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iRobot, (NASDAQ:IRBT)

Q3 2010 Earnings Conference Call

October 28, 2010 08:30 am ET

Executives

Elise Caffrey – Head of Investor Relations

Colin M. Angle – CEO, Chairman

John Leahy – CFO, Executive Vice President

Analysts

James Ricchiuti- Needham & Company

Paul Coster-JPMorgan

Adam Flek-Morningstar

James Mcilree- Merriman Curhan Ford & Co.

Brian Ruttenbur -Morgan, Keegan & Company, Inc.

Operator

Good morning ladies and gentlemen and welcome to iRobot third quarter 2010 financial results conference call. This call is being recorded. At this time, for opening remarks and introduction I would like to turn the call over to Elise Caffrey of iRobot Investor Relations. Please go ahead.

Elise Caffrey

Thank you and good morning. Before I introduce the iRobot management team I would like to note that statements made on today’s call that are not based on historical information are forward looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Act of 1995. This conference call may contain express or implied forward-looking statements relating to the company’s results, operations and tax rates for fiscal 2010 and the fourth quarter ending January 1, 2011. These analyses are long term expectations regarding gross margin, operating expense margin, operating cash flow and adjusted EBITDA, our plans for and demand for our government and industrial robots and related costs of services, orders for our SUGV robot, future levels of product life cycle revenue, timing and order fulfillment, demand for our home robots, including international demand, mix of product revenue, competitive position and market share and market conditions.

These statements are neither promises nor guarantees but are subject to a variety of risks and uncertainties many of which are beyond our control which could cause actual results to differ materially from those contemplated in these forward-looking statements. In particular, the links and uncertainties include those contained in our public filing with the Securities and Exchange Commission. Investors are cautioned not to place undue reliance on these forward-looking statements which speak only as of the day hereof. iRobot undertakes no obligation to update or revise these forward-looking statements, whether as a result of new information, future events or circumstances or otherwise.

During this conference call we will also disclose various non-GAAP financial measures as defined by SEC regulations G including net income excluding the impact of a one-time cash benefit, earnings per share excluding the impact of a one-time cash benefit and adjusted EBITDA which we define as earnings before interest, taxes, depreciation, amortization, merger and acquisition expenses and non-cash stock compensation expense. Reconciliations between net income excluding the impact of a one-time cash benefit and net income, earnings per share excluding the impact of a one-time cash benefit and earnings per share and net income, the GAAP measures must directly comparable to adjusted EBITDA and adjusted EBITDA are provided in the financial table at the end of the Q3, 2010 earnings press release issued last evening which is available on our website at www.iRobot.com.

A live audio broadcast of this conference is also available on the Investor Relations page of our website and an archive version of the broadcast will be available on the same page following the call. In addition, a replay of this conference call will be available through November 4th, 2010 and can be accessed by dialing 617-801-68888 access code 357-24-357.

On today’s call iRobot Chairman and CEO Colin Angle will provide a review of our company’s operations to achievements of the current quarter of 2010 as well as our outlook for business for the rest of 2010. And John Leahy, Chief Financial Officer will review jour financial results for the third quarter of 2010 and provide our outlook for the financial expectations for the fourth quarter ending January 1, 2011 and fiscal 2010, then we’ll open the call for questions.

At this point I’ll turn the call over to Colin Angle.

Colin M. Angle

Good morning and thank you for joining us. Our financial performance in the third quarter was exceptionally strong following our record first half results. Revenue was up 20% from Q3 last year and adjusted EBITDA for the quarter increased 37% to $11 million, far exceeding our expectations. EPS grew 80% to $0.18 excluding the impact of the $2.3 million one-time tax benefit.

During the quarter, we increased our investments in the business especially in the area of research and development while also exceeding our financial expectations. For the full year, we are raising 2010 revenue expectations one again to $395 million to $400 million, representing growth of more than 30% over 2009. We are increasing our expectations for EPS to a range of $0.80 to $0.82, more than two times our 2009 EPS; and adjusted EBITDA to $46 million to $48 million, more than double adjusted EBITDA last year.

Full year earnings per share excluding the one-time tax benefit are expected to be $0.72 to $0.74.

Possible growth in the quarter was driven by both divisions. Home robot revenue increased as a result of continuing strong demand in European and Asian markets. Increasing demand for our products continues to outpace concerns about softening international economy. During the quarter we also had our first land America sales in Chile. Our government and industrial robots divisions’ revenue growth in Q3 was driven by the sale of a significant number of small unmanned ground vehicles and tax off spare parts.

Our continued focus on strengthening the balance sheet resulted in quarter-end cash and investments of $107 million up 71% from $63 million a year ago. A critical component of improving our cash position over the past year has been through driving adjusted EBITDA and operating cash flow. Adjusted EBITDA was $11 million of revenue compared with $8 million in Q3 in 2009 and we generated $10 million of operating cash flow for the quarter. We are having a terrific 2010 on the heels of a strong 2009 and our future looks very exciting. We operate in global markets which are growing and represent multibillion dollar opportunities. Our continuous commitment to investing in our technology has provided us with a strong, defensible, intellectual property portfolio.

Ongoing investment in the iRobot brand coupled with our IT position gives us a sustainable competitive advantage that will allow us to continue to expand our share to these large abd growing markets.

To support my optimism about our growth opportunities, we made some organizational changes du ring the quarter. We promoted retired Vice [Head] Joe Dyer to Chief Operating Officer. Joe has served as President of our G&I Division since 2006. Prior to joining iRobot he served for 32 years in the US Navy in various capacities including program manager for the FA18 program and as commander of the $23 billion Navair Organization. In addition to operationally overseeing our home robot and G&I Divisions and healthcare business units, he will spend more time in Washington advancing our company’s interest at a national and congressional level. This new role will also allow me to spend more time focusing on a long-term strategy, M&A, pursued alliances and new avenues of growth.

Succeeding Joe as President of the G&I Division is Knob Moses. Prior to his promotion he was Senior Vice President of the division and had responsibility for managing the division’s operations since 2003.

To help insure our continued position as a leader in developing robotic technology-based solutions we are investing in a common software technology plan to drive product generation in the future. To lead that initiative I have selected Tom Wagner and promoted him to the position of Senior Vice President and Chief Technology Officer from his previous position as Divisional Technology Officer for the Government and Industrial Division.

And finally, we recently announced that Russ Campanello will join iRobot on November 1st as Senior Vice President of Human Resources. Renowned for his expertise in the strategic role of human resources in business, Russ brings more than 25 years of industry experience and will be responsible for all human and organizational development activities at iRobot. He joins the company from Phase Forward following three years as Senior Vice President of HR and Administration and prior to that at Keane, a $1 billion business process and information technology services firm with more than ten thousand employees worldwide where he served as SVP HR and Marketing.

By making these changes we are well positioned to continue to carefully manage our growth long into the future.

Now I’d like to take you through some of the other highlights of the third quarter. In the Home Robot Division strong demand in international markets particularly in several European countries and Japan continue to fuel Home Robot revenue growth. These markets are proving to be particularly resilient in face of worldwide macroeconomic pressures.

Home robot revenues overseas increased almost 60% year-over-year. During the quarter we began our planned penetration of Latin America with initial retail sales in Chile and expect to have signed distribution agreements in nine countries by year end. To support that sales activity we recently opened an office in Miami.

In the US we updated our research regarding our domestic target market as part of the refined sales strategy we discussed in previous calls. We confirmed the domestic market opportunity is significant; approximately 20 million households and that our current sales channels are reaching that market. Our target customers earn above average incomes, want meticulously clean homes and believe that technology can address their floor cleaning problems but need proof that the product will work. (Gaining) trust is also an important part of their purchase process. Its refined portfolio is consistent with that of our international customers.

A couple of weeks ago we held a major press event in New York called Engineering Awesome to highlight our iAdapt navigation technology and (room based vast) clean proof power management system. That event marked the first of several of North American marketing activities that will extent into 2011. Beginning in the fourth quarter we will kick off a targeted print, radio and online media advertising campaign in the US to coincide with the holiday shopping.

Revenue in the domestic market declined slightly in the third quarter due to product availability. Following substantial year-over-year growth in the second quarter, we continue to improve domestic home robot profit margins to a more strategic place in the product and selected channels. In the third quarter we generated gross margins of 39.7%, a 9.4% each point improvement over last year.

We are committed to our strategy of profitable growth; continuing to focus on higher end products and channels. Our potential in home robots is tremendous and we have only just begun to penetrate the markets we serve. As we discuss and analyze this, the annual worldwide market for vacuum cleaners that cost more than $200 is $4 billion a year. In 2010 we’ll capture approximately 5% of that market. The robot vacuum cleaner segment of this market is the fastest growing segment and our brand awareness and strong intellectual property position will enable us to continue growing our share in this market.

Our Government and Industrial Robot Edition also delivered a very solid quarter as we shipped 186 robots, more than half of which were SUGV 310s. In addition we recently received an order from the US Air force for 30 SUGV 310s worth $4 million. This represents an exciting expansion of our customer base and we’ll provide the Air force with the capability that our current customers have come to rely on in dealing with dangerous situations in warzones.

Earlier this month we announced a $14 million order for iRobot Aware 2 robot intelligent systems software and spare parts to upgrade the US Army’s fleet of PackBot FasTac robots. When we discussed this opportunity on analysts’ day, we had expected to upgrade between 500 and 1000 of these robots in 2010. However, the army has since determined that the capabilities afforded the robots to just upgraded software and hardware are so compelling that they will upgrade their entire inventory of 1500 FasTac robots over the next several months.

This order is a gain changer for both the army and iRobot. The new Aware2 software will enable a completely modular reconfigurable robot with plug and play payloads and implementation of assistance autonomous operations. The results of this upgrade will be a standardized speed that can readily accept future upgrades as autonomous capabilities increase and new payloads are developed. And for iRobots it is an important step in the implementation of our common software strategy.

Beyond supplying soft robots to the US government, we continue to expand our international footprint adding new countries to our growing list of customers. In the third quarter we delivered more than a dozen robots to our existing NATO customers in support of ongoing missions in Afghanistan. In addition, we saw an increase in the foreign military sales channel with new opportunities in Eastern Europe and the Middle East.

As with our Home Robot market the opportunity for our government robots is significant. We have delivered more than 3500 Unmanned Ground Vehicles primarily to the US military principally for use by bomb disposal teams. We are just beginning to see the substantial infantry market opportunity for Small Unmanned Ground Vehicles materialize. Over the next 47 years we expect orders for these robots to be between 10,000 units and 20,000 units or $1 billion to $2 billion. More importantly, we have the majority of the current market size for this size robot and have proven the defensibility of our intellectual property in the sector. In addition to supplying robots, we expect to continue generating product life cycle revenue equal to approximately 25% of product revenue.

In summary, both of our businesses are performing well and we expect each to grow more than 30% at the top line of 2010 while contributing a greater percentage to the bottom line. Because of our increased visibility through Q3, we are increasing our expectations for 2010 for the third time this year. For the full year we expect revenue to be between $395 million and $400 million, EPS to be between $0.80 and $0.82 and adjusted EBITDA to be between $46 million and $48 million.

I will now turn the call over to John to review our third quarter results in more detail.

John J. Leahy

Thank you Colin. Our performance in the third quarter was outstanding especially given our very strong first half. Earnings per share and EBITDA exceeded expectations while revenue came in at a high end. Revenue grew 20% year-over-year to $94 million in the third quarter driven by continued robust growth in our international home robot business which was up nearly 60% for the quarter. Earnings per share for the quarter were $0.27 compared with $0.10 in Q3 2009.

Excluding the impact of a $2.3 million tax benefit due to the release of state deferred tax allowances, EPS for the quarter would have been $0.18; an 80% increase over 2009. EBITDA was $11 million for Q3 compared with $8 million last year. Operating cash flow of $10 million in the third quarter has driven our cash and investments position to $107 million up $44 million from Q3 last year.

In the Home Robot Division shipments grew 7% to 308,000 units and revenue of $55 million increased 23% from a year ago. International revenue increased more than 50% in the quarter to $35 million and comprised 64% of Home Robot revenue. Total domestic revenue decreased approximately 10% year-over-year following a 20% increase in Q2.

The production capacity constraints were discussed on the call last quarter impacted domestic revenue as we allocated products across markets. However, we expect Q4 domestic revenue to increase year-over-year as we enter the holiday season.

Home robot gross margin improvement was due to an increase in international as a percent of the total revenue and favorable product and channel mix.

G&I Division revenue of $40 million was up 15% from a year ago. This growth was driven by higher unit shipments primarily SUGV 310s and higher product life cycle revenue or PLR. GI product revenue was $30 million in the third quarter compared with $25 million last year. PLR was $9 million or 30% of G&I product revenue up from $5 million in 2009.

Product backlog at the end of the quarter was $34 million compared with $12 million at the end of last quarter. This backlog position does not include the recent $14 million order for Aware 2 upgrades or the $4 million from the US Airforce for 30 SUGV 310s. Including these two orders, we now have 100% of G&I’s full year revenue.

For the total company, gross margin for the quarter was 35% compared to 31% last year. The improvement was driven primarily by the improved Home Robot mix I mentioned earlier. Operating expenses increased slightly as a percentage of revenue to 27% from 26% in Q3 last year as we doubled our dollar investment in research development.

Some of the sales and marketing expenditures we anticipated making in the third quarter were deferred to the fourth quarter and others were postponed until next year.

Q3 operating cash flow was nearly $10 million compared with $13 million last year. Year to date operating cash flow was $35 million or 12% of revenue.

Inventory was 34 million at quarter end, up from 25 million a year ago due to timing of shipments and higher revenues in both divisions. Accounts receivable continue to be well managed as evidenced by our DSO of 29 days compared with 54 days a year ago.

At the end of Q3 we had cash, including investments, totaling $107 million compared with $63 million a year ago.

Now I’d like to provide you with additional detail for the financial expectations Colin discussed. Our revenue expectations for the full year have increased slightly from last quarter. While we expect both divisions to grow roughly 30%, international demand for home robots allows us to increase our expectations for that division to a range of $223 million to $226 million.

Our revenue expectations for the G&I Division will remain at $172 million to $174 million for the year. We expect Q4 revenues to be higher than Q3 and higher than record-setting fourth quarter last year.

Home Robot revenue will be driven by continued demand from our international customer base, PLR, international orders, PackBots and shipments of SUGV 310s will drive G&I revenue for the fourth quarter.

As we discussed at analysts’ day, our three-year target for gross margin is 35% to37%. We’ve made significant progress towards that target over the past year and expect full year gross margin of approximately 35%. Operating expenses will be higher in Q4 than last year due to marketing program commitments we have made to our international partners and expenditures planned to support and strengthen our brand domestically. We’ve now added 130 employees over the last year (already) in sales.

We expect Q4 to be another strong quarter with revenue in the range of $108 million to $113 million up almost 10% from our record quarter (inaudible) and 31.5% for the full year reflecting the impact of the one-time benefit in Q3.

For the full year, we are once again increasing our expectations for revenue, EPS and EBITDA.

Finally, in 2011 we expect another year of full progress towards our long-term financial goals with reasonable top line growth and healthy growth in EBITDA and operating cash flow. Given the less seasonal nature of international Home Robot revenue, the 2011 HRD quarterly revenue pattern is more likely to resemble 2010’s than that of prior years. G&I’s revenue pattern is likely to be lumpier quarter to quarter next year but continue to show solid year-over-year growth.

Now I’d like to turn the call over to Colin.

Colin M. Angle

Thank you, John. I’m very excited to be talking to you today following great quarterly and year to date results with the confidence to increase our full year 2010 expectations once again. Just to reiterate those expectations, we anticipate revenue of $395 million to $400 million, EPS of $0.80 to $0.82 and adjusted EBITDA of $46 million to $48 million. We continue to successfully navigate through the dynamic and challenging global market place in which we operate. We’re making significant progress towards our three-year financial targets; we’re making ongoing investments in building for our future and maintaining our market-leading position. iRobot is a leader in robust global markets with current annual sales of more than $4 Million. The size of our markets will continue to grow and we are focused on expanding our share of these markets. We are confident that our strong branded intellectual properties will provide us with a sustainable competitive advantage. With that, we’ll take your questions.

Question-and-Answer Session

Operator

Thank you, ladies and gentlemen. (Operator instructions). Your first question comes from the line of James Ricchiuti representing Needham & Company, please proceed.

James Ricchiuti- Needham & Company

Hi good morning congratulations on the quarter.

Colin M. Angle

Thanks James.

James Ricchiuti- Needham & Company

Question that I have is on the home robot business. I am just trying to better understand the dynamics of what you are doing in terms of product allocations in the U.S verses international. It seems like you preferred some sales in marketing expense. I am assuming out of the U.S market was this a case where you just saw a stronger demand internationally and took advantage of the better margins in that business?

Colin M. Angle

The deferral of marketing expense was not just in t he U.S, we deferred some spend in both domestic and international channels. Some of that was execution related and some of that was chasing some opportunities that we saw a little later in the year.

John J. Leahy

And as far as the allocation goes, we made some assumptions as to where we were, what products we were building that the models are not…there is a difference( skills )that we sell internationally and domestically and how we made those decisions we are making, just allowing things to play out as our logistical capabilities allow.

James Ricchiuti- Needham & Company

And then from a capacity stand point, it seems like you are increasing your guidance for the home robot business and you are…I think assuming, I kind of think a little better international business but do have much flexibility in terms of capacity?

Colin M. Angle

We don’t I mean you’ll notice that our increase in revenue guidance is very modest and that is primarily due to product availability constraints. Now those are easing late in December as our new contract manufacturer comes online. So we don’t anticipate that being an issue next year.

James Ricchiuti- Needham & Company

And last question I’ll jump back in the queue, just with respect to the U.S business and…do you feel that there has been potentially any share loss in the U.S just given the capacity constraints you’ve faced this year?

Colin M. Angle

I don’t believe that there is any share loss. We have the…our retailers are very happy with us. We are creating the…despite the capacity constraints, we are certainly giving them a very strong selling product. and the challenge of making a robot that sells and stays sold is a very daunting challenge and that the retailers appreciate the success of the product and all of the work that’s gone into making sure that the customers are delighted with our product. We are up 2% year- over-year in the U.S. So certainly it’s not like the retailers are seeing a negative vector in sales, it’s far from it. The demand is very high.

James Ricchiuti- Needham & Company

Okay, thanks very much.

Operator

Your next question comes from the line of Paul Coster representing JPMorgan, please proceed.

Paul Coster - JPMorgan

Thank you, good morning. John in your final comment there you said the GNI business next year is likely to be lumpier quarter to quarter. Can you just provide us a little bit as to why this buying pattern is changing next year?

John J. Leahy

I think it’s really just more of uncertainty in terms of timing. We’ve seen some of that this year probably more behind the scenes than what’s been visible to you and those externally but there is just…it continues to be a lot of uncertainty around the timing of when orders will come in. And so we are anticipating that the quarter to quarter water flow may just not be as smooth as we would like.

Paul Coster - JPMorgan

Then again a little bit of detail there and I understand the reason why that visibility, is it because of uncertainty in terms of budget processes to your (theory) or is it something else this time around?

Colin M. Angle

This call is going to be…the GNI sales as your call, has always been lumpy. We thought for a while there was a pattern where the second quarter would have been the weakest. This year the second quarter was among the strongest, that the priorting reason for this is that the acquisition of robots is based on when various contracts are signed and every year we have a good idea which contracts are in the works but we see a variance of three to six months from the promise date in both directions as to when those actually get signed and we can start shipping products. So this is a character risk that we have developed processes around to deal with and have a very predictable on a full year basis record of anticipating of what’s going to happen, but quarter to quarter it’s always been difficult to predict and next year is no exception. That’s the reason for that lumpiness comment. It won’t look the same, the only thing can be certain about is that it won’t look the same as it did this year.

Paul Coster - JPMorgan

That having been said, you are also pointing to maxis growth potential for the infantry context. And clearly that means that at some point, that this would improve and so where in a transitional period it sounds like when do you think that infantry demand as a massive will start to ramp up. And how will investors know or get a handle on the visibility?

Colin M. Angle

Well you know we have delivered the first four robots under the LRF and we will be delivering the next thirty nine robots by the end of the year. That’s the first stage in a large program of record acquisition of robots. So certainly when we start talking about long term contracts with higher ceilings for higher levels of robots that would be a good sign that a long easily predictable flow of this SUGV robots in the military has begin . Although it may not happen solely like that but we are seeing is outside of the aggregate combat team modernization program. We are seeing increased demand for SUGV 310’s and 320’s. So the Pentagon is definitely looking at multiple different mechanisms for acquiring a robot and you have our commitment to give as much clarity as we have to you in helping set expectations. But you are correct in that, I can’t tell you exactly how it’s going to play out today.

Paul Coster - JPMorgan

The South American (home mobile) initiative will it be in place in time for the publicized season?

Colin M. Angle

The robots…we have had very good sales in Chile so far. The distribution agreement goal was to have an in pace by the end of this year and we will certainly do that. We previously stated that we don’t anticipate material sales this year but we do expect those sales to be material next year.

Paul Coster - JPMorgan

One more question John in your partake democracy or sense of that reasonable growth next year which raises all kind of questions as to definition of reasonable, but the kind of 20% growth story still here…30% perhaps you can elaborate.

John J. Leahy

Well as you would know Paul, we don’t want be giving specific 2011 guidance at this point but what we are trying to indicate is that we think we are well on track with those three year goals that we had set out and that in 2011 should be in line with those goals. So those goals were, that we would deliver mid to high teams revenue growth year in year in out, we would achieve mid teams evened out margins within a few years and then consistently generate operating cash flow. So our messaging is that we think 2010 has obviously been a terrific year at very high revenue profit growth and what we are indicating is that we think for the next couple of years we think we are on track to continue to progress towards long term targets.

Paul Coster - JPMorgan

Thank you very much.

Operator

Your next question comes from the line of Adam (Flek) representing (Morning) Star, please proceed.

Adam Flek - Morningstar

Hi good morning.

John J. Leahy

Good morning.

Adam Flek - Morningstar

Question about the…John you talked about RMD obviously is up here quite a bit in the quarter. In your internal research expenses, is that pretty much split evenly between the home robots side and the government or does that lean one way or the other?

John J. Leahy

Adam we have a more head count on the government side so it would be mostly towards the GNI division and keep in mind that an important part of our model for RMD is government funded, RMD as well which is obviously predominantly flowing into the government division as well. So overall, RMD percentage of revenue including funded runs 13-14% for the total company, but we have been investing over the last couple of quarters; more money, more headcount into RMD and that if for the comment of RMD dollars funding for the total company going up from Q2 to Q3.

Adam Flek - Morningstar

Great and then also we’ve seen nickel costs throughout the year creep up. Are your suppliers still headed on the year and then as you bring Jebel online and home robots side, do you anticipate that the double hedged nickel costs as well?

John J. Leahy

We have two or three battery suppliers now which is an improvement is from where we were a couple of years ago and we have locked in…we had for 2010 are pricing for batteries locked in before the beginning of the year. And with our major supplier of batteries, we’ve now already locked in pricing for 2011 which either will greatly minimize any risk from price flings in nickels. So we feel pretty good about the pricing that we’ve already secured for 2011.

Adam Flek - Morningstar

Great, that’s it from me thanks.

John J. Leahy

You are welcome.

Operator

The next question comes from the line of James Mcilree representing Merriman, please proceed.

James Mcilree - Merriman Curhan Ford & Co.

Thank you, good morning.

John J. Leahy

Good morning.

James Mcilree - Merriman Curhan Ford & Co.

Can you talk about the aware to shipment schedules, do you think that that entire $14 Million order will be completed this year or does it bleed in to the next?

Colin M. Angle

It will be completed over the next two quarters, so Q4 and Q1 of 2011.

James Mcilree - Merriman Curhan Ford & Co.

Okay and is it reasonable to think that’s its kind of evenly split or does that mean one of the….I am sorry?

John J. Leahy

More or less, I think it’s probably a little back-end loaded.

James Mcilree - Merriman Curhan Ford & Co.

Okay great. And then for 2011 in terms of the composition of the unit shipments of the GNI division, is that going to be almost all as you all serve these or is there still some residual PackBots in there?

Colin M. Angle

Well certainly, the PackBot product line continues to be vibrant but we are not going to give a detailed break down at this time of what we anticipate but the PackBot is strong internationally, we expect that to continue.

James Mcilree - Merriman Curhan Ford & Co.

Okay great. The operating expense deferrals in Q3, how much…it seem like you have a lot of flexibility to make those renown, make those this quarter and the next and I am trying to understand, what goes into your thinking to defer them or not defer them?

John J. Leahy

James you are right, we do have flexibility in the uptake in spending we anticipating for Q3, as Colin mentioned earlier in the marketing area and some of that did not come into fruition, and part just to challenges and executing those programs and also because we chose to (ring) and back a bit, largely because of the production constraints that we’ve talked about the last couple of quarters. But we do anticipate in Q4 to be upping our marketing spending both in domestically and overseas and as you suggested, we do have a fair amount of flexibility in terms of whether we choose to do that or not. But our expectations are that we will, because we do feel that the impact of supporting the brand in a heavier way than we have over the last couple of years will be beneficial in both the near term and the long term.

James Mcilree - Merriman Curhan Ford & Co.

Is it fair to say that part of the reason for the deferral was also based on the stronger European and Japanese demand than you have expected?

Colin M. Angle

I think it’s more operational the strong demand internationally calls a lot of excitement and work on those sides which lead to the deferring of some of these marketing programs but we are very committed to those programs until that they’ll put the (parts in good stand) as we finish the quarter and go into the next year; also just to point out that strength on our direct side, as that grows that also adds to our below the sales in marketing costs because that’s where we accrue some of those expenses.

James Mcilree - Merriman Curhan Ford & Co.

Right, okay and finally can you just comment briefly on Ranger where that is and in its development in international.

Colin M. Angle

Ranger is a new product development program so that we are at the sort of actively building and designing this product. We’ve had some prototype units that have been in operational tests but it is not yet a product. So that you should expect to hear more about…more information about when we would sell that to customers beyond the research community next year, so that’s sort t of a stay tuned in development program.

James Mcilree - Merriman Curhan Ford & Co.

Great , thank you and very impressive results.

Colin M. Angle

Thank you very much.

Operator

The next question comes from the line of Brian Ruttenbur representing Morgan Keegan, please proceed.

Brian Ruttenbur -Morgan, Keegan & Company, Inc.

Yes thank you very much, great quarter. The question that I have some of them have been touched on a little bit but can…you talked a little bit about going forward with the sales and marketing. The fourth quarter has been a ramp up obviously and can you talk about how you expect that top then drop off then in the first quarter and then go back up in the fourth quarter. Can you talk a little bit about seasonality of some of your operating expenses, I know you are not prepared to talk as much about revenue but may you can talk a little bit about expenses by quarter.

Colin M. Angle

Sure the…from the sales and marketing perspective on the home side, you have a couple of differently competing drivers. Domestically, we then tend to get the biggest return of generating demand around the modest day time frame and the holiday season. However we also think competing with that inherent two peak seasonality, is a desire to create a bit of a drum beat of awareness for the product because as Roomba continues to become more named strain, we are finding the product less as a gift and more as a “my” vacuum cleaner broke, I think maybe I will try out the room though maybe I am just tired of vacuuming the floor every day, let’s have a robot do it. And so it’s applying to the vacuum cleaners in particular and not inherently seasonal and so that we want to be the mind spaced of our customers year round. So that you will see an increased in sort of a drum beat with some spiking around those two areas domestically. Internationally, the product is much a less seasonal and that’s a consistent through the year awareness program would be the ideal.

Brian Ruttenbur -Morgan, Keegan & Company, Inc.

Okay so help me out within numbers, a little bit more concrete. We are going to see $14 to $15 Million in sales and marketing in the fourth quarter, is that a right number?

John J. Leahy

We don’t want to get into that level of detail but I would suggest to you Brian is that we do expect uplift in Q4 in sales and marketing and part due to the cost of the direct business and also investment in the brand. And we expect that as we go into next year and we will support the brands in a stronger way through sales and marketing efforts than we have in the last couple of years. The last couple of years we obviously… we really tightened down our Ex because of the uncertainty with regard Macros. Now we are seeing very good performance of the business and we are letting out the leash somewhat, and 2011 just like I mentioned earlier, we’ll have the ability to let that leash out or draw it back in based upon how the business is doing. But we expect and hope that we will be able to continue to invest more in sales and marketing as we have in the second half of this year than we did in ’08 and in ’09.

Brian Ruttenbur -Morgan, Keegan & Company, Inc.

Okay can you talk about targets per RMD as a percentage in sales and marketing then? And your target in three years is to have 6% RMD and 11% sales and marketing, give us some kind of a…

John J. Leahy

Sure our internal research and development target has long been between the range of 6 and 9% of top line. We have tended to be much closer to the 6% figure than the 9% figure. I think that given our revenue growth, despite our increased commitment to research and development that we would continue to be closer to that lower percentage figure than the higher percentage figure. But again let me remind you that we are highly successful at bringing in that government sponsored research and development dollar to more than double the IRND spent giving us mid team kind of type of overall investment as a company in research and development.

Brian Ruttenbur -Morgan, Keegan & Company, Inc.

Okay and then in sales and marketing, can you give me that same in GNI and give me that same kind of number?

Colin M. Angle

No we are not going to break that up but I can tell you that our three year target for Opex is 25 to 27% of the revenue.

Brian Ruttenbur -Morgan, Keegan & Company, Inc.

Great, thank you very much I appreciate your help.

Colin M. Angle

Sure.

Operator

Your next question comes as a follow up from the line of James Ricchiuti representing Needham & Company, please proceed.

James Ricchiuti- Needham & Company

With respect to new products in the consumer business you’ve been relatively quiet I guess for obvious reasons given the Macro economy but can you talk a little bit about 2011, in terms of new products in that area of the business?

Colin M. Angle

Well at that level let’s adjust back, I made the statement that before the next (annual stage) you see a product from home; I think that we certainly stand by that comment.

James Ricchiuti- Needham & Company

And Colin is it sounds like you are going to be sending a little bit more time in some of the newer market areas, your cash position is increasing quite a bit. I wonder if you will talk a little bit about your strategy with respect to acquisitions and you know what types of areas you might be considering in to the extent you are willing to talk a little bit about that.

Colin M. Angle

Well certainly our business performance or cash performance gives us a more significant ability to execute on MNX, so that’s exciting for us. As we think about MNX, we look at adjacencies to our current business. We look at technologies that have a unique benefit for a robot industry and we look for products that could take advantage of our existing sales channels, which you wouldn’t see us do is make a move in an industry where most of the sales and economic opportunity, lay outside of our industry like buying a new battery manufacturer would be something we’ll be less interested in because the economic opportunities, well it does overlap with robots predominantly lies outside of the world of robots.

James Ricchiuti- Needham & Company

Okay and last question from me, I wonder if it is anything neutrally important, anything that you are willing to talk about with respect to the home health in initiative that you have going on.

Colin M. Angle

Not at this time, when we announced that we try to set expectations that yes we were involved but this is a new business development opportunity and it’s something that is going to take some time to decide where the most attractive areas are for launch and then in our industry developing product is a (multi) year in endeavor . So we will keep you updated but nothing to report right now.

James Ricchiuti- Needham & Company

Okay thank you.

Colin M. Angle

Okay well that concludes our third quarter earnings call; we greatly appreciate your support and look forward to talking with you again in February to discuss Q4 results and our financial expectations for 2011.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference, this concludes your presentation. You may now disconnect, good day.

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