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 September 30, 2018

or

¨ 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 every Interactive Data File required to be submitted 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 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	¨	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 October 31, 2018 was 58,448,574.

AXON ENTERPRISE, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2018

			Page
Special Note Regarding Forward-Looking Statements			ii
PART I - FINANCIAL INFORMATION
	Item 1. Financial Statements		1
		Condensed Consolidated Balance Sheets as of September 30, 2018 (Unaudited) and December 31, 2017	1
		Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2018 and 2017	2
		Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2018 and 2017	3
		Notes to Unaudited Condensed Consolidated Financial Statements	4
	Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations		27
	Item 3. Quantitative and Qualitative Disclosures About Market Risk		45
	Item 4. Controls and Procedures		46
PART II - OTHER INFORMATION
	Item 1. Legal Proceedings		48
	Item 1A. Risk Factors		48
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		48
	Item 3. Defaults Upon Senior Securities		48
	Item 4. Mine Safety Disclosures		48
	Item 5. Other Information		48
	Item 6. Exhibits		49
	SIGNATURES		50

Special Note Regarding Forward-Looking Statements

This Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), including statements regarding our expectations, beliefs, intentions and strategies regarding the future. We intend that such forward-looking statements be subject to the safe-harbor provided by the Private Securities Litigation Reform Act of 1995.From time to time, we also provide forward-looking statements in other materials we release to the public as well as verbal forward-looking statements. These forward-looking statements include, without limitation, statements regarding: proposed products and services and related development efforts and activities; expectations about the market for our current and future products and services; expectations about customer behavior; statements concerning projections, predictions, expectations, estimates or forecasts as to our business, financial and operational results and future economic performance; and statements of management’s strategies, goals and objectives and other similar expressions; as well as the ultimate resolution of financial statement items requiring critical accounting estimates, including those set forth in our Form 10-K for the year ended December 31, 2017. Such statements give our current expectations or forecasts of future events; they do not relate strictly to historical or current facts. Words such as “may,” “will,” “should,” “could,” “would,” “predict,” “potential,” “continue,” “expect,” “anticipate,” “future,” “intend,” “plan,” “believe,” “estimate,” and similar expressions, as well as statements in future tense, identify forward-looking statements. However, not all forward-looking statements contain these identifying words.

We cannot guarantee that any forward-looking statement will be realized, although we believe we have been prudent in our plans and assumptions. Achievement of future results is subject to risks, uncertainties and potentially inaccurate assumptions. The following important factors could cause actual results to differ materially from those in the forward-looking statements: customer purchase behavior, including adoption of our software as a service delivery model; our exposure to cancellations of government contracts due to appropriation clauses, exercise of a cancellation clause, or non-exercise of contractually optional periods; our ability to design, introduce and sell new products or features; our ability to manage our supply chain and avoid production delays or shortages; changes in the costs of product components and labor; defects in our products; the impact of product mix on projected gross margins; loss of customer data, a breach of security or an extended outage, including our reliance on third party cloud-based storage providers; negative media publicity regarding our products; our ability to defend against litigation and protect our intellectual property, and the resulting costs of this activity; changes in government regulations in the U.S. and in foreign markets, especially related to the classification of our product by the United States Bureau of Alcohol, Tobacco, Firearms and Explosives; counter-party risks relating to cash balances held in excess of FDIC insurance limits; our ability to integrate acquired businesses; and our ability to attract and retain key personnel. Many events beyond our control may determine whether results we anticipate will be achieved. Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could differ materially from past results and those anticipated, estimated or projected. You should bear this in mind as you consider forward-looking statements. The Annual Report on Form 10-K that we filed with the SEC on March 1, 2018 listed various important factors that could cause actual results to differ materially from expected and historical results. These factors are intended as cautionary statements for investors within the meaning of Section 21E of the Exchange Act and Section 27A of the Securities Act. Readers can find them under the heading “Risk Factors” in the Report on Form 10-K and in this Report on Form 10-Q, and investors should refer to them. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider any such list to be a complete set of all potential risks or uncertainties.

Except as required by law, we undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our Form 10-Q, 8-K and 10-K reports to the Securities and Exchange Commission ("SEC"). Our filings with the SEC may be accessed at the SEC’s web site at www.sec.gov.

ii

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

AXON ENTERPRISE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

	September 30, 2018			December 31, 2017
	(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	324,371		$	75,105
Short-term investments	500			6,862
Accounts and notes receivable, net of allowance of $1,559 and $754 as of September 30, 2018 and December 31, 2017, respectively	116,518			56,064
Contract assets, net	13,263			—
Inventory	39,221			45,465
Prepaid expenses and other current assets	30,514			21,696
Total current assets	524,387			205,192
Property and equipment, net of accumulated depreciation of $38,599 and $36,477 as of September 30, 2018 and December 31, 2017, respectively	35,613			31,172
Deferred income tax assets, net	18,080			15,755
Intangible assets, net	16,956			18,823
Goodwill	25,043			14,927
Long-term notes receivable, net of current portion	38,220			36,877
Other assets	23,396			15,366
Total assets	$	681,695		$	338,112
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	8,998		$	8,592
Accrued liabilities	36,908			23,502
Current portion of deferred revenue	89,637			70,401
Customer deposits	4,111			3,673
Current portion of business acquisition contingent consideration	1,736			1,693
Other current liabilities	115			89
Total current liabilities	141,505			107,950
Deferred revenue, net of current portion	69,382			54,881
Liability for unrecognized tax benefits	1,805			1,706
Long-term deferred compensation	3,590			3,859
Business acquisition contingent consideration, net of current portion	—			1,048
Other long-term liabilities	5,751			1,224
Total liabilities	222,033			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 September 30, 2018 and December 31, 2017	—			—
Common stock, $0.00001 par value; 200,000,000 shares authorized; 58,419,742 and 52,969,869 shares issued and outstanding as of September 30, 2018 and December 31, 2017, respectively	1			1
Additional paid-in capital	447,933			201,672
Treasury stock at cost, 20,220,227 shares as of September 30, 2018 and December 31, 2017	(155,947		)	(155,947		)
Retained earnings	169,301			123,185
Accumulated other comprehensive loss	(1,626		)	(1,467		)
Total stockholders’ equity	459,662			167,444
Total liabilities and stockholders’ equity	$	681,695		$	338,112

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

1

AXON ENTERPRISE, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME (LOSS)

(in thousands, except per share data)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Net sales from products	$	80,923		$	73,985		$	238,618		$	208,351
Net sales from services	23,913			16,277			66,659			40,796
Net sales	104,836			90,262			305,277			249,147
Cost of product sales	32,953			34,573			96,474			91,817
Cost of service sales	6,250			5,924			15,566			13,258
Cost of sales	39,203			40,497			112,040			105,075
Gross margin	65,633			49,765			193,237			144,072
Operating expenses:
Sales, general and administrative	39,685			36,398			114,787			99,079
Research and development	21,982			14,166			55,602			39,618
Total operating expenses	61,667			50,564			170,389			138,697
Income (loss) from operations	3,966			(799		)	22,848			5,375
Interest and other income, net	1,274			1,430			2,242			3,320
Income before provision for income taxes	5,240			631			25,090			8,695
Provision for (benefit from) income taxes	(471		)	209			(2,032		)	1,417
Net income	$	5,711		$	422		$	27,122		$	7,278
Net income per common and common equivalent shares:
Basic	$	0.10		$	0.01		$	0.49		$	0.14
Diluted	$	0.10		$	0.01		$	0.47		$	0.14
Weighted average number of common and common equivalent shares outstanding:
Basic	58,340			52,831			55,681			52,663
Diluted	59,805			53,843			57,254			53,762
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Net income	$	5,711		$	422		$	27,122		$	7,278
Foreign currency translation adjustments	(107		)	(1,560		)	(159		)	(2,111		)
Comprehensive income (loss)	$	5,604		$	(1,138	)	$	26,963		$	5,167

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

2

AXON ENTERPRISE, INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

	Nine Months Ended September 30,
	2018			2017
Cash flows from operating activities:
Net income	$	27,122		$	7,278
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization	8,226			5,677
Purchase accounting adjustments to goodwill	—			(23		)
Loss on disposal and impairment of property and equipment, net	290			—
Loss on disposal and abandonment of intangible assets	2,103			—
Bond premium amortization	34			594
Stock-based compensation	15,302			11,423
Deferred income taxes	(2,326		)	(4,155		)
Unrecognized tax benefits	99			(134		)
Change in assets and liabilities:
Accounts and notes receivable and contract assets	(51,172		)	(26,027		)
Inventory	9,033			(19,074		)
Prepaid expenses and other assets	(12,081		)	(11,252		)
Accounts payable, accrued and other liabilities	4,306			3,382
Deferred revenue	31,700			26,460
Net cash provided by (used in) operating activities	32,636			(5,851		)
Cash flows from investing activities:
Purchases of investments	(4,331		)	(19,950		)
Proceeds from maturity/call of investments	10,658			49,633
Purchases of property and equipment	(6,880		)	(9,072		)
Purchases of intangible assets	(460		)	(431		)
Business acquisitions	(4,990		)	(10,629		)
Net cash provided by (used in) investing activities	(6,003		)	9,551
Cash flows from financing activities:
Net proceeds from equity offering	233,993			—
Proceeds from options exercised	713			1,255
Income and payroll tax payments for net-settled stock awards	(11,973		)	(2,830		)
Payment of contingent consideration for a business acquisition	(575		)	—
Net cash provided by (used in) financing activities	222,158			(1,575		)
Effect of exchange rate changes on cash, cash equivalents and restricted cash	(381		)	703
Net increase in cash, cash equivalents and restricted cash	248,410			2,828
Cash, cash equivalents and restricted cash, beginning of period	78,438			43,969
Cash, cash equivalents and restricted cash, end of period	$	326,848		$	46,797
Supplemental disclosures:
Cash and cash equivalents	$	324,371		$	43,471
Restricted cash (Note 6)	2,477			3,326
Total cash, cash equivalents and restricted cash shown in the statements of cash flows	$	326,848		$	46,797
Cash paid for income taxes, net of refunds	$	7,957		$	12,206
Non-cash transactions
Property and equipment purchases in accounts payable and accrued liabilities	$	1,114		$	556
Non-cash purchase consideration related to business combinations	$	12,508		$	1,007

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

3

AXON ENTERPRISE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Organization and Summary of Significant Accounting Policies

Axon Enterprise, Inc. (“Axon,” the “Company,” "we," or "us") 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, we have 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. We sell our products worldwide through our direct sales force, distribution partners, online store and third-party resellers. Axon was incorporated in Arizona in September 1993, and reincorporated in Delaware in January 2001. Our corporate headquarters and manufacturing facilities are located in Scottsdale, Arizona. Our main software development division is located in Seattle, Washington, and we develop artificial intelligence technologies through our wholly-owned subsidiary in Vietnam, Axon Public Safety Southeast Asia LLC. During 2018, we established Axon Public Safety Finland OY in Tampere, Finland that operates a connected hardware team focused on the development of our hardware products. Axon Public Safety BV, a wholly owned subsidiary, supports our international sales and marketing efforts, and is located in Amsterdam, Netherlands. Axon Public Safety BV wholly owns two subsidiaries, Axon Public Safety U.K. Limited and Axon Public Safety Australia Pty Ltd., that serve as direct sales operations in the United Kingdom ("U.K.") and Australia, respectively. We also sell to certain international markets through a wholly-owned subsidiary, Axon Public Safety Germany SE, and sell into the Canadian market through our wholly-owned subsidiary, Axon Public Safety Canada, Inc.

The accompanying unaudited condensed consolidated financial statements include the accounts of Axon Enterprise, Inc. and our wholly owned 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 SEC. Certain information related to our 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 our annual consolidated financial statements for the year ended December 31, 2017, as filed on Form 10-K, with the exception of our adoption of certain accounting pronouncements which we describe below and in Note 2. 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 our 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 our Form 10-K for the year ended December 31, 2017. The results of operations for the nine months ended September 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,

• stock-based compensation,

• 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

Our operations are 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, we specify sales of products and services. Revenue from our “products” in the Software and Sensors segment are generally from 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 our “services” in the Software and Sensors segment comprise sales related to the Axon Cloud, which includes Axon Evidence, 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, we include only

4

AXON ENTERPRISE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

revenues and costs attributable to that segment, which costs 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.

Our 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. We organize and review operations based on products and services. We perform an annual analysis of our reportable segments. Additional information related to our business segments is summarized in Note 14.

Geographic Information and Major Customers

For the three and nine months ended September 30, 2018, and for the nine months ended September 30, 2017 no individual country outside the U.S. represented more than 10% of total net sales. For the three months ended September 30, 2017, one country, the U.K. represented more than 10% of the Company's net sales at 10.5%. Individual sales transactions in the international market are generally larger and occur more intermittently than in the domestic market due to the profile of our customers.

For the three and nine months ended September 30, 2018 and 2017, no customer represented more than 10% of total net sales. At September 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 our 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 September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017
Numerator for basic and diluted earnings per share:
Net income	$	5,711	$	422	$	27,122	$	7,278
Denominator:
Weighted average shares outstanding	58,340		52,831		55,681		52,663
Dilutive effect of stock-based awards	1,465		1,012		1,573		1,099
Diluted weighted average shares outstanding	59,805		53,843		57,254		53,762
Anti-dilutive stock-based awards excluded	6,793		575		6,760		506
Net income per common share:
Basic	$	0.10	$	0.01	$	0.49	$	0.14
Diluted	$	0.10	$	0.01	$	0.47	$	0.14

5

AXON ENTERPRISE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Standard Warranties

We warranty our 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 repair or 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 condensed consolidated balance sheets. 

Changes in our estimated product warranty liabilities were as follows (in thousands):

	Nine Months Ended September 30,
	2018			2017
Balance, beginning of period	$	644		$	780
Utilization of accrual	(384		)	(178		)
Warranty expense	699			117
Balance, end of period	$	959		$	719

Fair Value Measurements and Financial Instruments

The fair value framework 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. We categorize each of our 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 our own assumptions about inputs that market participants would use in pricing an asset or liability.

We have cash equivalents and investments, which at September 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 our cash equivalents and investments in Note 3. Included in the balance of Other assets as of September 30, 2018 and December 31, 2017 was $3.9 million related to corporate-owned life insurance policies which are used to fund our deferred compensation plan. We determine the fair value of insurance contracts by obtaining the cash surrender value of the contracts from the issuer, a Level 2 valuation technique.

Our financial instruments also include accounts and notes receivable, accounts payable and accrued liabilities. Due to the short-term nature of these instruments, their carrying values approximate their fair 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

6

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. During the three months ended September 30, 2018, we abandoned certain developed technology acquired in a business combination resulting in an impairment charge of $2.0 million, which was included in sales, general and administrative expense in the accompanying condensed consolidated statement of operations.

We do 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. We perform our annual goodwill and intangible asset impairment tests in the fourth quarter of each year.

Recently Issued Accounting Guidance

Recently Adopted Accounting Pronouncements

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, we 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 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. We adopted ASU 2016-15 effective January 1, 2018, and the adoption of this ASU did not have a material impact on our condensed 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. We adopted ASU 2016-16 effective January 1, 2018, and the adoption of this ASU did not have a material impact on our condensed 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.  We adopted ASU 2016-18 effective January 1, 2018, and retrospectively updated the presentation of our 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.

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. We adopted ASU 2017-01 effective January 1, 2018, and the adoption of this ASU did not have a material impact on our condensed 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. We adopted ASU 2017-09 effective January 1, 2018, and the adoption of this ASU did not have a material impact on our condensed consolidated financial statements.

In September 2018, the FASB issued ASU 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. The guidance reduces complexity for the accounting for costs of implementing a cloud computing service arrangement and  aligns

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AXON ENTERPRISE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license).  The accounting for the service element of a hosting arrangement that is a service contract is not affected by the amendments. We adopted ASU 2018-15 prospectively effective July 1, 2018, and the adoption of this ASU did not have a material impact on our condensed consolidated financial statements.

Effective the first quarter of 2019:

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which is intended to increase transparency and comparability among organizations by requiring the recognition of right-of-use (“ROU”) assets and lease liabilities on the balance sheet. In July 2018, the FASB issued additional guidance which provided an additional transition method for adopting the updated guidance.  Under the additional transition method, entities may elect to recognize a cumulative-effect adjustment to the opening balance of retained earnings in the year of adoption. We currently plan to adopt this standard using this modified retrospective approach.

Most prominent among the changes in the standard is the requirement for lessees to recognize ROU assets and lease liabilities for those leases classified as operating leases under current U.S. GAAP. The standard requires additional disclosures to enable users of financial statements to assess the amount, timing, and certainty of cash flows arising from leases. We intend to elect certain of the available practical expedients upon adoption. We have evaluated our existing lease portfolio and believe that our population of leases is relatively low in number. We have implemented key processes and controls to enable the accurate assessment of leases and preparation of related financial information.

We are nearing completion of the opening balance sheet adjustment related to ASU 2016-02. We expect adoption of the standard will result in the recognition of ROU assets of between $10 million and $12 million and lease liabilities of between $11 million and $13 million for operating leases as of January 1, 2019, with no impact to retained earnings. Additionally, we anticipate that our accounting for capital leases will remain substantially unchanged.

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. The adoption of this ASU is not expected to have a material impact on our condensed consolidated financial statements.

Effective the first quarter of 2020:

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 includes an impairment model (known as the current expected credit loss model) that is based on expected losses rather than incurred losses. Under the new guidance, an entity recognizes as an allowance its estimate of expected credit losses, which the FASB believes will result in more timely recognition of such losses. The use of forecasted information is intended to incorporate more timely information in the estimate of expected credit loss. Early adoption is permitted.We are currently in the process of evaluating the impact of adoption of ASU 2016-13 on our condensed consolidated financial statements.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement. ASU 2018-13 eliminates, adds and modifies certain disclosure requirements for fair value measurements. The amendments apply to the disclosures of changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. Early adoption is permitted, and an entity is also permitted to early adopt any removed or modified disclosures and delay adoption of the additional disclosures until their effective date. As ASU 2018-13 only revises disclosure requirements, it will not have a material impact on our condensed 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.

8

2. Revenues

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

On January 1, 2018, we 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. We 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 net sales of $2.1 million and $4.4 million, respectively, for the three and nine months ended September 30, 2018, and a net decrease to sales, general and administrative expenses of approximately $0.4 million and $2.0 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	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 we expect to receive in exchange for those products or services. We enter into contracts that can include various combinations of products and services, each of which is generally distinct and accounted for as a separate performance obligation. 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, we allocate the contract transaction price to each performance obligation using our estimate of the standalone selling price ("SSP") of each distinct good or service in the contract.

Performance obligations to deliver products, including CEWs, cameras and related accessories such as cartridges, batteries and docks, are generally satisfied at the point in time we ship 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 Axon Evidence and other cloud services, are generally satisfied over time as the customer receives and consumes the benefits of these services over the stated service period.

9

We have 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 our revenues by primary product and service offering (in thousands):

	Three Months Ended September 30, 2018						Three Months Ended September 30, 2017 (1)
	TASER Weapons		Software and Sensors		Total		TASER Weapons		Software and Sensors		Total
TASER X26P	$	17,998	$	—	$	17,998	$	13,264	$	—	$	13,264
TASER X2	20,392		—		20,392		22,717		—		22,717
TASER Pulse and Bolt	1,402		—		1,402		1,069		—		1,069
Single cartridges	18,406		—		18,406		17,474		—		17,474
Axon Body	—		4,744		4,744		—		4,527		4,527
Axon Flex	—		1,325		1,325		—		2,563		2,563
Axon Fleet	—		1,809		1,809		—		1,113		1,113
Axon Dock	—		2,178		2,178		—		2,639		2,639
Axon Evidence and cloud services	—		23,915		23,915		—		16,200		16,200
TASER Cam	—		717		717		—		922		922
Extended warranties	4,123		3,161		7,284		3,086		1,945		5,031
Other	1,345		3,321		4,666		1,806		937		2,743
Total	$	63,666	$	41,170	$	104,836	$	59,416	$	30,846	$	90,262

	Nine Months Ended September 30, 2018						Nine Months Ended September 30, 2017 (1)
	TASER Weapons		Software and Sensors		Total		TASER Weapons		Software and Sensors		Total
TASER X26P	$	52,618	$	—	$	52,618	$	45,167	$	—	$	45,167
TASER X2	62,686		—		62,686		57,755		—		57,755
TASER Pulse and Bolt	3,849		—		3,849		2,892		—		2,892
Single cartridges	51,763		—		51,763		49,005		—		49,005
Axon Body	—		15,082		15,082		—		11,725		11,725
Axon Flex	—		4,529		4,529		—		7,889		7,889
Axon Fleet	—		6,640		6,640		—		1,113		1,113
Axon Dock	—		7,332		7,332		—		7,409		7,409
Axon Evidence and cloud services	—		64,513		64,513		—		40,698		40,698
TASER Cam	—		2,839		2,839		—		2,407		2,407
Extended warranties	11,567		8,521		20,088		8,920		4,982		13,902
Other	5,331		8,007		13,338		6,364		2,821		9,185
Total	$	187,814	$	117,463	$	305,277	$	170,103	$	79,044	$	249,147

⁽¹⁾ Amounts for the three and nine months ended September 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.

We derive revenue from two primary sources: (1) the sale of physical products, including CEWs, 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 our Axon Evidence digital evidence management SaaS (including secure cloud-based storage fees and other ancillary services), which includes varying levels of support. To a lesser extent, we also recognize revenue from training, professional services and revenue related to other software and cloud services.

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Many of our products and services are sold on a standalone basis. We also bundle our hardware products and services together and sell them to our 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 us at a future date. Additionally, we offer 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 we are obligated to deliver unlimited products at the customer’s request, we account for these arrangements as stand-ready obligations, and recognize revenue ratably over the contract period. Cost of product sales is recognized as the products are shipped to the customer.

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

	Three Months Ended September 30,								Nine Months Ended September 30,
	2018				2017 (1)				2018				2017 (1)
United States	$	88,125	84	%	$	73,203	81	%	$	244,806	80	%	$	204,155	82	%
Other countries	16,711		16		17,059		19		60,471		20		44,992		18
Total	$	104,836	100	%	$	90,262	100	%	$	305,277	100	%	$	249,147	100	%

⁽¹⁾ Amounts for the three and nine months ended September 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.

Contract Balances

The timing of revenue recognition may differ from the timing of invoicing to customers. We generally have an unconditional right to consideration when we invoice our customers and record a receivable. We record 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 our subscription programs where we satisfy 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 our future performance of a SaaS service obligation under the contract. We recognize a portion of the amount allocated to hardware products shipped to the customer as accounts receivable when invoiced to the customer, and record the remaining allocated value as a contract asset as we have generally fulfilled our hardware performance obligation upon shipment.

Contract liabilities generally consist of deferred revenue on our subscription programs where we generally invoice customers at the beginning of each annual period and record 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 our Axon Evidence 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 Axon Evidence 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 our contract assets, contract liabilities and certain information related to these balances as of and for the nine months ended September 30, 2018 (in thousands):

	September 30, 2018
Contract assets, net	$	13,263
Contract liabilities (deferred revenue)	159,019
Revenue recognized in the period from:
Amounts included in contract liabilities at the beginning of the period	63,475

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

	September 30, 2018						December 31, 2017 (1)
	Current		Long-Term		Total		Current		Long-Term		Total
Warranty:
TASER Weapons	$	11,256	$	18,085	$	29,341	$	12,501	$	18,619	$	31,120
Software and Sensors	8,525		5,195		13,720		6,293		4,195		10,488
	19,781		23,280		43,061		18,794		22,814		41,608
Hardware:
TASER Weapons	7,389		15,927		23,316		4,164		11,401		15,565
Software and Sensors	17,681		19,833		37,514		16,956		14,781		31,737
	25,070		35,760		60,830		21,120		26,182		47,302
Software and Sensors Services	44,786		10,342		55,128		30,487		5,885		36,372
Total	$	89,637	$	69,382	$	159,019	$	70,401	$	54,881	$	125,282

	September 30, 2018						December 31, 2017 (1)
	Current		Long-Term		Total		Current		Long-Term		Total
TASER Weapons	$	18,645	$	34,012	$	52,657	$	16,665	$	30,020	$	46,685
Software and Sensors	70,992		35,370		106,362		53,736		24,861		78,597
Total	$	89,637	$	69,382	$	159,019	$	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 September 30, 2018, we had approximately $820 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 September 30, 2018. We expect to recognize between 15% - 20% of this balance over the next twelve months, and expect the remainder to be recognized over the following five to seven years, subject to risks related to delayed deployments, budget appropriation or other contract cancellation clauses.

Costs to Obtain a Contract

We recognize 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, we apply the practical expedient to expense these sales commissions when incurred. These costs are recognized as incurred within sales, general and administrative expenses on the accompanying condensed consolidated statement of operations and comprehensive income.

As of September 30, 2018, our assets for costs to obtain contracts were as follows (in thousands):

	September 30, 2018
Current deferred commissions (1)	$	6,207
Deferred commissions, net of current portion (2)	14,175
	$	20,382

⁽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.

During the three and nine months ended September 30, 2018, we recognized $1.5 million and $3.8 million, respectively, of

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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

Our 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 and contract assets, liabilities, and other accounts will be made accordingly.

Our 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. We consider 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 Axon Evidence and other cloud services.

In contracts where there are timing differences between when we transfer a promised good or service to the customer and when the customer pays for that good or service, we have determined that, with the exception of our TASER 60 installment purchase arrangements, our contracts generally do not include a significant financing component. For the three and nine months ended September 30, 2018, we recorded revenue of $11.9 million and $36.1 million, respectively, including $0.4 million and $1.0 million, respectively, of interest income under our TASER 60 plan. For the three and nine months ended September 30, 2017, we recorded revenue of $7.5 million and $20.8 million, respectively, including $0.2 million and $0.5 million, respectively, of interest income under our TASER 60 plan. Amounts for the three and nine months ended September 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.We analyze separate sales of our products and services as a basis for estimating the SSP of our products and services and then use that SSP as the basis for allocating the transaction price when our 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 we do not sell the product or service separately, we determine the SSP using information that may include market conditions, time value of money and other observable inputs. We typically have 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, we may use information such as 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 our cash, cash equivalents, and held-to-maturity investments at September 30, 2018 and December 31, 2017 (in thousands):

	As of September 30, 2018
	Amortized Cost		Gross Unrealized Losses		Fair Value		Cash and Cash Equivalents		Short-Term Investments
Cash	$	120,539	$	—	$	120,539	$	120,539	$	—
Level 1:
Money market funds	203,832		—		203,832		203,832		—
Level 2:
Corporate bonds	500		—		500		—		500
Total	$	324,871	$	—	$	324,871	$	324,371	$	500

	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

We believe unrealized losses on our 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 we have the ability and intent to hold these investments to maturity, we do not consider these investments to be other than temporarily impaired 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 September 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 September 30, 2018 and December 31, 2017 (in thousands):

	September 30, 2018		December 31, 2017
Raw materials	$	19,942	$	20,119
Finished goods	19,279		25,346
Total inventory	$	39,221	$	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 nine months ended September 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	—			10,285			10,285
Foreign currency translation adjustment	(84		)	(85		)	(169		)
Balance, end of period	$	1,369		$	23,674		$	25,043

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

		September 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	$	(656	)	$	2,505	$	3,161	$	(428	)	$	2,733
Issued patents	4-15 years	2,916		(1,054		)	1,862		2,697		(913		)	1,784
Issued trademarks	3-11 years	1,052		(567		)	485		860		(397		)	463
Customer relationships	4-8 years	3,724		(755		)	2,969		1,377		(451		)	926
Non-compete agreements	3-4 years	545		(423		)	122		556		(346		)	210
Developed technology	3-7 years	15,449		(8,573		)	6,876		13,469		(3,956		)	9,513
Re-acquired distribution rights	2 years	1,973		(1,644		)	329		2,133		(711		)	1,422
Total amortized		28,820		(13,672		)	15,148		24,253		(7,202		)	17,051
Not amortized:
TASER trademark		900					900		900					900
Patents and trademarks pending		908					908		872					872
Total not amortized		1,808					1,808		1,772					1,772
Total intangible assets		$	30,628	$	(13,672	)	$	16,956	$	26,025	$	(7,202	)	$	18,823

During the three months ended September 30, 2018, we abandoned certain developed technology acquired in a business combination resulting in an impairment charge of approximately $2.0 million.

15

AXON ENTERPRISE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Amortization expense of intangible assets for the three and nine months ended September 30, 2018 was $1.6 million and $4.6 million, respectively. Amortization expense of intangible assets for the three and nine months ended September 30, 2017 was $1.4 million and $3.3 million, respectively. Estimated amortization for intangible assets with definite lives for the remaining three months of 2018, the next five years ended December 31, and thereafter, is as follows (in thousands):

2018	$	1,209
2019	3,357
2020	3,296
2021	2,854
2022	1,200
2023	1,393
Thereafter	1,839
Total	$	15,148

6. Other Assets

Other assets consisted of the following at September 30, 2018 and December 31, 2017 (in thousands):

	September 30, 2018		December 31, 2017
Cash surrender value of corporate-owned life insurance policies	$	3,949	$	3,846
Deferred commissions (1)	14,175		6,803
Restricted cash (2)	2,477		3,333
Prepaid expenses, deposits and other	2,795		1,384
Total other long-term assets	$	23,396	$	15,366

⁽¹⁾ Represents assets for the incremental costs of obtaining contracts with customers, which consist primarily of sales commissions. These costs are ascribed to or allocated to the underlying performance obligations in the contracts 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 our adoption of Topic 606, we recorded an adjustment of $7.3 million as of January 1, 2018, and of that amount, $5.4 million was recorded within other assets. The adjusted balance of long-term deferred commissions as of January 1, 2018 was $12.2 million.

⁽²⁾ As of September 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 September 30, 2018, the proceeds are held in escrow until certain billing milestones are achieved, and then specified amounts are transferred to our operating accounts.

7. Accrued Liabilities

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

	2018		2017
Accrued salaries, benefits and bonus	$	15,057	$	8,957
Accrued professional, consulting and lobbying fees	2,910		3,870
Accrued warranty expense	959		644
Accrued income and other taxes	4,913		2,558
Other accrued liabilities	13,069		7,473
Accrued liabilities	$	36,908	$	23,502

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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. We continue to analyze the impact of the Tax Act and expect 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 September 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.

We file income tax returns for federal purposes and in many states, as well as in multiple foreign jurisdictions. Our tax filings remain subject to examination by applicable tax authorities for a certain length of time, generally three to four years, following the tax year to which these filings relate. Our U.S. federal income tax return for fiscal year 2016 is currently under audit by the Internal Revenue Service.

Deferred Tax Assets

Net deferred income tax assets at September 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. Our total net deferred tax assets at September 30, 2018 were $18.1 million.

In preparing our condensed consolidated financial statements, management assesses the likelihood that its deferred tax assets will be realized from future taxable income. In evaluating our ability to recover our deferred income tax assets, management considers all available positive and negative evidence, including our 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 our provisions for income taxes, our deferred tax assets and liabilities, and our future taxable income for purposes of assessing our ability to utilize any future tax benefit from our deferred tax assets.

Although management believes that our 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 September 30, 2018, we continue to demonstrate three-year cumulative pre-tax income in the U.S. federal and Arizona tax jurisdictions; however, our 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 our 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 our deferred tax assets will not be realized and has established a valuation allowance.

We have 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 $3.6 million as of September 30, 2018. In addition, management accrued $0.2 million for estimated uncertain tax positions related to certain federal and state income tax liabilities, for a total liability for unrecognized tax benefit as of September 30, 2018 of $3.8 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 $3.8 million be recognized, our effective tax rate would be favorably impacted. Approximately $2.2 million of the unrecognized tax benefit associated with R&D credits has been netted against the R&D deferred tax asset.

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Effective Tax Rate

Our overall effective tax rate for the nine months ended September 30, 2018, after discrete period adjustments, was (8.1)%. Before discrete adjustments, the tax rate was 24.0%, 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, and 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 an $8.1 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 nine months ended September 30, 2018. Of this amount, $3.4 million related to stock options exercised by our CEO in connection with our follow-on offering, as discussed in Note 9.

9. Stockholders’ Equity

Follow-On Offering

In May 2018, we sold 4,645,000 shares of our 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 after deducting fees, commissions, and other expenses related to the offering were $234.0 million.

CEO Performance Award

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, our 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 for purposes of the CEO Performance Award ("Adjusted EBITDA (CEO Performance Award)") is defined as net income (loss) attributable to common stockholders before interest expense, investment interest income, provision (benefit) for income taxes, depreciation and amortization,and stock-based compensation expense.

Eight Separate Revenue Goals (1) (in thousands)	Eight Separate Adjusted EBITDA (CEO Performance Award) 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 acquisition 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 September 30, 2018, the following operational goals were considered probable of achievement:

• Adjusted EBITDA (CEO Performance Award) of $125.0 million; and

• Total revenue of $710.1 million

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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 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 in sales, general, and administrative operating expense on our condensed 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 September 30, 2018. However, as there are two operational goals considered probable of achievement, we recorded stock-based compensation expense of $1.8 million related to the CEO Performance Award from the Grant Date through September 30, 2018. The number of stock options expected to vest is 1.1 million shares.

As of September 30, 2018, we had $43.4 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 8.3 years. As of September 30, 2018, we had unrecognized stock-based compensation expense of $200.7 million for the performance goals that were considered not probable of achievement.

We measured the grant date 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, our 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 September 30, 2018.

Performance-based stock awards

We have issued performance-based stock options and performance-based RSUs, the vesting of which is contingent upon the achievement of certain performance criteria related to our operating performance, as well as successful and timely development and market acceptance of our products.

RSUs are classified as equity and measured at the fair market value of the underlying stock at the grant date. We recognize 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.

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Restricted Stock Units

The following table summarizes RSU activity for the nine months ended September 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	341		45.52
Released	(556	)	23.62
Forfeited	(248	)	23.79
Units outstanding, end of period	1,885		27.45		$	128,991

Aggregate intrinsic value represents our closing stock price on the last trading day of the period, which was $68.43 per share, multiplied by the number of RSUs outstanding. As of September 30, 2018, there was $39.6 million in unrecognized compensation costs related to RSUs under our stock plans. We expect to recognize the cost related to the RSUs over a weighted average period of 2.43 years years. RSUs are released when vesting requirements are met.

During the nine months ended September 30, 2018, we granted 0.1 million performance-based RSUs. As of September 30, 2018, the performance criteria had not been met for any of the 0.4 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 our 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.

Certain RSUs that vested in the nine months ended September 30, 2018 were net-share settled such that we 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 related to RSUs were 0.1 million and had a value of $5.6 million on their respective vesting dates as determined by the closing stock price on such dates. Payments for the employees’ tax obligations are reflected as a financing activity within the statement of cash flows. We record a liability for the tax withholding to be paid by us as a reduction to additional paid-in capital.

Stock Option Activity

The following table summarizes stock option activity for the nine months ended September 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	(445	)	5.26
Expired / terminated	(43	)	4.46
Options outstanding, end of period	6,682		27.45		9.23	$	238,748
Options exercisable, end of period	311		4.66		0.69	19,871
Options expected to vest, end of period	1,061

Aggregate intrinsic value represents the difference between the exercise price of the underlying stock option awards and the closing market price of our common stock of $68.43 on September 30, 2018. The intrinsic value of options exercised for the nine months ended September 30, 2018 and 2017 was $20.5 million and $2.6 million, respectively. As of September 30, 2018, total options outstanding included 6.4 million unvested performance-based stock options, of which 1.1 million are expected to vest.

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Of the total stock options exercised during the nine months ended September 30, 2018, 0.3 million were exercised and the shares then sold by our CEO in connection with our 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 we 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 closing stock price on that day. Payments for the employees’ tax obligations are reflected as a financing activity within the statement of cash flows. We record a liability for the tax withholding to be paid by us 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 nine months ended September 30, 2018 and 2017 (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017
Cost of products sold and services delivered	$	93	$	134	$	359	$	368
Sales, general and administrative expenses	3,748		2,099		8,783		6,282
Research and development expenses	2,414		1,767		6,160		4,773
Total stock-based compensation	$	6,255	$	4,000	$	15,302	$	11,423

Stock Repurchase Plan

In February 2016, our Board of Directors authorized a stock repurchase program to acquire up to $50.0 million of our outstanding common stock subject to stock market conditions and corporate considerations. During the nine months ended September 30, 2018 and 2017, no common shares were purchased under the program. As of September 30, 2018, $16.3 million remains available under the plan for future purchases. We suspended our 10b5-1 plan during 2016, and any future purchases will be discretionary.

10. Line of Credit

We have a $10.0 million revolving line of credit with a domestic bank. At both September 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 September 30, 2018, we had letters of credit outstanding of $3.1 million under the facility, and available borrowing of $6.9 million. The line is secured by substantially all of our assets, 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. Our agreement with the bank requires us 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 September 30, 2018, our funded debt to EBITDA ratio was 0.001 to 1.00.

11. Commitments and Contingencies

Product Litigation

We are 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/or design defect, and the plaintiffs are seeking monetary damages. The information in this note is current through the date of these financial statements.

As a general rule, it is our policy not to settle suspect injury or death cases. Exceptions are sometimes made where the settlement is strategically beneficial to us. Due to the confidentiality of our litigation strategy and the confidentiality agreements that are executed in the event of a settlement, we do not identify or comment on which specific lawsuits have been settled or the amount of any settlement.

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

We intend to continue our 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 we were 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
Taylor	Mar-17	U.S, District Court, Southern District of Texas	Officer Injury	Dispositive Motion Phase: We filed our motion for summary judgment on April 20, 2018.
Wiggington	Apr-18	U.S, District Court, Western District Court of Missouri	Wrongful Death	Pleading Phase
Lewis	Oct-18	General Court of Justice Superior Court Division, Stanly County, NC	Wrongful Death	Pleading Phase

Through the date of these financial statements, one product liability case was dismissed with prejudice on October 1, 2018. There are no product litigation matters in which we are involved that are currently on appeal.

The claims, and in some instances the defense, of each of these lawsuits have been submitted to our insurance carriers that maintained insurance coverage during the applicable periods. We continue to maintain product liability insurance coverage with varying limits and deductibles. The following table provides information regarding our product liability insurance. Remaining insurance coverage is based on information received from our 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
Jan-Jun 2012	12/15/2011	6/25/2012	7.0		1.0		N	7.0		Ramsey
2015	12/15/2014	12/15/2015	10.0		5.0		N	10.0		Bennett
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, Lewis

Other Litigation

Phazzer Patent Infringement Litigation

In February 2016, we 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 our 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. Phazzer's multiple attempts to stay the injunction pending appeal have been denied by both the district and appellate courts. The appeal was argued on October 2, 2018, and the Federal Circuit issued its opinion affirming the both judgment and injunction in all respects on October 26, 2018.

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On April 4, 2018, the Court entered a judgment for us against Phazzer in an amount exceeding $7.8 million which included an award to us of compensatory and treble damages for willful infringement, and also an award of reasonable attorneys’ fees and costs. Post-judgment collection efforts are underway, but the collectability of this judgment is in doubt since Phazzer has informed the Court it is insolvent. On May 1, 2018, Phazzer appealed the damages award to the Federal Circuit. Briefing is not yet complete.

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 our patent with the U.S. Patent and Trademark Office ("USPTO"). Our 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. We are appealing this decision. Our patent remains valid and enforceable unless and until all appeals are exhausted and the patent is formally canceled (estimated to be at least a 2-year process).

Our 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 are confusingly similar to, or not more than a colorable imitation of, TASER CEW cartridges. During the litigation, Phazzer filed a petition to cancel our 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, we were served with a first amended complaint filed by Digital Ally Inc. (“Digital”) in the U.S. District Court for the District of Kansas (Case No. CV-16-02032-CM-JPO) alleging patent infringement regarding our Axon Signal technology, commercial bribery, antitrust, and unfair competition. In March 2016, we were 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; this ruling was affirmed by the Federal Circuit in May 2018, and the Supreme Court denied certiorari on October 1, 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 one independent claim for resolution by the Court. We believe the remaining claim of the ‘452 patent is invalid and not infringed, and are 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 our invalidity challenge on June 1, 2018. Although this patent is no longer at issue in the litigation, we are 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. Fact discovery concluded on October 8, 2018, and expert reports and discovery are now underway. 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 (at which a trial date will likely be set).

Antoine di Zazzo Arbitration

In April 2016, we were served with a notice of arbitration claim filed by Antoine di Zazzo, our 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. Our records reflect that all commissions that were due Mr. di Zazzo under his contract were paid or offered to him and we 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 us 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

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States who purchased or acquired a TASER Pulse, TASER X2 and TASER X26P model CEW in the four-year period preceding the complaint. Richey claimed his Pulse CEW discharged while in its case in his jacket pocket due to a faulty safety switch. He was not injured. Richey voluntarily dismissed the case on August 9, 2018.

Amani Kendi Kiogora Employment Related Litigation

On October 24, 2018, Amani Kendi Kiogora, a former employee of VIEVU, LLC ("VIEVU"), filed a lawsuit in the Superior Court of Washington for King County (Case No. 18-2-26784-6 SEA) naming us, VIEVU and Safariland, LLC in an employment dispute relating to Washington’s wage laws, laws against discrimination, and the Equal Opportunity Act. Ms. Kiogora claims disparate treatment against her and wrongful withholding of commission payments related to the New York Police Department (NYPD) body worn camera contract while employed with VIEVU. We acquired VIEVU in May 2018; see Note 15 for further discussion. We are tendering this matter to Safariland, LLC for defense and indemnification.

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 awaiting decision. The other three appeals relating to the district court’s April 4, 2018 damages award in our favor (No. 18-1914) and its May 4, 2018 contempt order as to Phazzer (No. 18-2059) and its agent Steven Abboud (No. 20-1857) were consolidated and are in the briefing stage.

We have appealed two decisions from the USPTO proceedings relating (1) to the patent examiner’s rejection of the ‘262 patent in a second reexamination petition filed by Phazzer, and (2) the PTAB’s denial of Axon’s IPR petition regarding Digital’s ‘292 patent (Federal Circuit No. 18-2217). Briefing has not yet begun in either appeal.

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

On or about June 14, 2018, we received a letter from the U.S. Federal Trade Commission (“FTC”) with respect to its non-public investigation into our acquisition of VIEVU, LLC in May of 2018.  In the letter, the FTC has requested that we provide, on a voluntary basis, certain information and documentation relating to our acquisition of VIEVU. We are cooperating with the investigation. 

General

From time to time, we are notified that we may be a party to a lawsuit or that a claim is being made against us. It is our policy to not disclose the specifics of any claim or threatened lawsuit until the summons and complaint are actually served on us. After carefully assessing the claim, and assuming we determine that we are not at fault or we disagree with the damages or relief demanded, we vigorously defend any lawsuit filed against us. In certain legal matters, we record a liability when losses are deemed probable and reasonably estimable. In evaluating matters for accrual and disclosure purposes, we take 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. We reevaluate and update accruals as matters progress over time.

Based on our assessment of outstanding litigation and claims as of September 30, 2018, we have determined that it is not reasonably possible that these lawsuits will individually, or in the aggregate, materially affect our 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 our 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, we use letters of credit and surety bonds to guarantee our performance under various contracts, principally in connection with the installation and integration of Axon cameras and related technologies. Certain of our letters of credit and surety bonds have stated expiration dates with others being released as the contractual performance terms are completed. At September 30, 2018, we had outstanding letters of credit of $3.1 million that are expected to expire in May 2019. Additionally,

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

we had $14.1 million of outstanding surety bonds at September 30, 2018, with $0.6 million expiring in 2018, $0.4 million expiring in 2019, $0.1 million expiring in 2020, $2.4 million expiring in 2021, $3.1 million expiring in 2022 and the remaining $7.5 million expiring in 2023.

Land Lease Purchase Agreement

On September 14, 2018, we entered into a Purchase and Sale Agreement (the "agreement") to purchase a leasehold interest to a parcel of land located in Maricopa County, Arizona for a period of 69 years, on which we intended to construct our new headquarters. On November 2, 2018, we canceled the agreement. We expect our escrow deposit of approximately $0.2 million will be returned, and no further amounts are owed under the agreement.

12. Related Party Transactions

We subscribe to various cloud-based applications from Salesforce. Bret Taylor, a member of our Board of Directors, serves as President and Chief Product Officer of Salesforce. We incur costs at different times throughout the year, typically in advance of services being provided, and subsequently amortize these costs ratably to expense as services are provided over the contractual term. We made payments of $1.7 million related to these services during the nine months ended September 30, 2018, and made payments of $1.2 million during the nine months ended September 30, 2017, respectively. Payments during the three months ended September 30, 2018 and 2017 were each less than $0.1 million.

13. Employee Benefit Plans

We have a defined contribution 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.

We also have 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 us. 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 we do not guarantee a rate of return on deferred balances. Assets related to this plan consist of corporate-owned life 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 our general creditors.

Contributions to the plans are made by both the employee and us. Our contributions to the 401(k) plan are based on the level of employee contributions and are immediately vested. Our matching contributions to the 401(k) plan for the three months ended September 30, 2018 and 2017, were $0.9 million and $0.6 million, respectively, and $2.4 million and $1.9 million for the nine months ended September 30, 2018 and 2017, respectively. Future matching contributions to the plans are at our sole discretion.

14. Segment Data

Our operations are 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, we specify sales of products and services. Revenue from our “products” in the Software and Sensors segment are generally from 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 our “services” in the Software and Sensors segment comprise sales related to the Axon Cloud, which includes Axon Evidence, 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, we include only revenues and costs attributable to that segment which costs include: costs of sales for both products and services, direct labor,

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AXON ENTERPRISE, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

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. Our Chief Executive Officer, who is the CODM, is not provided asset information by segment, and therefore, no asset information is provided.

Information relative to our reportable segments was as follows (in thousands):

	Three Months Ended September 30, 2018						Three Months Ended September 30, 2017 (1)
	TASER Weapons		Software and Sensors		Total		TASER Weapons		Software and Sensors		Total
Net sales from products	$	63,666	$	17,257	$	80,923	$	59,416	$	14,569	$	73,985
Net sales from services	—		23,913		23,913		—		16,277		16,277
Net sales	63,666		41,170		104,836		59,416		30,846		90,262
Cost of product sales	19,256		13,697		32,953		19,237		15,336		34,573
Cost of service sales	—		6,250		6,250		—		5,924		5,924
Cost of sales	19,256		19,947		39,203		19,237		21,260		40,497
Gross margin	44,410		21,223		65,633		40,179		9,586		49,765
Sales, general and administrative