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Colin Angle - CEO

Analysts

Mark Strouse - JPMorgan

iRobot Corporation (IRBT) JPMorgan Global Technology, Media and Telecom Conference Call May 14, 2013 2:50 PM ET

Mark Strouse

Thank you all for coming. My name is Mark Strouse; I help cover Applied and Emerging Technologies here at JPMorgan. We are very happy to have Colin Angle the CEO of iRobot which if you guys aren’t familiar with the company I think is probably one of the coolest little companies to do research on. So, very happy to have you here. If we can just get started, spend a couple of minutes assume there is some people in the audience that aren’t familiar with the story and give a brief overview of what you guys do?

Colin Angle

We are happy too, thank you and I’m glad to be here. So iRobot is a 23 year old company found back in 1990 on the premise that it was about time that the robot revolution that we all expected would be here finally got here. Through our history we have investigated and developed product in a number of different markets, we’ve worked in the oil industry, we’ve worked in the toy industry, we’ve worked in the industrial cleaning industry and we worked with the military in the early days. This all led to sort of the modern era iRobot which I think was appropriately born in 2002 when we sent our military robots to Afghanistan to help with the Bomb Disposal Program and launched the Roomba robot floor vacuum same year. After that the company has grown very substantially to where we are today. We’ve shipped over 5000 robots to the military more importantly we’ve delivered over 9 million Roomba robot vacuum cleaners and other home robots into the market.

The Roomba has grown and established a new category in home care so the robot vacuuming category is now acknowledged and tracked and in some areas of world such as Spain the Roomba is the number one selling vacuum cleaner in the entire country, vacuum cleaner. So we take in about depending on the region between 13% and 18% of the dollars spent on vacuums over $200 so that the category actually has grown and is a very nice size and growth rates in the business are quite attractive where we’ve guided to increasing our Home Robot business of about 22% for 2013 and are off to a very, very nice start on that figure.

So the last thing I’ll say is that again the iRobot as we are constituted today about 90% of our revenue comes from the Home Robot side, about 10% of our business comes from the military side. The significant shift from two years ago last year we saw a changing environment on the defense side, but we took action and now we have a good right-sized defense business and we believe the defense will continue to be approximately 10% of our business on a go-forward basis. We’ve developed a number of new products that I’m sure we will talk about but that is my quick overview.

Mark Strouse

Okay, nice. So because Home Robot is 90% let’s start with that obviously. So iRobot is now truly a global company about two-thirds of that segment’s revenue comes internationally. At your Analyst Day which you guys had last week you pegged your global market share in the low double-digits and again this is for high-end vacuums not just robotic vacuums but high end vacuums in general in the low double-digits. Where do we think that penetration can get in a couple of years, five years, 10 years from now?

Colin Angle

Well, the – it is a better way to vacuum your floor and so we believe that anyone who is currently employing a vacuum cleaner is in our target for eventual replacement and allowing them to upgrade to use robots. The – from a household penetration perspective and let me just be clear on these statistics the number of households is still in the low single digits of homes that have Roomba’s but we are commanding a significant part of – percentage of the dollars spent around, in Europe it’s about 13% of the dollars spent on vacuums over $200 comes to iRobot.

So, where can it go, well I think that you can look there was a study done a number of years ago where the question was posed of the people interested in buying a vacuum cleaner over the next 12 months, what vacuum cleaner would you like to buy and 30% of them said a robot vacuum cleaner. So at least four years ago and I would claim that the awareness and maturation of the robot vacuuming industry has only improved this statistic over time but four years ago about 30% of the people stated that they plan on buying a robot over the next 12 months, of course that overstates the number of people who actually do but I think it is an accurate assessment of desire for this type of product. So I think bottom line we’re still in early days as far as the penetration of robot vacuum cleaners and we have a lot of growth opportunity ahead of us.

Mark Strouse

Right. Okay, so let’s just kind of go by region here. APAC a couple of years ago you guys pegged at your market share around 5% last week it’s now you’re saying now it’s now 13%. Is there a specific country that’s responsible for that Japan, China and then regarding China how material is that I mean you guys have been talking about it for few quarters now, how far along are we in establishing that channel?

Colin Angle

Sure. The dominant channel today in market size is Japan, so Japan is our largest market currently outside of the United States. It is a channel which grows, it’s been amongst our most sustained high growth channels and again where we’ve guided to it growing in excess of 20% again in 2013 so remained vibrant and healthy. And of that 13% of vacuums that figure is almost entirely driven by Japan.

It is still early days in China. We have selected a distributor, we have presence in retail, we established that last year and this year we’re beginning to scale so that it will be contributing single digit millions of dollars to our revenue this year but I can tell you the growth is exciting, it is off a small base but we sold more robots in April than we sold all last year. So the expansion in retail presence has afforded that and we feel like this is going to be a market which will be very, very important. We’ve seen comparable sort of high end consumer goods being sold in China where the manufacturers would report that China is the largest market outside of the U.S. for them. So I think that this will be a growth driver very material in the coming years.

Mark Strouse

Okay. I think people that have known the story for a few years kind of know the secret sauce but for those people that are new to the story and see you going into China. How do you get them comfortable with the threat of knock-offs?

Colin Angle

Well, the grey import, the knock-off risk of products manufactured in China coming into other markets is something that we have long had to deal with about 18 months after we first launched Roomba 2002 we saw the beginning the first Chinese knock-offs. The challenge is that building a robot is a very, very challenging thing is expensive, millimeters matters and the reliability of something that is operating for hours on end on your floors is a very daunting task and then with more as the market has matured we’ve added sophisticated navigation technology, HEPA filtration, Dirt Detection.

And so, even to be feature competitive you need to have technology which is not easily available and obviously all protected by strong IP. And so, we have seen well over 100 attempts at creating Roomba knock-offs but none of them have achieved market relevancy. The competitive threat that we do see comes from more established consumer electronics firms probably our biggest competitor and this is only in Europe is Samsung, they are a much smaller player in Asia and in North America based on the strength of our IP we have seen very, very limited competition if any.

So, in Europe our IP portfolio is now maturing and issuing giving us more tools, should we ever need to use it, we tend to like to rapidly obsolete our own technology and move quickly and raise the bar as our preferred method of protecting ourselves from competition but we certainly have a formidable IP defense should we ever need to put into play.

Mark Strouse

Okay. So switching to Europe and I mean obviously they’ve had macro issues there for several years now. iRobot though just started feeling pressure there within the last quarter or two. Why was there a delay and what are you guys doing to address that weakness?

Colin Angle

Okay. So in Europe, we have been able to defy gravity relative to their economic malaise for a number of years. I think this is predominantly because the newness of the robots in the market created demand growth in excess of the chilling effect from the economy. What we are seeing is a continuing deepening of the economic malaise and at this point it is impacting us so that our growth rates have in fact slowed. And as we look at the small domestic appliance data we’ve certainly still handily outperforming the category as a whole but do – are not fully immune to these economic macros.

So, what are we doing about it, certainly our distributors are advertising we are also upping our marketing dollars to help more people become aware of these products that is effective, we’re also rolling out a new product which is our electrostatic cloth cleaning hard floor robot called (Brava). And this is a product which was specifically targeted at European and Asian distribution. So we’re very optimistic that this will be a well received addition to the lineup and should allow us through adding this product on to our portfolio compensate and allow us to regain the types of growth rates that we’ve targeted and talked about.

Mark Strouse

Yeah. Just switching to the U.S., we went through a period where iRobot was kind of right-sizing its channel. So revenues just kind of bumped along but on the good side your margins increased dramatically and then last year revenues reaccelerated and you are able to maintain and even grow the margins. Why was that, is it just the new higher ASP products or expansion, re-expansion of the channel and I guess how should we think about the domestic market going forward?

Colin Angle

So, the – if you think of a typical U.S. technology product company and look at markets Asia, Europe and North America typically North America would be your largest market followed by Asia and lastly by Europe. For iRobot for a number of historical reasons that’s actually inverted so we are significantly underperforming in North America relative to the natural order of things. And the reason for that had to do with the fact that we were in North America first at a time when we had very little leverage with the retailers. As we are able to gain that leverage and apply it that led to higher margin product and with higher margin product became the ability to make money with a promoted advertised product.

And so, this was a systematic plan, fixed margins with margins fixed then begin investing in TV advertising and print and radio. And last year was the first year where we substantially increased by nearly 70% or $10 million the amount of money we spent on advertising and we are able to parlay that into a 30% growth net of a return adjustment with a return adjustment it actually shown in our book is over 40% increase for the year in sales in North America. So that advertising showed that the demand was there if we could get the right TV commercial and we continue that same program this year. And so net-net we think that growth is we have an opportunity for continued strong growth and based on the fact that North America is still below the other regions of the world again we have great confidence that we have number of years of runway in North America.

Mark Strouse

Okay. Colin, I get a lot of questions on margins I mean I think people look at the historicals and see gross margin 30% four or five years ago now they are at least on the Home Robot side in the mid to upper 40s. Are there further costs that can be taken out I mean how should we think about margins over the next not necessarily 2013 but next two or three years?

Colin Angle

Our long-term financial model is sustained growth in the mid to high teens and our EBITDA percentage in the high teens. We’re currently around 13% EBITDA and so that I think that what we have committed in our site line too is around four to five points of EBITDA expansion that’s going to come from both product margin improvements as well as OpEx reductions, our OpEx is still higher than its natural state because of the integration, completing the integration of Evolution Robotics as well as the finishing, the right-sizing of the defense business which is at this point is complete but now the cost need to flow through and our P&L.

So, we see good opportunities to bring down the cost and on the product margin side not a lot on the Roomba side from the factories reducing our BOM cost instead we see opportunities adding features enabled by a software continuing to look at the high-end of the marketplace as an opportunity for expansion and monetizing some of the more software enabled dimension of the product. So, we’ve got expansion in front of us, it’s just probably not going to be based on optimization of the cost of ABS plastic.

Mark Strouse

All right, okay. So let’s switch to healthcare…

Colin Angle

Okay.

Mark Strouse

You haven’t quite or you’re not breaking it out, it’s still in Home Robot so still early days but can you explain to us what exactly the robot is the RP-VITA and the used case for hospitals and the super bear argument would be why not just have an iPad at the end of hospital there?

Colin Angle

Sure. So, just to be clear, you are right. We are consolidating the financials for a Remote Presence business unit in home currently but we do have an independent standalone business unit focused on Remote Presence Technologies. So what we developed is a system where robot can be driven around in environment, create a usable map of that environment and then with a touch screen based interface deploy that robot anywhere on the map. This system has been through FDA approval and that navigation system coupled with a communication system is being rolled out into hospitals today for use by doctors to diagnose patients at a distance. The key reason why you want a robot as opposed to a Tablet or a video conferencing system in a cart has to do with integrating technology into the hospital.

Hospitals don’t change well IT and hospitals is a very challenging area and if you are asking someone if every time you wanted to create a dialog with the patient, with a doctor at a distance you needed to involve IT or even if you needed to involve a nurse to wheel the cart containing the technology into the room where the patient is, you are creating nearly a very challenging barriers to overcome as far as increasing the utilization of the robot. It’s more important than it sounds. What this RP-VITA system allows is the hospital to operate like it has traditionally operated except the doctor is in a different state. So someone comes in the hospital with a stroke they need to see the strokes specialist, the strokes specialist is summoned instead of calling the doctor and having him walk from his office to the patient the iPad is contacted with the doctor, cell phone is contacted and the robot is sent to where the patient is and the doctor joins when the robot has self-deployed to where the patient is.

There then a very high fidelity interaction where the doctor can go look at any of the instruments and monitors in the room can interact with the patient bend over, touch your toes, do whatever the interaction needs to be in order to make the diagnosis with the diagnosis made, the doctor then signs off and the doctor – and sorry the robot goes and plugs itself back into recharge. The nurse doesn’t have to do anything, there is no IT involvement in having to do anything and so the process is identical to the old process and that is very, very important in gaining acceptance and practically deploying this type of technology. It also opens the door for more opportunities for the unit to be used. There are new opportunities where the robot could be used to diagnose or manage patients which require specialists in many different parts of the hospital and so again self-deploying of that technology is crucial in order to exploit that.

So, we’re just at early days, we’ve shipped about two dozen of these robots in hospitals and we’ve got about eight robots fully up and running and there was a raft of reporters that were descended upon the doctors and some very exciting reports coming out from those reporters recently about how effective and impactful the system is.

Mark Strouse

To the extent that you guys have shared this. Can you just talk about the economics a bit for RP-VITA? You are partnering with In-Touch Health initially. And I guess just what are the ASPs for the robots, what’s the split between iRobot and In-Touch and then a follow-up would be, if there is any other Remote Presence customers or partners that are in the pipeline?

Colin Angle

Sure. So we chose to develop this healthcare business in partnership with In-Touch Health. In-Touch Health is a private startup company about 10 years old founded by a gentleman Dr. Yulun Wang, who is one of the father of robotic surgeries if you ever, if you know of Intuitive Surgical and the da Vinci Robot, well here is the guy that was in at the beginning, his company Computer Motion merged with Intuitive and so he is a heavyweight in the space. The economic model for RP-VITA is a leasing model where In-Touch Health leases the robot to the hospital for about $5000 a month. iRobot sells our system to In-Touch on an OEM basis, so we have a direct sale so we can reckon as revenue and a service contract. So the leasing front-end to the customer is all managed by In-Touch Health. We haven’t at this point released the pricing and margin so I’m not going to give you an answer on that one.

Mark Strouse

Okay. So moving on Jeff Beck your COO now, right has talked about applications for the whole house, roof, curtains, garden, drive-ways et cetera. What kind of timeline, do you think is realistic before the company can express itself in these areas?

Colin Angle

Sure. I think I’ll get to your question in two parts. You asked about next markets for the RP-VITA technology and we have talked about the fact that the healthcare is really the first step in rolling this type of Remote Presence technology out broadly. We chose healthcare because our long-term strategy involves providing doctor and nursing services into the home when the price of the systems are correct, right now they are too expensive. But this was important to us to bring that technology into the company but also because it was the highest value system so that we could charge money for the solution because of the value of what was being brought which allowed us to have a installation service and support service which were somewhat labor-intensive over time the cost go down and our opportunities for new markets expand. There are opportunities in security, opportunities in retail, opportunities in business collaboration mobile video conferencing in business that I think are also very, very exciting. And what I will commit to is that by the end of the year we’ll have talked in great detail about what our next new market is for this technology.

So, with regard to Jeff’s comment about the future of the autonomous or the robot enabled home, again, we are still in early days. I think we have crossed the chasm and created a wonderful business with the robot vacuuming. As I talked about we’ve got our channel under control now, we have advertising under control and that are enjoying very aggressive growth of the Roomba. The next target is applying that same marketing energy against our floor washing robots and our swiffer robots. So these are products that have been announced are in the marketplace but are under marketed at this point in time and so that is low-hanging fruit.

Then in the home there are many other things that we don’t currently have products that people care a lot about from ironing to washing windows to mop loading, mowing lawns and I think that we began talking at Analyst Day about how excited we are that at the lawn mowing market it’s already developed into a $100 million dollar business in Europe we are not currently in the lawn mowing market but we do think that it’s an interesting place that we should be moving into and Jeff did confirm the existence of a lawn mowing initiative. Unfortunately, we don’t yet have an initiative in laundry folding or ironing but I'm waiting for that probably will happen as well. This is harder because you have to have grasping and arms at a price point that consumers could afford, we’re not there yet.

Mark Strouse

Right. Okay. So defense is only 10% of revenue. So, I’m going to spend a little bit of time on that but I guess the big question is, I mean how much visibility do you have in your guidance for the year and sequestration just what is the expected impact on any of your programs?

Colin Angle

Well, sequestration and the challenges that the federal government has in making and committing to budgets had a devastating impact on our military business last year. Our revenues decreased by over a $100 million on the defense side and it was a challenge. We took significant action to right-size the division and to also broaden our channel who you’re selling to and so that we put a significant energy into international markets as well as state and local police. And we are now at a point where I think we’ve got things under well under control we have over 80% visibility into the year in the form of committed backlog or delivered product. And so we feel, which is by comparison a higher percentage than we have ever had for year at this point.

Mark Strouse

Right.

Colin Angle

So that’s well in hand and looking forward we can start to see how we’re going to build up next year. So, this is a business again that is unfortunately reduced from prior year but our exposure to the defense industry being reduced to something I'm actually quite happy with 10% is at a point of revenue where we’re unlikely for that to meaningfully affect our business at this time.

Mark Strouse

Right. So, last one from me and then we’ll open it up. I think Paul walked away from the Analyst Day last week feeling that iRobot has a lot of patents regarding perception, cognizant technology, his impression I guess was that there are many applications beyond robotics that this company could address. I guess first of all, do you agree and then I mean how could you go about monosizing that. For example I think he talked about patented technology that can recognize that an object is indeed a chair and is certain type of chair?

Colin Angle

Sure, the much of the technology that is the mobile technology set out there today, he started off in the robot industry. We cared a lot about mobile because our robots moved around and so voice and video-over-IP a lot of early research was done in the robot industry computer vision, speaker recognition and gestural interfaces which are now the domain of the video gaming industry all had origins in robotics. What Paul saw was some of the computer vision technologies that we have been working on for well over a decade and we are and some other technologies that we have developed at Evolution Robotics the company that we recently purchased and the value of the technology we purchased was one of the drivers for doing that deal.

So, we have some very important technology using cameras to navigate around buildings inside is called vSLAM and iRobot has some of the fundamental patents in this type of technology - this type of navigation, which will be the winner because we use cheap cameras, very small amount of computational power and can flexibly build and navigate in maps, build maps and navigate in them that’s important.

You mentioned iSpot, which is the technology we developed, which crawls the web looking for classes of objects so you train it on chairs, it goes and sucks down tens of thousands of images of chairs, extracts the chariness characteristics that can be visually interpreted and then in real-time you can scan this room and we’ll put a nice box around every chair regardless of the lighting for the partial occlusion because you are sitting in it with very, very high accuracy that’s critically important as robots are being expected to higher value, perform higher valve tasks in our world. They need to start understanding more about the world if you want to tell the robot to go to the kitchen well you can say, well, this is the room that’s got the stove and the washing machine and its probably the kitchen that’s a great value.

Now and then we have another technology about that has a very, very high probability of recognizing specific objects you showed a dollar bill and then you showed another dollar bill it will recognize all of these thing as dollar bills even with the partial view of that technology. So, these were all great for robots, for us. So we have applications outside the field of robotics and iRobot is interested thought it has not to-date been part of our business model.

We certainly would entertain opportunities to license this technology outside of robotics within the field of robotics we’ll differentiate ourselves from our competition through the use of these technologies. So, I don’t think it’s something that relative of emerging value as the sophistication what people are willing to do with the mobile devices starts to intersect with some of the visions for how robots could be used in the future. So, I think he is right and we’re willing to do it.

Mark Strouse

Pretty amazing stuff. Any questions from the audience? Go ahead, sir.

Question-and-Answer Session

Unidentified Analyst

The key question is (inaudible) but maybe you can talk about the competition?

Colin Angle

So the competition for talent I think it’s the question of how where we going to long-term succeed in that competition. I think that at this point, if you are interested in robotics you come and talk to us first. We are, our brand is very well known. We are located in Boston, which is sort of the world center of robotics research although there is some very fine organizations on the West Coast as well. So, we get the inflow of résumés and to-date have been very able to attract what we believe to be the best and the brightest.

And so, what you are describing is not something that iRobot has had to address at this point. Certainly the company needs to be very competitive with salary we can as a public company that giving stock options that’s an advantage over for engineers or for many private companies especially on the East Coast amortization of stock over it’s been more speculative grants of stock with prior companies that helps us in the East Coast less so in the West Coast they like stock options. But not yet a problem but something we track and we hired one of the best HR guys in the United States to be, to lead our HR organization, so he keeps us well abreast of that Russ Campanello.

Mark Strouse

All right. That’s all the time we have. Thank you very much, Colin.

Colin Angle

Thank you.

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