Currently trading with a market capitalization, or company price tag, of roughly $10 billion, shares of Axon Enterprise (AXON +0.87%) are down over 30% from their 52-week highs. Seemingly caught up in the broader growth-stock sell-off in the market over the recent few months, Axon's long-term investing thesis remains more robust than ever -- making its upcoming earnings call on the 24th of February quite interesting.
Specifically, the company's dollar-based net retention (DBNR) rate will be critical to investors. Continued strength in this metric would reinforce the longer-term promise of Axon's operations -- potentially setting the stage for a rebound in its stock price over the next few years.
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Growing sales from existing customers
Operating in two segments, Taser and Software & Sensors, Axon has quietly been transforming into a subscription-driven business model, slowly shifting away from its historical focus on tasers. This subscription model's core is the Axon Cloud unit, which comprises the larger portion of the Software & Sensors segment.
Through this Axon Cloud, the company offers various software as a service (SaaS) solutions to its customers, including data storage on its cloud -- most notably video footage from its different cameras on evidence.com. However, this is just the beginning of Axon's broader cloud ambitions as it looks to build out its real-time operations (such as dispatch), automated recordkeeping, and augmented and virtual reality training for officers.
I've highlighted this Software & Sensors segment as it is ultimately the driving force behind the company's impressive 119% dollar-based net retention (DBNR) rates. In Axon's case, this DBNR rate includes software, services, and cloud sales while leaving hardware sales out, as the company uses the metric to track its overall SaaS growth.
DBNR measures the year-over-year change in sales generated from existing customers -- including customers lost to churn. Generally speaking, a number above 100% alludes to growth from its installed customer base, making Axon's mark of 119% very promising -- especially since it has been at that level for the last five quarters.
Thanks partly to this solid organic growth from its existing customers, Axon has seen its annual revenue grow by 39% year over year. Furthermore, in addition to spurring this revenue growth, DBNR is pivotal to Axon's long-term investment thesis as it directly tracks the expansion of the company's cloud and software solutions, which are the company's new focus.
Why dollar-based net retention is key to Axon's success
As DBNR goes, so will Axon's SaaS growth story go. Annually recurring SaaS revenue is quickly becoming the driving force behind Axon's growth story, now accounting for one-third of the company's total sales.
Not only are these SaaS sales incredibly high-margin, with Axon Cloud posting 75% gross margins, but they add a level of predictability to its financials, providing valuable recurring payments from customers. While Axon's original Taser segment has solid gross margins of its own at 66%, the company's shift from 34% of sales tied to subscription bundles in 2016 to its current mark of 73% highlights this more consistent revenue model.
The beauty of this DBNR rate for Axon investors is that it allows for direct insight into these SaaS sales every quarter, providing a valuable checkup on the company's land-and-expand business model within its software categories. For example, by initially getting its foot in the door with taser and body camera sales, it now looks to build longer-term relationships with its customers through its cloud offerings.
Looking ahead to earnings on the 24th, I will be primarily focused on this DBNR rate to make sure it stays at or improves from its 119% mark, signaling strength in its cloud-focused future. While Axon still trades at nearly 100 times free cash flow, its combination of solid sales growth, promising DBNR, and developing profitability in its high-margin cloud unit have it poised to grow into this seemingly expensive valuation.
In addition to DBNR, it will be essential to watch Axon's stock-based compensation for Q4 as these expenses have weighed heavily upon its operating margins over the last few years. Paying $35 million in stock-based compensation versus $232 million in overall revenue during the third quarter, Axon will need to reign in these payments in to boost profitability over the long-term.
