Stun gun maker Axon Enterprise (NASDAQ:AXON) stunned investors last quarter after sales and profits fell short of analyst and even company expectations. The market reacted by dumping Axon stock; it dropped 18%. It has mostly continued falling and now trades 24% below where it was the day before the last earnings report, and more than 30% below the 52-week high.

Yet there were indications the original response to the earnings report was an overreaction, and there is little basis for the continued weakness in the stock. With the company scheduled to report third-quarter earnings on Thursday, Nov. 7, let's see what investors might expect.

Police officer with body camera and Taser weapon.

What every well-equipped police officer is wearing: an Axon 3 body cam and a Taser 7 stun gun. Image source: Axon Enterprise.

A shocking miss

The cause for Axon's shortfall last quarter was its new conducted electrical weapon (CEW), the Taser 7, which the company is counting on for future growth. Both a battery component supplier issue and a design change in the cartridges that fire the projectiles meant it didn't have enough product to ship. That caused a total revenue shortfall of $6 million, split evenly between the two problems.

The cartridge change also hurt margins by about $1.6 million, because Axon had to scrap old inventory it had on hand that no longer worked with the new design, while also experiencing temporarily higher labor costs. 

Fortunately, the less-than-smooth rollout of the Taser 7 wasn't a lost sales opportunity, only a delayed one. Axon worked with the battery component supplier to help it manufacture at scale, and as of the end of Q2 said it is now capable of meeting production needs.

Why the response was an overreaction

Although the delays hurt Q2 results and draw out the realization of the revenue longer, they are not forgone sales. The $3 million in sales related to the battery issue that should have been in the second quarter will now appear in the third, while the other $3 million for the cartridge change will probably mostly show up in the fourth quarter.

The benefit to Axon is that the last-minute changes it introduced help reduce the cost of making the cartridges, and it expects to see a 33% reduction of material costs by the end of the year.

Not only is the Taser 7 a new weapon that it hopes to upsell to customers, but it also introduces to Axon a new cartridge business model and a new training program. Perhaps most important of all, it introduces a new subscription-based software model that provides Axon with recurring revenue streams.

Look for Axon to grow from here

A subscription model will provide Axon with a more stable base to grow from than the previous one-and-done sales model. The company's evidence-management database system has proved especially sticky with customers who, once drawn into the ecosystem, are loath to leave.

In its Q2 shareholder letter, Axon said: "Year over year, we have doubled the percentage of Taser device orders tied to a subscription from 30% to 60% of total orders."  The new Taser 7 further integrates the weapons into the ecosystem, because the batteries, which are good only for the Taser 7 system, collect data on the CEWs' usage.

When the Taser is deployed and powered up, the lithium energy cell battery is recording, even if the electrical charges are never deployed. It provides date and time data on when it was armed, when the trigger was pulled, how long it was pulled, and when it powered down. When the battery is inserted into the dock for recharging, all of the data is automatically uploaded to for review.

There is a big incentive for law enforcement agencies looking for greater accountability to upgrade to the Taser 7 to maintain all of their records in one easily accessible place. That drives more subscriptions.

How will it play out in the quarter?

Axon says it expects Q3 revenue to be between $120 million and $125 million, up as much as 19% from last year. Even subtracting the $3 million pushed into the quarter from the supplier issue, it's still a 15% increase, on par with the year-ago gains. Analysts have staked out a middle ground with a consensus expectation of $122.8 million in sales, while they forecast earnings will grow 30% year over year to $0.26 per share.

Although the Q2 miss was unfortunate, it was not a fatal mistake. Because the company now has a whole suite of solutions for law enforcement beyond just stun guns -- including body cameras that are continuously being upgraded -- there's no reason to expect Axon won't grow from here.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.