AXON ENTERPRISE, INC. - Quarter Report: 2006 September (Form 10-Q)

e10vq

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, 2006


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		86-0741227
(State or other jurisdiction		(I.R.S. Employer
of incorporation or organization)		Identification Number)

17800 N. 85^th St., SCOTTSDALE, ARIZONA		85255
(Address of principal executive offices)		(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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer o Accelerated Filer þ Non-accelerated Filer o

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 61,923,053 shares of the issuer’s common stock, par value $0.00001 per share, outstanding as of November 2, 2006.

TASER INTERNATIONAL, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006
TABLE OF CONTENTS


	Page
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
Balance sheets as of September 30, 2006 and December 31, 2005		3
Statements of operations for the three and nine months ended September 30, 2006 and 2005 (as restated)		4
Statements of cash flows for the nine months ended September 30, 2006 and 2005 (as restated)		5
Notes to financial statements		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		21
Item 3. Quantitative and Qualitative Disclosures About Market Risk		28
Item 4. Controls and Procedures		28

PART II — OTHER INFORMATION
Item 1. Legal Proceedings		30
Item 1A. Risk Factors		34
Item 2. Unregistered Sales and Equity Securities and Use of Proceds		40
Item 6. Exhibits		41
SIGNATURES		42
INDEX TO EXHIBITS		43

Exhibit 31.1

Exhibit 31.2

Exhibit 32.1

Exhibit 32.2
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TASER INTERNATIONAL, INC.

BALANCE SHEETS

(UNAUDITED)


	September 30, 2006			December 31, 2005
ASSETS

Current assets
Cash and cash equivalents	$	15,833,820		$	16,351,909
Short-term investments		5,638,637			—
Accounts receivable, net of allowance of $110,000 and $111,000 in 2006 and 2005, respectively		10,387,944			5,422,027
Inventory		8,531,385			10,105,336
Prepaids and other assets		2,330,459			2,795,576
Insurance settlement proceeds receivable		4,538,852			575,000
Income tax receivable		66,511			44,454
Current deferred income tax asset		8,209,718			6,955,500


Total current assets		55,537,326			42,249,802
Long-term investments		29,028,942			27,548,120
Property and equipment, net		20,794,976			21,061,754
Deferred income tax asset		21,828,408			20,040,788
Intangible assets, net		1,492,672			1,340,783


Total assets	$	128,682,324		$	112,241,247


LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities
Current portion of capital lease obligations	$	44,669		$	43,111
Accounts payable and accrued liabilities		6,604,931			6,315,654
Current deferred revenue		930,152			561,165
Deferred insurance settlement proceeds		660,824			476,515
Litigation settlement liabilities		21,750,000			—
Customer deposits		259,351			190,256


Total current liabilities		30,249,927			7,586,701
Capital lease obligations, net of current portion		42,485			76,188
Deferred revenue, net of current portion		1,580,598			839,983


Total liabilities		31,873,010			8,502,872


Commitments and Contingencies		—			—

Stockholders’ equity

Preferred stock, $0.00001 par value per share; 25 million shares authorized; 0 shares issued and outstanding at September 30, 2006 and December 31, 2005		—			—
Common stock, $0.00001 par value per share; 200 million shares authorized; 61,922,153 and 61,938,654 shares issued and outstanding at September 30, 2006 and December 31, 2005, respectively		619			619
Additional paid-in capital		80,427,462			78,742,862
Treasury stock		(2,208,954	)		—
Retained earnings		18,590,187			24,994,894


Total stockholders’ equity		96,809,314			103,738,375


Total liabilities and stockholders’ equity	$	128,682,324		$	112,241,247

The accompanying notes are an integral part of these financial statements.

TASER INTERNATIONAL, INC.

STATEMENTS OF OPERATIONS

(UNAUDITED)


	For the Three Months Ended					For the Nine Months Ended
	September 30, 2006			September 30, 2005		September 30, 2006			September 30, 2005
				(As restated, see note 3)					(As restated, see note 3)
Net Sales	$	18,311,543		$	11,675,611	$	48,430,303		$	35,086,431


Cost of Products Sold:
Direct manufacturing expense		5,099,381			2,932,791		12,858,166			9,568,667
Indirect manufacturing expense (1)		1,580,182			1,002,919		4,594,840			4,021,200


Total Cost of Products Sold		6,679,563			3,935,710		17,453,006			13,589,867


Gross Margin		11,631,980			7,739,901		30,977,297			21,496,564

Sales, general and administrative expenses (1)		7,125,408			6,724,899		21,982,755			19,242,541
Research and development expenses (1)		772,976			360,689		1,999,777			1,103,593
Litigation Settlement		—			—		17,650,000			—


Income(loss) from operations		3,733,596			654,313		(10,655,235	)		1,150,430

Interest income		483,371			306,761		1,281,399			853,473
Interest expense		(1,760	)		—		(5,650	)		(103	)
Other expense, net		—			—		(228	)		(59,735	)


Income (loss) before income taxes		4,215,207			961,074		(9,379,714	)		1,944,065
Provision(credit) for income taxes		1,819,309			586,194		(2,975,007	)		1,066,675


Net income(loss)	$	2,395,898		$	374,880	$	(6,404,707	)	$	877,390


Income per common and common equivalent shares
Basic	$	0.04		$	0.01	$	(0.10	)	$	0.01
Diluted	$	0.04		$	0.01		(0.10	)	$	0.01

Weighted average number of common and common equivalent shares outstanding
Basic		62,031,850			61,385,863		62,003,727			61,266,387
Diluted		64,717,904			63,694,740		62,003,727			63,951,621


	For the Three Months Ended				For the Nine Months Ended
	September 30, 2006		September 30, 2005		September 30, 2006		September 30, 2005
(1) Stock-based compensation was allocated as follows:
Indirect manufacturing expense	$	33,419	$	—	$	95,964	$	—
Sales, general and administrative		194,885		—		695,265		—
Research and development expenses		46,388		—		157,111		—

	$	274,692	$	—	$	948,340	$	—

The accompanying notes are an integral part of these financial statements.

TASER INTERNATIONAL, INC.

STATEMENTS OF CASH FLOWS

(UNAUDITED)


	For the Nine Months Ended
	September 30, 2006			September 30, 2005
				(As restated, see note 3)
Cash Flows from Operating Activities:
Net income (loss)	$	(6,404,707	)	$	877,390
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		1,548,115			1,185,374
Loss on disposal of fixed assets		—			56,872
Provision for excess and obsolete inventory		3,623			—
Provision for warranty		310,359			150,415
Stock-based compensation expense		948,340			—
Deferred insurance settlement proceeds recognized		(40,691	)		—
Deferred income taxes		(3,041,838	)		52,645
Excess tax benefits from stock-based compensation		—			1,026,539
Change in assets and liabilities:
Accounts receivable		(4,965,917	)		1,154,734
Inventory		1,570,328			(2,227,579	)
Prepaids and other assets		465,117			178,158
Insurance settlement proceeds receivable		(3,963,852	)		—
Income tax receivable		(22,057	)		10,597
Accounts payable and accrued liabilities		203,918			(3,028,743	)
Deferred revenue		1,109,602			83,289
Accrued litigation settlement		21,750,000			—
Customer deposits		69,095			116,353


Net cash provided (used) by operating activities		9,539,435			(363,956	)


Cash Flows from Investing Activities:
Purchases of investments		(75,487,096	)		(26,985,127	)
Proceeds from investments		68,367,637			36,702,634
Purchases of property and equipment		(1,252,576	)		(7,380,839	)
Purchases of intangible assets		(180,650	)		(66,153	)


Net cash provided (used) by investing activities		(8,552,685	)		2,270,515


Cash Flows from Financing Activities:
Payments under capital leases		(32,145	)		(4,642	)
Proceeds from options exercised		736,260			474,629
Repurchase of common stock		(2,208,954	)		—


Net cash provided by financing activities		(1,504,839	)		469,987


Net increase (decrease) in cash and cash equivalents		(518,089	)		2,376,546
Cash and cash equivalents, beginning of period		16,351,909			14,757,159


Cash and Cash Equivalents, end of period	$	15,833,820		$	17,133,705


Supplemental Disclosure:
Cash paid for interest	$	5,650		$	103
Non Cash Transactions-
Increase to deferred tax asset related to tax benefits realized from the exercise of stock options (with a related increase to additional paid in capital of $0 and $1,179,138)	$	—		$	726,586
Increase to property and equipment with a corresponding increase in accounts payable	$	—		$	1,121,091

The accompanying notes are an integral part of these financial statements.

TASER INTERNATIONAL, INC.

NOTES TO FINANCIAL STATEMENTS (unaudited)

1. Company background

TASER International, Inc. (“TASER” or the “Company”) is a global leader in the development and manufacture of advanced electronic control devices designed for use in law enforcement, corrections, private security and personal defense. The Company’s core expertise includes proprietary, patented technology which is uniquely capable of incapacitating highly focused and aggressive subjects. The Company’s proprietary Neuro-Muscular Incapacitation (NMI) technology uses electrical impulses to interfere with a subject’s neuron-muscular system, causing substantial incapacitation regardless of whether the subject feels or responds to pain. The Company’s current flagship products are the TASER M26 and TASER X26 models. Both the M26 and the X26 are hand-held devices which launch two wire-tethered probes at a remote target up to a maximum distance of 35 feet. These wire tethered probes serve to form an electrical connection from the TASER device to the subject, thereby eliminating the need for the user to make close contact with the potentially dangerous target. In addition to the hand-held devices, the Company also sells disposable cartridges which contain the probes, wires, and proprietary nitrogen propulsion system. These cartridges are disposable and provide a recurring revenue stream from the Company’s installed customer base. There are several models of cartridges with ranges from 15 feet to 35 feet and include both electrically active cartridges and inert simulation cartridges used only in training. The Company also sells batteries, chargers, holsters and other accessories.

It should be noted that the Company’s products are often used in aggressive confrontations that may result in serious, permanent bodily injury or death to those involved. A person injured in a confrontation or otherwise in connection with the use of the Company’s products may bring legal action against the Company to recover damages on the basis of theories including personal injury, wrongful death, negligent design, dangerous product or inadequate warning. The Company is currently subject to a number of such lawsuits. The Company may also be subject to lawsuits involving allegations of misuse of its products. The Company has seen and expects to continue to see additional complaints filed against it alleging injuries resulting from the use of a TASER device. If successful, personal injury, misuse and other claims could have a material adverse effect on the operating results and financial condition of the Company. Although the Company carries product liability insurance, significant litigation could also result in a diversion of management’s attention and resources, negative publicity and an award of monetary damages in excess of its insurance coverage. The outcome of any litigation is inherently uncertain and there can be no assurance that existing or any future litigation will not have a material adverse effect on the Company’s revenues, financial condition or financial results.

The Company’s deferred tax asset includes approximately $78 million in net operating loss carryforwards. The amount of the deferred tax asset is considered realizable; however, it could be reduced in the near term if estimates of future taxable income during the carry forward period are reduced.

2. Summary of significant accounting policies

a. Basis of presentation

The accompanying unaudited financial statements of TASER International, Inc. include all adjustments (consisting only of normal recurring accruals) which management considers necessary for the fair presentation of the Company’s operating results, financial position and cash flows as of September 30, 2006 and September 30, 2005 and for the periods then ended. Certain information and note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted from these unaudited financial statements in accordance with applicable rules.

The results of operations for the three and nine month periods ended Spetember 30, 2006 are not necessarily indicative of the results to be expected for the full year (or any other period) and should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K as filed on March 16, 2006.

TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued

b. Segment information

Management has determined that its operations are comprised of one reportable segment. For the three and nine months ended September 30, 2006 and 2005, sales by geographic area were as follows:


	For the Three Months Ended						For the Nine Months Ended
	September 30,			September 30,			September 30,			September 30,
	2006			2005			2006			2005
United States		88	%		86	%		89	%		88	%
Other Countries		12	%		14	%		11	%		12	%


Total		100	%		100	%		100	%		100	%

Sales to customers outside the United States are denominated in U.S. dollars. Substantially all assets of the Company are located in the United States.

c. Stock-Based compensation

Prior to January 1, 2006, the Company accounted for its stock-based compensation plans under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB Opinion No. 25”) and related interpretations, as permitted by Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”). Accordingly, no stock-based compensation expense was recognized in the income statement for the three and nine month periods ended September 30, 2005, as all options granted under the Company’s stock-based employee compensation plans had an exercise price equal to the market value of the underlying common stock on the date of grant. As permitted by SFAS No. 123, stock-based compensation was included as a pro forma disclosure in the notes to the Company’s financial statements for the three and nine month periods ended September 30, 2005.

Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123(R), “Share Based Payment” (“SFAS No. 123(R)”) using the modified prospective transition method. Under that transition method, compensation cost recognized in the three and nine months ended September 30, 2006 includes: (a) compensation cost for all stock-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all stock-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). Results for prior periods have not been restated, as provided for under the modified-prospective method.

Total stock-based compensation expense recognized in the income statement for the three and nine months ended September 30, 2006 was $274,692 and $948,340 before income taxes, respectively. The related total deferred tax benefits were approximately $120,000 and $341,000 for the three and nine months ended September 30, 2006, respectively.

Prior to the adoption of SFAS No. 123(R), the Company presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the consolidated statements of cash flows. SFAS No. 123(R) requires the tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options (“excess tax benefits”) to be classified and reported as both an operating cash outflow and a financing cash inflow on a prospective basis upon adoption.

The following table shows the effect on net income and basic and diluted earnings per share for the three and nine months ended September 30, 2005 had compensation cost been recognized based upon the estimated fair value on the grant date of stock options in accordance with SFAS 123, as amended by SFAS No. 148 “Accounting for Stock-Based Compensation – Transition and Disclosure”.

TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued


	Three Months Ended			Nine Months Ended
	September 30, 2005			September 30, 2005
Net income, as reported	$	374,880		$	877,390
Add: Total stock-based compensation included in net income as reported		—			—
Deduct: Total stock-based employee compensation determined under fair value based method for all awards, net of related tax effects		(1,755,000	)		(4,037,000	)


Net loss — pro forma	$	(1,380,120	)	$	(3,159,610	)


Net income per common share — as reported:
Basic	$	0.01		$	0.01
Diluted	$	0.01		$	0.01

Net loss per common share — pro forma:
Basic, pro forma	$	(0.02	)	$	(0.05	)
Diluted, pro forma	$	(0.02	)	$	(0.05	)

Basic		61,385,863			61,266,387
Diluted		63,694,740			63,951,621

Disclosures for the three and nine month periods ended September 30, 2006 are not presented because the amounts are recognized in the financial statements in connection with the adoption of SFAS 123R.

SFAS No. 123R requires the use of a valuation model to calculate the fair value of stock-based awards. The Company has elected to use the Black-Scholes-Merton (“BSM”) option valuation model, which incorporates various assumptions including volatility, expected life, and interest rates. The assumptions used for the three and nine month periods ended September 30, 2006 and September 30, 2005 and the resulting estimates of weighted-average fair value per share of options granted during those periods are as follows:


	For the Three Months Ended						For the Nine Months Ended
	September 30, 2006			September 30, 2005			September 30, 2006			September 30, 2005
Expected Life	3.49 years			1.5 — 3 years			3.49 years			1.5 — 3 years
Volatility		68.8% — 69.2	%		103	%		67.8% — 70.3	%		106	%
Risk Free Interest Rate		4.86% — 5.14	%		3.50	%		4.5% — 5.14	%		3.50	%
Dividend Yield		—			—			—			—
Weighted average fair value of options granted during the period	$	4.18		$	5.23		$	4.43		$	4.72

The expected life of the 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 future employee behavior. For 2006, 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. Prior to the adoption of SFAS 123R, expected stock price volatility was estimated using only the historical volatility of the Company’s stock. 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 near future.

TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued

d. Income per Common Share

The Company accounts for earnings per share in accordance with SFAS No. 128, “Earnings per Share.” Basic income per share is computed by dividing net income by the weighted average number of common shares outstanding during the periods presented. Diluted income 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:


	Earnings Per Share				Earnings Per Share
	For the Three Months Ended				For the Nine Months Ended
	September 30, 2006		September 30, 2005		September 30, 2006			September 30, 2005
Numerator for basic and diluted earnings per share
Net income	$	2,395,898	$	374,880	$	(6,404,707	)	$	877,390


Denominator for basic earnings per share — weighted average shares outstanding		62,031,850		61,385,863		62,003,727			61,266,387
Dilutive effect of shares issuable under stock options outstanding		2,686,054		2,308,877		—			2,685,234


Denominator for diluted earnings per share — adjusted weighted average shares outstanding		64,717,904		63,694,740		62,003,727			63,951,621


Net income per common share
Basic	$	0.04	$	0.01	$	(0.10	)	$	0.01
Diluted	$	0.04	$	0.01	$	(0.10	)	$	0.01

Basic net income (loss) per share is based upon the weighted average number of common shares outstanding during the period. For the three months ended September 30, 2006, the effects of 1,813,325 stock options were excluded from the calculation of diluted income per share as their effect would have been antidilutive and increased the net income per share. As a result of the net loss for the nine months ended September 30, 2006, 3,563,310 of potential dilutive securities were considered anti-dilutive and excluded from the calculation. For the three and nine months ended September 30, 2005, the effects of 558,406 and 370,906 stock options were excluded from the calculation of diluted income per share as their effect would have been antidilutive and increased the net income per share.

e. Warranty Costs

The Company warrants its products 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. The Company also sells extended warranties for periods of up to four years after the expiration of the limited one year warranty. The Company tracks historical data related to returns and related warranty costs on a quarterly basis, and estimates future warranty claims by applying the estimated average return rate to the product sales for the period. Historically, the reserve amount is increased if the Company becomes aware of a component failure that could result in larger than anticipated returns from its customers. After the one year warranty expires, if the device fails to operate properly for any reason, the Company will replace the ADVANCED TASER device for a fee and the TASER X26 for a prorated discounted price depending on when the product was placed into service. These fees are intended to cover the handling and repair costs and include a profit. A summary of changes in the warranty accrual for the nine months ended September 30, 2006 and 2005 is as follows:


	September 30, 2006			September 30, 2005
Balance at Beginning of Period	$	851,920		$	457,914
Utilization of Accrual		(427,227	)		(599,193	)
Warranty Expense		310,359			749,607


Balance at End of the Period	$	735,052		$	608,328

f. Recent Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109.” This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. This Interpretation is effective for fiscal years beginning after December 15, 2006. Management is currently assessing the impact of the Interpretation on its financial statements.

In November 2005, the Financial Accounting Standards Board (the “FASB”) issued FASB Staff Position No. FAS 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards” (“FSP 123(R)-3”). Under the provisions of FSP 123(R)-3, entities may follow either the transition guidance for the additional paid-in capital pool as prescribed by SFAS 123(R), or elect to use the alternative transition method as described in the FSP. An entity that adopts SFAS 123(R) using the modified prospective application method may make a one-time election to adopt the transition method described in the FSP. The Company is currently evaluating the available transition alternatives and has until November 2006, which is one year from the effective date of the FSP, to finalize the one-time election.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when quantifying Misstatements in Current Year Financial Statements (SAB 108). SAB 108 requires companies to evaluate the materiality of identified unadjusted errors on each financial statement and related financial statement disclosure using both the rollover approach and the iron curtain approach, as those terms are defined in SAB 108. The rollover approach quantifies misstatements based on the amount of the error in the current year financial statement, whereas the iron curtain approach quantifies misstatements based on the effects of correcting the misstatement existing in the balance sheet at the end of the current year, irrespective of the misstatement’s year(s) of origin. Financial statements would require adjustment when either approach results in quantifying a misstatement that is material. Correcting prior year financial statements for immaterial errors would not require previously filed reports to be amended. If a Company determines that an adjustment to prior year financial statements is required upon adoption of SAB 108 and does not elect to restate its previous financial statements, then it must recognize the cumulative effect of applying SAB 108 in fiscal 2006 beginning balances of the affected assets and liabilities with a corresponding adjustment to the fiscal 2006 opening balance in retained earnings. SAB 108 is effective for interim periods of the first fiscal year ending after November 15, 2006. Management does not expect the adoption of SAB 108 to have a material impact on its financial statements.

TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued

3. Restatement of Previously Issued Financial Statements for Manufacturing Overhead and Error Corrections

On May 11, 2006, the Company concluded that its financial statements at March 31, 2005, June 30, 2005 and September 30, 2005 and for the periods then ended, included in its Form 10-Qs for the periods ended March 31, 2005, June 30, 2005 and September 30, 2005, respectively, should no longer be relied upon due to an error in those financial statements which resulted in the incorrect calculation of manufacturing overhead costs being applied to inventory. The Company has restated its results for the quarters ended March 2005 and June 2005 in its Form 10-Q’s filed for the periods ended March 31, 2006 and June 30, 2006, respectively, and is amending the results of the quarter ended September 30, 2005 herein. No restatement of the Company’s financial statements for the years ended December 31, 2005 and December 31, 2004 is necessary as a result of the matters discussed below as the Company has determined they are not material to those periods based on the materiality guidelines contained in SEC Staff Accounting Bulletin No. 99 – “Materiality”.

During the first quarter of 2006, the Company determined that its historical methodology for the calculation of indirect manufacturing overhead costs applied to inventory was incorrect and also identified a clerical error in the calculation of the overhead applied to inventory for the three months ended December 31, 2005. The Company originally recorded an adjustment in the first quarter of 2006 to correct the net cumulative impact of the change in methodology and the clerical error. However, as it was subsequently determined that the impact of correcting the methodology related to prior periods was material to the operating results of the first quarter of 2006, a further adjustment was necessary to reflect the cumulative impact against the relevant prior year periods. Additionally, the Company has recorded the impact of previously unrecorded adjustments related to cut-off errors primarily for legal and professional fees and the related income tax effects which were previously deemed to be immaterial.

A summary of the impact to correct the cumulative amount of manufacturing overhead costs applied to inventory, record previously unrecorded proposed cut-off errors and the related income tax effects on the financial statements for the quarter ended September 30, 2005 is as follows:


	Three Months Ended September 30, 2005										Nine Months Ended September 30, 2005
	As										As
	Previously		Overhead			Cut-off					Previously		Overhead			Cut-off
	Reported		Adjustments			Adjustments			As Restated		Reported		Adjustments			Adjustments			As Restated
Statements of Income

Indirect manufacturing expense	$	894,450	$	108,469		$	—		$	1,002,919	$	3,531,611	$	489,589		$	—		$	4,021,200
Total Cost of Products Sold		3,827,241		108,469			—			3,935,710		13,100,278		489,589			—			13,589,867
Gross Margin		7,848,370		(108,469	)		—			7,739,901		21,986,153		(489,589	)		—			21,496,564
Sales, general and administrative expenses		6,909,018		(149,741	)		(34,378	)		6,724,899		19,740,112		(342,086	)		(155,485	)		19,242,541
Income from operations		578,663		41,272			34,378			654,313		1,142,448		(147,503	)		155,485			1,150,430
Income before provision for income taxes		885,424		41,272			34,378			961,074		1,936,083		(147,503	)		155,485			1,944,065
Provision for income taxes		555,000		17,018			14,176			586,194		982,000		20,133			64,542			1,066,675
Net income	$	330,424	$	24,254		$	20,202		$	374,880	$	954,083	$	(167,636	)	$	90,943		$	877,390

Income per common share
Basic	$	0.01	$	—		$	—		$	0.01	$	0.02	$	—		$	—		$	0.01
Diluted	$	0.01	$	—		$	—		$	0.01	$	0.01	$	—		$	—		$	0.01


	Nine Months Ended September 30, 2005
	As
	Previously			Overhead			Cut-off
	Reported			Adjustments			Adjustments			As Restated
Statement of Cash Flows

Net income		954,083			(167,636	)		90,943			877,390
Deferred income taxes		(32,030	)		20,133			64,542			52,645
Change in assets and liabilities:
Inventory		(2,375,082	)		147,503			—			(2,227,579	)
Accounts Payable and accrued liabilities		(2,873,258	)		—			(155,485	)		(3,028,743	)

TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued

4. 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 original maturities of 90 days to one year. Long-term investments include securities having original maturities of more than one year. The Company’s long-term investments are invested in federal agency mortgage-backed securities, and are classified as held to maturity. These investments are recorded at amortized cost. The Company intends to hold these securities until maturity. The Company intends to reinvest the proceeds from maturing short and long term investments into securities with similar original maturities.

The following is a summary of cash, cash equivalents and held-to-maturity investments by type at September 30, 2006 and December 31, 2005:


	September 30, 2006									December 31, 2005
			Gross Unrealized		Gross Unrealized							Gross Unrealized		Gross Unrealized
	Cost		Gains		Losses			Fair Value		Cost		Gains		Losses			Fair Value
Cash	$	13,841,485	$	—	$	—		$	13,841,485	$	6,387,796	$	—	$	—		$	6,387,796
Government sponsored entity securities		36,659,914		39,064		(261,478	)		36,437,500		37,512,233		22,887		(388,252	)		37,146,868


Total cash, cash equivalents and investments	$	50,501,399	$	39,064	$	(261,478	)	$	50,278,985	$	43,900,029	$	22,887	$	(388,252	)	$	43,534,664


	September 30,		December 31,
	2006		2005

Government sponsored entity securities reported as:
Cash equivalents	$	1,992,335	$	9,964,113
Short term investments		5,638,637		—
Long term investments		29,028,942		27,548,120

	$	36,659,914	$	37,512,233

The following table summarizes the contractual maturities of government sponsored entity securities at September 30, 2006 and December 31, 2005:


	September 30,		December 31,
	2006		2005
Less than 1 year	$	17,777,577	$	14,980,493
1-3 years		18,882,337		22,531,740

	$	36,659,914	$	37,512,233

The following table provides information about held-to-maturity investments with gross unrealized losses and the length of time that individual investments have been in a continuous unrealized loss position at September 30, 2006:


	Less than 12 months					12 months or more					Total
			Gross					Gross					Gross
			Unrealized					Unrealized					Unrealized
Description of Securities	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Government sponsored entity securities	$	2,988,451	$	(1,337	)	$	24,750,515	$	(260,141	)	$	27,738,966	$	(261,478	)

The unrealized losses on the Company’s investment in government sponsored entity securities were caused by interest rate increases. The contractual cash flows of these investments are guaranteed by an agency of the U.S. Government and, accordingly it is expected that the securities would not be settled for a price less than the amortized cost of the investment. Since the decline in fair value was attributable to interest rates and not credit quality, and because the Company has the ability and intent to hold these investments to maturity, the Company does not consider these investments to be other than temporarily impaired at September 30, 2006.

TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued

5. Inventories

Inventories are stated at the lower of cost or market. Cost is determined using the weighted average cost which approximates the first-in, first-out (FIFO) method. Provisions are made to reduce potentially excess, obsolete or slow-moving inventories to their net realizable value. Inventories as of September 30, 2006 and December 31, 2005 consist of the following:


	September 30, 2006			December 31, 2005
Raw materials and work-in-process	$	4,948,095		$	8,054,683
Finished goods		3,724,785			2,311,403
Reserve for excess and obsolete inventory		(141,495	)		(260,750	)


Total Inventory	$	8,531,385		$	10,105,336

6. Intangible assets

Intangible assets consist of the following at September 30, 2006 and December 31, 2005:


			September 30, 2006						December 31, 2005
			Gross						Gross
			Carrying		Accumulated		Net Carrying		Carrying		Accumulated		Net Carrying
	Useful Life		Amount		Amortization		Amount		Amount		Amortization		Amount
Amortized intangible assets:
TASER.com domain name	5 Years		$	60,000	$	60,000	$	—	$	60,000	$	56,000	$	4,000
Issued patents		4 to 15 Years		223,894		77,528		146,366		168,280		59,238		109,042
Issued trademarks		9 to 11 Years		16,872		1,809		15,063		14,198		695		13,503
Non compete agreement	7 Years			50,000		23,214		26,786		50,000		17,857		32,143

				350,766		162,551		188,215		292,478		133,790		158,688

Unamortized intangible assets:
TASER Trademark				900,000				900,000		900,000				900,000
Patents and trademarks pending				404,457				404,457		282,095				282,095

				1,304,457				1,304,457		1,182,095				1,182,095



Total intangible assets			$	1,655,223	$	162,551	$	1,492,672	$	1,474,573	$	133,790	$	1,340,783

Amortization expense for the three months ended September 30, 2006 and 2005 was $8,616 and $9,782, respectively. Amortization expense for the nine months ended September 30, 2006 and 2005 was $28,761 and $20,145, respectively. Estimated amortization expense of intangible assets for the balance of 2006, the next four years and thereafter is as follows:


Year Ending December 31
2006	$	8,875
2007		35,499
2008		35,499
2009		23,577
2010		15,423
Thereafter		69,342

	$	188,215

TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued

7. Accounts payable and accrued liabilities

Accounts payable and accrued liabilities consist of the following at September 30, 2006 and December 31, 2005:


	September 30, 2006		December 31, 2005
Accounts payable	$	3,763,794	$	4,027,335
Accrued expenses		1,001,013		954,908
Accrued warranty expense		735,052		851,920
Accrued salaries and benefits		1,105,072		481,491

Total	$	6,604,931	$	6,315,654

8. Income taxes

The deferred income tax asset at September 30, 2006 is comprised primarily of a net operating loss carryforward, which resulted from the compensation expense the Company recorded for income tax purposes when employees exercised stock options in 2004. For the three and nine months ended September 30, 2006, the Company did not recognize additional tax benefits related to disqualifying dispositions of stock options exercised. A total tax benefit of $1,277,945 was credited to additional paid-in capital in the nine months ended September 30, 2005 for these disqualifying dispositions. Additionally, warranty and inventory reserves, accrued vacation and other items have contributed to the deferred income tax asset.

The Company’s total current and long term deferred tax asset at September 30, 2006 is $30.0 million. In preparing the Company’s financial statements, the Company has assessed the likelihood that its deferred tax assets will be realized from future taxable income. In evaluating the ability to recover its deferred income tax assets, the Company 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. The Company 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 the Company believes that its tax estimates are reasonable, the ultimate tax determination involves significant judgments that could become subject to audit by tax authorities in the ordinary course of business. As a result of the shareholder litigation settlement expense recorded in the second quarter of 2006, the Company 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 not be fully realized. Accordingly, the Company has recorded a valuation allowance of $250,000, against its deferred tax assets as of September 30, 2006. Management believes that, other than as previously described, as of September 30, 2006, based on an evaluation and projections of future sales and profitability, no other valuation allowance was deemed necessary as the Company concluded that it is more likely than not that the Company’s net deferred tax assets will be realized. However, the deferred tax asset could be reduced in the near-term if estimates of future taxable income during the carryforward period are reduced.

TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued

9. Stockholders equity

Stock Repurchase

In August 2006, TASER’s Board of Directors authorized a stock repurchase program to acquire up to $10 million of the Company’s outstanding common stock. During the third quarter of 2006, the Company repurchased 300,000 shares at a weighted average cost of $7.36 per share and a total cost of approximately $2.2 million.

Stock Award Activity

At September 30, 2006, the Company had three stock-based compensation plans, which are described more fully in Note 11 to the financial statements included in the Company’s Annual Report on Form 10-K as filed on March 16, 2006.

The following table summarizes the stock options available and outstanding as of September 30, 2006 as well as activity during the nine months then ended:


				Outstanding Options
	Shares						Weighted
	Available for			Number of			Average
	Grant			options			Exercise Price
Balance at December 31, 2005		5,381,980			6,161,933		$	4.92
Granted		(114,125	)		114,125		$	8.84
Exercised		—			(273,321	)	$	2.36
Expired/terminated		132,599			(132,599	)	$	5.75

Balance at September 30, 2006		5,400,454			5,870,138		$	5.09

The options outstanding as of September 30, 2006 have been segregated into five ranges for additional disclosure as follows:


					Options Outstanding						Options Exercisable
									Weighted
							Weighted		Average				Weighted
					Number		Average		Remaining		Number		Average
Range of Exercise Price					Outstanding		Exercise Price		Contractual Life		Exercisable		Exercise Price

$	0.28	—	$	0.99		1,325,101	$	0.36		6.1		1,325,101	$	0.36
$	1.03	—	$	2.41		1,688,532	$	1.55		2.8		1,683,697	$	1.54
$	5.89	—	$	9.65		2,360,980	$	8.07		7.3		2,207,220	$	8.07
$	10.10	—	$	19.76		430,025	$	14.37		8.0		339,549	$	14.72
$	20.12	—	$	29.98		65,500	$	23.85		7.8		53,290	$	23.53



$	0.28	—	$	29.98		5,870,138	$	5.09		5.8		5,608,857	$	4.84

Aggregate intrinsic value of options outstanding and options exercisable at September 30, 2006 was $20.6 million and $20.5 million, respectively. Aggregate intrinsic value represents the difference between the Company’s closing stock price on the last trading day of the fiscal period, which was $7.25 as of September 30, 2006, and the exercise price multiplied by the number of options outstanding. Total intrinsic value of options exercised was $1.7 million and $4.5 million for the nine-month periods ended September 30, 2006 and 2005, respectively. As of September 30, 2006, total unrecognized stock-based compensation expense related to non-vested stock options was approximately $1.3 million, which is expected to be recognized over a weighted average period of approximately 11.6 months.

The total fair value of options vested was $14.0 million and $11.5 million for the nine-month periods ended September 30, 2006 and 2005, respectively.

TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued

10. Line of credit

The Company has a line of credit agreement with a bank which provides for a total availability of $10 million. The line is secured primarily by the Company’s accounts receivable and inventory and bears interest at varying rates of interest, ranging from LIBOR plus 1.5% to prime. 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 June 30, 2008 and requires monthly payments of interest only. At September 30, 2006, the available borrowing was $8.5 million and there was no amount outstanding under the line of credit. 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. For the quarter ended September 30, 2006, the Company was in violation of a covenant prohibiting the repurchase of shares of its common stock. Effective November 1, 2006, the Company signed an amendment to its existing agreement with the bank which waived the violation and permits the repurchase of shares up to an aggregate amount of $10 million.

11. Commitments and Contingencies

Legal proceedings

Securities Litigation
Securities Class Action Litigation

Beginning on or about January 10, 2005, numerous securities class action lawsuits were filed against the Company and certain of its officers and directors. These actions were filed on behalf of the purchasers of the Company’s stock in various class periods, beginning as early as May 29, 2003 and ending as late as January 14, 2005. The majority of these lawsuits were filed in the District of Arizona. Four actions were filed in the United States District Court for the Southern District of New York and one in the Eastern District of Michigan. The New York and Michigan actions were transferred to the District of Arizona. The class actions were consolidated by Judge Susan Bolton and Lead Plaintiff and Lead Counsel were selected. The Lead Plaintiff filed a consolidated complaint (which became the operative complaint for all of the class actions) on August 29, 2005. The operative class period is May 29, 2003 to January 11, 2005. The defendants filed a motion to dismiss the consolidated complaint, which has been fully briefed for the Court but was not decided.

The consolidated complaint alleges, among other things, violations of the Securities Exchange Act of 1934, as amended, and Rule 10B-5, promulgated thereunder, and seeks unspecified monetary damages and other relief against all defendants. The consolidated amended complaint generally alleges that the Company and the individual defendants made false or misleading public statements regarding, among other things, the safety of the Company’s products and the Company’s ability to meet its sales goals, including the validity of a $1.5 million sales order with the Company’s distributor, Davidson’s, in the fourth quarter of 2004. The consolidated complaint also alleges that product defects were leading to excessive product returns by customers.

      On July 25, 2006, Lead Plaintiff, Lead Counsel, defendants and defendants’ counsel engaged in a mediation conference, and in subsequent discussions, in an attempt to settle the consolidated securities class actions. On August 9, 2006, the parties filed a joint notice of settlement stating, among other things, that the parties had reached an agreement in principal setting all consolidated actions, subject to documentation, notice and Court approval. On August 11, 2006, the Court issued an Order staying the class action for 60 days to allow the parties to complete and submit settlement documents, and further denying as moot the defendants’ pending motion to dismiss the consolidated complaint. On October 11, 2006, the parties filed a joint Stipulation of Settlement and related documents, and plaintiff filed a motion in support of the proposed order preliminarily approving the settlement, to which motion the defendants consented.

     The Stipulation of Settlement and related documents filed on October 11, 2006 set forth terms of settlement including, among other things, full releases of any and all related known or unknown claims among the plaintiff, plaintiff class and the defendants, and payment of $20 million from TASER for the benefit of the plaintiff class to be comprised of $12 million in cash (approximately $4.1 million to be provided from the Directors’ and Officers’ Liability Insurance policy), and $8 million in Company common stock valued as of the date at which the stock is transferred (1,103,448 shares based on a closing market price of $7.25 at September 29, 2006). The number of shares is subject to change based on the market price of the Company’s stock at the consumation of the settlement. At the Company’s election, the stock portion of the settlement may be funded with cash.

      Any Settlement of the consolidated securities class actions is conditioned upon approval by the Court and other factors. There is no assurance that the settlement will be completed on the terms set forth in the parties’ Stipulation of Settlement and related documents filed with the Court, or at all. In the event that a settlement occurs, it is expected that the consolidated securities class actions will be dismissed.

Shareholder Derivative Litigation

Beginning on or about January 11, 2005, numerous shareholder derivative actions were also filed against the Company’s officers and directors. Such actions have been filed in the United States District Court for the District of Arizona, the Arizona Superior Court in Maricopa County, and the Delaware Chancery Court in New Castle County. The derivative actions pending in the Arizona Superior Court and the Delaware Chancery Court have been stayed pending resolution of the consolidated Arizona District Court action.

The plaintiffs in the Arizona District Court action filed a consolidated complaint on May 13, 2005. The Company and the individual defendants filed motions to dismiss the consolidated complaint on August 19, 2005. On March 17, 2006, the Court denied the motions to dismiss. Defendants answered the consolidated complaint on April 21, 2006. Discovery has commenced and no trial date has been set.

TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued

The derivative complaints are based on similar facts and events as those alleged in the securities class action complaints. The complaints generally allege that the individual defendants breached the fiduciary duties that they owe to the Company and its shareholders by reason of their positions as officers and/or directors of the Company. The complaints claim that such duties were breached by defendants’ disclosure of allegedly false or misleading statements about the safety and effectiveness of Company products and the Company’s financial results. The complaints also claim that fiduciary duties were breached by defendants’ alleged use of non-public information regarding the safety of Company products and the Company’s financial condition and future business prospects to commit insider trading of the Company’s stock. The derivative plaintiffs seek damages and restitutionary, equitable, injunctive and other relief.

On July 25, 2006, the parties to the Arizona District Court action engaged in a mediation conference in an attempt to settle the shareholder derivative litigation. On August 9, 2006, the parties to the Arizona District Court action filed a joint notice of settlement stating, among other things, that the parties had reached an agreement in principal settling all consolidated actions, subject to documentation, notice and Court approval. On August 11, 2006, the Court issued an Order staying the Arizona District Court action for 60 days to allow the parties to complete and submit settlement documents. On October 13, 2006, the Court, upon the joint stipulation of the parties to the Arizona District Court action, entered an Order continuing the stay of the Arizona District Court action through November 6, 2006 to complete and submit settlement documents.

Terms of the proposed settlement include, among other things, that TASER would adopt certain measures to improve the Company’s corporate governance, and that TASER would pay the attroneys’ fees in the Arizona District Court action in the amount of $1,750,000 comprised of the Company’s common stock valued as of the date of which the stock is transferred (241,379 shares, based on a closing market price of $7.25 of September 29, 2006), in exchange for a release by plaintiffs and current TASER shareholders of all claims based on or arising out of the shareholder derivative complaint. All parties to the Arizona District Court action, the Arizona State Court action and the Delaware Chancery Court action anticipate that the settlement will include each of these actions. Any settlement of these derivative actions would be conditioned upon approval by the Court and other factors. There is no assurance that the settlement will be completed on the foregoing terms or at all. In the event that a settlement occurs, it is expected that the derivative actions would be dismissed.

Proposed Class Action and Derivative Lawsuit Settlement

As a result of the aforementioned proposed settlements, the Company has established a litigation settlement liability of $21.75 million, recorded a receivable of $4.5 million to reflect insurance proceeds, and recorded a liability of approximately $400,000 for legal fees. The total litigation settlement expenses reflected in the income statement for the nine months ended September 30, 2006 are $17.65 million, which are net of insurance proceeds after legal fees. The Company has tax effected the settlement expenses in accordance with APB 28.

Demand for Inspection of Documents Litigation

On May 4, 2005, a Company shareholder filed an action in the Delaware Chancery Court against the Company under Section 220 of Delaware General Corporation Law, demanding the inspection of certain corporate documents. The Company filed an answer to the complaint on June 7, 2005. The plaintiff commenced discovery. Based upon the negotiations of the parties and the plaintiff’s review of certain Company documents related to the demand, on August 21, 2006, the parties filed a stipulation of dismissal of the action with prejudice on the merits.

Securities and Exchange Commission Investigation

In December 2004, the Company was informed that the staff of the Securities and Exchange Commission had commenced an informal inquiry concerning the Company’s public statements regarding the safety and performance of the Company’s products, certain disclosure issues and the accounting for certain transactions. The Company voluntarily provided documents and information to the SEC staff. In August 2005, the Company was informed that the staff of the SEC had initiated a formal investigation as of June 20, 2005, regarding the Company’s disclosures concerning the medical safety of its products; the accounting and disclosure of certain transactions; and the unauthorized acquisition of confidential information from the Company by persons outside the Company for the possible purpose of manipulating the Company’s stock. The Company provided additional information at the request of the SEC staff. In December 2005, the SEC staff advised the Company that it had completed its investigation into the Company’s disclosures concerning the medical safety of the Company’s products; and into the accounting and disclosure issues. The SEC staff further advised the Company that it had determined that it would not recommend that the Commission institute any enforcement proceedings as to these matters. The SEC staff also advised the Company that it was continuing to investigate issues relating to trading in the Company’s stock. In May 2006, the SEC staff advised the Company that the SEC investigation has been terminated in its entirety with no recommendation for enforcement action.

TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued

Contract Litigation

In March 2000, Thomas N. Hennigan, a sales representative for our products from late 1997 through early 2000, sued the Company and certain of our shareholders in the United States District Court, Southern District of New York. The Company previously sued him in February 2000 in the United States District Court for the District of Arizona, but had not served him. After the New York case was dismissed in February 2001 for lack of personal jurisdiction, Mr. Hennigan brought a counterclaim in the United States District Court for the District of Arizona. Mr. Hennigan claims the exclusive right to sell our products to many of the largest law enforcement, corrections, and military agencies in the United States. He sought monetary damages that may amount to as much as $500,000 against us allegedly arising in connection with his alleged service to the Company as a distributor. His claims rest on theories of our failure to pay commissions, breach of contract, promissory estoppel, breach of fiduciary duty, and on related theories. No written contract was ever signed with Mr. Hennigan. We believe that he has no reasonable basis for claims based on informal or implied contractual rights and will be unable to prove his damages with reasonable certainty. Mr. Hennigan died in April 2001 and the case is now being prosecuted by his estate. On May 24, 2002, H.A. Russell was permitted to proceed as an additional defendant-counterclaimant. We filed various motions in November 2002 for partial summary judgment including a motion to dismiss his claims. On September 30, 2003, the Court issued an order granting our motion for partial summary judgment to dismiss Mr. Russell’s claims and struck Hennigan’s jury demand. On April 14, 2004, the Court issued an opinion partially granting our motion for partial summary judgment on certain joint venture, post-termination, post-death and exclusivity claims. A pretrial conference was held on July 28, 2005 and the trial started on August 31, 2005. At the conclusion of Hennigan’s case in chief, we made a motion to dismiss Hennigan’s case. The court issued a briefing schedule on our motion and the trial was suspended pending the court’s decision on our motion. On August 4, 2006 the Court issued an opinion and order dismissing with prejudice all of plaintiffs claims, except the Court set a briefing schedule for an alleged remaining nominal claim. On September 28, 2006, the court entered an order granting judgment for plaintiff in the amount of the nominal claim. In October 2006, we reached a settlement agreement under which plaintiff agreed not to appeal the court’s order and we agreed to pay plaintiff the judgment and forego the Company’s claim for an award of attorney’s fees as the prevailing party under an offer of judgment.

In September 2004, the Company was served with a summons and complaint in the matter of Roy Tailors Uniform Co., Inc. v. TASER International in which the plaintiff alleges that it is entitled to commissions for disputed sales that were made to customers that are claimed to be plaintiff’s customers for which plaintiff is seeking monetary damages. Plaintiff failed to sign a distributor agreement with the Company and did not have distribution rights with the Company. This case is in the discovery phase and a trial date has been scheduled for April 2007. In October 2006, a request for dismissal of this lawsuit was filed with the court.

Other Class Action Litigation

In August 2005, the Company was served with a summons and complaint in the matter of Village of Dolton v. TASER International in which the Plaintiff alleges that defendant misled the plaintiff about the safety of the TASER device when they purchased the TASER device and are seeking damages. The plaintiff is seeking to certify the lawsuit as a class action. We have filed an answer to the complaint and a motion to dismiss. In October 2005, we filed a declaration of the former chief of police for the Village of Dolton which refutes many of the allegations made in the complaint and we filed a motion for sanctions. In October 2005, the Court issued an order partially granting our Motion to Dismiss, and denied the balance of the motions. In October 2006, the Company reached an agreement with the plaintiffs to dismiss this lawsuit the terms of which are subject to a confidentiality agreement.

Product Liability Litigation

The Company is currently named as a defendant in 56 lawsuits in which the plaintiffs alleged 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. In addition, 26 other lawsuits have been dismissed and are not included in this number. Two of the lawsuits that have been dismissed or judgment entered in favor of TASER, are on appeal. With respect to each of these pending 56 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. This table also lists those cases which were dismissed during the most recent fiscal quarter. Cases that were dismissed 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 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 $250,000 in per incident deductibles. We are defending each of these lawsuits vigorously.

TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued


	Month
Plaintiff	Served	Jurisdiction	Claim Type	Status
Alvarado	4/2003	CA Superior Court	Wrongful Death	Jury Verdict for TASER
City of Madera	6/2003	CA Superior Court	Wrongful Death	Dismissed by Summary Judgment, Appeal Pending
Thompson	9/2004	MI Circuit Court	Wrongful Death	Dismissed
Pierson	11/2004	US District Court, CD CA	Wrongful Death	Dismissed
Glowczenski	10/2004	US District Court, ED NY	Wrongful Death	Case Stayed
LeBlanc	12/2004	US District Court, CD CA	Wrongful Death	Discovery Phase
M. Elsholtz	12/2004	TX District Court	Wrongful Death	Discovery Phase
Washington	5/2005	US District Court, ED CA	Wrongful Death	Discovery Phase
Sanders	5/2005	US District Court ED CA	Wrongful Death	Discovery Phase
Fleming	5/2005	US District Court ED LA	Wrongful Death	Trial Scheduled for April 9, 2007
Woolfolk	6/2005	US District Court MD FL	Wrongful Death	Trial Scheduled for March 2007.
Graff	9/2005	AZ Superior Court	Wrongful Death	Discovery Phase
Holcomb	9/2005	US District Court, ND OH	Wrongful Death	Dismissed with Prejudice
Tucker	10/2005	US District Court, NV	Wrongful Death	Discovery Phase
Hammock	10/2005	District Court, Tarrant County, TX	Wrongful Death	Dismissed with Prejudice
Heston	11/2005	US District Court, ND CA	Wrongful Death	Discovery Phase
Rosa	11/2005	US District Court, ND CA	Wrongful Death	Discovery Phase
Gosserand	10/2005	US District Court, ED LA	Wrongful Death	Discovery Phase
O’Donnell/Hasse	11/2005	Circuit Court, Cook County, IL	Wrongful Death	Discovery Phase
Yeagley	11/2005	Hillsborough County Circuit Court, FL	Wrongful Death	Discovery Phase
Neal-Lomax	12/2005	US District Court, NV	Wrongful Death	Discovery Phase
Yanga Williams	12/2005	Gwinnett County State Court, GA	Wrongful Death	Discovery Phase
Mann	12/2005	US District Court, ND GA, Rome Div	Wrongful Death	Discovery Phase
King	12/2005	US District Court, MD FL, Jacksonville	Wrongful Death	Discovery Phase
Robert Williams	1/2006	US District Court, TX	Wrongful Death	Discovery Phase
Lee	1/2006	Davidson County, TN Circuit Court	Wrongful Death	Discovery Phase, Trial Scheduled for June 2008.
Zaragoza	2/2006	CA Superior Court, Sacramento County	Wrongful Death	Discovery Phase
Tapia	4/2006	CA Superior Court, Los Angeles County	Wrongful Death	Discovery Phase
Kinkle	6/2006	US District Court, ND MS	Wrongful Death	Discovery Phase
Nunez	6/2006	72^nd District Court, Lubbock County, TX	Wrongful Death	Discovery Phase
Bagnell	7/2006	Supreme Court for British Columbia, Canada	Wrongful Death	Discovery Phase
Salazar	7/2006	Maricopa County Superior Court, AZ	Wrongful Death	Discovery Phase
Gillson	7/2006	US District Court, NV	Wrongful Death	Discovery Phase
Hollman	8/2006	US District Court, ED NY	Wrongful Death	Complaint Served
Oliver	9/2006	FL Ninth Circuit Court	Wrongful Death	Complaint Served
Teran/LiSaola	10/2006	CA District Court	Wrongful Death	Complaint Served
Powers	11/2003	AZ Superior court	Training Injury	Verdict for TASER, Appeal Pending
Cook	8/2004	NV District Court	Training Injury	Discovery Phase
Stevens	10/2004	OH Court Common Pleas	Training Injury	Dismissed with Prejudice
Dimiceli	3/2005	FL Circuit Court	Training Injury	Dismissed with Prejudice
Allen	5/2005	AZ Superior Court	Training Injury	Dismissed with Prejudice
J.J	7/2005	FL Circuit Court	Training Injury	Discovery Phase
J.B	7/2005	FL Circuit Court	Training Injury	Discovery Phase
Howard	8/2005	AZ Superior Court	Training Injury	Discovery Phase
Wagner	8/2005	AZ Superior Court	Training Injury	Discovery Phase
Gerdon	8/2005	AZ Superior Court	Training Injury	Discovery Phase
Gallant	8/2005	AZ Superior Court	Training Injury	Discovery Phase
Herring	8/2005	Circuit Court of City of St. Louis, MO	Training Injury	Discovery Phase
Stewart	10/2005	Circuit Court for Broward County, FL	Training Injury	Discovery Phase
Lewandowski	1/2006	US District Court, NV	Training Injury	Discovery Phase
Peterson	1/2006	US District Court, NV	Training Injury	Discovery Phase
Husband	3/2006	British Columbia Supreme Court, Canada	Training Injury	Discovery Phase
Wright	4/2006	Court of Common Pleas, Clinton County Ohio	Training Injury	Discovery Phase
Howard	4/2006	US District Court, KS (Companion to AZ lawsuit)	Training Injury	Dismissed
Richthofen	7/2006	22^nd Judicial District Court, St. Tammany Parish, LA	Training Injury	Discovery Phase
Wilson	8/2006	US District Court, ND GA	Training Injury	Complaint Served
Gray	8/2006	Second Judicial District, Davis County, Utah	Training Injury	Dismissed with Prejudice
Diamond	8/2006	Circuit Court, Douglas County, Oregon	Training Injury	Complaint Served
Cuckovic	8/2006	Circuit Court, McDonald County, Missouri	Personal Injury	Complaint Served
Cosby	8/2004	US District Court, SD NY	Injury During Arrest	Discovery Phase
Blair	3/2005	US District Court, MD NC	Injury During Detention	Dismissed with Prejudice
Lewis	7/2005	US District Court Tal FL	Injury During Arrest	Dismissed with Prejudice
Lash	8/2005	US District Court ED MO	Injury During Arrest	Dismissed with Prejudice
Games	8/2005	Circuit Court, Multnomah County, OR	Injury During Arrest	Dismissed with Prejudice
Bynum	10/2005	US District Court SD NY	Injury During Arrest	Discovery Phase
Lopez	11/2005	US District Court, ND IL Eastern Div	Injury During Police Call	Discovery Phase
Bellemore	2/2006	AZ Superior Court	Injury During Arrest	Discovery Phase
Wieffenbach	6/2006	Circuit Court of 12^th Judicial District, Will County, Il	Injury During Arrest	Discovery Phase
Cruz	7/2006	CA Superior Court, Los Angeles County	Injury During Arrest	Discovery Phase
Turner	8/2006	US District Court, CD, CA	Injury During Arrest	Complaint Served
Molina	9/2006	US District Court, ND West Virginia	Injury During Detention	Complaint Served
Short	10/2006	US District Court, SD West Virginia	Injury During Arrest	Complaint Served

TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued

In December 2005, the Company received a defense verdict in the Samuel Powers v. TASER International personal injury case. As part of its legal strategy to aggressively defend these cases, the Company entered into a settlement agreement with its own insurance provider in order to prevent its insurance provider from settling the case with the plaintiff. Under the terms of the settlement, the Company received $575,000 from its liability insurance provider associated with a settlement and release agreement and the Company assumed all future potential liability and costs from and after the date the settlement and release agreement was signed. After offsetting approximately $100,000 in legal expenses to defend and win the trial, the Company has recorded the remaining balance of approximately $475,000 as deferred insurance settlement proceeds on its balance sheet. This deferred income will be used to cover any costs through all appeals and the remaining balance if any will be recorded as “other income” when final resolution is completed. During the three and nine month period ended September 30, 2006, the Company expended approximately $3,000 and $41,000, respectively, in connection with the appeal and reduced the deferred amount by these costs.

In November 2006, the Company received a defense verdict in the Alvarado v. Taser International in-custody death case. In September 2006, as part of its legal strategy to aggressively defend these cases, the Company entered into a settlement agreement with its own insurance provider in order to prevent its insurance provider from settling the case with the plaintiff. Under the terms of the settlement, the Company received $225,000 from its liability insurance provider associated with a settlement and release agreement and the Company assumed all future potential liability and costs from and after the date the settlement and release agreement was signed. The Company has recorded the $225,000 as deferred insurance settlement proceeds on its balance sheet. This deferred income will be used to cover any costs through all appeals and the remaining balance if any will be recorded as “other income” when final resolution is completed. No such defense costs were paid in the three months ended September 30, 2006.

Other Litigation

In January 2005, we filed litigation in U.S. District Court for the Western District of North Carolina against Stinger Systems, Inc. and Robert Gruder alleging false advertising and a violation of the Lanham Act. The defendants have filed a counterclaim against the Company alleging defamation. This case is in the discovery phase and no trial date has been set.

In February 2005, we filed litigation in Superior Court for Maricopa County against Thomas G. Watkins III, our former patent attorney, for declaratory judgment, breach of fiduciary duty, constructive fraud, and breach of contract. Mr. Watkins originally filed patent applications on our behalf as our patent attorney for inventions utilized in the TASER X26 device in February and May 2003. In each patent application he filed a declaration stating that Magne Nerheim, our employee, was the sole inventor. These patent applications are pending. Mr. Nerheim assigned his interest in these patent applications to us. In December 2004 Mr. Watkins informed us that he now felt that he was the inventor of a portion of this invention. We vigorously dispute his claim and we believe that we are the sole owner of this invention. We have filed a motion for summary judgment in this litigation in February 2006 which motion is pending before the Court. On February 14, 2006, U.S. Patent No. US 6,999,295 entitled “Dual Operating Mode Electronic Disabling Device For Generating A Time-Sequenced, Shaped Voltage Output Waveform” was issued to named inventors Thomas G. Watkins, III and Mr. Nerheim. Mr. Nerheim assigned his interest in this patent to us. This patent covers a portion of the technology utilized in the TASER X26 device. This patent was applied for by Mr. Watkins without our knowledge or consent. Since we are a joint owner of this patent, this patent will not restrict us from manufacturing and selling the TASER X26 device. We have other patent applications pending that cover inventions contained in this patent. In March 2006, the Court issued a temporary restraining order and a preliminary injunction preventing Mr. Watkins from selling, assigning, transferring or licensing this patent to a third party during the duration of this litigation. On August 2, 2006, the Court issued an order granting our motion for partial summary judgment on liability, leaving open the matter of remedies and other residual issues for resolution in subsequent proceedings.

In November 2005 and April 2006, we filed lawsuits in Marion County Circuit Court, Indiana and in Fairfax County Circuit Court, Virginia, respectively, against James Ruggieri for defamation, product disparagement, intentional interference with a business relationship, Lanham Act violations and tortuously affecting the fairness and integrity of litigation as adverse third-party witness. Mr. Ruggieri has counterclaimed for defamation and infliction of distress. This case is entering the discovery phase and no trial date has been set. In October 2006, we reached a settlement agreement with Mr. Ruggieri and a dismissal was entered in this litigation.

In December 2005, we filed a lawsuit in Vigo County, Indiana, Superior Court against Roland M. Kohr for defamation, product disparagement, Lanham Act violations, tortuously affecting the fairness and integrity of litigation as adverse third-party witness, and intentional interference with a business relationship. Dr. Kohr was the Medical Examiner and expert witness in the James Borden wrongful death litigation which litigation was dismissed with prejudice. This case is in the discovery phase and no trial date has been set.

In June 2006, we filed a lawsuit in U.S. District Court for the Central District of California against Bestex Company, Inc. for patent infringement, false patent marking, unfair competition and breach of written contract. Bestex filed a counterclaim for unfair competition and false advertising. This case is entering the discovery phase and no trial date has been set.

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. We intend to pursue and defend any lawsuit filed against or by the Company vigorously. Although we do not expect the outcome in any individual case to be material, the outcome of any litigation is inherently uncertain and there can be no assurance that any expense, liability and 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. The Company may settle a lawsuit in situations where a settlement can be obtained for nuisance value and for an amount which is expected to be less than the cost of defending a lawsuit. Due to the confidentiality of our litigation strategy and the confidentiality agreements that are executed in the event of a settlement, the Company will not identify or comment on which lawsuits have been settled or the amount of any settlement.

TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued

12. Related Party Transactions

Aircraft charter

Prior to 2006, the Company chartered an aircraft for business travel from Four Futures Corporation, which is wholly-owned by Thomas P. Smith, President of the Company, and his family. Beginning in 2006, the Company began reimbursing Thomas P. Smith for business use of his personal aircraft. For the three and nine months ended September 30, 2006, the Company incurred expenses of approximately $125,000 and $327,000 respectively, to Thomas P. Smith and Four Futures Corporation. For the three and nine months ended September 30, 2005, the Company incurred expenses of approximately $141,000 and $340,000, respectively, to Thomas P. Smith and Four Futures Corporation. Any personal use of the aircraft by Mr. Smith prior to 2006 was billed to Four Futures Corporation for reimbursement. At September 30, 2006 and December 31, 2005, the Company had outstanding payables of approximately $72,000 and $67,000, respectively to Thomas P. Smith, and no amounts due from Thomas P. Smith or Four Futures Corporation. The Company believes that the rates charged by Mr. Smith or Four Futures Corporation are equal to or below commercial rates the Company would pay to charter similar aircraft from independent charter companies.

Prior to 2006, the Company also chartered an aircraft for business travel from Thundervolt, LLC, which is wholly owned by Patrick W. Smith, Chief Executive Officer of the Company, and Phillips W. Smith, Chairman of the Company’s Board. During January 2006, the Company ceased the charter of this aircraft. For the three and nine months ended September 30, 2005, the Company incurred charter expenses of approximately $98,000 and $335,000, respectively, to Thundervolt, LLC. Any personal use of the aircraft by Patrick, Phillip or Thomas Smith was billed to Thundervolt, LLC, or directly to the individual, for reimbursement. For the three and nine months ended September 30, 2005, the Company billed approximately $118,000 and $293,000, to Thundervolt, LLC, Patrick W. Smith, Phillips W. Smith and Thomas P. Smith for personal use of the aircraft. The Company believes that the rates charged by Thundervolt, LLC were 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 relationships in accordance with the provisions of Financial Accounting Standards Board Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (FIN 46R). Neither of the relationships were determined to meet the definition of a variable interest entity (VIE) as defined by FIN 46R as both Four Futures Corporation and Thundervolt, LLC are adequately capitalized, their owners possess all of the essential characteristics of a controlling financial interest, and the Company does not have any voting rights in either entity. Therefore, the entities are not required to be consolidated into the Company’s results.

TASER Foundation

In November 2004, the Company established the TASER Foundation. The TASER Foundation is a 501(c)3 non-profit corporation and has made application to the IRS for tax exempt status. 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. Daniel M. Behrendt an officer of the Company serves on the Board of Directors of the TASER Foundation. Patrick W. Smith and Thomas P. Smith resigned from the Board of Directors of the TASER Foundation in January 2006. 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, 2006, the Company incurred approximately $28,000 and $148,000, respectively, in such administrative costs. For the three and nine months ended September 30, 2005, the Company incurred approximately $32,000 and $92,000, respectively in administrative costs. For the three and nine months ended September 30, 2006, the Company contributed $100,000 and $175,000 to the TASER Foundation. For the three and nine months ended September 30, 2005, the Company contributed $100,000 and $225,000 to the TASER Foundation

Consulting services

Beginning in August 2005, the Company agreed to pay Mark Kroll, a member of the Board of Directors, a retainer of $8,000 per month to provide consultancy services. The cumulative expense for the three and nine months ended September 30, 2006 were approximately $50,000 and $159,000, respectively. At September 30, 2006, the Company had accrued liabilities of approximately $14,000 related to these services.

13. Employee Benefit Plan

In January 2006, the Company established 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 $15,000. The Company matches 50% of the first 6% of eligible compensation contributed to the Plan by each participant. The Company’s matching contributions vest after four years of service, at age 59 1/2 regardless of service, upon the death or permanent disability of the employee, or upon termination of the Plan. The Company’s matching contributions to the Plan for the three and nine months ended September 30, 2006 were $51,383 and $143,686, respectively. Future matching or profit sharing contributions to the Plan are at the Company’s sole discretion.

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 and results of operations for the three and nine months ended September 30, 2006 and September 30, 2005. The following discussion may be understood more fully by reference to the financial statements, notes to the financial statements, and the Management’s Discussion and Analysis of Financial Condition and Results of Operations section contained in the Company’s Annual Report on Form 10-K filed on March 16, 2006.

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: expected revenue and earnings growth; 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; growth expectations for new and existing accounts; expansion of production capability; new product introductions; and our business model. 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 and pending class action and derivative litigation; 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 including in “Part II — Item 1A. Risk Factors” in this report on Form 10-Q .

Overview

We are a global leader in the development and manufacture of advanced electronic control devices designed for use in law enforcement, corrections, private security and personal defense. 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 with a view toward international markets.

Our core expertise includes proprietary, patented technology which is uniquely capable of incapacitating highly focused and aggressive subjects. 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 subject’s neuron-muscular system, causing substantial incapacitation regardless of whether the subject feels or responds to pain. Our NMI technology stimulates the motor nerves which control muscular movement.

Law enforcement, military and corrections agencies represent our primary target markets. In each of these markets, the decision to purchase TASER devices is normally made by a group of people including the agency head, his or her training staff, and weapons experts. Depending on the size and cost of the device deployment, the decision may involve political decision-makers such as city council members and the federal government. The decision making process can take as little as a few weeks or as long as several years.

Our devices are not considered to be a “firearm” by the U.S. Bureau of Alcohol, Tobacco, Firearms and Explosives. Therefore, no firearms-related regulations apply to the sale and distribution of our devices within the United States. However, many states have regulations restricting the sale and use of stun guns, which we believe apply to our devices as well. Our products are often used in aggressive confrontations that may result in serious, permanent bodily injury or death to those involved. Our products may cause or be associated with these injuries. A person injured in a confrontation or otherwise in connection with the use of our products may bring legal action against us to recover damages on the basis of theories including personal injury, wrongful death, negligent design, dangerous product or inadequate warning. We are currently subject to a number of such lawsuits. We may also be subject to lawsuits involving allegations of misuse of our products. If successful, personal injury, misuse and other claims could have a material adverse effect on our operating results and financial condition. Although we carry product liability insurance, significant litigation could also result in a diversion of management’s attention and resources, negative publicity and an award of monetary damages in excess of our insurance coverage. The outcome of any litigation is inherently uncertain and there can be no assurance that our existing or any future litigation will not have a material adverse effect on our revenues, our financial condition or financial results.

Critical Accounting Policies

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 financial statements, and the reported amounts of revenue and expenses during the reporting periods. There can be no assurance that actual results will not differ from those estimates. We have identified the following policies as critical to our business operations and the understanding of our results of operations.

Revenue Recognition

Our revenue recognition policy is significant because our revenue is a key component of our results of operations. We recognize revenues when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, title has transferred, the price is fixed and collectability is reasonably assured. All of our sales are final and our customers do not have a right to return the product. We charge certain of our customers shipping fees, which are recorded as a component of net sales. We record training revenue as the service is provided. In 2003, we began offering our customers the right to purchase extended warranties on our ADVANCED TASER product and TASER X26 product. Revenue for extended warranty purchases is deferred at the time of sale, and recognized over the warranty period. At September 30, 2006 and December 31, 2005, we deferred $2,322,000 and $1,233,000 under this program, respectively. We also defer revenue associated with the one-on-one private citizen training and background checks that are included with the purchase of an X26 ^C private citizen device. The revenue associated with these items is deferred until the service is provided. At September 30, 2006 and December 31, 2005, we had deferred approximately $189,000 and $150,000, respectively, relating to these items and another $18,000 at December 31, 2005 relating to the training of federal firearms licensed dealers who will sell the X26 ^C device. Changes in judgments on these assumptions and estimates could impact the timing or amount of our revenue recognition.

Standard Warranty Costs

We warrant our products from manufacturing defects for a period of one year after purchase and will replace any defective unit with a new one for a fee. We track historical data related to returns and related warranty costs on a quarterly basis, and estimate future warranty claims by applying our four quarter average return rate to our product sales for the period. We have also historically increased our reserve amount if we become aware of a component failure that could result in a larger than anticipated returns from our customers. As of September 30, 2006, our reserve for warranty returns was $735,000 compared to a $852,000 reserve at December 31, 2005. In the event that product returns under warranty differ from these estimates, changes to our warranty reserves might become necessary.

Inventory

Inventories are stated at the lower of cost or market, with cost determined using the weighted average cost, which approximates the first-in, first-out (FIFO) method. 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. In the event that actual excess, obsolete or slow-moving inventories differ from these estimates, changes to our inventory reserves might become necessary. Our reserve for excess and obsolete inventory was $141,000 at September 30, 2006 compared to $261,000 at December 31, 2005.

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. These allowances represent our best estimates and are 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. In the event that actual uncollectible amounts differ from these estimates, changes in our allowances for doubtful accounts might become necessary. Our allowance for doubtful accounts was $110,000 at September 30, 2006 compared to $111,000 at December 31, 2005.

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. No such impairment charges 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

Statement of Financial Accounting Standards No. 109, or SFAS No. 109, Accounting for Income Taxes, establishes financial accounting and reporting standards for the effect of income taxes. In accordance with SFAS No. 109, 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.

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 financial statements.

In preparing our financial statements, we assess the likelihood that our deferred tax assets will be realized from future taxable income. In evaluating our ability to recover our deferred income tax assets we consider all available positive and negative evidence, including our operating results, ongoing tax planning and forecasts of future taxable income. We establish a valuation allowance if we determine that it is more likely than not that some portion or all of the net deferred tax assets will not be realized. We exercise significant judgment in determining our provisions for income taxes, our deferred tax assets and liabilities and our future taxable income for purposes of assessing our ability to utilize any future tax benefit from our deferred tax assets. Although we believe that our tax estimates are reasonable, the ultimate tax determination involves significant judgments that could become subject to audit by tax authorities in the ordinary course of business. As a result of the shareholder litigation settlement expense recorded in the second quarter of 2006, we have determined that it is more likely than not that our net operating loss carryforwards for the state of Arizona, which expire in 2009, will not be fully realized. Accordingly, we have recorded a valuation allowance of $250,000 against our deferred tax assets as of September 30, 2006. As of September 30, 2006, other than as previously described, based on our evaluation, no other valuation allowance was deemed necessary as it is more likely than not that our net deferred tax assets will be realized. However, our deferred tax asset could be reduced in the near term if estimates of taxable income during the carryforward period are reduced.

Contingencies

We are subject to the possibility of various loss contingencies 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.

Results of Operations

Three and Nine Months Ended September 30, 2006 Compared to the Three and Nine Months Ended September 30, 2005

The following table sets forth, for the periods indicated, our statements of income expressed as a percentage of revenue:


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006			2005			2006			2005
Net sales		100.00	%		100.00	%		100.00	%		100.00	%
Cost of products sold		36.48	%		33.71	%		36.04	%		38.73	%

Gross margin		63.52	%		66.29	%		63.96	%		61.27	%
Sales, general and administrative expenses		38.91	%		57.60	%		45.39	%		54.84	%
Research and development expenses		4.22	%		3.09	%		4.13	%		3.15	%
Litigation settlement		0.00	%		0.00	%		36.44	%		0.00	%

Income(loss) from operations		20.39	%		5.60	%		-22.00	%		3.28	%
Interest income		2.64	%		2.63	%		2.65	%		2.43	%
Interest expense		-0.01	%		0.00	%		-0.01	%		0.00	%
Other income and expense		0.00	%		0.00	%		0.00	%		-0.17	%

Income(loss) before income taxes		23.02	%		8.23	%		-19.36	%		5.54	%
Provision(credit) for income taxes		9.94	%		5.02	%		-6.14	%		3.04	%

Net income(loss)		13.08	%		3.21	%		-13.22	%		2.50	%

Net Sales

For the three and nine months ended September 30, 2006 and 2005, sales by product line and by geography were as follows (amounts in thousands):


	Three Months Ended September 30,								Nine Months Ended September 30,
	2006				2005				2006				2005
Sales by Product Line
TASER X26	$	13,013	71	%	$	7,788	67	%	$	33,973	70	%	$	22,193	63	%
TASER Cam		872	5	%		—	0	%		1,271	3	%		—	0	%
ADVANCED TASER		521	3	%		674	6	%		1,959	4	%		2,027	6	%
AIR TASER		22	0	%		15	0	%		88	0	%		65	0	%
Single Cartridges		3,709	20	%		2,813	24	%		10,538	22	%		9,655	28	%
Research Funding		—	0	%		105	1	%		146	0	%		245	1	%
Other		175	1	%		281	2	%		455	1	%		901	3	%


Total	$	18,312	100	%	$	11,676	100	%	$	48,430	100	%	$	35,086	100	%


	For the Three Months Ended						For the Nine Months Ended
	September 30,			September 30,			September 30,			September 30,
	2006			2005			2006			2005
United States		88	%		86	%		89	%		88	%
Other Countries		12	%		14	%		11	%		12	%


Total		100	%		100	%		100	%		100	%

Net sales increased $6.6 million, or 57%, to $18.3 million for the third quarter of 2006 compared to $11.7 million for the third quarter of 2005. For the first nine months of 2006, net sales were $48.4 million, an increase of $13.3 million, or 38%, over the same period in 2005. We believe the principal reasons for the increases in net sales are related to us overcoming certain elements of the various types of negative publicity we experienced during the course of 2005. Specifically, as a result of an SEC investigation, ongoing negative press coverage and increased amounts of litigation concerning our products and their use, prospective customers, particularly law enforcement agencies, frequently postponed implementation decisions. With the resolution of key portions of the SEC investigation in December 2005, we noted that many of the agencies that were postponing decisions began moving forward with their evaluation and implementation programs and decisions to purchase our products which had a positive impact on our sales for both the third quarter and first nine months of 2006.

Further, in the third quarter of 2006, we advanced our international presence with the shipment of 1,000 TASER® X26s and 1,000 TASER CAM^TM systems to France, following a lengthy trial and evaluation process. This represents the first shipment under a tender award to the Company’s distributor which was authorized by the French Government to purchase up to 5,000 TASER systems. Also contributing to the increase in net sales in both the third quarter and first nine months of 2006 was the introduction of the TASER Cam™ product which began shipping in the second quarter of 2006. Sales of the TASER Cam™ contributed $872,000 and $1.3 million to net revenues in the third quarter and first nine months of 2006, respectively.

Sequentially, our net sales for the third quarter of 2006 increased by $2.1 million, or 13%, over the second quarter of 2006.

Sales of the TASER X26 product line increased $5.2 million to $13.0 million for the third quarter of 2006 compared to $7.8 million for the third quarter of 2005. For the first nine months of 2006, sales of the TASER X26 product line were $34.0 million, an increase of $11.8 million or 53% over the same period in 2005. Single cartridge sales increased $0.9 million for the third quarter of 2006 to $3.7 million compared to $2.8 million for the third quarter of 2005. For the first nine months of 2006, cartridge sales increased $0.8 million to $10.5 million compared to $9.7 million for the same period of 2005. International sales for the third quarter and first nine months of 2006 represented approximately $2.2 million, or 12%, and $5.4 million, or 11%, of total net sales, respectively. This compares to international sales for the third quarter and first nine months of 2005 of $1.6 million, or 14% and $4.2 million, or 12%, of total net sales, respectively.

Grant funding from the Office of Naval Research (ONR) was $0 and $105,000 for the three months ended September 30, 2006 and 2005, respectively. For the first nine months of 2006 and 2005, the grant funding was $146,000 and $245,000, respectively. We were awarded a grant for $515,000 in late 2004 to fund Phases 3 and 4 of the extended range projectile project for which the related work was performed and revenue recognized in 2005 and the first quarter of 2006 based upon the completion of specified milestones. We have fully billed the ONR for the work performed and received final payment in the second quarter of 2006. Other sales represent shipping and training and warranty revenues net of cash and distributor discounts.

Cost of Products Sold

Cost of products sold increased by $2.7 million, or 70%, to $6.7 million for the third quarter of 2006 compared to $3.9 million for the third quarter of 2005. As a percentage of net sales, cost of products sold increased to 36% for the third quarter of 2006 compared to 34% for the third quarter of 2005. The increase in cost of products sold as a percentage of net sales was driven by a combination of a change in sales mix with the introduction of the lower margin TASERCam^TM product, a rise in raw material costs due to higher price of certain petroleum based product components and higher temporary labor costs due to the increased production levels.

For the first nine months of 2006, cost of product sold were $17.5 million, an increase of $3.9 million, or 28%, over the same period in 2005. However, as a percentage of net sales, cost of products sold decreased by 3% to 36% for the first nine months of 2006 compared to 39% for the same period in the prior year. The decrease in cost of products sold as a percentage of sales for the first nine months of 2006 is attributable to improved production throughput and lower scrap expense. Specifically, on one X26 assembly line, production yield improved from approximately 69% in the first quarter of 2005 to greater than 98% for the first nine months of 2006. In addition, the increased volume of device and ancillary product sales in 2006 resulted in a larger number of units over which to apply indirect manufacturing expenses, resulting in lower per unit costs. Indirect expenses primarily include indirect salaries for manufacturing support personnel including manufacturing engineering, quality and materials management, scrapped materials, freight, supplies and depreciation.

Gross Margin

Gross margin increased $3.9 million, or 50%, to $11.6 million for the third quarter of 2006 compared to $7.7 million for the third quarter of 2005. As a percentage of net sales, gross margins decreased to 64% for the third quarter of 2006 compared to 66% for the third quarter of 2005. The decrease in gross margin was attributable to the increased percentage of direct costs as a percentage of net sales as noted above.

Gross margin increased $9.5 million, or 44%, to $31.0 million for the first nine months of 2006 compared to $21.5 million for the first nine months of 2005. As a percentage of net sales, gross margin increased to 64% for the first nine months of 2006 compared to 61% for the first nine months of 2005. The increase in gross margin was due to the lower cost of sales per unit from the improved leverage of indirect manufacturing expenses and improved production yields as discussed above.

Sales, General and Administrative Expenses

For the three and nine months ended September 30, 2006 and 2005, sales, general and administrative expenses were comprised as follows (amounts in thousands):


	Three Months Ended September 30,												Nine Months Ended September 30,
							$			%									$			%
	2006			2005			Change			Change			2006			2005			Change			Change
Salaries and benefits	$	1,520		$	1,201		$	319			26.5	%	$	4,357		$	3,507		$	850			24.2	%
Legal expenses		1,092			1,031			61			5.9	%		3,428			2,942			486			16.5	%
Professional, consulting and lobbying fees		1,166			1,249			(83	)		-6.6	%		3,660			3,331			329			9.9	%
Travel and meals		684			830			(146	)		-17.6	%		2,314			2,373			(59	)		-2.5	%
D&O and liability insurance		538			513			25			4.8	%		1,600			1,297			303			23.3	%
Depreciation and amortization		307			309			(2	)		-0.6	%		989			765			224			29.3	%
Stock-based compensation		195			—			195			100.0	%		707			—			707			100.0	%
Other		1,623			1,592			31			1.9	%		4,928			5,028			(100	)		-1.9	%


Total	$	7,125		$	6,725		$	400			6.0	%	$	21,983		$	19,243		$	2,740			14.2	%

Sales, general and administrative as % of net sales		39	%		58	%								45	%		54	%

Sales, general and administrative expenses were $7.1 million and $6.7 million in the third quarter of 2006 and 2005, respectively, an increase of $0.4 million, or 6%. As a percentage of total net sales, sales, general and administrative expenses decreased to 39% for the third quarter of 2006 compared to 58% for the third quarter of 2005. The dollar increase for the third quarter of 2006 over the same period in 2005 is substantially attributable to a $319,000, or 26%, growth in salaries and benefits related to an increase in personnel to support the expansion of our business infrastructure combined with employee bonuses and $195,000 of stock-based compensation costs associated with our adoption of SFAS 123(R), effective January 1, 2006. In addition, continuing costs incurred by us in order to defend against numerous litigation matters contributed to a $61,000 increase in legal expenses. These increases were partially offset by a decrease in travel and meals of $146,000 and professional, consulting and lobbying fees of $83,000, a function of the intensive lobbying efforts undertaken in the third quarter of 2005.

Sales, general and administrative expenses were $22.0 million and $19.2 million for the first nine months of 2006 and 2005, respectively, an increase of $2.7 million, or 14%. As a percentage of total net sales, sales, general and administrative expenses decreased to 45% for the first nine months of 2006 compared to 54% for same period in 2005. The dollar increase for the first nine months of 2006 compared to the first nine months of 2005 is primarily due to a $850,000, or 24%, increase in salaries and benefits related to an increased headcount and employee bonuses and an $815,000 increase in legal, professional, consulting and lobbying fees associated with the continuing costs of defending against numerous litigation matters and our ongoing efforts via public relations and lobbying to educate the public in regard to the safety and efficacy of our products. In addition, we incurred $707,000 of stock-based compensation expense, D&O and liability insurance costs increased by $303,000 as a result of higher premiums due to increased coverage, and depreciation expense increased $224,000 with our new facility and related equipment which were not placed into service until April 2005.

Research and Development Expenses.

Research and development expenses increased $412,000, or 114%, to $773,000 for the third quarter of 2006 compared to $361,000 for the third quarter of 2005. Research and development expenses increased $896,000, or 81%, to $2.0 million, for the first nine months of 2006 compared to $1.1 million for the first nine months of 2005. The increase on both a quarterly and nine month basis is predominantly related to growth in salary, supply and consulting costs to support our continuing efforts to develop new products such as the TASERCam and the XREP (Extended Range Electro-Muscular Projectile). Additionally, $46,000 and $157,000 of the increase in research and development expenses for the third quarter and first nine months of 2006, respectively, is related to stock-based compensation expense recognized in those periods.

Litigation settlement expenses.

Litigation settlement expenses for the first nine months of 2006 represent $17.65 million recorded in the second quarter of 2006 as a result of an agreement in principle for the proposed settlement of our shareholder class action litigation and derivative lawsuits.

Interest Income.

Interest income increased $176,000, or 57%, to $483,000 for the third quarter of 2006 compared to $307,000 for the third quarter of 2005. Interest income increased $426,000, or 50%, to $1.3 million for the first nine months of 2006 compared to $854,000 for the same period in 2005. The increase on both a quarterly and nine month basis is a function of the growth in our cash and investment balances and higher average yields on our investments. Our cash and investment accounts earned interest at an approximate average rate of 3.88% and 3.62% during the third quarter and first nine months of 2006, respectively, compared to 2.83% and 2.47% during the third quarter and first nine months of 2005, respectively.

Income Taxes.

The provision for income taxes increased by $1.2 million to $1.8 million for the third quarter of 2006 compared to $586,000 for the third quarter of 2005. This is attributable to the growth in income before provision for income taxes to $4.2 million in the third quarter of 2006 compared to $961,000 for the same period in the prior year.

The provision for income taxes decreased by $4.1 million from $1.1 million for the first nine months of 2005 to a credit for income taxes of $3.0 million for the first nine months of 2006. The decrease is substantially the result of the loss before provision for income taxes of $9.4 million for the nine months ended September 30, 2006, which was generated by the shareholder litigation expense of $17.65 million recorded in the second quarter of 2006. The effective income tax rate for the third quarter and first nine months of 2006 was 43.2% and 31.7%, respectively, compared to 61% and 54.9% for the third quarter and first nine months of 2005, respectively.

The net deferred tax asset as of September 30, 2006 totaled $30.0 million compared to $27.0 million at December 31, 2005.

Net Income (Loss).

Net income increased by $2.0 million to $2.4 million for the third quarter of 2006 compared to $375,000 for the same period in the prior year. Income per basic and diluted share increased to $0.04 in the third quarter of 2006 from $0.01 for the third quarter of 2005.

Net income decreased by $7.3 million from $877,000 for the first nine months of 2005 to a net loss of $6.4 million for the first nine months of 2006. Income per basic and diluted share decreased from $0.01 for the first nine months of 2005 to a loss of $0.10 for the first nine months of 2006.

Liquidity and Capital Resources

Liquidity.

As of September 30, 2006, we had working capital of $25.3 million compared to working capital of $34.7 million at December 31, 2005. The decrease in working capital is mainly attributable to the recording of the litigation settlement partially offset by an increase in accounts receivable and insurance settlement proceeds receivable.

Net cash provided by operating activities for the first nine months of 2006 was mainly comprised of a decrease in inventory of $1.6 million attributable to increased sales of finished goods and our ongoing efforts to reduce our investment in inventory and,a $1.1 million increase in deferred revenue created by the growth in sales of extended warranties. Primarily due to the net shareholder litigation settlement of $17.65 million accrued in the second quarter of 2006, these items were partially offset by a net loss of $6.4 million which includes non cash depreciation and amortization expense of $1.5 million and stock based compensation expense of $0.9 million, a net increase in deferred income taxes of $3.0 million from the associated net operating loss carryforwards and a net increase of $4.0 million in related insurance settlement proceeds receivable. Also offsetting the cash provided by operations was an increase in accounts receivable of $5.0 million attributable to the increased sales levels in the third quarter.

As previously discussed in note 11 to the financial statements, we have reached a tentative agreement to settle our shareholder class action and derivative lawsuits. The terms of the agreement call for us to pay approximately $12 million of cash, $4.1 of which will be provided by insurance. In addition, we will make a final payment of $8 million of stock or cash at our discretion. These payments are expected to be made in the next six months. We expect to fund the projected settlement payments from existing cash balances and cash generated from operations. In addition, our Board has approved, in connection with the settlement, a stock repurchase of up to $10 million subject to stock market conditions and corporate considerations. During the third quarter of 2006, we repurchased 300,000 shares of our common stock for $2.2 million.

We used $8.6 million of cash in investing activities during the nine months ended September 30, 2006, compared to $2.3 million of cash provided by investing activities for the same period in 2005. Net cash used in investing activities for the nine months ended September 30, 2006 was comprised of net increases in our investments of $7.1 million combined with $1.3 million in acquisitions of property and equipment, which mainly related to building improvements and production and office equipment. In 2005, proceeds from investments which matured in the first nine months of $36.7 million were partially offset by the purchase of other investments of $27.0 million and $7.4 million of investments in property and equipment. Of the funds used in the acquisition of property and equipment in the first nine months of 2005, $5.3 million was used for the construction of our manufacturing and administrative facility in Scottsdale, Arizona, $0.9 million was used for production equipment and $1.1 million was used to purchase and install new computer equipment and software, including investments associated with a new ERP system.

During the first nine months of 2006, we used $1.5 million of cash in financing activities, compared to $0.5 million generated from financing activities for the same period in 2005. The $1.5 million of cash used by financing activities in 2006 was mainly comprised of the repurchase of 300,000 shares of or common stock for $2.2 million offset by proceeds from stock options exercised of $0.7 million. We generated $0.5 million of proceeds from stock options exercised in the same period of 2005.

Capital Resources.

On September 30, 2006, we had cash and investments of $50.5 million and $0.1 million of capital lease obligations outstanding.

We negotiated a revolving line of credit on July 13, 2004 through a domestic bank. The total availability on the line is $10 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 June 30, 2008 and requires monthly payments of interest only. At September 30, 2006, there was a calculated availability of $8.5 million based on the defined borrowing base, which is based on our eligible accounts receivable and inventory. However, there was no outstanding balance under the line of credit at September 30, 2006, and no borrowings under the line as of the date of the filing of this Form 10-Q.

We believe that our existing balance of cash and investments of $50.5 million as of September 30, 2006, together with cash expected to be generated from operations and availability under the line of credit will be adequate to fund our operations for at least the next 12 months. However, we may require additional resources to expedite manufacturing of new and existing technologies in order to meet possible demand for our products. Although we believe financing will be available at terms favorable to us, both through our existing credit lines and possible additional equity financing, there is no assurance that such funding will be available, or on terms acceptable to us.

Commitments and Contingencies.

Other than as described in footnote 11 to our financial statements, with respect to the proposed class action and derivative lawsuit settlements, there have been no material changes in future contractual financial obligations as of September 30, 2006 compared to the information at December 31, 2005 set forth in our Annual Report on Form 10-K.

Off Balance Sheet Arrangements

We have no off balance sheet arrangements as of September 30, 2006.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

We invest in a limited number of financial instruments, consisting principally of investments in high credit quality government sponsored entity securities, denominated in United States dollars.

We account for our investment instruments in accordance with Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” , (SFAS No. 115 ). All of our cash equivalents and marketable securities are treated as “held-to-maturity” under SFAS No. 115. Investments in fixed rate interest earning instruments carry a degree of interest rate risk as their market value may be adversely impacted due to a rise in interest rates. As a result, we may suffer losses in principal if forced to sell securities that decline in market value due to changes in interest rates. However, because we classify our debt securities as “held-to-maturity,” no gains or losses are recognized due to changes in interest rates and, as such, a 10% change in interest rates would not have a material adverse affect on our results of operations. These securities are reported at amortized cost, which approximates fair value.

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. 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, because there has been insufficient time in which to demonstrate the consistent operational effectiveness of the remediation efforts related to the material weaknesses in internal control over financial reporting as described below, our disclosure controls and procedures were ineffective as of September 30, 2006 to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission 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.

Status of Remediation Efforts with Respect to Previously Disclosed Material Weaknesses

Restatement of previously issued financial statements due to an error in those financial statements which resulted from the incorrect calculation of manufacturing overhead applied to inventory

On May 11, 2006, we concluded that our financial statements at March 31, 2005, June 30, 2005 and September 30, 2005 and for the periods then ended, included in our Form 10-Qs for such periods should no longer be relied upon due to an error in those financial statements as we determined that our historical methodology for the calculation of indirect manufacturing expense applied to inventory was incorrect. We also identified a clerical error in the calculation of the overhead applied to inventory for the three months ended December 31, 2005. We had historically been calculating the rate used to capitalize overhead into inventory using an incorrect amount of direct labor hours, the result of which was to overstate the rate used to capitalize overhead into inventory which overstated both inventory and income. In addition, when reviewing the historical overhead calculation, a formulaic spreadsheet error was identified in the calculations for the fourth quarter of 2005. The effect of these errors on the our results was to reduce net income for the year ended December 31, 2005 by approximately $6,000 and to increase net income for the three months ended March 31, 2006 by approximately $113,000. The changes had no impact on revenues for the periods.

As a result of these errors, adjustments were required to correct the cumulative impact both in the first quarter of 2006 and in the relevant prior periods. We disclosed the impact of these errors on the prior periods in footnote 3 to the financial statements included in Item 1 of our Form 10-Q filed for the periods ended March 31, 2006 and June 30, 2006 and we have restated the September 30, 2005 balances in this Form 10-Q. Since the errors were not previously identified in the prior periods in which they occurred, a material weakness in our internal controls was deemed to exist.

Management corrected the methodology for calculating indirect manufacturing expense applied to inventory in the first quarter of 2006 and implemented additional procedures and controls surrounding the preparation and review of the overhead calculation, including verification of spreadsheet accuracy. We consulted with and advised our Audit Committee of our Board of Directors of our determination.

Even though management believes it has implemented remediation efforts as described above, insufficient time has elapsed to demonstrate that the control is consistently operating effectively to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles.

Changes in internal control over financial reporting.

Other than as noted above with respect to our remediation efforts, there has been no change in our internal control over financial reporting during our quarter ended September 30, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Securities Litigation

Securities Class Action Litigation

The consolidated complaint alleges, among other things, violations of the Securities Exchange Act of 1934, as amended, and Rule 10b-5, promulgated thereunder, and seeks unspecified monetary damages and other relief against all defendants. The consolidated amended complaint generally alleges that the Company and the individual defendants made false or misleading public statements regarding, among other things, the safety of the Company’s products and the Company’s ability to meet its sales goals, including the validity of a $1.5 million sales order with the Company’s distributor, Davidson’s, in the fourth quarter of 2004. The consolidated complaint also alleges that product defects were leading to excessive product returns by customers.

      On July 25, 2006, Lead Plaintiff, Lead Counsel, defendants and defendants’ counsel engaged in a mediation conference, and in subsequent discussions, in an attempt to settle the consolidated securities class actions. On August 9, 2006, the parties filed a joint notice of settlement stating, among other things, that the parties had reached an agreement in principal settling all consolidated actions, subject to documentation, notice and Court approval. On August 11, 2006, the Court issued an Order staying the class action for 60 days to allow the parties to complete and submit settlement documents, and further denying as moot the defendants’ pending motion to dismiss the consolidated complaint. On October 11, 2006, the parties filed a joint Stipulation of Settlement and related documents, and plaintiff filed a motion in support of the proposed order preliminarily approving the settlement, to which motion the defendants consented.

     The Stipulation of Settlement and related documents filed on October 11, 2006 set forth terms of settlement including, among other things, full releases of any and all related known or unknown claims among the plaintiff, plaintiff class and the defendants, and payment of $20 million from TASER for the benefit of the plaintiff class to be comprised of $12 million in cash (approximately $4.1 million to be provided from the Directors’ and Officers’ Liability Insurance policy), and $8 million in Company common stock valued as of the date at which the stock is transferred (1,103,448 shares based on a closing market price of $7.25 at September 29, 2006. The number of shares is subject to change based on the market price of the Company’s stock at the consumation of the settlement. At the Company’s election, the stock portion of the settlement may be funded with cash.

      Any Settlement of the consolidated securities class actions is conditioned upon approval by the Court and other factors. There is no assurance that the settlement will be completed on the terms set forth in the parties’ Stipulation of Settlement and related documents filed with the Court, or at all. In the event that a settlement occurs, it is expected that the consolidated securities class actions will be dismissed.

Shareholder Derivative Litigation

On July 25, 2006, the parties to the Arizona District Court action engaged in a mediation conference in an attempt to settle the shareholder derivative litigation. On August 9, 2006, the parties to the Arizona District Court action filed a joint notice of settlement stating, among other things, that the parties had reached an agreement in principal settling all consolidated actions, subject to documentation, notice and Court approval. On August 11, 2006, the Court issued an Order staying the Arizona District Court action for 60 days to allow the parties to complete and submit settlement documents. On October 13, 2006, the Court, upon the joint stipulation of the parties to the Arizona District Court action, entered an Order continuing the stay of the Arizona District Court action through November 6, 2006 to complete and submit settlement documents.

Terms of the proposed settlement include, among other things, that TASER would adopt certain measures to improve the Company’s corporate governance, and that TASER would pay the attroneys’s fees in the Arizona District Court action in the amount of $1,750,000 comprised of the Company’s common stock valued as of the date of which the stock is transferred (241,379 shares, based on a closing market price of $7.25 of September 29, 2006), in exchange for a release by plaintiffs and current TASER shareholders of all claims based on or arising out of the shareholder derivative complaint. All parties to the Arizona District Court action, the Arizona State Court action and the Delaware Chancery Court action anticipate that the settlement will include each of these actions. Any settlement of these derivative actions would be conditioned upon approval by the Court and other factors. There is no assurance that the settlement will be completed on the foregoing terms or at all. In the event that a settlement occurs, it is expected that the derivative actions would be dismissed.

Demand for Inspection of Documents Litigation

On May 4, 2005, a Company shareholder filed an action in the Delaware Chancery Court against the Company under Section 220 of Delaware General Corporation Law, demanding the inspection of certain corporate documents. The Company filed an answer to the complaint on June 7, 2005. The plaintiff commenced discovery. Based upon the negotiations of the parties and the plaintiff’s review of certain Company document related to the demand, on August 21, 2006, the parties filed a stipulation of dismissal of the action with prejudice on the merits.

Securities and Exchange Commission Investigation

Contract Litigation

In March 2000, Thomas N. Hennigan, a sales representative for our products from late 1997 through early 2000, sued the Company and certain of our shareholders in the United States District Court, Southern District of New York. The Company previously sued him in February 2000 in the United States District Court for the District of Arizona, but had not served him. After the New York case was dismissed in February 2001 for lack of personal jurisdiction, Mr. Hennigan brought a counterclaim in the United States District Court for the District of Arizona. Mr. Hennigan claims the exclusive right to sell our products to many of the largest law enforcement, corrections, and military agencies in the United States. He sought monetary damages that may amount to as much as $500,000 against us allegedly arising in connection with his alleged service to the Company as a distributor. His claims rest on theories of our failure to pay commissions, breach of contract, promissory estoppel, breach of fiduciary duty, and on related theories. No written contract was ever signed with Mr. Hennigan. We believe that he has no reasonable basis for claims based on informal or implied contractual rights and will be unable to prove his damages with reasonable certainty. Mr. Hennigan died in April 2001 and the case is now being prosecuted by his estate. On May 24, 2002, H.A. Russell was permitted to proceed as an additional defendant-counterclaimant. We filed various motions in November 2002 for partial summary judgment including a motion to dismiss his claims. On September 30, 2003, the Court issued an order granting our motion for partial summary judgment to dismiss Mr. Russell’s claims and struck Hennigan’s jury demand. On April 14, 2004, the Court issued an opinion partially granting our motion for partial summary judgment on certain joint venture, post-termination, post-death and exclusivity claims. A pretrial conference was held on July 28, 2005 and the trial started on August 31, 2005. At the conclusion of Hennigan’s case in chief, we made a motion to dismiss Hennigan’s case. The court issued a briefing schedule on our motion and the trial was suspended pending the court’s decision on our motion. On August 4, 2006 the Court issued an opinion and order dismissing with prejudice all of plaintiffs claims, except the Court set a briefing schedule for an alleged remaining nominal claim. On September 28, 2006 the court entered an order granting judgment for plaintiff in the amount of the nominal claim. In October 2006 we reached a settlement agreement under which plaintiff agreed not to appeal the court’s order and we agreed to pay plaintiff the judgment and forego the Company’s claim for an award of attorney’s fees as the prevailing party under an offer of judgment.

In September 2004, the Company was served with a summons and complaint in the matter of Roy Tailors Uniform Co., Inc. v. TASER International in which the plaintiff alleges that it is entitled to commissions for disputed sales that were made to customers that are claimed to be plaintiff’s customers for which plaintiff is seeking monetary damages. Plaintiff failed to sign a distributor agreement with the Company and did not have distribution rights with the Company. This case is in the discovery phase and a trial date has been scheduled for April 2007. In October 2006 a dismissal of this lawsuit was filed with the court.

Other Class Action Litigation

Product Liability Litigation

The Company is currently named as a defendant in 56 lawsuits in which the plaintiffs alleged 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. In addition, 26 other lawsuits have been dismissed and are not included in this number. Two of the lawsuits that have been dismissed or judgment entered in favor of TASER are on appeal. With respect to each of these pending 56 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. This table also lists those cases which were dismissed during the most recent fiscal quarter. Cases that were dismissed 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 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 $250,000 in per incident deductibles. We are defending each of these lawsuits vigorously.


	Month
Plaintiff	Served	Jurisdiction	Claim Type	Status
Alvarado	4/2003	CA Superior Court	Wrongful Death	Jury Verdict for TASER
City of Madera	6/2003	CA Superior Court	Wrongful Death	Dismissed by Summary Judgment, Appeal Pending
Thompson	9/2004	MI Circuit Court	Wrongful Death	Dismissed
Pierson	11/2004	US District Court, CD CA	Wrongful Death	Dismissed
Glowczenski	10/2004	US District Court, ED NY	Wrongful Death	Case Stayed
LeBlanc	12/2004	US District Court, CD CA	Wrongful Death	Discovery Phase
M. Elsholtz	12/2004	TX District Court	Wrongful Death	Discovery Phase
Washington	5/2005	US District Court, ED CA	Wrongful Death	Discovery Phase
Sanders	5/2005	US District Court ED CA	Wrongful Death	Discovery Phase
Fleming	5/2005	US District Court ED LA	Wrongful Death	Trial Scheduled for April 9, 2007
Woolfolk	6/2005	US District Court MD FL	Wrongful Death	Trial Scheduled for March 2007.
Graff	9/2005	AZ Superior Court	Wrongful Death	Discovery Phase
Holcomb	9/2005	US District Court, ND OH	Wrongful Death	Dismissed with Prejudice
Tucker	10/2005	US District Court, NV	Wrongful Death	Discovery Phase
Hammock	10/2005	District Court, Tarrant County, TX	Wrongful Death	Dismissed with Prejudice
Heston	11/2005	US District Court, ND CA	Wrongful Death	Discovery Phase
Rosa	11/2005	US District Court, ND CA	Wrongful Death	Discovery Phase
Gosserand	10/2005	US District Court, ED LA	Wrongful Death	Discovery Phase
O’Donnell/Hasse	11/2005	Circuit Court, Cook County, IL	Wrongful Death	Discovery Phase
Yeagley	11/2005	Hillsborough County Circuit Court, FL	Wrongful Death	Discovery Phase
Neal-Lomax	12/2005	US District Court, NV	Wrongful Death	Discovery Phase
Yanga Williams	12/2005	Gwinnett County State Court, GA	Wrongful Death	Discovery Phase
Mann	12/2005	US District Court, ND GA, Rome Div	Wrongful Death	Discovery Phase
King	12/2005	US District Court, MD FL, Jacksonville	Wrongful Death	Discovery Phase
Robert Williams	1/2006	US District Court, TX	Wrongful Death	Discovery Phase
Lee	1/2006	Davidson County, TN Circuit Court	Wrongful Death	Discovery Phase, Trial Scheduled for June 2008.
Zaragoza	2/2006	CA Superior Court, Sacramento County	Wrongful Death	Discovery Phase
Tapia	4/2006	CA Superior Court, Los Angeles County	Wrongful Death	Discovery Phase
Kinkle	6/2006	US District Court, ND MS	Wrongful Death	Discovery Phase
Nunez	6/2006	72^nd District Court, Lubbock County, TX	Wrongful Death	Discovery Phase
Bagnell	7/2006	Supreme Court for British Columbia, Canada	Wrongful Death	Discovery Phase
Salazar	7/2006	Maricopa County Superior Court, AZ	Wrongful Death	Discovery Phase
Gillson	7/2006	US District Court, NV	Wrongful Death	Discovery Phase
Hollman	8/2006	US District Court, ED NY	Wrongful Death	Complaint Served
Oliver	9/2006	FL Ninth Circuit Court	Wrongful Death	Complaint Served
Teran/LiSaola	10/2006	CA District Court	Wrongful Death	Complaint Served
Powers	11/2003	AZ Superior court	Training Injury	Verdict for TASER, Appeal Pending
Cook	8/2004	NV District Court	Training Injury	Discovery Phase
Stevens	10/2004	OH Court Common Pleas	Training Injury	Dismissed with Prejudice
Dimiceli	3/2005	FL Circuit Court	Training Injury	Dismissed with Prejudice
Allen	5/2005	AZ Superior Court	Training Injury	Dismissed with Prejudice
J.J	7/2005	FL Circuit Court	Training Injury	Discovery Phase
J.B	7/2005	FL Circuit Court	Training Injury	Discovery Phase
Howard	8/2005	AZ Superior Court	Training Injury	Discovery Phase
Wagner	8/2005	AZ Superior Court	Training Injury	Discovery Phase
Gerdon	8/2005	AZ Superior Court	Training Injury	Discovery Phase
Gallant	8/2005	AZ Superior Court	Training Injury	Discovery Phase
Herring	8/2005	Circuit Court of City of St. Louis, MO	Training Injury	Discovery Phase
Stewart	10/2005	Circuit Court for Broward County, FL	Training Injury	Discovery Phase
Lewandowski	1/2006	US District Court, NV	Training Injury	Discovery Phase
Peterson	1/2006	US District Court, NV	Training Injury	Discovery Phase
Husband	3/2006	British Columbia Supreme Court, Canada	Training Injury	Discovery Phase
Wright	4/2006	Court of Common Pleas, Clinton County Ohio	Training Injury	Discovery Phase
Howard	4/2006	US District Court, KS (Companion to AZ lawsuit)	Training Injury	Dismissed
Richthofen	7/2006	22^nd Judicial District Court, St. Tammany Parish, LA	Training Injury	Discovery Phase
Wilson	8/2006	US District Court, ND GA	Training Injury	Complaint Served
Gray	8/2006	Second Judicial District, Davis County, Utah	Training Injury	Dismissed with Prejudice
Diamond	8/2006	Circuit Court, Douglas County, Oregon	Training Injury	Complaint Served
Cuckovic	8/2006	Circuit Court, McDonald County, Missouri	Personal Injury	Complaint Served
Cosby	8/2004	US District Court, SD NY	Injury During Arrest	Discovery Phase
Blair	3/2005	US District Court, MD NC	Injury During Detention	Dismissed with Prejudice
Lewis	7/2005	US District Court Tal FL	Injury During Arrest	Dismissed with Prejudice
Lash	8/2005	US District Court ED MO	Injury During Arrest	Dismissed with Prejudice
Games	8/2005	Circuit Court, Multnomah County, OR	Injury During Arrest	Dismissed with Prejudice
Bynum	10/2005	US District Court SD NY	Injury During Arrest	Discovery Phase
Lopez	11/2005	US District Court, ND IL Eastern Div	Injury During Police Call	Discovery Phase
Bellemore	2/2006	AZ Superior Court	Injury During Arrest	Discovery Phase
Wieffenbach	6/2006	Circuit Court of 12^th Judicial District, Will County, Il	Injury During Arrest	Discovery Phase
Cruz	7/2006	CA Superior Court, Los Angeles County	Injury During Arrest	Discovery Phase
Turner	8/2006	US District Court, CD, CA	Injury During Arrest	Complaint Served
Molina	9/2006	US District Court, ND West Virginia	Injury During Detention	Complaint Served
Short	10/2006	US District Court, SD West Virginia	Injury During Arrest	Complaint Served

In November 2006, the Company received a defense verdict in the Alvarado v. TASER International in-custody death case. In September 2006, as part of its legal strategy to aggressively defend these cases, the Company entered into a settlement agreement with its own insurance provider in order to prevent its insurance provider from settling the case with the plaintiff. Under the terms of the settlement, the Company received $225,000 from its liability insurance provider associated with a settlement and release agreement and the Company assumed all future potential liability and costs from and after the date the settlement and release agreement was signed. The Company has recorded the $225,000 as deferred insurance settlement proceeds on its balance sheet. This deferred income will be used to cover any costs through all appeals and the remaining balance if any will be recorded as “other income” when final resolution is completed. No such defense costs were paid in the three months ended September 30, 2006.

Other Litigation

In February 2005, we filed litigation in Superior Court for Maricopa County against Thomas G. Watkins III, our former patent attorney, for declaratory judgment, breach of fiduciary duty, constructive fraud, and breach of contract. Mr. Watkins originally filed patent applications on our behalf as our patent attorney for inventions utilized in the TASER X26 device in February and May 2003. In each patent application he filed a declaration stating that Magne Nerheim, our employee, was the sole inventor. These patent applications are pending. Mr. Nerheim assigned his interest in these patent applications to us. In December 2004 Mr. Watkins informed us that he now felt that he was the inventor of a portion of this invention. We vigorously dispute his claim and we believe that we are the sole owner of this invention. We have filed a motion for summary judgment in this litigation in February 2006 which motion is pending before the Court. On February 14, 2006, U.S. Patent No. US 6,999,295 entitled “Dual Operating Mode Electronic Disabling Device For Generating A Time-Sequenced, Shaped Voltage Output Waveform” was issued to named inventors Thomas G. Watkins, III and Mr. Nerheim. Mr. Nerheim assigned his interest in this patent to us. This patent covers a portion of the technology utilized in the TASER X26 device. This patent was applied for by Mr. Watkins without our knowledge or consent. Since we are a joint owner of this patent, this patent will not restrict us from manufacturing and selling the TASER X26 device. We have other patent applications pending that cover inventions contained in this patent. In March 2006, the Court issued a temporary restraining order and a preliminary injunction preventing Mr. Watkins from selling, assigning, transferring or licensing this patent to a third party during the duration of this litigation. On August 2, 2006 the Court issued an order granting our motion for partial summary judgment on liability, leaving open the matter of remedies and other residual issues for resolution in subsequent proceedings.

In November 2005 and April 2006, we filed lawsuits in Marion County Circuit Court, Indiana and in Fairfax County Circuit Court, Virginia, respectively, against James Ruggieri for defamation, product disparagement, intentional interference with a business relationship, Lanham Act violations and tortuously affecting the fairness and integrity of litigation as adverse third-party witness. Mr. Ruggieri has counterclaimed for defamation and infliction of distress. This case is entering the discovery phase and no trial date has been set. In October we reached a settlement agreement with Mr. Ruggieri and a dismissal was entered in this litigation.

In June 2006 we filed a lawsuit in U.S. District Court for the Central District of California against Bestex Company, Inc. for patent infringement, false patent marking, unfair competition and breach of written contract. Bestex filed a counterclaim for unfair competition and false advertising. This case is entering the discovery phase and no trial date has been set.

General

Item 1A. Risk Factors

We are materially dependent on acceptance of our products by the law enforcement and corrections market, and if law enforcement and corrections agencies do not purchase our products, our revenues will be adversely affected and we may not be able to expand into other markets.

A substantial number of law enforcement and corrections agencies may not purchase our conducted energy, non-lethal devices. In addition, if our products are not widely accepted by the law enforcement and corrections market, we may not be able to expand sales of our products into other markets. Law enforcement and corrections agencies may be influenced by claims or perceptions that conducted energy weapons are unsafe or may be used in an abusive manner. In addition, earlier generation conducted energy devices may have been perceived as ineffective. Sales of our products to these agencies may also be delayed or limited by these claims or perceptions.

We substantially depend on sales of the TASER X26 products, and if these products are not widely accepted, our growth prospects will be diminished.

In the three and nine months ended September 30, 2006 and 2005, we derived our revenues predominantly from sales of the TASER X26 brand devices and related cartridges, and we expect to depend on sales of these products for the foreseeable future. A decrease in the prices of or demand for these products, or their failure to achieve broad market acceptance, would significantly harm our growth prospects, operating results and financial condition.

If we are unable to manage the growth in our business, our prospects may be limited and our future profitability may be adversely affected.

We intend to expand our sales and marketing programs and our manufacturing capacity as needed to meet future demand. Any significant expansion may strain our managerial, financial and other resources. If we are unable to manage our growth, our business, our operating results and financial condition could be adversely affected. We will need to continually improve our operations, financial and other internal systems to manage our growth effectively, and any failure to do so may lead to inefficiencies and redundancies, and result in reduced growth prospects and profitability.

We may face personal injury, wrongful death and other liability claims that harm our reputation and adversely affect our sales and financial condition.

Our products are often used in aggressive confrontations that may result in serious, permanent bodily injury or death to those involved. Our products may cause or be associated with these injuries. A person injured in a confrontation or otherwise in connection with the use of our products may bring legal action against us to recover damages on the basis of theories including personal injury, wrongful death, negligent design, dangerous product or inadequate warning. We are currently subject to a number of such lawsuits. We may also be subject to lawsuits involving allegations of misuse of our products. If successful, personal injury, misuse and other claims could have a material adverse effect on our operating results and financial condition. Although we carry product liability insurance, we do incur significant legal expenses within our self insured retention in defending these lawsuits and significant litigation could also result in a diversion of management’s attention and resources, negative publicity and a potential award of monetary damages in excess of our insurance coverage. The outcome of any litigation is inherently uncertain and there can be no assurance that our existing or any future litigation will not have a material adverse effect on our revenues, our financial condition or financial results.

Pending litigation may subject us to significant litigation costs, judgments in excess of insurance coverage, and divert management attention from our business.

We are involved in various litigation matters relating to our products or the use of such products, litigation against persons who we believe have defamed our products, litigation against a competitor, litigation against our former patent attorney as well as shareholder class action lawsuits and derivative lawsuits. Such matters have resulted and are expected to continue to result in substantial costs to us and a likely diversion of our management’s attention, which could adversely affect our business, financial condition or operating results. In particular, we recently reached an agreement to settle our shareholder class action lawsuits and derivative lawsuits for approximately $21.75 million, of which approximately $4.1 million is covered by insurance.

Our future success is dependent on our ability to expand sales through distributors and our inability to recruit new distributors would negatively affect our sales.

Our distribution strategy is to pursue sales through multiple channels with an emphasis on independent distributors. Our inability to recruit and retain police equipment distributors who can successfully sell our products would adversely affect our sales. In addition, our arrangements with our distributors are generally short-term. If we do not competitively price our products, meet the requirements of our distributors or end-users, provide adequate marketing support, or comply with the terms of our distribution arrangements, our distributors may fail to aggressively market our products or may terminate their relationships with us. These developments would likely have a material adverse effect on our sales. Our reliance on the sales of our products by others also makes it more difficult to predict our revenues, cash flow and operating results.

If we are unable to design, introduce and sell new products successfully, our business and financial results could be adversely affected.

Our future success will depend on our ability to develop new products that achieve market acceptance in a timely and cost-effective manner. The development of new products is complex, and we may experience delays in completing the development and introduction of new products. We cannot provide any assurance that products that we may develop in the future will achieve market acceptance. If we fail to develop new products on a timely basis that achieve market acceptance, our business, financial results and competitive position could be adversely affected.

We expend significant resources in anticipation of a sale due to our lengthy sales cycle and may receive no revenue in return.

Generally, law enforcement and corrections agencies consider a wide range of issues before committing to purchase our products, including product benefits, training costs, the cost to use our products in addition to or in place of other non-lethal products, budget constraints and product reliability, safety and efficacy. The length of our sales cycle may range from a few weeks to as long as several years. Adverse publicity surrounding our products or the safety of such products has in the past and could in the future result in long sales cycles with customers. In particular, we believe our revenue decrease for the year ended December 31, 2005 compared to the year ended December 31, 2004 was impacted by the adverse effect on customers and potential customers of the negative publicity surrounding our products or use of our products. We may incur substantial selling costs and expend significant effort in connection with the evaluation of our products by potential customers before they place an order. If these potential customers do not purchase our products, we will have expended significant resources and received no revenue in return.

Most of our end-users are subject to budgetary and political constraints that may delay or prevent sales.

Most of our end-user customers are government agencies. These agencies often do not set their own budgets and therefore have little control over the amount of money they can spend. In addition, these agencies experience political pressure that may dictate the manner in which they spend money. As a result, even if an agency wants to acquire our products, it may be unable to purchase them due to budgetary or political constraints. Some government agency orders may also be canceled or substantially delayed due to budgetary, political or other scheduling delays which frequently occur in connection with the acquisition of products by such agencies.

Government regulation of our products may adversely affect sales.

Federal regulation of sales in the United States: Our devices are not firearms regulated by the Bureau of Alcohol, Tobacco, Firearms and Explosives, but are consumer products regulated by the United States Consumer Product Safety Commission. Although there are currently no federal laws restricting sales of our devices in the United States, future federal regulation could adversely affect sales of our products.

Federal regulation of international sales: Our devices are controlled as a “crime control” product by the United States Department of Commerce, or DOC, for export directly from the United States. Consequently, we must obtain an export license from the DOC for the export of our devices from the United States other than to Canada. Our inability to obtain DOC export licenses on a timely basis for sales of our devices to our international customers could significantly and adversely affect our international sales.

State and local regulation: Our devices are controlled, restricted or their use prohibited by several state and local governments. Our devices are banned from private citizen sale or use in seven states: New York, New Jersey, Rhode Island, Michigan, Wisconsin, Massachusetts and Hawaii. Law enforcement use of our products is also prohibited in New Jersey. Some municipalities, including Omaha, Nebraska and Washington, D.C., also prohibit private citizen use of our products. Other jurisdictions may ban or restrict the sale of our products and our product sales may be significantly affected by additional state, county and city governmental regulation.

Foreign regulation: Certain foreign jurisdictions, including Japan, Australia, Italy and Hong Kong, prohibit the sale of conducted energy devices, limiting our international sales opportunities.

Environmental laws and regulations subject us to a number of risks and could result in significant liabilities and costs.

We may be subject to various state, federal and international laws and regulations governing the environment, including restricting the presence of certain substances in electronic products and making producers of those products financially responsible for the collection, treatment, recycling and disposal of those products. Recent environmental legislation within the European Union (EU) may increase our cost of doing business internationally and impact our revenues from EU countries as we comply with and implement these new requirements.

The EU has published directives on the restriction of certain hazardous substances in electronic and electrical equipment (the RoHS Directive) which became effective in July 2006, and on electronic and electrical waste management (the WEEE Directive). The RoHS Directive restricts the use of a number of substances, including lead. The Waste Electrical and Electronic Equipment Directive, or WEEE directs members of the European Union to enact laws, regulations, and administrative provisions to ensure that producers of electric and electronic equipment are financially responsible for the collection, recycling, treatment and environmentally responsible disposal of certain products sold into the market after August 15, 2005 and from products in use prior to that date that are being replaced. In addition, similar environmental legislation has been or may be enacted in other jurisdictions, including the U.S. (under federal and state laws) and other countries, the cumulative impact of which could be significant.

We continue to evaluate the impact of specific registration and compliance activities required by the RoHS and WEEE Directives. We endeavor to comply with these environmental laws, yet compliance with such laws could increase our operations and product costs; increase the complexities of product design, procurement, and manufacturing; limit our ability to manage excess and obsolete non-compliant inventory; limit our sales activities; and impact our future financial results. Any violation of these laws can subject us to significant liability, including fines, penalties, and prohibiting sales of our products into one or more states or countries, and result in a material adverse effect on our financial condition.

If we are unable to protect our intellectual property, we may lose a competitive advantage or incur substantial litigation costs to protect our rights.

Our future success depends in part upon our proprietary technology. Our protective measures, including patents, trademarks and trade secret laws, may prove inadequate to protect our proprietary rights. Our United States patent on the construction of the gas cylinder used to store the compress nitrogen in our cartridges expires in 2015. Our patent on the process by which compressed gases launch the probes in our cartridges expires in 2009. The scope of any patent to which we have or may obtain rights may not prevent others from developing and selling competing products. The validity and breadth of claims covered in technology patents involve complex legal and factual questions, and the resolution of such claims may be highly uncertain, lengthy and expensive. In addition, our patents may be held invalid upon challenge, or others may claim rights in or ownership of our patents.

On February 14, 2006, U.S. Patent No. US 6,999,295 entitled “Dual Operating Mode Electronic Disabling Device For Generating A Time-Sequenced, Shaped Voltage Output Waveform” was issued to named inventors Thomas G. Watkins, III and Magne Nerheim. Mr. Nerheim assigned his interest in this patent to us. This patent covers a portion of the technology utilized in the TASER X26 device. This patent was applied for by Mr. Watkins, who was our former patent attorney, without our knowledge or consent. Mr. Watkins originally filed patent applications on our behalf as our patent attorney for the same inventions in February and May 2003 with the U.S. Patent and Trademark Office. In each application he filed a declaration stating that Mr. Nerheim was the sole inventor. These patent applications are pending. In December 2004, he informed us that he now felt that he was the inventor of a portion of this invention. We vigorously dispute his claim and we have filed litigation against Mr. Watkins for declaratory judgment, breach of fiduciary duty, constructive fraud, and breach of contract. We believe that we are the sole owner of this invention. Since we are a joint owner of this patent, this patent will not restrict us from manufacturing and selling the TASER X26 device. We have other patent applications pending that cover inventions contained in this patent. In March 2006, the court issued a temporary restraining order and a preliminary injunction preventing Mr. Watkins from selling, assigning, transferring, or licensing this patent to a third party during the duration of this litigation. However, there can be no assurance as to the ultimate outcome of this litigation.

We may be subject to intellectual property infringement claims, which will cause us to incur litigation costs and divert management attention from our business.

Any intellectual property infringement claims against us, with or without merit, could be costly and time-consuming to defend and divert our management’s attention from our business. If our products were found to infringe a third party’s proprietary rights, we could be required to enter into royalty or licensing agreements in order to be able to sell our products. Royalty and licensing agreements, if required, may not be available on terms acceptable to us or at all.

Competition in the law enforcement and corrections market could reduce our sales and prevent us from achieving profitability.

The law enforcement and corrections market is highly competitive. We face competition from numerous larger, better capitalized and more widely known companies that make other non-lethal devices and products. Increased competition may result in greater pricing pressure, lower gross margins and reduced sales. In this regard, in 2005 two different competitors announced plans to introduce new products. We are unable to predict the impact such products will have on our sales or our sales cycle, but existing or potential customers may choose to evaluate such products which could lengthen our sales cycle and potentially reduce our future sales.

Defects in our products could reduce demand for our products and result in a loss of sales, delay in market acceptance and injury to our reputation.

Complex components and assemblies used in our products may contain undetected defects that are subsequently discovered at any point in the life of the product. In 2002, we recalled a series of ADVANCED TASER devices due to a defective component. In connection with the recall, we incurred expenses of approximately $25,000. Defects in our products may result in a loss of sales, delay in market acceptance and injury to our reputation, potential legal liability and increased warranty costs.

Component shortages could result in our inability to produce volume to adequately meet customer demand. This could result in a loss of sales, delay in deliveries and injury to our reputation.

Single source components used in the manufacture of our products may become unavailable or discontinued. Delays caused by industry allocations, or obsolescence may take weeks or months to resolve. In some cases, part obsolescence may require a product re-design to ensure quality replacement circuits. These delays could cause significant delays in manufacturing and loss of sales, leading to adverse effects significantly impacting our financial condition or results of operations.

Our dependence on third party suppliers for key components of our devices could delay shipment of our products and reduce our sales.

We depend on certain domestic and foreign suppliers for the delivery of components used in the assembly of our products. Our reliance on third-party suppliers creates risks related to our potential inability to obtain an adequate supply of components or subassemblies and reduced control over pricing and timing of delivery of components and sub-assemblies. Specifically, we depend on suppliers of sub-assemblies, machined parts, injection molded plastic parts, printed circuit boards, custom wire fabrications and other miscellaneous customer parts for our products. We also do not have long-term agreements with any of our suppliers. We believe that there are readily available alternative suppliers in most cases, however there is no guarantee that supply will not be interrupted. Any material interruption of supply for any components of our products could significantly delay the shipment of our products and have a material adverse effect on our revenues, profitability and financial condition.

Our dependence on foreign suppliers for key components of our products could delay shipment of our finished products and reduce our sales.

We depend on foreign suppliers for the delivery of certain components used in the assembly of our products. Due to regulatory changes imposed for imports of foreign products into the United States, as well as potential port closures and delays created by terrorist threats, public health issues or national disasters, we are exposed to risk of delays caused by freight carriers or customs clearance issues for our imported parts. Delays caused by our inability to obtain components for assembly could have a material adverse effect on our revenues, profitability and financial condition.

We may experience a decline in gross margins due to rising raw material and transportation costs associated with the increase in petroleum prices.

A significant number of our raw materials are comprised of petroleum based products, or incur some form of landed cost associated with transporting the raw materials or components to our facility. The continued rise in oil prices could adversely impact our ability to sustain current gross margins, by eliminating our ability to control component pricing.

Our revenues and operating results may fluctuate unexpectedly from quarter to quarter, which may cause our stock price to decline.

Our revenues and operating results have varied significantly in the past and may vary significantly in the future due to various factors, including, but not limited to: market acceptance of our products and services, the outcome of any existing or future litigation, adverse publicity surrounding our products, the safety of our products, or the use of our products, increased raw material expenses, changes in our operating expenses, regulatory changes that may affect the marketability of our products, and budgetary cycles of municipal, state and federal law enforcement and corrections agencies. As a result of these and other factors, we believe that period- to-period comparisons of our operating results may not be meaningful in the short term, and our performance in a particular period may not be indicative of our performance in any future period.

The Sarbanes-Oxley Act and other recent changes in securities laws and regulations have increased our costs.

The Sarbanes-Oxley Act of 2002 as well as rules subsequently implemented by the Securities and Exchange Commission and the NASDAQ Stock Market, have required changes to some of our accounting and corporate governance practices, including a report on our internal controls as required by Section 404 of the Sarbanes-Oxley Act of 2002. These rules and regulations have increased our accounting, legal and other costs, and made some activities more difficult, time consuming and/or costly. In particular, complying with the internal control requirements of Sarbanes-Oxley Section 404 has resulted and will continue to result in increased internal efforts, significantly higher fees from our independent registered public accounting firm and significantly higher fees from third party contractors. These rules and regulations could make it more difficult and expensive for us to obtain director and officer liability insurance in the future and could also make it more difficult for us to attract and retain qualified executive officers and qualified members of our board of directors, particularly to serve on our audit committee.

We have experienced difficulties in complying with Sarbanes-Oxley Section 404.

Beginning with our Annual Report on Form 10-K for the fiscal year ending December 31, 2005, as filed on March 16, 2006, we are required to furnish a report by our management on our internal control over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002. Such report contained among other matters, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year (December 31, 2005), including a statement as to whether or not our internal control over financial reporting was effective. Such report also contained a statement that our independent registered public accounting firm has issued an attestation report on management’s assessment of such internal controls.

Based on the material weaknesses described in our Form 10-K, our management concluded that our internal control over financial reporting was not effective as of December 31, 2005. Our independent registered public accounting firm, Grant Thornton LLP, who also audited our consolidated financial statements, audited management’s assessment and independently assessed the effectiveness of our internal control over financial reporting. Grant Thornton LLP issued their attestation report, which was included in Part II, Item 9A of our Form 10-K.

As described in Item 4 of this Form 10-Q, because of the fact that there has been insufficient time in which to demonstrate the consistent operational effectiveness of the remediation efforts related to a previously disclosed material weakness in internal control over financial reporting, our disclosure controls and procedures were ineffective as of September 30, 2006. Our disclosure controls and procedures include components of our internal control over financial reporting.

In connection with our ongoing Section 404 compliance efforts, we are also continuing to make improvements to our systems, procedures and controls. Due to our conclusion that our internal control over financial reporting was not effective at December 31, 2005 and our conclusion that our disclosure controls and procedures were not effective at September 30, 2006, we could lose investor confidence in the accuracy and completeness of our financial reports, which could have an adverse effect on our stock price.

Recent regulations related to equity compensation has resulted in significantly higher expenses and could adversely affect our ability to attract and retain key personnel.

Stock options are a fundamental component of our employee compensation packages. We believe that stock options directly motivate our employees to maximize long-term stockholder value and, through the use of vesting, encourage employees to remain with us. In December 2004, the Financial Accounting Standards Board (FASB) issued Statement 123R, Share-Based Payment, which requires all companies to measure compensation cost for all share-based payments (including employee stock options) at fair value. This requirement was effective for us beginning in the first quarter of 2006. Statement 123R has and will negatively impact our earnings. We recorded stock-based compensation for the third quarter and first nine months of 2006 of $275,000 and $948,000, respectively. In addition, regulations implemented by The NASDAQ Stock Market requiring shareholder approval for all stock option plans as well as regulations implemented by the NYSE prohibiting NYSE member organizations from giving a proxy to vote on equity-compensation plans unless the beneficial owner of the shares has given voting instructions could make it more difficult for us to grant options to employees in the future. To the extent that new regulations make it more difficult or expensive to grant options to employees, we may incur additional cash compensation costs, change our equity compensation strategy or find it difficult to attract, retain and motivate employees, each of which could materially and adversely affect our business.

Foreign currency fluctuations may affect our competitiveness and sales in foreign markets.

The relative change in currency values creates fluctuations in product pricing for potential international customers. These changes in foreign end-user costs may result in lost orders and reduce the competitiveness of our products in certain foreign markets. These changes may also negatively affect the financial condition of some existing or potential foreign customers and reduce or eliminate their future orders of our products.

Use of estimates may cause our financial results to differ from expectations.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

We face risks associated with rapid technological change and new competing products.

The technology associated with non-lethal devices is receiving significant attention and is rapidly evolving. While we have patent protection in key areas of electro-muscular disruption technology, it is possible that new non-lethal technology may result in competing products that operate outside our patents and could present significant competition for our products.

To the extent demand for our products increases, our future success will be dependent upon our ability to ramp manufacturing production capacity which will be accomplished by the implementation of customized manufacturing automation equipment.

Although our revenue decreased in 2005 compared to 2004, we experienced significant revenue growth in 2003 and 2004 and our revenue grew in the third quarter and first nine months of 2006 compared to the same periods in 2005. To the extent demand for our products increases significantly in future periods, one of our key challenges will be to ramp our production capacity to meet sales demand, while maintaining product quality. Our primary strategies to accomplish this include increasing the physical size of our assembly facilities, the hiring of additional production staff, and the implementation of customized automation equipment. We have limited previous experience in implementing automation equipment, and the investments made on this equipment may not yield the anticipated labor and material efficiencies. Our inability to meet any future increase in sales demand or effectively manage our expansion could have a material adverse affect on our revenues, financial results and financial condition.

We depend on our ability to attract and retain our key management and technical personnel.

Our success depends upon the continued service of our key management personnel. Our success also depends on our ability to continue to attract, retain and motivate qualified technical personnel. Although we have employment agreements with certain of our officers, the employment of such persons is “at-will” and either we or the employee can terminate the employment relationship at any time, subject to the applicable terms of the employment agreements. The competition for our key employees is intense. The loss of the service of one or more of our key personnel could harm our business.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table sets forth our purchase of our common stock in the third quarter of 2006 and the footnote below designates the repurchase program that the shares were purchased under.

Issuer Purchases of Equity Securities

(c) Total Number of

(d) Maximum

(a) Total

Shares Purchased

Number of Shares

Number of

(b) Average

as Part of Publicity

that May Yet Be

Shares

Price Paid per

Announced

Purchased Under the

Period

Purchased

Share

Programme

Program

August 1, 2006 - August 31, 2006

300,000

7.36

300,000

(a)

1,075,868

(b)

(a)		In August 2006, our Board of Directors authorized the repurchase of up to $10 million of our common stock between the date of authorization and the date of final payment of the shareholder class action settlement subject to stock market conditions and corporate considerations. The final payment of the settlement will take place after final point approval of the formal shareholder class action settlement agreement, a process expected to take several months.

(b)		Calculated based on a closing stock price of $7.25 on September 29, 2006.

ITEM 6. EXHIBITS

31.1		Chief Executive Officer Certification pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

31.2		Chief Financial Officer Certification pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

32.1		Chief Executive Officer Certification pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Chief Financial Officer Certification pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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. (Registrant)

Date: November 8, 2006		/s/ Patrick W. Smith

		Patrick W. Smith,
		Chief Executive Officer
		(Principal Executive Officer)

Date: November 8, 2006		/s/ Daniel M. Behrendt

		Daniel M. Behrendt
		Chief Financial Officer
		(Principal Financial and Accounting Officer)

Index to Exhibits


Exhibits:
31.1			Chief Executive Officer Certification pursuant to Rule 13a-14(a) under the Securities exchange Act of 1934.

31.2			Chief Financial Officer Certification pursuant to Rule 13a-14(a) under the Securities exchange Act of 1934.

32.1			Chief Executive Officer Certification pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2			Chief Financial Officer Certification pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.