iRobot's (IRBT) CEO Colin Angle on Q4 2015 Results - Earnings Call Transcript

| About: iRobot Corporation (IRBT)

Start Time: 08:30

End Time: 09:29

iRobot Corporation (NASDAQ:IRBT)

Q4 2015 Earnings Conference Call

February 11, 2016, 08:30 AM ET

Executives

Colin Angle - Chairman, CEO and Co-Founder

Alison Dean - EVP and CFO

Elise Caffrey - IR

Analysts

James Ricchiuti - Needham & Co.

Josephine Millward - Benchmark

Troy Jensen - Piper Jaffray

Bobby Burleson - Canaccord Genuity

Mark Strouse - JPMorgan

Adam Fleck - Morningstar

Marc Estigarribia - Chardan Capital Markets

Operator

Good day, everyone, and welcome to the iRobot Fourth Quarter and Full Year 2015 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 or circumstances.

During this conference call, we will also disclose non-GAAP financial measures as defined by SEC Regulation G, including adjusted EBITDA, which we define as earnings before interest, taxes, depreciation, amortization, merger, acquisition and divestiture expenses, restructuring expenses, net intellectual property litigation expenses and non-cash stock compensation expense. A reconciliation of GAAP and non-GAAP metrics can be found in the financial tables at the end of the fourth quarter 2015 earnings press release issued last evening, which is available on our Web site.

On today's call, iRobot Chairman and CEO, Colin Angle, will provide a review of the company's operations and achievements for the fourth quarter and full year 2015 as well as our outlook on the business for 2016. Alison Dean, Chief Financial Officer, will review our financial results for the fourth quarter and full year 2015; and, Colin and Alison will also provide our financial expectations for the first quarter ending April 2, 2016 and fiscal 2016. Then we'll open the call for questions.

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

Colin Angle

Good morning, and thank you for joining us. 2015 was another great year for iRobot. Last night, we reported a record Q4 that resulted in full year revenue and EPS that exceeded our expectations. These results were driven by strategic investments we made throughout the year in domestic demand generation, China go-to-market improvements, technologies supporting connectivity, navigation and mapping, advancements in product quality, exploring adjacent Home Robot markets, and supporting demand generation efforts of our overseas partners.

We also took steps to become more focused on the large Home market and to fuel future growth. We created better nuanced messaging of Roomba, driving sell-through and further adoption, successfully launched our first connected robot Roomba using vSLAM navigation to dynamically create and update maps. We reallocated R&D resources from a next generation Remote Presence platform to home opportunities. We began to reinvigorate overseas Home Robot growth and we identified potential acquirers for our Defense & Security business.

As a result of these efforts, Home Robot revenue grew more than 30% in the fourth quarter, driven by sales in United States and China, which were up 46% and more than 70%, respectively, over Q4 in 2014. Likewise, our D&S business grew more than 25% in the quarter, driving full year revenue to 55 million and a return to pro forma fully allocated profitability for the first time in many years.

For the full year 2015, company revenue was up 11% to $617 million. Earnings per share were $1.47, including the positive $0.05 impact of the investment tax credit and adjusted EBITDA was 92 million or 15% of revenue. We delivered this strong performance in the face of significant currency headwinds, the economic collapse of Russia, recession in Japan, our largest international market and increasing competition.

During the year, we took the steps required becoming more focused on our well-established and substantial market opportunity in Home by identifying a buyer for our Defense & Security business. On February 4, 2016, after a very thorough process, we announced the anticipated sale of the business to Arlington Capital Partners for consideration of up to 45 million. Upon completion, this divestiture not only creates an additional opportunity to return capital to shareholders, but also allows the remainder of the business to become razor focused on the much larger opportunity the Home market provides.

In 2016, our financial performance will be driven by our Home Robot business. It is expected to grow 12% to 13%, as we expand worldwide distribution of Roomba 980, tap further into a growing market in China and build our wet floor care business.

To execute our 2016 plan and achieve our three-year financial targets, we need to continue to strategically invest in a number of areas to strengthen our marketing capabilities globally and accelerate worldwide consumer adoption of Roomba in order to maintain our market-leading position in robotic vacuum cleaners.

We need to better position ourselves in China to capture an even larger share of the rapidly growing market for robotic floor care. We will develop our wet floor care business to generate a material, secondary revenue stream; scale the infrastructure required to support connected products; explore, develop and grow adjacent non-floor care Home Robot products that can generate meaningful diversified revenue streams; and make continued operational improvements that can reduce product and operating costs.

For 2016, we expect revenue of 630 million to 642 million, EPS of $1.20 to $1.40 and adjusted EBITDA of $80 million to $90 million. Expectations include the impact of one quarter of Defense & Security stub period and one-time divesture costs, most of which will be recognized in Q1.

Growth is expected to be driven by the expanded worldwide consumer adoption of Roomba supported by targeted marketing programs; wider geographic distribution of the Roomba 980; accelerated growth of wet floor care products; regional growth, particular in China and the United States; and a new product introduction in the first half of the year.

Now I’ll take you through some of the details of 2015, and our expectations for 2016. Our Home Robot business had a solid year despite the significant overseas macroeconomic headwinds. Exceptional domestic growth of 46% in Q4 and 25% for the full year over 2014 was driven by investment in ad media, national promotions, launch of the Roomba 980, and the addition of Target as a new channel in the fourth quarter.

Our Roomba marketing programs were highly successful in the United States and we saw significant return on investments. Sell-through, for example, at our top five retailers in Q4 was up more than 70% over Q4 2014 validating our marketing strategy. We ran similar programs in Q2 over Mothers’ Day and Fathers’ Day with equally positive results, but wanted to further evaluate them during the Q4 holidays before declaring victory.

We are highly confident that we have the right formula to export overseas to accelerate growth in those markets. During 2016, we will focus our marketing efforts on the Japanese market where we have already kicked off several initiatives. If we are successful, we should start seeing impact on demand generation by the end of the year.

In 2015, wet floor care revenue grew roughly 5% but within the category, Braava grew more than 30% over 2014. This growth is due largely to Braava’s successful adoption in Japan and China where the product was first introduced in 2014. The predominantly hard floor surfaces in the region, coupled with the need for daily mopping, particularly in China, make the product ideal for those households.

We continue to see a growth opportunity for the wet floor care market worldwide as we improve its positioning and better articulate its value proposition. In 2016, we will invest in optimizing the positioning and go-to-market strategy of this category by reaching out to existing Roomba customers, creating advertising to build awareness of the products and functional differentiation from Roomba, educating the U.S. retail in-store sales personnel about how to promote the category.

Growth in China was more than 70% year-over-year in 2015. We first entered that market in 2012 and have continued to evolve our go-to-market strategy. In 2015, e-commerce was the growth driver, especially on the 11/11 and 12/12 holidays. We have said that we thought China could grow to be our second largest market and are confident that with 2016 investment to focus on further accelerating growth in the e-commerce channel we can more quickly reach that goal.

We do plan to launch a new Home Robot product in the first half of the year, but I’m not going to provide any additional information on timing or product category at this time. Regionally, we expect the United States and APAC to deliver mid-high teen growth and EMEA to deliver mid-single digit growth in 2016.

Japan’s strong fourth quarter followed three quarters of year-over-year declines during 2015. We are cautiously optimistic that a positive trend will continue in 2016 resulting in mid-single digit growth for the year. APAC as a region is expected to grow in the mid-high teens up from 2% in 2015, driven by another year of strong growth in China.

In EMEA, we are cautiously optimistic about a return to growth with a mid-single digit revenue increase in 2016 from a flat year-over-year performance in 2015. We expect Russia to grow off a much reduced base and Western Europe countries to post gains.

Turning now to our Defense & Security business, Q4 and full year results were in line with our expectations. With revenue up 21% year-over-year in 2015, D&S reported its first growth since 2011. As we announced on February 4, 2016, we are divesting this business in a transaction expected to close in the next few months. The business opportunity and the leadership team are strong, making it the right time for this transaction to occur.

While worldwide macros still present a challenging backdrop in the near term, we are excited that on a global basis, the Home business is growing significantly. Looking out over a three-year horizon, we anticipate Home Robot revenue growth to accelerate from 12% to 13% in 2016 to high-teen annual growth by 2018. The business has developed from one in which we established the robot vacuum cleaner category, became the market leader with the first mover advantage, and increased ASPs as we incorporated features and functionality through technology.

Going forward, we will maintain Roomba’s market leadership while positioning it as a key component in the connected Home. We must also build a secondary material revenue stream, which we expect to do with our wet floor care products. As we execute on these strategies, in 2016 we will expect a small decline in adjusted EBITDA margin as we invest in these revenue growth initiatives, but expect to return to mid-teen adjusted EBITDA margins in 2017 and 2018.

In 2015, we began to further monetize our navigation technologies through the introduction of Roomba 980 with Visual Simultaneous Location and Mapping or vSLAM. In 2016, we are divesting our Defense & Security business and curtailing R&D investments in a next generation Remote Presence platform in order to solidify iRobot’s position as the leader in diversified Home Robots and to focus on key technologies, with a focus on software that allow our robots to understand the homes in which they operate. It is our intent to continue investing in these critical technologies and the economic opportunities that they unlock.

There is a lot to be excited about. We had great results in 2015. Q4 was a record quarter for us and it was driven from the successful investments we made leading up to 2015 and during the year as we responded well to the changing market environment.

We expect even higher revenue growth in 2016, driven by strong performance again in U.S. and China, with Japan and EMEA turning the corner. And as we exit the Defense & Security business, we are more focused.

Our confidence in the future is demonstrated by a decision to make significant capital allocation choices in 2016 that will drive future revenue diversification for our Home business and further revenue growth acceleration in 2017, 2018 and beyond.

I’ll now turn the call over to Alison to review our fourth quarter and full year results in more detail.

Alison Dean

Thanks, Colin. Our fourth quarter and full year revenue and EPS results exceeded expectations due to better than anticipated domestic Home Robot performance. Adjusted EBITDA was in line with our expectations. Revenue of 206 million increased 29% from Q4 last year driven by growth in Home Robot revenue.

EPS was $0.65 for the quarter compared with $0.31 in Q4 2014. An investment tax credit positively impacted 2015 EPS by $0.05 and 2014 EPS by $0.04. Q4 adjusted EBITDA was 35 million or 15% of revenue compared with 20 million or 12% last year.

We also recorded a fourth quarter gain on investment of $0.06 per share or 3 million in pre-tax income from the sale of an investment we made several years ago. We noted this on last quarter’s call and increased our expectations accordingly in October.

Domestic Home Robot revenue growth was 46% for Q4 and 25% for the year, reflecting the positive impacts of our marketing programs and successful launch of Roomba 980, our first connected product.

Q4 domestic revenue was partially impacted by a favorable adjustment to the product return accrual of 1.9 million. This compares with a 1.1 million favorable adjustment in 2014. International revenue grew 2% for the full year with EMEA flat year-over-year and APAC up 2%.

Defense & Security revenue of 31 million in Q4 was up 26% year-over-year as expected. Roughly, 65% of this quarterly revenue was from PLR and the balance from robot sales. For the total company, gross margin was 46% for the fourth quarter and 47% for the full year 2015.

Q4 operating expenses were 35% of revenue, down from 40% in Q4 last year. We said on our Q3 earnings call that we would curtail sales and marketing spending in Japan in Q4. That contributed to lower overall sales and marketing expenses for the quarter as a percent of revenue.

For the full year, sales and marketing was 16% of total revenue compared with 15% in prior years consistent with our expectations. Keep in mind the higher full year expense reflects the overseas investments we made earlier in the year to support our international distributors. OpEx for the full year was 37%, unchanged from last year.

EBITDA for the quarter was 35 million compared with 20 million last year with full 2015 results of 92 million or 15% compared with 80 million or 14% last year. EPS in Q4 was $0.65 and $1.47 for the full year. Full year EPS was favorably impacted by $0.05 from the enactment of the 2015 investment tax credit in late December.

We ended the year with 213 million in cash, down from 220 million a year ago. During the year, we repurchased 1.26 million shares of our stock for 37 million under our buyback program. 2015 year end inventory was 62 million or 51 days compared with 48 million or 53 days last year. The improvement in year-over-year DII was due to significantly higher Q4 Home Robot revenue.

Now, I’d like to provide you with additional detail and some of the underlying assumptions for our Q1 and full year 2016 financial expectations. The outlook for our Home Robot business remains strong with growth drivers identified for the next couple of years.

We expect full year revenue of 630 million to 642 million comprised primarily of Home Robot revenue. These expectations assume the divestiture closes in Q1 2016. As in the past several years, revenue will be more heavily weighted in the second half of the year when we expect to deliver more than 50% of the year’s revenue.

While we provide quarterly expectations, we manage our business from a full year perspective. Keep in mind that it is difficult to predict precise order timing between quarters and especially between Q3 and Q4.

We anticipate total company Q1 2016 revenue to be up 6% to 14% year-over-year to 125 million to 135 million, including a quarter of D&S revenue. After Q1, we expect Home revenue to increase sequentially throughout 2016 as it did in 2015.

As Colin discussed, Home Robot’s growth will be driven by full year distribution of the Roomba 980, growth in China and promotion of our wet floor care products. Overall, we expect Home Robot revenue to grow 12% to 13% in 2016, fueled by growth in the United States and China.

We expect Q1 EPS of negative $0.03 to positive $0.04 and full year EPS of $1.20 to $1.40. Adjusted EBITDA in Q1 is expected to be 8 million to 11 million and for the full year is expected to be 80 million to 90 million.

The Q1 and full year expectations include the impact of one quarter of a D&S stub period and divestiture costs expected to be incurred primarily in Q1, in total approximately $0.10 to $0.11 of EPS loss for the quarter.

Note that for the full year 2015 and 2016, we have included a schedule in the earnings release showing comparable year-over-year data, without D&S, to help you model the impact of the divestiture. When we provide Q1 2016 results in April, we will also provide a comparable view of Q1 2015 results.

Given the investments outlined by Colin, we expect OpEx to increase to between 38% and 39% of revenue for the full year before beginning to decline to lower levels in 2017 and 2018.

For 2016, we are also assuming gross margin of 47% to 48%; stock comp expense of roughly 16 million; depreciation and amortization expense of approximately 14 million; and a diluted share count of approximately 28.2 million shares after the executions of the additional share repurchases. We are estimating a tax rate of 30% for 2016 inclusive of an investment tax credit.

Building from our 2016 expectations, we are establishing our financial targets through 2018. Home Robot revenue growth of 12% to 13% in 2016 is expected to accelerate annually to high teens by 2018.

Our EPS of $1.20 to $1.40 for 2016 is expected to grow more than 25% in 2017 and 2018 as we anniversary one-time costs associated with D&S and the divestiture, lever operating expense and continue to offset growth in share count through buybacks. And 2016 adjusted EBITDA margins of 13% to 14% are expected to return to 14% to 15% levels in 2017 and 2018.

When we announced the planned divestiture of the D&S business, we also announced a $65 million increase to our current share repurchase initiative, partially funded from the expected proceeds, bringing the total 2016 program to more than 100 million. We are evaluating several vehicles for this incremental share repurchase, including an accelerated share repurchase program.

We intend to initiate the incremental program in Q1 in conjunction with deal closing. This initiative, coupled with our previous return of capital, effectively balances our interest to return cash to shareholders while maintaining sufficient cash to operate the business and make appropriate investments and acquisitions.

I’ll now turn the call back to Colin.

Colin Angle

Thank you. We expect our Home Robot business to deliver strong financial performance in 2016 that will in turn fund critical investments in future technologies and marketing to solidify our position as the leader in diversified Home Robots as well as to drive long-term shareholder value.

With that, we will take your questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Jim Ricchiuti from Needham & Co. Jim, your line is open.

James Ricchiuti

Thank you. Good morning. Just a couple of questions. First of all, what you’re seeing in Japan? It sounds like you saw a little bit of growth in the quarter. Can you quantify that? And I don’t know, Alison, if there’s any way to look at it on a constant currency basis just in terms of the – is this a modest recovery in this market?

Alison Dean

Yes, I would view it as a modest recovery at this point, Jim. Certainly, Q4 was a good quarter in Japan. We are still being sort of cautiously optimistic about this being the start of a return to growth for 2016 but we were definitely pleased with what we saw happen in that market in Q4.

James Ricchiuti

And in EMEA, what was the growth rate there, can you help us? Just any color ex currency, how that’s progressing?

Alison Dean

Well, overall, for us it was a flat region year-on-year. Again, based on what we saw coming out of the year in Q4, we are expecting to return to growth albeit somewhat moderate sort of in the middle-single digits for 2016.

Colin Angle

Jim, you do have to unpack it a little bit with the dramatic decline in Russia, which Western Europe was more healthy, it was – and certainly the dramatic currency devaluations, which impacted the region at the beginning of the year also significantly reduced the effective growth rate in dollars. And so all-in, it was flat. We see stabilization and as I mentioned, albeit off of dramatically lower base will return to some modest growth in Russia. So we feel like we took a lot of different hits in Europe as well as in Japan last year, but now we have established a new baseline which we can grow from.

James Ricchiuti

Okay. And operating expense, last year you talked about making some additional investments to support your international distributors. How should we think of that activity in 2016? And also if you could just maybe give us a little bit of color in terms of how we should think about R&D?

Alison Dean

So, Jim, last year in '15, we definitely did invest some OpEx to help our overseas distributors; EMEA during the year, Japan primarily at the beginning of the year. As we said, we weren’t having the return we expected at the end of the year, so we curtailed that investment. We do expect to continue to invest to assist our overseas distributors in 2016. We’re going to do it a little differently in that we are going to leverage some of the components of the marketing campaigns that we ran so successfully in the U.S. and tailor those to the international markets overseas. So, we definitely plan to continue to support the distributors next year but in a slightly different fashion than we had done it in 2015. From an R&D perspective, as a percent of revenue, we think we will maintain fairly constant investment in R&D as a percent of revenue going into 2016. But all of that R&D focus will now be on the Home business products and technologies.

James Ricchiuti

Okay. Are you assuming any meaningful revenue from the new product in your guidance?

Colin Angle

We are. It’s less than 5% of our revenue but we are expecting to be actively selling the product.

James Ricchiuti

Okay. Thank you.

Colin Angle

You bet.

Operator

Our next question comes from Josephine Millward. Josephine, your line is open.

Josephine Millward

Good morning, Colin. Good morning, Alison.

Colin Angle

Good morning.

Alison Dean

Hi, Josephine.

Josephine Millward

Congratulations on a great Q4.

Colin Angle

Thank you.

Josephine Millward

Colin, can you share with us your growth strategy in China? How do you plan to better position iRobot in light of a broad economic slowdown? And what’s your growth assumption there in China?

Colin Angle

Sure. We think that long term, China is a tremendous market that could in the relatively short term become our largest market outside of the United States. And in the slightly longer term could surpass the United States as our largest single market. With that in mind, we are making real investments in establishing an iRobot on-the-ground operation in China. That’s one of the investment items that are driving our 2016 P&L. We expect that entity to focus primarily on e-commerce. That is the most rapidly growing path to market in China. And as we said, we think it’s going to be one of the two largest growth drivers alongside of North America in 2016 performance, as well as contributing strongly to our long-term financial model of high-teen revenue growth in '17, '18. So, this is a key investment area for us. We will start to enjoy the benefits of the investments in 2016 but won’t fully enjoy the scale and the growth engine that China we believe can be until '17 and '18. It’s true that as you point out, the macros in China are not as strong as they were a year ago, but as we’ve seen in other emerging markets for robotic floor care, we believe that we’re currently at a level where the overall macros have less of an impact on overall growth than they would in a more mature market like Europe and Japan. So certainly those macros will slow us down somewhat but we still think there is dramatic growth opportunities in front of us.

Josephine Millward

Can you give us a sense of revenue contribution from China last year? Was it roughly 30 million, 40 million?

Alison Dean

We don’t specifically quantify that, Josephine. It was definitely a significant grower at more than 70% over the prior year and it’s becoming a much more substantial driver of performance in APAC overall.

Josephine Millward

Can you compare the size of China relative to Japan just to give us a sense of how big China is roughly?

Alison Dean

Japan is still the dominant country by far within the APAC region, but China is closing the gap for sure.

Josephine Millward

All right. Thank you.

Colin Angle

Okay.

Operator

Our next question comes from Troy Jensen. Troy, your line is open.

Troy Jensen

Thanks. Congrats also on the nice fourth quarter.

Colin Angle

Thank you very much. It was an achievement and demonstrated that this growth strategy that we’re articulating in the investments that we’re undertaking in 2016 have great potential, so I appreciate that.

Troy Jensen

Yes, that would be great. Colin, quickly for you and maybe Alison can jump in on this but can you discuss the number of headcount reductions or the amount of operating expense reductions related to the sale of the Defense & Security business. And to that point, can you tell us what the company’s return on invested capital has been prior to selling it and what it should be going forward?

Alison Dean

So, Troy, in terms of headcount, you should be thinking probably approximately 100 people leaving iRobot related to the divestiture. And in our additional schedule that we added to the press release, we quantified the impact of the D&S divestiture on many fronts; revenue, gross margin and OpEx for you. For example, in 2015, per that schedule we were showing about 20 million of OpEx associated with the D&S business as a rule of thumb. And then --

Troy Jensen

Okay, that’s fair. And then – go ahead, sorry.

Alison Dean

From a return on invested capital perspective, for the last several years we have made basically a point improvement in our ROIC exiting this year at about 11%.

Troy Jensen

Perfect. Just two other questions from me. Are you also doing like a strategic assessment on the Remote Presence business?

Colin Angle

We did during the year and as I mentioned in the script, we found that the need and opportunity related with the Home surpassed the Remote Presence assessment of opportunity. And so we wholesale moved our engineering resources dedicated to the Remote Presence into the investments required to ensure a smooth and industry-leading growth in the connected dimension of our Home business into which we’re making significant investments, as well as into the new product pipeline for Home. So, we’ve really dramatically reduced the level of investment and the Remote Presence endeavors at this point are really looking more on a business development side at partnerships. But from an engineering and material capital investment perspective, it’s no longer significant.

Troy Jensen

Okay, that’s fair. And the last question, I know you don’t want to talk about what the new product is, but can you tell us when was the last time you refreshed Braava and Scooba and how often do you refresh those products?

Colin Angle

So, when we made the acquisition of Evolution Robotics over sort of the year following, we went and refreshed that Braava line. And certainly we’re excited by its performance, as I mentioned earlier, particularly in Asia. I think that for Roomba, we’re on – we’ll have annual refreshes that are minor and every two to three years have a major refresh is sort of our historical cadence. On the wet floor care, we think that the biggest near-term opportunity is actually helping to position that product adjacent to Roomba, because we think that there’s still significant opportunities and a lot of confusion at retailers to what are these products and why are they different. If you go into many retail stores, you’ll see Braava sort of next to the robot vacuum cleaners and in some cases even labeled as a robot vacuum cleaner. So we think that there are tremendous opportunities to get our go-to-market strategy correct for wet floor care products. And so you should expect to see a lot of attention played to this second leg on the Home revenue stool.

Troy Jensen

Okay. All right. Thank you and good luck in 2016.

Colin Angle

Thank you very much.

Operator

Our next question comes from Bobby Burleson. Bobby, your line is open.

Bobby Burleson

Hi. Thanks for taking my questions. I just wanted to just follow up on the Remote Presence. You talked about reallocating R&D resources to Home and I’m wondering whether or not there’s any incremental kind of accretive to earnings savings that you’re getting there? And if all of that headcount is being reallocated, or some of it’s actually being reduced?

Colin Angle

It is not being reduced. It is keeping within the R&D budget for 2016, which on a percentage basis is flat to 2015. As I tried to convey in the script, the company is – we’re going for it. We believe that the growth opportunities in Home are immense and accelerating. And crucial to achieving those growth rates is both product leadership within the Roomba category and the establishment of the second leg on the stool, and within Roomba that means connectivity. And so we are certainly putting a lot of incremental investment in the connectivity dimension of Roomba in order to – if you look at the competitive landscape, the real players are connected. And given our market share, we are scaling the connected robot business at a very, very fast rate and so we’re pushing at sort of the bleeding edge of a lot of different back office technologies for connected product and are also making investments to ensure that the information that the robots are collecting is being done in a way that we can leverage in the future for the performance of the robot and also as part of an important element of the connected homes. So these are major investments. We think that they are fundamental to our long-term growth strategy. And I think the technologies that were developed for the Remote Presence and the skill set that was represented by the engineers in the Remote Presence business unit were exactly the skill sets and talents that we needed to affect what I just described. And also I alluded to in the call looking at non-floor care product opportunities, which will be a little further away in our product roadmap and certainly some of the technology that we worked at higher price points in the commercial world can be redeployed and pointed at the Home as well. So, we took the opportunity to maintain that skill base very opportunistically while staying within our R&D budget.

Bobby Burleson

Okay, great. And then I guess just a follow on. Now that you’re more laser-focused on home robots with the D&S divestiture and the shift in R&D resources away from next-gen Remote Presence, are there other areas besides headcount where you get some OpEx optimization or R&D optimization, simply because you’ve got basically one platform now that you’re – or one broader platform now that you’re focusing the spending on?

Colin Angle

Yes. I think that as the clock rolls forward, you’ll see R&D continue to grow but it will not grow as a percentage of revenue and so they’ll be some leverage there. We think that there are opportunities on product costs to leverage some additional scale and certainly as our robots become more significantly value-enabled by software, incremental features can also allow us to drive some improved margin on that front. So those are two areas that we certainly do see leverage coming in the future. Sales and marketing, as we go forward, it will continue to be a significant part of our expenditure but the other expenses as a percent of revenue we think we can drive down.

Bobby Burleson

Okay, interesting. And you guys talked about 12% to 13% Home Robot growth this year and I’m wondering if Japan is a main continuing caution around what you’re seeing in Japan, even though you had a good quarter there. Is that the main reason for not guiding kind of a mid-teens for Home Robot this year?

Colin Angle

Japan certainly has risk associated with it and we think that EMEA has some risk associated with it as well. And so North America and China are great but I think that there’s a little bit of a wait and see as far as how strong EMEA and Japan will be.

Bobby Burleson

Okay. Thank you.

Colin Angle

You bet.

Operator

Our next question comes from Mark Strouse. Mark, your line is open.

Mark Strouse

Thanks. Good morning. Thanks for taking our questions.

Colin Angle

Sure. Hi, Mark.

Mark Strouse

Good morning. So just thinking about the three-year targets and the revenue acceleration in 2017 and 2018, can you kind of break that down into how much of that is expected from new products versus better positioning, better marketing, versus potentially easing macro headwinds in the out years?

Colin Angle

The short answer is all of the above. What we did in Q4 in North America is what gives us confidence to embark on what I think is a pretty bold growth strategy for the company. We know and have developed a demand generation engine that we proved out in 2015. And the investments that we make in 2016, a significant portion of those, is effectively exporting the ability to execute on that program in other countries. And so that has to do with relationships with our distributors, it has to do with people on the ground in China as I described, it has to do with developing and putting the creative on air. And so that is something that we will be doing in 2016. Diversification of revenue is another element of our long-term growth acceleration plans and so that is going to be most visibly manifested in 2016 with what we’re doing in the wet category. As I mentioned, we think this is a nascent market particularly in Asia where hard floor care is the default standard. And so that even driving vacuuming growth is asking, particularly in China, customers to embrace a different methodology of cleaning their floors. They’re much more used to mopping and so Braava as a robot mop is a smaller leap than in some cases buying an upright push vacuum cleaner. So we think that the investments we’re making in driving sales and our organizational sophistication in Asia will benefit wet floor care. We’ve also talked about, hey, we’ve got a new product coming. And in the past have talked about other new products that are coming down the pipeline. So certainly part of driving revenue growth in '17, '18 and beyond will happen from adding product categories to our Home lineup. Again, that is accelerated by this focusing of the business on the Home that we have successfully executed in the last three, four months. And of course macroeconomic headwinds, in 2015 it seems like we weren’t catching any breaks with the currency devaluation and the collapse of Russia. Certainly, as the world economy stabilizes even somewhat, we think we can enjoy some benefit from that.

Mark Strouse

Okay, and that’s really helpful. Thanks, Colin. And then just thinking about the product roadmap over time, do you think there is potential for further increases in ASP or where the 980 is, do you think that’s where new Roomba ASPs would be? And then they would just be more feature rich? And then vice versa on the Braava on the lower end, do you think there is a need or potentially I guess offset the margin impact of the volumes if you brought the Braava ASPs down?

Colin Angle

To your first question, what I can say is there is not an example of a competitive product in the robot vacuum cleaning space having much success over $1,000. And so it may be that that is the practical ceiling for ASPs and what we’re going to see is functional improvements in the $300, $400 to $1,000 range in the category. And so I don’t expect a lot of growth driven simply by the increase in ASPs of Roomba. As it relates to Braava, again, ASPs as a metric for iRobot is going to become less relevant because we’re expecting growth in the wet floor care category, which carries with it lower ASPs, higher volumes but similar margin structures.

Mark Strouse

Got it, okay. That was actually my next question, so I’m all set. Thank you very much.

Colin Angle

You bet.

Operator

Our next question comes from Adam Fleck. Adam, your line is open.

Adam Fleck

Thanks. Hi. Thanks for taking my questions.

Colin Angle

Hi, Adam.

Adam Fleck

I had a few follow-up questions on the D&S divestiture. So, first of all, I appreciate the commentary in the press release on the margin and revenue impact from the business, but is there any specific cash flow items we should be aware of, any inventory impact or capital spending needs that go along with that business?

Alison Dean

Capital D&S wasn’t an overly capital intensive business, so the primary capital spend for D&S was tooling related to new products, which we hadn’t done a lot of in the last few years. Inventory, I don’t expect the go-forward business DII situation to change much. It might go up a little bit upon the divestiture of D&S. Certainly, the overall value of the inventory we’re carrying will go down. And we’ll be able to give a lot more color on that at the end of Q1 when the deal is actually closed.

Adam Fleck

Okay. Thanks. And then when you look at the intellectual property in that business, so are there any key patents in the sale that go along with D&S, particularly any that are used on the Home side from, I don’t know, a navigation perspective or anything like that?

Colin Angle

The IP, we are able to affect in a relatively clean fashion. There’s the IP that went with the deal, was IP that was exclusively used on the D&S side. There’s some patents that D&S use and the Home business use, which stayed with iRobot and there was a use license given to Defense. And to ensure that we didn’t make any mistakes, we gave ourselves at iRobot a license to the IP that went with D&S as well. And so that certainly iRobot comes out of the transaction no worse from an IP perspective and yet we were able to give the new divested entity the access to the IP it needs to succeed.

Adam Fleck

That’s great to hear. Thanks. And then finally I know we talked last week of the $45 million consideration, about 15 million or so was an incentive-driven payment based on the revenue performance this year. Can you share with us targets from a revenue perspective and your confidence that the business can hit those?

Alison Dean

Well, the earn-out will start coming into effect at revenue over 60 million. And as you know, we did 55 million in that business this year. The earn-out is complete, the full 15 gets earned at a revenue number just under 70 million. So that’s the range of revenue that needs to be achieved for a return on that earn-out payment.

Adam Fleck

Okay, great. Thank you.

Operator

Our next question comes from Marc Estigarribia. Mark, your line is open.

Marc Estigarribia

Thank you. Thank you for the opportunity and congratulations on the quarter.

Colin Angle

Thank you.

Marc Estigarribia

Just want to I guess take a step back and look at some of the themes out there, Colin, with regards to IoT, the smart home, getting into sort of the privacy and security. Just want to get your update on where we are in that and with regards to how iRobot is tackling the privacy and security issues and questions which are not a problem for earlier adapters, but is it holding back the functionality offerings for the Home Robot?

Colin Angle

The overarching philosophy that we have relative to privacy on our Home Robot is, let’s be cautious. The 980 robot as is currently architected, all the information collected stays resident on the robot. It is our expectation to slowly allow some information to flow up to the cloud but it will be done with the permission of the owner, because that owner actually wants to enjoy the benefit of that information going up to the cloud. So if you want to see, for example, a picture of what the Roomba did, you would enable the robot to go and send that information up. We are working to be cautious. We have our partners in the back office associated with the connectivity of the robot are best-in-class and we think that the value of the information collected by the robot in 2016 is 100% focused on making the Roomba clean and operate more effectively. And we will slowly move into a domain where we’re able to think about and expand the value and potential consumer base for the value of that connectivity.

Marc Estigarribia

Thank you. And with regards to functionality, the new upgrades and functionalities for the Home Robot, in your opinion – maybe we can just take a step back in terms of what you’re thinking at the outlook of the market. But should we expect voice activated technology on the same line of Alexa or Siri with the Roomba, or are there other features or color on the connectivity functionalities that we should expect this year by iRobot?

Colin Angle

The interface to the robot is something that is an active area of development and we try a lot of things. I think that we made a – I believe that the cell phone is not the remote control but it is something that is a great way to configure preferences for you connected home device. And so an example of that is using the mobile app to schedule your Roomba should lead to a far larger percentage of Roomba customers actually scheduling their Roomba, which leads to better customer satisfaction and a more complete delivery on the promise of robot vacuuming. The question of is there a voice interface gets at what is the right way of controlling the smart home. And so very quickly now we’re talking about the future of the smart home and what is iRobot’s role in it. A lot of that has yet to be publicly talked about and played out. But I would say that the core value that iRobot brings to the smart home has to do with the creation of maps. The idea that in order for objects within the home that are connected to kind of do the right thing, they need to know where they are. And having a mapping mobile robot able to go and discover and capture that information ultimately is going to be something that iRobot has IP, market presence and scale to deliver, and those are all significant barriers that I think we’re uniquely possessing. As we talked about, what is iRobot’s role in the connected home of the future, it’s going to build off that very defensible, very exciting positioning.

Marc Estigarribia

Thank you. And just a little more color, if you can please, on the one-time impacts of the divestiture cost, and maybe just a little bit more color on what the divestiture costs are please?

Alison Dean

So we’ve sized the actual divestiture cost to be about $0.05 and those are primarily related to fees associated with bankers, lawyers, accountants, et cetera.

Marc Estigarribia

Okay, great. And how should we look at the investment tax credit, maybe a little more color there going forward? Was that just a one-time in the fourth quarter? How should we model that going forward for 2016? Thank you.

Alison Dean

Our guidance assumes the investment tax credit will continue, which was announced with its confirmation for 2015. So it was a permanent tax credit, so it’s now permanently part of our guidance.

Marc Estigarribia

Thank you very much.

Alison Dean

You’re welcome.

Colin Angle

Okay. I think that we have exhausted our questions and so that concludes our fourth quarter and full year 2015 earnings call. We appreciate your support and look forward to talking with you again in April to discuss our Q1 results.

Operator

Thank you. Ladies and gentlemen, this concludes today’s conference. Thank you for participating. You may now disconnect.

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