AGB 2024.5 - Axon Enterprise (AXON)
Technology Driven Growth for Public Safety
Subscribe to AGB - One analysis of a good business in each issue.
Axon Enterprise
“Our company's reason to exist, our mission, is for exactly moments like right now - to protect life. We are on a mission to make energy weapons so safe and so effective that we make bullets obsolete. We preserve truth. Body cameras protect officers from bad claims and citizens from bad behavior, increasing transparency and reducing social conflict. We accelerate justice with advanced cloud software and AI that have potential to make the entire justice system more fair and more effective. When you think of gun violence, social conflict and a fair justice system, most people don't think of these as technology problems, but as political problems. We frame them as problems where technology can play a transformative role.”
– Founder and CEO, Patrick Smith, on the company’s 2Q 2020 earnings call
Axon Enterprise is the leading provider of conducted electrical weapons under its TASER brand. The company also sells sensors (mainly body and fleet cameras) and software solutions (evidence management, records, justice discovery, etc.) to its customers. Over its history, Axon has transformed from mainly a hardware provider to a subscriptions based hardware + software solutions provider. In 2023, the company’s Software and Sensors segment accounted for 61% of its $1.56B in revenues. By contrast in 2015, this segment was just 18% of its $198M in revenues.
Axon was founded in 1993 with the goal of reducing unnecessary gun-related deaths through the use of TASER weapons instead of lethal firearms. TASER devices when triggered shoot a set of probes that shock a person on contact. This usually temporarily immobilizes the target, leading to quick de-escalation. One of the main benefits is that TASER devices have much less risk to cause injury or death. In a study conducted by Axon, TASER devices have saved almost 300k lives and resulted in minimal injuries, especially when compared to other methods of de-escalation like firearms, batons or physical force. The company has a goal of cutting gun-related deaths between the police and the public in the U.S. by half over the next decade.
Axon’s TASER products have improved over time, leading higher adoption rates and more frequent usage. TASER 7 was introduced in 2018 and this was the first version that came with the feature to automatically record every use of the device and upload the data to Axon’s digital evidence management solution. This alleviated the task of officers needing to upload the discharge logs manually. And it also meant that officers were more accountable for each use of the device. This also benefited the company’s software division since a subscription to Axon’s evidence software was necessary to use the device.
Axon introduced TASER 10 in 2022, which improved upon the TASER 7 in many ways. TASER 10 holds up to 10 rounds (vs. just 2 in TASER 7) and can be shot from up to 45 feet away (vs. 25 feet for TASER 7). So far orders for the TASER 10 are surpassing the TASER 7 by a factor of more than two and many of the incremental orders are coming outside of the company’s core customer base. TASER 10 should also lead to more cartridges being used, given the increased range and shots available per device. Axon’s TASER segment generated revenues of $610M in 2023 (39% of total).
Axon’s software and sensors segment ($951M in 2023 and 61% of total) is mainly comprised of its cloud based evidence management software, and its body and fleet cameras. Body cameras are becoming much more prevalent with law enforcement, both to ensure that there is less unwarranted physical violence against civilians but also for the safety of the officers, especially to protect them from bad claims against them. At its 2017 Analyst Day, Axon claimed that complaints against officers were down 93%, use of force down 80% and guilty pleas up 20% for officers that used body cameras.
AB3 was introduced in 2019, which came with improved battery life and camera resolution vs. the previous generation. This version was also the first to come standard with internet connectivity, which allowed live streaming capabilities. AB4 was introduced in 2023 and the main improvement was two way communication, so that other parties have the ability to interact with persons at the incident through the camera feed by voice.
Fleet cameras are installed on vehicles and have similar capabilities as the body cameras. They can also automatically read license plates with an added software subscription. These ALPR (automated license plate reading) enabled cameras read license plates as they come into the cameras view and will indicate if there are outstanding warrants or something else associated with the vehicle in real time.
Axon’s evidence management software makes up the majority the software and sensors segment. Evidence.com is a repository of all video evidence that’s created from the various body and fleet cameras as well as the data logs from the TASER devices. Customers also can add other software modules like Transcription, which automatically transcribes spoken words in a video, and Redaction Assistant, which automatically removes of certain faces, screens and license plates from videos, and Performance, which provides statistics for camera usage and logs.
Customers of Axon are primarily U.S. state and local law enforcement agencies. The company has over 17k law enforcement customers. Axon has also made meaningful strides to penetrate the Federal government after achieving the required certifications like FedRAMP Compliance, FedRAMP Moderate, FedRAMP High, IL4 and IL5.
Competition for Axon varies depending on the product line. For TASER devices, the company competes with other less-lethal alternatives to firearms like rubber bullets, pepper spray and stun guns. These are generally less effective or have much lower range than the newest TASER devices. For body cameras, there are many other manufacturers like Digital Ally, Motorola Solutions, Wrap Technologies, Wolfcom, etc. And for the software segment, there are vendors like OpenText, Oracle, Central Square, etc.
As mentioned earlier, Axon has transformed the business from a razor/razor blade model, i.e. TASER devices + cartridges, to a subscription model with very low churn. Software modules are seeing high attach rates to TASER devices and the company’s camera products. To solidify this even further, Axon introduced Officer Safety Plan (OSP) subscriptions with the launch of TASER 7. This plan allows the costs to be smoothed out over a 5+ year period, reducing the impact of upfront costs when purchasing the hardware. Included in the plan are the evidence management software, and the various software modules like Transcription, Redaction, Performance, etc.
This benefited Axon in two main ways. First, it made the future financial profile of the company much more predictable due to the subscription model. This is evidenced by Axon’s growth in remaining performance obligations (RPO) and deferred revenue. As of 2023, RPO increased to $7.1B. This was $900M in 2018, when it was first introduced. RPO growth has outpaced revenue growth by more 2.5x during this time period.
And second, it reduced the sharing of TASER devices among officers. Because every user on an OSP is assigned his or her own TASER device and body camera, sharing is not necessary. Furthermore, because discharges of TASER devices are automatically logged into the evidence management software, it makes less sense to share devices.
In 2022, TASER provided guidance of to reach $2B in revenues by 2025 with an adjusted EBITDA margin of 25%. The company is tracking to reach a revenue number much higher than that given 2024 guidance. It’s likely that Axon will come close to reaching its 2025 target a year early. Going forward, the company expects +20% revenue CAGR and 25% margins as the long-term model.
Why is it a good business?
Axon mostly benefits from their customers’ increasing switching costs. The company’s TASER devices are used by most of the state and local law enforcement agencies in the U.S. Goldman estimates that there are over 900k professional TASER devices used globally as of 2023. With the adoption of TASER devices, Axon was able to successfully cross sell its software and sensors products to the installed base.
With the addition of body and fleet cameras, which also integrate with the company’s evidence management software and the officers that gain familiarity with using the added software modules it becomes much more difficult to switch to another provider. Then there is the data that’s stored on the evidence management platform, that can’t easily be transported to another software provider.
Once a law enforcement agency adopts the TASER devices and subsequently adds software and sensors, it’s very unlikely that the agency will churn or switch. What’s interesting is that state and local law enforcement agencies typically go down this route, adopting the TASER device first and then the other products over time. But with Federal customers, Axon is seeing many cases where sensors and software are being adopted first and then TASER devices being added on subsequently.
The company’s annual churn rate is very low because of its multi-year contracts. Typically, customers will sign 5 to 10 year contracts, usually in the form of subscriptions to Axon’s hardware and software offerings. As we know from studying other low churn software companies like Workday, ServiceNow and Salesforce.com, high annual gross retention (a low churn) has a huge impact on the total life time value (LTV) to customer acquisition costs (CAC) ratio. Even churn for its body cameras was less than 1% among all customers and 0.1% for the top 1200 customers in 2018. We shouldn’t confuse this with net retention which includes up-sells, but even that metric is impressive for Axon. Net retention has averaged 121% over the past 4 years.
As the company moved from hardware point solutions to bundled subscriptions, the business became that much more predictable. A OSP 10+ Premium bundle typically includes a TASER device, a body camera, cartridges and access to Axon cloud software. Body cameras are replaced every two years and the TASER device every 5 years. The annual payment from the customer is slightly higher in year 1, dips lower in year 2 and gradually moves higher with annual increases until year 10.
Subscriptions benefit the customers by allowing them to smooth out their budget for Axon products over time and not have to determine which new features to add over time. Subscriptions benefit the company by reducing sharing of TASER devices and encourages hardware refreshes in a more predictable time frame.
Bundled subscriptions have become a much more meaningful part of the company’s financials over time. In 2016, 34% of the company’s revenues were tied to subscriptions and that number has jumped to 95% by 2023. Annual recurring revenues are now $697M as of the 4th quarter of 2023. As a result, the company’s RPO has increased to $7.1B or 455% of revenues.
Returns on incremental capital?
Over the past 10 years, Axon has spent 17% of its capital on capex, 69% on R&D and 14% on M&A. Aside from typical PP&E expenditures, most of the company’s capex is related to software development costs that have been capitalized. This is evident as capex saw a jump starting in 2020, increasing from 2%-3% of revenues to 5%-6%. Capitalized software costs + R&D means that most of Axon’s capital spend is related to product development. Whether it’s the latest hardware devices like TASERS, cameras, drones, etc. or new and updated software models that integrate with the hardware, most of Axon’s growth engine has been through its internal R&D efforts.
M&A has been more of a recent phenomenon. Because Axon has built a strong foundation with its customer base, most of its M&A efforts have been tuck-in, technology acquisitions. The company has always been conservative when it comes to M&A, typically leaning towards partnerships first. Here is Axon’s CEO discussing M&A opportunities on the 2020 Q2 earnings call:
“But either we get a ton of inbound inquires, and the vast majority of the time we say no, because we are on a mission, we've got a lot of focus. But we are starting to see there are things that will be interesting partnerships, and there are some things that could be interesting acquisitions, and we have plenty of cash to have the flexibility to do it when it makes sense. But I just want to reassure you, we start from a position of no and that we have to overcome some pretty skeptical hurdles before we would spend the money, you our shareholders, gave us. We're going to treat it very carefully, as if it's the same money I was using to pay those light bills 25 years ago.”
Here are some of the recent notable acquisitions.
In 2023, Sky-Hero was acquired. Sky-Hero is a leading manufacturer of indoor drones that aree mainly used by SWAT teams and special forces teams around the world. Axon’s view is that drones were a good way for (1) first responders to interact with their targets, and (2) law enforcement to get visuals behind obstructed views, and get photos of crime scenes and accidents. Sky-Hero was based in Belgium, so there was also less concern from law enforcement agencies that the technology could be compromised. Sky-Hero helped unlock many customer relationships in Europe.
In 2024, Fusus was acquired. Fusus’ software allows most cameras and sensors to be compatible and integrate with law enforcement software platforms. So in Axon’s case, the software allowed most fixed cameras like CCTVs to be integrated with its evidence management software, creating a central repository for the different sources of video evidence. Along with Sky Hero, Fusus expanded Axon’s TAM by $13B.
Also in 2024, Dedrone was acquired. Dedrone is a defense drone company that tracks all of the existing drones in an area and has capabilities to remove enemy drones from the sky. Axon invested and partnered with Dedrone before deciding to acquire the company outright. The company estimates that the Dedrone acquisition increased Axon’s TAM by $14B. For these acquisitions, Axon stated that it could have built a similar product from the ground up but decided that the initial partnerships with these companies worked well and that an acquisition made sense.
One thing to note is that even though Axon usually acquires smaller companies that expand their technology position, sometimes they run into problems if it can viewed as anti-competitive. Vievu was acquired in 2018 when it was then one of the largest competitors to Axon in the police body camera market. After the acquisition, Axon had contracts with 47 of the 69 major U.S. city police departments. The FTC alleged that this was anticompetitive because consolidation between the top companies would lead to higher prices for their customers. In 2019, Axon was ordered to reverse the acquisition through a divestiture. The company responded by filing its own complaint against the FTC and eventually got the case into the appellate court. Axon eventually won and the complaint was withdrawn by the FTC in 2023.
We estimate that Axon generated returns on incremental capital between 35%-55% over the past 5 years. Because of the company’s strong growth in its software segment and push into hardware + software subscriptions, the returns on capital have been very high. Axon has averaged +30% revenue growth over this time period and the growth rates have not declined with increasing size.
Reinvestment potential?
Axon has a $77B TAM and this has expanded rapidly in recent years as the company has made tuck-in acquisitions to accelerate their development pipeline. Digital Evidence Management and other software is estimated to be an $18B TAM, Real-Time operations $16B, Axon Air $19B, Camera hardware $10B, AR/VR training $3B, TASER devices $12B (split $7B professional and $5B personal). By customer, the TAM is broken down into $17B U.S. state and local, $13B U.S, Federal, $26B International, $17B Enterprise and $5B Civilian. Axon revisits its TAM estimate every two years.
The company is further along in certain end markets than others. For example, the professional TASER market is 35% penetrated, body cameras 14%, and cloud services 4% in the U.S. Whereas in other markets like Europe (ex the U.K), Latin America and Asia (ex Japan and Australia) have very little penetration across the board.
There hasn’t been much growth in the Civilian TASER market when compared to the professional market. When the company used to give out unit sales by TASER device (last in 2022), device sales in the civilian market topped out in 2020 at 21% and hovered around 8%-10% in the years prior. Furthermore, the owners of civilian TASER devices typically use much fewer cartridges than the professional market so it had a lesser impact to the segment unit sales.
The company is just getting serious about the Enterprise market, particularly in ones where oversight can add value to their operations. Axon is targeting verticals like mining, construction, pharmaceuticals and energy. Axon has also won contracts with sports franchises for its body cameras and software products.
Axon’s highest growth vertical is currently Federal as the company has gained momentum after reaching certifications in FedRAMP (received in 2019) and IL4 and IL5. The agencies where Axon has gained the most traction are with the Department of Homeland Security, Department of Veteran Affairs and Department of Justice.
The international growth opportunity is likely the largest and has the most runway. For tier 1 markets, Axon focuses on selling subscription bundles, similar to the growth strategy in North America. For tier 2 and 3 markets, many of the packages require an upfront purchase because the company leverages established distributors in those markets, which could complicate a typical subscription package, and there is more risk of receiving payment over time in these markets. Asking for payment upfront does potentially create a higher hurdle to make a sale in those markets, but it does ensure that the company’s cash flow position is more secure.
There is also a different perspective from the buyer of TASER devices in certain international markets vs. the U.S. TASER can be viewed as the alternative to a lethal weapon in the U.S., whereas in many other countries TASER weapons could be one of the strongest uses of force for law enforcement. The company thinks that the installed base in the international segment has the potential to grow 500+% and a lot of that is because TASER devices could become the primary use of force weapon in many countries.
With a reinvestment rate between 30%-60% and a return on incremental capital between 35%-55%, we estimate that Axon has increased its intrinsic value between 16%-21% over the past 5 years. The reinvestment rate was recently elevated as M&A activity has picked up for the company. Looking ahead, the reinvestment rate could remain elevated if Axon continues to make product and technology acquisitions as well as utilize M&A to expand its international business.
What else is important?
What about the movement to defund the police?
There was a movement to defund the police during the beginning of the Covid related lockdowns in 2020. After the many protests that year, the movement has lost its momentum, especially as crime has gotten worse in many of the areas around the U.S. When asked about this, Axon’s response was that while there were certain instances of funding changes, most of it resulted in shifting of budgets to increase efficiency for law enforcement agencies.
This resulted in higher demand for body and fleet cameras as well as the company’s evidence management software. We also have to keep in mind that Axon’s products are a smaller part of the overall budget for law enforcement agencies, typically accounting for 1%-2% of budgets, and sometimes 3% if there is a high rate of adoption of Axon products.
There were also many states (Colorado, Connecticut, Illinois, Maryland, New Jersey, New Mexico, and South Carolina) that passed laws in 2020 to require body cameras to be worn by all law enforcement officers. In 2021, the Department of Justice also instituted a new policy to require federal agents to wear body cameras during the serving of arrest, search and seizure warrants or orders.
Optionality
While TASER devices likely are going to see a deceleration in growth in the U.S. market over time, the company has many other areas of growth so that the company can continue to achieve 20+% annual growth. Avenues for growth are the software packages, sensors, and the Federal and International markets. Optionality will likely come from new hardware devices that the company can sell into their installed base. Drones have a lot of potential right now, especially with Axon’s latest acquisitions of Sky Hero and Dedrone. The key to high ROI for these new growth avenues will likely come from integration with the Axon platform and unlocking new features and capabilities for law enforcement agencies.
If you made it this far, I hope you received some value from reading our analysis. Please subscribe to the newsletter and share with anyone that would find it valuable. Thank you for your support!
Nice job! I noticed this company back in 2017 when someone published an investment thesis on Seeking Alpha.