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AXON ENTERPRISE, INC. - Quarter Report: 2008 September (Form 10-Q)

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Table of Contents

 
 
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, 2008
or
     
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
(State or other jurisdiction
of incorporation or organization) 		  86-0741227
(I.R.S. Employer
Identification Number)
     
17800 N. 85th St., SCOTTSDALE, ARIZONA
(Address of principal executive offices) 		  85255
(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, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer þ   Accelerated filer o   Non-accelerated filer o   Smaller reporting company o
        (Do not check if a smaller reporting company)    
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 61,710,478 shares of the issuer’s common stock, par value $0.00001 per share, outstanding as of November 5, 2008.
 
 

 

TASER INTERNATIONAL, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2008
TABLE OF CONTENTS
       
    Page
     
     
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    18
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    28
 
      
     
    29
    29
Items 2, 3, 4 and 5 Not Applicable
      
    35
    36
    37
 
      
EX-31.1
      
 
      
EX-31.2
      
 
      
EX-32
      
 EX-31.1
 EX-31.2
 EX-32

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PART I — FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TASER INTERNATIONAL, INC.
BALANCE SHEETS
(UNAUDITED)
                 
    September 30, 2008     December 31, 2007  
ASSETS
                
 
                
Current assets:
                
Cash and cash equivalents
   $ 42,499,289     $ 42,801,461  
Short-term investments
     —       8,499,978  
Accounts receivable, net of allowance of $200,000 and $190,000 at September 30, 2008 and December 31, 2007, respectively
     11,600,310       11,691,553  
Inventory
     17,475,342       13,506,804  
Prepaids and other assets
     1,852,565       4,318,661  
Deferred income tax assets, net
     7,037,158       15,608,325  
 
            
 
                
Total current assets
     80,464,664       96,426,782  
Long-term investments
     5,002,858       9,006,493  
Property and equipment, net
     26,454,698       23,599,680  
Deferred income tax assets, net
     12,941,086       6,724,104  
Intangible assets, net
     2,253,026       1,925,139  
Other long-term assets
     29,828       81,203  
 
            
 
                
Total assets
   $ 127,146,160     $ 137,763,401  
 
            
 
                
LIABILITIES AND STOCKHOLDERS’ EQUITY
                
 
                
Current liabilities:
                
 
                
Accounts payable and accrued liabilities
   $ 6,766,847     $ 10,088,139  
Litigation judgment accrual
     5,200,000       —  
Current deferred revenue
     2,168,629       1,694,644  
Customer deposits
     292,308       266,728  
Current portion of capital lease obligations
     —       19,257  
Deferred insurance settlement proceeds
     —       404,848  
 
            
 
                
Total current liabilities
     14,427,784       12,473,616  
Capital lease obligations, net of current portion
     —       11,695  
Deferred revenue, net of current portion
     3,971,877       3,541,267  
Liability for unrecorded tax benefits
     1,056,619       1,100,073  
 
            
 
                
Total liabilities
     19,456,280       17,126,651  
 
            
 
Commitments and contingencies
               
Stockholders’ equity
               
Preferred stock, $0.00001 par value per share; 25 million shares authorized; no shares issued and outstanding at September 30, 2008 and December 31, 2007
     —       —  
Common stock, $0.00001 par value per share; 200 million shares authorized; 61,710,478 and 63,263,903 shares issued and outstanding at September 30, 2008 and December 31, 2007, respectively
     638       635  
Additional paid-in capital
     86,612,560       86,911,381  
Treasury stock, 2,091,600 and 300,000 shares at September 30, 2008 and December 31, 2007, respectively
     (14,708,237 )     (2,208,957 )
Retained earnings
     35,784,919       35,933,691  
 
            
 
                
Total stockholders’ equity
     107,689,880       120,636,750  
 
            
 
                
Total liabilities and stockholders’ equity
   $ 127,146,160     $ 137,763,401  
 
            
The accompanying notes are an integral part of these financial statements.

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TASER INTERNATIONAL, INC.
STATEMENTS OF OPERATIONS
(UNAUDITED)
                                 
    For the Three Months Ended September 30,     For the Nine Months Ended September 30,  
    2008     2007     2008     2007  
Net Sales
   $ 22,859,459     $ 28,533,419     $ 66,447,272     $ 69,698,610  
 
                        
 
                                
Cost of products sold:
                                
Direct manufacturing expense
     6,286,067       8,897,407       19,877,521       20,844,866  
Indirect manufacturing expense
     2,677,850       3,629,240       6,306,617       8,426,684  
 
                        
 
                                
Total cost of products sold
     8,963,917       12,526,647       26,184,138       29,271,550  
 
                        
 
                                
Gross margin
     13,895,542       16,006,772       40,263,134       40,427,060  
 
                                
Sales, general and administrative expenses
     9,055,060       8,145,117       27,925,704       24,071,952  
Research and development expenses
     3,331,697       978,011       8,463,231       3,211,646  
Litigation judgment expense
     —       —       5,200,000       —  
 
                        
 
                                
Income (loss) from operations
     1,508,785       6,883,644       (1,325,801 )     13,143,462  
 
                                
Interest and other income, net
     269,718       519,671       1,492,448       1,453,073  
 
                        
 
                                
Income before provision for income taxes
     1,778,503       7,403,315       166,647       14,596,535  
Provision for income taxes
     1,128,126       1,249,277       315,419       4,248,735  
 
                        
 
                                
Net income (loss)
   $ 650,377     $ 6,154,038     $ (148,772 )   $ 10,347,800  
 
                        
 
                                
Income (loss) per common and common equivalent shares
                                
Basic
   $ 0.01     $ 0.10     $ (0.00 )   $ 0.17  
Diluted
   $ 0.01       0.09       (0.00 )   $ 0.16  
 
                                
Weighted average number of common and common equivalent shares outstanding
                                
Basic
     61,714,889       62,950,482       62,568,846       62,441,170  
Diluted
     63,313,702       66,186,297       62,568,846       65,434,448  
The accompanying notes are an integral part of these financial statements.

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TASER INTERNATIONAL, INC.
STATEMENTS OF CASH FLOWS
(UNAUDITED)
                 
    For the Nine Months Ended September 30,  
    2008     2007  
Cash Flows from Operating Activities:
                
Net income (loss)
   $ (148,772 )   $ 10,347,800  
Adjustments to reconcile net income (loss) to net cash used for operating activities:
                
Depreciation and amortization
     1,945,526       1,843,272  
Loss on disposal of fixed assets
     78,207       4,930  
Provision for doubtful accounts
     10,023       —  
Provision for excess and obsolete inventory
     375,363       56,690  
Provision for warranty
     409,102       1,272,537  
Stock-based compensation expense
     1,396,113       1,007,814  
Deferred insurance settlement proceeds recognized
     (404,848 )     (23,924 )
Provision for deferred income taxes
     295,776       4,036,614  
Litigation judgment expense
     5,200,000       —  
Change in assets and liabilities:
                
Accounts receivable
     81,220       (2,937,920 )
Inventory
     (4,343,901 )     (1,755,736 )
Prepaids and other assets
     2,517,471       (141,330 )
Accounts payable and accrued liabilities
     (3,730,394 )     (739,274 )
Deferred revenue
     904,595       1,483,806  
Customer deposits
     25,580       226,269  
Accrued litigation settlement
     —       (8,000,000 )
 
            
 
                
Net cash provided by operating activities
     4,611,061       6,681,548  
 
            
 
                
Cash Flows from Investing Activities:
                
Purchases of investments
     (43,887,640 )     (100,823,821 )
Proceeds from maturity of investments
     56,391,253       103,868,680  
Purchases of property and equipment
     (4,791,190 )     (3,721,363 )
Purchases of intangible assets
     (446,400 )     (328,966 )
 
            
 
                
Net cash provided by (used in) investing activities
     7,266,023       (1,005,470 )
 
            
 
                
Cash Flows from Financing Activities:
                
Repurchase of common stock
     (12,499,280 )     —  
Proceeds from options exercised
     320,024       2,570,345  
Payments under capital leases
     —       (33,703 )
 
            
 
                
Net cash provided by (used in) financing activities
     (12,179,256 )     (33,703 )
 
            
 
                
Net increase (decrease) in Cash and Cash Equivalents
     (302,172 )     5,642,375  
Cash and Cash Equivalents, beginning of period
     42,801,461       18,773,685  
 
            
 
                
Cash and Cash Equivalents, end of period
   $ 42,499,289     $ 24,416,060  
 
            
 
                
Supplemental Disclosure:
                
Cash paid for interest
   $ —     $ 4,092  
Cash paid for income taxes — net
   $ 473,468     $ 350,000  
 
                
Non Cash Transactions:
                
Deferred tax asset correction (see footnote 6)
   $ 2,014,955     $ —  
Shareholder derivative lawsuit settlement
   $ —     $ 1,750,000  
The accompanying notes are an integral part of these financial statements.

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TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited)
1. Organization and Summary of Significant Accounting Policies
     TASER International, Inc. (“TASER” or the “Company”) is a developer and manufacturer of advanced electronic control devices (“ECDs”) designed for use in law enforcement, military, corrections, private security and personal defense. The Company sells its products worldwide through its direct sales force, distribution partners, online store and third party resellers. We were incorporated in Arizona in September 1993 and reincorporated in Delaware in January 2001. Our headquarter facilities are in Scottsdale, Arizona.
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, 2008 and for the periods ended September 30, 2008 and 2007. 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 September 30, 2008 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 for the year ended December 31, 2007.
b. Segment information and major customers
     Management has determined that its operations are comprised of one reportable segment. For the three and nine months ended September 30, 2008 and 2007, sales by geographic area were as follows:
                                 
    Three Months Ended September 30,   Nine Months Ended September 30,
    2008   2007   2008   2007
United States
     84 %     85 %     86 %     83 %
Other Countries
     16 %     15 %     14 %     17 %
 
                                
 
                                
Total
     100 %     100 %     100 %     100 %
 
                                
     Sales to customers outside of the United States are denominated in U.S. dollars and are attributed to each country based on the billing address of the distributor or customer. To date no individual country outside the U.S. has represented a material amount of total net sales. Substantially all assets of the Company are located in the United States.
     One distributor represented 13% of total net sales in the third quarter of 2008. In the third quarter of 2007 there were two distributors each comprising approximately 17% and 13% of total net sales. In the nine months ended September 30, 2008 and 2007 one distributor represented approximately 12% and 13%, respectively, of total net sales. At September 30, 2008, the Company had receivables from two customers comprising 17% and 11% of the aggregate accounts receivable balance. At December 31, 2007, the Company had receivables from two customers comprising 20% and 10% of the aggregate accounts receivable balance.
c. Stock-Based compensation
     The Company applies 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, 2008 and 2007 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).
     Total stock-based compensation expense recognized in the income statement for the three and nine months ended September 30, 2008 was $665,000 and $1,396,000 before income taxes, respectively, $317,000 and $881,000 of which was related to Incentive Stock Options (“ISOs”) for which no tax benefit is recognized. Total stock-based compensation expense recognized in the income statement for the three and nine months ended September 30, 2007 was $417,000 and $1,008,000 before income taxes, respectively, $338,000 and $817,000 of which was related to ISOs for which no tax benefit is recognized. During the three and nine months ended September 30, 2008 and 2007, the Company did not recognize the tax benefit related to the exercise of stock options as a result of SFAS No. 123(R). The tax benefit will be recorded when the Company realizes the benefit in cash or with an offset to taxes payable in future periods. The total unrecognized tax benefit related to the non-qualified disposition of stock options in the three and nine months ended September 30, 2008 was approximately $136,000 and $201,000, respectively. The total unrecognized tax benefit related to the non-qualified disposition of stock options in the three and nine months ended September 30, 2007 was approximately $22,000 and $63,000 respectively.

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TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued
     SFAS No. 123(R) requires the use of a valuation model to calculate the fair value of stock-based awards. Management has elected to use the Black-Scholes-Merton 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, 2008 and 2007 and the resulting estimates of weighted-average fair value per share of options granted during those periods are as follows:
                                 
    Three Months Ended September 30,   Nine Months Ended September 30,
    2008   2007   2008   2007
Expected life of options
   4.0 years   4.0 years   4.0 years   4.0 years
Weighted average volatility
     67.4 %     69.6 %     68.1 %     58.8 %
Weighted average risk-free interest rate
     3.0 %     4.4 %     3.0 %     4.7 %
Dividend rate
     0.0 %     0.0 %     0.0 %     0.0 %
Weighted average fair value of options granted
   $ 2.93     $ 8.53     $ 3.27     $ 5.05  
     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. 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. 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. As stock-based compensation expense is recognized on awards ultimately expected to vest, it is reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company forfeiture rate was calculated based on its historical experience of awards which ultimately vested.
d. Income (loss) per common share
     The Company accounts for income (loss) per share in accordance with SFAS No. 128, “Earnings per Share.” Basic income (loss) per share is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the periods presented. Diluted income (loss) 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:
                                 
    For the Three Months Ended September 30,     For the Nine Months Ended September 30,  
    2008     2007     2008     2007  
Numerator for basic and diluted earnings per share
                                
Net income (loss)
   $ 650,377     $ 6,154,038     $ (148,772 )   $ 10,347,800  
 
                        
 
                                
Denominator for basic earnings per share — weighted average shares outstanding
     61,714,889       62,950,482       62,568,846       62,441,170  
Dilutive effect of shares issuable under stock options outstanding
     1,598,813       3,235,815       —       2,993,278  
 
                        
 
                                
Denominator for diluted earnings per share — adjusted weighted average shares outstanding
     63,313,702       66,186,297       62,568,846       65,434,448  
 
                        
 
                                
Net income (loss) per common share
                                
Basic
   $ 0.01     $ 0.10     $ (0.00 )   $ 0.17  
Diluted
   $ 0.01     $ 0.09     $ (0.00 )   $ 0.16  
     Basic net income (loss) per share is based upon the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share includes the dilutive effect of potential stock option exercises, calculated using the treasury stock method. For the three months ended September 30, 2008, the effects of 3,822,794 stock options were excluded from the calculation of diluted net income per share as their exercise prices were greater than the closing price of our common stock on September 30, 2008. As a result of the net loss for the nine months ended September 30, 2008, 3,979,808 stock options were considered anti-dilutive and excluded from the calculation as their effect would have been to reduce the net loss per share. For the three and nine months ended September 30, 2007, the effects of 248,964 and 399,230 stock options, respectively, were excluded from the calculation of diluted net income per share as their exercise prices were greater than the closing price of our common stock on September 30, 2007.

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TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued
e. Warranty costs
          The Company warrants its X26 products from manufacturing defects on a limited basis for a period of one year after purchase, and thereafter will replace any defective unit for a fee. The C2 product is warranted for a period of 90 days after purchase. The Company also sells extended warranties for periods of up to four years after the expiration of the limited one year warranty. Management tracks historical data related to returns and warranty costs on a quarterly basis, and estimates future warranty claims by applying an estimated weighted average rolling four quarter return rate to the product sales for the period. In the fourth quarter of 2007, management made a revision to the basis of calculating the four quarter return rate as the result of being able to more accurately capture data relating to the number of units replaced under standard warranty versus extended warranty terms. In addition, given the trend of sales growth experienced in 2007, particularly in the second half of the year, the estimated four quarter return rate is weighted to account for the higher return rate experienced in those periods. If management becomes aware of a component failure that could result in larger than anticipated returns from its customers, the reserve would be increased. After the one year warranty expires, if the device fails to operate properly for any reason, the Company will replace the TASER X26 for a prorated price depending on when the product was placed into service and replace the ADVANCED TASER device for a fee of $75. These fees are intended to cover the handling and repair costs and include a profit. The following table summarizes the changes in the estimated product warranty liabilities for the nine months ended September 30, 2008 and 2007:
                 
    2008     2007  
Balance at January 1,
   $ 919,254     $ 713,135  
Utilization of accrual
     (558,593 )     (828,058 )
Warranty expense
     409,102       1,272,537  
 
            
 
                
Balance at September 30,
   $ 769,763     $ 1,157,614  
 
            
f. Recent accounting pronouncements
          In December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 141 (revised) (“SFAS 141(R)”), Business Combinations. The standard changes the accounting for business combinations by requiring that an acquiring entity measure and recognize identifiable assets acquired and liabilities assumed at the acquisition date fair value with limited exceptions. SFAS 141(R) is effective for fiscal years beginning after December 15, 2008, with early adoption prohibited. Management does not expect the adoption of SFAS 141(R) to have an impact on the Company’s financial statements when effective, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of acquisitions, if any, the Company consummates after the effective date.
          In December 2007, the Emerging issues Task Force (“EITF”) reached a consensus on EITF issue No. 07-1 “Accounting for Collaborative Arrangements” (“EITF 07-1”). EITF 07-1 establishes the accounting and disclosure requirements for participants in collaborative arrangements conducted without the creation of a separate legal entity. EITF 07-1 was effective for annual periods beginning after December 15, 2007. The adoption of EITF 07-1 did not have a material impact on the Company’s financial position.
          In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”). SFAS No. 159 allows entities the option to measure eligible financial instruments at fair value as of specified dates. Such election, which may be applied on an instrument by instrument basis, is typically irrevocable once made. Management adopted SFAS No. 159 beginning in the first quarter of 2008. The adoption of SFAS No. 159 did not have a material impact on the Company’s financial position.
          In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, SFAS No. 157 does not require any new fair value measurements. Management adopted SFAS No. 157 beginning in the first quarter of fiscal 2008. The adoption of SFAS No. 157 did not have a material impact on the Company’s financial position.

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TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued
2. 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 maturities of 90 days to one year. Long-term investments include securities having 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. Management intends to hold these securities until maturity. The Company’s cash equivalent investments held in money market funds as of September 19, 2008 are insured by the Federal Government as part of the Temporary Guarantee Program for Money Market Funds.
          The following is a summary of cash, cash equivalents and held-to-maturity investments by type at September 30, 2008 and December 31, 2007:
                                                                 
    September 30, 2008     December 31, 2007  
            Gross     Gross                     Gross     Gross        
            Unrealized     Unrealized                     Unrealized     Unrealized        
    Cost     Gains     Losses     Fair Value     Cost     Gains     Losses     Fair Value  
Cash and money market funds
   $ 42,499,289     $ —     $ —     $ 42,499,289     $ 29,687,138     $ —     $ —     $ 29,687,138  
Commercial paper
     —       —       —       —       13,114,323       —       (37,838 )     13,076,485  
Government sponsored entity securities
     5,002,858       6,793       —       5,009,651       17,506,471       14,238       (12,022 )     17,508,687  
 
                                                
 
                                                                
Total cash, cash equivalents and investments
   $ 47,502,147     $ 6,793     $ —     $ 47,508,940     $ 60,307,932     $ 14,238     $ (49,860 )   $ 60,272,310  
 
                                                
     The following table summarizes the classification of cash, cash equivalents and investments in the accompanying balance sheet.
                 
    September 30,     December 31,  
    2008     2007  
Cash
   $ 42,499,289     $ 29,687,138  
Cash equivalents
     —       13,114,323  
 
            
Total cash and cash equivalents
     42,499,289       42,801,461  
 
            
 
                
Short term investments
     —       8,499,978  
Long term investments
     5,002,858       9,006,493  
 
            
 
   $ 47,502,147     $ 60,307,932  
 
            
     The following table summarizes the contractual maturities of commercial paper and government sponsored entity securities, identified above as cash equivalents, short term and long term investments at September 30, 2008 and December 31, 2007. During the third quarter ended September 30, 2008, $5.5 million of long term investments held in government sponsored entity securities were called at par value.
                 
    September 30,     December 31,  
    2008     2007  
Less than 1 year
   $ —     $ 21,614,301  
1-3 years
     5,002,858       9,006,493  
 
            
 
   $ 5,002,858     $ 30,620,794  
 
            
     The Company had no unrealized losses on held-to-maturity investments at September 30, 2008.
3. Inventory
     Inventory is stated at the lower of cost or market. Cost is determined using the weighted average cost of raw materials which approximates the first-in, first-out (FIFO) method and manufacturing labor and overhead. Provisions are made to reduce excess, obsolete or slow-moving inventories to their net realizable value. Inventories as of September 30, 2008 and December 31, 2007 consisted of the following:
                 
    September 30, 2008     December 31, 2007  
Raw materials and work-in-process
   $ 9,200,467     $ 8,475,055  
Finished goods
     8,731,270       5,352,304  
Reserve for excess and obsolete inventory
     (456,395 )     (320,555 )
 
            
 
                
Total Inventory
   $ 17,475,342     $ 13,506,804  
 
            

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TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued
4. Intangible assets
     Intangible assets consisted of the following at September 30, 2008 and December 31, 2007:
                                                         
            September 30, 2008   December 31, 2007
            Gross           Net   Gross           Net
            Carrying   Accumulated   Carrying   Carrying   Accumulated   Carrying
    Useful Life   Amount   Amortization   Amount   Amount   Amortization   Amount
                 
Amortized intangible assets:
                                                        
TASER.com domain name
   5 Years   $ 60,000     $ 60,000     $ —     $ 60,000     $ 60,000     $ —  
Issued patents
   4 to 15 Years     648,153       150,316       497,837       402,058       115,863       286,195  
Issued trademarks
   9 to 11 Years     39,081       8,547       30,534       36,466       5,206       31,260  
Non compete agreements
   5 to 7 Years     150,000       72,500       77,500       150,000       52,143       97,857  
                     
 
             897,234       291,363       605,871       648,524       233,212       415,312  
                         
 
                                                        
Unamortized intangible assets:
                                                        
TASER Trademark
             900,000               900,000       900,000               900,000  
Patents and trademarks pending
             747,155               747,155       609,827               609,827  
 
                                                        
 
             1,647,155               1,647,155       1,509,827               1,509,827  
 
                                                        
 
                                                        
                     
Total intangible assets
           $ 2,544,389     $ 291,363     $ 2,253,026     $ 2,158,351     $ 233,212     $ 1,925,139  
                         
     Amortization expense for the three and nine months ended September 30, 2008 was $21,000 and $58,000, respectively. Amortization expense for the three and nine months ended September 30, 2007 was $16,000 and $45,000, respectively. Estimated amortization expense of intangible assets for the remaining three months of 2008, the next five years ended December 31, and thereafter is as follows:
         
2008 (remainder of year)
   $ 21,608  
2009
     74,425  
2010
     66,318  
2011
     58,606  
2012
     38,606  
2013
     38,605  
Thereafter
     307,703  
 
      
 
   $ 605,871  
 
      
5. Accounts payable and accrued liabilities
     Accounts payable and accrued liabilities consisted of the following at September 30, 2008 and December 31, 2007:
                 
    September 30, 2008     December 31, 2007  
Accounts payable
   $ 3,782,944     $ 7,304,112  
Accrued salaries and benefits
     962,852       1,046,534  
Accrued expenses
     1,251,288       818,239  
Accrued warranty expense
     769,763       919,254  
 
            
 
                
Total
   $ 6,766,847     $ 10,088,139  
 
            
6. Income taxes
     The deferred income tax assets at September 30, 2008 are 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, 2008, the Company did not recognize additional tax benefits related to stock options exercised. Additionally, capitalized research and development costs, research and development tax credits, warranty and inventory reserves, accrued vacation and other items have contributed to the deferred income tax assets.
     The Company’s total current and long term deferred tax asset balance at September 30, 2008 is $20.0 million. In preparing the Company’s interim financial statements, management has assessed the likelihood that its deferred tax assets will be realized from future taxable income. In evaluating the Company’s ability to recover its deferred income tax assets, management 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.

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TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued
     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. Management 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 management believes that its tax estimates are reasonable, the ultimate tax determination involves significant judgment that could become subject to audit by tax authorities in the ordinary course of business, as well as the generation of sufficient future taxable income. Primarily as a result of the shareholder litigation settlement expense recorded in the second quarter of 2006 and the litigation judgment expense recorded in the second quarter of 2008, management 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 a valuation allowance of $500,000 against its deferred tax assets as of September 30, 2008, $250,000 of which was recognized as a reduction to the net income tax benefit in the second quarter of 2008. Management believes that, other than as previously described, as of September 30, 2008 based on an evaluation and projections of future sales and profitability, no other valuation allowance was deemed necessary as management 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.
     In July 2000, the Company granted 136,364 warrants to acquire Company stock at an exercise price of $0.55 per share to a member of its Board of Directors as additional consideration for a $1.5 million loan. In October 2004, the stock warrants were exercised with an intrinsic value of $5,233,650. As a result of personnel changes, a 1099 was issued to the Board member in error. The Company included the $5,233,650 as stock compensation expense in its 2004 tax return and, because the Company had a net operating loss carryforward, recorded a $2,014,955 deferred tax asset on the balance sheet and a corresponding increase to additional paid in capital. The Company’s 2004 tax return was audited by the IRS in 2007 with no adjustment made to the stock compensation expense deduction recorded by the Company. During a tax examination of the Board member’s tax return it was determined that the exercise of the warrant should not have created taxable income and that the inclusion of the intrinsic value of the warrant in the director’s 1099 was in fact, an error. Accordingly, in the second quarter of 2008, the Company reduced its deferred tax asset balance and additional paid in capital by $2,014,955. The adjusting entry was a balance sheet only adjustment and had no impact on retained earnings and was not considered material to the associated account balances or the balance sheet as a whole.
     The FASB issued Interpretation 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), which the Company adopted effective January 1, 2007. FIN 48 addresses the determination of how tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, the Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. Under FIN 48, management must also assess whether uncertain tax positions as filed could result in the recognition of a liability for possible interest and penalties. The Company’s policy is to include interest and penalties related to unrecognized tax benefits as a component of income tax expense.
     In 2007, the Company completed a research and development tax credit study which identified $3.1 million in tax credits for Federal and Arizona income tax purposes related to the 2003 through 2006 tax years and an estimate for the 2007 tax year. As a result, the Company recognized $2.0 million in 2007 as a reduction in income tax expense. Management made the determination that it was more likely than not that the full benefit of the research and development tax credit would not be sustained on examination and recorded a liability for unrecognized tax benefits of $1.1 million as of December 31, 2007. Management has estimated that an additional $550,000 of tax credits are available for Arizona purposes for the 2008 tax year with a prorated portion recorded as a component of the effective tax rate for the three and nine months ended September 30, 2008. As of September 30, 2008, management does not expect the amount of the unrecognized tax benefit liability to increase or decrease within the next 12 months. Should the unrecognized tax benefit of $1.1 million be recognized, our effective tax rate would be favorably impacted.
     The following presents a rollforward of our liability for unrecognized tax benefits as of September 30, 2008:
         
    Unrecognized Tax  
    Benefits  
Balance at January 1, 2008
   $ 1,100,073  
Increase in prior year tax positions
     —  
Increase in current year tax positions
     5,389  
Decrease related to adjustment of previous estimates of 2007 activity
     (48,843 )
Decrease related to settlements with taxing authorities
     —  
Decrease related to lapse in statute of limitations
     —  
 
      
Balance at September 30, 2008
   $ 1,056,619  
 
      

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TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued
     The effective income tax rate for the third quarter of 2008 was 63.4% compared to 16.9% for the third quarter of 2007. The effective income tax rate for the first nine months of 2008 was 189.3% compared to 29.1% for the first nine months of 2007. The effective tax rate for the three and nine months ended September 30, 2008 increased compared to the same periods in the prior year due to the higher impact of certain non-deductible items such as lobbying expenses against a lower taxable income base expected for the year ended December 31, 2008. In addition the rate is impacted by the inclusion of the state research and development tax credit in the 2008 effective tax rate, while the 2007 effective tax rate was impacted by a $1.8 million reduction in income tax expense related to the initial research and development tax study competed in the third quarter of 2007. Further increasing the 2008 effective tax rate was the recording of the $250,000 valuation allowance against Arizona State NOL deferred tax assets discussed above.
     During the third quarter, the United States Internal Revenue Service completed its audit of the Company’s 2006 fiscal year tax returns with no significant findings.
7. Stockholders equity
Stock Repurchase
     In April 2008, TASER’s Board of Directors authorized a stock repurchase program to acquire up to $12.5 million of the Company’s outstanding common stock subject to stock market conditions and corporate considerations. During the nine months ended September 30, 2008, the Company repurchased 1.79 million shares at a weighted average cost of $6.98 and a total cost of $12.5 million.
Stock Option Award Activity
     At September 30, 2008, the Company had three stock-based compensation plans, which are described more fully in Note 10 to the financial statements included in the Company’s Annual Report on Form 10-K.
     The following table summarizes the stock options available and outstanding as of September 30, 2008 as well as activity during the nine months then ended:
                         
            Outstanding Options
    Shares Available for           Weighted Average
    Grant   Number of options   Exercise Price
Balance at December 31, 2007
     4,900,947       5,234,072     $ 6.06  
Granted
     (2,173,471 )     2,173,471     $ 6.11  
Exercised
     —       (263,409 )   $ 1.12  
Expired/terminated
     6,466       (6,466 )   $ 16.86  
 
                        
Balance at September 30, 2008
     2,733,942       7,137,668     $ 6.24  
 
                        
     The options outstanding as of September 30, 2008 have been segregated into five ranges for additional disclosure as follows:
                                         
    Options Outstanding   Options Exercisable
                    Weighted            
            Weighted   Average           Weighted
            Average   Remaining           Average
    Number   Exercise   Contractual   Number   Exercise
Range of Exercise Price   Outstanding   Price   Life   Exercisable   Price
         
$0.28 - $0.99
     1,014,886     $ 0.36       4.3       1,014,886     $ 0.36  
$1.03 - $2.41
     858,875     $ 1.58       3.9       858,875     $ 1.56  
$5.02 - $9.93
     4,291,608     $ 7.03       7.6       2,188,255     $ 7.97  
$10.07 - $19.76
     910,299     $ 12.27       7.6       603,559     $ 12.98  
$20.12 - $29.98
     62,000     $ 23.91       5.8       62,000     $ 23.91  
 
 
                                        
$0.28 - $29.98
     7,137,668     $ 6.24       6.7       4,727,575     $ 6.02  
 
                                        
     The total fair value of options exercisable at September 30, 2008 and 2007 was $14.8 million and $13.6 million, respectively. Aggregate intrinsic value of options outstanding and options exercisable was $14.3 million and $11.8 million, respectively, at September 30, 2008. Aggregate intrinsic value represents the difference between the Company’s closing stock price on the last trading day of the fiscal period, which was $7.15 per share, and the exercise price multiplied by the number of options outstanding. Total intrinsic value of options exercised for the three and nine month periods ended September 30, 2008 was $93,000 and $2.3 million, respectively. Total intrinsic value of options exercised for the three and nine month periods ended September 30, 2007 was $2.1 million and $7.0 million, respectively.

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TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued
     At September 30, 2008, the Company had 2,410,093 unvested options outstanding with a weighted average exercise price of $6.67 per share and weighted average remaining contractual life of 9.6 years. Of these unvested options outstanding, management estimates that approximately 2,308,870 options will ultimately vest based on its historical experience.
     A summary of the status of the Company’s unvested options as of September 30, 2008 and changes during the nine months ended September 30, 2008, is presented below:
                 
            Weighted Average
            Grant Date Fair
Unvested options   Options   Value
Unvested at January 1, 2008
     550,840     $ 5.12  
Granted
     2,173,471     $ 3.27  
Vested
     (314,218 )   $ 4.63  
Forfeited
     —     $ —  
 
                
Unvested at September 30, 2008
     2,410,093     $ 3.51  
 
                
     As of September 30, 2008, total unrecognized stock-based compensation expense related to unvested stock options was approximately $8.0 million, which is expected to be recognized over a remaining weighted average period of approximately 17 months.
     The Company granted 175,000 of performance-based stock options in the third quarter of 2008, the exercise of which is contingent upon the completion of certain performance criteria related to the successful development and market acceptance of future product introductions. These options will vest and compensation expense will be recognized based on the probability of the performance criteria being satisfied, adjusted at each balance sheet date. At September 30, 2008 the fair value of the performance-based options was estimated to be $336,000, and the Company recognized compensation expense of approximately $30,000.
8. Line of credit
     The Company has a line of credit agreement with a bank which provides for a total availability of $10.0 million. The line is secured by the Company’s accounts receivable and inventory and bears interest at varying rates of interest, ranging from LIBOR plus 1.5% to prime (4.5% at September 30, 2008). 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, 2010 and requires monthly payments of interest only. At September 30, 2008 there was no amount outstanding under the line of credit and the available borrowing was $10.0 million. 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. At September 30, 2008, the Company was in compliance with all such covenants.
9. Commitments and Contingencies
Equipment purchase commitment
     On July 2, 2007, the Company entered into a contract with Automation Tooling Systems Inc. for the purchase of equipment at a cost of approximately $7.7 million. Subsequent to the initial order, the Company placed a $0.7 million change order to this agreement for additional equipment and modifications. The equipment is expected to be delivered to and installed at the Company’s facility in the first quarter of 2009. Payments will be made in installments, with an initial $1.5 million deposit paid in 2007, installments of $2.9 million paid in the first nine months of 2008, and the balance of $4.0 million expected to be paid by December 31, 2008. The installments paid to date have been recorded in property, plant and equipment in the accompanying balance sheet.
Legal proceedings
Product Liability Litigation
     The Company is currently named as a defendant in 40 lawsuits in which the plaintiffs allege 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. Companion cases arising from the same incident have been combined into one for reporting purposes. Included in this number is the Heston lawsuit where a jury verdict was entered against the Company on June 7, 2008, but judgment has not yet been entered. See below for more detail specific to this case. In addition, 77 other lawsuits have been dismissed or judgment entered in favor of the Company which are not included in this number. An appeal was filed by the plaintiff in the Wilson (GA) litigation and the Neal-Lomax (NV) litigation where judgment was entered in favor of the Company. With respect to each of the pending 41 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 that 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 per incident deductibles from $10,000 to $500,000. We are defending each of these lawsuits vigorously.

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TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued
                 
Plaintiff   Served   Jurisdiction   Claim Type   Status
Glowczenski
  Oct-04   US District Court, ED NY   Wrongful Death   Discovery Phase
Washington
  May-05   US District Court, ED CA   Wrongful Death   Discovery Phase
Sanders
  May-05   US District Court ED CA   Wrongful Death   Case Stayed
Graff
  Sep-05   Maricopa Superior Court, AZ   Wrongful Death   Discovery Phase
Heston
  Nov-05   US District Court, ND CA   Wrongful Death   Plaintiff Verdict, punitive damages thrown out, post trial
motions pending, judgment not entered yet
Rosa
  Nov-05   US District Court, ND CA   Wrongful Death   Trial Scheduled July -09
Yeagley
  Nov-05   Hillsborough County Circuit County, FL   Wrongful Death   Discovery Phase
Neal-Lomax
  Dec-05   US District Court, NV   Wrongful Death   Dismissed, appeal pending
Yanga Williams
  Dec-05   Gwinnett County State Court, GA   Wrongful Death   Dismissed
 
                
Mann
  Dec-05   US District Court, ND GA, Rome Div   Wrongful Death   Summary judgment motion pending
 
                
Robert Williams
  Jan-06   US District Court, TX   Wrongful Death   Dismissed
Lee
  Jan-06   Davidson County, TN Circuit Court   Wrongful Death   Trial Scheduled Apr-09, Summary judgment motion pending
 
                
Zaragoza
  Feb-06   CA Superior Court, Sacramento County   Wrongful Death   Discovery Phase
Bagnell
  Jul-06   Supreme Court for British Columbia, Canada   Wrongful Death   Discovery Phase
 
                
Hollman
  Aug-06   US District Court, ED NY   Wrongful Death   Discovery Phase
Oliver
  Sep-06   US District Court, MD FL, Orlando   Wrongful Death   Trial Stayed
Teran/LiSaola
  Oct-06   CA District Court   Wrongful Death   Trial Scheduled March-09
Short, Rhonda
  Oct-06   US District Court, ND TX, Forth Worth   Wrongful Death   Dismissed
Augustine
  Jan-07   11th Judicial Circuit Court, Miami-Dade, FL   Wrongful Death   Discovery Phase
Bolander
  Aug-07   17th Circuit Court Broward County, FL   Wrongful Death   Trial Scheduled March-09, Summary judgment motion pending
Wendy Wilson,
  Aug-07   District Court Boulder County, CO   Wrongful Death   Discovery Phase
Estate of Ryan Wilson
                
Crawford, Estate of Russell Walker
  Oct-07   District Court Clark County, NV   Wrongful Death   Discovery Phase
Walker, Estate of Russell Walker
  Oct-07   US District Court District of NV   Wrongful Death   Discovery Phase
Companion to Crawford)
                
 
                
Jack Wilson, Estate of Ryan Wilson (Companion to Wendy Wilson)
  Nov-07   District Court, Boulder County, CO   Wrongful Death   Discovery Phase
Kasilyan
  Feb-08   District Court, Clark County, NV   Wrongful Death   Discovery Phase
Gilliam
  April-08   US District Court, MD, AL   Wrongful Death   Discovery Phase
Romero
  May-08   Dallas County District Court, TX   Wrongful Death   Discovery Phase
Guerrero
  June-08   US District Court, Central District CA   Wrongful Death   Discovery Phase, Trial Scheduled Oct-09
Marquez
  June-08   US District Court, Arizona   Wrongful Death   Discovery Phase
Preyer
  July-08   US District Court, Middle District, FL   Wrongful Death   Stayed
Salinas
  Aug-08   US District Court, Northern District CA   Wrongful Death   Complaint Served
Wells
  Sept-08   US District Court, Northern District CA   Wrongful Death   Complaint Served
R. Wilson
  Oct-08   SC Court Common Pleas, Charleston County   Wrongful Death   Complaint Served
Thomas (Pike)
  Oct-08   US District Court, WD Louisiana, Alexandria   Wrongful Death   Complaint Served
Stewart
  Oct-05   Circuit Court for Broward County, FL   Training Injury   Discovery Phase
Lewandowski
  Jan-06   US District Court, NV   Training Injury   Summary judgment motion pending
Peterson
  Jan-06   US District Court, NV   Training Injury   Summary judgment motion pending
Husband
  Mar-06   British Columbia Supreme Court, Canada   Training Injury   Discovery Phase
Wilson
  Aug-06   US District Court, ND GA   Training Injury   Dismissed, Appeal Filed
Perry
  July-08   US District Court CO   Training Injury   Complaint Filed
Grable
  Aug-08   FL 6th Judicial Circuit Court, Pinellas County   Training Injury   Complaint Filed
Bynum
  Oct-05   US District Court SD NY   Injury During Arrest   Discovery Phase
Wieffenbach
  Jun-06   Circuit Court of 12th Judicial District, Will County, Il   Injury During Arrest   Discovery Phase
Short, Harvey
  Oct-06   US District Court, SD West Virginia   Injury During Arrest   Dismissed
Payne
  Oct-06   Circuit Court of Cook County, Illinois   Injury During Arrest   Discovery Phase
Gomez
  May-07   Circuit Court 11th Judicial Dist. FL   Injury During Arrest   Discovery Phase
Kern / Banda
  Feb-08   District Court, Tarrant County, TX   Injury During Admittance   Dismissed
Butler
  Sept-08   CA Superior Court, Santa Cruz County   Injury During Arrest   Complaint Filed

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TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued
     The Company recorded a $5.2 million non-cash charge in the second quarter of 2008 for an adverse jury verdict received in the case of Betty Lou Heston, et al. v. City of Salinas, TASER International, Inc., et al. The jury found that Mr. Heston’s own actions were 85 percent responsible for his death. The jury assigned 15 percent of the responsibility to TASER for a “negligent failure to warn” that extended or multiple TASER ECD applications could cause muscle contractions, potentially contributing to acidosis to a degree that could cause cardiac arrest. As a result the jury awarded a total of $1.0 million in compensatory damages (for which the 15% or $153,000 attributable to the Company will be covered by liability insurance) and $5.2 million in punitive damages against the Company based on alleged negligent failure to warn. On October 24, 2008 the Court granted the Company’s Renewed Motion for Judgment meritorious with respect to the award of punitive damages, ordering that the $5.2 million in punitive damages against TASER be disregarded as the original jury award was inappropriate under California law. As a result, the Company may reverse the related $5.2 million expense in the fourth quarter of 2008 when the judgment is filed and the nature of plaintiffs’ appeals, if any, becomes apparent. The Court denied the Company’s motion for judgment as a matter of law on all grounds, with the sole exception to its challenge regarding the punitive damage awards. Additional pending motions of Officer Defendants’ Motion for Bill of Costs against Plaintiffs and Plaintiffs’ Motion for Attorney Fees against Defendant TASER will be heard by the Court on December 1, 2008.
Other 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 an 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. Both parties filed motions for summary judgment to dismiss the other parties’ claims, both of which motions were granted by the Court and the matter was resolved on those motions before the Court in January 2007. An appeal has been filed by Bestex.
     In January 2007, we filed a lawsuit in the U.S. District Court for the District of Arizona against Stinger Systems, Inc. alleging patent infringement, patent false marking, and false advertising. Defendant filed an answer and counterclaim for false advertising and punitive damages. Discovery has begun and no trial date has been set.
     In October 2007 we filed a lawsuit against Steve Ward and Mark Johnson, both former employees, and VIEVU Corporation, et. al. for breach of duty of loyalty, breach of contract, breach of fiduciary duty, and conversion. This lawsuit does not involve our core business and we don’t expect this litigation to have a material impact on our financial results. Defendants Ward and VIEVU Corporation filed an answer and counterclaim for declaration of non-infringement, tortious interference with contractual relations, tortious interference with business expectancy, abuse of process, injunctive relief and punitive damages. Discovery has begun and no trial date has been set.
     In July 2008 we filed a complaint against Morgan Stanley & Co., Inc., Goldman Sachs Group, Inc., Bear Stearns Securities Corp., Bear Stearns Capital Markets, Inc., Bear Stearns & Co, Inc., The Bear Stearns Companies, Inc., Merrill Lynch, Pierce, Fenner & Smith, Inc., Deutsche Bank Securities, Inc., Credit Suisse USA, Inc., Banc Of America Securities, LLC, and UBS Securities, LLC. for Violation of Georgia’s RICO Statute, Violation of the Georgia Securities Act, Violation of the Georgia Computer Systems Protection Act and Conversion. An answer has not yet been filed, discovery has not started and no trial date has been set.
     In July 2008 we were served with a summons and complaint in the lawsuit entitled Proformance Vend USA vs. TASER International, Inc. alleging breach of contract of a vending machine contract. We have filed an answer to this complaint. Discovery has begun and no trial date has been set.

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TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued
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 defend and pursue 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 or 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. In addition, the Company has eight lawsuits where the costs of legal defense incurred are in excess of its liability insurance deductibles. As of September 30, 2008, the Company has recorded approximately $222,000 in other assets related to the receivable from its insurance company for reimbursement of these legal costs. The Company may settle a lawsuit in situations where a settlement can be obtained for nuisance value and for an amount that is expected to be less than the cost of defending a lawsuit. The number of product liability lawsuits dismissed includes a small number of police officer training injury lawsuits that were settled by TASER International and dismissed in cases where the settlement economics to TASER were significantly less than the cost of litigation. One of the training injury lawsuits brought by a law enforcement officer was settled in June 2007 for an amount in excess of nuisance value by our insurance company. Our insurance coverage at that time did not cover our costs of defense if we won at trial. However, our insurance coverage at that time provided for a pro-rata reimbursement of our costs of defense if the lawsuit was settled. Upon final settlement of this case, the Company was paid $241,000 by our insurance company as reimbursement of the Company’s costs of defense. Due to the confidentiality of our litigation strategy and the confidentiality agreements that are executed in the event of a settlement, the Company does not identify or comment on which specific lawsuits have been settled or the amount of any settlement.
10. Related Party Transactions
Aircraft charter
     The Company reimburses Thomas P. Smith, Chairman of the Company’s Board of Directors, and Patrick W. Smith, the Company’s Chief Executive Officer, for business use of their personal aircraft. For the three and nine months ended September 30, 2008, the Company incurred expenses of approximately $18,000 and $161,000, respectively, to Thomas P. Smith. For the three and nine months ended September 30, 2007, the Company incurred expenses of approximately $86,000 and $304,000, respectively, to Thomas P. Smith. For the three and nine months ended September 30, 2008, the Company incurred expenses of $5,000 and $107,000 to Patrick W. Smith. For the three and nine months ended September 30, 2007, the Company incurred expenses of $37,000 and $54,000, respectively, to Patrick W. Smith. At September 30, 2008 and December 31, 2007, the Company had outstanding payables of $9,000 and $27,000, respectively, due to Thomas P. Smith. At September 30, 2008 and December 31, 2007, the Company had outstanding payables of $5,000 and $0, respectively, due to Patrick W. Smith. Management believes that the rates charged by Thomas P. Smith and Patrick W. Smith are equal to or below commercial rates the Company would pay to charter similar aircraft from independent charter companies.
     In the first quarter of 2007, the Company also entered into a charter agreement for future use of an aircraft for business travel from Thundervolt, LLC, a company owned by Patrick W. Smith, should the need arise. For the three and nine months ended September 30, 2008 and 2007, the Company did not incur any direct charter expenses pursuant to its relationship with Thundervolt, LLC. Management believes that the rates charged by Thundervolt, LLC are 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 relationship with Thundervolt, LLC, 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). The Company determined that the relationships did not meet the definition of a variable interest entity (VIE) as defined by FIN 46R as Thundervolt, LLC is adequately capitalized, its owners possess all of the essential characteristics of a controlling financial interest, and the Company does not have any voting rights in the entity. Therefore, the entity is not required to be consolidated into the Company’s results.

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TASER INTERNATIONAL, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) — Continued
TASER Foundation
     In November 2004, the Company established the TASER Foundation. The TASER Foundation is a 501(c)(3) non-profit corporation and has been granted tax exempt status by the IRS. 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. 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, 2008, the Company incurred approximately $30,000 and $137,000, respectively, in such administrative costs. For the three and nine months ended September 30, 2007, the Company incurred approximately $50,000 and $141,000, respectively, in such administrative costs. The Company is authorized by its Board of Directors to make a discretionary contribution up to a maximum of $200,000 per quarter. For the three and nine months ended September 30, 2008, the Company did not make a discretionary contribution to the TASER Foundation. For the three and nine months ended September 30, 2007, the Company made discretionary contributions of $75,000 and $200,000, respectively.
Consulting services
     Beginning in August 2005, the Company agreed to pay Mark Kroll, a member of the Board of Directors, for consultancy services. The cumulative expenses for the three and nine months ended September 30, 2008 were approximately $42,000 and $225,000, respectively. The cumulative expenses for the three and nine months ended September 30, 2007 were approximately $47,000 and $171,000, respectively. At September 30, 2008 and December 31, 2007, the Company had accrued liabilities of approximately $29,000 and $20,000, respectively, related to these services.
11. 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 $15,500. The Company currently matches 100% of the first 3% of eligible compensation contributed to the Plan by each participant and 50% of the next 2% of eligible compensation contributed to the plan by each participant. Beginning January 1, 2008, the Company’s matching contributions are immediately vested. During 2007 the Company’s matching contributions cliff vested at 20% per annum and become fully vested after five 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, 2008 were $104,000 and $300,000, respectively. The Company’s matching contributions to the Plan for the three and nine months ended September 30, 2007 were $69,000 and $190,000, respectively. Future matching or profit sharing contributions to the Plan are at the Company’s sole discretion.

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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 as of September 30, 2008 and results of operations for the three and nine months ended September 30, 2008 and September 30, 2007. 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 for the fiscal year ended December 31, 2007.
     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; our expectations that we will hold certain investments until maturity; our expectations about deferred income taxes; assumptions about the future vesting of outstanding stock options; the outcome of pending litigation including that judgments against us may be reversed or reduced; trends about our working capital and the sufficiency of our capital resources 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; 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 market leader in the development and manufacture of advanced electronic control devices designed for use in law enforcement, military, 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 in international markets. To date, over 12,400 law enforcement agencies in over 44 countries have made initial purchases of our TASER brand devices for testing or deployment. To date we do not know of any significant sales of any competing electronic control device products.
     Our core expertise includes proprietary, patented technology which is capable of incapacitating highly focused and aggressive persons. 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 person’s neuron-muscular system, causing substantial incapacitation regardless of whether the person feels or responds to pain. Our NMI technology stimulates the motor nerves which control muscular movement.

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Results of Operations
Three Months Ended September 30, 2008 Compared to the Three Months Ended September 30, 2007
The following table sets forth, for the periods indicated, our statements of operations as well as the percentage relationship to total net revenues of items included in our statements of operations (dollars in thousands):
                                                 
    Three Months Ended September 30,   Increase / (Decrease)
    2008   2007   $   %
Net sales
   $ 22,860       100.0 %   $ 28,533       100.0 %   $ (5,673 )     -19.9 %
Cost of products sold
     8,964       39.2 %     12,527       43.9 %     (3,563 )     -28.4 %
                             
Gross margin
     13,896       60.8 %     16,006       56.1 %     (2,110 )     -13.2 %
Sales, general and administrative expenses
     9,055       39.6 %     8,145       28.5 %     910       11.2 %
Research and development expenses
     3,332       14.6 %     978       3.4 %     2,354       240.7 %
                             
Income from operations
     1,509       6.6 %     6,883       24.1 %     (5,374 )     -78.1 %
Interest and other income, net
     270       1.2 %     520       1.8 %     (250 )     -48.1 %
                             
Income before income taxes
     1,779       7.8 %     7,403       25.9 %     (5,624 )     -76.0 %
Provision for income taxes
     1,128       4.9 %     1,249       4.4 %     (120 )     -9.6 %
                             
Net income
   $ 650       2.8 %   $ 6,154       21.6 %   $ (5,504 )     -89.4 %
                             
Net Sales
     For the three months ended September 30, 2008 and 2007, sales by product line and by geography were as follows (dollars in thousands):
                                 
    Three Months Ended September 30,  
    2008   2007
Sales by Product Line
                                
TASER X26
   $ 13,169       57.6 %   $ 17,264       60.5 %
TASER C2
     1,008       4.4 %     1,746       6.1 %
TASER Cam
     964       4.2 %     1,189       4.2 %
ADVANCED TASER
     377       1.6 %     591       2.1 %
Single Cartridges
     5,066       22.2 %     6,680       23.4 %
Other
     2,276       10.0 %     1,063       3.7 %
 
                            
 
                                
Total
   $ 22,860       100.0 %   $ 28,533       100.0 %
 
                            
                 
    Three Months Ended September 30,
    2008   2007
United States
     84 %     85 %
Other Countries
     16 %     15 %
 
                
 
                
Total
     100 %     100 %
 
                
     Net sales decreased $5.7 million, or 20%, to $22.9 million for the third quarter of 2008 compared to $28.5 million for the third quarter of 2007. We believe the decline in sales versus the prior year reflects lower municipal spending in the U.S. as agencies reassigned budget dollars due to economic constraints. As a result, sales of the TASER X26 product line decreased by $4.1 million, or 24%, to $13.2 million for the third quarter of 2008 compared to $17.3 million for the third quarter of 2007. Single cartridge sales also decreased by $1.6 million, or 24%. Sales of the TASER C2 Personal Protector consumer product, which began shipping in July 2007, also declined by $0.7 million. The decrease in TASER C2 sales can be attributed to the impacts of the economic downturn on consumer spending. The increase in other sales is primarily driven by growth in extended warranty revenues, out of warranty repairs and the elimination of distributor discounts in 2008. Other sales also include government grant, training and shipping revenues.
     International sales for the third quarter of 2008 and 2007 represented approximately $3.7 million, or 16%, and $4.3 million or 15%, of total net sales, respectively.

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Cost of Products Sold
     Cost of products sold decreased by $3.6 million, or 28%, to $9.0 million for the third quarter of 2008 compared to $12.5 million for the third quarter of 2007. As a percentage of net sales, cost of products sold decreased to 39.2% in the third quarter of 2008 compared to 43.9% in the third quarter of 2007. The 470 basis point improvement for the third quarter of 2008 compared to the third quarter of 2007 was the result of a combination of factors. Product costs decreased as a percentage of net sales driven by negotiated supplier price reductions in certain raw material components. Direct labor decreased as a percentage of net sales due to lower overtime and temporary labor costs and we reduced production scrap as the result of improved product quality and operating efficiencies. In addition, our provision for warranty decreased as we experienced a reduction in standard warranty replacements during the third quarter of 2008. Offsetting these decreases was an increase in indirect labor and manufacturing overhead as a percentage of sales due to reduced levels of manufacturing production during the third quarter, which, combined with a decrease in the overhead rate, resulted in a reduction in overhead absorption. The reserve for obsolete inventory also increased in the third quarter of 2008 in relation to slow moving raw material components.
Gross Margin
     Gross margin decreased $2.1 million, or 13%, to $13.9 million for the third quarter of 2008 compared to $16.0 million for the third quarter of 2007. As a percentage of net sales, gross margins increased to 60.8% for the third quarter of 2008 compared to 56.1% for the third quarter of 2007. The 470 basis point improvement in gross margin as a percentage of net sales for the third quarter of 2008 was attributable to the decreased product, direct labor, production scrap and change in warranty provision costs as a percentage of net sales attributable to the reasons noted above under the discussion of cost of products sold.
Sales, General and Administrative Expenses
     For the three months ended September 30, 2008 and 2007, sales, general and administrative expenses were comprised as follows (dollars in thousands):
                                 
    Three Months Ended September 30,  
                    $     %  
    2008     2007     Change     Change  
Salaries and benefits
   $ 2,250     $ 1,773     $ 477       26.9 %
Legal, professional and accounting fees
     1,460       999       461       46.1 %
Consulting and lobbying services
     690       627       63       10.0 %
Advertising
     464       215       249       115.8 %
Travel and meals
     689       1,179       (490 )     -41.6 %
D&O and liability insurance
     536       460       76       16.5 %
Depreciation and amortization
     447       466       (19 )     -4.1 %
Stock-based compensation
     443       295       148       50.2 %
Bonuses
     89       364       (275 )     -75.5 %
Other
     1,987       1,767       220       12.4 %
 
                          
 
                                
Total
   $ 9,055     $ 8,145     $ 910       11.2 %
 
                          
Sales, general and administrative as % of net sales
     39.6 %     28.5 %                
     Sales, general and administrative expenses were $9.1 million and $8.1 million in the third quarter of 2008 and 2007, respectively, an increase of $0.9 million, or 11%. As a percentage of total net sales, sales, general and administrative expenses increased to 40% for the third quarter of 2008 compared to 29% for the third quarter of 2007, a function of higher expense and the decrease in net sales.
     The dollar increase for the third quarter of 2008 over the same period in 2007 is attributable to a $477,000 growth in salaries and benefits related to an increase in personnel to support the expansion of our business infrastructure combined with an annual salary increase effective January 1, 2008. Legal, professional and accounting fees increased $461,000 driven by the timing of outstanding ligation in progress and advertising expense increased $249,000 due primarily to TASER C2 promotional efforts and infomercial costs. Stock based-compensation expense also increased $148,000 related to options granted during the third quarter of 2008. These increases were partially offset by a $490,000 decrease in travel and meals due to the annual TASER tactical conference which occurred in the third quarter of 2007 versus the second quarter of 2008 as well as a general decrease in travel related activity. Bonus expense also decreased $275,000 based on the reduced operating income during the third quarter of 2008.

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Research and Development Expenses
     Research and development expenses increased $2.4 million, or 241%, to $3.3 million for the third quarter of 2008 compared to $1.0 million for the third quarter of 2007. The increase is driven by a $1.3 million increase in third party consulting costs primarily associated with the development of AXON (Autonomous eXtended on-Officer Network). We expect to further increase research and development spending in the fourth quarter of 2008 as we accelerate development of new products. In addition, there was $379,000 growth in salary costs with headcount in our R&D department increasing 41% from 27 at September 30, 2007 to 38 at September 30, 2008, and a $424,000 increase in indirect supplies to support our continuing efforts to develop new products such as the XREP (Extended Range Electro-Muscular Projectile) and Shockwave.
Interest and Other Income, Net
     Interest and other income decreased by $250,000 or 48% to $270,000 for the third quarter of 2008 compared to $520,000 for the third quarter of 2007. The decrease is attributable to lower average yields on our cash and investments partially offset by a $3.7 million increase in total average funds invested in the third quarter of 2008 compared to the same period in 2007. Our cash and investment accounts earned interest at an average rate of 2.4% during the third quarter of 2008 compared to 4.2% during the third quarter of 2007.
Provision for Income Taxes
     The provision for income taxes decreased by $120,000 to a provision of $1.1 million for the third quarter of 2008 compared to $1.2 million for the third quarter of 2007. The effective income tax rate for the third quarter of 2008 was 63.4% compared to 16.9% for the third quarter of 2007. The increase in effective income tax rate is attributable to a combination of the higher impact of certain non-deductible items such as lobbying expenses against a lower taxable income base expected for the year ended December 31, 2008 and the impact of the research and development tax credit study completed during the third quarter of 2007 which resulted in a $1.8 million reduction in the provision for income taxes thus reducing the effective tax rate for that period.
Net Income
     Net income decreased by $5.5 million to $0.6 million for the third quarter of 2008 compared to net income of $6.2 million for the third quarter of 2007. Income per basic and diluted share was $0.01 for the third quarter of 2008. This compares to income per basic and diluted share of $0.10 and $0.09, respectively for the third quarter of 2007.
Nine Months Ended September 30, 2008 Compared to the Nine Months Ended September 30, 2007
     The following table sets forth, for the periods indicated, our statements of operations as well as the percentage relationship to total net revenues of items included in our statements of operations (dollars in thousands):
                                                 
    Nine Months Ended September 30,   Increase / (Decrease)
    2008   2007   $   %
             
Net sales
   $ 66,447       100.0 %   $ 69,699       100.0 %   $ (3,251 )     -4.7 %
Cost of products sold
     26,184       39.4 %     29,272       42.0 %     (3,087 )     -10.5 %
                     
Gross margin
     40,263       60.6 %     40,427       58.0 %     (164 )     -0.4 %
Sales, general and administrative expenses
     27,926       42.0 %     24,072       34.5 %     3,854       16.0 %
Research and development expenses
     8,463       12.7 %     3,212       4.6 %     5,252       163.5 %
Legal judgment expense
     5,200       7.8 %     —       —       5,200       100.0 %
                     
Income (loss) from operations
     (1,326 )     -2.0 %     13,143       18.9 %     (14,469 )     -110.1 %
Interest and other income, net
     1,492       2.2 %     1,453       2.1 %     38       2.6 %
                     
Income before income taxes
     166       0.3 %     14,596       20.9 %     (14,429 )     -98.9 %
Provision for income taxes
     315       0.5 %     4,248       6.1 %     (3,932 )     -92.6 %
                     
Net income (loss)
   $ (149 )     -0.2 %   $ 10,348       14.8 %   $ (10,497 )     -101.4 %
                     

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Net Sales
     For the nine months ended September 30, 2008 and 2007, sales by product line and by geography were as follows (dollars in thousands):
                                 
    Nine Months Ended September 30,  
    2008     2007  
Sales by Product Line
                                
TASER X26
   $ 35,807       53.9 %   $ 43,202       62.0 %
TASER C2
     4,376       6.6 %     1,746       2.5 %
TASER Cam
     2,748       4.1 %     2,949       4.2 %
ADVANCED TASER
     2,432       3.7 %     1,771       2.5 %
Single Cartridges
     15,290       23.0 %     17,619       25.3 %
Other
     5,794       8.7 %     2,412       3.5 %
 
                            
 
                                
Total
   $ 66,447       100.0 %   $ 69,699       100.0 %
 
                            
                 
    Nine Months Ended September 30,
    2008   2007
United States
     87 %     83 %
Other Countries
     13 %     17 %
 
                
 
                
Total
     100 %     100 %
 
                
     Net sales decreased $3.3 million, or 5%, to $66.4 million for the first nine months of 2008 compared to $69.7 million for the first nine months of 2007. The decline in the first nine months of 2008 was primarily driven by a decline in sales of our core X26 product line and single cartridges which we believe reflects lower municipal spending in the U.S. as agencies reassigned budget dollars due to economic constraints, including significantly higher than budgeted fuel costs. This resulted in reduced sales of the TASER X26 product line which decreased by $7.4 million, or 17%, to $35.8 million for the first nine months of 2008 compared to $43.2 million for the first nine months of 2007. Single cartridge sales also decreased by $2.3 million, or 13%. Partially offsetting these decreases was the introduction of the TASER C2 Personal Protector product which began shipping in July 2007. Sales of the TASER C2 were $4.4 million for the first nine months of 2008, an increase of $2.6 million over the same period in 2007. Additionally, sales of the Advanced TASER increased by $0.6 million due to a large purchase made by an international customer in the first quarter of 2008 and other sales have grown $3.4 million due to an increase in out of warranty replacement and extended warranty sales as well as the elimination of distributor discounts in 2008. Other sales also include government grant, training and shipping revenues.
     International sales for the first nine months of 2008 and 2007 represented approximately $8.7 million, or 13%, and $11.9 million or 17% of total net sales, respectively. The decline is due to several large non-recurring orders received in the first nine months of 2007.
Cost of Products Sold
     Cost of products sold decreased by $3.1 million, or 11%, to $26.2 million for the first nine months of 2008 compared to $29.3 million for the first nine months of 2007. As a percentage of net sales, cost of products sold decreased to 39.4% in the first nine months of 2008 compared to 42.0% in the first nine months of 2007. The 260 basis point improvement for the first nine months of 2008 compared to the first nine months of 2007 was the result of a reduction in indirect manufacturing costs as a percentage of net sales resulting from lower scrap expense as the result of improved product quality and operating efficiencies and having reasonably fixed indirect costs spread over increased production volumes compared to the prior year. In addition, our provision for warranty expense decreased as we experienced a reduction in standard warranty replacements during 2008. Total direct production costs remained flat as a percentage of net sales for the first nine months of 2008 compared to the same period in 2007 as lower direct labor costs resulting from a decrease in temporary labor and overtime were offset by increase in direct product costs primarily driven by a change in sales mix with the lower margin C2 product representing a higher percentage of net sales in 2008.
Gross Margin
     Gross margin decreased $0.2 million to $40.3 million for the first nine months of 2008 compared to $40.4 million for the first nine months of 2007. As a percentage of net sales, gross margins increased to 60.6% for the first nine months of 2008 compared to 58.0% for the first nine months of 2007. The 260 basis point improvement in gross margin as a percentage of net sales for the first half of 2008 was mainly attributable to the decreased percentage of indirect costs as a percentage of net sales for the reasons noted above under the discussion of cost of products sold.

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Sales, General and Administrative Expenses
     For the nine months ended September 30, 2008 and 2007, sales, general and administrative expenses were comprised as follows (dollars in thousands):
                                 
    Nine Months Ended September 30,  
                    $     %  
    2008     2007     Change     Change  
Salaries and benefits
   $ 6,581     $ 5,134     $ 1,447       28.2 %
Legal, professional and accounting fees
     4,278       4,490       (212 )     -4.7 %
Consulting and lobbying services
     2,113       1,861       252       13.5 %
Advertising
     1,825       541       1,284       237.3 %
Travel and meals
     2,664       2,809       (145 )     -5.2 %
D&O and liability insurance
     1,626       1,415       211       14.9 %
Depreciation and amortization
     1,354       1,315       39       3.0 %
Stock-based compensation
     934       721       213       29.5 %
Bonuses
     160       750       (590 )     -78.7 %
Other
     6,391       5,036       1,355       26.9 %
 
                          
 
                                
Total
   $ 27,926     $ 24,072     $ 3,854       16.0 %
 
                          
Sales, general and administrative as % of net sales
     42.0 %     34.5 %                
     Sales, general and administrative expenses were $27.9 million and $24.1 million in the first nine months of 2008 and 2007, respectively, an increase of $3.9 million, or 16%. As a percentage of total net sales, sales, general and administrative expenses increased to 42.0% for the first nine months of 2008 compared to 34.5% for the first nine months of 2007. The dollar increase for the first nine months of 2008 over the same period in 2007 is attributable to a combination of factors. Salaries and benefits grew $1.4 million related to an increase in personnel to support the expansion of our business infrastructure combined with an annual salary increase effective January 1, 2008. Advertising expense increased $1.3 million primarily due to expensing of $530,000 in capitalized production costs of the TASER C2 infomercial as well as ongoing promotion and infomercial airing costs. In addition consulting and lobbying services increased $252,000; stock based compensation increased $213,000 related to stock options granted in 2008 and D&O and liability insurance costs are up $211,000 from increased annual premiums. The $1.4 million increase in other expense is primarily attributable to a $497,000 increase in recruiting and relocation expenses driven by hiring of new vice presidents of sales and marketing, a $267,000 increase in computer licensing and maintenance fees and $229,000 increase in trade show expenses. These increases were partially offset by a $590,000 decrease in bonuses due to the lower pre-tax income in the first nine months of 2008 and a $212,000 decrease in legal, professional and accounting fees which is primarily attributable to the timing of proceedings of our outstanding litigation as well as an increased number of cases where we have exceeded our insurance deductible, subsequent to which we are reimbursed for expenses incurred.
Research and Development Expenses
     Research and development expenses increased $5.3 million, or 164%, to $8.5 million for the first nine months of 2008 compared to $3.2 million for the first nine months of 2007. The increase is driven by a $2.8 million increase in third party consulting costs primarily associated with the development of AXON (Autonomous eXtended on-Officer Network). We expect to further increase research and development spending in the fourth quarter of 2008 as we accelerate development of new products in the pipeline. In addition, there was $955,000 growth in salary costs with headcount increasing 41% from 27 at September 30, 2007 to 38 at September 30, 2008, and a $711,000 increase in indirect supplies to support our continuing efforts to develop new products such as the XREP (Extended Range Electro-Muscular Projectile) and Shockwave.
Litigation judgment expense
     We recorded a $5.2 million non-cash charge in the second quarter of 2008 for an adverse jury verdict in the case of Betty Lou Heston, et al. v. City of Salinas, TASER International, Inc., et al. which found that extended TASER device application contributed 15 percent to the death of Robert C. Heston. While the jury attributed 85 percent of the cause of death to the actions of Mr. Heston, the jury awarded a total of $1.0 million in compensatory damages (15% or $150,000 of which was attributable to TASER and for which damages will be covered by our liability insurance) and $5.2 million in punitive damages against TASER International based on alleged negligent failure to warn. Following post trial motions the judge ordered that the $5.2 million award of punitive damages by the jury be disregarded. As such we may reverse the $5.2 million judgment expense in the fourth quarter of 2008 once the judgment has been filed and the nature of plaintiff appeals, if any, becomes apparent.

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Interest and Other Income, Net
     Interest and other income increased by $38,000 or 3% to $1.49 million for the first nine months of 2008 compared to $1.45 million for the first nine months of 2007. The marginal increase is attributable to other income of $387,000 related to the unused deferred insurance settlement proceeds recognized in the second quarter of 2008 upon the dismissal of all final appeals in the Samuel Powers v. TASER International personal injury case. This was offset by a $354,000 decrease in interest income due to lower average yields on our investments, partially offset by a $5.7 million increase in total average funds invested during the first nine months of 2008 compared to the same period in 2007. Our cash and investment accounts earned interest at an average rate of 2.8% during the first nine months of 2008 compared to 4.1% during the first nine months of 2007.
Provision for Income Taxes
     The provision for income taxes decreased by $3.9 million from a provision of $4.2 million for the first nine months of 2007 to $0.3 million for the first nine months of 2008. The effective income tax rate for the first nine months of 2008 was 189.3% compared to 29.1% for the first nine months of 2007. The effective tax rate for 2008 is driven by the recording of a $250,000 valuation allowance against Arizona State NOL deferred tax assets which due to the low level of pretax income contributes 150% to the tax rate. Also contributing to the effective tax rate is the higher impact of certain non-deductible items such as lobbying expenses against a lower taxable income base expected for the year ended December 31, 2008. In addition the rate is affected by the inclusion of the state research and development tax credit in the 2008 effective tax rate. No benefit for any federal research and development tax credit has been included in the 2008 effective tax rate. The effective tax rate for the first nine months of 2007 was reduced due to the impact of the research and development tax credit study completed during the third quarter of 2007 which resulted in a $1.8 million reduction in the provision for income taxes.
Net Income
     Net income decreased by $10.5 million to a net loss of $0.1 million for the first nine months of 2008 compared to net income of $10.3 million for the first nine months of 2007. Loss per basic and diluted share was $0.00 for the first nine months of 2008. This compares to income per basic and diluted share of $0.17 and $0.16, respectively, for the first nine months of 2007.
Liquidity and Capital Resources
Liquidity
     As of September 30, 2008, we had $42.5 million in cash, cash equivalents and short term investments, a decrease of $8.8 million from December 31, 2007, which is primarily attributable to our use of $12.5 million to repurchase our common stock as well as investments in property and equipment and intangible assets, partially offset by net proceeds from the maturities of investment holdings. Net cash provided by operating activities was $4.6 million for the first nine months of 2008.
                 
    Nine Months Ended September 30,
    2008   2007
    (In thousands)
Net cash provided by operating activities
   $ 4,611     $ 6,682  
Net cash provided by (used in) investing activities
     7,266       (1,005 )
Net cash provided by (used in) financing activities
   $ (12,179 )   $ (34 )
     Net cash provided by operating activities for the first nine months of 2008 of $4.6 million was driven by non-cash adjustments to the net loss including $5.2 million in litigation judgment expenses, depreciation and amortization expense of $1.9 million, stock-based compensation expense of $1.4 million, provision for warranty expense of $409,000 and provision for excess and obsolete inventory of $375,000. In addition prepaid and other assets decreased $2.5 million due to i) the net receipt of insurance reimbursements of legal fees incurred in excess of policy retention limits; ii) a decrease in prepaid advertising due to the expensing of TASER C2 infomercial production costs and iii) amortization of prepaid liability and D&O insurance premiums. Deferred revenue also increased $905,000 driven by extended warranty sales in the first nine months of 2008. Offsetting these items was a $4.3 million increase in inventory as purposeful investment has been made in building cartridges along with the purchase of C2 and X26 raw materials, and building finished goods to support forecasted sales levels coupled with a $3.7 million reduction in accounts payable and accrued liabilities. The change in accounts payable and accrued liabilities reflects timing differences combined with a reduced rate of material purchasing as well as the payment in January 2008 of $1.2 million for the second installment for automation equipment which was accrued at December 31, 2007.

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     Net cash provided by investing activities was $7.3 million during the nine months ended September 30, 2008 which was comprised of $12.5 million in net proceeds from maturing investments over investment purchases partially offset by the use of $4.8 million to purchase property and equipment mainly related to new automation equipment and computer storage solutions. In addition, we invested $446,000 in intangible assets, primarily consisting of patent application costs.
     During the first nine months of 2008, we utilized $12.2 million in financing activities, a function of the $12.5 million to repurchase 1.8 million shares of our common stock partially offset by $320,000 of proceeds attributable to stock options exercised in the period.
Capital Resources
     On September 30, 2008 we had total cash and cash equivalents of $42.5 million.
     We negotiated a revolving line of credit with a domestic bank on July 13, 2004. 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, 2010 and requires monthly payments of interest only. At September 30, 2008, there was a calculated availability of $10.0 million based on the defined borrowing base, which is based on our eligible accounts receivable and inventory. At September 30, 2008, there were no borrowings under the line. Our agreement with the bank requires us to comply with certain financial and other covenants including maintenance of minimum tangible net worth and fixed charge coverage. At September 30, 2008 we were in compliance with all covenants.
     We expect that accounts receivable, inventory and accounts payable in the fourth quarter of 2008 will remain consistent with the levels at September 30, 2008; however, this will be managed closely to align with forecasted sales levels. Additionally, we expect to invest a further $4.0 million in manufacturing automation equipment in the fourth quarter of 2008 and anticipate continuing to invest in research and development spending as we accelerate development of new products in the pipeline.
     We believe that our balance of total cash and cash equivalents of $42.5 million as of September 30, 2008, together with cash expected to be generated from operations, will be adequate to fund our operations and litigation costs for the next 12 months. We may require additional resources to expedite manufacturing of new and existing technologies to meet demand for our products. Based on our strong balance sheet and the fact we have no outstanding debt at September 30, 2008 we believe financing will be available at terms favorable to us, both through our existing credit lines and possible additional equity financing. However, there is no assurance that such sources will be available, or on terms acceptable to us.
Commitments and Contingencies
     On July 2, 2007, we entered into a contract with ATS Automation Tooling Systems Inc. for the purchase of equipment at a cost of approximately $8.4 million including $0.7 million of change orders made in the first quarter of 2008 for additional equipment. The equipment is expected to be delivered to and installed at the Company’s facility in the first quarter of 2009. Payments will be made in installments, with an initial $1.5 million deposit paid in 2007, $1.2 million was accrued at December 31, 2007 due to contractual requirements and paid in January 2008, and a further $2.9 million paid in the first nine months of 2008. The balance of $4.0 million is expected to be paid in 2008 and 2009 from existing cash balances.
Off Balance Sheet Arrangements
     We have no off balance sheet arrangements as of September 30, 2008.

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Critical Accounting Estimates
     We have identified the following accounting estimates as critical to our business operations and the understanding of our results of operations. 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 period. There can be no assurance that actual results will not differ from those estimates. The effect of these policies on our business operations is discussed below.
Standard Product Warranty Reserves
     We warrant our law enforcement 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. We warrant our new TASER C2 product for 90 days. We track historical data related to returns and warranty costs on a quarterly basis, and estimate future warranty claims by applying our weighted average rolling four quarter return rate to our product sales for the period. In the fourth quarter of 2007, we made a revision to the basis of calculating the four quarter return rate as the result of being able to more accurately capture data relating to the number of units replaced under standard warranty versus extended warranty terms. In addition, given the trend of sales growth experienced in 2007, particularly in the second half of the year, the estimated four quarter return rate is weighted to account for the higher return rate experienced in those periods. We have also historically increased our reserve amount if we become aware of a component failure that could result in larger than anticipated returns from our customers. As of September 30, 2008, our reserve for warranty returns was $770,000 compared to a $919,000 reserve at December 31, 2007. Our reserve for warranty returns decreased at September 30, 2008 as the result of a reduced returns experience which we believe is a function of continuing improvements made in the manufacturing and quality processes. In the event that product returns under warranty differ from our estimates, changes to 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. Our reserve for excess and obsolete inventory increased to $456,000 at September 30, 2008 compared to $321,000 at December 31, 2007 due to additional reserves for slow moving raw material components. In the event that actual excess, obsolete or slow-moving inventories differ from these estimates, changes to inventory reserves might become necessary.
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. Our allowance for doubtful accounts was $200,000 and $190,000 at September 30, 2008 and December 31, 2007, respectively. In the event that actual uncollectible amounts differ from these estimates, changes in allowances for doubtful accounts might become necessary.
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. Management believes that no such impairments 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.

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     In July 2006, the FASB issued Interpretation 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), which we adopted effective January 1, 2007. FIN 48 addresses the determination of how tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, we recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. Under FIN 48, management must also assess whether uncertain tax positions as filed could result in the recognition of a liability for possible interest and penalties if any. Interest and penalties are recorded in the provision for income taxes. In 2007, we completed a research and development tax credit study which identified $3.1 million in tax credits for Federal and Arizona income tax purposes related to the 2003 through 2006 tax years and an estimate for the 2007 tax year, and as a result, we recognized $2.0 million in 2007 as a reduction in income tax expense. Additionally, we have estimated further $550,000 of tax credits are available for Arizona purposes for the 2008 tax year with as prorated portion recorded as a component of the effective tax rate for the three and nine months ended September 30, 2008. We made the determination that it was not more likely than not that the full benefit of these research and development tax credits would be sustained on examination and have increased the liability for unrecognized tax benefits to $1.2 million as of September 30, 2008. Our estimates are based on the information available to us at the time we prepare the income tax provisions. Our income tax returns are subject to audit by federal, state, and local governments, generally years after the returns are filed. These returns could be subject to material adjustments or differing interpretations of the tax laws.
     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 well as the ultimate realization of sufficient future taxable income. As a result of the shareholder litigation settlement expense recorded in the second quarter of 2006, we recorded a valuation allowance of $250,000 in 2006 against our deferred tax assets for Arizona Net Operating Losses (“NOL’s”). Further, as a result of the litigation judgment expense recorded in the second quarter of 2008, we recorded an additional $250,000 valuation allowance against the same deferred tax assets. We believe that, other than as previously described, as of September 30, 2008, based on our evaluation, no additional valuation allowance was deemed necessary as it is more likely than not that our net deferred tax assets will be realized. However, the deferred tax asset could be reduced in the near term if estimates of taxable income during the carryforward period are reduced.
Stock Based Compensation
     We account for stock-based compensation in accordance with the fair value recognition provisions of SFAS No. 123R. We use the Black-Scholes-Merton option pricing model which requires the input of highly subjective assumptions. These assumptions include estimating the length of time employees will retain their stock options before exercising them (“expected term”), the estimated volatility of our common stock price over the expected term and the number of options that will ultimately not complete their vesting requirements (“forfeitures”). Changes in the subjective assumptions can materially affect the estimate of fair value of stock-based compensation and consequently, the related amount recognized on our statements of operations.
Contingencies
     We are subject to the possibility of various loss contingencies including product related litigation, 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.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
     We invest in a limited number of financial instruments, consisting principally of commercial paper and 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 effect 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 our disclosure controls and procedures were effective as of September 30, 2008 to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act (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.
Changes in internal control over financial reporting
     There were no changes in internal control over financial reporting during the fiscal quarter ended September 30, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II—OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
     See discussion of legal proceedings in Note 9 to the financial statements included in PART I, ITEM 1 of this Form 10-Q.
ITEM 1A. RISK FACTORS
     Because of the following factors, as well as other variables affecting our operating results, past financial performance may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods.
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 electronic control 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 such as the military market. Law enforcement and corrections agencies may be influenced by claims or perceptions that conducted energy weapons such as our products 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 our 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, 2008 and 2007, we derived our revenues predominantly from sales of the TASER X26 brand devices and related cartridges, and 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 and new product introductions. Any significant expansion may strain our managerial, financial and other resources. If we are unable to manage our growth, our business, 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.
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.
     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 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 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, defective 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 large legal expenses within our self insured retention limit 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.

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Pending litigation may subject us to significant litigation costs, judgments, fines and penalties in excess of insurance coverage, and divert management attention from our business.
     We are involved in numerous litigation matters relating to our products or the use of such products, litigation against persons who we believe have defamed our products, litigation against medical examiners who made errors in their autopsy reports, litigation against a competitor and litigation against former employees. 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.
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 establish relationships with 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 or new product features successfully, our business and financial results could be adversely affected.
     Our future success will depend on our ability to develop new products or new product features that achieve market acceptance in a timely and cost-effective manner. The development of new products and new product features 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 or new product features 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 lengthen our sales cycle with customers. In the past, we believe we have experienced revenue decreases in part as the result of adverse effects on our customers and potential customers of 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.

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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 U.S. Bureau of Alcohol, Tobacco, Firearms and Explosives, but are consumer products regulated by the U.S. 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 U.S. 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 a number of 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 prohibit the sale of conducted energy devices such as our products, 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. 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 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 monitor the impact of specific registration and compliance activities required by the RoHS and WEEE Directives. We endeavor to comply with applicable 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 upon our proprietary technology. Our protective measures, including patents, trademarks and trade secret protection, may prove inadequate to protect our proprietary rights. The right to stop others from misusing our trademarks and service marks in commerce depends to some extent on our ability to show evidence of enforcement of our rights against such misuse in commerce. Our efforts to stop improper use, if insufficient, may lead to loss of brand loyalty and notoriety among our customers and prospective customers. Our earliest expiring United States patent generally covers projectile propellant devices having a container of compressed gas in place of gunpowder as a propellant. We use this technology in our cartridges. This patent expires in 2010. 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.

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     We have filed a lawsuit in Federal District Court against Stinger Systems that alleges infringement of three of our U.S. patents: 6,999,295; 7,102,870; and 7,234,262. As a tactical move, Stinger Systems filed a motion to stay this case pending a request for ex-parte re-examination filed with the U.S. Patent and Trademark Office (USPTO) concerning only one of the patents in suit, 7,234,262. On February 21, 2008 the court denied Stinger Systems’ motion to stay this case. On June 23, 2008, the USPTO denied Stinger’s request for re-examination of this patent.
We may be subject to intellectual property infringement claims, which could 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 costly 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.
If we face competition in foreign countries, we can enforce patent rights only in the jurisdictions in which our patent applications have been granted.
     Our U.S. patents only protect us from imported infringing products coming into the U.S. from abroad. Applications for patents in a few foreign countries have been made; however, these may be inadequate to protect markets for our products in other foreign countries. Each foreign patent is examined and granted according to the law of the country where it was filed independent of whether a U.S. patent on similar technology was granted.
Government regulations applied to our products may affect our markets for these products.
     We rely on the opinions of the U.S. Bureau of Alcohol, Tobacco, Firearms and Explosives, including the determination that a device that has projectiles propelled by the release of compressed gas, in place of the expanding gases from ignited gunpowder, is not classified as a firearm. Changes in statutes, regulations, and interpretation outside of our control may result in our products being classified or reclassified as firearms. Our market to civilians could be substantially reduced if consumers are required to obtain registration to own a firearm prior to purchasing our products.
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. During 2007, a competitor introduced a new device to compete with the TASER X26. 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. Defects in our products may result in a loss of sales, delay in market acceptance, injury to our reputation and increased warranty costs.

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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 and there is no guarantee that supply will not be interrupted. Any interruption of supply for any material 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.
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 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 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 an 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. Any significant rise in oil prices could adversely impact our ability to sustain current gross margins, by reducing 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
 
  •   changes in our sales mix
 
  •   new product introduction costs
 
  •   increased raw material expenses
 
  •   changes in our operating expenses
 
  •   regulatory changes that may affect the marketability of our products
 
  •   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.

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We may experience difficulties in the future in complying with Sarbanes-Oxley Section 404.
     We are required to evaluate our internal controls under Section 404 of the Sarbanes-Oxley Act of 2002. Beginning with our Annual Report on Form 10-K for the fiscal year ending December 31, 2005, we have been required to furnish a report by our management on our internal control over financial reporting. Such report contains, among other matters, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. Such report also contains a statement that our independent registered public accounting firm has audited internal control over financial reporting. In our Form 10-K for our 2005 fiscal year, because of our previously reported material weaknesses related to not having controls in place to record appropriate accruals related to professional fees in the appropriate accounting period and inadequate resources related to accounting and financial statement preparation particularly with respect to financial statement footnote preparation were not fully remediated and tested at December 31, 2005, our management assessment and the report of our independent registered public accounting firm concluded that our internal controls were not effective at December 31, 2005.
     Because of our prior material weaknesses, there is heightened risk that a material misstatement of our annual or quarterly financial statements will not be prevented or detected. While we completed our remediation efforts to address these material weaknesses and did not identify any materials weaknesses at September 30, 2008, we cannot assure you that material weaknesses will not occur in future periods. If we fail to maintain proper and effective internal controls in future periods, it could adversely affect our operating results, financial condition and our ability to run our business effectively and could cause investors to lose confidence in our financial reporting. We have incurred, and expect to continue to incur, increased expense and to devote additional management resources to Section 404 compliance. In the event that our chief executive officer, chief financial officer or our independent registered public accounting firm determine that our internal control over financial reporting is not effective as defined under Section 404, investor confidence in us may be adversely affected and could cause a decline in the market price of our stock.
Foreign currency fluctuations may affect our competitiveness and sales in foreign markets.
     The relative change in currency values creates fluctuations in our 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.
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.

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ITEM 6. EXHIBITS
31.1   Principal Executive Officer Certification pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
 
31.2   Principal Financial Officer Certification pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
 
32   Principal Executive Officer and Principal Financial Officer Certification pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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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.
 		  
Date: November 7, 2008  /s/ Patrick W. Smith    
  Patrick W. Smith,    
  Chief Executive Officer
(Principal Executive Officer) 		  
 
     
Date: November 7, 2008  /s/ Daniel M. Behrendt    
  Daniel M. Behrendt    
  Chief Financial Officer
(Principal Financial and Accounting Officer) 		  
 

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Index to Exhibits
Exhibits:
31.1   Principal Executive Officer Certification pursuant to Rule 13a-14(a) under the Securities exchange Act of 1934.
 
31.2   Principal Financial Officer Certification pursuant to Rule 13a-14(a) under the Securities exchange Act of 1934.
 
32   Principal Executive Officer and Principal Financial Officer Certification pursuant to U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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