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iRobot (NASDAQ:IRBT)

Q4 2010 Earnings Call

February 10, 20118:30 a.m. ET

Executives

Elise Caffrey – Head of Investor Relations

Colin M. Angle – CEO, Chairman

John Leahy – CFO, Executive Vice President

Analysts

James Ricchiuti- Needham & Company

Mark Strauss -JP Morgan

Alex Hamilton - EarlyBirdCapital

Josephine Millward - The Benchmark Company

Jim McIlree - Merriman

Brian Ruttenbur -Morgan Keegan

Adam Flek-Morningstar

Operator

Good day everyone, and welcome to the iRobot fourth quarter and full year 2010 financial results conference call. This call is being recorded. At this time, for opening remarks and introductions, 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'd 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 Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements.

Additional information on these risks and uncertainties can be found in our public filings with the Securities and Exchange Commission. 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, including adjusted EBITDA, which we define as earnings before interest, taxes, depreciation, amortization, merger and acquisition expenses, and non-cash stock compensation expense. A detailed reconciliations of GAAP and non-GAAP metrics can be found in the financial tables at the end of the Q4 and full year 2010 earnings press release issued last evening, which is available on our website.

On today’s call iRobot Chairman and CEO Colin Angle will provide a review of our company’s operations to achievements of the fourth quarter and full year 2010, as well as our outlook for the business in 2011, and John Leahy, Chief Financial Officer, will review jour financial results for the fourth quarter and full year 2010 and provide our outlook for financial expectations for the first quarter ending April 2, 2011 and fiscal 2011. 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. 2010 represented a watershed year for iRobot. We delivered record full year financial results after increasing expectations three times during the year and exceeding our increased expectations in every quarter.

Our international home robot revenues grew 70%, and we delivered game-changing technology with our Aware 2 software upgrades to 1,500 iRobot PackBots in the field and we completed several senior-level organizational moves, laying the groundwork for continued success.

2010 revenue increased 34% to $401 million for the full year, while adjusted EBITDA more than doubled to $49 million or 12% of revenue. Earnings per share of $0.96 for the year, which includes an impact of an $0.08 one-time tax benefit in Q3, was more than 7x greater than our 2009 EPS.

Our exceptional results were driven by strong performance in both divisions. We demonstrated our ability to improve profitability while continuing to invest in research and development and our brand, critical to maintaining our industry-leading position.

Our continued focus on strengthening the balance sheet resulted in year-end cash and investments of $122 million, up 59% from $77 million a year ago. In 2010 we generated $49 million in operating cash flow, as a result of significantly improved EBITDA.

During the year, we invested considerable resources in developing common software that can be used across common platforms. Our intellectual property is protected by more than 100 defensible worldwide patents that we will continue to defend should we detect infringement. Likewise, our brands are protected by 18 trademark registrations in the United States and more than 65 trademarks internationally. And we will continue to invest to support our brand.

In 2011, we will continue to widen our competitive moat by delivering robots that make a difference, built on common platforms, using highly integrated iRobot-developed technology that incorporates artificial intelligence with advanced concepts in navigation, autonomy, [inaudible], and manipulation.

Further, by leveraging technology developed by third parties in areas such as VOIP, user interface, voice control, and facial recognition, we will develop high-quality robots for multibillion-dollar automated home maintenance and remote presence markets.

In the spring, we will launch technology-rich products with exciting new capabilities. Our new home robots are the Scooba 230, the world's most compact floor-washing robot, and the Roomba 700 series, featuring persistent pass cleaning, HEPA-type filtration, a high-efficiency cleaning head, and extended battery life.

Our G&I division will offer our first autonomy package for Aware 2-enabled robots. A user-assist payload system will provide self-righting, retrotraverse, cruise control, and other features that will allow soldiers to maximize the robots' [inaudible] effectiveness while minimizing the time necessary to focus on the robot.

During the third quarter, we discussed organizational changes that we've made to capitalize on our long-term opportunities. Joe Dyer, formerly president of our G&I division, was promoted to chief operating officer. Knob Moses, formerly senior vice president of G&I, was promoted to president of the division. Tom Wagner was promoted to chief technology officer from his previous position as division technology officer for G&I. And we hired Russ Campanello, a highly experienced human resources and organizational development executive, as senior vice president of human resources.

In 2011, we expect to make good progress toward our three-year financial goals of mid- to high-teen revenue CAGR, mid-teen adjusted EBITDA margins, and high single-digit operating cash flow margins. For the full year 2011, we expect revenue to be $450-465 million, growth of 12-16% over 2010, with higher growth in the home robot division. We expect earnings per share to be $0.90 to $1.00, and adjusted EBITDA of $58-62 million, an 18-27% increase from adjusted EBITDA last year.

In the first quarter of 2011, we anticipate revenue of $102-106 million, EPS of $0.20 to $0.24, and adjusted EBITDA of $12-14 million.

Now I'd like to take you through some of the details of 2010 and our expectations for 2011. In the home robot division, strong demand overseas, particularly in longtime markets in France, Spain, Germany, and Japan, continued to fuel home robot revenue growth. International home robot revenue increased 70% year-over-year and we expect overseas demand to be the driving force for home robot revenue growth in 2011.

We extended our reach further into Latin America in the fourth quarter, and are expecting revenues from that region, especially Mexico and Brazil, to begin to contribute nominally in 2011. More than 50% of our international growth this year will come from distributors with whom we've been doing business for more than three years.

2010 domestic revenue was up slightly year-over-year, but the important story in that market was gross margin improvement. Repositioning the product as well as eliminating unprofitable SKUs, lower margin programs, customers, and channels helped us achieve home robot margins of 40% in 2010, an 8% increase over 2009.

In 2011, we will continue to reposition our product through brand messaging and selective channel mix to optimize profitably placement while rolling out our new home robot products. Sales of Roomba 700 and Scooba 230 will further enhance the division's margins.

In our 2011 expectations, we have assumed flat revenues domestically due to consumer spending uncertainty. As economic conditions improve, we are positioned to capitalize on increased customer spending, which would improve our domestic market performance.

At the Consumer Electronics Show last month, we introduced the iRobot Scooba 230, a floor-washing robot small enough to clean in tight spaces and around bathroom fixtures, and the iRobot Roomba 700 series, our smartest and most effective Roomba vacuum cleaning robot to date.

The Scooba 230 and iRobot Roomba 700 series use iAdapt responsive cleaning technology, a highly intuitive, flexible, and effective way to clean your floors. A system of software and sensors monitors the environment 64 times a second, using dozens of behaviors to ensure the entire floor is thoroughly cleaned. A dirt-centric approach and technology ensures thorough coverage, including under and around furniture, and multiple passes over the areas that need it most, that our robots will simply work better.

These products will be available for purchase on our website in the spring, and will be rolled out to our domestic retail and select international customers later this year. There is strong demand for our current generation of home robots in existing and emerging international markets, and the Roomba 700 series will augment our offerings in established markets. We have sold more than 6 million home robots worldwide, and continue to be the undisputed leader in this market.

Investment in initiatives implemented in 2010 in Latin America, new product introductions, tough decisions made regarding customers and channels in North America, and the addition of a new Tier 1 contract manufacturing partner, will enable us to extend the positive, profitable growth trends we have established in this division throughout 2011 and beyond.

Our potential in home robots is tremendous, and we have only just begun to penetrate the markets we serve. Annual worldwide market for vacuum cleaners that cost more than $200 is $4 billion. And in 2010, we captured less than 6% of that market. Based on research, we believe that the market for wet floor care products at this price point is equal to that of robot vacuum cleaners. Our brand awareness and strong intellectual property position will enable us to continue growing our share of both of these markets.

Our government and industrial robot division achieved some major milestones in 2010, including receipt of the low-rate initial production contract for SUGV under the Army's modernization program, reliability results achieved during limited user testing that exceeded the Army's objective requirement for low-rate and full-rate production, and probably most significantly, we received a contract to upgrade 1,500 PackBots in theater, setting the stage for periodic software block upgrades.

In 2011, we will see continued growth from sales of our robots due to wholesale adoption of robots by the military. Our tactical ground robot performed battlefield reconnaissance, bomb disposal, and route clearance missions, saving lives every day, and have become an essential piece of the war fighter's gear.

SUGV is a smaller, lighter version of the combat-proven PackBot, which makes it easy for soldiers to carry on the backpacks. A critical aspect for soldiers fighting in Afghanistan in particular, it is designed to give war fighters real time awareness of critical situations and allow them to complete missions from safe standoff distances. It is ideal for dangerous reconnaissance missions such as entering buildings, caves, and tunnels.

We began delivering SUGVs in the fourth quarter of 2009, and have shipped approximately 400 through 2010. Soldiers have seen firsthand, and Pentagon leaders clearly understand, how robots increase the tempo of operations by providing increased situational awareness. We are just beginning to see substantial infantry market opportunity for small unmanned ground vehicles materialize.

Our big opportunity continues to be embedding our robots at the squad level throughout the infantry. We can't tell you the exact timing of the inflection point when we'll see an acceleration of orders to fill this expectation, but it is likely to happen at some point beyond 2011.

In addition to buying robots, the U.S. Army is exploring ways to upgrade its suite of small tactical robots in Iraq and Afghanistan. On our last call we discussed the $14 million order we had received to upgrade the Army's fleet with our Aware 2 software as part of this process. We are looking at ways to add new capabilities to existing robots, enabling them to perform more functions and navigate uncertain terrain without needing their every move to be controlled or tele-operated by a human.

We are moving along with that spectrum, from tele-operating to semi-autonomy, where you can send a robot from point A to point B without any intervention. iRobot's Aware Head supervisory control system software enables semiautonomous navigation. The robot uses sensors to map an area by itself, allowing the human controller to point and click on a touchscreen and send the robot to a given destination.

Soldiers want robots with modularity, interoperability, and more autonomy that will free them to attend to the additional concerns or threats, and we are working to provide them with all of these features. This technology is currently being developed and tested, and we expect it to be available in 2012.

The results of the Aware 2 software upgrade will be a standardized fleet that can readily accept future upgrades as autonomous capabilities increase, and new payloads as they are developed. Some of the newer robotic capabilities we have developed, such as automatic self-righting and retrotraversing, enable robots to correct course, change direction, or turn right side up by themselves, and are currently being tested by soldiers in theater.

For us, this upgrade is an important step in the implementation of our common software strategy. It also paves the way for acceleration of recurring revenue, which will carry higher margins and enable expansion of our competitive moat.

In other defense department news, there has been much discussion about the state of the Brigade Combat Team Modernization, or BCTM. If you recall, BCTM is the successor to the Future Combat Systems program, FCS, originally competed in 2003. Our contract under the FCS program funded the development of the SUGV.

In June of 2009, Defense Secretary Gates announced the dissolution of FCS and the acceleration and expansion of four systems under the new BCTM. During limited user testing, our system was the only system whose reliability results exceeded not only the Army's requirement for low-rate initial production, but also for full-rate production.

In the fourth quarter, we received the formal contract to procure 45 SUGVs under the LRIP. We delivered 30 of the units in 2010 and will complete the delivery of the order in the first quarter of 2011. Last month, the DOD announced its intention to terminate two of the four systems being developed under BCTM and the Defense Acquisition Board recently announced that the Army will procure two additional low-rate additional production brigade sets of SUGV this year.

Should the U.S. begin drawing down troop levels as proposed, we would expect to see systematic infrastructure equipping programs replacing the urgent-need orders currently being funded under supplementals. Until now, most of our orders have come from the latter. As this shift occurs over the next few years, our current portfolio of contracting vehicles will also be replaced with longer term programs of record, which tend to provide better visibility.

Beyond supplying robots to the U.S. government, we continue to expand our international footprint, adding new countries to our growing list of customers. In 2010 we delivered 94 robots to our existing NATO customers through both direct sales and foreign military sales. In 2011, we plan to increase revenue through shipments of robots to our international customers and through foreign military sales, growing to about 15% of our product business.

As with our home robot market, the opportunity for our government robots is significant. We have received orders for more than 4,000 unmanned ground vehicles over the past few years, primarily for the U.S. military, principally for use by bomb disposal teams. We have a majority of the current market for this size robot, and have proven the defensibility of our intellectual property in this sector.

Expanding the fleet of robots provides not only current revenue, but a stream of recurring revenue potentially equal to twice that of the robot itself, through product lifecycle revenue such as the software block upgrades I described earlier.

In summary, both of our businesses performed well in 2010, and we expect each to grow in the mid-teens at the top line in 2011 while contributing a greater percentage to the bottom line. I will now turn the call over to John to review our fourth quarter results and 2011 expectations in more detail.

John Leahy

Thank you Colin. Our performance in the fourth quarter was very strong, with revenue reaching the highest quarterly level in our history. Earnings per share, EBITDA, and cash flow all exceeded expectations. Revenue of $114 million was up 12% for the quarter, driven by growth in our international home robot business.

Earnings per share for the quarter and full year were $0.26 and $0.96, compared with $0.20 and $0.13 in Q4 and full year 2009, respectively. Our full year 2010 EPS would have been $0.88 excluding the impact of the nonrecurring $2.3 million tax benefit we reported in Q3.

EBITDA for Q4 was $12 million and our full year EBITDA of $49 million was more than double 2009 EBITDA. Operating cash flow of $50 million drove our cash position to $122 million, up $45 million from the end of last year. Our focus on driving EBITDA and cash flow produced great results throughout 2010.

In the home robot division, shipments grew 17% while revenue of $69 million increased 27% from a year ago. For the full year, we shipped approximately 1.3 million home robots and generated revenue of $229 million, increases of 28% and 38% respectively over 2009.

International revenue increased nearly 50% in the quarter, $44 million, and comprised 64% of home robot revenue. Total domestic revenues were flat in Q4, and up slightly for the full year. Home robot gross margin improvement of 600 basis points for the quarter was due to an increase in international as a percent of total revenue and improved product costs and channel mix.

G&I's revenue of $45 million was down slightly from a year ago due to the timing of product shipments. Gross margins in the division improved 500 basis points in Q4 over last year, largely due to favorable product mix.

G&I product revenue was $34 million in the fourth quarter, compared with $36 million last year. Product lifecycle revenue, or PLR, $12 million, or 34% of G&I product revenue, up from $9 million in 2009. As Colin mentioned, a contract we received in 2010 for the Aware 2 software upgrade on 1,500 robots enables future software upgrades of our growing robot base.

Total company gross margin was 40% for the quarter and 36% for the year, up 600 and 500 basis points respectively. The improvement, which puts us well within our three year gross margin target range of 35-37%, was driven primarily by improved home robot mix and product costs.

Operating expenses increased as a percentage of revenue to 33% in Q4 from 25% last year, due to the higher spend in R&D and marketing we discussed on last quarter's call. Our tax rate in Q4 was 9%, primarily due to a year-to-date catch up on the investment tax credit recently approved by Congress. The low rate increased Q4 EPS by about $0.08. our full year rate of 25% was also favorably impacted by the Q3 state tax valuation reversal.

Q4 operating cash flow was $14 million. For the full year, operating cash flow was $49 million, or 12% of revenue. Importantly, most of our full year operating cash flow was due to net income as opposed to working capital reduction.

Inventory was $27 million at quarter end, down from $32 million a year ago, partly due to production capacity constraints in our home robot division. Accounts receivable continued to perform well, as evidenced by our DSO of 30 days, compared with 33 days a year ago. At the end of Q4, we had cash, including investments, totaling $122 million compared with $77 million a year ago.

Now I'd like to provide you with additional detail and some of the underlying assumptions of the 2011 financial expectations Colin discussed. We expect full year revenue of $450-465 million, up 12-16%, comprised of home robot revenue of $260-270 million and G&I revenue of $190-200 million.

We will be lapping a very strong first half of 2010, which grew 63% over 2009. Therefore, year-over-year revenue growth will be stronger in the second half. In home robots, growth will be driven by international sales, more than half of which will be to longtime distributors, while domestic revenue will be relatively flat year-over-year.

We expect roughly half of G&I unit revenue to come from SUGV, slightly less than that from PackBot sales. Contract revenue is expected to be between $30 million and $35 million, and product lifecycle revenue is expected to total 25-30% of revenue.

International sales, SUGVs, and PLR will drive revenue growth in 2011. Timing is difficult to predict on a quarterly basis, but we anticipate more than 60% of our G&I revenue to come in the second half of the year, a much different pattern than in 2010.

We once again anticipate positive EBITDA in each quarter in 2011. Q2, EBITDA may decrease sequentially due to higher operating expenses as we increase spending in R&D and marketing. These investments will continue throughout the year, resulting in operating expenses of approximately 30% of revenue for the full year. However, we expect to see further improvement in full year gross margins, largely offsetting operating expense increases.

A few additional data points. We are assuming stock comp expense of roughly $10 million, depreciation and amortization expense of approximately $8 million, a tax rate of 37%, diluted share count of 27 million shares, operating cash flow of roughly $35-40 million, and cap ex of $12-14 million.

Finally, in 2011 we expect another year of good progress towards our long-term financial goals, reasonable top line growth, and healthy growth in EBITDA and operating cash flow.

Now I'll turn the call back to Colin.

Colin M. Angle

Thank you John. 2010 was a great year for iRobot on all fronts. In particular, during the year we delivered record full year financial results after increasing and exceeding our increased expectations every quarter during the year. We strengthened our senior leadership team and made organizational changes that positioned us well to continue, carefully managing our growth long into the future.

We expanded the international reach of our home robot division, which grew by 70%. We began delivering our Aware 2 software to the military's installed base of PackBot robots, which allow us to provide additional functionality through periodic software block upgrades and thus widen our competitive moat. And we delivered on continuous commitment to investing in our technology and the iRobot brand, giving us a substantial competitive advantage that will allow us to continue to expand our share of our large and growing markets.

In 2011 we expect stronger revenue and earnings growth in the second half of the year due to the timing of G&I orders and year-over-year comparison with our record breaking first half in 2010. We will continue to make ongoing investment in building for our future and maintaining our market-leading position while delivering revenue of $450-465 million, EPS of $0.90 to $1.00, and adjusted EBITDA of $58-62 million.

We continue to successfully navigate through the dynamic and challenging global marketplace in which we operate. We're making significant progress toward our three-year financial targets while making ongoing investments in building for our future and maintaining our market leading position.

iRobot is a market leader in robust global markets with current annual sales well more than $4 billion. The size of our markets will continue to grow, and we are focused on expanding our share.

So with that, thank you, and we will take your questions.

Question-and-Answer Session

Operator

[Operator Instructions.] Our first question will come from the line of Jim Ricchiuti with Needham & Company. You may proceed with your question.

James Ricchiuti- Needham & Company

Question on the guidance you're giving for the home robot business in 2011. At the high end of that range, that $260-270 million range, what does that assume? Are you anticipating at that high end of the range a stronger pick up perhaps in the domestic portion of the business? Or would it come more from international?

John Leahy

As we said in the call, we're assuming that domestic is relatively flat. At the high end maybe it will be up a little bit, but if we really see some pick up on the domestic side, that is not fully modeled in the guidance that we're giving. So we're assuming that range is achievable within the landscape that we laid out.

James Ricchiuti- Needham & Company

Okay. That's helpful. And Colin, one follow up question. This just concerns the comment that you're making about patents and your intention to defend your IP in cases where you think there's been infringement. So my question is are there instances, are there examples, out there, cases, companies where you see your IP being infringed upon? And should we read into this that perhaps you're going to take some action this year?

Colin M. Angle

What you should read into it is that we think we have a very strong patent portfolio. At this point we have a very large percentage of the marketplace and one only takes action when it seems like it would make economic sense to do so. So at this moment in time, we're watching things carefully and trying to make prudent decisions about if and when we act. So we have no current things on the plate where action is imminent, but we certainly are looking carefully at what is happening.

Operator

Our next question comes from the line of Paul Coster with JP Morgan. You may proceed with your question.

Mark Strauss -JP Morgan

Good morning. It's Mark Strauss on behalf of Paul. Just first, you mentioned inventory was down due to capacity constraints. Can you just give us an update on the new contract manufacturer in home robots? If that's online yet?

Colin M. Angle

Sure, that new contract manufacturer, Jabil, is online and we do not expect in 2011 to see any reductions in revenue due to capacity constraints. That is behind us. We sort of bit the bullet in the fourth quarter and have come strongly out the other side. So we're in good shape and feel good about the supply side that we have in place.

Mark Strauss -JP Morgan

And then how much of a headwind do you think the delays in the passage of the DOD budget has been, and what does 2011 guidance assume as far as timing of that passage?

Colin M. Angle

If Congress continues to delay the defense bill and we continue operating under continuing resolution for the remainder of 2011, certainly it will slow down the pace that we have to get the contracts. And new starts are prohibited. The good news is we don't have any new starts in the 2011 budget, and the requirements that are driving the sales anticipated in 2011 are largely under the operational urgent operational needs category. So we don't see any significant impact. I think we're going to make it through 2011. I think that, again, it's a question of limiting our upside. So the guidance that we have given today is consistent with what we think is going to happen on the congressional level, which is perhaps not a full year of operating under continuing resolutions, but certainly having that be a slow and rather painful process.

Mark Strauss -JP Morgan

Got it. And then two quick modeling questions if I can. Pretty strong uptick in the G&I unit, ASPs in 4Q. What drove that and how should we think about that for the full year of '11?

John Leahy

There's two things that played out in Q4 regarding G&I. One was PLR, or the product lifecycle revenue, was very strong. It was well up over prior and it made up about a third of the overall product mix. So that carries higher margins and therefore it helps our ASP as well as the margins. And secondly, with SUGV now rolling out in terms of sales, the bad news is the SUGV orders are coming in small increments, which just makes predictability a little more difficult. The good news though, from our standpoint, is because they are smaller quantity orders they're carrying higher pricing and therefore higher margins. So PLR and SUGV benefitted us in Q4 and we expect to see that throughout 2011.

Mark Strauss -JP Morgan

Okay, and then last one. On the gross margins, you're expecting improvement on the full year '10 number. Can you give any more granularity as far as by home robot versus G&I? Is that primarily from consumer robots? Or can the G&I kind of get back to its historical average somewhere in the mid to high 30s, on the product side anyway?

Colin M. Angle

For the reasons I just described, with the increasing ASPs on the government side, we'll see some pick up on the gross margins, so that helps. Certainly growth helps as well, as we more fully observe our indirect costs on the G&I side. And on the home side, our new products, the 700 series Roomba and the Scooba 230, both help as well as our continued efforts domestically to shut down some of the lower priced, lower margin accounts and to rationalize our whole distribution strategy there. So this has been a multi-year, highly successful initiative within the company to improve our margins and we see it continuing into 2011 and beyond, frankly.

Operator

Our next question comes from the line of Alex Hamilton with EarlyBirdCapital. You may proceed with your question.

Alex Hamilton - EarlyBirdCapital

On Colin's opening statement, I think we can all agree that this was a watershed year. I guess my question is - there's two questions. Once you achieve your goals, which clearly you're making great progress to mid-teens EBITDA, how confident are you in the sustainability of that? And then how confident are you in the sustainability of your 30-day DSO?

Colin M. Angle

Meeting the revenue targets, we view that as a signpost on a longer journey. We don't think that we're done. We think that the trends you're seeing in how we operate the business, where our products are getting more functionality through increased technology, increased software content, allows us to build our moat out more significantly, our ability to defend and differentiate ourselves from the competition. And also, the inclusion of that technology leads to higher margins, and so we think that the gross margin story that we're talking about, and have made great progress against, is not complete next year, which would be the third year, three years after we gave our three-year long-term financial guidance. We are excited about 2012 and we're also excited about where we'll take it next. We've talked about, on a market perspective, how we believe we are just still in the early stages of building out the true market potential of what the remote presence and automated home maintenance markets can deliver to us. So we see a lot of runway beyond that. And as far as DSO, I'm going to turn it over to my learned colleague.

John Leahy

As you are well aware, in '09 and the first part of '10 working capital was a critical element for us in driving cash flow. The back half of '10 and as we look to '11, cash flow will be more driven by continued gains in EBITDA as opposed to working capital gains. So I would tell you that when you look at DSO, that's probably a low water mark that we'll hit at 30 days. Because it's just exceptional performance. Literally 100% of our receivable balance is within 30 days, so you can't get better than that.

And then in inventory, as Colin mentioned earlier, we actually ran leaner than we would have liked in Q4 because of the production constraints. So therefore, you'll probably see actually a little bit more inventory balance for us in the future. But importantly, we feel very confident that we'll continue to drive cash flow, but it will be more driven by net income.

Operator

Our next question comes from the line of Josephine Millward with the Benchmark Company. You may proceed with your question.

Josephine Millward - The Benchmark Company

Congratulations on a great year, and on being one of the few technologies moving forward with the BCTM. Colin, can you give us an update on the Army's long-term fielding strategy of the SUGV? When do you expect a decision, and do you think this capability will be fielded to all 45 combat brigades?

Colin M. Angle

A difficult question to answer with facts, certainly, and so I'll have to give a qualitative answer. It is the intent, and there is demand pull from both the soldiers and leadership at the Pentagon to drive SUGV onto a squad-level deployment throughout the Army. How long and how aggressively they're going to act to achieve that vision is something that we don't have great visibility, other than to say as they have set up hurdles, we have met them.

The reliability hurdle that we met toward the end of last year was a big one. There was real anxiety as to whether or not these very complicated machines and their very compact size could deliver sufficient reliability, whether the technology was mature enough, to make it into the field on a broad deployment basis. And we didn't just meet the spec, we substantially exceeded the spec. So we're very proud of that, and that opened the gate toward continued LRIP procurement.

So I think that 2011 is going to be sort of a linear growth year for G&I, that inflection point where we see a rate increase in the pace of procurement is not predicted to be in 2011. So we'll have to ride that out a little bit, but we do feel that the momentum continues to build, that the respect for the product and its increasingly documented improvements in squad effectiveness, the pace of operations and the survivability of the soldiers using it, continues to be shown. And so -

Josephine Millward - The Benchmark Company

That's great news. Colin, your guidance assumes shipment of about 1,000 military robots in the coming year. Since your backlog is down about 40%, can you give us a sense of timing on how you expect bookings to trend throughout the year?

Colin M. Angle

First off, 1,000 overstates the number of units a bit, but it is going to be back half weighted. The continuing resolution slows some things down. The programs that we're anticipating coming online got pushed right a little bit from where we might have thought they were going to be in the middle of last year. But we do have identified opportunities. We think our guidance and numbers are solid. But it's going to be 40% first half, 60% back half on the top line on the G&I side, at least in the product sales.

Josephine Millward - The Benchmark Company

Okay. I have a final modeling question. We saw significant increase in R&D and marketing expenses in Q4. Do you expect to continue at that run rate into '11? If you can help us with if you expect the same level for every quarter, or how that's going to trend?

Colin M. Angle

We've modeled our op ex up 2 points, from 28% to 30% of revenue, in 2011 over 2010. So on a run rate basis, that's down from Q4, but it is up on a full year basis. The reasons are simple. First, in 2011 we're launching two new products on the home side, whereas we launched nothing new last year. And so that's a big and exciting thing, and we're committed to making sure the world knows about these exciting new products, so we're going to spend against them and are very optimistic about the return on that spend. So that makes up one of those points.

The second is an increase in our IR&D from prior years, down slightly run rate from Q4, but certainly up for the year, putting our full year 2011 IRAD between 7% and 8%, which I believe is a healthy, sustainable number for a high tech company to be investing in new products, especially when you consider that our unique business model allows us to double down on that research and development through the acquisition of dollars from the U.S. government to support sponsored research.

But we think that's a healthy number, and we think that in the words of one of my mentors, you have to earn the right to be innovative, and the success we have made in increasing product margin has allowed us to sustainably increase our investment in IR&D by increasing our margin earned by the company and so while we are increasing this op ex expenditure, there's also increasing gross margin to more than make up for those increases.

Josephine Millward - The Benchmark Company

So Colin, based on your op ex guidance, you're implying a gross margin of 38% or better, right?

John Leahy

That's right, Josephine. We think gross margin will grow about 200 basis points, offsetting the roughly 200 basis point increase in op ex.

Operator

Our next question will come from the line of Jim McIlree with Merriman. You may proceed with your question

Jim McIlree - Merriman

Is the Aware software upgrade complete now? Or is there still more to do in 2011?

Colin M. Angle

The first round of Aware software upgrades, which is the $14 million contract we've mentioned a few times, is complete. We did about $5 million of the $14 in Q4 of last year, and $9 million in Q1 of this year. So that's done. We're anticipating further software upgrades to take advantage of this operating system upgrade. So you could view these as apps now running on top of Aware 2. We're anticipating that to happen toward the end of 2011.

Jim McIlree - Merriman

Great. And in your guidance for 2011 relative to SUGV, I'm assuming that you have the two additional brigades that the Army has indicated that they are going to purchase. Is that correct, and do you have anything beyond that on the SUGVs? Or is it just those two and then you'll figure out what happens in 2012?

Colin M. Angle

That is what we have in our expectations within BCTM, but SUGV has, we feel, both a 310 model, which is not being procured through BCTM or whatever it becomes next, and a [COTS] version of the 320, which we are selling outside of the BCTM program. So within our guidance, that's what we're assuming, but that only represents a modest percentage of our expectations of robot sales for the year.

Jim McIlree - Merriman

Great. And two more if I might. The pricing assumptions on the home robot for 2011, are you assuming up, down, or flat on ASPs?

Colin M. Angle

A little bit difficult question to answer, because we're launching this Scooba 230 robot, which is a different product line. But ASPs should go up modestly year-over-year.

Jim McIlree - Merriman

And anything for the unmanned underwater vehicles in 2011?

Colin M. Angle

We expect to see strong growth in the Seaglider sales. That is our ultra-long duration underwater [inaudible] platform. So we see that continuing to grow strongly. We're also continuing investing in development of some of our next maritime products, and that's the Ranger. So that will not be material in 2011. Think for 2012 for that to start contributing.

Operator

Our next question comes from the line of Brian Ruttenbur with Morgan Keegan. You may proceed with your question.

Brian Ruttenbur -Morgan Keegan

I have a question about kind of the longer-term, mid-term growth for your defense business, your G&I. It's impressive that you're going to grow mid-teens this year. That's great. Do you see that you can maintain that in fiscal 2012 with the fiscal '12 budget out there?

Colin M. Angle

I think that as we look at our military side of the business, the best is yet to come. We have stated needs and desire from the Army to do a large-scale equipping of the infantry squads, which is certainly not complete. It's only getting started.

We continue to see the impact of having robots in the field leading to greater acceptance of their utility as well as demands for the robots to do more, which dovetails with the software upgrades, with the increasing complexity of the missions, and thus the increasing desire for these robots to have advanced AI software onboard, which is frankly, our sweet spot. This is what our company does best, and as we're able to deliver those capabilities, it allows us to further differentiate from anyone else in this space. So we see that as huge.

Intermediate and long-term, we have both a growing desire for the platforms - and I should also mention growing desire for the platforms internationally as well as domestically - and an increased desire for these robots to be more sophisticated and there's a very public, stated desire from the Pentagon for more autonomy on these systems. So it's not just me saying this. This is a very easily researched and defendable statement I'm making, which is great for us. So the future is incredibly bright.

We are excited to be able to be on the phone here talking about mid-teen growth on the G&I side on a year which for many defense contractors looks to be very challenging. So we are very relieved and happy about that outlook, but the future is incredibly bright.

Brian Ruttenbur -Morgan Keegan

The delay in the fiscal '11 budget, and maybe even fiscal '12 - I mean it's too early to call delays - but what does that mean to you guys? Did that shift everything to the second half of the year, or did that hurt you guys? You would have actually been 20-plus-percent growth if it hadn't have been for the delays.

Colin M. Angle

Of course it hurt us. It did push things. That's why we're saying this year's going to be 60-40 split on the G&I side to the back half, calculating and putting that impact into the guidance we're giving you. And we are hopeful that the Congress can figure out how to get the defense bill passed and get off continuing resolutions.

But we tend to be pretty realistic about what's going to happen and luckily we are in a position where we have very strong pull from the theater, very strong support from the Pentagon, have been singularly identified as one of the high-impact new technologies that can increase soldier survivability and squad effectiveness. This is a good investment in our military, and thus we are seeing, even in difficult times, growth.

Brian Ruttenbur -Morgan Keegan

So if it hadn't have been for the fiscal '11 budget push out, you would have more equally weighted revenue throughout the year? Is that what you're telling me on the G&I side?

Colin M. Angle

Now you're asking me to speculate on things. The government business will always be lumpy and if not for that, it certainly would be different, and beyond that I would be speculating. But there you go.

Operator

Our next question will come from the line of Adam Flek with Morningstar. You may proceed with your question.

Adam Flek-Morningstar

I wanted to shift back to the home robot side. Colin, some time ago you had outlined higher-quality products that would result in decreased warranty expense. And we've seen those reserves really fall through the first nine months of the year. First, I was wondering if you could provide the warranty provision for this quarter, and then maybe talk about any potential realistic improvements that can be made there. Is there still potential for that? Or are we at more or less of a run rate here?

Colin M. Angle

First off, we don't break that return out. So I'll disappoint you and not give you the exact figure, but the qualitative response is we have made continuous improvements to the product and the return rates are moving in the right direction. And I think that one of the things that we view as a competitive advantage is that with 6 million robots out there we know an incredible amount about the challenges of keeping robots that live underneath couches and generate static electricity like you wouldn't believe because of their mission, so in very dirty environments, keeping these robots alive.

And so this is part of our IP. This is part of what makes us the industry leader, because we survive for many years in very, very difficult environments, and the robots we are making today live much longer than the ones we made just a year, 18 months ago. So we have a continuous improvement process, and we think that investing in higher quality is part of our strategic advantage and we will continue to do so for years to come. Certainly we're not done. Certainly this is real, hardcore IP that differentiates us.

Adam Flek-Morningstar

Okay great. Thanks. And then thinking longer term still, Colin, at the CES you showcased the new AVA robot. Is this more of a proof of concept type of robot, with technology that maybe we'll see in future Roombas, etc.? Or is this meant as maybe a potential foray into more of the healthcare space?

Colin M. Angle

It was a concept car, so a technology demonstrator that has many important ramifications for the business over time. So not material, not for sale. We're not even talking about pricing in 2011. But what does it mean? It's worth spending a little time on.

I talked in the call a little bit about remote presence. Our military business is focused on how do we allow soldiers to project themselves safely into very dangerous areas to gain situational awareness. I mentioned a few minutes ago about how the military is incredibly focused on more autonomy.

So here is a platform, a technology platform, which demonstrates the ability to navigate, the ability to have more advanced and sophisticated interfaces with people. That technology is going to find its way into our military products over time, and we wanted to show the world sort of where we are going.

Also, importantly, we wanted to demonstrate that we are leveraging the rapidly growing mobile computing industry to bring more technology on board and certainly open the door for people to speculate on what new products could come out of this platform we saw.

So we had a little bit of fun with it, I would admit, just teasing. But I think that the message really is there's a lot of amazing technology in our labs that is starting to get closer to being incorporated into product.

Operator

Our next question comes as a followup from Jim Ricchiuti with Needham & Company. Please proceed with your question.

James Ricchiuti- Needham & Company

The revenue growth that you showed in the home robot business in 2010, up 28%, clearly pretty impressive. I was wondering if you might give us a sense as to how much revenue you think you might have missed out on due to the capacity constraints. And then I have a quick followup on the Scooba 230.

John Leahy

Little hard to say, but clearly the inventory numbers, as we referred to earlier, show that we ran inventory down quite a bit in Q4. And as we indicated in the Q3 call, we were having to allocate product in that division across both international and domestic partners. So there was clearly more demand than we had product for.

Hard to say whether that's $1 million more of revenue or $2 million or $3 million. But it was a challenging situation for the division, but I think the important thing is with the backdrop of this had nothing to do with poor operational execution or did not have anything to do with issues of our manufacturers. It's just that really the division hit the ball out of the park, greatly exceeded our revenue expectations, and because of the lead times for components in particular, we just couldn't catch up.

But as Colin indicated earlier, with Jabil now fully on line, we do not anticipate having those sorts of constraints in 2011.

James Ricchiuti- Needham & Company

And just given the success of the Roomba in the international market, I'm just curious what you see as the opportunity, the reception, you think for the Scooba 230? And then finally I'll just add my congratulations on to you.

Colin M. Angle

Well thank you. What we've learned with new product introductions is it does pay off to pace ourselves in their launch. And so you're going to see a relatively conservative rollout of the Scooba 230 and as we get feedback and make sure that they're coming off the line the way we want to, roll out. So we'll sort of progress through markets as the supply chain of the product proves out itself.

That said, this is a fantastic robot. This is the robot that cleans your bathroom, that goes in and around your toilet. We are incredibly excited about what this means and what this can do for the business, and we can't wait to open the floodgates and get this thing out there, because we think it's going to be a home run.

Colin M. Angle

Thank you. So that concludes our fourth quarter and full year 2010 earnings call. We appreciate your support, and look forward to talking to you again in April to discuss our Q1 results.

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