period in 2021. Cost as a percentage of sales decreased to 39.0% from 41.5%. The decrease in cost of product and service sales as a percentage of sales was primarily driven by higher average selling prices and savings on cloud hosting costs as a percent of revenue, partially offset by increased indirect manufacturing costs and supplies.

Gross Margin

As a percentage of net sales, gross margin for the TASER segment decreased to 63.1% from 65.8% for the three months ended September 30, 2022 and 2021, respectively. The decrease was a result of higher labor costs and increased freight.

As a percentage of net sales, gross margin for the Software and Sensors segment increased to 61.0% from 58.5% for the three months ended September 30, 2022 and 2021, respectively. Within the Software and Sensors segment, hardware gross margin increased to 43.3% for the three months ended September 30, 2022 compared to 36.9% for the same period in 2021 due to increased unit sales and higher average selling prices of Axon Body 3 and Axon Fleet, and savings on cloud hosting costs. Service margins decreased slightly to 74.1% for the three months ended September 30, 2022 from 74.6% 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 September 30,						Dollar		Percent
	2022			2021			Change		Change
Total sales, general and administrative expenses	$	102,023		$	99,295		$	2,728	2.7
Sales, general, and administrative as a percentage of net sales		32.7	%		42.8	%

Stock-based compensation expense decreased $11.7 million in comparison to the prior year comparable period, which was primarily attributable to a decrease of $11.3 million in expense related to the CEO Performance Award and a $5.3 million decrease related to the XSPP. The decreases were 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. Partially offsetting the decreases was an increase in stock-based compensation expense for time-based awards due to higher headcount.

Net salaries, benefits, and bonus expense increased $4.3 million. An increase of $10.2 million in salaries, benefits, and bonus expense was attributable due to an increase in headcount and higher anticipated attainment on bonuses expected to be paid to employees at the senior director level and below. Offsetting the increase was a decrease of $5.9 million in payroll taxes related to the vesting of five tranches of our XSPP in September 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 $5.9 million. The increase was partially attributable to a $4.4 million increase related to employee commissions driven by higher revenue. The increase also reflects a $1.5 million increase in travel expenses, reflecting a return to normalized levels and an increase of in-person customer meetings. Also impacting higher travel expense was increased travel costs per trip.

Impairment expenses increased $1.4 million, primarily as a result of the decision to slow pacing on construction of our new Scottsdale, Arizona campus.

Research and Development Expenses

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



	Three Months Ended September 30,						Dollar		Percent
	2022			2021			Change		Change
Total research and development expenses	$	59,127		$	42,382		$	16,745	39.5
Research and development as a percentage of net sales		19.0	%		18.3	%

Within the TASER segment, R&D expense increased $3.4 million. An increase of $2.1 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.

R&D expense for the Software and Sensors segment increased $13.4 million, reflecting an increase of $8.9 million in salaries, benefits, and bonus expense due to higher headcount and higher anticipated attainment on bonuses expected to be paid to employees at the senior director level and below. Additionally, there was a $4.3 million increase related to stock-based compensation expense, primarily related to increased headcount.

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 $11.2 million for the three months ended September 30, 2022, compared to expense of $5.5 million for the same period in 2021. During the third quarter of 2022, we recorded a $10.6 million unrealized loss on marketable securities related to our investment in CLBT and a $0.7 million loss related to observable price changes on our existing strategic investments.

Provision for Income Taxes

The provision for income taxes was an expense of $8.7 million for the three months ended September 30, 2022, which was an effective tax rate of 41.8%. Our estimated full year effective income tax rate for 2022, before discrete period adjustments, is 28.0%, 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 unfavorably impacted by a $0.2 million discrete tax expense associated with shortfalls related to stock-based compensation for RSUs and PSUs that vested during the three months ended September 30, 2022.

Net Income

We recorded net income of $12.1 million for the three months ended September 30, 2022 compared to net income of $48.5 million for the same period in 2021. Net income per basic share was $0.17 for the three months ended September 30, 2022 compared to $0.73 net income per basic share for the same period in 2021. Net income per diluted share was $0.17 for the three months ended September 30, 2022 compared to $0.67 net income per diluted share for the same period in 2021.

Three Months Ended September 30, 2022 Compared to the Three Months Ended June 30, 2022

Net Sales

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


	Three Months Ended				Three Months Ended				Dollar		Percent
	September 30, 2022				June 30, 2022				Change		Change
TASER segment:
TASER 7	$	65,951	21.2	%	$	53,440	18.7	%	$	12,511	23.4	%
TASER X26P		5,897	1.9			12,339	4.3			(6,442)	(52.2)
TASER X2		8,298	2.7			4,534	1.6			3,764	83.0
TASER Consumer devices		1,702	0.6			1,687	0.6			15	0.9
Cartridges		46,475	14.9			49,845	17.5			(3,370)	(6.8)
Axon Evidence and cloud services		5,125	1.6			3,720	1.3			1,405	37.8
Extended warranties		7,290	2.3			7,459	2.6			(169)	(2.3)
Other		4,145	1.3			2,562	0.9			1,583	61.8
TASER segment		144,883	46.5			135,586	47.5			9,297	6.9
Software and Sensors segment:
Axon Body		35,427	11.4			27,468	9.6			7,959	29.0
Axon Flex		687	0.2			621	0.2			66	10.6
Axon Fleet		10,139	3.3			15,881	5.6			(5,742)	(36.2)
Axon Dock		4,830	1.5			5,849	2.0			(1,019)	(17.4)
Axon Evidence and cloud services		96,814	31.1			81,911	28.7			14,903	18.2
Extended warranties		14,511	4.6			12,498	4.4			2,013	16.1
Other		4,463	1.4			5,799	2.0			(1,336)	(23.0)
Software and Sensors segment		166,871	53.5			150,027	52.5			16,844	11.2
Total net sales	$	311,754	100.0	%	$	285,613	100.0	%	$	26,141	9.2	%

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


	Three Months Ended
			Unit	Percent
	September 30, 2022	June 30, 2022	Change	Change
TASER 7	40,502	32,790	7,712	23.5	%
TASER X26P	3,745	8,831	(5,086)	(57.6)
TASER X2	5,120	2,745	2,375	86.5
TASER Consumer devices	7,180	5,157	2,023	39.2
Cartridges	1,481,169	1,536,332	(55,163)	(3.6)
Axon Body	71,070	59,851	11,219	18.7
Axon Flex	1,188	1,136	52	4.6
Axon Fleet	2,342	6,146	(3,804)	(61.9)
Axon Dock	3,822	5,314	(1,492)	(28.1)

Net sales within the TASER segment increased by approximately $9.3 million or 6.9% as compared to the prior quarter, primarily due to an increase of $12.5 million in TASER 7 revenue due to increased units sold. Cartridge revenue decreased $3.4 million due to a small decrease in the overall average selling prices and a decrease in legacy cartridge units. An overall decrease in sales for our TASER legacy devices was driven by lower unit sales for TASER X26P devices, partially offset by higher average selling prices and an increase in sales of our TASER X2 devices.

Within the Software and Sensors segment, net sales increased $16.8 million or 11.2% during the three months ended September 30, 2022 compared to the prior quarter. Net sales of Axon Body drove increases in the aggregate number of users, which resulted in increased Axon Evidence revenue of $14.9 million. Axon Body revenue increased $8.0 million due to increased unit sales and higher average selling prices. Partially offsetting the increases in segment revenue, Axon Fleet revenue decreased $5.7 million as a result of decreased units sold, partially offset by higher average selling prices.

Nine months ended September 30, 2022 Compared to the Nine Months Ended September 30, 2021


	Nine Months Ended September 30,
	2022				2021
Net sales from products	$	586,653	68.7	%	$	463,116	71.7	%
Net sales from services		267,140	31.3			182,687	28.3
Net sales		853,793	100.0			645,803	100.0
Cost of product sales		260,578	30.5			195,253	30.2
Cost of service sales		70,256	8.2			44,701	6.9
Cost of sales		330,834	38.7			239,954	37.1
Gross margin		522,959	61.3			405,849	62.9
Operating expenses:
Sales, general and administrative		287,157	33.6			403,554	62.5
Research and development		165,090	19.4			143,352	22.2
Total operating expenses		452,247	53.0			546,906	84.7
Income (loss) from operations		70,712	8.3			(141,057)	(21.8)
Interest and other income, net		91,076	10.6			36,896	5.7
Income (loss) before provision for income taxes		161,788	18.9			(104,161)	(16.1)
Provision for (benefit from) income taxes		43,824	5.1			(57,651)	(8.9)
Net income (loss)	$	117,964	13.8	%	$	(46,510)	(7.2)	%

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


	Nine Months Ended September 30,
	2022				2021
United States	$	707,304	83	%	$	518,050	80	%
Other Countries		146,489	17			127,753	20
Total	$	853,793	100	%	$	645,803	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):


	Nine Months Ended September 30,								Dollar		Percent
	2022				2021				Change		Change
TASER segment:
TASER 7	$	169,457	19.8	%	$	112,760	17.5	%	$	56,697	50.3	%
TASER X26P		27,715	3.2			28,618	4.4			(903)	(3.2)
TASER X2		16,451	1.9			39,001	6.0			(22,550)	(57.8)
TASER Consumer devices		5,085	0.6			4,873	0.8			212	4.4
Cartridges		134,145	15.7			116,409	18.0			17,736	15.2
Axon Evidence and cloud services		11,862	1.4			5,809	0.9			6,053	104.2
Extended warranties		21,428	2.5			17,602	2.7			3,826	21.7
Other		8,686	1.1			7,946	1.3			740	9.3
TASER segment		394,829	46.2			333,018	51.6			61,811	18.6
Software and Sensors segment:
Axon Body		92,603	10.9			60,545	9.4			32,058	52.9
Axon Flex		2,637	0.3			3,481	0.5			(844)	(24.2)
Axon Fleet		39,840	4.7			15,073	2.3			24,767	164.3
Axon Dock		18,159	2.1			18,889	2.9			(730)	(3.9)
Axon Evidence and cloud services		258,664	30.3			175,933	27.2			82,731	47.0
Extended warranties		36,070	4.2			24,632	3.8			11,438	46.4
Other		10,991	1.3			14,232	2.3			(3,241)	(22.8)
Software and Sensors segment		458,964	53.8			312,785	48.4			146,179	46.7
Total net sales	$	853,793	100.0	%	$	645,803	100.0	%	$	207,990	32.2	%

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


	Nine Months Ended September 30,		Unit	Percent
	2022	2021	Change	Change
TASER 7	104,687	77,421	27,266	35.2	%
TASER X26P	18,914	21,837	(2,923)	(13.4)
TASER X2	9,871	24,188	(14,317)	(59.2)
TASER Consumer devices	18,538	18,225	313	1.7
Cartridges	4,107,440	3,751,060	356,380	9.5
Axon Body	193,483	149,914	43,569	29.1
Axon Flex	5,451	6,801	(1,350)	(19.9)
Axon Fleet	14,235	6,655	7,580	113.9
Axon Dock	17,200	20,625	(3,425)	(16.6)

Net sales for the TASER segment increased 18.6% primarily due to an increase of $56.7 million in TASER 7 devices and $17.7 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 cartridge revenue was impacted by an increase in unit sales and by higher average selling prices, driven by the increase in TASER 7 cartridge units. The increase in revenue from Axon Evidence and cloud services was driven by revenue from our VR training offering and an increase in the number of TASER 7 devices in the field. Offsetting the increases were decreased unit sales for our legacy TASER devices. During the nine months ended September 30, 2022, we recognized $33.3 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 46.7%, or $146.2 million during the nine months ended September 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 $82.7 million. Increased unit sales of our Axon Body 3 camera drove the $32.1 million increase in Axon Body. The $24.8 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. An increase in cameras and docks in the field drove the $11.4 million increase in extended warranties, as most of those devices are sold with extended warranties. Partially offsetting the overall increase in the Software and Sensors segment revenue was a $3.2 million decrease of Other revenue, driven primarily by $2.8 million of contra-revenue during the period related to a free trial program of third party products. During the nine months ended September 30, 2022, we recognized $14.7 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 $142.5 million for the nine months ended September 30, 2022 from $112.4 million for the same period in 2021, primarily related to higher unit sales and increased cost on raw materials. Cost as a percentage of sales increased to 36.1% from 33.7%. The increase was primarily attributable to higher labor and freight costs as well as increased manufacturing overhead costs due to expanding our manufacturing capabilities. While we continue to adjust strategic inventory levels based on areas of risk to mitigate potential supply disruption, global supply conditions could further impact our margins.

Within the Software and Sensors segment, cost of product and service sales increased to $188.3 million for the nine months ended September 30, 2022 from $127.6 million for the same period in 2021. Cost as a percentage of sales increased slightly to 41.0% from 40.8%. The increase was primarily driven by product mix and an increase in 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 decreased to 63.9% from 66.3% for the nine months ended September 30, 2022 and 2021, respectively. The decrease was a result of higher labor costs and increases on freight and raw materials.

As a percentage of net sales, gross margin for the Software and Sensors segment decreased slightly to 59.0% from 59.2% for the nine months ended September 30, 2022 and 2021, respectively. Within the Software and Sensors segment, hardware gross margin was 42.3% for the nine months ended September 30, 2022 compared to 39.2% for the same period in 2021, while the service margins were 72.4% and 74.7% 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
	2022			2021			Change		Change
Total sales, general and administrative expenses	$	287,157		$	403,554		$	(116,397)	(28.8)	%
SG&A expenses as a percentage of net sales		33.6	%		62.5	%

Stock-based compensation expense decreased $175.2 million in comparison to the prior year comparable period, which was primarily attributable to a decrease of $116.0 million in expense related to the CEO Performance Award and a decrease of $74.3 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 for time-based awards due to higher headcount.

Salaries, benefits, and bonus expense increased $17.9 million. Of the total increase, $21.0 million is attributable to an increase in salaries and related primarily to increased headcount. An increase in bonus expense of $6.1 million reflected higher anticipated attainment on bonuses expected to be paid to employees at the senior director level and below, as well as on our annual bonus. Partially offsetting the increase was a decrease of $9.2 million in payroll taxes related to the vesting of nine tranches of the XSPP in the nine months ending September 30, 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 $21.5 million. The increase was primarily driven by a $9.2 million increase in commissions expense tied to higher revenue. Also impacting the change in expense was an increase in travel expenses of $8.6 million reflecting increased in-person customer and vendor meetings. Increased travel costs per trip also impacted higher travel expenses. An increase of $4.3 million 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 $7.4 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):


	Nine Months Ended September 30,						Dollar		Percent
	2022			2021			Change		Change
Total research and development expenses	$	165,090		$	143,352		$	21,738	15.2	%
R&D expenses as a percentage of net sales		19.4	%		22.2	%

Within the TASER segment, R&D expense increased $5.0 million. An increase of $6.1million in salaries, benefits and bonus expense reflected higher headcount. Additionally, indirect manufacturing costs and supplies increased $2.5 million related to the development of next generation products. Fully offsetting these increases was a decrease in stock-based compensation expense of $5.6 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 $16.7 million, reflecting an increase of $21.5 million in salaries, benefits, and bonus expense due to higher headcount, higher attainment on bonuses expected to be paid to employees at the senior director level and below and on our annual bonus. Partially offsetting the increase was a decrease in stock-based compensation expense of $5.8 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 $91.1 million for the nine months ended September 30, 2022, compared to income of $36.9 million for the same period in 2021. During the nine months ended September 30, 2022, we recorded a

net unrealized gain of $129.4 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 $36.9 million unrealized loss on marketable securities related to our investment in CLBT. For the nine months ended September 30, 2021, 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.

Provision for Income Taxes

The provision for income taxes was an expense of $43.8 million for the nine months ended September 30, 2022, which was an effective tax rate of 27.1%. Our estimated full year effective income tax rate for 2022, before discrete period adjustments, is 28.0%, 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 $1.4 million discrete tax benefit primarily associated with net windfalls related to stock-based compensation for RSUs and PSUs that vested during the nine months ended September 30, 2022.

Net Income

We recorded net income of $118.0 million for the nine months ended September 30, 2022 compared to net loss of $46.5 million for the same period in 2021. Net income per basic share was $1.66 for the nine months ended September 30, 2022 compared to $0.71 net loss per basic share for the same period in 2021. Net income per diluted share was $1.63 for the nine months ended September 30, 2022 compared to $0.71 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						Nine Months Ended
	September 30,		June 30,		September 30,		September 30,		September 30,
	2022		2022		2021		2022		2021
Net income (loss)	$	12,131	$	50,962	$	48,524	$	117,964	$	(46,510)
Depreciation and amortization		6,206		6,210		4,838		18,171		13,420
Interest expense		3		3		5		14		27
Investment interest (income) loss		(1,098)		584		(123)		(168)		(1,158)
Provision for (benefit from) income taxes		8,727		17,475		(51,164)		43,824		(57,651)
EBITDA	$	25,969	$	75,234	$	2,080	$	179,805	$	(91,872)

Adjustments:
Stock-based compensation expense		28,204		21,162		35,062		74,454		262,221
Adjusted EBITDA (CEO Performance Award)	$	54,173	$	96,396	$	37,142	$	254,259	$	170,349

Liquidity and Capital Resources

Summary

As of September 30, 2022, we had $147.7 million of cash and cash equivalents, a decrease of $208.6 million as compared to December 31, 2021. Cash and cash equivalents and investments totaled $370.9 million, representing a decrease of $31.2 million from December 31, 2021.

Our ongoing sources of cash include cash on hand, investments, and cash flows from operations. Restricted cash balance of $1.7 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 Term SOFR 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, 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 September 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 September 30, 2022, we believe financing will be available, both through our existing revolving credit facility 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,
	2022		2021
Operating activities	$	104,241	$	111,564
Investing activities		(302,001)		93,412
Financing activities		(2,465)		(76,902)
Effect of exchange rate changes on cash and cash equivalents		(6,783)		(1,827)
Net increase (decrease) in cash and cash equivalents and restricted cash	$	(207,008)	$	126,247

Operating activities

Net cash provided by operating activities in the first nine months of 2022 of $104.2 million reflects net income of $118.0 million, non-cash income statement items totaling $41.6 million, and a decrease of $55.3 million for the net change in operating assets and liabilities. Included in the non-cash items were $74.5 million in stock-based compensation expense, a decrease of $30.3 million in deferred income taxes, net, $18.2 million in depreciation and amortization expense, and a $92.5 million gain on the change in fair value of strategic investments and marketable securities, net. Cash provided by operations was favorably impacted by increased deferred revenue of $115.2 million, which was primarily attributable to increased sales where payment is received from the customer before performance occurs. Additionally, accounts payable, accrued and other liabilities increased $28.7 million due to an increase in accounts payable due to the timing of invoice payments and to increased accrued commissions on higher revenue. Offsetting this activity was an increase of accounts and notes receivables and contract assets of $115.0 million, an increase of $66.3 million in inventory, and an increase in prepaid expenses and other assets of $17.9 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. Inventory increases were a result of advance purchases to support future sales. 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 nine months of 2021 of $111.6 million reflects a net loss of $46.5 million, 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.

Investing activities

We used $302.0 million of cash for investing activities during the first nine months of 2022. Cash outflows from investing activities included $70.5 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 $178.7 million for the purchase of available-for-sale investments, net of proceeds from calls and maturities. Property and equipment purchases totaled $44.0 million, net of proceeds on disposals.

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.

Financing activities

Net cash used in financing activities was $2.5 million during the first nine 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 $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.

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

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. 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.

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 nine months ended September 30, 2022.

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