Document

10-Q 1 aaxnq22018-10xqdocument.htm 10-Q Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2018



¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 001-16391

Axon Enterprise, Inc.

(Exact name of registrant as specified in its charter)



Delaware		86-0741227
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

17800 North 85th Street Scottsdale, Arizona		85255
(Address of principal executive offices)		(Zip Code)

(480) 991-0797

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer	ý	Accelerated filer	¨

Non-accelerated filer	¨ (Do not check if a smaller reporting company)	Smaller reporting company	¨

		Emerging growth company	¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý

The number of shares of the registrant’s common stock outstanding as of July 31, 2018 was 58,319,695.

Table of Contents

AXON ENTERPRISE, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2018



			Page
PART I - FINANCIAL INFORMATION
	Item 1. Financial Statements		3
		Condensed Consolidated Balance Sheets as of June 30, 2018 (Unaudited) and December 31, 2017	3
		Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income for the Three and Six Months Ended June 30, 2018 and 2017	4
		Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017	5
		Notes to Unaudited Condensed Consolidated Financial Statements	6
	Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations		29
	Item 3. Quantitative and Qualitative Disclosures About Market Risk		46
	Item 4. Controls and Procedures		47
PART II - OTHER INFORMATION
	Item 1. Legal Proceedings		49
	Item 1A. Risk Factors		49
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		49
	Item 3. Defaults Upon Senior Securities		49
	Item 4. Mine Safety Disclosures		49
	Item 5. Other Information		49
	Item 6. Exhibits		50
	SIGNATURES		51

Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

AXON ENTERPRISE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)



	June 30, 2018			December 31, 2017
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	307,507		$	75,105
Short-term investments	4,124			6,862
Accounts and notes receivable, net of allowance of $1,327 and $754 as of June 30, 2018 and December 31, 2017, respectively	94,296			56,064
Contract assets, net	10,468			—
Inventory	43,967			45,465
Prepaid expenses and other current assets	26,604			21,696
Total current assets	486,966			205,192
Property and equipment, net of accumulated depreciation of $37,142 and $36,477 as of June 30, 2018 and December 31, 2017, respectively	34,503			31,172
Deferred income tax assets, net	15,813			15,755
Intangible assets, net	20,442			18,823
Goodwill	24,684			14,927
Long-term notes receivable, net of current portion	37,158			36,877
Other assets	22,831			15,366
Total assets	$	642,397		$	338,112
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	9,213		$	8,592
Accrued liabilities	29,995			23,502
Current portion of deferred revenue	76,583			70,401
Customer deposits	2,970			3,673
Current portion of business acquisition contingent consideration	1,946			1,693
Other current liabilities	191			89
Total current liabilities	120,898			107,950
Deferred revenue, net of current portion	61,456			54,881
Liability for unrecognized tax benefits	1,918			1,706
Long-term deferred compensation	3,560			3,859
Business acquisition contingent consideration, net of current portion	203			1,048
Other long-term liabilities	5,520			1,224
Total liabilities	193,555			170,668
Commitments and contingencies (Note 11)
Stockholders’ equity:
Preferred stock, $0.00001 par value; 25,000,000 shares authorized; no shares issued and outstanding as of June 30, 2018 and December 31, 2017	—			—
Common stock, $0.00001 par value; 200,000,000 shares authorized; 58,289,613 and 52,969,869 shares issued and outstanding as of June 30, 2018 and December 31, 2017, respectively	1			1
Additional paid-in capital	442,717			201,672
Treasury stock at cost, 20,220,227 shares as of June 30, 2018 and December 31, 2017	(155,947		)	(155,947		)
Retained earnings	163,590			123,185
Accumulated other comprehensive loss	(1,519		)	(1,467		)
Total stockholders’ equity	448,842			167,444
Total liabilities and stockholders’ equity	$	642,397		$	338,112

The accompanying notes are an integral part of these condensed consolidated financial statements.

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AXON ENTERPRISE, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

(in thousands, except per share data)



	Three Months Ended June 30,						Six Months Ended June 30,
	2018			2017			2018			2017
Net sales from products	$	76,721		$	66,875		$	157,695		$	134,366
Net sales from services	22,505			12,768			42,746			24,519
Net sales	99,226			79,643			200,441			158,885
Cost of product sales	31,087			30,172			63,521			57,244
Cost of service sales	4,996			3,834			9,316			7,334
Cost of sales	36,083			34,006			72,837			64,578
Gross margin	63,143			45,637			127,604			94,307
Operating expenses:
Sales, general and administrative	39,343			31,824			75,102			62,681
Research and development	18,501			12,989			33,620			25,452
Total operating expenses	57,844			44,813			108,722			88,133
Income from operations	5,299			824			18,882			6,174
Interest and other income (expense), net	(295		)	1,684			968			1,890
Income before provision for income taxes	5,004			2,508			19,850			8,064
Provision for (benefit from) income taxes	(3,481		)	232			(1,561		)	1,208
Net income	$	8,485		$	2,276		$	21,411		$	6,856
Net income per common and common equivalent shares:
Basic	$	0.15		$	0.04		$	0.39		$	0.13
Diluted	$	0.15		$	0.04		$	0.38		$	0.13
Weighted average number of common and common equivalent shares outstanding:
Basic	55,527			52,736			54,330			52,578
Diluted	57,054			53,770			55,892			53,723

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Net income	$	8,485		$	2,276		$	21,411		$	6,856
Foreign currency translation adjustments	655			(716		)	(52		)	(551		)
Comprehensive income	$	9,140		$	1,560		$	21,359		$	6,305

The accompanying notes are an integral part of these condensed consolidated financial statements.

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AXON ENTERPRISE, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



	Six Months Ended June 30,
	2018			2017
Cash flows from operating activities:
Net income	$	21,411		$	6,856
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization	5,161			3,400
Loss on disposal and impairment of property and equipment, net	153			—
Loss on disposal and abandonment of intangible assets	54			—
Bond premium amortization	30			427
Stock-based compensation	9,047			7,423
Deferred income taxes	(58		)	(1,458		)
Unrecognized tax benefits	212			282
Change in assets and liabilities:
Accounts and notes receivable and contract assets	(24,791		)	(15,925		)
Inventory	4,508			(25,768		)
Prepaid expenses and other assets	(7,429		)	(10,055		)
Accounts payable, accrued and other liabilities	(2,688		)	7,531
Deferred revenue	10,496			14,829
Net cash provided by (used in) operating activities	16,106			(12,458		)
Cash flows from investing activities:
Purchases of investments	(4,331		)	(19,950		)
Proceeds from maturity of investments	7,038			34,377
Purchases of property and equipment	(4,665		)	(5,741		)
Purchases of intangible assets	(254		)	(170		)
Business acquisitions	(5,014		)	(6,479		)
Net cash provided (used in) by investing activities	(7,226		)	2,037
Cash flows from financing activities:
Net proceeds from equity offering	233,993			—
Proceeds from options exercised	586			1,241
Payroll tax payments for net-settled stock awards	(10,807		)	(2,572		)
Payment of contingent consideration for a business acquisition	(575		)	—
Net cash provided by (used in) financing activities	223,197			(1,331		)
Effect of exchange rate changes on cash, cash equivalents and restricted cash	(538		)	(857		)
Net increase (decrease) in cash, cash equivalents and restricted cash	231,539			(12,609		)
Cash, cash equivalents and restricted cash, beginning of period	78,438			43,969
Cash, cash equivalents and restricted cash, end of period	$	309,977		$	31,360

Supplemental disclosures:
Cash and cash equivalents	$	307,507		$	28,038
Restricted cash (Note 6)	2,470			3,322
Total cash, cash equivalents and restricted cash shown in the statements of cash flows	$	309,977		$	31,360

Cash paid for income taxes, net of refunds	$	7,758		$	9,934

Non-cash transactions
Property and equipment purchases in accounts payable and accrued liabilities	$	665		$	1,351
Non-cash purchase consideration related to business combinations	$	12,288		$	1,026

The accompanying notes are an integral part of these condensed consolidated financial statements.

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AXON ENTERPRISE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Summary of Significant Accounting Policies

Axon Enterprise, Inc. (“Axon” or the “Company”) is a developer and manufacturer of advanced conducted electrical weapons (“CEWs”) designed for use by law enforcement, military, corrections, private security personnel, and by private individuals for personal defense. In addition, the Company has developed full technology solutions for the capture, secure storage and management of video/audio evidence as well as other tactical capabilities for use in law enforcement. The Company sells its products worldwide through its direct sales force, distribution partners, online store and third-party resellers. The Company was incorporated in Arizona in September 1993, and reincorporated in Delaware in January 2001. The Company’s corporate headquarters and manufacturing facilities are located in Scottsdale, Arizona. The Company’s main software development division is located in Seattle, Washington, and it develops artificial intelligence technologies through its wholly-owned subsidiary in Vietnam, Axon Public Safety Southeast Asia LLC. During 2018, the Company established Axon Public Safety Finland OY in Tampere, Finland that operates a connected hardware team focused on the development of the Company's hardware products. Axon Public Safety BV, a wholly owned subsidiary of the Company, supports the Company's international sales and marketing efforts, and is located in Amsterdam, Netherlands. Axon Public Safety BV wholly owns two subsidiaries, Axon Public Safety U.K. LTD and Axon Public Safety AU, that serve as direct sales operations in the United Kingdom ("U.K.") and Australia, respectively. The Company also sells to certain international markets through a wholly-owned subsidiary, Axon Public Safety Germany SE, and sells into the Canadian market through its wholly-owned subsidiary, Axon Public Safety Canada, Inc.

The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany accounts, transactions, and profits have been eliminated.

Basis of Presentation and Use of Estimates

These unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information related to the Company’s organization, significant accounting policies and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) has been condensed or omitted. The accounting policies followed in the preparation of these unaudited condensed consolidated financial statements are consistent with those followed in the Company’s annual consolidated financial statements for the year ended December 31, 2017, as filed on Form 10-K, with the exception of the Company's adoption of Topic 606. In the opinion of management, these unaudited condensed consolidated financial statements contain all material adjustments, consisting only of normal recurring adjustments, necessary to fairly state the Company’s financial position, results of operations and cash flows for the periods presented and the presentations and disclosures herein are adequate when read in conjunction with the Company’s Form 10-K for the year ended December 31, 2017. The results of operations for the six months ended June 30, 2018 and 2017 are not necessarily indicative of the results to be expected for the full year (or any other period). Significant estimates and assumptions in these unaudited condensed consolidated financial statements include:


•	product warranty reserves,


•	inventory valuation,


•	revenue recognition,


•	valuation of goodwill, intangible and long-lived assets,


•	recognition, measurement and valuation of current and deferred income taxes,


•	fair value of stock awards issued and the estimated vesting periods for performance-based stock awards,


•	recognition and measurement of contingencies and accrued litigation expense, and


•	fair values of identified tangible and intangible assets acquired and liabilities assumed in business combinations.

Actual results could differ materially from those estimates.

Segment Information

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AXON ENTERPRISE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

professional services, and is sometimes referred to as Axon Cloud revenue. Within the Software and Sensors segment, the Company includes only revenues and costs attributable to that segment which include: costs of sales for both products and services, direct labor, selling expenses for the sales team, product management and research and development ("R&D") for products included, or to be included, within the Software and Sensors segment. All other costs are included in the TASER Weapons segment.

The Company’s Chief Executive Officer, who is the Chief Operating Decision Maker (the “CODM”), is not provided asset information by segment. Reportable segments are determined based on discrete financial information reviewed by the CODM for the Company. The Company organizes and reviews operations based on products and services. The Company performs an annual analysis of its reportable segments. Additional information related to the Company’s business segments is summarized in Note 14.

Geographic Information and Major Customers

For the three and six months ended June 30, 2018 and 2017, no individual country outside the U.S. represented more than 10% of total net sales. Individual sales transactions in the international market are generally larger and occur more intermittently than in the domestic market due to the profile of the Company's customers.

For the three and six months ended June 30, 2018 and 2017, no customer represented more than 10% of total net sales. At June 30, 2018 and December 31, 2017, no customer represented more than 10% of the aggregate accounts and notes receivable balance and contract assets.

Income per Common Share

Basic income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the periods presented. Potentially dilutive securities include outstanding stock options and unvested restricted stock units ("RSUs"). The dilutive effect of potentially dilutive securities is reflected in diluted earnings per share by application of the treasury stock method. Under the treasury stock method, an increase in the fair market value of the Company’s common stock can result in a greater dilutive effect from potentially dilutive securities.

The calculation of the weighted average number of shares outstanding and earnings per share are as follows (in thousands except per share data):



	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017
Numerator for basic and diluted earnings per share:
Net income	$	8,485	$	2,276	$	21,411	$	6,856
Denominator:
Weighted average shares outstanding	55,527		52,736		54,330		52,578
Dilutive effect of stock-based awards	1,527		1,034		1,562		1,145
Diluted weighted average shares outstanding	57,054		53,770		55,892		53,723
Anti-dilutive stock-based awards excluded	3,023		544		1,533		690
Net income per common share:
Basic	$	0.15	$	0.04	$	0.39	$	0.13
Diluted	$	0.15	$	0.04	$	0.38	$	0.13

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AXON ENTERPRISE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Standard Warranties

The Company warranties its CEWs, Axon cameras and certain related accessories from manufacturing defects on a limited basis for a period of one year after purchase and, thereafter, will replace any defective unit for a fee. Estimated costs for the standard warranty are charged to cost of products sold when revenue is recorded for the related product. Future warranty costs are estimated based on historical data related to warranty claims on a quarterly basis and this rate is applied to current product sales. Historically, reserve amounts have been increased if management becomes aware of a component failure or other issue that could result in larger than anticipated warranty claims from customers. The warranty reserve is reviewed quarterly to verify that it sufficiently reflects the remaining warranty obligations based on the anticipated expenditures over the balance of the warranty obligation period, and adjustments are made when actual warranty claim experience differs from estimates. The warranty reserve is included in accrued liabilities on the accompanying consolidated balance sheets.

Changes in the Company’s estimated product warranty liabilities were as follows (in thousands):



	Six Months Ended June 30,
	2018			2017
Balance, beginning of period	$	644		$	780
Utilization of accrual	(149		)	(120		)
Warranty expense (recovery)	10			(96		)
Balance, end of period	$	505		$	564

Fair Value Measurements and Financial Instruments

The Company uses the fair value framework that prioritizes the inputs to valuation techniques for measuring financial assets and liabilities measured on a recurring basis and for non-financial assets and liabilities when these items are re-measured. Fair value is considered to be the exchange price in an orderly transaction between market participants to sell an asset or transfer a liability at the measurement date. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. The Company categorizes each of its fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:


•	Level 1 – Valuation techniques in which all significant inputs are unadjusted quoted prices from active markets for assets or liabilities that are identical to the assets or liabilities being measured.

•

Level 2 – Valuation techniques in which significant inputs include quoted prices from active markets for assets or liabilities that are similar to the assets or liabilities being measured and/or quoted prices for assets or liabilities that are identical or similar to the assets or liabilities being measured from markets that are not active. Also, model-derived valuations in which all significant inputs and significant value drivers are observable in active markets are Level 2 valuation techniques.


•	Level 3 – Valuation techniques in which one or more significant inputs or significant value drivers are unobservable. Unobservable inputs are valuation technique inputs that reflect the Company's own assumptions about inputs that market participants would use in pricing an asset or liability.

The Company has cash equivalents and investments, which at June 30, 2018 and December 31, 2017 were comprised of money market funds, state and municipal obligations, corporate bonds, and certificates of deposits. See additional disclosure regarding the fair value of the Company’s cash equivalents and investments in Note 3. Included in the balance of Other assets as of June 30, 2018 and December 31, 2017 was $3.8 million related to corporate-owned life insurance policies which are used to fund the Company’s deferred compensation plan. The Company determines the fair value of its insurance contracts by obtaining the cash surrender value of the contracts from the issuer, a Level 2 valuation technique.

The Company’s financial instruments also include accounts and notes receivable, accounts payable, notes payable and accrued liabilities. Due to the short-term nature of these instruments, their fair values approximate their carrying values on the accompanying condensed consolidated balance sheets.

Valuation of Goodwill, Intangibles and Long-lived Assets

Management evaluates whether events and circumstances have occurred that indicate the remaining estimated useful life of long-lived assets and identifiable intangible assets, excluding goodwill and intangible assets with indefinite useful lives, may

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AXON ENTERPRISE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

warrant revision or that the remaining balance of these assets may not be recoverable. Such circumstances could include, but are not limited to, a change in the product mix, a change in the way products are created, produced or delivered, or a significant change in the way products are branded and marketed. In performing the review for recoverability, management estimates the future undiscounted cash flows expected to result from the use of the assets and their eventual disposition. The amount of the impairment loss, if impairment exists, is calculated based on the excess of the carrying amounts of the assets over their estimated fair value computed using discounted cash flows.

The Company does not amortize goodwill and intangible assets with indefinite useful lives; rather such assets are required to be tested for impairment at least annually or sooner whenever events or changes in circumstances indicate that the assets may be impaired. The Company performs its goodwill and intangible asset impairment tests in the fourth quarter of each year.

Recently Issued Accounting Guidance

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”) and Accounting Standards Codification ("ASC") Subtopic 340-40, Other Assets and Deferred Costs - Contracts with Customers ("ASC 340-40"), (collectively, “Topic 606”). On January 1, 2018, the Company adopted Topic 606 by applying the modified retrospective method of adoption for all contracts that were not substantially completed as of the adoption date. ASU 2014-09 requires entities to recognize revenue through the application of a five-step model, which includes identification of the contract, identification of the performance obligations, determination of the transaction price, allocation of the transaction price to the performance obligations and recognition of revenue as the entity satisfies the performance obligations. Refer to Note 2 for further discussion.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) in order to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet for those leases classified as operating leases under existing GAAP guidance. ASU 2016-02 requires a lessee to recognize a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term on the balance sheet. ASU 2016-02 is effective for the fiscal year beginning after December 15, 2018 (including interim periods within that year) using a modified retrospective approach and early adoption is permitted. The Company is currently in the process of evaluating the impact of adoption of this ASU on its consolidated financial statements, but expects that the adoption of ASU 2016-02 will have a material impact on the Company's consolidated balance sheet.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses, which amends ASC 326. The new guidance differs from existing GAAP guidance wherein previous standards generally delayed recognition of credit losses until the loss was probable. ASU 2016-13 eliminates the probable initial recognition threshold and, instead, reflects an entity’s current estimate of all expected credit losses. The use of forecasted information is intended to incorporate more timely information in the estimate of expected credit loss. ASU 2016-13 is effective for the fiscal year beginning after December 15, 2019, and interim periods within that fiscal year, and early adoption is permitted. The Company is currently in the process of evaluating the impact of adoption of ASU 2016-13 on its consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 eliminates the diversity in practice related to the classification of certain cash receipts and payments. ASU 2016-15 designates the appropriate cash flow classification, including requirements to allocate certain components of these cash receipts and payments among operating, investing and financing activities. The Company adopted ASU 2016-15 effective January 1, 2018, and the adoption of this ASU did not have a material impact on its consolidated financial statements.

In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740) - Intra-Entity Transfers of Assets Other Than Inventory. ASU 2016-16 requires an entity to recognize income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. This removes the exception to postpone recognition until the asset has been sold to an outside party. The Company adopted ASU 2016-16 effective January 1, 2018, and the adoption of this ASU did not have a material impact on its consolidated financial statements.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows - Restricted Cash (Topic 230), which amends the existing guidance relating to the treatment of restricted cash and restricted cash equivalents on the statement of cash flows. The Company adopted ASU 2016-18 effective January 1, 2018, and retrospectively updated the presentation of its unaudited consolidated statements of cash flows to include amounts of restricted cash with cash and cash equivalents when reconciling the beginning-of-period and end-of-period amounts. The adoption of ASU 2016-18 did not have a material impact on the Company's consolidated financial statements.

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AXON ENTERPRISE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805) to provide a more robust framework to use in determining when a set of acquired assets and activities is a business. The amendments in ASU 2017-01 provide a screen to determine when a set of acquired integrated assets and activities is not a business, and if the screen is not met it may result in fewer transactions that qualify as a business combination under ASC Topic 805. The Company adopted ASU 2017-01 January 1, 2018, and the adoption of this ASU did not have a material impact on the Company's consolidated financial statements.

In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718), which provides guidance on determining which changes to the terms and conditions of share-based payment awards require an entity to apply modification accounting under Topic 718. The Company adopted ASU 2017-09 effective January 1, 2018, and the adoption of this ASU did not have a material impact on its consolidated financial statements.

In June 2018, the FASB issued ASU 2018-07, Compensation - Stock Compensation (Topic 718), expanding the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. ASU 2018-07 is effective for the fiscal year beginning after December 15, 2018, and interim periods within that fiscal year, and the adoption of this ASU is not expected to have a material impact on the Company's consolidated financial statements.

Reclassification of Prior Year Presentation

Certain prior year amounts have been reclassified for consistency with the current year presentation. These reclassifications had no effect on the reported results of operations.

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2. Revenues

Adoption of ASC Topic 606, "Revenue from Contracts with Customers"

On January 1, 2018, the Company adopted Topic 606 using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are not adjusted, and continue to be reported in accordance with our historic accounting under ASC 605. The Company recorded a net increase in stockholders’ equity (retained earnings) of $19.0 million as of January 1, 2018 due to the cumulative impact of adopting Topic 606 on contracts that were not complete as of that date. The areas most significantly impacted were contracts with contingent hardware revenue and the treatment of incremental costs of obtaining contracts with customers. The impacts as a result of applying Topic 606 were a net increase to revenue of $0.6 million and $2.3 million, respectively, for the three and six months ended June 30, 2018, and a net decrease to selling, general and administrative expenses of approximately $0.9 million and $1.6 million, respectively, related to the costs of obtaining contracts for the same periods, as compared to what would have been recognized under ASC 605. The impacts to the December 31, 2017 balance sheet of adopting Topic 606 are presented below (in thousands):



	December 31, 2017 (As reported)		Impact of Adoption of Topic 606 on Opening Balance Sheet			January 1, 2018 (As adjusted)
Accounts and notes receivable, net	$	56,064	$	28,915		$	84,979
Contract assets, net	—		5,512			5,512
Prepaid expense and other current assets	21,696		2,003			23,699
Total impacted current assets	77,760		36,430			114,190
Deferred income tax assets, net	15,755		(5,158		)	10,597
Long-term notes receivable, net of current portion	36,877		(12,977		)	23,900
Other assets	15,366		5,323			20,689
Total impacted assets	145,758		23,618			169,376

Accrued liabilities	23,502		2,512			26,014
Current portion of deferred revenue	70,401		863			71,264
Total impacted current liabilities	93,903		3,375			97,278
Deferred revenue, net of current portion	54,881		1,249			56,130
Total impacted liabilities	148,784		4,624			153,408
Retained earnings	123,185		18,994			142,179
Total impacted stockholders' equity	123,185		18,994			142,179
Total impacted liabilities and stockholders' equity	271,969		23,618			295,587

Revenue Recognition

Revenues are recognized upon transfer of control of promised products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company enters into contracts that can include various combinations of products and services, each of which are generally distinct and accounted for as separate performance obligations. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental taxing authorities.

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in Topic 606. For contracts with multiple performance obligations, the Company allocates the contract transaction price to each performance obligation using the Company's estimate of the standalone selling price ("SSP") of each distinct good or service in the contract.

Performance obligations to deliver products, including CEWs, Axon cameras and related accessories such as cartridges, batteries and docks, are generally satisfied at the point in time the Company ships the product, as this is when the customer obtains control of the asset under our standard terms and conditions. In certain contracts with non-standard terms and conditions, these performance obligations may not be satisfied until formal customer acceptance occurs. Performance obligations to fulfill service-type extended warranties and provide our Software-as-a-Service (“SaaS”) offerings, including Evidence.com and other cloud

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services, are generally satisfied over time as the customer receives and consumes the benefits of these services over the stated service period.

The Company has elected to recognize shipping costs as an expense in Cost of product sales when the control of hardware products or accessories have transferred to the customer.

Nature of Products and Services

The following table presents the Company's revenues by primary product and service offering (in thousands):



	Three Months Ended June 30, 2018						Three Months Ended June 30, 2017 ⁽¹⁾
	TASER Weapons		Software and Sensors		Total		TASER Weapons		Software and Sensors		Total
TASER X26P	$	18,146	$	—	$	18,146	$	16,235	$	—	$	16,235
TASER X2	18,362		—		18,362		16,052		—		16,052
TASER Pulse and Bolt	1,101		—		1,101		801		—		801
Single cartridges	17,243		—		17,243		14,867		—		14,867
Axon Body	—		4,780		4,780		—		3,752		3,752
Axon Flex	—		1,535		1,535		—		3,851		3,851
Axon Dock	—		2,119		2,119		—		2,783		2,783
Axon Fleet	—		2,715		2,715		—		—		—
Evidence.com and cloud services	—		20,357		20,357		—		12,756		12,756
TASER Cam	—		762		762		—		766		766
Extended warranties	3,738		2,870		6,608		2,991		1,619		4,610
Other	2,034		3,464		5,498		2,070		1,100		3,170
Total	$	60,624	$	38,602	$	99,226	$	53,016	$	26,627	$	79,643



	Six Months Ended June 30, 2018						Six Months Ended June 30, 2017 ⁽¹⁾
	TASER Weapons		Software and Sensors		Total		TASER Weapons		Software and Sensors		Total
TASER X26P	$	34,620	$	—	$	34,620	$	31,903	$	—	$	31,903
TASER X2	42,294		—		42,294		35,038		—		35,038
TASER Pulse and Bolt	2,447		—		2,447		1,823		—		1,823
Single cartridges	33,357		—		33,357		31,531		—		31,531
Axon Body	—		10,338		10,338		—		7,198		7,198
Axon Flex	—		3,204		3,204		—		5,326		5,326
Axon Dock	—		5,154		5,154		—		4,770		4,770
Axon Fleet	—		4,831		4,831		—		—		—
Evidence.com and cloud services	—		40,598		40,598		—		24,498		24,498
TASER Cam	—		2,122		2,122		—		1,485		1,485
Extended warranties	7,444		5,360		12,804		5,834		3,037		8,871
Other	3,986		4,686		8,672		4,558		1,884		6,442
Total	$	124,148	$	76,293	$	200,441	$	110,687	$	48,198	$	158,885

⁽¹⁾ Amounts for the three and six months ended June 30, 2017 have not been adjusted under the modified retrospective method of adoption of Topic 606, and are presented consistent with the prior period amounts reported under ASC 605.

The Company derives revenue from two primary sources: (1) the sale of physical products, including CEWs, Axon cameras, Axon Signal enabled devices, corresponding hardware extended warranties, and related accessories such as Axon docks, cartridges and batteries, among others, and (2) subscription to the Company's Evidence.com digital evidence management SaaS (including secure cloud-based storage fees and other ancillary services), which includes varying levels of support. To a lesser extent, the Company also recognizes revenue from training, professional services and revenue related to other software and cloud services.

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Many of the Company's products and services are sold on a standalone basis. The Company also bundles its hardware products and services together and sells them to its customers in single transactions, where the customer can make payments over a multi-year period. These sales may include payments for upfront hardware and services, as well as payments for hardware and services to be provided by the Company at a future date. Additionally, the Company offers customers the ability to purchase CEW cartridges and certain services on an unlimited basis over the contractual term. Due to the unlimited nature of these arrangements whereby the Company is obligated to deliver unlimited products at the customer’s request, the Company accounts for these arrangements as stand-ready obligations, and recognizes revenue ratably over the contract period. Cost of product sales will be recognized as the products are shipped to the customer.

The following table presents the Company's revenues disaggregated by geography (in thousands):



	Three Months Ended June 30,								Six Months Ended June 30,
	2018				2017 ⁽¹⁾				2018				2017 ⁽¹⁾
United States	$	78,731	79	%	$	66,200	83	%	$	156,681	78	%	$	130,952	82	%
Other countries	20,495		21		13,443		17		43,760		22		27,933		18
Total	$	99,226	100	%	$	79,643	100	%	$	200,441	100	%	$	158,885	100	%

Contract Balances

The timing of revenue recognition may differ from the timing of invoicing to customers. The Company generally has an unconditional right to consideration when it invoices its customers and records a receivable. The Company records a contract asset when revenue is recognized prior to invoicing, or a contract liability (deferred revenue) when revenue will be recognized subsequent to invoicing.

Contract assets generally result from the Company's subscription programs where the Company satisfies a hardware performance obligation upon shipment to the customer and the right to the portion of the transaction price allocated to that hardware performance obligation is conditional on the Company’s future performance of a SaaS service obligation under the contract. The Company recognizes a portion the amount allocated to hardware products shipped to the customer as accounts receivable when invoiced to the customer, and records the remaining allocated value as a contract asset as the Company has generally fulfilled its hardware performance obligation upon shipment.

Contract liabilities generally consist of deferred revenue on the Company’s subscription programs where the Company generally invoices customers at the beginning of each annual period and records a receivable at the time of invoicing when there is an unconditional right to consideration.

Deferred revenue is comprised mainly of unearned revenue related to the Company's Evidence.com SaaS platform, secure cloud-based storage, service-type extended warranties, stand-ready obligations in our cartridge programs, and rights to future CEW, camera and related accessories hardware in our subscription programs. Revenue for Evidence.com and cloud-based storage, our service-type extended warranties and stand-ready cartridge programs is generally recognized on a straight-line basis over the subscription term. Revenue for the rights to future hardware is generally recognized at the point in time the hardware products are shipped to the customer.

Payment terms and conditions vary by contract type and geography, but our standard terms are that payments are due within 30 days from the date of invoice.

The following table presents the Company's contract assets, contract liabilities and certain information related to these balances as of and for the six months ended June 30, 2018 (in thousands):



	June 30, 2018
Contract assets ⁽¹⁾	$	11,021
Contract liabilities (deferred revenue)	138,039
Revenue recognized in the period from:
Amounts included in contract liabilities at the beginning of the period	43,282

⁽¹⁾ Of the $11.0 million balance of contract assets as of June 30, 2018, $0.6 million was classified as long-term and included within "Other assets" on the accompanying condensed consolidated balance sheet.

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Contract liabilities (deferred revenue) consisted of the following (in thousands):



	June 30, 2018						December 31, 2017 ⁽¹⁾
	Current		Long-Term		Total		Current		Long-Term		Total
Warranty:
TASER Weapons	$	11,593	$	16,508	$	28,101	$	12,501	$	18,619	$	31,120
Software and Sensors	7,001		5,551		12,552		6,293		4,195		10,488
	18,594		22,059		40,653		18,794		22,814		41,608
Hardware:
TASER Weapons	6,264		14,787		21,051		4,164		11,401		15,565
Software and Sensors	15,931		15,379		31,310		16,956		14,781		31,737
	22,195		30,166		52,361		21,120		26,182		47,302
Software and Sensors Services	35,794		9,231		45,025		30,487		5,885		36,372
Total	$	76,583	$	61,456	$	138,039	$	70,401	$	54,881	$	125,282



	June 30, 2018						December 31, 2017 ⁽¹⁾
	Current		Long-Term		Total		Current		Long-Term		Total
TASER Weapons	$	17,857	$	31,295	$	49,152	$	16,665	$	30,020	$	46,685
Software and Sensors	58,726		30,161		88,887		53,736		24,861		78,597
Total	$	76,583	$	61,456	$	138,039	$	70,401	$	54,881	$	125,282

⁽¹⁾ Amounts as of December 31, 2017 have not been adjusted under the modified retrospective method of adoption of Topic 606, and are presented consistent with the prior period amounts reported under ASC 605.

Remaining Performance Obligations

As of June 30, 2018, the Company had approximately $750 million of remaining performance obligations, which included both recognized contract liabilities as well as amounts that will be invoiced and recognized in future periods. The remaining performance obligations are limited only to arrangements that meet the definition of a contract under Topic 606 as of June 30, 2018. The Company expects to recognize between 15% - 20% of this balance over the next twelve months and expects the remainder to be recognized over the following five to seven years, subject to risks related to delayed deployments, budget appropriation or other contract cancellation clauses.

Costs to Obtain a Contract

The Company recognizes an asset for the incremental costs of obtaining a contract with a customer, which consist primarily of sales commissions. These costs are ascribed to or allocated to the underlying performance obligations in the contract and amortized consistent with the recognition timing of the revenue for the underlying performance obligations.

For contract costs related to performance obligations with an amortization period of one year or less, the Company applies the practical expedient to expense these sales commissions when incurred. These costs are recorded as incurred within sales, general and administrative expenses on the accompanying condensed consolidated statement of operations and comprehensive income.

As of June 30, 2018, the Company's assets for costs to obtain contracts were as follows (in thousands):



	June 30, 2018
Current deferred commissions ⁽¹⁾	$	5,941
Deferred commissions, net of current portion ⁽²⁾	13,766
	$	19,707

⁽¹⁾ Current deferred commissions are included within "Prepaid expenses and other current assets" on the accompanying condensed consolidated balance sheet.

⁽²⁾Deferred commissions, net of current portion, are included in "Other assets" on the accompanying condensed consolidated balance sheet.

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During the three and six months ended June 30, 2018, the Company recognized $1.2 million and $2.3 million, respectively, of amortization related to deferred commissions. These costs are recorded within sales, general and administrative expenses on the accompanying condensed consolidated statement of operations and comprehensive income.

Significant Judgments

The Company’s contracts with certain municipal government customers may be subject to budget appropriation, other contract cancellation clauses or future periods which are optional. In contracts where the customer’s performance is subject to budget appropriation clauses, we generally consider the likelihood of non-appropriation to be remote when determining the contract term and transaction price. Contracts with other cancellation provisions or optional periods may require judgment in determining the contract term, including the existence of material rights, transaction price and identifying the performance obligations.

At times, customers may request changes that either amend, replace or cancel existing contracts. Judgment is required to determine whether the specific facts and circumstances within the contracts require the changes to be accounted for as a separate contract or as a modification. Generally, contract modifications containing additional goods and services that are determined to be distinct and sold at their SSP are accounted for as a separate contract. For contract modifications where both criteria are not met, the original contract is updated and the required adjustments to revenue will be made accordingly.

The Company's contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately rather than together may require significant judgment. The Company considers CEW devices and related accessories as well as cameras and related accessories to be separately identifiable from each other as well as from extended warranties on these products and the SaaS subscriptions to Evidence.com and other cloud services.

In contracts where there are timing differences between when the Company transfers a promised good or service to the customer and when the customer pays for that good or service, the Company has determined that, with the exception of its TASER 60 installment purchase arrangements, its contracts generally do not include a significant financing component. For the three and six months ended June 30, 2018, the Company recorded revenue of $10.2 million and $24.2 million, respectively, including $0.3 million and $0.6 million, respectively, of interest income, under the Company’s TASER 60 plan. For the three and six months ended June 30, 2017, the Company recorded revenue of $5.3 million and $13.3 million, respectively, including $0.2 million and $0.3 million, respectively, of interest income, under the Company’s TASER 60 plan. Amounts for the three and six months ended June 30, 2017 have not been adjusted under the modified retrospective method of adoption of Topic 606.

Judgment is required to determine the SSP for each distinct performance obligation. The Company analyzes separate sales of its products and services as a basis for estimating the SSP of its products and services and then uses that SSP as the basis for allocating the transaction price when its products and services are sold together in a contract with multiple performance obligations. In instances where the SSP is not directly observable, such as when the Company does not sell the product or service separately, it determines the SSP using information that may include market conditions, time value of money and other observable inputs. The Company typically has more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, the Company may use information such geographic region and distribution channel in determining the SSP.

Sales are typically made on credit and we generally do not require collateral. We perform ongoing credit evaluations of our customers’ financial condition and maintain an allowance for doubtful accounts. Uncollectible accounts are written off when deemed uncollectible, and accounts and notes receivable are presented net of an allowance for doubtful accounts. This allowance represents our best estimate and is based on our judgment after considering a number of factors including third-party credit reports, actual payment history, customer-specific financial information and broader market and economic trends and conditions. In the event that actual uncollectible amounts differ from our estimates, additional expense could be necessary.

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AXON ENTERPRISE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

3. Cash, Cash Equivalents and Investments

The following tables summarize the Company's cash, cash equivalents, and held-to-maturity investments at June 30, 2018 and December 31, 2017 (in thousands):



	As of June 30, 2018
	Amortized Cost		Gross Unrealized Losses			Fair Value		Cash and Cash Equivalents		Short-Term Investments
Cash	$	47,837	$	—		$	47,837	$	47,837	$	—

Level 1:
Money market funds	256,679		—			256,679		256,679		—
Corporate bonds	4,528		(3		)	4,525		1,000		3,528
Subtotal	261,207		(3		)	261,204		257,679		3,528

Level 2:
State and municipal obligations	2,587		—			2,587		1,991		596
Total	$	311,631	$	(3	)	$	311,628	$	307,507	$	4,124



	As of December 31, 2017
	Amortized Cost		Gross Unrealized Losses			Fair Value		Cash and Cash Equivalents		Short-Term Investments
Cash	$	53,459	$	—		$	53,459	$	53,459	$	—

Level 1:
Money market funds	20,884		—			20,884		20,884		—
Corporate bonds	6,632		(6		)	6,626		—		6,632
Subtotal	27,516		(6		)	27,510		20,884		6,632

Level 2:
State and municipal obligations	992		—			992		762		230
Total	$	81,967	$	(6	)	$	81,961	$	75,105	$	6,862

The Company believes the unrealized losses on its investments are due to interest rate fluctuations. As these investments are short-term in nature, are expected to be redeemed at par value, and/or because the Company has the ability and intent to hold these investments to maturity, the Company does not consider these investments to be other than temporarily impaired at June 30, 2018 or as of December 31, 2017.

4. Inventory

Inventories are stated at the lower of cost and net realizable value. Cost is determined using the weighted average cost of raw materials which approximates the first-in, first-out (“FIFO”) method and includes allocations of manufacturing labor and overhead. Included in finished goods at June 30, 2018 and December 31, 2017 was $1.7 million and $1.4 million, respectively, of trial and evaluation hardware units. Provisions are made to reduce excess, obsolete or slow-moving inventories to their net realizable value. Inventory consisted of the following at June 30, 2018 and December 31, 2017 (in thousands):



	2018		2017
Raw materials	$	20,288	$	20,119
Finished goods	23,679		25,346
Total inventory	$	43,967	$	45,465

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AXON ENTERPRISE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

5. Goodwill and Intangible Assets

The changes in the carrying amount of goodwill for the six months ended June 30, 2018 were as follows (in thousands):



	TASER Weapons			Software and Sensors			Total
Balance, beginning of period	$	1,453		$	13,474		$	14,927
Goodwill acquired	—			9,870			9,870
Foreign currency translation adjustment	(56		)	(57		)	(113		)
Balance, end of period	$	1,397		$	23,287		$	24,684

Intangible assets (other than goodwill) consisted of the following (in thousands):



		June 30, 2018							December 31, 2017
	Useful Life	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Amortized:
Domain names	5-10 years	$	3,161	$	(580	)	$	2,581	$	3,161	$	(428	)	$	2,733
Issued patents	4-15 years	2,858		(1,004		)	1,854		2,697		(913		)	1,784
Issued trademarks	3-11 years	1,010		(545		)	465		860		(397		)	463
Customer relationships	4-8 years	3,742		(616		)	3,126		1,377		(451		)	926
Non-compete agreements	3-4 years	548		(398		)	150		556		(346		)	210
Developed technology	3-7 years	15,449		(5,594		)	9,855		13,469		(3,956		)	9,513
Re-acquired distribution rights	2 years	2,023		(1,349		)	674		2,133		(711		)	1,422
Total amortized		28,791		(10,086		)	18,705		24,253		(7,202		)	17,051
Not amortized:
TASER trademark		900					900		900					900
Patents and trademarks pending		837					837		872					872
Total not amortized		1,737					1,737		1,772					1,772
Total intangible assets		$	30,528	$	(10,086	)	$	20,442	$	26,025	$	(7,202	)	$	18,823

Amortization expense of intangible assets for the three and six months ended June 30, 2018 was $1.7 million and $3.0 million, respectively. Amortization expense of intangible assets for the three and six months ended June 30, 2017 was $1.0 million and $1.9 million, respectively. Estimated amortization for intangible assets with definite lives for the remaining six months of 2018, the next five years ended December 31, and thereafter, is as follows (in thousands):



2018	$	3,179
2019	4,884
2020	3,417
2021	2,847
2022	1,192
2023	926
Thereafter	2,260
Total	$	18,705

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AXON ENTERPRISE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

6. Other Long-Term Assets

Other long-term assets consisted of the following at June 30, 2018 and December 31, 2017 (in thousands):



	2018		2017
Cash surrender value of corporate-owned life insurance policies	$	3,847	$	3,846
Deferred commissions ⁽¹⁾	13,766		6,803
Restricted cash ⁽²⁾	2,470		3,333
Prepaid expenses, deposits and other	2,748		1,384
Total other long-term assets	$	22,831	$	15,366

⁽¹⁾Represents assets for the incremental costs of obtaining a contract with a customer, which consist primarily of sales commissions. These costs are ascribed to or allocated to the underlying performance obligations in the contract and amortized consistent with the recognition timing of the revenue for the underlying performance obligations. The amounts as of December 31, 2017 have not been adjusted under the modified retrospective method of adoption of Topic 606, and are presented consistent with the prior period amounts. In connection with the Company's adoption of Topic 606, it recorded an adjustment of $7.3 million as of January 1, 2018, and of that amount, $5.4 million was recorded within long-term other assets. The adjusted balance of long-term deferred commissions as of January 1, 2018 was $12.2 million.

⁽²⁾ As of June 30, 2018 and December 31, 2017, restricted cash primarily consisted of $1.8 million and $2.7 million, respectively, of sales proceeds related to long-term contracts with customers. As of June 30, 2018, the proceeds are held in escrow until certain billing milestones are achieved, and then specified amounts are transferred to the Company's operating accounts.

7. Accrued Liabilities

Accrued liabilities consisted of the following at June 30, 2018 and December 31, 2017 (in thousands):



	2018		2017
Accrued salaries, benefits and bonus	$	12,527	$	8,957
Accrued professional, consulting and lobbying fees	2,683		3,870
Accrued warranty expense	505		644
Accrued income and other taxes	2,894		2,558
Other accrued liabilities	11,386		7,473
Accrued liabilities	$	29,995	$	23,502

8. Income Taxes

ASC 740 requires a company to record the effects of a tax law change in the period of enactment; however, shortly after the enactment of the Tax Cuts and Jobs Act (the "Tax Act"), the SEC staff issued Staff Accounting Bulletin 118 ("SAB 118"), which allows a company to record a provisional amount when it does not have the necessary information available, prepared, or analyzed in reasonable detail to complete its accounting for the change in the tax law. The measurement period ends when the company has obtained, prepared and analyzed the information necessary to finalize its accounting, but cannot extend beyond one year. The Company continues to analyze the impact of the Tax Act and expects that as additional guidance from IRS Treasury is provided, further updates will be necessary.

The Tax Act imposes a U.S. entity tax on global intangible low-taxed income ("GILTI") earned by certain foreign subsidiaries. The FASB Staff Q&A, Topic 740, No. 5, Accounting for Global Intangible Low-Taxed Income, states that an entity can make an accounting policy election to either recognize deferred taxes for temporary basis differences expected to reverse as GILTI in future years or provide for the tax expense related to GILTI in the year the tax is incurred as a period expense only. Given the complexity of the GILTI provisions, we are still evaluating the effects of the GILTI provisions and have not yet determined our accounting policy. At June 30, 2018, because we are still evaluating the GILTI provisions and our analysis of future taxable income that is subject to GILTI, we have included GILTI related to current-year operations only in our EAETR (estimated annual effective tax rate) and have not provided additional GILTI on deferred items.

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AXON ENTERPRISE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Deferred Tax Assets

Net deferred income tax assets at June 30, 2018, include capitalized R&D costs, R&D tax credits, stock-based compensation expense, deferred revenue, warranty and inventory reserves, accrued vacation, and other items, partially offset by accelerated depreciation expense and intangible amortization that is not tax deductible. The Company’s total net deferred tax assets at June 30, 2018 were $15.8 million.

In preparing the Company’s condensed consolidated financial statements, management assesses the likelihood that its deferred tax assets will be realized from future taxable income. In evaluating the Company’s ability to recover its deferred income tax assets, management considers all available positive and negative evidence, including its operating results, ongoing tax planning and forecasts of future taxable income on a jurisdiction by jurisdiction basis. A valuation allowance is established if it is determined that it is more likely than not that some portion or all of the net deferred tax assets will not be realized. Management exercises significant judgment in determining its provisions for income taxes, its deferred tax assets and liabilities, and its future taxable income for purposes of assessing its ability to utilize any future tax benefit from its deferred tax assets.

Although management believes that its tax estimates are reasonable, the ultimate tax determination involves significant judgments that could become subject to audit by tax authorities in the ordinary course of business. As of each reporting date, management considers new evidence, both positive and negative, that could impact management’s view with regard to future realization of deferred tax assets. As of June 30, 2018, the Company continues to demonstrate three-year cumulative pre-tax income in the U.S. federal and Arizona tax jurisdictions; however, the Company's Arizona R&D Tax Credits start to expire in 2018 with a significant tranche with a gross value of $1.2 million expiring if not used by the end of 2019. It appears that the Company’s long term investments, which impact short term profits, will likely result in some of the R&D credits expiring before they are utilized. Therefore, management has concluded that it is more likely than not that a portion of the Company’s deferred tax assets will not be realized and has established a valuation allowance.

The Company has claimed R&D tax credits of approximately $17.0 million for federal, Arizona and California income tax purposes related to tax years 2003 to 2018. Management has made the determination that it is more likely than not that the full benefit of the R&D tax credits will not be sustained upon examination and recorded a liability for unrecognized tax benefits of $3.8 million as of June 30, 2018. In addition, management accrued $0.1 million for estimated uncertain tax positions related to certain state income tax liabilities, for a total unrecognized tax benefit as of June 30, 2018 of $3.9 million. Management expects the amount of unrecognized tax benefit liability to increase by $0.2 million within the next 12 months. Should the unrecognized benefit of $3.9 million be recognized, the Company's effective tax rate would be favorably impacted. Approximately $2.1 million of the unrecognized tax benefit associated with R&D credits has been netted against the R&D deferred tax asset.

Effective Tax Rate

The Company’s overall effective tax rate for the six months ended June 30, 2018, after discrete period adjustments, was (7.9)%. Before discrete adjustments, the tax rate was 22.8%, which is more than the federal statutory rate primarily due to state taxes and non-deductible expenses for items such as meals and entertainment, executive compensation limitation under IRC section 162(m), lobbying fees, an income inclusion from GILTI, offset by a reduction for foreign-derived intangible income ("FDII"). This was partially offset by R&D tax credit deductions. The effective tax rate was favorably impacted by a $6.1 million discrete tax benefit primarily associated with windfalls related to stock-based compensation for RSUs that vested or stock options that were exercised during the six months ended June 30, 2018. Of this amount $3.4 million related to stock options exercised by the Company's CEO in connection with the Company's follow-on offering.

9. Stockholders’ Equity

Follow-On Offering

In May 2018, the Company sold 4,645,000 shares of its common stock, which included 645,000 shares pursuant to the full exercise of the underwriters' option to purchase additional shares, in an underwritten public offering at a price of $53.00 per share, which resulted in gross proceeds of $246.2 million. Net proceeds to the Company after deducting fees, commissions, and other expenses related to the offering were $234.0 million.

CEO Performance Award

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On May 24, 2018 (the “Grant Date”), our stockholders approved the Board of Directors’ grant of 6,365,856 stock option awards to Patrick W. Smith, the Company's CEO (the “CEO Performance Award”). The CEO Performance Award consists of 12 vesting tranches with a vesting schedule based entirely on the attainment of both operational goals (performance conditions) and market capitalization goals (market conditions), assuming continued employment either as the CEO or as both Executive Chairman and Chief Product Officer and service through each vesting date. Each of the 12 vesting tranches of the CEO Performance Award have a 10-year contractual term and will vest upon certification by the Board of Directors that both (i) the market capitalization goal for such tranche, which begins at $2.5 billion for the first tranche and increases by increments of $1.0 billion thereafter, and (ii) any one of the following eight operational goals focused on revenue or eight operational goals focused on Adjusted EBITDA have been met for the previous four consecutive fiscal quarters. Adjusted EBITDA is defined as net income (loss) attributable to common stockholders before interest expense, provision (benefit) for income taxes, depreciation and amortization, gains and losses on dispositions of property and equipment and intangible assets, and stock-based compensation expense.



Eight Separate Revenue Goals ⁽¹⁾ (in thousands)		Eight Separate Adjusted EBITDA-Goals (in thousands)
Goal #1, $710,058		Goal #9, $125,000
Goal #2, $860,058		Goal #10, $155,000
Goal #3, $1,010,058		Goal #11, $175,000
Goal #4, $1,210,058		Goal #12, $190,000
Goal #5, $1,410,058		Goal #13, $200,000
Goal #6, $1,610,058		Goal #14, $210,000
Goal #7, $1,810,058		Goal #15, $220,000
Goal #8, $2,010,058		Goal #16, $230,000

⁽¹⁾In connection with the business combination that was completed during the three months ended June 30, 2018 (Note 15), the revenue goals have been adjusted for the acquiree's Target Revenue, as defined in the CEO Performance Award agreement.

As of June 30, 2018, the following operational goals were considered probable of achievement:


•	Total revenue of $710.1 million; and


•	Adjusted EBITDA of $125.0 million

Stock-based compensation expense associated with the CEO Performance Award is recognized over the longer of the expected achievement period for each pair of market capitalization and operational goals, beginning at the point in time when the relevant operational goal is considered probable of being met. The market capitalization goal period and the valuation of each tranche are determined using a Monte Carlo simulation and is used as the basis for determining the expected achievement period of the market capitalization goal. The probability of meeting an operational goal and the expected achievement point in time for meeting a probable operational goal are based on a subjective assessment of our forward-looking financial projections, taking into consideration statistical analysis. Even though no tranches of the CEO Performance Award vest unless a market capitalization and a matching operational goal are both achieved, stock-based compensation expense is recognized only when an operational goal is considered probable of achievement regardless of whether a market capitalization goal is actually achieved. Additionally, stock-based compensation represents a non-cash expense and is recorded as a selling, general, and administrative operating expense on the Company's condensed and consolidated statement of operations.

None of the stock options granted under the CEO Performance Award have vested thus far as the market capitalization goals and operational goals have not yet been achieved as of June 30, 2018. However, as there are two operational goals considered probable of achievement, the Company recorded stock-based compensation expense of $0.5 million related to the CEO Performance Award from the Grant Date through June 30, 2018. The number of stock options expected to vest is 1.1 million shares.

As of June 30, 2018, the Company had $44.8 million of total unrecognized stock-based compensation expense for the performance goals that were considered probable of achievement, which will be recognized over a weighted-average period of 9.2 years. As of June 30, 2018, the Company had unrecognized stock-based compensation expense of $200.7 million for the performance goals that were considered not probable of achievement.

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The Company measured the fair value of the CEO Performance Award using a Monte Carlo simulation approach with the following assumptions: risk-free interest rate of 2.98%, expected term of 10 years, expected volatility of 47.71% and dividend yield of 0.00%.

Stock Incentive Plan

In May 2018, the Company’s stockholders approved a new stock incentive plan authorizing an additional 1.0 million shares, plus remaining available shares under prior plans, for issuance under the new plan. Combined with the legacy stock incentive plans, there are 1.7 million shares available for grant as of June 30, 2018.

Performance-based stock awards

The Company has issued performance-based stock options and performance-based restricted stock units ("RSUs"), the vesting of which is contingent upon the achievement of certain performance criteria related to the operating performance of the Company, as well as successful and timely development and market acceptance of the Company's products.

RSUs are classified as equity and measured at the fair market value of the underlying stock at the grant date. The Company recognizes RSU expense using the straight-line attribution method over the requisite service period. For performance-based RSUs containing only performance conditions, compensation cost is recognized using the accelerated attribution model over the explicit or implicit service period. For awards containing multiple service, performance or market conditions, where all conditions must be satisfied prior to vesting, compensation expense is recognized over the longest explicit, implicit or derived service period, based on management’s estimate of the probability of the performance criteria being satisfied, adjusted at each balance sheet date.

For performance-based options, stock-based compensation expense is recognized over the expected performance achievement period of individual performance goals when the achievement of each individual performance goal becomes probable. For performance-based options with a vesting schedule based entirely on the attainment of both performance and market conditions, stock-based compensation expense is recognized for each pair of performance and market conditions over the longer of the expected achievement period of the performance and market conditions, beginning at the point in time that the relevant performance condition is considered probable of achievement. The fair value of such awards is estimated on the grant date using Monte Carlo simulations.

Restricted Stock Units

The following table summarizes RSU activity for the six months ended June 30, 2018 (number of units and aggregate intrinsic value in thousands):



	Number of Units		Weighted Average Grant-Date Fair Value		Aggregate Intrinsic Value
Units outstanding, beginning of year	2,348		$	23.47
Granted	281		40.79
Released	(436	)	24.08
Forfeited	(172	)	22.40
Units outstanding, end of period	2,021		25.89		$	127,687

Aggregate intrinsic value represents the Company’s closing stock price on the last trading day of the period, which was $63.18 per share, multiplied by the number of RSUs outstanding. As of June 30, 2018, there was $41.7 million in unrecognized compensation costs related to RSUs under the Company's stock plans. The Company expects to recognize the cost related to the RSUs over a weighted average period of 2.58 years. RSUs are released when vesting requirements are met.

During the six months ended June 30, 2018, the Company granted 0.1 million performance-based RSUs. As of June 30, 2018, the performance criteria had not been met for any of the 0.5 million performance-based RSUs outstanding.The performance-based RSUs granted in 2018, 2017 and 2016 contain provisions whereby the amount of RSUs that ultimately vest is dependent upon the level of achievement of performance metrics. The amount of RSUs included in the table above related to such grants is the target level, which is the Company's best estimate of the amount of RSUs that will vest. The maximum additional number of performance-based RSUs that could be earned is 0.4 million, which are not included in the table above.

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Certain RSUs that vested in the six months ended June 30, 2018 were net-share settled such that the Company withheld shares with value equivalent to the employees’ minimum statutory obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities. Total shares withheld were 0.1 million and had a value of $4.6 million on their respective vesting dates as determined by the Company’s closing stock price on such dates. Payments for the employees’ tax obligations are reflected as a financing activity within the statement of cash flows. The Company records a liability for the tax withholding to be paid by the Company as a reduction to additional paid-in capital.

Stock Option Activity

The following table summarizes stock option activity for the six months ended June 30, 2018 (number of units and aggregate intrinsic value in thousands):



	Number of Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (years)	Aggregate Intrinsic Value
Options outstanding, beginning of year	804		$	4.99
Granted	6,366		28.58
Exercised	(418	)	5.30
Expired / terminated	—		—
Options outstanding, end of period	6,752		27.21		9.40	$	242,866
Options exercisable, end of period	382		4.65		1.06	22,354
Options expected to vest, end of period	1,062

Aggregate intrinsic value represents the difference between the exercise price of the underlying stock option awards and the closing market price of the Company's common stock of $63.18 on June 30, 2018. The intrinsic value of options exercised for the six months ended June 30, 2018 and 2017 was $18.8 million and $2.6 million, respectively. As of June 30, 2018, total options outstanding included 6.4 million unvested performance-based stock options, of which 1.1 million are expected to vest.

Of the total stock options exercised during the six months ended June 30, 2018, 0.3 million were exercised and the shares then sold by the Company's CEO in connection with the Company's follow-on offering. The CEO surrendered already owned shares to cover the exercise price of the option exercises. The option exercises were net-share settled such that the Company withheld shares with value equivalent to the CEO’s minimum statutory obligation for the applicable income and other employment taxes, and remitted the cash to the appropriate taxing authorities. Total shares withheld for tax purposes and surrendered to cover the option exercises were 0.1 million and 29,854, respectively, and had a value of $6.2 million and $1.6 million, respectively, on the exercise date as determined by the Company’s closing stock price on that day. Payments for the employees’ tax obligations are reflected as a financing activity within the statement of cash flows. The Company records a liability for the tax withholding to be paid by the Company as a reduction to additional paid-in capital.

Stock-based Compensation Expense

The following table summarizes the composition of stock-based compensation for the three and six months ended June 30, 2018 and 2017 (in thousands):



	Three Months Ended June 30,				Six Months Ended June 30,
	2018		2017		2018		2017
Cost of products sold and services delivered	$	125	$	155	$	266	$	234
Sales, general and administrative expenses	2,731		2,155		5,035		4,183
Research and development expenses	2,098		1,666		3,746		3,006
Total stock-based compensation	$	4,954	$	3,976	$	9,047	$	7,423

Stock Repurchase Plan

In February 2016, the Company's Board of Directors authorized a stock repurchase program to acquire up to $50.0 million of the Company’s outstanding common stock subject to stock market conditions and corporate considerations. During the six

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months ended June 30, 2018 and 2017, no common shares were purchased under the program. As of June 30, 2018, $16.3 million remains available under the plan for future purchases. The Company suspended its 10b5-1 plan during 2016, and any future purchases will be discretionary.

10. Line of Credit

The Company has a $10.0 million revolving line of credit with a domestic bank. At both June 30, 2018 and December 31, 2017, there were no borrowings under the line. Under the terms of the line of credit, available borrowings are reduced by outstanding letters of credit. As of June 30, 2018, the Company had letters of credit outstanding of $2.7 million under the facility, and available borrowing of $7.3 million. The line is secured by substantially all of the assets of the Company, and bears interest at varying rates (currently LIBOR plus 1.25% or Prime less 0.50%). The line of credit matures on December 31, 2018, and requires monthly payments of interest only. The Company’s agreement with the bank requires it to comply with a maximum funded debt to earnings before interest, taxes, depreciation and amortization ("EBITDA") ratio, as defined, of no greater than 2.00 to 1.00 based upon a trailing twelve-month period. At June 30, 2018, the Company’s funded debt to EBITDA ratio was 0.002 to 1.00.

11. Commitments and Contingencies

Product Litigation

The Company is currently named as a defendant in seven lawsuits in which the plaintiffs allege either wrongful death or personal injury in situations in which a TASER CEW was used by law enforcement officers in connection with arrests. While the facts vary from case to case, the product liability claims are typically based on an alleged product defect resulting in injury or death, usually involving a failure to warn, and the plaintiffs are seeking monetary damages. The information throughout this note is current through the date of these financial statements.

As a general rule, it is the Company’s policy not to settle suspect injury or death cases. Exceptions are sometimes made where the settlement is strategically beneficial to the Company. Also, on occasion, the Company’s insurance company has settled such lawsuits over the Company’s objection where the risk is over the Company’s liability insurance deductibles. Due to the confidentiality of the Company's litigation strategy and the confidentiality agreements that are executed in the event of a settlement, the Company does not identify or comment on which specific lawsuits have been settled or the amount of any settlement.

In 2009, the Company implemented new risk management strategies, including revisions to product warnings and training to better protect both the Company and its customers from litigation based on “failure to warn” theories - which comprise the vast majority of the cases against the Company. These risk management strategies have been highly effective in reducing the rate and exposure from litigation post-2009. From the third quarter of 2011 to the second quarter of 2018, product liability cases have been reduced from 55 to seven active cases.

Management believes that pre-2009 cases have a different risk profile than cases which have occurred since the risk management procedures were introduced in 2009. Therefore, the Company necessarily treats certain pre-2009 cases as exceptions to the Company’s general no settlement policy in order to reduce caseload, legal costs and liability exposure.

The Company intends to continue its successful practice of aggressively defending and generally not settling litigation except in very limited and unusual circumstances as described above. With respect to each of the pending lawsuits, the following table lists the name of plaintiff, the date the Company was served with process, the jurisdiction in which the case is pending, the type of claim and the status of the matter.



Plaintiff	Month Served	Jurisdiction	Claim Type	Status
Derbyshire	Nov-09	Ontario, Canada Superior Court of Justice	Officer Injury	Discovery Phase. Trial scheduled for October 14, 2019.
Shymko	Dec-10	The Queen's Bench, Winnipeg Centre, Manitoba	Wrongful Death	Pleading Phase, currently inactive
Ramsey	Jan-12	12th Judicial Circuit Court, Broward County, FL	Wrongful Death	Discovery Phase, currently inactive
Bennett	Sep-15	11th Judicial Circuit Court, Miami-Dade County, FL	Wrongful Death	Discovery Phase
Masters	Nov-16	U.S. District Court, Western District of Missouri	Suspect Injury	Discovery Phase. Trial scheduled for December 10, 2018.
Taylor	Mar-17	U.S, District Court, Southern District of Texas	Officer Injury	Dispositive Motion Phase: The Company filed its motion for summary judgment on April 20, 2018
Wiggington	Apr-18	U.S, District Court, Western District Court of Missouri	Wrongful Death	Pleading Phase

No product liability cases were dismissed or judgments entered during the first six months of 2018 and through the date of these financial statements and there are no product litigation matters in which the Company is involved that are currently on appeal.

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The claims, and in some instances the defense, of each of these lawsuits have been submitted to the Company’s insurance carriers that maintained insurance coverage during the applicable periods. The Company continues to maintain product liability insurance coverage with varying limits and deductibles. The following table provides information regarding the Company’s product liability insurance. Remaining insurance coverage is based on information received from the Company’s insurance provider (in millions).



Policy Year	Policy Start Date	Policy End Date	Insurance Coverage		Deductible Amount		Defense Costs Covered	Remaining Insurance Coverage		Active Cases and Cases on Appeal
2009	12/15/2008	12/15/2009	$	10.0	$	1.0	N	$	10.0	Derbyshire
2010	12/15/2009	12/15/2010	10.0		1.0		N	10.0		Shymko
2011	12/15/2010	12/15/2011	10.0		1.0		N	10.0		n/a
Jan-Jun 2012	12/15/2011	6/25/2012	7.0		1.0		N	7.0		Ramsey
Jul-Dec 2012	6/25/2012	12/15/2012	12.0		1.0		N	12.0		n/a
2013	12/15/2012	12/15/2013	12.0		1.0		N	12.0		n/a
2014	12/15/2013	12/15/2014	11.0		4.0		N	11.0		n/a
2015	12/15/2014	12/15/2015	10.0		5.0		N	10.0		Bennett
2016	12/15/2015	12/15/2016	10.0		5.0		N	10.0		Masters
2017	12/15/2016	12/15/2017	10.0		5.0		N	10.0		Taylor
2018	12/15/2017	12/15/2018	10.0		5.0		N	10.0		Wiggington

Other Litigation

Phazzer Patent Infringement Litigation

In February 2016, the Company filed a complaint against Phazzer Electronics Inc. (“Phazzer”) for patent infringement, trademark infringement and false advertising. On July 21, 2017, the U.S. District Court for the Middle District of Florida (Case No. 6:16-cv-00366-PGB-KRS) granted the Company's Motion for Sanctions and for a Permanent Injunction against Florida-based Phazzer. The Court issued a broad permanent injunction against Phazzer banning sales of the infringing Phazzer Enforcer CEWs and dart cartridges. The injunction prohibits Phazzer and its officers, agents, employees, and anyone acting in concert with them, from making, using, offering for sale, selling, distributing, importing or exporting Phazzer CEWs and associated cartridges. Phazzer is further enjoined from dumping its infringing inventory by “donating” CEWs to law enforcement, and from false advertising and comparison to TASER brand products. Both Phazzer and its U.S. distributors are barred from exporting CEWs or cartridges to fill foreign orders. On August 10, 2017, Phazzer filed a notice of appeal to the Federal Circuit, which is fully briefed but remains pending. Phazzer's multiple attempts to stay the injunction pending appeal have been denied by both the district and appellate courts.

On April 4, 2018, the Court entered a judgment for the Company against Phazzer in an amount exceeding $7.8 million which included an award to the Company of compensatory and treble damages for willful infringement, and also an award of reasonable attorneys’ fees and costs. The collectability of this judgment is in doubt since Phazzer has informed the Court that it is insolvent. On May 1, 2018, Phazzer appealed the damages award to the Federal Circuit. On May 11, 2018, the district court entered final judgment against Phazzer ending the district court proceedings.

In imposing severe sanctions against Phazzer, the Court found that Phazzer “engaged in a pattern of bad faith conduct designed and intended to delay, stall, and increase the cost of this litigation,” and that Phazzer repeatedly disregarded Court Orders thereby exhibiting “contemptuous”, “egregious”, “flagrant” and “intentional obstructionist behavior” resulting in willful “abuse [of] the judicial process.” The Court made similar findings in both the damages and contempt orders.

On April 27, 2017, during the district court litigation, Phazzer filed a second petition for reexamination of the Company’s patent with the USPTO. The Company’s patent (U.S. No. 7,234,262) at issue in the litigation relates to the CEW’s data recording of date and time of each trigger operation and duration of the stimulus. On April 2, 2018, the examiner issued a final office action rejecting all claims. The Company is appealing this decision. The Company’s patent remains valid and enforceable unless and until all appeals are exhausted and the patent is formally canceled (at least a 2-year process). The Phazzer injunction remains in full force and effect.

The Company's trademark that is the subject of the injunction is Federal Registration No. 4,423,789, relating to the non-functional shape of TASER CEW cartridges used to launch the darts. The injunction covers all Phazzer CEW dart cartridges that

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are confusingly similar to, or not more than a colorable imitation of, TASER CEW cartridges. During the litigation, Phazzer filed a petition to cancel the Company’s trademark, which the Trademark Board stayed until the conclusion of the district court litigation and all related appeals.

Digital Ally Patent Litigation

In February 2016, the Company was served with a first amended complaint filed by Digital Ally Inc. (“Digital”) in the District of Kansas (Case No. CV-16-02032-CM-JPO) alleging patent infringement regarding the Company's Axon Signal technology, commercial bribery, antitrust, and unfair competition. In March 2016, the Company was served with a second amended complaint with similar allegations. The second amended complaint seeks a judgment of infringement, monetary damages, a permanent injunction, punitive damages and attorneys’ fees and costs.

Digital Ally’s complaint has been substantially narrowed based on (1) the district court’s dismissal of all of Digital’s antitrust claims in January 2017, which was affirmed by the Federal Circuit in May 2018; (2) the district court’s dismissal of Digital’s ‘292 patent from the litigation with prejudice in March 2018, and Digital’s execution of a covenant not to sue Axon on that patent on all existing Axon products; and (3) Digital’s dismissal of certain inconsistent claims in the ‘452 patent, leaving only independent claim 10 for resolution by the Court. The Company believes the remaining claim of the ‘452 patent is invalid and not infringed, and is vigorously defending this litigation.

After instituting inter parte review of Digital’s ‘292 patent in June 2017, the Patent Trial and Appeal Board ("PTAB") ultimately rejected the Company’s invalidity challenge on June 1, 2018. Although this patent is no longer at issue in the litigation, the Company is appealing this ruling.

On July 19, 2018, the district court issued its claim construction ruling on three disputed claim terms in the remaining claim 10 of Digital’s ‘452 patent. This ruling now triggers various discovery and other deadlines in the litigation, including mandatory mediation. No trial date has been set, but the Court has set certain other deadlines, including mediation no later than December 3, 2018 and a pretrial conference on January 16, 2019 (where a trial date may be set).

Antoine di Zazzo Arbitration

In April 2016, the Company was served with a notice of arbitration claim filed by Antoine di Zazzo, the Company’s former distributor in France, for commissions allegedly owed Mr. di Zazzo. The arbitration claim was filed with the International Court of Arbitration of the International Chamber of Commerce in Paris, France, and the amount that is claimed in controversy is $0.6 million. The Company’s records reflect that all commissions that were due Mr. di Zazzo under his contract were paid or offered to him and the Company will vigorously defend this arbitration claim.

Richey Class Action Litigation

On June 25, 2018, consumer weapon purchaser Douglas Richey (“Richey”) filed a class action lawsuit against the Company in the Northern District of California (Case No. 3:18-cv-03751-WHA) purporting to assert claims on behalf of all persons in the United States who purchased or acquired a TASER Pulse, TASER X2 and TASER X26P model CEW in the four-year period preceding the complaint. Richey claims his Pulse CEW discharged while in its case in his jacket pocket due to a faulty safety switch. He was not injured. He alleges violation of the Magnuson-Moss Warranty Act, 15 U.S.C. § 2310(D)(1), the Song-Beverly Consumer Warranty Act for Breach of Express Warranty, Cal. Civ. Code § 1790, and California's Consumers Legal Remedies Act, as well as fraudulent omission and unjust enrichment. The Company is preparing to file a motion to dismiss the complaint, which it believes is meritless.

Appeals

Four appeals are currently pending in the Federal Circuit regarding various orders entered in the Phazzer litigation (see above). Appeal No. 17-2637 relates to the district court’s July 21, 2017 sanctions order and permanent injunction and is fully briefed. The other three appeals relating to the district court’s April 4, 2018 damages award in the Company’s favor (No. 18-1914) and its May 4, 2018 contempt order as to Phazzer (No. 18-2059) and Abboud (No. 20-1857) have been consolidated. Phazzer and Abboud’s opening briefs are due August 10, 2018.

On May 2, 2018, the Federal Circuit issued its judgment in the Company’s favor affirming the district court’s dismissal of

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Digital’s antitrust claims (discussed above). On July 6, 2018, Digital filed a Petition for Writ of Certiorari with the U.S. Supreme Court. The Company has waived its response believing the petition is frivolous.

Voluntary Request Letter from the U.S. Federal Trade Commission

On or about June 14, 2018, the Company received a letter from the U.S. Federal Trade Commission (“FTC”) with respect to its non-public investigation into the Company’s recent acquisition of VIEVU, LLC. See Note 15 for additional information regarding the VIEVU acquisition. In the letter, the FTC has requested that the Company provide, on a voluntary basis, certain information and documentation relating to its acquisition of VIEVU. The Company is reviewing the letter and the information request and is cooperating with the investigation.

General

From time to time, the Company is notified that it may be a party to a lawsuit or that a claim is being made against it. It is the Company’s policy to not disclose the specifics of any claim or threatened lawsuit until the summons and complaint are actually served on the Company. After carefully assessing the claim, and assuming the Company determines that it is not at fault or it disagrees with the damages or relief demanded, the Company vigorously defends any lawsuit filed against the Company. In certain legal matters, the Company records a liability when losses are deemed probable and reasonably estimable. In evaluating matters for accrual and disclosure purposes, the Company takes into consideration factors such as our historical experience with matters of a similar nature, the specific facts and circumstances asserted, the likelihood of our prevailing, the availability of insurance, and the severity of any potential loss. The Company reevaluates and updates accruals as matters progress over time.

Based on the Company's assessment of outstanding litigation and claims as of June 30, 2018, the Company has determined that it is not reasonably possible that these lawsuits will individually, or in the aggregate, materially affect its results of operations, financial condition or cash flows. However, the outcome of any litigation is inherently uncertain and there can be no assurance that any expense, liability or damages that may ultimately result from the resolution of these matters will be covered by its insurance or will not be in excess of amounts recognized or provided by insurance coverage and will not have a material adverse effect on our operating results, financial condition or cash flows.

Off-Balance Sheet Arrangements

Under certain circumstances, the Company uses letters of credit and surety bonds to guarantee its performance under various contracts, principally in connection with the installation and integration of its Axon cameras and related technologies. Certain of the Company's letters of credit and surety bonds have stated expiration dates with others being released as the contractual performance terms are completed. At June 30, 2018, the Company had outstanding letters of credit of $2.7 million that are expected to expire in May 2019. Additionally, the Company had $14.1 million of outstanding surety bonds at June 30, 2018, with $1.0 million expiring in 2018, $0.1 million expiring in 2020, $2.3 million expiring in 2021, $3.1 million expiring in 2022 and the remaining $7.5 million expiring in 2023.

12. Related Party Transactions

The Company subscribes to various cloud-based applications from Salesforce. Bret Taylor, a member of the Company's Board of Directors, serves as President and Chief Product Officer of Salesforce. The Company incurs costs at different times throughout the year, typically in advance of services being provided, and subsequently amortizes these costs ratably to expense as services are provided over the contractual term. The Company made payments of $1.7 million related to these services during each of the three and six months ended June 30, 2018, and made payments of $0.2 million and $1.2 million during the three and six months ended June 30, 2017, respectively.

13. Employee Benefit Plans

The Company has a defined contribution profit sharing 401(k) plan for eligible employees, which is qualified under Sections 401(a) and 401(k) of the Internal Revenue Code of 1986, as amended. Employees are entitled to make tax-deferred contributions of up to the maximum amount allowed by law of their eligible compensation.

The Company also has a non-qualified deferred compensation plan for certain executives, key employees and non-employee directors through which participants may elect to postpone the receipt and taxation of a portion of their compensation, including stock-based compensation, received from the Company. The non-qualified deferred compensation plan allows eligible participants to defer up to 80% of their base salary and up to 100% of other types of compensation. The plan also allows for matching and discretionary employer contributions. Employee deferrals are deemed 100% vested upon contribution. Distributions from the plan are made upon retirement, death, separation of service, specified date or upon the occurrence of an unforeseeable emergency. Distributions can be paid in a variety of forms from lump sum to installments over a period of years. Participants in the plan are entitled to select from a wide variety of investments available under the plan and are allocated gains or losses based upon the performance of the investments selected by the participant. All gains or losses are allocated fully to plan participants and the Company does not guarantee a rate of return on deferred balances. Assets related to this plan consist of corporate-owned life

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insurance contracts and are included in other assets in the condensed consolidated balance sheets. Participants have no rights or claims with respect to any plan assets and any such assets are subject to the claims of the Company’s general creditors.

Contributions to the plans are made by both the employee and the Company. Company contributions to the 401(k) plan are based on the level of employee contributions and are immediately vested. The Company’s matching contributions to the 401(k) plan for the three months ended June 30, 2018 and 2017, were $0.8 million and $0.6 million, respectively, and $1.6 million and $1.3 million for the six months ended June 30, 2018 and 2017, respectively. Future matching or profit sharing contributions to the plans are at the Company’s sole discretion.

14. Segment Data

The Company is comprised of two reportable segments: the manufacture and sale of CEWs, batteries, accessories, extended warranties and other products and services (the “TASER Weapons” segment); and the software and sensors business, which includes the sale of devices, wearables, applications, cloud and mobile products (collectively, the “Software and Sensors” segment). Within the Software and Sensors segment, the Company specifies sales of products and services. Revenue from the Company's “products” in the Software and Sensors segment are generally sales of sensors, including on-officer body cameras, Axon Fleet cameras, other hardware sensors, warranties on sensors,and other products, and is sometimes referred to as Sensors and Other revenue. Revenue from the Company's “services” in the Software and Sensors segment comprise sales related to the Axon Cloud, which includes Evidence.com, cloud-based evidence management software revenue, other recurring cloud-hosted software revenue and related professional services, and is sometimes referred to as Axon Cloud revenue. Within the Software and Sensors segment, the Company includes only revenues and costs attributable to that segment which include: costs of sales for both products and services, direct labor, selling expenses for the sales team, product management and R&D for products included, or to be included, within the Software and Sensors segment. All other costs are included in the TASER Weapons segment. The Company’s Chief Executive Officer, who is the CODM, is not provided asset information by segment, and therefore, no asset information is provided.

Information relative to the Company’s reportable segments was as follows (in thousands):



	Three Months Ended June 30, 2018						Three Months Ended June 30, 2017 ⁽¹⁾
	TASER Weapons		Software and Sensors		Total		TASER Weapons		Software and Sensors		Total
Net sales from products ⁽²⁾	$	60,624	$	16,097	$	76,721	$	53,016	$	13,859	$	66,875
Net sales from services ⁽³⁾	—		22,505		22,505		—		12,768		12,768
Net sales	60,624		38,602		99,226		53,016		26,627		79,643
Cost of product sales	17,681		13,406		31,087		16,078		14,094		30,172
Cost of service sales	—		4,996		4,996		—		3,834