AXON ENTERPRISE, INC. - Quarter Report: 2011 September (Form 10-Q)

 

 

United States Securities and Exchange Commission

Washington, D.C. 20549

Form 10-Q

o		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 001-16391

TASER INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

DELAWARE		86-0741227
(State or other jurisdiction		(I.R.S. Employer
of incorporation or organization)		Identification Number)
17800 N. 85th St., SCOTTSDALE, ARIZONA		85255 (Zip Code)
(Address of principal executive offices)

(480) 991-0797
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 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.

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

There were 55,580,092 shares of the issuer’s common stock, par value $0.00001 per share, outstanding as of November 7, 2011.

 

 

TASER INTERNATIONAL, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED September 30, 2011
TABLE OF CONTENTS

		Page
PART I — FINANCIAL INFORMATION
Item 1. Consolidated financial statements (unaudited)
Consolidated balance sheets as of September 30, 2011 and December 31, 2010			3
Consolidated statements of operations for the three and nine months ended September 30, 2011 and 2010			4
Consolidated statements of cash flows for the three and nine months ended September 30, 2011 and 2010			5
Notes to consolidated financial statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			20
Item 3. Quantitative and Qualitative Disclosures About Market Risk			31
Item 4. Controls and Procedures			31
PART II — OTHER INFORMATION
Item 1. Legal Proceedings			31
Item 1A. Risk Factors			32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			32
Item 6. Exhibits			33
SIGNATURES			33
INDEX TO EXHIBITS			34
Exhibit 31.1
Exhibit 31.2
Exhibit 32
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT

Items 3, 4 and 5 are not applicable.

PART I — FINANCIAL INFORMATION

ITEM 1.		CONSOLIDATED FINANCIAL STATEMENTS

TASER INTERNATIONAL, INC.

		September 30, 2011				December 31, 2010
ASSETS
Current Assets:
Cash and cash equivalents		$	24,574,858			$	42,684,241
Short term investments			6,175,147				—
Accounts receivable, net of allowance of $200,000 at September 30, 2011 and December 31, 2010, respectively			12,525,734				13,542,535
Inventory			15,469,128				17,815,405
Prepaid expenses and other current assets			1,969,884				1,999,525
Deferred income tax assets, net			8,864,276				6,284,489
Total current assets			69,579,027				82,326,195
Property and equipment, net			29,821,661				35,905,765
Deferred income tax assets, net			13,819,753				13,919,753
Intangible assets, net			3,183,944				3,090,876
Other long-term assets			753,716				944,346
Total assets		$	117,158,101			$	136,186,935
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable		$	5,147,800			$	4,550,789
Accrued liabilities			7,703,524				3,759,800
Current portion of deferred revenue			3,154,183				3,265,260
Customer deposits			207,974				372,145
Total current liabilities			16,213,481				11,947,994
Deferred revenue, net of current portion			4,219,021				4,392,860
Liability for unrecorded tax benefits			2,639,346				2,281,840
Total liabilities			23,071,848				18,622,694
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, 2011 and December 31, 2010, respectively			—				—
Common stock, $0.00001 par value per share; 200 million shares authorized; 56,767,754 and 62,621,268 shares issued and outstanding at September 30, 2011 and December 31, 2010, respectively			647				647
Additional paid-in capital			99,699,075				97,122,085
Treasury stock, 7,969,683 and 2,091,600 shares at September 30, 2011 and December 31, 2010, respectively			(39,597,054	)			(14,708,237	)
Retained earnings			34,046,376				35,185,191
Accumulated other comprehensive loss			(62,791	)			(35,445	)
Total stockholders’ equity			94,086,253				117,564,241
Total liabilities and stockholders’ equity		$	117,158,101			$	136,186,935

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

TASER INTERNATIONAL, INC.

		For the Three Months Ended September 30,								For the Nine Months Ended September 30,
		2011				2010				2011				2010
Net sales		$	24,383,110			$	21,084,081			$	68,698,115			$	64,048,507
Total cost of products sold			11,279,502				10,668,399				31,145,151				30,519,891
Gross margin			13,103,608				10,415,682				37,552,964				33,528,616
Sales, general and administrative expenses			9,477,548				9,416,372				27,887,357				29,718,724
Research and development expenses			2,362,721				1,686,062				7,908,420				8,881,027
Litigation judgment expense			—				—				3,301,243				—
Loss on impairment			3,353				—				1,353,857				—
Loss on write down / disposal of property and equipment, net			47,894				37,981				796,353				37,981
Income (loss) from operations			1,212,092				(724,733	)			(3,694,266	)			(5,109,116	)
Interest and other income, net			15,265				10,364				1,303,470				24,466
Income (loss) before provision (benefit) for income taxes			1,227,357				(714,369	)			(2,390,796	)			(5,084,650	)
Provision (benefit) for income taxes			91,072				1,621,109				(1,251,981	)			(897,178	)
Net income (loss)		$	1,136,285			$	(2,335,478	)		$	(1,138,815	)		$	(4,187,472	)
Income (loss) per common and common equivalent shares
Basic		$	0.02			$	(0.04	)		$	(0.02	)		$	(0.07	)
Diluted		$	0.02			$	(0.04	)		$	(0.02	)		$	(0.07	)
Weighted average number of common and common equivalent shares outstanding
Basic			58,787,274				62,342,775				60,617,787				62,495,957
Diluted			60,037,328				62,342,775				60,617,787				62,495,957

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

TASER INTERNATIONAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

		For the Nine Months Ended September 30,
		2011				2010
Cash Flows from Operating Activities:
Net Loss		$	(1,138,815	)		$	(4,187,472	)
Adjustments to reconcile net loss to net cash (used) provided by operating activities:
Loss on impairment			1,353,857				—
Depreciation and amortization			6,112,612				5,243,225
Bond premium amortization			304,346				—
Loss on write down / disposal of property and equipment, net			826,170				83,179
Provision for doubtful accounts			22,047				2,764
Provision / write-off of excess and obsolete inventory			746,669				1,086,795
Provision for warranty			249,652				594,196
Stock-based compensation expense			2,533,444				2,838,998
Litigation judgment accrual			3,300,000				—
Excess tax benefits from stock-based compensation			—				(97,273	)
Deferred income taxes			(2,479,787	)			(1,327,426	)
Provision for unrecognized tax benefits			357,506				(3,148	)
Change in assets and liabilities:
Accounts receivable			991,401				2,425,430
Inventory			1,206,962				(4,026,860	)
Prepaids and other assets			(309,166	)			(1,617,257	)
Accounts payable and accrued liabilities			1,009,573				(3,715,501	)
Deferred revenue			(284,916	)			411,830
Customer deposits			(164,171	)			(124,623	)
Net cash provided (used) by operating activities			14,637,384				(2,413,143	)
Cash Flows from Investing Activities:
Purchases of investments			(11,479,493	)			—
Proceeds from call / maturity of investments			5,000,000				—
Proceeds from disposal of capital assets			148,000				26,020
Purchases of property and equipment			(1,171,193	)			(3,601,501	)
Purchases of intangible assets			(310,501	)			(275,988	)
Net cash used by investing activities			(7,813,187	)			(3,851,469	)
Cash Flows from Financing Activities:
Excess tax benefits from stock-based compensation			—				97,273
Repurchase of common stock			(24,888,817	)			—
Proceeds from stock options exercised			43,546				968,913
Net cash (used) provided by financing activities			(24,845,271	)			1,066,186
Effect of exchange rate change on cash and cash equivalents			(88,309	)			(25,549	)
Net decrease in cash and cash equivalents			(18,021,074	)			(5,198,426	)
Cash and cash equivalents, beginning of period			42,684,241				45,505,049
Cash and cash equivalents, end of period		$	24,574,858			$	40,281,074
Supplemental Disclosure:
Cash paid for income taxes — net		$	49,659			$	703,982
Non-Cash Transactions:
Property and equipment purchases in accounts payable		$	42,473			$	76,909

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

TASER INTERNATIONAL, INC.

1. The Company 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. In addition, the Company has developed full technology solutions for the capture, storage and management of video/audio evidence as well as other tactical capabilities for use in law enforcement. The Company sells its products worldwide through its direct sales force, distribution partners, online store and third party resellers. The Company was incorporated in Arizona in September 1993 and reincorporated in Delaware in January 2001. The Company’s corporate headquarters and manufacturing facilities are located in Scottsdale, Arizona. The Company’s internet services and software development division facilities are located in Carpenteria, California.

The accompanying consolidated financial statements include the accounts of the Company, and its wholly owned subsidiary, TASER International Europe SE (“TASER Europe”). TASER Europe was established in 2010 to facilitate sales and provide customer service to our customers in the European region. All material intercompany accounts, transactions, and profits have been eliminated.

a. Basis of presentation, preparation and use of estimates

The accompanying unaudited consolidated financial statements of TASER include all adjustments (consisting only of normal recurring accruals) that in the opinion of management are necessary for the fair presentation of the Company’s operating results, financial position and cash flows as of September 30, 2011, and for the three and nine months ended September 30, 2011 and 2010. The preparation of these consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make estimates and assumptions that affect the amounts reported in these consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates.

Certain information and note disclosures normally included in consolidated financial statements prepared in accordance with U.S. GAAP have been omitted from these unaudited consolidated financial statements in accordance with applicable rules. The results of operations for the three and nine months ended September 30, 2011 and 2010, are not necessarily indicative of the results to be expected for the full year (or any other period) and all results of operations included herein 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, 2010.

b. Segment information and major customers

Management has determined that its operations presently are comprised of one reportable segment, the sale of ECDs, accessories and other products and services. Based on the introduction of new product offerings in 2010, management is evaluating how the operating results of the Company will be reviewed internally on a go forward basis in order to improve the level of resource decision making and assessment of segment performance. Based on this evaluation, management will make the necessary changes to its internal management reporting system and subsequently, will perform a review to determine if the Company will redefine its reportable operating segments in accordance with U.S. GAAP. For the three and nine months ended September 30, 2011 and 2010, sales by geographic area were as follows:

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
United States			81	%			89	%			78	%			82	%
Other Countries			19	%			11	%			22	%			18	%
Total			100	%			100	%			100	%			100	%

Sales to customers outside of the United States are typically denominated in U.S. dollars and are attributed to each country based on the billing address of the distributor or customer. For the three and nine months ended September 30, 2011 and 2010, no individual country outside of the U.S. represented a material amount of total net sales.

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

In the three months ended September 30, 2011, two distributors represented approximately 15% and 10% of total net sales. In the three months ended September 30, 2010, three distributors represented approximately 18%, 14%, and 11% of total net sales. In the nine months ended September 30, 2011, one distributor represented approximately 13% of total net sales. In the nine months ended September 30, 2010, one distributor represented approximately 10% of total net sales. At September 30, 2011, the Company had receivables from three distributors comprising 17%, 15%, and 13% of its aggregate accounts receivable balance. At December 31, 2010, the Company had receivables from three customers comprising 19%, 11%, and 10% of its aggregate accounts receivable balance. These customers are unaffiliated distributors of the Company’s products.

c. Income (loss) per common 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 per share reflects the potential dilution that could occur if outstanding stock options were exercised using the treasury stock method. The calculation of the weighted average number of shares outstanding and income (loss) per share are as follows:

		For the Three Months Ended September 30								For the Nine Months Ended September 30,
		2011				2010				2011				2010
Numerator for basic and diluted income (loss) per share
Net income (loss)		$	1,136,285			$	(2,335,478	)		$	(1,138,815	)		$	(4,187,472	)
Denominator for basic income (loss) per share — weighted average shares outstanding			58,787,274				62,342,775				60,617,787				62,495,957
Dilutive effect of shares issuable under stock options outstanding			1,250,054				—				—				—
Denominator for diluted income (loss) per share — adjusted weighted average shares outstanding			60,037,328				62,342,775				60,617,787				62,495,957
Net Income (loss) per common share
Basic		$	0.02			$	(0.04	)		$	(0.02	)		$	(0.07	)
Diluted		$	0.02			$	(0.04	)		$	(0.02	)		$	(0.07	)

For the three months ended September 30, 2011, the effects of 7,119,854 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, 2011. As a result of the net loss per share for the nine months ended September 30, 2011, the effects of 8,389,298 stock options were excluded from the calculation as their effect would have been to reduce net loss per share. As a result of the net loss for the three and nine months ended September 30, 2010, the effects of 7,440,030 and 5,662,678 stock options, respectively, were excluded from the calculation as their effect would have been to reduce the net loss per share.

d. Warranty costs

The Company warrants its X2 ECDs, X3 ECDs, X26 ECDs, M26 ECDs, XREP, TASER CAM, Shockwave, AXON Tactical Computer, Com Hub user interface, Synapse Evidence Transfer Manager (ETM), and HeadCam 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 TASER 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. After the one year standard warranty expires, if the device fails to operate properly for any reason, the Company will replace the TASER X26 for a prorated discounted price depending on when the product was placed into service. These fees are intended to cover the handling and repair costs and include a profit. Management tracks historical data related to returns and warranty costs on a quarterly basis, and estimates future warranty claims by applying the estimated weighted average return rate to the product sales for the period. If management becomes aware of a component failure that could result in larger than anticipated returns from its customers, the reserve would be increased. The reserve for warranty returns is included in accrued liabilities on the consolidated balance sheet. The following table summarizes the changes in the estimated product warranty liabilities for the nine months ended September 30, 2011 and 2010.

		2011				2010
Balance at January 1,		$	646,113			$	369,311
Utilization of accrual			(456,823	)			(328,135	)
Warranty expense			249,652				594,196
Balance at September 30,		$	438,942			$	635,372

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

e. Capitalized software development costs

For development costs related to EVIDENCE.com, the Company’s Software as a Service (SaaS) product, the Company capitalized qualifying computer software costs that were incurred during the application development stage, which was completed in the second quarter of 2010. Costs related to preliminary project planning activities and post-implementation activities were expensed as incurred. The Company did not capitalize any such costs in the three months ended September 30, 2011. For the nine months ended September 30, 2010, the Company capitalized $1,320,000 of qualifying software development costs.

f. Fair value of financial instruments

The Company uses the fair value framework for measuring financial assets and liabilities measured on a recurring basis and for non-financial assets and liabilities when these items are remeasured. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. The Company categorizes each of its fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:

	•		Level 1 — Valuation techniques in which all significant inputs are unadjusted quoted prices from active markets for assets or liabilities that are identical to the assets or liabilities being measured.
	•		Level 2 — Valuation techniques in which significant inputs include quoted prices from active markets for assets or liabilities that are similar to the assets or liabilities being measured and/or quoted prices for assets or liabilities that are identical or similar to the assets or liabilities being measured from markets that are not active. Also, model-derived valuations in which all significant inputs and significant value drivers are observable in active markets are Level 2 valuation techniques.
	•		Level 3 — Valuation techniques in which one or more significant inputs or significant value drivers are unobservable. Unobservable inputs are valuation technique inputs that reflect our own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company has cash equivalents, which at September 30, 2011 and December 31, 2010, were comprised of money market mutual funds, valued using Level 1 valuation techniques. At September 30, 2011, the Company also held short-term investments consisting of commercial paper. Based on management’s ability and intent to hold these investments to maturity, they are recorded at amortized cost on the balance sheet. Refer to note 2 for additional fair value disclosures for these short-term investments. The Company’s financial instruments also include accounts receivable, accounts payable and accrued liabilities. Due to the short-term nature of these instruments, their fair values approximate their carrying values on the balance sheet.

g. 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.

In the nine months ended September 30, 2011, the Company recognized $1,353,857 in impairment charges associated with its Protector product line following the Company’s decision to abandon ongoing operations relating to this line. No impairment charges were recorded in the three months ended September 30, 2011 or the three or nine months ended September 30, 2010.

In addition, in the nine months ended September 30, 2011, the Company recognized a loss of $0.8 million from the write down / disposal of property and equipment, following the decision to dispose of surplus equipment for EVIDENCE.com operations.

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

h. Recently adopted accounting guidance

In October 2009, the FASB issued authoritative guidance on revenue recognition that became effective for the Company beginning January 1, 2011. Under the new guidance on arrangements that include software elements, tangible products that have software components that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance, and software-enabled products will now be subject to other relevant revenue recognition guidance. Additionally, the FASB issued authoritative guidance on revenue arrangements with multiple deliverables that are outside the scope of the software revenue recognition guidance. Under the new guidance, when vendor specific objective evidence or third party evidence for deliverables in an arrangement cannot be determined, a best estimate of the selling price is required to separate deliverables and allocate arrangement consideration using the relative selling price method. The new guidance includes new disclosure requirements on how the application of the relative selling price method affects the timing and amount of revenue recognition. The adoption of this new guidance did not have a material impact on the Company’s consolidated financial statements.

In December 2010, the FASB issued authoritative guidance on business combinations concerning the disclosure of supplementary pro forma information which will be effective for the Company prospectively for business combinations for which the acquisition date is on or after January 1, 2011. The new guidance clarifies the acquisition date that should be used for reporting the pro forma financial information disclosures when comparative financial statements are presented. The amendments are also designed to improve the usefulness of the pro forma revenue and earnings disclosures by requiring a description of the nature and amount of material, nonrecurring pro forma adjustments that are directly attributable to the business combination. Management does not expect adoption of this new guidance to have a material impact on the Company’s consolidated financial statements.

In December 2010, the FASB issued guidance to improve the disclosures that an entity provides about the credit quality of its financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate by portfolio segment or class certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses. The guidance became effective for the Company effective January 1, 2011 and its adoption did not have a material impact on the Company’s consolidated financial statements.

In June 2011, the FASB issued guidance to require presentation of the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. This guidance will be effective for the Company on January 1, 2012, and management does not believe its adoption will have a material impact on the Company’s consolidated financial statements.

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. The Company’s short-term investments are invested in commercial paper, which, based on management’s intent and ability, are classified as held to maturity investments, recorded at amortized cost.

The following is a summary of cash, cash equivalents and held-to-maturity investments by type at September 30, 2011 and December 31, 2010:

		September 30, 2011																December 31, 2010
										Gross												Gross				Gross
						Gross Unrealized				Unrealized												Unrealized				Unrealized
		Cost				Gains				Losses				Fair Value				Cost				Gains				Losses				Fair Value
Cash and money market funds		$	24,574,858			$	—			$	—			$	24,574,858			$	42,684,241			$	—			$	—			$	42,684,241
Commercial paper			6,075,147								14,367				6,060,780				—				—				—				—
Certificate of Deposit			100,000				—				130				99,870				—				—				—				—
Total cash, cash equivalents and investments		$	30,750,005			$	—			$	14,497			$	30,735,508			$	42,684,241			$	—			$	—			$	42,684,241

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

The following table summarizes the classification of cash, cash equivalents and investments in the accompanying balance sheet:

		September 30,				December 31,
		2011				2010
Cash		$	5,369,481			$	12,282,389
Cash equivalents			19,205,377				30,401,852
Total cash and cash equivalents			24,574,858				42,684,241
Short term investments			6,175,147				—
Long term investments			—				—
		$	30,750,005			$	42,684,241

The commercial paper investments, identified above as short-term investments at September 30, 2011, have contractual maturities of less than one year. At September 30, 2011, held-to-maturity short-term investments have gross unrealized losses of $14,497, which have been in a continuous unrealized loss position for less than 12 months. The unrealized losses on the Company’s investments in commercial paper are due to interest rate fluctuations. As these investments were originally purchased at a premium, are short-term in nature, are expected to be redeemed at par value and because the Company has the ability and intent to hold these investments to maturity, the Company does not consider these investments to be other than temporarily impaired at September 30, 2011.

3. Inventory

Inventories are 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 includes allocations of manufacturing labor and overhead. Provisions are made to reduce potentially excess, obsolete or slow-moving inventories to their net realizable value. Inventories as of September 30, 2011 and December 31, 2010, consisted of the following:

		September 30, 2011				December 31, 2010
Raw materials and work-in-process		$	12,514,911			$	11,817,579
Finished goods			3,873,847				6,348,490
Reserve for excess and obsolete inventory			(919,630	)			(350,664	)
		$	15,469,128			$	17,815,405

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

4. Intangible assets

Intangible assets consisted of the following at September 30, 2011 and December 31, 2010:

						September 30, 2011												December 31, 2010
						Gross								Net				Gross								Net
						Carrying				Accumulated				Carrying				Carrying				Accumulated				Carrying
		Useful Life				Amount				Amortization				Amount				Amount				Amortization				Amount
Amortized intangible assets:
Domain names		5 Years				$	168,428			$	93,318			$	75,110			$	237,911			$	66,006			$	171,905
Issued patents			4 to 15 Years				1,463,821				320,767				1,143,054				1,040,148				264,716				775,432
Issued trademarks			9 to 11 Years				263,742				57,295				206,447				207,721				37,659				170,062
Non compete agreements			5 to 7 Years				150,000				145,000				5,000				150,000				130,000				20,000
							2,045,991				616,380				1,429,611				1,635,780				498,381				1,137,399
Unamortized intangible assets:
TASER Trademark							900,000								900,000				900,000								900,000
Patents and trademarks pending							854,333								854,333				1,053,477								1,053,477
							1,754,333								1,754,333				1,953,477								1,953,477
						$	3,800,324			$	616,380			$	3,183,944			$	3,589,257			$	498,381			$	3,090,876

Amortization expense for the three and nine months ended September 30, 2011, was approximately $38,000 and $118,000, respectively. Amortization expense for the three and nine months ended September 30, 2010, was approximately $28,000 and $76,000, respectively. Estimated amortization expense of intangible assets for the remaining three months of 2011, the next five years ended December 31, and thereafter is as follows:

2011 (remainder of year)		$	24,592
2012			106,448
2013			106,451
2014			133,614
2015			124,862
2016			111,991
Thereafter			821,653
		$	1,429,611

5. Accrued liabilities

Accrued liabilities consisted of the following at September 30, 2011 and December 31, 2010:

		September 30, 2011				December 31, 2010
Accrued salaries and benefits		$	1,520,079			$	1,411,716
Accrued litigation judgment expense			3,300,000				—
Accrued expenses			1,972,336				1,668,477
Accrued warranty expense			438,942				646,113
Accrued income tax			472,167				33,494
		$	7,703,524			$	3,759,800

6. Income taxes

Deferred Tax Assets

The net deferred income tax assets at September 30, 2011, include net operating loss and alternative minimum tax carryforwards, capitalized research and development costs, research and development tax credits, non-qualified stock-based compensation expense, deferred warranty revenue, warranty and inventory reserves and accrued vacation, partially offset by accelerated depreciation expense. The Company’s total current and long term deferred tax assets balance at September 30, 2011, is $22.7 million.

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

In preparing the Company’s consolidated financial statements, management assesses 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. 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. Management believes that, as of September 30, 2011, based on an evaluation and projections of future sales and profitability for fiscal 2011, no valuation allowance is necessary. However, such deferred tax assets could be reduced in the future if projections of future taxable income during the carryforward period are reduced.

The Company has completed research and development tax credit studies which identified approximately $5.9 million in tax credits for Federal, Arizona and California income tax purposes related to the 2003 through 2010 tax years, net of the federal benefit on the Arizona and California research and development tax credits. Management has made the determination that it is more likely than not that the full benefit of the research and development tax credit will not be sustained on examination and accordingly, has established a cumulative liability for unrecognized tax benefits of $2.5 million as of September 30, 2011. In addition, management has accrued approximately $106,000 for estimated uncertain tax positions related to certain state income tax liabilities. As of September 30, 2011, management does not expect the amount of the unrecognized tax benefit liability to increase or decrease significantly within the next 12 months. Should the unrecognized tax benefits of $2.6 million be recognized, the Company’s effective tax rate would be favorably impacted.

The following presents a rollforward of our liability for unrecognized tax benefits as of September 30, 2011:

		Unrecognized
		Tax Benefits
Balance at January 1, 2011		$	2,281,840
Decrease in prior year tax positions			—
Increase in current year tax positions			58,629
Increase related to adjustment of previous estimates of activity			298,877
Decrease related to settlements with taxing authorities			—
Decrease related to lapse in statute of limitations			—
Balance at September 30, 2011		$	2,639,346

Effective Tax Rate

Our estimated full year effective tax rate, before discrete period adjustments, is approximately 50%, which is above the statutory rate due to the impact of non-deductible expenses for items such as Incentive Stock Option (“ISO”) expense, meals and entertainment and lobbying fees, which make our projected annual net income for tax purposes significantly higher than our pre-tax book income. The overall effective tax rate of 7.4% for the three months ended September 30, 2011, was below our estimated annual effective tax rate due to a discrete tax provision amount recorded in the third quarter of 2011 related to a 2010 tax return to provision true up adjustment, attributable to higher than expected research and development tax credits. The overall effective tax rate of 52.4% for the nine months ended September 30, 2011, was above our estimated annual effective tax rate due to treating the litigation judgment expense, asset impairment expense and the lawsuit settlement proceeds as discrete items due to their significant and unusual nature and therefore tax effecting them at the statutory rate, offset by the return to provision true up adjustment for research and development credits which favorably impacted the current quarter’s provision amount and increased the tax benefit for the nine months ended September 30, 2011.

7. Stockholders’ equity

Stock Repurchase

In March 2011, 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. In July 2011, TASER’s Board of Directors authorized an additional repurchase program to acquire up to $20 million of the Company’s outstanding common stock, subject to stock market conditions and corporate considerations.

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

Through September 30, 2011, the Company repurchased approximately 5.9 million shares at an average cost, including commissions, of $4.23 per share and a total cost of approximately $24.9 million.

Stock Option Activity

At September 30, 2011, the Company had four stock-based compensation plans, three of which are described more fully in Note 10 to the consolidated 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, 2011, as well as activity during the nine months then ended:

						Outstanding Options
		Options Available								Weighted Average
		for Grant				Number of options				Exercise Price
Balance at December 31, 2010			2,478,768				7,507,286			$	5.71
Granted			(997,728	)			997,728			$	4.64
Exercised			—				(24,569	)		$	1.77
Expired/terminated			91,147				(91,147	)		$	5.22
Balance at September 30, 2011			1,572,187				8,389,298			$	5.60

The options outstanding as of September 30, 2011, have been segregated into five ranges for additional disclosure as follows:

		Options Outstanding												Options Exercisable
						Weighted												Weighted
						Average				Weighted Average								Average
						Exercise				Remaining				Number				Exercise
Range of Exercise Price		Number Outstanding				Price				Contractual Life				Exercisable				Price
$0.28 - $0.99			469,255			$	0.37				1.4				469,255			$	0.37
$1.03 - $2.41			634,391			$	1.60				1.0				634,391			$	1.60
$3.53 - $9.93			6,727,539			$	5.77				6.5				5,358,240			$	6.05
$10.07 - $19.76			533,413			$	11.94				4.1				533,413			$	11.94
$20.12 - $29.98			24,700			$	22.91				2.7				24,700			$	22.91
			8,389,298			$	5.60				5.6				7,019,999			$	5.84

The total fair value of options exercisable at September 30, 2011 and 2010 was $21.3 million and $20.3 million, respectively. The aggregate intrinsic value of options outstanding and options exercisable at September 30, 2011, was $3.8 million and $3.7 million, respectively. Aggregate intrinsic value represents the difference between the Company’s closing stock price on the last trading day of the fiscal period, which was $4.31 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, 2011, was approximately $49,000 and approximately $63,000, respectively. Total intrinsic value of options exercised for the three and nine month periods ended September 30, 2010 was approximately $89,000 and $2.2 million respectively.

At September 30, 2011, the Company had approximately 1.4 million unvested options outstanding with a weighted average exercise price of $4.71 per share, weighted average grant date fair value of $2.15 per share and a weighted average remaining contractual life of 8.6 years. Of these unvested options outstanding, management estimates that approximately 1.3 million options will ultimately vest based on its historical experience.

As of September 30, 2011, total unrecognized stock-based compensation expense related to unvested stock options was approximately $3.6 million, which is expected to be recognized over a remaining weighted average period of approximately 14 months.

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

Stock-Based Compensation Expense

The Company calculates the fair value of stock-based awards using 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, 2011 and 2010, 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,
		2011				2010				2011				2010
Expected life of options		4.5 years				4.5 years				4.5 years				4.5 years
Weighted average volatility			54.4	%			58.9	%			55.6	%			61.2	%
Weighted average risk-free interest rate			0.9	%			1.3	%			1.7	%			2.0	%
Dividend rate			0.0	%			0.0	%			0.0	%			0.0	%
Weighted average fair value of options granted		$	1.97			$	1.87			$	2.16			$	2.62

The expected life of 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 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 publicly 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. The estimated fair value of stock-based compensation awards and other options is amortized to expense on a straight line basis over the requisite service period. As share-based compensation expense is recognized on awards ultimately expected to vest, it is reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company’s forfeiture rate was calculated based on its historical experience of awards which ultimately vested.

Reported share-based compensation was classified as follows for the three and nine months ended September 30, 2011 and 2010:

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Cost of Products Sold		$	30,238			$	107,947			$	135,217			$	259,932
Sales, general and administrative expenses			518,513				692,420				1,891,258				2,215,010
Research and development expenses			144,769				112,411				506,969				364,056
		$	693,520			$	912,778			$	2,533,444			$	2,838,998

Total share-based compensation expense recognized in the income statement for the three and nine months ended September 30, 2011, includes approximately $251,000 and $1.2 million, respectively, related to Incentive Stock Options (“ISOs”) for which no tax benefit is recognized. Total share-based compensation expense recognized in the income statement for the three and nine months ended September 30, 2010, includes approximately $414,000 and $1.7 million, respectively, related to ISOs for which no tax benefit is recognized. The Company did not tax effect the share-based compensation expense for tax purposes related to the non-qualified disposition of ISOs exercised and sold as the benefit will be recorded when the Company is in a position to realize the benefit 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, 2011, was approximately $49,000 and $63,000, respectively. The total unrecognized tax benefit related to the non-qualified disposition of stock options in the three and nine months ended September 30, 2010, was approximately $89,000 and $2.2 million, respectively.

The Company has granted a cumulative total of 950,800 performance-based stock options from 2008 through September 30, 2011, the vesting of which is contingent upon the achievement of certain performance criteria related to the successful and timely development and market acceptance of future product introductions, as well as the future sales and operating performance of the Company. Compensation expense is recognized over the implicit service period (the date the performance condition is expected to be achieved) based on management’s estimate of the probability of the performance criteria being satisfied, adjusted at each balance sheet date. At September 30, 2011, 219,067 unvested performance options with a fair value of approximately $541,000 remain outstanding. No performace-based options were forfeited during the three or nine months ended September 30, 2011. During the nine months ended September 30, 2010, 225,000 of these options were forfeited, resulting in the reversal of approximately $346,000, of previously recognized compensation expense. No performance-based options were forfeited during the three months ended September 30, 2010.

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

8. Line of credit

The Company has a line of credit agreement with 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, currently LIBOR plus 1.25%. The line of credit which was amended and renewed in June 2011, primarily to remove the borrowing base restriction, matures on June 30, 2013, and requires monthly payments of interest only. At September 30, 2011, there was no amount outstanding under the line of credit. There have been no borrowings under the line of credit to date. The Company’s agreement with the bank requires compliance with certain financial and other covenants including maintenance of minimum tangible net worth and a fixed charge coverage ratio. The ratio of total liabilities to tangible net worth can be no greater than 1:1, and the fixed coverage charge ratio can be no less than 1.25:1, based upon a trailing twelve-month period. At September 30, 2011, the Company’s tangible net worth ratio was 0.25:1 and its fixed charge coverage ratio was 3.9:1. Accordingly, the Company was in compliance with those covenants.

9. Commitments and Contingencies

Product Litigation

The Company is currently named as a defendant in 55 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 in connection with arrests or during training exercises. Companion cases arising from the same incident have been combined into one for reporting purposes.

In addition, 136 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 Lee (TN), Thompson (MI), Marquez (AZ), Oliver (FL) and Rosa (CA) cases where judgment was entered in favor of the Company. In July 2011, the Court of Appeals affirmed the judgment in favor of the Company in the Lee (TN) appeal and in August denied the plaintiff’s request for a rehearing. These cases are not included in this number or in the table below.

Also not included in the number of pending lawsuits or in the table below is the Heston lawsuit in which a jury verdict was entered against the Company on June 6, 2008, and judgment was entered against the Company on January 30, 2009 in the amount of $153,150 as compensatory damages, $1,423,127 as attorney fees, and $182,000 as costs. These damages, fees and costs are covered by the Company’s insurance policies. The jury found that Mr. Heston’s own actions were 85% responsible for his death. The jury assigned 15% of the responsibility to TASER for a “negligent failure to warn” that extended or multiple TASER ECD applications could cause muscle contractions that could potentially contribute to acidosis to a degree that could cause cardiac arrest. The jury inappropriately awarded $5,200,000 in punitive damages against TASER, which were subsequently disallowed by the Court on October 24, 2008. The Court denied the balance of the Company’s motion for judgment as a matter of law on all other grounds. The Company has filed a notice of appeal with respect to the judgment and plaintiffs have filed a notice of cross appeal. In May 2011 the U.S. Circuit Court of Appeals for the Ninth Circuit ruled in the Company’s favor on three of four significant damages issues: the elimination of punitive damages was upheld, the award of attorneys’ fees was vacated, and the damage award to the estate of Mr. Heston was vacated. The court upheld the damage award to the parents in the amount of $150,000. The Company is also responsible for $52,700 in costs and interest.

The Turner (NC) lawsuit was tried in July 2011 and resulted in a jury verdict of $10 million against the Company. The Company has filed post-trial motions seeking judgment as a matter of law notwithstanding the verdict and in the alternative, a new trial or alternatively a remittitur of the jury award. The court has not yet entered judgment. The Company recorded a litigation judgment expense of $3.3 million in the second quarter of 2011, which represents management’s best estimate of the Company’s uninsured portion of the judgment after consideration of available insurance coverage.

With respect to each of the pending 55 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. While the facts vary from case to case, the product liability claims are typically based on an alleged product defect resulting in injury or death, usually involving a failure to warn, and the plaintiffs are seeking monetary damages. This table also lists those cases that were dismissed, (or where a dismissal is pending) or judgment entered during the most recent fiscal quarter. Cases that were dismissed or judgment entered in prior fiscal quarters are not included in this table. The claims and in some instances, the defense of each of these lawsuits has been submitted to our insurance carriers that maintained insurance coverage during these applicable periods and we continue to maintain product liability insurance coverage with varying limits and deductibles. Our product liability insurance coverage during these periods ranged from $5,000,000 to $10,000,000 in coverage limits and from $10,000 to $1,000,000 in per incident deductibles. For the 2010 insurance policy year, our product liability insurance coverage was $10 million and, as noted above, in the Turner (NC) case the Company received an adverse $10 million jury verdict. After consideration of the remaining available insurance coverage, the Company’s uninsured exposure related to this case is approximately $3.3 million. While the Company will explore every possible legal channel to have this verdict overturned, in the event the verdict stands, the Company’s insurance coverage for the 2010 policy year will be exhausted and, for any other claims relating to the 2010 policy year, the Company will not have insurance coverage for defense costs or any other adverse judgments, should they arise. We are defending each of these lawsuits vigorously and do not expect these lawsuits to individually and in the aggregate, materially affect our business, results of operations or financial condition.

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

		Month
Plaintiff		Served		Jurisdiction		Claim Type		Status
Glowczenski		Oct-04		US District Court, ED NY		Wrongful Death		Trial rescheduled, date to be determined
Washington		May-05		US District Court, ED CA		Wrongful Death		Discovery Phase
Hollman		Aug-06		US District Court, ED NY		Wrongful Death		Motion Phase
Wendy Wilson, Estate of Ryan Wilson		Aug-07		District Court Boulder County, CO		Wrongful Death		Dismissal pending
Jack Wilson, Estate of Ryan Wilson (Companion to Wendy Wilson)		Nov-07		District Court Boulder County, CO		Wrongful Death		Dismissal pending
Salinas		Aug-08		US District Court, ND CA		Wrongful Death		Motion Phase, trial scheduled Sept 2012
Thomas (Pike)		Oct-08		US District Court, WD Louisiana, Alexandria		Wrongful Death		Motion Phase
Shrum		May-09		Allen County District Court, Iola, KS		Wrongful Death		Trial scheduled November 2012
Athetis		May-09		US District Court, AZ		Wrongful Death		Discovery Phase
Abrahams		Jul-09		CA Superior Court, Yolo County		Wrongful Death		Discovery Phase, trial scheduled September 2012
Humphreys		Oct-09		CA Superior Court, San Joaquin County		Wrongful Death		Discovery Phase
Terriquez		Feb-10		CA Superior Court, Orange County		Wrongful Death		Discovery Phase, trial scheuduled May 2012
Rich		Feb-10		US District Court, NV		Wrongful Death		Motion Phase
McKenzie		Feb-10		US Disctrict Court, ED CA		Wrongful Death		Dismissed
Turner		Feb-10		General Court of Justice, Superior Court Div, Mecklenburg County, NC		Wrongful Death		Jury award for $10 million. Post trial motions filed, judgment not filed
Doan		Apr-10		The Queens Bench Alberta, Red Deer Judicial Dist.		Wrongful Death		Pleading Phase
Piskkura		May-10		US District Court, OH		Wrongful Death		Discovery Phase, trial scheuduled March 2012
Corbin		Jun-10		Houston County Court, MD AL		Wrongful Death		Discovery Phase, trial scheuduled June 2012
DuBoise		Aug-10		US District Court, ED MO		Wrongful Death		Discovery Phase, trial scheduled February 2013
Kelly		Oct-10		District Court for Harris County, TX		Wrongful Death		Discovery Phase, trial scheduled May 2012
Jacobs		Oct-10		District Court for Travis County, TX		Wrongful Death		Discovery Phase, trial scheduled October 2012
Shymko		Dec-10		The Queens Bench, Winnipeg Centre, Manitoba		Wrongful Death		Pleading Phase
Williams		Dec-10		US District Court, MS		Wrongful Death		Discovery Phase, trial scheduled April 2012
English		May-11		US District Court, WD VA		Wrongful Death		Discovery Phase, trial scheduled April 2012
Wilson		May-11		US District Court, ED MO		Wrongful Death		Discovery Phase
Terrell		Jun-11		US District Court, SD TX		Wrongful Death		Discovery Phase
Sylvester		Jun-11		US District Court, ND CA		Wrongful Death		Discovery Phase
La Day		Jun-11		US District Court, ED TX		Wrongful Death		Discovery Phase
Cobb		Aug-11		Guilford County Superior Court, NC		Wrongful Death		Discovery Phase
Nelson		Aug-11		CA Superior Court, Riverside County		Wrongful Death		Discovery Phase
Bachtel		Aug-11		14th Judicial District Circuit Court, Randolph County, MO		Wrongful Death		Discovery Phase
Ridelhuber		Sep-11		US District Court, Greenwood Division, SC		Wrongful Death		Pleading Phase
Cosentino		Oct-11		US District Court, CD CA		Wrongful Death		Pleading Phase
Coto		Oct-11		CA Superior Court, Los Angeles County		Wrongful Death		Pleading Phase
Stewart		Oct-05		Circuit Court for Broward County, FL		Training Injury		Discovery Phase
Husband		Mar-06		British Columbia Supreme Court, Canada		Training Injury		Discovery Phase, trial scheduled March 2012
Grable		Aug-08		FL 6th Judicial Circuit Court, Pinellas County		Training Injury		Discovery Phase
Koon		Dec-08		17th Judicial Circuit Court, Broward County, FL		Training Injury		Discovery Phase
Bickle		Mar-09		18th Judicial District Court, Gallatin County, MT		Training Injury		Dismissal pending
Peppler		Apr-09		Circuit Court 5th Judicial Dist., Sumter City, FL		Training Injury		Motion Phase
Kandt		Jun-09		US District Court, ND NY		Training Injury		Discovery Phase
Maynard		Apr-10		Superior Court, Hartford Judicial District, CT		Training Injury		Discovery Phase
Butler		Jan-11		US District Court, ND TX		Training Injury		Discovery Phase, trial scheduled April 2012
Derbyshire		Nov-09		Ontario Superior Court of Justice		Officer Injury		Discovery Phase
Hollenback		Dec-10		St. Louis County Circuit Court MO		Officer Injury		Discovery Phase, trial scheduled January 2012
Juran		Dec-10		Hennepin County District Court, 4th Judicial District		Officer Injury		Discovery Phase
Strough		Feb-11		US District Court, ED MO		Officer Injury		Discovery Phase, trial scheduled December 2012
Wheat		Jul-09		CA Superior Court, Los Angeles County		Suspect Injury During Arrest		Motion Phase, trial scheduled March 2012
Fahy		Dec-09		Circuit Court of City of St. Louis		Suspect Injury During Arrest		Discovery Phase, trial scheduled August 2012
Thompson		Mar-10		11th Judicial Circuit Court Miami-Dade County, FL		Suspect Injury During Arrest		Discovery Phase
Wilson		Apr-10		US District Court, ND IL, ED		Suspect Injury During Arrest		Dismissed
Patterson		Jun-10		Circuit Court Pontotoc County, MS		Suspect Injury During Arrest		Dismissed
Streeter		Dec-10		US District Court, OR		Suspect Injury During Arrest		Discovery Phase, trial scheduled April 2012
Valkanet		Mar-11		US District Court, ND IL		Suspect Injury During Arrest		Discovery Phase
Sanders		Mar-11		US District Court, ND IL		Suspect Injury During Arrest		Discovery Phase
Payne		Mar-11		Blount County Circuit Court, TN		Suspect Injury During Arrest		Discovery Phase
Jefferson		Apr-11		US District Court, ED TX		Injury During Incarceration		Discovery Phase
Fountain		May-11		US District Court, MD FL		Suspect Injury During Arrest		Discovery Phase, trial scheduled April 2013
Alusa (UT)		May-11		US District Court, CD UT		Suspect Injury During Arrest		Discovery Phase
Diehl (PA)		Jun-11		Court of Common Pleas, Blair County, PA		Suspect Injury During Arrest		Discovery Phase
Gray		Sep-11		US District Court, WD LA		Suspect Injury During Arrest		Pleading Phase

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

Other Litigation

In October 2007, we filed a lawsuit in Arizona Superior Court for Maricopa County against Steve Ward and Mark Johnson, both former TASER employees, and VIEVU LLC et. al. for breach of duty of loyalty, breach of contract, breach of fiduciary duty, and conversion. This lawsuit does not involve our ECD business and we do not expect this litigation to have a material impact on our financial results. Defendants Ward and VIEVU LLC filed an answer and counterclaim for declaration of non-infringement, tortious interference with contractual relations, tortious interference with business expectancy, and abuse of process. In its lawsuit the Company sought compensatory damages, constructive trust, exemplary damages, injunctive relief, and attorneys’ fees, costs and disbursements. Cross motions for summary judgment were filed and on March 4, 2009, the Court denied Defendants’ motion for summary judgment on the trade secret claim and on April 9, 2009, the Court granted TASER’s motion for summary judgment against Ward on the breach of fiduciary duty and the breach of duty of loyalty claims. We filed a Motion to Extend Discovery Period by and to reconvene the Deposition of Steve Ward, and Defendants have filed Defendant’s Response in Opposition to this motion. In addition, Defendants Steve Ward and VIEVU LLC filed a Motion for Reconsideration or in the alternative to make the Court’s Ruling a Final Judgment and Stay Proceeding Pending Outcome of Appeal. The Court denied the Motion for Reconsideration, but granted the motion to make the Court’s Ruling a Final Judgment and Stayed the Proceeding Pending Outcome of Appeal. An appeal was filed by Defendants Ward and VIEVU LLC to the Arizona State Court of Appeals. The appellate court reversed the Superior Court and remanded the case for trial. On June 14, 2010 TASER filed a petition for review with the Arizona Supreme Court and Ward filed a cross petition for review on June 29, 2010. The Arizona Supreme Court declined review of both petitions and the case was resolved to the mutual satisfaction of the parties and the case was dismissed in August 2011.

In February 2009, we filed a complaint in the United States District Court for the District of Nevada against James F. McNulty, Jr., Robert Gruder, and Stinger Systems, Inc. alleging securities fraud under 15 U.S.C. § 78j, trade libel, unfair competition under the Lanham Act, 15 U.S.C. § 1125, abuse of process, and deceptive trade practices. Our complaint seeks compensatory damages, punitive damages, injunctive relief, attorneys’ fees and costs. Defendants filed motions to dismiss and on March 25, 2010 the Court denied Defendants’ motion on all claims except the securities fraud claim. Defendant McNulty filed a counterclaim on August 2, 2010 alleging that TASER’s XREP product infringes U.S. Patents 5,831,199 and 6,877,434. The counterclaim seeks declaratory and injunctive relief, compensatory, treble and punitive damages, and attorney’s fees. The court issued a ruling in July 2011 dismissing TASER’s claims for civil conspiracy and abuse of process and affirming the magistrate’s order requiring defendants to disclose tax and stock information to TASER and ruling that TASER’s counterclaim for declaratory judgment with respect to the patent claims should not be dismissed. Mr. McNulty has filed a motion for summary judgment, which is pending before the court. No trial date has been set.

In January 2011, we were served with a complaint in the matter of GEOTAG, Inc. v. TASER International, Inc. et. al. that was filed in the United States District Court for the Eastern District of Texas, Marshall Division, which alleges that a dealer geographical locator feature on TASER’s website infringes upon plaintiff’s US Patent No. 5,930,474. The complaint seeks a judgment of infringement, a permanent injunction against infringement, an award for damages, costs, expenses and pre-judgment and post-judgment interest, and an award for enhanced damages and attorneys’ fees. TASER has licensed this locator feature from a third party and has denied liability for infringement. This lawsuit is at the pleading phase and no trial date has been set.

In July 2011, we were served with a complaint in the matter of Integrity Staffing Professionals v. TASER International, Inc., et.al. that was filed in the Superior Court for the County of Ventura, California which alleges that the Company owes Integrity Staffing Professionals a fee for hiring two consultants. The complaint alleges breach of contract, breach of implied covenants, intentional and negligent interference with contractual relationships, civil conspiracy and unfair business practices. The complaint seeks compensatory, general, punitive damages, interest, and attorneys’ fees and costs. This lawsuit was resolved to the mutual satisfaction of the parties and the case was dismissed in September 2011.

In September 2011, the Company filed a motion with the U.S. District Court for the District of Arizona to re-open the lawsuit in which TASER was granted a permanent injunction against Stinger Systems, Inc. which was granted in October 2011. The permanent injunction restrained Stinger and its officers, agents and employees, which would include Robert Gruder who was formerly an officer and employee of Stinger and who is currently CEO of Karbon Arms, Inc., from making, using, offering to sell, or selling in or from the United States, the Stinger S-200 electronic control devices and all other products that are only colorably different from the S-200 ECDs in the context of claims 2 or 40 of TASER’s 6,999,295 patent. This case was re-opened by the Court to consider a motion by TASER for contempt against Karbon Arms and Gruder for violation of TASER’s permanent injunction by making, offering to sell and selling the Karbon Arms MPID electronic control device. A hearing has been scheduled for December 15, 2011, to consider TASER’s motion for contempt.

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

In August 2011 the Company filed a complaint against Karbon Arms, L.L.C. for infringement of U.S. Patent Nos. 7,800,885 (the “‘885 patent”) and 7,782,592 (the “‘592 patent”) in U.S. District Court for the District of Delaware seeking damages, injunctive relief and an award of attorney’s fees. This lawsuit is in the discovery phase and no trial date has been set.

General

From time to time, the Company is notified that it may be a party to a lawsuit or that a claim is being made against it. It is the Company’s policy to not disclose the specifics of any claim or threatened lawsuit until the summons and complaint are actually served on the Company. After carefully assessing the claim, and assuming we determine that we are not at fault, we vigorously defend and pursue any lawsuit filed against or by the Company. Although we do not expect the outcome in any pending 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 one lawsuit where the costs of legal defense incurred are in excess of its liability insurance deductibles. As of September 30, 2011, the Company has been fully reimbursed by its insurance company for 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 the Company and dismissed in cases where the settlement economics to the Company were significantly less than the cost of litigation. In addition, it is the Company’s policy to not settle suspect injury or death cases, although the Company’s insurance company may settle such lawsuits over the Company’s objection where the case is over the Company’s liability insurance deductibles. 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, the Chairman of the Board of Directors for business use of his personal aircraft. For the three and nine months ended September 30, 2011, the Company incurred expenses of approximately $57,000 and $135,000, respectively, to Thomas P. Smith. For the three and nine months ended September 30, 2010, the Company incurred expenses of approximately $16,000 and $162,000, respectively, to Thomas P. Smith. At September 30, 2011, there was approximately $14,000 of outstanding payables due to Thomas P. Smith. At December 31, 2010, the Company had no outstanding payables due to Thomas P. Smith. Management believes that the rates charged by Thomas P. Smith are equal to or below commercial rates the Company would pay to charter similar aircraft from independent charter companies.

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 Internal Revenue Service. 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. 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, 2011, the Company incurred approximately $1,000 and $4,500, respectively, in such administrative costs. For the three and nine months ended September 30, 2010, the Company incurred approximately $17,000 and $93,000, respectively, in such administrative costs. The Company is authorized by its Board of Directors to make a discretionary contribution to the TASER Foundation up to a maximum of $200,000 per quarter. For the three and nine months ended September 30, 2011 and 2010, the Company did not make a discretionary contribution to the TASER Foundation.

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

Consulting services

The Company engages Mark Kroll, a member of the Board of Directors, to provide consulting services. The expenses relating to these services for the three and nine months ended September 30, 2011, were approximately $43,000 and $159,000, respectively. The expenses relating to these services for the three and nine months ended September 30, 2010, were approximately $53,000 and $109,000, respectively. At September 30, 2011 and December 31, 2010, the Company had accrued liabilities of approximately $28,000 and $20,000, respectively, for these services.

11. Employee Benefit Plan

The Company has 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 $16,500. 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. The Company’s matching contributions to the Plan for the three and nine months ended September 30, 2011, were approximately $136,000 and $391,000, respectively. The Company’s matching contributions to the Plan for the three and nine months ended September 30, 2010 were approximately $116,000 and $382,000, respectively. Future matching or profit sharing contributions to the Plan are at the Company’s sole discretion.

ITEM 2.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following is a discussion of the Company’s financial condition as of September 30, 2011, and results of operations for the three and nine months ended September 30, 2011 and 2010. The following discussion may be understood more fully by reference to the consolidated financial statements, notes to the consolidated financial statements, and 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 year ended December 31, 2010.

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: the impact of recently adopted accounting standards and guidance; estimated amortization charges in future years and our projected tax rate for 2011; our expectations about unrecognized tax benefits and deferred income taxes; assumptions about the future vesting of outstanding stock options and the amortization of costs relating thereto; our litigation strategy; our intentions to hold our investment securities to maturity and expectations relating to the redemption prices of these securities; our plans concerning our stock repurchase program; the outcome of pending litigation against us; our intentions to evaluate our internal reporting structure and operating segments; the sufficiency of our valuation reserves, including warranty, accounts receivable, deferred taxes and inventory reserves; our plan to not pay dividends; the sufficiency of our capital resources and the availability of financing to the Company and our strategy with respect to hedging activities. 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: the impact that new product lines could have on sales of existing product lines; market acceptance of our products; budgetary and political constraints of prospects and customers; litigation risks resulting from alleged product-related injuries and media publicity concerning allegations of deaths occurring after use of the TASER device and the negative impact this publicity could have on sales; our dependence on sales of our TASER X26 ECDs; our ability to manage our growth; our ability to ramp manufacturing production to meet demand; the outcome of pending litigation; establishment and expansion of our direct and indirect distribution channels; the acceptance of our EVIDENCE.com software model; our ability to design, introduce and sell new products; delays in development schedules; risks relating to acquisitions and joint ventures; the length of our sales cycle and our ability to realize benefits from our marketing and selling efforts; risks of governmental regulations, including regulations of our products by the U.S. Consumer Product Safety Commission, regulation of our products as a “crime control” product by the Federal government, state and local government regulation and foreign regulation, our compliance with regulations governing the environment, including but not limited to, regulations within the European Union; our ability to protect our intellectual property; intellectual property infringement claims and relating litigation costs; competition in foreign countries relating to foreign patents; our successful identification of existing intellectual property rights that might infringe on our developments; the adverse effects that could result from our products being classified as firearms by the United States Bureau of Alcohol and Firearms; product defects; rapid technological change; our dependence on third party suppliers for key components of our products; component shortages; our dependence on foreign suppliers for key components; rising costs of raw materials and transportation relating to petroleum prices; catastrophic events; security vulnerabilities and service outages and disruptions relating to our EVIDENCE.com service; fluctuations in quarterly operating results; foreign currency fluctuations; counterparty risks relating to cash balances held in excess of FDIC insurance limits; employee retention risks and other factors identified in documents filed by us with the Securities and Exchange Commission, including those set forth in our Form 10-K for the year ended December 31, 2010, and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2011, under the caption “Risk Factors.”

Overview

Our core mission is to protect life, prevent conflict and resolve disputes through technologies that make communities safer. We are a market leader in the development and manufacture of advanced electronic control devices (ECDs) designed for use in law enforcement, military, corrections, private security and personal defense.

Our mission to protect life has also been extended to prevent conflict and resolve disputes. We have learned that bringing a subject into custody is not the end of the challenge for law enforcement. In fact, it is typically just the beginning since a significant number of incidents that start as a physical conflict transition into a legal conflict. Whether it’s prosecuting and convicting the individual arrested, or responding to excessive use of force allegations, the post-incident legal process is a considerable part of the challenge that law enforcement faces on a continual basis and can often take years and millions of litigation dollars to resolve in the courtroom. To help law enforcement address this challenge, we have developed a fully integrated hardware and software solution that will provide our law enforcement customers the capabilities to capture, store, manage, share and analyze video and other digital evidence. Finally, the optimum situation is to have prevented the conflict from ever escalating. TASER ECDs and AXON on-officer video have a measured and positive effect on better suspect and officer behavior, as well as achieving compliance without escalation of force.

TASER solutions deliver significant results to our customers and to communities in which they are deployed. With over 275 independent studies confirming the safety of TASER ECDs relative to other force options, TASER ECDs have proven to be a safer alternative to other uses of force in situations of conflict. Further, most reporting agencies demonstrate overall decreases in use of force, and decreases in suspect and officer injuries resulting from conflict. Reducing uses of force and gaining compliance by use of a TASER ECD has provided significant reductions in worker’s compensation expenses and claims for excessive use of force for agencies, cities and taxpayers.

Technological innovation is the foundation for our long-term growth and we intend to maintain our commitment to the research and development of our technology for both new and existing products that further our mission. At the same time we have established industry leading training services to provide our users a comprehensive overview of legal and policy issues, medical information and risk mitigation relating to our ECDs and the use of force. We have built a network of distribution channels for selling and marketing our products and services to law enforcement agencies, primarily in North America, with ongoing focus and effort placed on expanding these programs in international, military and other markets. Over 16,000 law enforcement agencies in over 40 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 ECD products.

Results of Operations

Three Months Ended September 30, 2011 Compared to the Three Months Ended September 30, 2010

The following table sets forth, for the periods indicated, our consolidated statements of operations as well as the percentage relationship to total net sales of items included in our consolidated statements of operations (dollars in thousands):

		Three Months Ended September 30,																Increase / (Decrease)
		2011								2010								$				%
Net sales		$	24,383				100.0	%		$	21,084				100.0	%		$	3,299				15.6	%
Cost of products sold			11,280				46.3	%			10,668				50.6	%			611				5.7	%
Gross margin			13,104				53.7	%			10,416				49.4	%			2,688				25.8	%
Sales, general and administrative expenses			9,478				38.9	%			9,416				44.7	%			62				0.7	%
Research and development expenses			2,363				9.7	%			1,686				8.0	%			677				40.1	%
Loss on write down / disposal of fixed assets			48				0.2	%			38				0.2	%			10				26.1	%
Income (loss) from operations			1,212				5.0	%			(725	)			-3.4	%			1,937				*
Interest and other income, net			15				0.1	%			10				0.0	%			5				50.0	%
Income (loss) before provision for income taxes			1,227				5.0	%			(714	)			-3.4	%			1,941				*
Provision for income taxes			91				0.4	%			1,621				7.7	%			(1,530	)			-94.4	%
Net Income/(loss)		$	1,136				4.7	%		$	(2,335	)			-11.1	%		$	3,471				*

Net Sales

For the three months ended September 30, 2011 and 2010, sales by product line and by geography were as follows (dollars in thousands):

		Three Months Ended September 30,
		2011								2010
Sales by Product Line
TASER X26		$	8,659				35.5	%		$	11,600				55.0	%
Single Cartridges			7,631				31.3	%			5,145				24.4	%
TASER X2			3,697				15.2	%			—				*
TASER Cam			706				2.9	%			545				2.6	%
TASER C2			578				2.4	%			767				3.6	%
ADVANCED TASER			724				3.0	%			237				1.1	%
AXON/EVIDENCE.com			181				*				137				*
TASER X3			6				*				190				*
XREP			74				*				168				*
Other			2,127				8.7	%			2,295				10.9	%
Total		$	24,383				100.0	%		$	21,084				100.0	%

		Three Months Ended September 30,
		2011				2010
United States			81	%			89	%
Other Countries			19	%			11	%
Total			100	%			100	%

Net sales increased $3.3 million, or 16%, to $24.4 million for the third quarter of 2011 compared to $21.1 million for the third quarter of 2010. The increase in sales versus the prior year quarter was primarily driven by stronger domestic law enforcement sales as the TASER X2 comprised 15% of total net sales in its first full quarter of production. Additionally, international sales improved with an increase in follow on cartridge orders placed by several international customers. Sales of our X26 ECDs declined as customers are upgrading to the X2, while cartridge sales increased $2.5 million or 48% due to international shipments in the quarter. Sales of other ECD products and accessories including TASER Cam, TASER C2, ADVANCED TASER, TASER X3 and XREP increased by $0.2 million and on a combined basis represented 9% of total net sales in both the third quarters of 2011 and 2010. Other sales, which include extended warranty revenue, out of warranty repairs, government research grants, training and shipping revenues, decreased $0.2 million driven by training revenue from our annual TASER Master Instructor Conference which took place in the third quarter of the prior year compared to the second quarter of 2011.

International sales for the third quarter of 2011 and 2010 represented approximately $4.6 million, or 19%, and $2.3 million, or 11%, of total net sales, respectively.

Cost of Products Sold

Cost of products sold increased by $0.6 million, or 6%, to $11.3 million for the third quarter of 2011 compared to $10.7 million for the third quarter of 2010. As a percentage of net sales, cost of products sold decreased to 46.3% in the third quarter of 2011 compared to 50.6% in the third quarter of 2010. The net decrease in cost of products sold as a percentage of sales was driven by a combination of offsetting factors including a more favorable market segment mix with increased contribution from higher margin international sales; improved leverage on fixed indirect manufacturing costs following a 16% increase in sales; and a reduction in costs of EVIDENCE.com operations as the prior year costs included a higher level of maintenance effort immediately following the launch of the service. Diluting these improvements, the Company offered an upgrade program which provides customers purchasing a new TASER X2 kit with a $300 trade-in credit to replace any existing ECD. This offer generated approximately $1.0 million of trade-in credits during the third quarter, which reduced the average selling price on X2 sales and consequently reduced gross margin by 180 basis points.

Gross Margin

Gross margin increased $2.7 million, or 26%, to $13.1 million for the third quarter of 2011 compared to $10.4 million for the third quarter of 2010. As a percentage of net sales, gross margin increased to 53.7% for the third quarter of 2011 compared to 49.4% for the third quarter of 2010, a result of the factors discussed above under cost of products sold.

Sales, General and Administrative Expenses

For the three months ended September 30, 2011 and 2010, sales, general and administrative (“SG&A”) expenses were comprised of the following (dollars in thousands):

		Three Months Ended September 30,
										$				%
		2011				2010				Change				Change
Salaries, benefits and bonus		$	2,678			$	2,538			$	140				5.5	%
Legal, professional and accounting fees			1,583				1,469				114				7.8	%
Travel and meals			739				784				(45	)			-5.7	%
Stock-based compensation			519				692				(173	)			-25.0	%
Consulting and lobbying			663				787				(124	)			-15.8	%
Depreciation and amortization			489				533				(44	)			-8.3	%
Sales and Marketing			650				791				(141	)			-17.8	%
D&O and liability insurance			451				410				41				10.0	%
Other			1,706				1,412				294				20.8	%
Total		$	9,478			$	9,416			$	62				0.7	%
Sales, general and administrative as % of net sales			38.9	%			44.7	%

Sales, general and administrative expenses were $9.5 million and $9.4 million in the third quarter of 2011 and 2010, respectively, an increase of $62,000, or less than 1%. As a percentage of total net sales, SG&A expenses decreased to 38.9% for the third quarter of 2011 compared to 44.7% for the third quarter of 2010. The slight dollar increase for the third quarter of 2011 compared to the same period in 2010 is attributable to a $0.1 million increase in salaries, benefits and bonus driven by annual salary increases and an increase in legal, professional and accounting fees attributable to the timing of various legal proceedings. This was partially offset by reductions in sales and marketing related costs including advertising, tradeshows and outside commissions, and consulting and lobbying fees as we continue to focus on maintaining strong cost control measures. Stock based compensation expense also decreased as previously granted options became fully vested throughout 2011. In addition, $0.2 million relating to a litigation settlement for an officer training injury claim was included in other expense in the third quarter of 2011.

Research and Development Expenses

Research and development expenses were $2.4 million and $1.7 million for the third quarter of 2011 and 2010, respectively, an increase of $0.7 million, or 40%, compared to the prior period. The increase was primarily attributable to a reduction in the allocation of EVIDENCE.com service and maintenance costs to cost of sales from in the third quarter of 2011. The costs allocated in the third quarter of 2010 were elevated immediately following the launch of the service. Additionally, professional fees increased associated with new product development.

Provision for Income Taxes

The provision for income taxes decreased by $1.5 million to $0.1 million for the third quarter of 2011 compared to $1.6 million for the third quarter of 2010. Our estimated full year effective tax rate for 2011, before discrete period adjustments, is approximately 50%, which is above the statutory rate due to the impact of non-deductible expenses for items such as ISO stock option expense, meals and entertainment and lobbying fees, which make our projected annual net income for tax purposes significantly higher than our pre-tax book income. Additionally, we recorded a discrete tax provision amount in the third quarter of 2011 related to a 2010 tax return to provision true-up adjustment, primarily driven by higher than expected research and development tax credits, resulting in an effective tax rate of 7% for the third quarter of 2011.

During the third quarter of 2010 a provision for income taxes was recorded despite the net pre-tax loss since the quarterly tax provision is computed from the year-to-date provision less the cumulative tax provision recognized through the previous quarter end. As such, the year to date tax provision reflected our expected annual effective tax rate based on projected 2010 results. At the end of the third quarter of 2010, our estimated full year effective tax rate, before discrete period adjustments, was a 22% benefit which was below the statutory rate due to the impact of non-deductible expenses which made our net loss for tax purposes significantly lower than our pre-tax book loss. Additionally, we also recorded a discrete tax provision amount in the third quarter of 2010 related to a 2009 tax return to provision true-up adjustment, primarily driven by lower than expected research and development tax credits.

Net Income (Loss)

Our net income increased to $1.1 million, or $0.02 per basic and diluted share, for the third quarter of 2011 compared to a net loss of $2.3 million, or $(0.04) per basic and diluted share, for the third quarter of 2010.

Nine Months Ended September 30, 2011 Compared to the Nine Months Ended September 30, 2010

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)
		2011								2010								$				%
Net sales		$	68,698				100.0	%		$	64,049				100.0	%		$	4,649				7.3	%
Cost of products sold			31,145				45.3	%			30,520				47.7	%			625				2.0	%
Gross margin			37,553				54.7	%			33,529				52.3	%			4,024				12.0	%
Sales, general and administrative expenses			27,887				40.6	%			29,719				46.4	%			(1,832	)			-6.2	%
Research and development expenses			7,908				11.5	%			8,881				13.9	%			(973	)			-11.0	%
Litigation judgment expense			3,301				4.8	%			—				—				3,301				100.0	%
Asset impairment			1,354				2.0	%			—				—				1,354				100.0	%
Loss on write down / disposal of fixed assets			796				1.2	%			38				0.1	%			758				*
Loss from operations			(3,694	)			-5.4	%			(5,109	)			-8.0	%			1,415				-27.7	%
Interest and other income, net			1,303				1.9	%			24				0.0	%			1,279				*
Loss before benefit for income taxes			(2,391	)			-3.5	%			(5,085	)			-7.9	%			2,694				-53.0	%
Benefit for income taxes			(1,252	)			-1.8	%			(897	)			-1.4	%			(355	)			39.5	%
Net loss		$	(1,139	)			-1.7	%		$	(4,187	)			-6.5	%		$	3,048				-72.8	%