During its fourth-quarter earnings call, Axon Enterprise (AXON 1.27%) and its chief financial officer, Jawad Ahsan, essentially laid the company's cards on the table for everyone to see, acknowledging that it had reached a threshold of crucial importance to investors.
Speaking about Axon's three pillars of its financial strategy -- top-line growth, bottom-line leverage, and cash generation -- Ahsan homed in on generation of free cash flow (FCF) and its ability to keep the company "nimble and flexible." Highlighting exactly how this would work, Ahsan said, "This flexibility will be built on the stable foundation of a subscription-based business model that generates highly recurring cash flows."
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With Axon having a history of lumpy (to put it nicely) FCF generation, let's discuss why this quote is so crucial to the company's operations and, ultimately, investors' returns over the long term.
Axon envisions becoming a cash machine
Axon is an Arizona-based company that develops technology and weapons products for military, law enforcement, and civilians. Its best known as the maker of the Taser electroshock weapon, but it has expanded its product line and now makes products like police body cams, dashboard cams, and various technologies and services to store and analyze the captured video footage.
Axon has posted strong sales growth over the past decade, leading to more than a 3,000% increase in its share price over that same time.
However, as the company continues its maturation, it will be of utmost importance to turn this sales growth into free cash flow (FCF) as its operations continue to scale and reach more substantial efficiencies.
AXON revenue (TTM). Data by YCharts. TTM = trailing 12 months.
As the chart above shows, Axon's revenue growth has been a smooth ride up and to the right, but its FCF has taken a more turbulent route to an overall increase.
This FCF volatility is primarily due to Axon's transformational change in its operations, as it gradually shifted from solely Taser sales to a subscription-based offering built around the company's budding Axon Cloud. Trading short-term margins for long-term recurring sales, FCF has been understandably lumpy, yet it looks poised to show stable growth.
With 65% of the company's Taser sales coming from subscription bundles and most of Axon Cloud's revenue being recurring in nature, the company has a solid foundation on which to build its cash machine.
Axon Cloud is crucial to investors: It ties together all of the company's law-enforcement products and services -- building a justice-focused ecosystem.
What this means for Axon's stock
With a gross margin of 74%, these Axon Cloud sales are incredibly high margin and help support Ahsan's theory of becoming a cash machine through its recurring revenue and subscription bundles.
Management is guiding for FCF of $125 million to $145 million in 2022, compared to the $74 million in 2021. Using Axon's market capitalization (or company price tag) of $9.7 billion, this would leave it trading around 70 times forward FCF.
That's a relatively expensive valuation. But with management focusing on boosting FCF, and its high-margin Axon Cloud growing 36% in 2021, the company's stock could look cheap a decade from now.
Furthermore, with a $52 billion target addressable market outlined by management in November 2021, Axon's market cap could turn out to be far too small given its decades-long ambitions.
