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EX-31.1 - EXHIBIT 31.1 - AXON ENTERPRISE, INC.c91943exv31w1.htm
EX-32 - EXHIBIT 32 - AXON ENTERPRISE, INC.c91943exv32.htm
EX-31.2 - EXHIBIT 31.2 - AXON ENTERPRISE, INC.c91943exv31w2.htm
Table of Contents

 
 
United States Securities and Exchange Commission
Washington, D.C. 20549
Form 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2009
or
     
o   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
TASER INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
     
DELAWARE
(State or other jurisdiction
of incorporation or organization)
  86-0741227
(I.R.S. Employer
Identification Number)
     
17800 N. 85th St., SCOTTSDALE, ARIZONA
(Address of principal executive offices)
  85255
(Zip Code)
(480) 991-0797
(Registrant’s telephone number, including area code)
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 þ       No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes o       No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer o   Accelerated filer þ   Non-accelerated filer o   Smaller reporting company o
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o       No þ
There were 61,970,801 shares of the issuer’s common stock, par value $0.00001 per share, outstanding as of November 3, 2009.
 
 

 

 


 

TASER INTERNATIONAL, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2009
TABLE OF CONTENTS
         
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Items 2,3, 4 and 5 are not applicable.
       
 
       
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32

 

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PART I — FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
TASER INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
                 
    September 30, 2009     December 31, 2008  
 
ASSETS
               
 
               
Current Assets:
               
Cash and cash equivalents
  $ 45,414,569     $ 46,880,435  
Short-term investments
          2,498,998  
Accounts receivable, net of allowance of $200,000 at September 30, 2009 and December 31, 2008, respectively
    16,318,653       16,793,553  
Inventory
    13,227,387       13,467,117  
Prepaids and other assets
    1,771,464       2,528,539  
Deferred income tax assets, net
    9,430,073       9,430,073  
 
           
 
               
Total current assets
    86,162,146       91,598,715  
Property and equipment, net
    35,631,871       27,128,032  
Deferred income tax assets, net
    12,584,846       8,826,778  
Intangible assets, net
    2,624,384       2,447,011  
Other long-term assets
    116,245       14,970  
 
           
 
               
Total assets
  $ 137,119,492     $ 130,015,506  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
 
               
Current Liabilities:
               
Accounts payable
  $ 7,704,600     $ 3,856,961  
Accrued liabilities
    3,847,560       4,275,907  
Current portion of deferred revenue
    6,267,807       2,510,645  
Customer deposits
    293,510       312,686  
 
           
 
               
Total current liabilities
    18,113,477       10,956,199  
Deferred revenue, net of current portion
    4,821,519       4,840,965  
Liability for unrecorded tax benefits
    2,135,401       1,692,080  
 
           
 
               
Total liabilities
    25,070,397       17,489,244  
 
           
 
               
Commitments and Contingencies
               
 
               
Stockholders’ Equity
               
Preferred stock, $0.00001 par value per share; 25 million shares authorized; no shares issued and outstanding at September 30, 2009 and December 31, 2008
           
Common stock, $0.00001 par value per share; 200 million shares authorized; 61,970,635 and 61,795,712 shares issued and outstanding at September 30, 2009 and December 31, 2008, respectively
    641       638  
Additional paid-in capital
    91,553,138       87,663,129  
Treasury stock, 2,091,600 shares at September 30, 2009 and December 31, 2008, respectively
    (14,708,237 )     (14,708,237 )
Retained earnings
    35,203,553       39,570,732  
 
           
 
               
Total stockholders’ equity
    112,049,095       112,526,262  
 
           
 
               
Total liabilities and stockholders’ equity
  $ 137,119,492     $ 130,015,506  
 
           
The accompanying notes are an integral part of these consolidated financial statements.

 

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TASER INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
                                 
    For the Three Months Ended Sept 30,     For the Nine Months Ended Sept 30,  
    2009     2008     2009     2008  
Net Sales
  $ 23,310,457     $ 22,859,459     $ 69,748,635     $ 66,447,272  
 
                       
 
                               
Cost of products sold:
                               
Direct manufacturing expense
    7,372,091       6,286,067       20,081,221       19,877,521  
Indirect manufacturing expense
    2,672,554       2,677,850       8,033,623       6,306,617  
 
                       
 
                               
Total cost of products sold
    10,044,645       8,963,917       28,114,844       26,184,138  
 
                       
 
                               
Gross margin
    13,265,812       13,895,542       41,633,791       40,263,134  
 
                               
Sales, general and administrative expenses
    11,419,527       9,055,060       33,689,688       27,925,704  
Research and development expenses
    6,656,536       3,331,697       15,246,764       8,463,231  
Legal judgment expense
                      5,200,000  
 
                       
 
                               
Income (loss) from operations
    (4,810,251 )     1,508,785       (7,302,661 )     (1,325,801 )
 
                               
Interest and other income, net
    19,994       269,718       162,044       1,492,448  
 
                       
 
                               
Income (loss) before provision (benefit) for income taxes
    (4,790,257 )     1,778,503       (7,140,617 )     166,647  
Provision (benefit) for income taxes
    (1,614,241 )     1,128,126       (2,773,438 )     315,419  
 
                       
 
                               
Net income (loss)
  $ (3,176,016 )   $ 650,377     $ (4,367,179 )   $ (148,772 )
 
                       
 
                               
Income (loss) per common and common equivalent shares
                               
Basic
  $ (0.05 )   $ 0.01     $ (0.07 )   $ (0.00 )
Diluted
  $ (0.05 )   $ 0.01       (0.07 )     (0.00 )
 
                               
Weighted average number of common and common equivalent shares outstanding
                               
Basic
    61,937,769       61,714,889       61,891,638       62,568,846  
Diluted
    61,937,769       63,313,702       61,891,638       62,568,846  
The accompanying notes are an integral part of these consolidated financial statements.

 

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TASER INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
                 
    For the Nine Months Ended September 30,  
    2009     2008  
 
Cash Flows from Operating Activities:
               
Net loss
  $ (4,367,179 )   $ (148,772 )
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Depreciation and amortization
    2,408,269       1,945,526  
Loss on disposal of fixed assets
    63,113       78,207  
Provision for doubtful accounts
    3,000       10,023  
Provision for excess and obsolete inventory
    290,353       375,363  
Provision for warranty
    (31,140 )     409,102  
Stock-based compensation expense
    3,782,181       1,396,113  
Deferred insurance settlement proceeds
          (404,848 )
Deferred income taxes
    (3,758,068 )     295,776  
Provision for unrecognized tax benefits
    443,321        
Litigation judgment expense
          5,200,000  
Change in assets and liabilities:
               
Accounts receivable
    471,900       81,220  
Inventory
    (50,623 )     (4,343,901 )
Prepaids and other assets
    654,798       2,517,471  
Accounts payable and accrued liabilities
    1,831,628       (3,730,394 )
Deferred revenue
    3,737,716       904,595  
Customer deposits
    (19,176 )     25,580  
 
           
 
               
Net cash provided by operating activities
    5,460,093       4,611,061  
 
           
 
               
Cash Flows from Investing Activities:
               
Purchases of investments
          (43,887,640 )
Proceeds from maturity of investments
    2,500,000       56,391,253  
Purchases of property and equipment
    (9,291,237 )     (4,791,190 )
Purchases of intangible assets
    (242,553 )     (446,400 )
 
           
 
               
Net cash provided by (used in) investing activities
    (7,033,790 )     7,266,023  
 
           
 
               
Cash Flows from Financing Activities:
               
Repurchase of common stock
          (12,499,280 )
Proceeds from options exercised
    107,831       320,024  
 
           
 
               
Net cash provided by (used in) financing activities
    107,831       (12,179,256 )
 
           
 
               
Net decrease in cash and cash equivalents
    (1,465,866 )     (302,172 )
Cash and cash equivalents, beginning of period
    46,880,435       42,801,461  
 
           
 
               
Cash and cash equivalents, end of period
  $ 45,414,569     $ 42,499,289  
 
           
 
               
Supplemental Disclosure:
               
Cash paid for income taxes — net
  $ 878,063     $ 473,468  
 
               
Non-Cash Transactions:
               
Deferred tax asset correction
  $     $ 2,014,955  
The accompanying notes are an integral part of these consolidated financial statements.

 

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TASER INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. The Company and Summary of Significant Accounting Policies
TASER International, Inc. (“TASER” or the “Company”) is a developer and manufacturer of advanced electronic control devices (“ECDs”) designed for use in law enforcement, military, corrections, private security and personal defense. In addition, the Company is developing full technology solutions for the capture, storage and management of video/audio evidence as well as other tactical capabilities for use in law enforcement. The Company sells its products worldwide through its direct sales force, distribution partners, online store and third party resellers. The Company was incorporated in Arizona in September 1993 and reincorporated in Delaware in January 2001. The Company’s corporate headquarters and manufacturing facilities are located in Scottsdale, Arizona. The Company’s internet services and software development division facilities are located in Santa Barbara, California.
The accompanying consolidated financial statements include the accounts of the Company, and its wholly owned subsidiary, TASER International Europe SE (“TASER Europe”). TASER Europe was established in the third quarter of 2009 to facilitate sales and provide customer service to our customers in the European region. All material intercompany accounts, transactions, and profits have been eliminated.
a. Basis of presentation, preparation and use of estimates
The accompanying unaudited consolidated financial statements of TASER include all adjustments (consisting only of normal recurring accruals) which in the opinion of management are necessary for the fair presentation of the Company’s operating results, financial position and cash flows as of September 30, 2009 and for the three and nine months ended September 30, 2009 and 2008. The preparation of these consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the amounts reported in these consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates.
Certain information and note disclosures normally included in consolidated financial statements prepared in accordance with U.S. GAAP have been omitted from these unaudited consolidated financial statements in accordance with applicable rules. The results of operations for the three and nine month periods ended September 30, 2009 are not necessarily indicative of the results to be expected for the full year (or any other period) and all results of operations included herein should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.
The Company has evaluated subsequent events through the date and time the consolidated financial statements were issued on November 5, 2009.
b. Segment information and major customers
Management has determined that its operations are comprised of one reportable segment. For the three and nine months ended September 30, 2009 and 2008, sales by geographic area were as follows:
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2009     2008     2009     2008  
 
                               
United States
    81 %     84 %     75 %     86 %
Other Countries
    19 %     16 %     25 %     14 %
 
                       
 
                               
Total
    100 %     100 %     100 %     100 %
 
                       
Sales to customers outside of the United States are denominated in U.S. dollars and are attributed to each country based on the billing address of the distributor or customer. For the three months ended September 30, 2009, sales to Australia represented approximately 15% of total net sales. For the three months ended September 30, 2008, no individual country outside of the U.S. represented a material amount of total net sales. For the nine months ended September 30, 2009 and 2008, no individual country outside of the U.S. represented a material amount of total net sales. Substantially all assets of the Company are located in the United States.
In the three months ended September 30, 2009, two distributors represented approximately 25% and 15% of total net sales. In the three months ended September 30, 2008, one distributor represented approximately 13% of total net sales. In the nine months ended September 30, 2009, one distributor represented approximately 12% of total net sales. In the nine months ended September 30, 2008, one distributor represented approximately 12% of total net sales. At September 30, 2009, the Company had receivables from two customers comprising 30% and 13%, respectively, of the aggregate accounts receivable balance. At December 31, 2008, the Company had receivables from two customers comprising 30% and 12%, respectively, of the aggregate accounts receivable balance. These customers are unaffiliated distributors of the Company’s products.

 

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TASER INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS— Continued
(unaudited)
c. Income (loss) per common share
Basic income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the periods presented. Diluted income (loss) per share reflects the potential dilution that could occur if outstanding stock options were exercised. The calculation of the weighted average number of shares outstanding and earnings per share are as follows:
                                 
    For the Three Months Ended September 30,     For the Nine Months Ended September 30,  
    2009     2008     2009     2008  
Numerator for basic and diluted earnings per share
                               
Net income (loss)
  $ (3,176,016 )   $ 650,377     $ (4,367,179 )   $ (148,772 )
 
                       
 
                               
Denominator for basic earnings per share — weighted average shares outstanding
    61,937,769       61,714,889       61,891,638       62,568,846  
Dilutive effect of shares issuable under stock options outstanding
          1,598,813              
 
                       
 
                               
Denominator for diluted earnings per share — adjusted weighted average shares outstanding
    61,937,769       63,313,702       61,891,638       62,568,846  
 
                       
 
                               
Net income (loss) per common share
                               
Basic
  $ (0.05 )   $ 0.01     $ (0.07 )   $ (0.00 )
Diluted
  $ (0.05 )   $ 0.01     $ (0.07 )   $ (0.00 )
Net income (loss) per share includes the dilutive effect of potential stock option exercises, calculated using the treasury stock method. As a result of the net loss for the three and nine months ended September 30, 2009, we excluded 6,560,918 and 8,171,700 stock options, respectively, from the calculation as their effect would have been to reduce the net loss per share. For the three months ended September 30, 2008, the effects of 3,822,497 stock options were excluded from the calculation of diluted net income per share as their exercise prices were greater than the closing price of our common stock on September 30, 2008. As a result of the net loss for the nine months ended September 30, 2008, we excluded 3,979,808 stock options from the calculation as their effect would have been to reduce the net loss per share.
d. Revenue Recognition
On July 27, 2009, the Company announced a temporary trade-in program to enable agencies who purchase a TASER X26 ECD for deployment in the United States the opportunity to upgrade the product in exchange for a partial credit against the purchase of the newly announced semi-automatic TASER X3 ECD. The Company has accounted for the trade-in right on new sales as a separate element, which has been deferred based on the relative fair value of the credit to the arrangement as a whole. The trade-in offer, which expires on December 31, 2009, resulted in deferred revenue of $3.5 million at September 30, 2009, which is included in current deferred revenue in the accompanying consolidated balance sheet. The Company will recognize the deferred revenue at the earlier of the respective trade-in during the fourth quarter or when the offer expires on December 31, 2009.
e. Warranty costs
The Company warrants its X26, Advanced, TASER Cam, XREP and Shockwave products from manufacturing defects on a limited basis for a period of one year after purchase. The C2 product is warranted for a period of 90 days after purchase. After the one year warranty expires, if the device fails to operate properly for any reason, the Company will replace the X26 for a prorated price depending on when the product was placed into service and replace the ADVANCED TASER device for a fee of $75. These fees are intended to cover the handling and repair costs and provide a profit for the Company. The Company also sells extended warranties, primarily for the X26, for periods of up to four years after the expiration of the limited one year warranty. Management tracks historical data related to returns and warranty costs on a quarterly basis, and estimates future warranty claims based upon historical experience. If management becomes aware of a component failure that could result in larger than anticipated returns from its customers, the reserve would be increased. The reserve for warranty returns is included in accrued liabilities on the consolidated balance sheet. The following table summarizes the changes in the estimated product warranty liabilities for the nine months ended September 30, 2009 and 2008.

 

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TASER INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS— Continued
(unaudited)
                 
    2009     2008  
 
               
Balance at January 1,
  $ 615,031     $ 919,254  
Utilization of accrual
    (286,138 )     (558,593 )
Warranty true up expense (benefit)
    (30,440 )     409,102  
 
           
 
               
Balance at September 30,
  $ 298,453     $ 769,763  
 
           
f. Capitalized software development costs
For development costs related to EVIDENCE.com, the Company’s Software as a Service (SaaS) product, the Company capitalizes qualifying computer software costs that are incurred during the application development stage. Costs related to preliminary project planning activities and post-implementation activities are expensed as incurred. For the three and nine months ended September 30, 2009, the Company capitalized $852,000 and $1,500,000 of qualifying software development costs. The Company will begin amortizing capitalized software development costs over an estimated useful life of 36 months once all final product testing is substantially complete, which is expected to be during the fourth quarter of 2009.
g. Fair value of financial instruments
The Company accounts for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. The Company categorizes each of its fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:
    Level 1 — Valuation techniques in which all significant inputs are unadjusted quoted prices from active markets for assets or liabilities that are identical to the assets or liabilities being measured.
 
    Level 2 — Valuation techniques in which significant inputs include quoted prices from active markets for assets or liabilities that are similar to the assets or liabilities being measured and/or quoted prices for assets or liabilities that are identical or similar to the assets or liabilities being measured from markets that are not active. Also, model-derived valuations in which all significant inputs and significant value drivers are observable in active markets are Level 2 valuation techniques.
 
    Level 3 — Valuation techniques in which one or more significant inputs or significant value drivers are unobservable. Unobservable inputs are valuation technique inputs that reflect our own assumptions about the assumptions that market participants would use in pricing an asset or liability.
h. Recently adopted accounting guidance
On July 1, 2009, the Company adopted the authoritative guidance issued by the Financial Accounting Standards Board (“FASB”) that the Accounting Standard Codification (“ASC”) be recognized as the source of authoritative U.S. generally accepted accounting principles (“U.S. GAAP”). The Codification did not change U.S. GAAP, but instead introduced a new structure that combines all authoritative standards into a comprehensive, topically organized single source of authoritative GAAP. Adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
On July 1, 2009, the Company adopted the guidance issued by the FASB on subsequent events which establishes the accounting for and disclosure of events that occur after the balance sheet date but before consolidated financial statements are issued or are available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date (that is, whether that date represents the date the consolidated financial statements were issued or were available to be issued). See “Basis of presentation, preparation and use of estimates” included in “Note 1 — The Company and Summary of Significant Accounting Policies” for the related disclosure. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

 

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TASER INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS— Continued
(unaudited)
On January 1, 2009, the Company adopted the authoritative guidance issued by the FASB on business combinations. The guidance expands the definition of a business and a business combination; requires the acquirer to recognize the assets acquired, liabilities assumed and non-controlling interests (including goodwill), measured at fair value at the acquisition date; requires acquisition-related expenses and restructuring costs to be recognized separately from the business combination; requires assets acquired and liabilities assumed to be recognized at their acquisition-date fair values with subsequent changes recognized in earnings; and requires in-process research and development to be capitalized at fair value as an indefinite-lived intangible asset. This guidance will impact acquisitions, if any, closed after January 1, 2009.
On January 1, 2009, the Company adopted the authoritative guidance issued by the FASB that changes the accounting and reporting for non-controlling interests. Non-controlling interests are to be reported as a component of equity separate from the parent’s equity, and purchases or sales of equity interests that do not result in a change in control are to be accounted for as equity transactions. In addition, net income or loss attributable to a non-controlling interest is to be included in net income and, upon a loss of control, the interest sold, as well as any interest retained, is to be recorded at fair value with any gain or loss recognized in net income. Adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
On January 1, 2009, the Company adopted the authoritative guidance on fair value measurement for nonfinancial assets and liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements, as management has not adopted the fair value option for any non-financial assets or liabilities.
On January 1, 2009, the Company adopted the authoritative guidance on the determination of the useful life of intangible assets which amended the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under previously issued goodwill and intangible assets guidance. This change was intended to improve the consistency between the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of the asset under topics related to business combinations and other U.S. GAAP. Adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
Recent accounting guidance not yet adopted
In October 2009, the FASB issued authoritative guidance on revenue recognition that will become effective for the Company beginning January 1, 2011, with earlier adoption permitted. Under the new guidance on arrangements that include software elements, tangible products that have software components that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance, and software-enabled products will now be subject to other relevant revenue recognition guidance. Additionally, the FASB issued authoritative guidance on revenue arrangements with multiple deliverables that are outside the scope of the software revenue recognition guidance. Under the new guidance, when vendor specific objective evidence or third party evidence for deliverables in an arrangement cannot be determined, a best estimate of the selling price is required to separate deliverables and allocate arrangement consideration using the relative selling price method. The new guidance includes new disclosure requirements on how the application of the relative selling price method affects the timing and amount of revenue recognition. Management is evaluating the impact that adoption of this new guidance will have on the Company’s consolidated financial statements.
In June 2009, the FASB issued authoritative guidance on the consolidation of variable interest entities, which is effective for the Company beginning January 1, 2010. The new guidance requires revised evaluations of whether entities represent variable interest entities, ongoing assessments of control over such entities, and additional disclosures for variable interests. Management believes adoption of this new guidance will not have a material impact on the Company’s consolidated financial statements.
2. Cash, cash equivalents and investments
Cash and cash equivalents include funds on hand and short-term investments with original maturities of three months or less. Short-term investments include securities generally having maturities of 90 days to one year. Long-term investments include securities having maturities of more than one year. At September 30, 2009, the entire $45.4 million of the Company’s cash and cash equivalents was comprised of cash and money market funds. In February 2009, the Company’s remaining short-term investment in a government sponsored entity was called at par value by the issuing agency.
The Company valued its cash equivalents in money market accounts using observable inputs that reflect quoted prices for securities with identical characteristics, and accordingly, management classified the valuation techniques that use these inputs as Level 1.

 

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TASER INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS— Continued
(unaudited)
3. Inventory
Inventory is stated at the lower of cost or market. Cost is determined using the weighted average cost of raw materials, which approximates the first-in, first-out (FIFO) method, and an allocation of manufacturing labor and overhead. Provisions are made to reduce excess, obsolete or slow-moving inventories to their net realizable value. Inventories as of September 30, 2009 and December 31, 2008 consisted of the following:
                 
    September 30, 2009     December 31, 2008  
 
               
Raw materials and work-in-process
  $ 9,456,429     $ 7,371,608  
Finished goods
    4,035,403       6,225,409  
Reserve for excess and obsolete inventory
    (264,445 )     (129,900 )
 
           
 
               
 
  $ 13,227,387     $ 13,467,117  
 
           
4. Intangible assets
Intangible assets consisted of the following at September 30, 2009 and December 31, 2008:
                                                     
        September 30, 2009   December 31, 2008  
        Gross             Net     Gross             Net        
        Carrying     Accumulated     Carrying     Carrying     Accumulated     Carrying  
    Useful Life   Amount     Amortization     Amount     Amount     Amortization     Amount  
Amortized intangible assets:
                                                   
Domain names
  5 Years   $ 146,753     $ 60,000     $ 86,753     $ 117,756     $ 60,000     $ 57,756  
Issued patents
  4 to 15 Years     832,338       194,447       637,891       677,808       156,297       521,511  
Issued trademarks
  9 to 11 Years     103,179       15,900       87,279       46,283       9,888       36,395  
Non compete agreements
  5 to 7 Years     150,000       99,643       50,357       150,000       79,286       70,714  
 
                                       
 
        1,232,270       369,990       862,280       991,847       305,471       686,376  
 
                                       
Unamortized intangible assets:
                                                   
TASER Trademark
        900,000               900,000       900,000               900,000  
Patents and trademarks pending
        862,104               862,104       860,635               860,635  
 
                                           
 
        1,762,104               1,762,104       1,760,635               1,760,635  
 
                                           
 
                                                   
 
      $ 2,994,374     $ 369,990     $ 2,624,384     $ 2,752,482     $ 305,471     $ 2,447,011  
 
                                       
Amortization expense for the three and nine months ended September 30, 2009 was approximately $21,000 and $65,000, respectively. Amortization expense for the three and nine months ended September 30, 2008 was approximately $21,000 and $58,000, respectively. Estimated amortization expense of intangible assets for the remaining three months of 2009, the next five years ended December 31, and thereafter is as follows:
         
2009 (remainder of year)
  $ 21,820  
2010
    85,726  
2011
    76,102  
2012
    56,103  
2013
    57,882  
2014
    51,441  
Thereafter
    513,206  
 
     
 
  $ 862,280  
 
     

 

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TASER INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS— Continued
(unaudited)
5. Accrued liabilities
Accrued liabilities consisted of the following at September 30, 2009 and December 31, 2008:
                 
    September 30, 2009     December 31, 2008  
 
               
Accrued salaries and benefits
  $ 1,487,708     $ 1,145,634  
Accrued expenses
    2,061,399       2,249,193  
Accrued warranty expense
    298,453       615,031  
Accrued income tax
          266,049  
 
           
 
               
 
  $ 3,847,560     $ 4,275,907  
 
           
6. Income taxes
The deferred income tax assets at September 30, 2009 are comprised of capitalized research and development costs, research and development tax credits, non-qualified stock-based compensation expense, deferred warranty revenue, warranty and inventory reserves and accrued vacation. The Company’s total current and long term deferred tax assets balance at September 30, 2009 is $22.0 million.
In preparing the Company’s consolidated financial statements, management assesses the likelihood that its deferred tax assets will be realized from future taxable income. In evaluating the Company’s ability to recover its deferred income tax assets, management considers all available positive and negative evidence, including its operating results, ongoing tax planning and forecasts of future taxable income on a jurisdiction by jurisdiction basis. A valuation allowance is established if it is determined that it is more likely than not that some portion or all of the net deferred tax assets will not be realized. Management exercises significant judgment in determining its provisions for income taxes, its deferred tax assets and liabilities, and its future taxable income for purposes of assessing its ability to utilize any future tax benefit from its deferred tax assets. Although management believes that its tax estimates are reasonable, the ultimate tax determination involves significant judgment that could become subject to audit by tax authorities in the ordinary course of business, as well as the generation of sufficient future taxable income. Based on consideration of the above factors, management has determined that it is more likely than not that its net operating loss carryforwards for the state of Arizona, which expire in 2009, will be fully realized as a result of significant permanent tax items generating taxable income. Accordingly, the valuation allowance of $200,000 the Company carried against its deferred tax assets as of December 31, 2008 is expected to be reversed and the benefit recognized during 2009 as a reduction of the effective tax rate. Management believes that, other than as previously described, as of September 30, 2009 based on an evaluation and projections of future sales and profitability for the fourth quarter of 2009, no other valuation allowance is necessary. However, such deferred tax assets could be reduced in the future if projections of future taxable income during the carryforward period are reduced.
The effective income tax rate for the first nine months of 2009 was 38.8% compared to 189.3% for the first nine months of 2008. The effective tax rate for the nine months ended September 30, 2009 decreased compared to the same period in the prior year due to the nature of the effective tax rate calculation. Due to a significant variability in the projected 2009 annual effective tax rate caused by relatively small differences in projected fourth quarter results, we were unable to reliably estimate the 2009 effective annual tax rate as of the end of the third quarter and as such calculated an estimated year-to-date tax provision based on current year-to-date results. There will likely be variability in the fourth quarter effective tax rate depending on fourth quarter results and the likelihood that the impact of non-deductible expenses for items such as incentive stock option (“ISO”) expense, meals and entertainment and lobbying, which reduced the effective tax benefit rate in the third quarter, will result in taxable income significantly higher than book pre-tax income. The effective tax rate for the nine months ended September 30, 2008 significantly exceeds the statutory rate due to the impact of certain non-deductible items such as stock-based compensation expense related to ISOs and lobbying expenses against a lower taxable income base expected for the year ended December 31, 2008. The recording of a $250,000 valuation allowance against expiring state (Arizona) net operating loss deferred tax assets resulted in an increase in the effective tax rate in the third quarter of 2008.
The Company has completed research and development tax credit studies which identified approximately $4.0 million in tax credits for Federal and Arizona income tax purposes related to the 2003 through 2008 tax years, net of the federal benefit on the Arizona research and development tax credits. Management has made the determination that it is more likely than not that the full benefit of the research and development tax credit will not be sustained on examination and recorded a liability for unrecognized tax benefits of $2.1 million as of September 30, 2009. Management has estimated that an additional $425,000 of tax credits are available for the nine months ended September 30, 2009. In addition, management accrued approximately $94,000 for estimated uncertain tax positions related to certain state income tax liabilities. As of September 30, 2009, management does not expect the amount of the unrecognized tax benefit liability to increase or decrease significantly within the next 12 months. Should the unrecognized tax benefit of $2.1 million be recognized, the Company’s effective tax rate would be favorably impacted.

 

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TASER INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS— Continued
(unaudited)
The following presents a rollforward of our liability for unrecognized tax benefits as of September 30, 2009:
         
    Unrecognized Tax  
    Benefits  
 
       
Balance at January 1, 2009
  $ 1,692,080  
Increase in prior year tax positions
     
Increase in current year tax positions
    443,321  
Decrease related to adjustment of previous estimates of activity
     
Decrease related to settlements with taxing authorities
     
Decrease related to lapse in statute of limitations
     
 
     
Balance at September 30, 2009
  $ 2,135,401  
 
     
 
       
7. Stockholders’ equity
Stock Option Activity
At September 30, 2009, the Company had four stock-based compensation plans, three of which are described more fully in Note 10 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K. On March 31, 2009, the Company’s Board of Directors approved, subject to stockholder approval, the 2009 Stock Incentive Plan, under which the Company reserved 1,000,000 shares of common stock available for future grants. The 2009 Stock Incentive Plan was approved at the Annual Meeting of Stockholders on May 28, 2009.
The following table summarizes the stock options available and outstanding as of September 30, 2009, as well as activity during the nine months then ended:
                         
            Outstanding Options  
    Shares Available             Weighted Average  
    for Grant     Number of options     Exercise Price  
 
                       
Balance at December 31, 2008
    702,680       9,108,930     $ 5.87  
Granted
    (451,270 )     451,270     $ 4.50  
Exercised
          (174,923 )   $ 0.62  
Expired/terminated
    421,855       (421,855 )   $ 6.28  
Additional shares approved
    1,000,000                
 
                   
Balance at September 30, 2009
    1,673,265       8,963,422     $ 5.86  
 
                   
The options outstanding as of September 30, 2009 have been segregated into five ranges for additional disclosure as follows:
                                         
                            Options Exercisable  
    Options Outstanding             Weighted  
            Weighted     Weighted Average             Average  
    Number     Average     Remaining     Number     Exercise  
Range of Exercise Price   Outstanding     Exercise Price     Contractual Life     Exercisable     Price  
$0.28 – $0.99     821,503     $ 0.35       3.4       821,503     $ 0.35  
$1.03 – $2.41     822,578     $ 1.57       3.0       822,578     $ 1.57  
$3.53 – $9.93     6,424,952     $ 6.14       7.8       3,397,555     $ 6.98  
$10.07 – $19.76     834,089     $ 12.20       6.5       710,560     $ 12.41  
$20.12 – $29.98     60,300     $ 24.00       4.5       60,300     $ 24.00  
                                     
 
 
    8,963,422     $ 5.86       6.8       5,812,496     $ 6.11  
 
                                   

 

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TASER INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS— Continued
(unaudited)
The total fair value of options exercisable at September 30, 2009 and 2008 was $18.5 million and $14.8 million, respectively. The aggregate intrinsic value of options outstanding and options exercisable was $6.7 million and $6.3 million, respectively, at September 30, 2009. Aggregate intrinsic value represents the difference between the Company’s closing stock price on the last trading day of the fiscal period, which was $4.72 per share, and the exercise price multiplied by the number of options outstanding. Total intrinsic value of options exercised for the three and nine month periods ended September 30, 2009 was approximately $193,000 and $721,000, respectively. Total intrinsic value of options exercised for the three and nine month periods ended September 30, 2008 was approximately $93,000 and $2.3 million, respectively.
At September 30, 2009, the Company had 3,150,926 unvested options outstanding with a weighted average exercise price of $5.49 per share, weighted average grant date fair value of $2.82 per share and a weighted average remaining contractual life of 9.3 years. Of these unvested options outstanding, management estimates that approximately 3,017,642 options will ultimately vest based on its historical experience.
As of September 30, 2009, total unrecognized stock-based compensation expense related to unvested stock options was approximately $9.0 million, which is expected to be recognized over a remaining weighted average period of approximately 13 months.
Stock-Based Compensation Expense
The Company calculates the fair value of stock-based awards using the Black-Scholes-Merton option valuation model, which incorporates various assumptions including volatility, expected life, and interest rates. The assumptions used for the periods ended September 30, 2009 and 2008 and the resulting estimates of weighted-average fair value per share of options granted during those periods are as follows:
                                 
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2009     2008     2009     2008  
 
Expected life of options
  4.5 years     4.0 years     4.5 years     4.0 years  
Weighted average volatility
    64.9 %     67.4 %     73.0 %     68.1 %
Weighted average risk-free interest rate
    2.3 %     3.0 %     1.9 %     3.0 %
Dividend rate
    0.0 %     0.0 %     0.0 %     0.0 %
Weighted average fair value of options granted
  $ 2.66     $ 2.93     $ 2.62     $ 3.27  
The expected life of options represents the estimated period of time until exercise and is based on the Company’s historical experience of similar awards, giving consideration to the contractual terms, vesting schedules and expectations of employee exercise patterns. Expected stock price volatility is based on a combination of historical volatility of the Company’s stock and the one-year implied volatility of its traded options for the related vesting periods. The risk-free interest rate is based on the implied yield available on U.S. Treasury zero-coupon issues with an equivalent remaining term. The Company has not paid dividends in the past and does not plan to pay any dividends in the foreseeable future. As stock-based compensation expense is recognized on awards ultimately expected to vest, it is reduced for estimated forfeitures. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company’s forfeiture rate was calculated based on its historical experience of awards which ultimately vested.

 

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TASER INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS— Continue
(unaudited)
Reported share-based compensation was classified as follows for the three and nine months ended September 30, 2009 and 2008:
                                 
    For the Three Months Ended September 30,     For the Nine Months Ended September 30,  
    2009     2008     2009     2008  
 
                               
Cost of Products Sold
  $ 62,154     $ 72,730     $ 260,517     $ 182,838  
Sales, general and administrative expenses
    814,159       442,892       2,441,178       932,015  
Research and development expenses
    146,550       149,997       1,080,486       281,260  
 
                       
 
  $ 1,022,863     $ 665,619     $ 3,782,181     $ 1,396,113  
 
                       
Total share-based compensation expense recognized in the income statement for the three and nine months ended September 30, 2009 includes $480,000 and $2.0 million, respectively, related to Incentive Stock Options (“ISO”s) for which no tax benefit is recognized. Total share-based compensation expense recognized in the income statement for the three and nine months ended September 30, 2008 includes $317,000 and $881,000, respectively, related to Incentive Stock Options (“ISO”s) for which no tax benefit is recognized. The Company did not tax effect the share-based compensation expense for tax purposes related to the non-qualified disposition of ISOs exercised and sold as the benefit will be recorded when the Company is in a position to realize the benefit with an offset to taxes payable in future periods. The total unrecognized tax benefit related to the non-qualified disposition of stock options in the three and nine months ended September 30, 2009, was approximately $193,000 and $721,000 respectively. The total unrecognized tax benefit related to the non-qualified disposition of stock options in the three and nine months ended September 30, 2008 was approximately $136,000 and $201,000, respectively.
The Company granted 826,000 performance-based stock options in 2008 and the first half of 2009, the vesting of which is contingent upon the achievement of certain performance criteria related to the successful and timely development and market acceptance of future product introductions, as well as the future operating performance of the Company. Compensation expense is recognized over the implicit service period (the date the performance condition is expected to be achieved) based on management’s estimate of the probability of the performance criteria being satisfied, adjusted at each balance sheet date. At September 30, 2009, management determined that approximately 100,000 of these options were either forfeited or no longer expected to vest resulting in the reversal of $164,000 of previously recognized compensation expense. The fair value of the performance-based options outstanding and still expected to vest was estimated to be $985,000, and the Company reversed and recognized related compensation expense of $(97,000) and $512,000, respectively, in the three and nine months ended September 30, 2009.
8. Line of credit
The Company has a line of credit agreement with a bank which provides for a total availability of $10.0 million. The line is secured by the Company’s accounts receivable and inventory and bears interest at varying rates of interest, ranging from LIBOR plus 1.5% to prime (3.25% at September 30, 2009). The availability under this line is computed on a monthly borrowing base, which is based on the Company’s eligible accounts receivable and inventory. The line of credit matures on September 30, 2010 and requires monthly payments of interest only. At September 30, 2009, there was no amount outstanding under the line of credit and the available borrowing was $10.0 million. There have been no borrowings under the line of credit to date.
The Company’s agreement with the bank requires the Company to comply with certain financial and other covenants including maintenance of minimum tangible net worth and fixed charge coverage ratios. At September 30, 2009, the Company was in compliance with all such covenants.
9. Commitments and Contingencies
Equipment purchase commitment
On July 2, 2007, the Company entered into a contract with Automation Tooling Systems Inc. for the purchase of equipment at a cost of approximately $8.4 million. The equipment was delivered and installed at the Company’s facility during the third quarter of 2009. Payments have been made in installments, with total installments paid to date of $6.9 million, with the remaining balance of $1.5 million, which was accrued in accounts payable at September 30, 2009, likely to be paid in the fourth quarter upon final acceptance. The installments paid and accrued to date have been recorded in property, plant and equipment in the accompanying balance sheets.
Lease commitment
On June 24, 2009, the Company entered into an operating lease agreement with IBM Credit, LLC for various data center server equipment used to host EVIDENCE.com. Total future minimum lease payments are $882,432 for terms ranging from 36 to 42 months in duration. The equipment was placed in service in the third quarter of 2009.

 

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TASER INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS— Continued
(unaudited)
Legal proceedings
Product Liability Litigation
The Company is currently named as a defendant in 43 lawsuits in which the plaintiffs allege either wrongful death or personal injury in situations in which the TASER device was used (or present) by law enforcement officers or during training exercises. Companion cases arising from the same incident have been combined into one for reporting purposes.
In addition, 97 other lawsuits have been dismissed or judgment entered in favor of the Company which are not included in this number. An appeal was filed by the plaintiff in both the Mann (GA) litigation, Thompson (MI) litigation, and the Neal-Lomax (NV) litigation where judgment was entered in favor of the Company.
Also not included in the number of pending lawsuits is the Heston lawsuit in which a jury verdict was entered against the Company on June 6, 2008, and judgment was entered against the Company on January 30, 2009 in the amount of $153,150 as compensatory damages, $1,423,127 as attorney fees, and $182,000 as costs. These damages, fees and costs are covered by the Company’s insurance policies. The jury found that Mr. Heston’s own actions were 85 percent responsible for his death. The jury assigned 15 percent of the responsibility to TASER for a “negligent failure to warn” that extended or multiple TASER ECD applications could cause muscle contractions that could potentially contribute to acidosis to a degree that could cause cardiac arrest. The jury inappropriately awarded $5,200,000 in punitive damages against TASER, which were subsequently disallowed by the Court on October 24, 2008. The Court denied the balance of the Company’s motion for judgment as a matter of law on all other grounds. The Company has filed a notice of appeal with respect to the judgment and plaintiffs have filed a notice of cross appeal.
With respect to each of the pending 43 lawsuits, the following table lists the name of plaintiff, the date the Company was served with process, the jurisdiction in which the case is pending, the type of claim and the status of the matter. While the facts vary from case to case, the product liability claims are typically based on an alleged product defect resulting in injury or death, usually involving a failure to warn, and the plaintiffs are seeking monetary damages. This table also lists those cases that were dismissed or judgment entered during the most recent fiscal quarter. Cases that were dismissed or judgment entered in prior fiscal quarters are not included in this table. In each of the pending lawsuits, the plaintiff is seeking monetary damages from the Company. The claims and in some instances, the defense of each of these lawsuits has been submitted to our insurance carriers that maintained insurance coverage during these applicable periods and we continue to maintain product liability insurance coverage with varying limits and deductibles. Our product liability insurance coverage during these periods ranged from $5,000,000 to $10,000,000 in coverage limits and from $10,000 to $1,000,000 in per incident deductibles. We are defending each of these lawsuits vigorously and do not expect these to individually and in the aggregate, materially affect our business, results of operations or financial condition.

 

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TASER INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS— Continued
(unaudited)
                 
    Month            
Plaintiff   Served   Jurisdiction   Claim Type   Status
 
               
Glowczenski
  Oct-04   US District Court, ED NY   Wrongful Death   Trial Schedued Feb-2010
Washington
  May-05   US District Court, ED CA   Wrongful Death   Discovery Phase
Sanders
  May-05   US District Court ED CA   Wrongful Death   Discovery Phase, trial scheduled Sept-2010
Graff
  Sep-05   Maricopa Superior Court, AZ   Wrongful Death   Discovery Phase
Heston
  Nov-05   US District Court, ND CA   Wrongful Death   Plaintiff Jury Verdict, punitive damages thrown out, judgment entered against TASER for $153,150 compensatory damages, $1,423,127 attorney fees and $182,000 costs, appeal filed
 
               
Rosa
  Nov-05   US District Court, ND CA   Wrongful Death   Trial Scheduled Dec — 09
Yeagley
  Nov-05   Hillsborough County Circuit County, FL   Wrongful Death   Discovery Phase
Neal-Lomax
  Dec-05   US District Court, NV   Wrongful Death   Dismissed, Appeal Pending
Mann
  Dec-05   US District Court, ND GA, Rome Div   Wrongful Death   Dismissed, Appeal Pending
Zaragoza
  Feb-06   CA Superior Court, Sacramento County   Wrongful Death   Dismissed
Bagnell
  Jul-06   Supreme Court for British Columbia, Canada   Wrongful Death   Discovery Phase
Hollman
  Aug-06   US District Court, ED NY   Wrongful Death   Discovery Phase
Oliver
  Sep-06   US District Court, MD FL, Orlando Division   Wrongful Death   Trial Stayed
Teran/LiSaola
  Oct-06   US District Court, ND CA   Wrongful Death   Taken off Trial Calendar
Augustine
  Jan-07   11th Judicial Circuit Court, Miami-Dade, FL   Wrongful Death   Discovery Phase
Bolander
  Aug-07   17th Circuit Court Broward County, FL   Wrongful Death   Dismissed
Wendy Wilson, Estate of Ryan Wilson
  Aug-07   District Court Boulder County, CO   Wrongful Death   Discovery Phase
 
               
Crawford, Estate of Russell Walker
  Oct-07   District Court Clark County, NV   Wrongful Death   Dismissed, Summary Judgment Granted
Walker, Estate of Russell Walker (Companion to Crawford)
  Oct-07   US District Court District of NV   Wrongful Death   Dismissed, Summary Judgment Granted
Jack Wilson, Estate of Ryan Wilson (Companion to Wendy Wilson)
  Nov-07   District Court Boulder County, CO   Wrongful Death   Discovery Phase
Marquez
  Jun-08   US District Court, Arizona   Wrongful Death   Discovery Phase
Preyer
  Jul-08   US District Court, Middle District, FL   Wrongful Death   Dismissed
Salinas
  Aug-08   US District Court, Northern District CA   Wrongful Death   Trial Scheduled April-2010
Thomas (Pike)
  Oct-08   US District Court, WD Louisiana, Alexandria   Wrongful Death   Discovery Phase
Haake
  Nov-08   US District Court, Kansas   Wrongful Death   Dismissed
Dwyer
  Nov-08   US District Court, ED TX, Marshall Division   Wrongful Death   Discovery Phase
Nykiel
  Dec-08   Common Pleas Court, Allegheny County, PA   Wrongful Death   Discovery Phase
Carroll
  Mar-09   US District Court, Southern District TX   Wrongful Death   Discovery Phase
Shrum
  May-09   Allen County District Court, Iola, Kansas   Wrongful Death   Discovery Phase
Athetis
  May-09   Maricopa Superior Court, AZ   Wrongful Death   Discovery Phase
Hagans
  May-09   Common Pleas Court, Franklin County, OH   Wrongful Death   Discovery Phase-trial scheduled May — 2010
Martinez
  May-09   US District Court, SD CA   Wrongful Death   Discovery Phase
Bartley
  Jun-09   US District Court, ED LA   Wrongful Death   Discovery Phase
Sapinoso
  Jul-09   CA Superior Court, Los Angeles, S Central Dist.   Wrongful Death   Discovery Phase-trial scheduled Oct — 2010
Abrahams
  Jul-09   CA Superior Court, Yolo County   Wrongful Death   Discovery Phase-trial scheduled Oct — 2010
Humphreys
  Oct-09   CA Superior Court, San Joaquin County   Wrongful Death   Complaint Served
Stewart
  Oct-05   Circuit Court for Broward County, FL   Training Injury   Discovery Phase
Lewandowski
  Jan-06   US District Court, NV   Training Injury   Summary judgment motion pending
Peterson
  Jan-06   US District Court, NV   Training Injury   Trial scheduled Jan — 2010
Husband
  Mar-06   British Columbia Supreme Court, Canada   Training Injury   Discovery Phase
Perry
  Jul-08   US District Court CO   Training Injury   Dismissed
Grable
  Aug-08   FL 6th Judicial Circuit Court, Pinellas County   Training Injury   Discovery Phase
Koon
  Dec-08   17th Judicial Circuit Court, Broward County, FL   Training Injury   Discovery Phase
Bickle
  Mar-09   18th Judicial District Court, Gallatin County, MT   Training Injury   Discovery Phase
Foley
  Mar-09   US District Court, MA   Training Injury   Discovery Phase
Peppler
  Apr-09   Circuit Court 5th Judicial Dist., Sumter City, FL   Training Injury   Discovery Phase
Kandt
  Jun-09   US District Court, ND NY   Training Injury   Complaint Served
Wieffenbach
  Jun-06   Circuit Court of 12th Judicial District, Will County, Il   Injury During Arrest   Discovery Phase
Payne
  Oct-06   Circuit Court of Cook County, Illinois   Injury During Arrest   Discovery Phase
Butler
  Sep-08   CA Superior Court, Santa Cruz County   Injury During Arrest   Discovery Phase, trial scheduled Mar — 2010
Reston
  Apr-09   Circuit Court 4th Judicial Dist., Duval Cty, FL   Injury During Arrest   Discovery Phase
Lucas
  Jun-09   US District Court, ED CA   Injury During Arrest   Discovery Phase
Spence
  Jul-09   CA Superior Court, Marin County   Injury During Arrest   Discovery Phase
Wheat
  Jul-09   CA Superior Court, Los Angeles County   Injury During Arrest   Discovery Phase, trial scheduled Aug — 2010

 

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TASER INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — Continued
(unaudited)
Other Litigation
In November 2006, we filed a lawsuit against the Chief Medical Examiner of Summit County, OH, in the Court of Common Pleas of Summit County Ohio, to seek the correction of erroneous cause of death determinations relating to autopsy reports prepared by medical examiner, Dr. Lisa Kohler, which determined that the TASER device was a contributing factor in the deaths of Richard Holcomb, Dennis Hyde and Mark McCullaugh. We asked the Court to order a hearing on the appropriate causes of death of Messrs. Hyde, Holcomb and McCullaugh, and to order changes in the medical examiner’s cause of death determinations for Messrs. Hyde, Holcomb and McCullaugh removing all references to any TASER device causing or contributing to the causes of death for Messrs. Hyde, Holcomb and McCullaugh. Defendant filed a motion to dismiss for lack of standing and that motion was denied by the Court in January 2007. The City of Akron joined this lawsuit as a co-plaintiff. This case went to trial in April 2008 and on May 2, 2008, the Court entered an order ruling in favor of TASER and the City of Akron and ordered the medical examiner to remove any reference to the TASER device as a cause of death and to change the manner of death for Holcomb and Hyde to accidental and for McCullaugh to undetermined. Defendant filed an appeal and on March 30, 2009, the Ohio’s 9th Judicial District Court of Appeals entered an order affirming the trial court’s order. On May 15, 2009, Defendant filed an appeal to the Ohio Supreme Court, and the Company and the City of Akron have filed responsive briefs.
In January 2007, we filed a lawsuit in the U.S. District Court for Arizona against Stinger Systems, Inc. alleging patent infringement, patent false marking, and false advertising. Defendant filed an answer and counterclaim for false advertising and punitive damages. Discovery has begun and no trial date has been set. On February 2, 2009, the court issued an order based on a Markman hearing (patent claims construction hearing) held on May 7, 2008 in which the Court adopted TASER’s claim construction on the disputed patent claim term in TASER’s U.S. patent number 7,102,870 and all of TASER’s claim construction on all of the disputed patent claim terms in TASER’s U.S. patent number 7,234,262. In addition, the Court adopted TASER’s claim construction on one of the disputed patent claim terms in TASER’s U.S. patent number 6,999,295 and rejected both parties’ claim construction in the other disputed claim term in this patent. Discovery is ongoing and no trial date has been sent. Both parties have filed motions for summary judgment.
In October 2007, we filed a lawsuit in Arizona Superior Court for Maricopa County against Steve Ward and Mark Johnson, both former TASER employees and VIEVU LLC, et. al. for breach of duty of loyalty, breach of contract, breach of fiduciary duty, and conversion. This lawsuit does not involve our electronic control device business and we do not expect this litigation to have a material impact on our financial results. Defendants Ward and VIEVU LLC filed an answer and counterclaim for declaration of non-infringement, tortious interference with contractual relations, tortious interference with business expectancy, and abuse of process. The lawsuit seeks compensatory damages, constructive trust, exemplary damages, injunctive relief attorneys’ fees, costs and disbursements. Discovery has begun and no trial date has been set. Cross motions for summary judgment were filed and on March 4, 2009, the Court denied Defendants’ motion for summary judgment on the trade secret claim and on April 9, 2009, the Court granted TASER’s motion for summary judgment against Ward on the breach of fiduciary duty and the breach of duty of loyalty claims. We filed a Motion to Extend Discovery Period by and to Reconvene the Deposition of Steve Ward, and Defendants have filed Defendant’s Response in Opposition to this motion. In addition, Defendants Steve Ward and VIEVU LLC have filed a Motion for Reconsideration or in the alternative to make the Court’s Ruling a Final Judgment and Stay Proceeding Pending Outcome of Appeal. The Court denied the Motion for Reconsideration, but granted the motion to make the Court’s Ruling a Final Judgment and Stayed the Proceeding Pending Outcome of Appeal. An appeal has been filed by Defendants to the Arizona State Court of Appeals.
In June 2008, we filed an amended complaint in the State Court of Fulton County, Georgia joining as a plaintiff in an existing lawsuit previously filed by certain current and former stockholders of the Company against Morgan Stanley & Co., Inc., and ten other brokerage firms alleging a conspiracy to unlawfully, deceptively, and fraudulently manipulate the price of the Company’s common stock in the context of illegal naked shorting. Specifically, the amended complaint alleges that the defendants committed conspiracy and endeavored to violate the Georgia Racketeer Influenced and Corrupt Organization Act; Securities Fraud; Theft By Taking; Theft By Deception; Violation of The Georgia Computer Systems Protection Act; Violation of the Georgia Securities Act; Violation of the Georgia Computer Systems Protection Act; and Conversion. The lawsuit seeks compensatory and punitive damages as well as expenses of litigation including attorneys’ fees and costs. Defendants have filed motions to dismiss or alternatively a motion for a more definite statement and, on July 29, 2009, the Court entered an order denying Defendants’ motion to dismiss and alternatively a motion for a more definite statement. Discovery has begun in this litigation.

 

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TASER INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS— Continued
(unaudited)
In July 2008, we were served with a summons and complaint in the lawsuit entitled Proformance Vend USA vs. TASER International, Inc. which was filed in Arizona Superior Court for Maricopa County alleging breach of contract of a vending machine contract and seeking money damages, including tort damages, attorney’s fees and costs. We have filed an answer to this complaint. Discovery has begun and no trial date has been set.
In February 2009, we filed a complaint in the United States District Court for the District of Nevada against James F. McNulty, Jr., Robert Gruder, and Stinger Systems, Inc. alleging securities fraud under 15 U.S.C. § 78j, trade libel, unfair competition under the Lanham Act, 15 U.S.C. § 1125, abuse of process, and deceptive trade practices. Our complaint seeks compensatory damages, punitive damages, injunctive relief, attorneys’ fees and costs. Motions to dismiss are pending.
General
From time to time, the Company is notified that it may be a party to a lawsuit or that a claim is being made against it. It is the Company’s policy to not disclose the specifics of any claim or threatened lawsuit until the summons and complaint are actually served on the Company. After carefully assessing the claim, and assuming we determine that we are not at fault, we vigorously defend and pursue any lawsuit filed against or by the Company. Although we do not expect the outcome in any pending individual case to be material, 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 provided by insurance coverage and will not have a material adverse effect on our business, operating results or financial condition. In addition, the Company has seven lawsuits where the costs of legal defense incurred are in excess of its liability insurance deductibles. As of September 30, 2009, the Company has been fully reimbursed by its insurance company for these legal costs. The Company may settle a lawsuit in situations where a settlement can be obtained for nuisance value and for an amount that is expected to be less than the cost of defending a lawsuit. The number of product liability lawsuits dismissed includes a small number of police officer training injury lawsuits that were settled by the Company and dismissed in cases where the settlement economics to the Company were significantly less than the cost of litigation. One of the training injury lawsuits brought by a law enforcement officer was settled in June 2007 for an amount in excess of nuisance value by our insurance company. Our insurance coverage at that time did not cover our costs of defense if we won at trial. However, our insurance coverage at that time provided for a pro-rata reimbursement of our costs of defense if the lawsuit was settled. Upon final settlement of this case, the Company was paid $241,000 by our insurance company as reimbursement of the Company’s costs of defense. Due to the confidentiality of our litigation strategy and the confidentiality agreements that are executed in the event of a settlement, the Company does not identify or comment on which specific lawsuits have been settled or the amount of any settlement.
10. Related Party Transactions
Aircraft charter
The Company reimburses Thomas P. Smith, Chairman of the Company’s Board of Directors, and Patrick W. Smith, the Company’s Chief Executive Officer, for business use of their personal aircraft. For the three and nine months ended September 30, 2009, the Company incurred expenses of approximately $88,000 and $238,000, respectively, to Thomas P. Smith. For the three and nine months ended September 30, 2008, the Company incurred expenses of approximately $18,000 and $161,000, respectively, to Thomas P. Smith. For the nine months ended September 30, 2009, the Company incurred expenses of approximately $10,000 to Patrick W. Smith. No expense was incurred for the three months ended September 30, 2009. For the three and nine months ended September 30, 2008, the Company incurred expenses of approximately $5,000 and $107,000 to Patrick W. Smith. At September 30, 2009 and December 31, 2008, the Company had outstanding payables of approximately $38,000 and $0, respectively, due to Thomas P. Smith. At September 30, 2009 and December 31, 2008, the Company had no outstanding payables due to Patrick W. Smith. Management and the Audit Committee believes that the rates charged by Thomas P. Smith and Patrick W. Smith are equal to or below commercial rates the Company would pay to charter similar aircraft from independent charter companies.
In the first quarter of 2007, the Company also entered into a charter agreement for future use of an aircraft for business travel from Thundervolt, LLC, a company owned by Patrick W. Smith. For the three and nine months ended September 30, 2009 and 2008, the Company did not incur any direct charter expenses pursuant to its relationship with Thundervolt, LLC. Management and the Audit Committee believes that the rates charged by Thundervolt, LLC are equal to or below commercial rates the Company would pay to charter similar aircraft from independent charter companies.
The Company performed a review of the above relationship with Thundervolt, LLC, and determined that the relationship did not meet the definition of a variable interest entity (VIE) as Thundervolt, LLC is adequately capitalized, its owners possess all of the essential characteristics of a controlling financial interest, and the Company does not have any voting rights in the entity. Therefore, the entity is not required to be consolidated into the Company’s results.

 

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TASER INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS— Continued
(unaudited)
TASER Foundation
In November 2004, the Company established the TASER Foundation. The TASER Foundation is a 501(c)(3) non-profit corporation and has been granted tax exempt status by the IRS. The TASER Foundation’s mission is to honor the service and sacrifice of local and federal law enforcement officers in the United States and Canada lost in the line of duty by providing financial support to their families. Over half of the initial $1 million endowment was contributed directly by TASER International, Inc. employees. The Company bears all administrative costs of the TASER Foundation in order to ensure 100% of all donations are distributed to the families of fallen officers. For the three and nine months ended September 30, 2009, the Company incurred approximately $66,000 and $184,000, respectively, in such administrative costs. For the three and nine months ended September 30, 2008 the Company incurred approximately $30,000 and $137,000, respectively, in such administrative costs. The Company is authorized by its Board of Directors to make a discretionary contribution up to a maximum of $200,000 per quarter. For the three and nine months ended September 30, 2009 and 2008, the Company did not make a discretionary contribution to the TASER Foundation.
Consulting services
Beginning in August 2005, the Company agreed to pay Mark Kroll, a member of the Board of Directors of the Company (“Board”), for consultancy services. Consulting expenses to Mr. Kroll for the three and nine months ended September 30, 2009 were approximately $57,000 and $202,000, respectively. Consulting expenses to Mr. Kroll for the three and nine months ended September 30, 2008 were approximately $42,000 and $225,000, respectively. At September 30, 2009 and December 31, 2008, the Company had approximately $19,000 and $23,000, respectively, recorded as a payable for these services.
Settlement agreement
On May 15, 2009, Bruce and Donna Culver, husband and wife (the “Culvers”), and the Company, entered into a settlement and release agreement (the “Agreement”), the background and material terms of which are described below. Mr. Culver has served as a director of the Company since January 1994. In addition, he currently chairs the Nominating Committee of the Board and is a member of the Audit Committee of the Board.
In July 2000, the Culvers provided a loan to the Company in exchange for a promissory note and warrants to purchase 136,364 shares of the Company’s common stock for $0.55 per share. In October 2004, the Culvers exercised the warrants, and the Company issued them a Form 1099, which included the in-the-money value of the warrants as stock compensation based upon the advice of the Company’s then-current outside tax advisors. In 2007, the Culvers informed the Company that their personal tax advisors had determined that the 2004 Form 1099 was not the proper tax treatment for the transaction, and that the value of the warrants should not have been included as compensation because the warrants were issued in connection with the loan rather than services. The Company responded by issuing an amended Form 1099 excluding the value of the warrants, and the Culvers filed an amended 2004 federal tax return seeking a refund. The Culvers are also seeking a refund with respect to their 2004 California tax return.
The parties entered into the Agreement to settle any disputes that the Culvers might have with the Company in connection with the original Form 1099 that was issued in October 2004 and the Culvers’ resulting tax liability. Pursuant to the Agreement, the Company agreed to pay the Culvers $350,000 upon execution in exchange for a full release. The Agreement also contains a claw-back provision, pursuant to which the Culvers agreed to pay to the Company the amount of any refund they receive from the federal government and/or the State of California, up to the $350,000 amount of the settlement payment. The Culvers will be entitled to keep 100% of any refund(s) they receive in excess of $350,000. As of September 30, 2009 the Culvers had not received any tax refunds.
11. Employee Benefit Plan
The Company has a defined contribution profit sharing 401(k) plan (the “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 allowed by law of their eligible compensation, but not exceeding $16,500. The Company currently matches 100% of the first 3% of eligible compensation contributed to the Plan by each participant and 50% of the next 2% of eligible compensation contributed to the plan by each participant. Beginning January 1, 2008, the Company’s matching contributions are immediately vested. The Company’s matching contributions to the Plan for the three and nine months ended September 30, 2009 were $119,000 and $348,000, respectively. The Company’s matching contributions to the Plan for the three and nine months ended September 30, 2008 were $104,000 and $300,000, respectively. Future matching or profit sharing contributions to the Plan are at the Company’s sole discretion.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following is a discussion of the Company’s financial condition as of September 30, 2009, and results of operations for the three and nine months ended September 30, 2009 and 2008. The following discussion may be understood more fully by reference to the consolidated financial statements, notes to the consolidated financial statements, and Management’s Discussion and Analysis of Financial Condition and Results of Operations section contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008.
Certain statements contained in this report may be deemed to be forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995, and the Company intends that such forward-looking statements be subject to the safe-harbor created thereby. Such forward-looking statements may relate to, among other things: estimates regarding the size of our target markets; successful penetration of the law enforcement market; expansion of product sales to the private security, military and consumer self-defense markets; expansion of production capability; new product introductions; the timing of the implementation of new equipment and payments relating thereto; our anticipated research and development spending in the fourth quarter of 2009; our cash flow activity in accounts receivable, inventory and accounts payable in the fourth quarter of 2009; projections about our fourth quarter effective tax rate; estimates regarding the commencement and amortization period of software development costs relating to our EVIDENCE.com product; the impact of recently adopted accounting guidance; our dividend policy; our anticipated capital expenditures in the fourth quarter of 2009; our expectations that we will hold certain investments until maturity; our expectations about unrecognized tax benefits, deferred income taxes and the reversal of our valuation allowance; assumptions about the future vesting of outstanding stock options and the amortization of costs relating thereto; our litigation strategy; the outcome of pending litigation including that judgments against us may be reversed or reduced; trends about our working capital and the sufficiency of our capital resources and the availability of financing to the Company. We caution that these statements are qualified by important factors that could cause actual results to differ materially from those reflected by the forward-looking statements herein. Such factors include, but are not limited to: market acceptance of our products; establishment and expansion of our direct and indirect distribution channels; attracting and retaining the endorsement of key opinion-leaders in the law enforcement community; the level of product technology and price competition for our products; the degree and rate of growth of the markets in which we compete and the accompanying demand for our products; potential delays in international and domestic orders; implementation risks of manufacturing automation; risks associated with rapid technological change; execution and implementation risks of new technology; new product introduction risks; ramping manufacturing production to meet demand; litigation resulting from alleged product-related injuries; risks related to government inquiries; media publicity concerning allegations of deaths occurring after use of the TASER device and the negative impact this publicity could have on sales; product quality risks; potential fluctuations in quarterly operating results; competition; financial and budgetary constraints of prospects and customers; dependence upon sole and limited source suppliers; fluctuations in component pricing; risks of governmental regulations; dependence on a single product; dependence upon key employees; employee retention risks; and other factors detailed in the Company’s filings with the Securities and Exchange Commission. We assume no obligation to update, and do not intend to update, our forward-looking statements.
Overview
Our mission is to protect life by providing safer, more effective use of force options and technologies. We are a market leader in the development and manufacture of advanced electronic control devices (ECDs) designed for use in law enforcement, military, corrections, private security and personal defense. In addition, we are developing full technology solutions for the capture, storage and management of video/audio evidence as well as other tactical capabilities for use in law enforcement. We have focused our efforts on the continuous development of our technology for both new and existing products as well as industry leading training services while building distribution channels for marketing our products and services to law enforcement agencies, primarily in North America with increasing efforts on expanding these programs in international markets. To date, over 14,000 law enforcement agencies in over 45 countries have made initial purchases of our TASER brand devices for testing or deployment. To date, we do not know of any significant sales of any competing ECD products.
Our core expertise includes proprietary, patented technology which is capable of incapacitating highly focused and aggressive persons. Competing non-lethal weapons rely primarily on pain to dissuade subjects from continuing unwanted behavior. Our proprietary Neuro-Muscular Incapacitation (NMI) technology uses electrical impulses to interfere with a person’s neuron-muscular system, causing substantial incapacitation regardless of whether the person feels or responds to pain. Our NMI technology stimulates the motor nerves which control muscular movement.

 

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Results of Operations
Three Months Ended September 30, 2009 Compared to the Three Months Ended September 30, 2008
The following table sets forth, for the periods indicated, our consolidated statements of operations as well as the percentage relationship to total net sales of items included in our consolidated statements of operations (dollars in thousands):
                                                 
    Three Months Ended September 30,     Increase / (Decrease)  
    2009     2008     $     %  
 
                                               
Net sales
  $ 23,310       100.0 %   $ 22,859       100.0 %   $ 451       2.0 %
Cost of products sold
    10,044       43.1 %     8,964       39.2 %     1,080       12.0 %
 
                                     
Gross margin
    13,266       56.9 %     13,895       60.8 %     (629 )     -4.5 %
Sales, general and administrative expenses
    11,420       49.0 %     9,055       39.6 %     2,364       26.1 %
Research and development expenses
    6,656       28.6 %     3,332       14.6 %     3,324       99.8 %
 
                                     
Income (loss) from operations
    (4,810 )     -20.6 %     1,508       6.6 %     (6,317 )     -419.0 %
Interest and other income, net
    20       0.1 %     270       1.2 %     (250 )     -92.6 %
 
                                     
Income (loss) before provision (benefit) for income taxes
    (4,790 )     -20.5 %     1,778       7.8 %     (6,567 )     -369.4 %
Provision (benefit) for income taxes
    (1,614 )     -6.9 %     1,128       4.9 %     (2,742 )     -243.1 %
 
                                     
Net income (loss)
  $ (3,176 )     -13.6 %   $ 650       2.8 %   $ (3,826 )     -588.3 %
 
                                     
Net Sales
For the three months ended September 30, 2009 and 2008, sales by product line and by geography were as follows (dollars in thousands)
                                 
    Three Months Ended September 30,  
    2009     2008  
Sales by Product Line
                               
 
                               
TASER X26
  $ 14,870       63.8 %   $ 13,169       57.6 %
TASER C2
    1,103       4.7 %     1,008       4.4 %
TASER Cam
    749       3.2 %     964       4.2 %
ADVANCED TASER
    281       1.2 %     377       1.6 %
Single Cartridges
    6,932       29.7 %     5,066       22.2 %
XREP
    364       1.6 %            
Shockwave
    41       0.2 %            
X3
    8                    
Other
    2,428       10.4 %     2,275       10.0 %
Trade-In Deferral
    (3,466 )     -14.9 %            
 
                           
 
                               
Total
  $ 23,310       100.0 %   $ 22,859       100.0 %
 
                           
                 
    Three Months Ended September 30,  
    2009     2008  
 
United States
    81 %     84 %
Other Countries
    19 %     16 %
 
           
 
               
Total
    100 %     100 %
 
           
Net sales increased $0.5 million, or 2.0%, to $23.3 million for the third quarter of 2009 compared to $22.9 million for the third quarter of 2008. The increase in sales versus the prior year quarter was primarily driven by growth in our Federal business including an order from the U.S. Customs and Border Patrol as well as solid international sales during the quarter including follow-on orders to customers in Australia. The growth in international business offset a decline in domestic sales, which we believe reflects lower municipal spending in the U.S., as agencies have reassigned or reduced budget dollars due to ongoing economic constraints. During the third quarter of 2009, $3.5 million of revenue was deferred related to our temporary trade-in program which enables agencies who purchase a X26 ECD for deployment in the United States the opportunity to upgrade the product in exchange for a partial trade-in credit against the purchase of the newly announced X3 ECD. Sales of our X26 ECDs, before excluding the $3.5 million impact of the trade-in deferral, increased $1.7 million, or 12.9%, while sales of single cartridges increased $1.9 million, or 36.8%, compared to the prior year. Sales of the TASER C2 consumer product increased by $95,000, or 9.4%. Other sales include extended warranty revenue, out of warranty repairs, government grants, training and shipping revenues.
International sales for the third quarter of 2009 and 2008 represented approximately $4.5 million, or 19%, and $3.7 million, or 16%, of total net sales, respectively.

 

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Cost of Products Sold
Cost of products sold increased by $1.1 million, or 12.1%, to $10 million for the third quarter of 2009 compared to $9.0 million for the third quarter of 2008. As a percentage of net sales, cost of products sold increased to 43.1% in the third quarter of 2009 compared to 39.2% in the third quarter of 2008. The trade-in deferral which resulted in a $3.5 million reduction in net sales reduced gross margin by 560 basis points in the third quarter of 2009, which was partially offset by improved leverage on indirect manufacturing expenses as a relatively fixed pool of indirect manufacturing costs remained flat while sales increased.
Gross Margin
Gross margin decreased $630,000, or 4.5%, to $13.3 million for the third quarter of 2009 compared to $13.9 million for the third quarter of 2008. As a percentage of net sales, gross margin decreased to 56.9% for the third quarter of 2009 compared to 60.8% for the third quarter of 2008. The 390 basis point decline in gross margin as a percentage of net sales for the third quarter of 2009 reflects the impact of the trade in deferral, offset by decreased indirect manufacturing costs.
Sales, General and Administrative Expenses
For the three months ended September 30, 2009 and 2008, sales, general and administrative expenses were comprised of the following (dollars in thousands):
                                 
    Three Months Ended September 30,  
                    $     %  
    2009     2008     Change     Change  
 
Salaries, benefits and bonus
  $ 3,192     $ 2,489     $ 703       28.2 %
Legal, professional and accounting fees
    1,112       1,406       (294 )     -20.9 %
Sales and Marketing
    1,659       1,110       549       49.5 %
Consulting and lobbying services
    911       690       221       32.0 %
Stock-based compensation
    814       443       371       83.7 %
Travel and meals
    968       709       259       36.5 %
D&O and liability insurance
    449       536       (87 )     -16.2 %
Depreciation and amortization
    510       386       124       32.1 %
Other
    1,805       1,286       519       40.4 %
 
                         
 
                               
Total
  $ 11,420     $ 9,055     $ 2,365       26.1 %
 
                         
Sales, general and administrative as % of net sales
    49.0 %     39.6 %                
Sales, general and administrative expenses were $11.4 million and $9.1 million in the third quarter of 2009 and 2008, respectively, an increase of $2.4 million, or 26.1%. As a percentage of total net sales, sales, general and administrative expenses increased to 49.0% for the third quarter of 2009 compared to 39.6% for the third quarter of 2008, partially due to a reduction of leverage resulting from the $3.5 million trade-in deferral which had a 6.3% impact. The dollar increase for the third quarter of 2009 over the same period in 2008 is attributable to a $703,000 growth in salaries, benefits and bonuses primarily related to an increase in personnel to support the expansion of our business infrastructure as we introduce new products and enter new markets. Stock based-compensation expense increased $371,000 which is attributed to the increased employee headcount in the fourth quarter of 2008 and the first half of 2009. Sales and marketing increased $549,000 and travel and meals increased $259,000 in the third quarter of 2009, due to increased efforts to support new product launches as well as the annual TASER Conference, which was held in the third quarter of 2009 (compared to being held in the second quarter of 2008). These increases were partially offset by a $294,000 decrease in legal, professional and accounting fees.

 

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Research and Development Expenses
Research and development expenses were $6.7 million for the third quarter, which is an increase of $3.3 million over the prior year mostly driven by a $1.8 million increase in indirect supplies, component costs and expediting fees associated with the development of the TASER X3 and AXON (Autonomous eXtended on-Officer Network) units shown at our TASER Conference and the IACP trade shows. Tooling and scrap costs increased by $443,000, also related to the development of the TASER X3 and AXON. Salaries, benefits, and stock options expenses increased by $1.1 million to support both hardware development and our new software development team headquartered in California. These increases were partially offset by $852,000 of capitalized internal salary and external consulting costs specifically related to the development of EVIDENCE.com in the third quarter of 2009. We expect this level of research and development spending will decrease during the fourth quarter of 2009 as TASER X3 and AXON are launched into the market.
Interest and Other Income, Net
Interest and other income decreased by $250,000, or 92.6%, to $20,000 for the third quarter of 2009 compared to $270,000 for the third quarter of 2008. The decrease is attributable to a significantly lower average yield on our cash and investments.
Provision (Benefit) for Income Taxes
The provision for income taxes decreased by $2.7 million to a benefit of $1.6 million for the third quarter of 2009 compared to a provision of $1.1 million for the third quarter of 2008. The effective income tax rate for the third quarter of 2009 was 33.7% compared to 63.4% for the third quarter of 2008. The effective tax rate for the three months ended September 30, 2009 decreased compared to the same period in the prior year due to the nature of the effective tax rate calculation. The quarterly tax provision is computed from the year-to-date provision less the cumulative tax provision recognized through the previous quarter end. Due to a significant variability in the projected 2009 annual effective tax rate caused by relatively small differences in projected fourth quarter results, we were unable to reliably estimate the 2009 effective annual tax rate as of the end of the third quarter and as such calculated an estimated year-to-date tax provision based on current year to date results. There will likely be some variability in the fourth quarter effective tax rate depending on fourth quarter results and the likelihood that the impact of non-deductible expenses for items such as ISO stock option expense, meals and entertainment and lobbying will make the income for tax purposes significantly higher than book pre-tax income. The high effective income tax rate in the third quarter of 2008 was attributable to a the higher impact of non-deductible items expenses against a low taxable income base expected for the year ended December 31, 2008
Net Income (Loss)
Our net income declined by $3.8 million to a net loss of $3.2 million for the third quarter of 2009 compared to net income of $650,000 for the third quarter of 2008. Net loss per basic and diluted share was $0.05 for the third quarter of 2009 compared to net income per basic and diluted share of $0.01 for the third quarter of 2008.
Nine Months Ended September 30, 2009 Compared to the Nine Months Ended September 30, 2008
The following table sets forth, for the periods indicated, our statements of operations as well as the percentage relationship to total net sales of items included in our statements of operations (dollars in thousands):
                                                 
    Nine Months Ended September 30,     Increase / (Decrease)  
    2009     2008     $     %  
 
                                               
Net sales
  $ 69,749       100.0 %   $ 66,447       100.0 %   $ 3,302       5.0 %
Cost of products sold
    28,115       40.3 %     26,184       39.4 %     1,931       7.4 %
 
                                     
Gross margin
    41,634       59.7 %     40,263       60.6 %     1,371       3.4 %
Sales, general and administrative expenses
    33,690       48.3 %     27,926       42.0 %     5,764       20.6 %
Research and development expenses
    15,246       21.9 %     8,463       12.7 %     6,783       80.1 %
Legal judgment expense
          0.0 %     5,200       7.8 %     (5,200 )     -100.0 %
 
                                     
Loss from operations
    (7,302 )     -10.5 %     (1,326 )     -2.0 %     (5,976 )     450.7 %
Interest and other income, net
    162       0.2 %     1,492       2.2 %     (1,330 )     -89.1 %
 
                                     
Income (loss) before provision (benefit) for income taxes
    (7,140 )     -10.2 %     166       0.2 %     (7,306 )     4401.2 %
Provision (benefit) for income taxes
    (2,773 )     -4.0 %     315       0.5 %     (3,088 )     980.3 %
 
                                     
Net loss
  $ (4,367 )     -6.3 %   $ (149 )     -0.2 %   $ (4,218 )     2830.9 %
 
                                     

 

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Net Sales
For the nine months ended September 30, 2009 and 2008, sales by product line and by geography were as follows (dollars in thousands):
                                 
    Nine Months Ended September 30,  
    2009     2008  
Sales by Product Line
                               
 
                               
TASER X26
  $ 37,976       54.4 %   $ 35,807       53.9 %
TASER C2
    3,732       5.4 %     4,268       6.4 %
TASER Cam
    2,179       3.1 %     2,748       4.1 %
ADVANCED TASER
    2,245       3.2 %     2,432       3.7 %
Single Cartridges
    20,151       28.9 %     15,290       23.0 %
XREP
    389       0.6 %            
Shockwave
    45       0.1 %            
X3
    8                    
Other
    6,490       9.3 %     5,902       8.9 %
Trade-In Deferral
    (3,466 )     -5.0 %            
 
                           
 
                               
Total
  $ 69,749       100.0 %   $ 66,447       100.0 %
 
                           
                 
    Nine Months Ended September 30,  
    2009     2008  
 
               
United States
    75 %     87 %
Other Countries
    25 %     13 %
 
           
 
               
Total
    100 %     100 %
 
           
Net sales increased $3.3 million, or 5.0%, to $69.7 million for the first nine months of 2009 compared to $66.4 million for the first nine months of 2008. The increase in sales versus the prior year was primarily driven by significant international shipments during the year, and sales related to a contract from the U.S. Customs and Border Patrol. The growth in international and Federal business offset a decline in domestic sales, which we believe reflects lower municipal spending in the U.S. as agencies reassigned budget dollars due to ongoing economic constraints. During the third quarter, $3.5 million of revenue was deferred related to a trade-in program which enables agencies who purchase a X26 ECD for deployment in the United States the opportunity to upgrade the product in exchange for a partial trade-in credit against the purchase of the newly announced X3 ECD. Sales of single cartridges increased $4.9 million, or 31.8%, compared to the prior year and X26 sales, before excluding the $3.5 million impact the trade-in deferral, increased $2.2 million, or 6.1%. TASER C2 consumer product sales declined by $536,000, or 12.6%, attributable to the adverse impact of the economic downturn on consumer spending. The increase in other sales is primarily driven by growth in extended warranty revenues, out of warranty repairs and the elimination of distributor discounts during 2008. Other sales also include government grants, training and shipping revenues.
International sales for the first nine months of 2009 and 2008 represented approximately $17.6 million, or 25%, and $8.7 million or 13% of total net sales, respectively.
Cost of Products Sold
Cost of products sold increased by $1.9 million, or 7.4%, to $28.1 million for the first nine months of 2009 compared to $26.2 million for the first nine months of 2008. As a percentage of net sales, cost of products sold increased to 40.3% in the first nine months of 2009 compared to 39.4% in the first nine months of 2008. The increase in cost of products sold as a percentage of net sales for the first nine months of 2009 compared to the first nine months of 2008 was driven by a combination of factors. The trade-in deferral, which resulted in a $3.5 million reduction in net sales reduced gross margin by 190 basis points. Exclusive of the deferral, total direct costs decreased as a percentage of sales primarily driven by negotiated supplier price reductions in certain raw material components. Direct labor decreased as a percentage of net sales due to lower temporary labor costs and indirect manufacturing expense decreased as production scrap and engineering supplies were reduced, resulting from improved product quality and operating efficiencies. In addition, our provision for warranty costs decreased as we experienced a reduction in product returns during the first nine months of 2009. Offsetting these cost reductions, the allocation of indirect manufacturing overhead to inventory decreased significantly as a reduction in the number of production hours in the first nine months of 2009 compared to the same period in 2008 resulted in an increased indirect manufacturing overhead rate and the under absorption of a relatively fixed pool of indirect manufacturing costs.

 

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Gross Margin
Gross margin increased $1.4 million, or 3.4%, to $41.6 million for the first nine months of 2009 compared to $40.3 million for the first nine months of 2008. As a percentage of net sales, gross margins decreased to 59.7% for the first nine months of 2009 compared to 60.6% for the first nine months of 2008. The 190 basis point decrease in gross margin as a percentage of net sales for the first half of 2009 reflects the factors noted above under the discussion of cost of products sold.
Sales, General and Administrative Expenses
For the nine months ended September 30, 2009 and 2008, sales, general and administrative expenses were comprised as follows (dollars in thousands):
                                 
    Nine Months Ended September 30,  
                    $     %  
    2009     2008     Change     Change  
 
                               
Salaries, benefits and bonus
  $ 8,811     $ 7,315     $ 1,496       20.5 %
Legal, professional and accounting fees
    4,630       4,242       388       9.1 %
Consulting and lobbying services
    3,194       2,110       1,084       51.4 %
Stock-based compensation
    2,441       932       1,509       161.9 %
Travel and meals
    2,646       2,712       (66 )     -2.4 %
Sales and Marketing
    4,141       3,952       189       4.8 %
D&O and liability insurance
    1,415       1,626       (211 )     -13.0 %
Depreciation and amortization
    1,397       1,168       229       19.6 %
Other
    5,015       3,869       1,146       29.6 %
 
                         
 
                               
Total
  $ 33,690     $ 27,926     $ 5,764       20.6 %
 
                         
Sales, general and administrative as % of net sales
    48.3 %     42.0 %                
Sales, general and administrative expenses were $33.7 million and $27.9 million in the first nine months of 2009 and 2008, respectively, an increase of $5.8 million, or 20.6%. As a percentage of total net sales, sales, general and administrative expenses increased to 48.3% for the first nine months of 2009 compared to 42.0% for the first nine months of 2008, partially due to a reduction of leverage resulting from the $3.5 million trade-in deferral. The dollar increase for the first nine months of 2009 over the same period in 2008 is attributable to a $1.5 million growth in salaries and benefits related to an increase in personnel to support the expansion of our business infrastructure as we introduce new products and enter new markets. Stock based-compensation expense also increased $1.5 million related to a full nine months expense for stock options granted during the third and fourth quarters of 2008 as well as new employee stock options grants in the first nine months of 2009. Consulting and lobbying services increased $1.1 million primarily related to strategic selling and marketing, advertising and IT process improvement related efforts while legal, professional and accounting fees increased $388,000 driven by the timing of outstanding ligation in progress. Sales and marketing expenses also increased by a net amount of $189,000 as increases in our tradeshow costs and our selling costs in support of new product introductions were partially offset by a $1.3 million decrease in general media advertising spend primarily due to $530,000 of infomercial production costs expensed in the first quarter of 2008 as well as reduced emphasis placed on consumer marketing programs. The $1.1 million increase in other costs was primarily driven by a $350,000 settlement expense paid to a Board member (see “Settlement agreement” in Note 10) as well as increased computer licensing and maintenance costs.

 

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Research and Development Expenses
Research and development expenses increased $6.8 million, or 80.2%, to $15.2 million for the first nine months of 2009 compared to $8.5 million for the first nine months of 2008. The increase is driven by a $2.9 million increase in salary and benefits as we have expanded our research and development headcount to support new product development, including an Internet service and software development team. Stock-based compensation expenses increased $799,000 for stock options granted in the second half of 2008 and the first half of 2009. Indirect supplies and tooling costs increased $3.0 million primarily associated with the development of the TASER X3, AXON (Autonomous eXtended on-Officer Network) and EVIDENCE.com. In particular, during the third quarter of 2009 we expedited the build of AXON and X3 prototype display units for the TASER Tactical conference and the International Association of Chiefs of Police (IACP) conference. These increases are offset by the capitalization of $1.5 million of internal salary and external consulting costs specifically related to the development of EVIDENCE.com in the second and third quarters of 2009. We expect the level of research and development spending in the fourth quarter will normalize to levels consistent with the quarterly run rate in the first half of the year.
Litigation Judgment Expense
We recorded a $5.2 million non-cash charge in the second quarter of 2008 for an adverse jury verdict in a product liability case. On October 24, 2008, this jury award of $5.2 million was disallowed by the Court and we reversed the expense in the fourth quarter of 2008.
Interest and Other Income, Net
Interest and other income decreased by $1.3 million, or 89.1%, to $162,000 for the first nine months of 2009 compared to $1.5 million for the first nine months of 2008. The decrease is attributable to a significantly lower average yield on our cash and investments. Additionally, other income in the first nine months of 2008 included $387,000 related to unused deferred insurance settlement proceeds recognized upon the dismissal of all final appeals in the Samuel Powers v. TASER International personal injury case.
Provision (Benefit) for Income Taxes
The provision for income taxes decreased by $3.1 million to a benefit of $2.8 million for the first nine months of 2009 compared to a provision of $315,000 for the first nine months of 2008. The effective income tax rate for the first nine months of 2009 was 38.8% compared to 189.3% for the first nine months of 2008. The effective tax rate for the nine months ended September 30, 2009 decreased compared to the same period in the prior year due to the nature of the effective tax rate calculation. The quarterly tax provision is computed from the year-to-date provision less the cumulative tax provision recognized through the previous quarter end. Due to a significant variability in the projected 2009 annual effective tax rate caused by relatively small differences in projected fourth quarter results, we were unable to reliably estimate the 2009 effective annual tax rate as of the end of the third quarter and as such calculated an estimated year-to -date tax provision based on current year to date results. There will likely be some variability in the fourth quarter effective tax rate depending on fourth quarter results and the likelihood that the impact of non-deductible expenses for items such as ISO stock option expense, meals and entertainment and lobbying, which reduced the effective tax benefit rate in the third quarter, will make the income for tax purposes significantly higher than book pre-tax income on a year-to-date basis. The effective tax rate for the nine months ended September 30, 2008 significantly exceeds the statutory rate due to the impact of certain non-deductible items such as stock-based compensation expense related to ISO’s and lobbying expenses against a lower taxable income base expected for the year ended December 31, 2008. Offsetting the credit provision and reducing the effective tax rate in the third quarter of 2008 was the recording of a $250,000 valuation allowance against expiring state (Arizona) net operating loss deferred tax assets.
Net Loss
The net loss increased by $4.2 million to $4.4 million for the first nine months of 2009 compared to a net loss of $149,000 for the first nine months of 2008. Net loss per basic and diluted share was $0.07 for the first nine months of 2009 compared to $0.00 for the first nine months of 2008.
Liquidity and Capital Resources
Liquidity
Our most significant sources of liquidity continue to be funds generated by operating activities and available cash and cash equivalents. We believe funds generated from our expected results of operations and available cash and cash equivalents will be sufficient to finance our operations and strategic initiatives for the next 12 months. In addition, as necessary, our revolving credit facility is available for additional working capital needs or investment opportunities although we currently have no balance outstanding on our revolving credit facility. There can be no assurance, however, that we will continue to generate cash flows at or above current levels or that we will be able to maintain our ability to borrow under our revolving credit facility.

 

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As of September 30, 2009, we had $45.4 million in cash and cash equivalents, a decrease of $1.5 million from the end of 2008, which is primarily attributable to net cash provided by operations of $5.5 million in the first nine months of 2009 and proceeds from the maturities of investment holdings, offset by investments in property and equipment and intangible assets. Accounts receivable at September 30, 2009, decreased by $0.5 million compared to December 31, 2008. Accounts payable and accrued liabilities increased $1.8 million driven by timing of purchasing activity. Additionally, we expect to invest a further $3 to $5 million in capital expenditures in 2009, including $1.5 million of automation equipment received and accrued at September 30, 2009. We expect to fund these capital expenditures with available working capital.
                 
    Nine Months Ended September 30,  
    2009     2008  
    (In thousands)  
Net cash provided by operating activities
  $ 5,460     $ 4,611  
Net cash (used) provided by investing activities
    (7,034 )     7,266  
Net cash provided (used) by financing activities
  $ 108     $ (12,179 )
Net cash provided by operating activities for the first nine months of 2009 of $5.5 million was driven by the net loss for the period adjusted for the add back of non-cash expenses including stock-based compensation expense of $3.8 million; depreciation and amortization expense of $2.4 million partially offset by a $3.8 million net increase in deferred tax assets related to the benefit recognized in the first nine months of 2009. In addition, deferred revenue increased $3.8 million, $3.5 million of which relates to the deferral of revenue in the third quarter of 2009 related to the X26 trade-in program. Changes in working capital include a $0.5 million decrease in accounts receivable and a $1.8 million increase in accounts payable and accrued liabilities as discussed above.
Net cash used by investing activities was $7.0 million during the nine months ended September 30, 2009, which was comprised of $9.3 million to purchase property and equipment mainly related to new automation production equipment and Evidence.Com data center hardware as well as $1.5 million of capitalized software development. In addition, we invested $243,000 in intangible assets, primarily consisting of patent and trademark costs. This net use was partially offset by $2.5 million in net proceeds from called investments.
During the first nine months of 2009, net cash provided by financing activities was $108,000, attributable to proceeds from stock options exercised during the period.
Capital Resources
We have a revolving line of credit with a domestic bank with a total availability of $10.0 million. The line is secured by substantially all of our assets, other than intellectual property, and bears interest at varying rates, ranging from LIBOR plus 1.5% to prime. The line of credit matures on September 30, 2010, and requires monthly payments of interest only. At September 30, 2009, there were no borrowings under the line and $10.0 million of the line was available based on the defined borrowing base, which is calculated based on our eligible accounts receivable and inventory. Our agreement with the bank requires us to comply with certain financial and other covenants including maintenance of minimum tangible net worth and fixed charge coverage. At September 30, 2009, we were in compliance with those covenants.
We believe that our balance of total cash and cash equivalents of $45.4 million as of September 30, 2009, together with cash expected to be generated from operations and our existing credit facility will be adequate to fund our operations for at least the next 12 months. We may require additional resources to expedite manufacturing of new and existing technologies in order to meet possible demand for our products. Based on our strong balance sheet and the fact that we had no outstanding debt at September 30, 2009, we believe financing will be available, both through our existing credit line and possible additional financing. However, there is no assurance that such funding will be available on terms acceptable to us, or at all. Capital markets in the United States and throughout the world remain disrupted and under stress. This disruption and stress is evidenced by a lack of liquidity in the debt capital markets, the re-pricing of credit risk in the syndicated credit market, and the failure of certain major financial institutions. This stress is compounded by the ongoing severe worldwide recession. Reflecting this situation, many lenders and capital providers have reduced, and in some cases ceased to provide, debt funding to borrowers. The resulting lack of available credit, lack of confidence in the financial sector, increased volatility in the financial markets and reduced business activity could materially and adversely affect our ability to obtain additional or alternative financing should the need arise for us to access the debt markets.

 

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Commitments and Contingencies
On July 2, 2007, the Company entered into a contract with Automation Tooling Systems Inc. for the purchase of equipment at a cost of approximately $8.4 million. The equipment was delivered and installed at the Company’s facility during the third quarter of 2009. Payments have been made in installments, with total installments paid to date of $6.9 million, with the remaining balance of $1.5 million, which was accrued at September 30, 2009, likely to be paid in the fourth quarter. The installments paid or accrued to date have been recorded in property, plant and equipment in the accompanying consolidated balance sheets.
On June 24, 2009, the Company entered into an operating lease agreement with IBM Credit, LLC for various data center server equipment used to host EVIDENCE.com. Total future minimum lease payments are $882,432 with terms ranging from 36 to 42 months in duration. The equipment is expected to be placed in service in the third quarter of 2009.
Off Balance Sheet Arrangements
We have no off balance sheet arrangements as of September 30, 2009.
Critical Accounting Estimates
We have identified the following accounting estimates as critical to our business operations and the understanding of our results of operations. The preparation of this Quarterly Report on Form 10-Q requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates. The effect of these policies on our business operations is discussed below.
Standard Product Warranty Reserves
We warrant our law enforcement ECD’s from manufacturing defects on a limited basis for a period of one year after purchase and thereafter, will replace any defective TASER unit for a fee. We warrant our new TASER C2 product for 90 days. We track historical data related to returns and warranty costs on a quarterly basis, and estimate future warranty claims based upon our historical experience. We have also historically increased our reserve amount if we become aware of a component failure that could result in larger than anticipated returns from our customers. As of September 30, 2009, our reserve for warranty returns was $298,000 compared to a $615,000 reserve at December 31, 2008. Our reserve for warranty returns decreased at September 30, 2009, as the result of an improved product returns experience, particularly in our X26 product line which we believe is a function of continuing improvements made in the manufacturing and quality processes. In the event that product returns under warranty differ from our estimates, changes to warranty reserves might become necessary.
Inventory
Inventories are stated at the lower of cost or market, with cost determined using the weighted average cost of raw materials, which approximates the first-in, first-out (FIFO) method, and an allocation of manufacturing labor and overhead costs. The allocation of manufacturing labor and overhead costs includes management judgments of what constitutes normal capacity of our production facilities, and a determination of what costs are considered to be abnormal fixed production costs which are expensed as current period charges. Provisions are made to reduce potentially excess, obsolete or slow-moving inventories to their net realizable value. These provisions are based on our best estimates after considering historical demand, projected future demand, inventory purchase commitments, industry and market trends and conditions and other factors. Our reserve for excess and obsolete inventory increased to $264,000 at September 30, 2009, compared to $130,000 at December 31, 2008. In the event that actual excess, obsolete or slow-moving inventories differ from these estimates, changes to inventory reserves might become necessary.
Accounts Receivable
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 estimated potential losses. Uncollectible accounts are written off when deemed uncollectible, and accounts 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. Our allowance for doubtful accounts was $200,000 at September 30, 2009 and December 31, 2008. In the event that actual uncollectible amounts differ from these estimates, changes in allowances for doubtful accounts might become necessary.

 

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Valuation of Long-lived Assets
We review long-lived assets, such as property and equipment and intangible assets subject to amortization, whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. We utilize a two-step approach to testing long-lived assets for impairment. The first step tests for possible impairment indicators. If an impairment indicator is present, the second step measures whether the asset is recoverable based on a comparison of the carrying amount of the asset to the estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Our review requires the use of judgment and estimates. Management believes that no such impairments have occurred to date. However, future events or circumstances may result in a charge to earnings if we determine that the carrying value of a long-lived asset is not recoverable.
Income Taxes
We recognize federal, state and foreign current tax liabilities or assets based on our estimate of taxes payable or refundable in the current fiscal year by tax jurisdiction. We also recognize federal, state and foreign deferred tax assets or liabilities, as appropriate, for our estimate of future tax effects attributable to temporary differences and carryforwards.
We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. Management must also assess whether uncertain tax positions as filed could result in the recognition of a liability for possible interest and penalties if any. We have completed research and development tax credit studies which identified approximately $4.0 million in tax credits for Federal and Arizona income tax purposes related to the 2003 through 2008 tax years, net of the federal benefit on the Arizona research and development tax credits. Management has estimated that an additional $425,000 of tax credits are available for Arizona purposes for the 2009 tax year with a prorated portion recorded as a component of the effective tax rate for the three and nine months ended September 30, 2009. Management made the determination that it was more likely than not that the full benefit of the research and development tax credit would not be sustained on examination and recorded a liability for unrecognized tax benefits of $2.1 million as of September 30, 2009. As of September 30, 2009, management does not expect the amount of the unrecognized tax benefit liability to increase or decrease significantly within the next 12 months. Should the unrecognized tax benefit of $2.1 million be recognized, the Company’s effective tax rate would be favorably impacted. Also included as part of the $2.1 million liability for unrecognized tax benefits is a management estimate of $94,000 related to uncertain tax positions for certain state income tax liabilities. Our estimates are based on the information available to us at the time we prepare the income tax provisions. Our income tax returns are subject to audit by federal, state, and local governments, generally years after the returns are filed. These returns could be subject to material adjustments or differing interpretations of the tax laws.
Our calculation of current and deferred tax assets and liabilities is based on certain estimates and judgments and involves dealing with uncertainties in the application of complex tax laws. Our estimates of current and deferred tax assets and liabilities may change based, in part, on added certainty or finality to an anticipated outcome, changes in accounting or tax laws in the United States, or changes in other facts or circumstances. In addition, we recognize liabilities for potential United States tax contingencies based on our estimate of whether, and the extent to which, additional taxes may be due. If we determine that payment of these amounts is unnecessary or if the recorded tax liability is less than our current assessment, we may be required to recognize an income tax benefit or additional income tax expense in our consolidated financial statements.
In preparing the Company’s consolidated financial statements, management assesses the likelihood that its deferred tax assets will be realized from future taxable income. In evaluating the Company’s ability to recover its deferred income tax assets, management considers all available positive and negative evidence, including its operating results, ongoing tax planning and forecasts of future taxable income on a jurisdiction by jurisdiction basis. A valuation allowance is established if it is determined that it is more likely than not that some portion or all of the net deferred tax assets will not be realized. Management exercises significant judgment in determining its provisions for income taxes, its deferred tax assets and liabilities and its future taxable income for purposes of assessing its ability to utilize any future tax benefit from its deferred tax assets.

 

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Although management believes that its tax estimates are reasonable, the ultimate tax determination involves significant judgment that could become subject to audit by tax authorities in the ordinary course of business, as well as the generation of sufficient future taxable income. Based on consideration of the above factors, management has determined that it is more likely than not that its net operating loss carryforwards for the state of Arizona, which expire in 2009, will be fully realized. Accordingly, the valuation allowance of $200,000 the Company carried against its deferred tax assets as of December 31, 2008, is expected to be reversed with the benefit recognized during 2009 as a reduction of the current-year effective tax rate. Management believes that, other than as previously described, as of September 30, 2009, based on an evaluation and projections of future sales and profitability, no other valuation allowance was deemed necessary. However, such deferred tax assets could be reduced in the future if projections of future taxable income during the carryforward period are reduced.
The effective income tax rate for the first nine months of 2009 was 38.8% compared to 189.3% for the first nine months of 2008. The effective tax rate for the nine months ended September 30, 2009 decreased compared to the same period in the prior year due to the nature of the effective tax rate calculation. Due to a significant variability in the projected 2009 annual effective tax rate caused by relatively small differences in projected fourth quarter results, we were unable to reliably estimate the 2009 effective annual tax rate as of the end of the third quarter and as such calculated an estimated year to date tax provision based on current year to date results. There will likely be some variability in the fourth quarter effective tax rate depending on fourth quarter results and the likelihood that the impact of non-deductible expenses for items such as ISO stock option expense, meals and entertainment and lobbying, which reduced the effective tax benefit rate in the third quarter, will make the income for tax purposes significantly higher than book pre-tax income on a year to date basis.
Stock Based Compensation
We estimate the fair value of our stock based compensation by using the Black-Scholes-Merton option pricing model which requires the input of highly subjective assumptions. These assumptions include estimating the length of time employees will retain their stock options before exercising them (“expected term”), the estimated volatility of our common stock price over the expected term and the number of options that will ultimately not vest (“forfeitures”). We granted 811,000 performance-based stock options in 2008 and 15,000 in the first quarter of 2009, the exercise of which is contingent upon the achievement of certain performance criteria including the successful development and market acceptance of future product introductions as well as our future operating performance. These options will vest and compensation expense will be recognized based on management’s best estimate of the probability of the performance criteria being satisfied using the most currently available projections of future product adoption and operating performance, adjusted at each balance sheet date. Changes in the subjective and probability based assumptions can materially affect the estimate of fair value of stock-based compensation and consequently, the related amount recognized on our statements of operations. Refer to Note 7 to our consolidated financial statements for further discussion of how we determined our valuation assumptions.
Revenue Recognition
On July 27, 2009, we announced a temporary trade-in program to enable agencies who purchase a TASER X26 ECD for deployment in the United States the opportunity to upgrade the product in exchange for a partial credit against the purchase of the newly announced semi-automatic TASER X3 ECD. We accounted for the trade-in right on new sales as a separate element, which has been deferred based on management’s estimate of the relative fair value of the available credit to the arrangement as a whole. The trade-in offer, which expires on December 31, 2009, resulted in deferred revenue of $3.5 million at September 30, 2009, which is included in current deferred revenue in the accompanying consolidated balance sheet. We will recognize the deferred revenue at the earlier of the respective trade-in during the fourth quarter or when the offer expires on December 31, 2009.
Contingencies
We are subject to the possibility of various loss contingencies including product related litigation, arising in the ordinary course of business. We consider the likelihood of loss or impairment of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss in determining loss contingencies. An estimated loss contingency is accrued when it is probable that an asset has been impaired or a liability has been incurred and the amount of loss can be reasonably estimated. We regularly evaluate current information available to us to determine whether such accruals should be adjusted and whether new accruals are required.

 

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
All of our cash equivalent and marketable securities investments are treated as “held-to-maturity” . As of September 30, 2009, our cash equivalents are invested in highly liquid money market funds denominated in United States dollars. As such, we currently have no interest rate risk related to holding fixed or floating rate securities.
Exchange Rate Risk
We consider our direct exposure to foreign exchange rate fluctuations to be minimal. Currently, sales to customers provide for pricing and payment in United States dollars, and therefore are not subject to exchange rate fluctuations. However, the cost to our customers increases when the U.S. dollar strengthens against their local currency. In this difficult economy this risk of loss becomes a credit-risk for non-payment. To date, we have not engaged in any currency hedging activities, although we may do so in the future. Fluctuations in currency exchange rates could harm our business in the future.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures.
Our Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of September 30, 2009, to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission’s rules and forms and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Our disclosure controls and procedures are designed to provide reasonable assurance that such information is accumulated and communicated to our management. Our disclosure controls and procedures include components of our internal control over financial reporting. Management’s assessment of the effectiveness of our internal control over financial reporting is expressed at the level of reasonable assurance because a control system, no matter how well designed and operated, can provide only reasonable, but not absolute, assurance that the control system’s objectives will be met.
Changes in internal control over financial reporting
There was no change in internal control over financial reporting, during the fiscal quarter ended September 30, 2009, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II—OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See discussion of legal proceedings in Note 9 to the consolidated financial statements included in PART I, ITEM 1 of this Form 10-Q.
ITEM 1A. RISK FACTORS
There have been no material changes to the factors disclosed in ITEM 1A — RISK FACTORS of our Annual Report on Form 10-K for the year ended December 31, 2008.
ITEM 6. EXHIBITS
         
  31.1    
Principal Executive Officer Certification pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
       
 
  31.2    
Principal Financial Officer Certification pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
       
 
  *32    
Principal Executive Officer and Principal Financial Officer Certifications pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
*   Furnished

 

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
         
  TASER INTERNATIONAL, INC.
 
 
Date: November 6, 2009  /s/ Patrick W. Smith    
  Patrick W. Smith   
  Chief Executive Officer
(Principal Executive Officer) 
 
     
Date: November 6, 2009  /s/ Daniel M. Behrendt    
  Daniel M. Behrendt   
  Chief Financial Officer
(Principal Financial and Accounting Officer) 
 

 

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Index to Exhibits
Exhibits:
         
  31.1    
Principal Executive Officer Certification pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
       
 
  31.2    
Principal Financial Officer Certification pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
       
 
  *32    
Principal Executive Officer and Principal Financial Officer Certifications pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
*   Furnished