Welcome to the Q2 2012 TASER International corporate earnings conference call. My name is Dawn, and I will be your operator for today's call. At this time, all participants are in listen only mode. Later, we will conduct a question and answer session. Please note that the conference is being recorded. I will now turn the call over to Rick Smith. Mr. Smith, you may begin.
Thank you. Welcome, everyone. Appreciate you joining us this morning. Before we get started, I'm going to ask Dan to read the safe harbor statement.
Thanks, Rick. Certain statements contained in this presentation may be deemed to be forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995, and TASER International intends that such forward-looking statements be subject to the safe harbor created thereby. Such forward-looking statements relate to expected revenue and earnings growth, estimations regarding the size of our target markets, successful penetration of law enforcement market, expansion of product sales to the private security, military, and consumer defense markets, growth expectations for new and existing accounts, expansion of production capability, new product introductions, product safety, and our business model. We caution 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 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 risk of manufacturing automation, risks associated with rapid technological change, execution and implementation risk of new technology, new product introduction risks, ramping manufacturing production to meet demand, litigation resulting from alleged product-related injuries and deaths, media publicity concerning product uses and allegations of injury and death and the negative impact this could have on sales, product quality risk, potential fluctuations in quarterly operating results, competition, negative reports concerning TASER devices uses, financial and budgetary constraints of prospects and customers, dependence upon sole or limited source suppliers, fluctuations in component pricing, risks of government investigations and regulations, TASER product tests and reports, dependence upon key employees, employee retention risk, and other factors detailed in the company's filings with the Securities and Exchange Commission.
I'll turn it back over to Rick Smith.
Thanks, Dan. Okay. As I'm sure everybody's seen by now, this morning we reported Q2 sales were up $7 million, or 33% year-over-year, coming in at $28.2 million. Perhaps even more importantly, if you look at the cash generation of the business, we generated $9.7 million in cash from operations. Of course, if you do the math on that, we were generating cash at an annualized rate in the second quarter of $0.73 per share. Operating income came in at $6.1 million. If you go back and touch on the cash as well, again, I'll point out the obvious, that was inclusive across the entire business. If you look at the core ECD business, which has been funding our investments in the new video business, obviously that number is significantly higher in the core business if you look at it on a standalone basis.
Margins improved year-over-year, although they declined slightly sequentially. It came in at 58.5% compared to 57.8% last year. Of course, if you look in our core ECD business, 63.7% gross margin, a number we're very proud of. Again, we break this out so that it helps us as a management team, you as investors, to monitor how well we're managing our core business so it doesn't get obfuscated by the investments that we're making in the new business. Revenues in the ECD business increased 8% sequentially from $24.8 million to $26.9 million. In the core ECD business, operating income was $8.6 million. We're running at 32% operating income in the core ECD business. Revenues in the video business increased 47% sequentially, albeit from a small base of $884,000 in the first quarter to $1.3 million in the second quarter.
That growth was really driven primarily by TASER CAM and the new TASER CAM HD, as the Axon Flex didn't ship until late in the quarter. If we look at the SG&A expenses coming down as a result of a continued focus on efficiency and cost controls. Research and development also decreased by $800,000 to $2.0 million. I'm sure people are wondering, is TASER investing sufficiently in research and development? I would tell you the decreases are really about this continued streamlining of our research and development efforts. We are more efficient than we've ever been. This is largely attributable to reduction in professional consulting fees. Basically, some of the bulge resources when you have to go out and bring in external consultants when you're finishing up major projects. I'd say at this point, we're innovating at a much more efficient and better pace.
We've also moved to an OEM model, looking to insource technology from other providers rather than building it ourselves. For example, if you look at the Axon Flex, in our partnership with Looxcie, we were able to buy the major components of the Axon Flex and then only focus on engineering that is required to customize for our marketplace. It's a far more efficient and faster way to get to market than if you look at the previous Axon Pro product we've developed where we developed the computer, the communication hub, and the camera all from the ground up in-house. That's a longer, slower, more expensive way to develop products. I'm very proud of what we've accomplished in our R&D segment. Again, I'd say we're getting better, we're doing more with less, and we believe that we are right-sized in terms of how we're approaching R&D.
With that, I'm going to turn it over to Dan to take us through the financial results in greater detail.
Great. Thank you, Rick. As Rick said, revenue for Q2 was $28.2 million. This is up approximately $7 million, or 33%, over the prior year. The increase in sales versus prior is driven by the continued adoption and extension of the upgrade program for the X2 electronic control device, as well as a significant order we got during the quarter from Brazil. One of the bright spots for the quarter is the North American law enforcement market continues to be strong, mostly driven by the upgrade cycle to the new X2 device. North American law enforcement sales are actually up 39% year-over-year. This follows a 25% year-over-year improvement in the fourth quarter of last year and the first quarter of this year. We've got three quarters in a row of significant growth, almost completely driven by the adoption cycle of the new X2 device.
Gross margin for the quarter was $16.5 million, or 58.5% of revenue. That's up 70 basis points from 57.8% in the prior year. This is actually the fifth consecutive quarter of gross margin improvement. We continue to benefit from the higher operating leverage in the business, as well as the favorable product mix. The SG&A expenses of $8.4 million in the second quarter versus $9.1 million in the prior year. The reduction in SG&A expenses were driven by the continuing cost controls in the business. SG&A as a percentage of sales was actually 29.8% of net sales in Q2 of 2012. That compares to 42.8% in the same quarter of last year. If you look at our history over the last four quarters, we've ranged from this sort of low water mark of $8.4 million all the way up to $10.3 million over the last four quarters.
We are going to be making some strategic investments in France and Brazil, along with some new hires. We do expect that SG&A expenses will tick up a little bit in the second half of 2012, but still within the range of what we've seen over the last four quarters. We are continuing to focus on those cost controls. Research and development expenses of $2 million for the second quarter, which were favorable by $800,000 compared to the 2011 second quarter. Again, due to the continued cost controls, as Rick mentioned. The biggest drivers there are the reductions in outside consulting costs, as well as some headcount reductions we've taken over last year. Again, similar to SG&A, we do expect R&D expenses to tick up a little bit in the second half as we make some critical hires to drive that business going forward.
We're focused on the continued cost controls, we don't expect it to get significantly up from the sort of range we've been over the last four quarters. Adjusted operating income, which excludes the impact of stock-based compensation charges, depreciation, amortization, and litigation judgment expenses, was $8.4 million in the second quarter of 2012. This is actually a $7.2 million increase from the adjusted operating income of $1.2 million in the second quarter of 2011. The GAAP income from operations for the quarter was $6.1 million. This compares to a GAAP loss of $5 million in the second quarter of 2011. Again, the second quarter of 2011 was impacted by a number of sort of significant one-time items. We had the Turner judgment protector impairment last year, and also the impairment of some of our assets for Evidence.com data centers.
That was a driver for the loss last year. Again, even on an adjusted basis, we're up significantly over the prior year. Net income for the second quarter of 2012 was $3.4 million, or $0.06 per share on both a basic and diluted basis, compared to a loss of $2.3 million, or a $0.04 loss on a basic and diluted basis in the second quarter of last year. We finished the quarter with $23.2 million worth of cash equivalents, and short-term investments. That's actually a decrease of $3.3 million from the year-end cash levels, investment levels. The biggest driver there is the buyback of stock. As we announced on April 25th, the board of directors authorized a $20 million buyback of stock. We actually purchased $16.1 million worth of stock in the second quarter, that was offset by the operating cash flow.
The cash came down slightly. Again, the significant cash generation in the business is funding that buyback of stock. Accounts receivable of $14.7 million are up actually $2.9 million from the prior year end, again, due to increased sales in the second quarter of 2012 versus the fourth quarter of 2011. Inventory at June 30th is $10.5 million. This is actually down $1 million from the prior year-end balance. Decreases attributed to reductions in finished goods due to the strong sales in the second quarter. The total assets for the business at June 30th were $97.8 million. As we move on to the liability side of the balance sheet, accounts payable of $3.9 million is actually down $0.6 million from the year-end balance due to some timing of some check runs and just purchasing activity versus the fourth quarter.
Accrued liabilities of $6.6 million are actually down $1.1 million, primarily due to the litigation judgment expense reversal of $2.2 million that we took last quarter relating to the Turner case. The total deferred revenue line on the balance sheet of $9.2 million is actually increased $1.3 million from the 2011 year-end levels. This is due to a number of factors. The increased sales of the X2 are driving that because of a number of the extended warranties that are purchased with that X2 trade-in program, as well as we sell more Flex units. We do defer roughly between 50% and 60% of the Flex sales to reflect the fact that it does come with an Evidence.com service, and we'll be recognizing that Evidence.com service over the service life, which is anywhere from one to three years.
That you'll see that deferred revenue line tick up as we see further traction, both the X2 trade-in program and the increase in our Flex sales over time. The total liabilities are $22.5 million, and we finished the quarter with $75.3 million stockholders' equity. Again, that's down a little bit from the year-end, just driven by the stock buyback that we executed during the second quarter. Continue to have no debt on the balance sheet and have plenty of liquidity to fund both the R&D efforts and sales expansion efforts internationally. As we move on to the cash flow information, the company had cash provided from operations of $9.7 million during the second quarter of 2012. For the six months ended June 30th, we've generated $13.4 million of cash from operations.
The cash used by investing activities for the six months ended June 30th was $1 million, compared to $11.6 million in the same period last year. Again, the cash usage this year is really driven mostly by the purchasing activity and some property and equipment, mostly some computers and also some of the production equipment for some of the new products we've launched this year. Cash used in financing activities was $15.7 million for the six months ended June 30th, 2012, compared to $12.5 million used in the same period of 2011. Again, the biggest driver there is the repurchase of $16.1 million worth of the company's stock during the quarter. We did purchase approximately 3.1 million shares during the June 30th quarter. We ended the quarter with $18 million in cash and $5.2 million in short-term investments, for a total of $23.2 million of cash in investments.
We still feel very confident in the strong liquidity position and the ability to continue to invest in the business. With that, I just want to move on to sort of the sales statistics for people modeling the business here. For the second quarter, we actually sold 11,292 of the X26 ECDs. We sold 8,338 of the X2 ECDs. That's up sharply from the first quarter. M26s, we sold 790 units. We sold 25 of the X3 product, 2,708 C2 units, and 2,351 TASER CAMs. Again, that's up pretty sharply from the first quarter as well. For cartridge sales, we had 364,104 cartridges sold in the quarter. Again, that's comparable to the first quarter, but we're seeing a pretty strong year in cartridge sales so far. With that, I'll turn it back over to Rick Smith, our CEO.
Great. Thanks, Dan. Before we wrap up, I want to revisit our three core strategic foci that we've talked about the last several conference calls. Those areas of focus are, number one, upgrading our installed base of ECDs that are greater than five years old. Number two, accelerating the penetration of our video and cloud business. Number three, expanding international sales. First, let's talk about the X2 and expanding our installed base. I saw a number of significant orders this quarter. One of the more important ones was in Australia, 775 X2 ECDs. The international markets tend to take a longer time period to approve new products, so we're delighted to see Australia being the first country to move in a significant way to the X2, and also 475 TASER CAM HDs. It was also a strong quarter for state patrols.
Oregon State Patrol went full deployment with 454 X2s, North Carolina State Highway Patrol with 422 X2s, and the Ohio State Highway Patrol upgraded from M26s to X26s with 485 units. We also saw in the municipal area some strong X2 purchases, 250 units going to Manchester, 162 units going to Las Vegas, beginning their transition. Obviously, that's a very large department, I believe over 3,000 officers. This is hopefully the start of a larger transition. We also had another large agency purchase 2,500 X2 units. That agency, for operational security reasons, asked us not to disclose who it was, so we're not going to. In terms of the upgrades themselves, obviously some of these were new purchases. We like to keep tabs on how much of the installed base is actually upgrading.
At the end of Q1, we had upgraded approximately 3.3% of the installed base of ECDs that are greater than five years old. At the end of Q2, this number had risen from 3.3% to 5%, so we're making some progress there. This was partially due to the reintroduction of an upgrade program this year. We had an upgrade program last year that sunsetted at the end of the year. We did see a dip in X2 sales in the first quarter, so we revamped a new upgrade that declines in value each quarter, starting at $250 and declining to $160 by year-end. We believe that helped to reinvigorate upgrades. Today, we just announced a new program that we believe could also have a significant impact on upgrades. This is a new initiative to help our customers transition called the TASER Protection Plan, or TPP.
The protection plan allows our customers to pay for TASER ECDs, accessories, and consumables in five equal payments over a five-year time period. This program offers two key advantages. First, it allows our customers to avoid the difficult process of getting large, singular capital equipment purchase approvals. Instead, we allow them to use roughly one-fifth and break it into annual outlays from their operating budget. This creates a predictable ongoing budgetary line item that can be used to replace after the fifth year, to replace or upgrade their ECD units.
Basically, if we're able to get an operating line item, obviously in government, that's a very helpful thing, because once you're there, tendency is makes it a lot easier in year six to just continue that line item, go ahead and upgrade those units with a new extended payment purchase or a lease purchase in year six, as opposed to once every five or six or longer number of years, having to go back for abnormal approvals for capital equipment expenditures. We believe this will allow for a more seamless transition to upgrading over time, and we expect this budgetary dynamic could allow for a much larger % of the market to upgrade their devices in a more timely fashion than we've seen historically.
Over the past year, we've seen around 5% of the market upgrade to the newer product, 5% of devices that are over five years old. Obviously, we can take that 5% up to a greater number. It'll have a significant impact on the business. We only started test marketing this TPP to a small number of agencies over the last 45 days. We've already received our first order from Colorado Springs for 525 X2s. We do have several other deals in the pipeline now, and we're planning a full rollout in the middle of August. We're preparing distributor training and all of the items needed to scale this program from a small test to a full rollout.
I should also point out that we are partnering with leasing partners that enable us to accelerate the payment, basically so that we would get paid up front with the lease partners exercising their core competencies in operating over the term of the lease, which obviously means we can outsource the credit risk and the payments over time. We can accomplish this due to the way we're structuring these programs without degrading our operating margins. Let's flip to our second area now, the video and Evidence.com. Very proud to report we've had two full deployments within weeks of shipping. BART, the Bay Area Rapid Transit Police, is up to 220 units. They started with an initial order of, I believe, around 160, and then expanded it within a matter of weeks to a full 220. Modesto, California, 131 Axon Flex cameras.
The other thing we're seeing that's quite encouraging is the major cities are moving much faster than we experienced with the ECD launch 10 years ago. Both Mesa and Fort Worth have 50 units in the field. We have several other major cities that are currently testing and many of them who expressed interest. We'd anticipated that we'd see the smaller agencies outpacing the large agencies just due to the dynamics of the purchasing environment. Again, we've been pleasantly surprised as large agencies seem to be moving more quickly. Let me share a couple of customer quotes from agencies that have been testing these out in the field over the last several weeks. These actually just came back in the last week or two. From a first officer, "I've been a law enforcement officer for nine years. I've tested several body-worn cameras for years now.
By far, the Axon Flex rates the best in every category. I personally wear a camera every day on duty and believe that officer-worn video is the wave of the future. It not only protects officers from false claims, which it has done for me several times, but it reminds people that their actions are being recorded and can be shown to a judge. Often, that is enough for them to act differently towards the officer. I was surprised that I never ran out of battery power or filled up the camera's recordings. Even on super long days when the camera was on the entire time, it never failed me. And on traffic stops, they would start getting mouthy, then see the camera and stop talking.
That's a reaction we've not been able to elicit with this group in the 50 years we've been dealing with them." And finally, "Just this past weekend on foot patrol, I had someone tell me I looked more intimidating than the six-foot-five deputy standing next to me because of the camera." From another officer, "I'm very pleased with the performance of the TASER Axon Flex camera system. I used it on every shift since it was assigned to me, uploading hundreds of videos to Evidence.com website. I found the system is very easy to operate. I found it does not interfere with my performance in any way. And I use the camera in rain, in the sun, in the heat, in the cold.
I use it on my motorcycle, in a patrol car, in daytime, and at night, and I've been nothing short of amazed at the performance of the system, the clarity of the picture, et cetera. In closing, I highly recommend the purchase of the TASER Axon Flex body-worn camera by our city. Please." So we're obviously delighted to be getting this sort of user feedback. The product is being very well received. New bookings this quarter for the Axon Flex were roughly flat at a little over $400,000, which we attribute largely due to the fact that the Flex did not begin shipping until late in the quarter and most agencies were just receiving test units. However, the TASER CAM HD, which had started shipping earlier in the year, did accelerate total sales in our video segment up to $1.3 million from $884,000 in the first quarter.
Let's turn our attention to international sales. We had very solid results at $4.8 million in international sales. We'd already talked about the orders from Australia, which were significant. We also had an 800 unit X26 order from Brazil. This is important as Brazil historically has been primarily buying the M26. We believe we'll see some transition to the X26 and even the X2 in Brazil. As mentioned, we have a team that's going in-country to set the foundation. They were at the International Association of Chiefs of Police Conference in Brazil this week. And they will be located full-time in Brazil by the end of the year. In Brazil, we put out a press release in conjunction with our distributor and some government agencies down in Brazil that we do plan to invest approximately $6 million in the country.
We've received several questions whether we're writing a check today, this is an immediate expense. The answer is no. This is being funded out of revenues from Brazil over the next several years. Brazil's been around a $3 million a year country for us in revenues. We expect this investment to come from positive net margins in the country, not a large upfront capital investment. We're focused on being efficient and growing our business in Brazil intelligently. We're not building a company-owned facility in Brazil. Rather, one of our core contract manufacturing partners that already manufactures some of the more complicated and complex components for us here in the U.S., they have their own facility in Brazil, which is well-established. We're partnering with that same contract manufacturer, in order to do the final assembly of the complete unit, in Brazil.
We will be sending a team of several U.S. employees to spend the next year in Brazil and help us build out the local team and grow the country over the long term. Again, we expect it to be funded out of operating margin from that country. In Europe, we've also expanded our presence. We have two employees who've relocated from the U.S. to help the team of four that we already had in Europe. They're located in France and Germany. Earlier this month, you saw we announced several significant orders out of TASER Europe, we're seeing our investment in greater customer engagement begin to bear fruit. In conclusion, we've been very pleased with the performance of the company in the first half of 2012. Your employees have been working hard, cutting costs, improving our processes across the board.
All that effort is paying off with the results that we're so proud to report today. We believe the products and programs are in place, such as the new TPP payment plan, which will set the foundation for a strong second half to 2012. However, I should remind you that the third quarter tends to be seasonally weaker than the second quarter, as always, it still remains difficult to predict the timing of large orders and the rate of adoption for our newest products. Thanks for taking the time to join us today. We look forward to talking with you all again in October. With that, we'll open it up for a few questions.
Thank you. We will now begin the question and answer session. If you do have a question, please press star then one on your touchtone phone. If you wish to be removed from the queue, please press the pound sign or hash key. If you're using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you do have a question, please press star then one on your touchtone phone. Our first question comes from Steve Dyer from Craig-Hallum. Please go ahead.
Good morning, and congratulations on the good results.
Thank you.
A question just generally on the phase-out of the X26, or I shouldn't say phase-out, but it's my understanding that departments have been made aware that essentially five years is the useful life for an X26. I'm just wondering in general anecdotal reaction to that. Do you see that driving upgrade cycles? Are there people just sort of deciding they're gonna roll the dice? What's the general reaction to that?
We are seeing that it is helping our customers to sort of get focused on upgrading their technology. The X26 is a 10-year-old platform. Now, in the current budgetary environment, we've seen many agencies have been putting out their capital equipment purchases. Vehicles that they normally replace every three or four years, they're getting several extra years out of them. We're certainly not seeing across the board that people are immediately moving to upgrade or refresh units that are getting past their useful life, but it's starting to make a difference. We believe the most important and compelling aspect are the improved safety features of the newer products, which helps give them a more compelling reason to upgrade. We're certainly hoping that this new TASER Protection Plan helps them to do it out of operating budgets and accelerate the upgrade. It is making a difference.
It's not 100% across the board certainly that people are immediately moving to upgrade units outside the useful life.
Have you noticed any difference, and maybe it's just too early to say, but in cartridge usage with the X2 versus the X26?
This is Dan. Steve, nothing significant so far. Because you've got the ability to display the warning arc, we are hearing from the field that they're getting compliance from people just displaying that warning arc, which they're more likely to do with the X2 because the X26, you have to basically unload the weapon to display that warning arc, where the X2, one of the key features and the key benefits is the fact you can do that while it's loaded, so you don't create an officer safety issue. Anecdotally, we are hearing that they're getting a lot of compliance from that. We haven't really seen that translate into a difference in the cartridge usage so far.
Yeah. I think the dynamics that we would look at, in general, if we had to estimate it, between 10%-20% of our cartridges that are sold are actually used in the field. 80%-90% are used in training. Because of the multi-shot capability of the X2, we actually see greater numbers of cartridges being fired in training, but we may see less cartridges being fired in the field due to the surrenders. The net effect, it's too early to say which direction it nets out.
Okay. That's helpful. Then, Dan, how will the revenue be recognized under the new TPP program? Is that gonna be a deferred revenue scenario, or is that all upfront and just the cash flows are deferred?
It's gonna depend on whether we actually sell the paper. This first deal with Colorado Springs, we're actually partnered with a leasing company, so we'll get paid upfront. We'll recognize the revenue upfront. If we hold the paper, we'll likely end up recognizing it over time. For the most part, our goal here will be to, depending on the deal structure, most of these deals, we expect that we won't hold the paper, so it'll be recognized in the sales upfront.
Is that the full normal ASP, or does the leasing company shave anything off for themselves?
Yeah. There's a little bit of a discount, as Rick said, we think we can do that and still maintain our normal operating profits, because of just the fact that this is driving higher sales and just some of the other considerations as part of the sale. Even though there's a little bit of a haircut we take, the overall profitability of the deal will still be strong.
Okay, my last question, I'll jump back in the queue. Gross margins have been really very good the last couple of quarters. I'm trying to figure out going forward, if that's a sustainable level, how much of that is just attributable to the higher revenue run rate versus, do we have, maybe with the X2 and the Axon, maybe a kind of a permanent shift in mix that's going to take those up some?
Yeah, that's a good question. I think that overall, certainly the higher operating leverage we have is helping. There's a lot of indirect manufacturing costs that are relatively fixed, having higher sales levels certainly helps in that regard. I think the X2 has certainly helped in that regard because of the higher ASP versus the X26. With Flex, as we see more adoption of Flex, I think that'll be, in the near term, a little bit of a drag just because of the deferred revenue. We're only recognizing roughly half that sale up front, and then the other half over time. It'll kind of normalize over time. In the beginning, because of the deferred revenue component of the Flex sales, as the Axon Flex takes off and becomes a bigger part of the business, those margins won't be quite as strong as the ECD margins.
Okay. Very helpful. Congratulations again.
Thanks, Steve.
Thank you. Our last question comes from Greg McKinley from Dougherty. Please go ahead.
Yeah, thank you. First of all, Dan, I missed the number you gave on cartridge units. Could you repeat that, please?
Yeah, sure thing. We sold 364,104 cartridges in the quarter.
Okay, great. Can you remind me of the X2 rebate rate currently in effect? What reductions, if any, have occurred, and then how you expect that rebate to sort of bleed off later this year?
Yeah. For the second quarter, it was $250 a unit.
In the third quarter, it'll come down to $210 a unit. I think as sort of difference from where we were year-on, we've kind of announced the rebates throughout the year. We want to encourage customers to move as quickly as they can and their budgets allow because the rebate is coming down over the year. It's $250 in Q2, it'll come down to $210 in Q3. Certainly, felt that it helped us a little bit in Q2. It created impetus for certain customers that did want to move a little quicker to make sure they took advantage of that higher trade-in value.
Great. It was also $250 in Q1, is that correct?
That's correct.
Yeah. Okay. Getting back to the TASER Protection Plan for a moment. You would envision if most transactions occur, such as the one that you're doing with Colorado Springs, and my sense is that is how you expect most of these to be handled. On the P&L, we're just going to see revenue and cost of sales. The leasing company, in essence, is your direct customer. Maybe just a slightly lower gross margin rate, but you'll make up for operating margin just with operating expense leverage on higher volume. Is that how you're thinking about it?
Yeah. That's exactly right.
Okay. You wouldn't anticipate holding long-term deferred receivables. You think most of them, the receivable will be with the leasing company rather than yourself.
Yeah, that's the current intent. Obviously, we'll have to sort of see how this plays out over time. We've got a strong cash generation in the business. For right now, we think we'll let the leasing companies do what they're good at, and we'll do what we're good at, as long as the economics work. Obviously, if that discount the leasing company wants to take becomes a part where we don't think the economics work, we certainly reserve rights to take that paper ourself. For right now, what we're seeing, is that we can do this and have them be responsible, both take the credit risk and also do the sort of recurring billings and everything else with that.
Yeah.
I think that's the model we intend on going forward with, I think it should work. We're talking to a number of different companies, leasing companies. That should help keep it competitive so the rates we sell the paper at remains attractive for us.
Any ballpark guidance on what kind of discount you're going to be seeing on those sales?
No. Nothing I can really say. It's going to depend on each deal. Part of it will depend on the sort of the inferred interest rate that's baked into the lease.
Yeah
Lower the rate, the bigger the discount that we take.
Yeah.
Nothing I can really talk to. I think overall, like I said, I think it won't change our operating margins.
Yeah
For the business. We still feel that even if we do more of these deals over time, we don't think it'll be net accretive to earnings.
Oh, okay. Thank you. Then on the video business, I wonder if you could just talk a little bit about how you guys are assessing the performance of the business from a higher level perspective in terms of, what do we need to see out of it in order to continue justifying heavy investment back into it. Maybe also give us a framework for what type of annual revenue run rate might need to be achieved before it's no longer dilutive to operating income. What kind of milestones do you need to be seeing in the next six to nine months where you say, "Yeah, this is something we want to continue to pursue?
Yeah, those are great questions. I think one of the things we're going to look at is really just the traction. I think for us, if you look at the first quarter results, we actually had a net investment in the video business of about $3 million. That's been reduced down to about $2.5 million. Obviously, we want to continue to see that work its way towards break even and then start contributing. I think that we're going to monitor it closely, both for the net investment, but we're encouraged by the traction we're seeing. We're encouraged by the feedback we're getting from some of the early customers. We still remain convinced that this can be a very interesting and material part of our business. I think as long as we continue to feel that way, we think the investment's warranted.
I think the same as you guys will be doing from an investor's perspective, we're going to monitor the performance of that and really want to see that we continue to get traction in both the sales and profitability of that business.
Any feel on what required revenues in the video segment to sort of have that segment be a break-even proposition?
It's tough to answer that because it'll sort of depend on how quickly we get there. The good thing about the video business, because we're deferring some of the Flex sales, that'll actually help in the future because the cost of running our sort of the infrastructure, there's sort of a fixed and variable part of that. As those deferred revenues start being recognized, that'll actually help the profitability. It's a tough thing to model, but certainly, I think that sort of the best way to look at it will be just sort of see the trends and be able to sort of see, predict kind of when we kind of cross that break-even threshold.
Yeah. All right, thank you.
Sure thing, Greg.
At this time, we have no further questions. Do you have any concluding remarks?
Well, I'd just say again, thanks, everybody. Obviously, we really enjoy days like today. It's been a long road the last several years to get here. I think we've really tuned up the organization. Any shareholders that would like to come take a visit to your company, please feel free to contact our IR department by email at ir@taser.com. I'd be happy to show you around your company, and we look forward to hopefully continued strong performance in the back half of the year and as we move into 2013. Look forward to joining you all again in late October for our next conference call. Thanks, and have a great day.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.