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Colin Angle - Chairman & CEO

Analysts

Paul Coster - JPMorgan

iRobot (IRBT) JPMorgan TMT Conference May 15, 2012 2:50 PM ET

Paul Coster – JPMorgan

My name is Paul Coster; I am the Senior Analyst covering applied emerging technology at JPMorgan. This is the 40th Annual Technology Meeting and Telecom Conference. It feels like sometimes doesn’t it? Anyway, thank you for joining us and thank you Colin Angle, CEO, Founder of iRobot for joining us making the trip in from Bedford. We appreciate it. So Colin perhaps let’s assume some of the folks in your audience are not familiar with the story, what is that iRobot does?

Colin Angle

Sure iRobot is a 23 year old company focused on practical robotics and over the years we have developed a tremendous technology base, explored a number of markets and are currently 75% of our business comes from selling consumer robots through retail channels globally to vacuum your floors, scrub your floors, clean your gutters clean your pools. We also have a defense and security business which is has put over 4500 robots into service primarily USDOD but also international customers. Those robots are predominantly light weight, ground vehicles that are used in service today for diffusing bombs, addressing the improvise explosive device threat and starting to be fielded by the regular army for a variety of intelligence gathering and situation awareness increasing operations.

Paul Coster – JPMorgan

And the heart of this is aware?

Colin Angle

The heart of this is aware, this is our robot intelligent system; it's a set of software tools and libraries that run on top of Linux that we have developed over the past 15 years that allow our robots to understand their environment. Most notably we are starting to feel robots and demonstrate prototypes of robots that can autonomously map their environments, feedback to the operators, a map of the environment that would resemble a CAD style map and allow the robot to drive around those environments cluttered by object and people but reliably and swiftly so this navigation capability is something that is coming online and is a key feature in some of our upcoming products and technology programs.

Paul Coster – JPMorgan

So the company has been through a number of phases, we were just talking about this and I kind of plus three years or so fabulous growth both for the defense and intelligence or government and industrial sector rather and for the home robotics segment and the company embraced a the EBITDA venture (ph) but pretty serious about profitable growth. We are now entering, it so feels like a hiatus rather than the phase for me because the defense segment just lost a bit of visibility, is that how you see things as well the (inaudible) another phase for iRobot.

Colin Angle

Well I think the company has always been diversified and the government, dimension of the business the driving hypothesis are still completely valid. We started off working on packbot robots for the improvised explosive device threat, Bid 4 (ph) competed one the future combat system program for small ground robots for the infantry, took in over a $100 million to develop the SUGV and successfully I have been delivering on the low rate initial production and then the challenge with government contracting it is lumpy and certainly election year, politics, sequestration, spectur (ph) and continuing resolutions have been pushing things to right and so that I think that you are part, I think that as we think about the next 18 months or so that the military side of the business is not going to be the growth driver, but remember it's only 25% of our business, the growth driver for the company has shifted to what is growing like a weed the home robot business unit has taken over very, very profitably and has really gone mainstream vacuuming robots, this might surprise you in Europe vacuuming robots about one in five vacuum sold in Europe today is a robot with the Spain being one in three vacuum sold being a robot and you say what’s special about Spain, absolutely nothing other than they have a lousy economy and are not viewed typically as technology adopters.

So that it starts to say well that giving has gone main stream, marketing such as what we did in Spain is impactful and in Q1 we saw North America really light up after being a relative slow grower where we worked on that profitability that you talked about actually exited some of our doors because of the unacceptable trade relationships we had while we were up 20% in the first quarter and subsequent to that figure have started a very aggressive marketing program we put $10 million this year into TV advertising that some of you may have seen around the main streaming of Roomba.

Paul Coster – JPMorgan

All right so it's kind of like you are the (inaudible) of the robotics industry this in time because you are not getting any respect for what you are doing on the home robot side, you definitely get penalized for the ongoing slump in the defense side of your business which is out of your control. So let’s try and sort of address this perception as to why it is that the defense segment was until recently anyway valued by investors more highly than the home robotics and I think it something to do with visibility and magnitude of the market and so on.

Let’s go back to the home robotics business because it obviously it defied the skeptics now for about 5 years, everyone says well it's going to come to an end and it's nothing of that sort. Why is that?

Colin Angle

Well as I think that at the core if you build a product that actually works and deliver at an appropriate price. We have the reliability, it's going to work and it's going to be a good business. People don’t actually want to vacuum their homes. They want to come home and have their home vacuumed for them and the room that can actually deliver the goods every single day and we have it's out for this is the 10th anniversary that we have sold over 7.5 million of them and I think we are on the 7th generation currently.

So this is certainly transitioned from hey isn’t that a cool gadget to this is a main stream appliance category and now the more people that own it you see the work of mouth coming into play which certainly leverages our sales power and I think that we have also had a few interesting opportunistic ways of driving our global brand. Last year, we had, last year we sent robots to the Fukushima reactor in Japan. This was a humanitarian effort, we gave our defense and security business a relief on their annual operating plan put four robots in a plane, six people sent them over and a strange thing happened, A, they were useful they are still been used every day over there but there was a complete media blackout around the news coming out of the reactor.

Three weeks passed when we finally started to get news out of the reactor it was images of our robots inside doing the critical measurements figuring out what the radiation levels were. Got global coverage and sometimes you do good and something good happens unintentionally out of such a thing happen, our (inaudible) recognition for iRobot and Roomba is in Japan is actually higher than it is here in the states and that became instead of having the Roomba sales taper off like retail sales in Japan did they actually skyrocketed and became a great growth engine and is continued for ever since we sent the robots deliver so that it's a great story and you know by hook or crook iRobot has continued to keep a national attention around itself and grow our brand which I think is part of the reason we have been able to succeed.

Paul Coster – JPMorgan

Like I thought you were going somewhere else you can see that if you clean up Fukushima you can definitely clean up my daughter’s bedroom.

Colin Angle

Maybe I can borrow that for next advertising campaign.

Paul Coster – JPMorgan

All right, okay so I mean that’s and it's been extraordinary, I mean Jeff Beck the gentlemen that took over the division under the license The Rockstar and he has just been spectacular execution, I mean he has done a terrific job, what is it that he has really done is different from his predecessors and that keeps us, I mean it's an underpenetrated market it's your basic, large underpenetrated market is your assertion, awareness is still quite modest but clearly growing in places like Japan. What is he doing, is keeping this thing from growing at 20% plus per annum?

Colin Angle

Well Jeff, when he came to us it was coincident with our committee to changing from growth at all cost to profitable growth and the bigger thing that he did was work to change our vendor relationships change our pricing strategy so that we could go from what was 20 point margins in North America to over 40 points in North America and then you do also to cool awareness programs and make money on them and so that we actually pulled out of target, pulled out of Sears reducing our doors well increasing our sales and increasing our margins and radically improve the business in same process.

So it was making the hard calls who is going to work with us, who is going to wants to sit on the sideline and decisions like that at the company allowed us to make the home robot business unit profitable. Gave us the resources to reinvest, we also continued every year to improve our product quality and so that the early robots where we had some performance and reliability issues with the current 500 and 700 models the customer experience is much better and so that like a I think we are following a technology maturation model where you can hit some real hurdles the product needed to last more than a year.

We needed a logistics and manufacturing capability within the company that would allow our inventories. Also Jeff Beck came in but also John Leahy, CFO and our inventory levels today are dramatically lower than they were back in 2008 despite the great increases in our sales, volume and revenue. So the business matured and it's a challenging business to manage products of the complexity of robot with the customer skepticism which is our primary barrier to purchase and the relationships with the retailers but you get all that lined up and you have got a high IP content, high margin market that is some wonderful growth characteristics because everybody they are home back in.

Paul Coster – JPMorgan

So basically there was this thesis just spending the channel that’s not true anymore because your sell through on a year-over-year basis you are experiencing growth, you also happen to be expanding the channels still there is nothing wrong with that there is another source of growth. Margins are in the 40s now where they were in the 20s and they seem to be sustainably high. There is no evidence of anyone, I mean I saw some news of some new Japanese robots the other day which is speaking in three languages or something but it's 1200 a bucks a piece right, so they have never even with that they have not attempted to come into North America because of the patent protection. So this presumably why you believe that the HRD business really deserves more respect.

Colin Angle

I agree we have over 100 patents issued in the U.S.; we have additional patents covering the key intellectual property globally plus a very robust pipeline. So we have got the formidable note we have this international brand and I said it's software, it's high IP content software in a box sold into a big market and we think that we are getting the respect by the customers currently to challenge the major consumer home appliance firms and thus really reshape what is a $6 billion per year market place and that is $1 spent on vacuum cleaners over $200 and so that’s our target with the Roomba and I think you pointed out that over the past two years the majority of the increases that we have seen and it's been over 20%, in some cases over 30% a year growth have come from same store sales not from channel expansion.

We have some very exciting channel expansion opportunities. Next year is China, we started selling in 2011 in China this is our adolescent year in China where we are scaling up with our ion materiality in 2013 so that is a major new market expansion. We also are expanding in Latin America, Mexico is on track and Brazil is moving along as a new market. So it's the demand for the product, the appeal for this product is global and then the last thing I will add is it's not all about Roomba because if you say okay well Roomba is a great 6 billion addressable market we believe that overtime 50% of that spend should be on robot.

Right now we are well below that but that to me is where I think we can achieve but there is also other devices that we are bringing to market in the home. We have got two new floor scrubbing robots, right there, the newest one it's Scooba 230 is a 6 inch diameter robot designed to clean your bathroom and this is launched April of last year and limited distribution and in ’12 is been expanded into mass distribution but here is a fantastic robot because Roomba cleans more diligently than a regular vacuum does it places the irregular vacuum can’t go but the Scooba actually cleans better because we are putting down clean fluids, scrubbing and vacuuming up the dirty water where as your slipper, wet (inaudible) or your mop and bucket is about taking some of the dirt off and putting in the bucket and spreading the rest of the dirt around.

So that from a physics perspective the robotic technology we put into the Scooba products actually does a better job so that we are 98% cleaning of bacteria before you put in chemicals. So if adjust Scooba with water you got that 98% cleanliness. So this is I am about passionate about cleaning but then I run a robot cleaning company among other things so I get to do that.

Paul Coster – JPMorgan

All right so let’s now turn to the defense segment which is what I used to be most excited about because I did drink the (inaudible) which is this could potentially be a 10X expansion in the market as robotics get embraced by the military for many, many more task beyond simply combat not that’s simply but combating IEDs to you know communications, breaching, carrying ammo through live fire situations, fire second applications and goodness what else but it does feel like the next 18 months any ways probably pretty not such an interesting period for this segment, is that correct and what has to change for the growth that to suddenly to take off again?

Colin Angle

Well the investment thesis in the ground robot to sound, there is a requirement on the books for even with the recent reductions and scope for well over 5000 robots to be delivered into the regular infantry. We have delivered maybe 200 of those robots thus far, these are the SUGVs I described as earlier they are 30 pound robots into which the government has invested $100 million, that’s going happen and so the question is when is it going to happen and at what rate and that’s where things get a little bit more cloudy. In 2012, the President’s budget has $25 million added for the procurement of these systems, that’s 25 million out of what we are currently guiding to around the $120 million in overall defense and security revenue. But I think looking at the side B (ph) is what you have to do in order to answer your question about when we come out of it.

So 25 million this year, in the President's budget for 2013 which is through the house of representative but not past. It's not done yet. The line item for SUGV is 86 million. Well that's directionally pretty exciting. Is it going to survive the current political climate, I believe much of it will but it's very, very difficult to predict and tell you at this point exactly what's going to happen. And so what does that do? That buys another 300 SUGV, still radically lower than the 5000 state meeting their requirements. So, we're on the right path but I am not standing here saying that again, over the next 18 months, we have this very, very exciting growth engine which is taking off and driving the business far more predictably than trying to figure out what's going to happen in Washington over the next few months and so our perspective is okay, we took our hit, whether it was a fair hit or not is debatable question, but around disappointing the government focused investors as to the fact that we're going to be driven by increases in defense matter, offset that with domestic business and then if we do, if and when the DoD comes back against this very real requirement, we're going to see some very nice upside unlike having lame seats for things that are going to come out in the future and as long as people view it as nothing crazy can happen in either direction, or basis focus on the consumer side, we'll do just fine.

Paul Coster – JPMorgan

I suppose my concern is not that you hit a period in which government budgets were uncertain. It's really going back to this notion that we're essentially talking about a 10X increase in market. And we've been talking about that for four years and it just sort of feels like that kind of expansion, that kind of market opportunity would be exhibited somehow and other through thick and thin through good times and bad times. If the value proposition is really that compelling for you (inaudible) in the military.

Colin Angle

Well I mean I think that lets put this in perspective. The future combat system was a 60 to $200 billion program. Every single program within FCS has been cancelled with the exception of one and that is SUGV. So we're still in the fight, that we survived what was an incredibly lethal and negative environment in congress in the pentagon around the program and well we haven't managed to accelerate the procurement of SUGVs. We're still on a time line that is exciting despite the fact that we had a huge change over in leadership in Washington facing another election with uncertainty there. The soldiers want the robots. The program started off as a $20 million program within FCS, grew to be $100 million program and is still continuing with significant investment. Is it small compared to the size of the defense budget? Absolutely. Is it very, very high impact and does it offer quantified performance around saving people's lives, increasing squad effect, absolutely. So why aren't they buying them in droves at a highly political environment. Change happens slowly in the military and with the reduction and elimination of supplemental budgets; you have a lot of very, very powerful forces at work trying to figure out how to keep things going. But we have been sufficiently protected the SecDef has said that demand is one of the areas which is going to be protected over time. We're going to have to play it out and I am having the luxury and don't have the choice otherwise of being somewhat patient and allowing things to play out and the luxury because this other side of the business have been doing so, so well.

If you go back to 2008-2009 when the home robot division was the thing that was stagnating and wasn’t driving the profits and we built the company on the government side, we certainly had seen a reversal over the last few years.

Paul Coster – JPMorgan

[Question Inaudible]. You had talked about marine area and oceanography and we are seeing a tremendous amount of money being spent by individual people in that area. Are you still in the arena of marine and oceanography?

Colin Angle

Absolutely, we have a maritime business unit that is looking at both government, military, survey and academic and then oil and gas opportunities for technology. Our product that we're selling today, product called the Sea Glider which is a, probably was most notably deployed in to the gulf of Mexico where it was the device that discovered the underwater plumes of oil back when it was the deep horizon oil disaster. That platform is extraordinary that it can travel halfway around the world over span of six to nine months without recharging its batter. So it is a great exploration tool and we are developing applications for it but it is actively being sold. Right now that is a business line which is very modest in its revenue potential but we think there is real potential there as they can find, well get beyond survey for government purposes which unfortunately pushing graphics there which is not a large volume business. It's more of an academically interesting small profit business and get into areas where there can be helping discover information that can be monetized more aggressively by industry.

Unidentified Analyst

[Question Inaudible].

Colin Angle

Okay, the question is how much R&D; I will give you a non-answer. We don't break that out. It is part of our overall IRD budget which is around 8% of our top line revenue but then of course we bring in significant amounts of externally funded research and development to augment our IRD budgets to give you more complete picture.

Paul Coster – JPMorgan

Can you talk briefly about FirstLook and Warrior?

Colin Angle

So I focus on SUGV because the question about what drives us back into rapid growth mode and I think it is SUGV but the vision for our footprint in the DoD expands beyond that 30 pound platform. FirstLook is a 5 pound robot for which there is urgent requirement and to allow a solider basically to have a man portable device that can actually throw through a window and send back audio and video information as well as set up adhoc RF networks in side buildings so the information of larger systems can be reliably sent out of building in situations where there is not Wi-Fi nodes in every room. So that is a system we sold over 100 of these units in the first quarter and we expect that to help around out the business in 2012, we talked about 25 million out of the 120 million which is our current guidance, a good chunk of that delta is this FirstLook robot.

So that is on a very exciting vector and it's like his big brother is the Warrior, this is a 400 pound robot. You can think about it as being these first practical human replacement robot. That means that this robot can carry more than you can, run faster than you can and still operate inside buildings designed for people. It is tracked; it is a very, very capable platform. We recently had our first non-military sale of Warrior to Progress Energy so that we are looking at applications of this technology in the industrial base and the robot is also being used and tested in various government labs and so that you don't have the program of record yet to feel the systems and volume, but it is a capability and a product that do help complement our overall defense and security industry.

Paul Coster – JPMorgan

I don't know how you guys feels but I've kind of always felt that this is a really big idea and a really big company, you saw busting get out of iRobot. If you ask of all the early stage companies that you cover for which is the most likely to be the next at. This company still feels to me like it's got the potential. The issue really is about timeline and we're talking decades, it feels like before robots really sort of started to become assisted living entities and we seem them in healthcare and we've seen them in retail and hospitality and so on. Do you still have this big vision? I am sure you do according to what this company is about and what needs to happen for us to see iRobot move from a $1 billion company to being a $5 billion and then we'll talk about the rest later.

Colin Angle

Fair enough. Absolutely, at the maddening part of being in the robot industry is the timeline. The fact these robots are incredibly complicated and expensive to design and build. That's the negative. The positive is that they are incredibly expensive and challenging to build and thus that creates formidable barriers to entry. But the industry is going to progress based on excellent business model and excellent robots being delivered and we've got Roomba established. It's not going anywhere. This is a sustainable rapidly growing asset that will drive our business in the short and intermediate long term not that the achieving your $5 billion goal is going to be based on okay, what's next. How do we continue to build out the vision? Because I think that if you look at my non-military vision, in my mind, it's all about extending independent living at home. We need as a society the capability of allowing our ageing demographic to live independently longer. We can't afford nursing homes, far too expensive. We can't afford hospital centric healthcare in the same fashion we are currently delivering it. It's going to become more and more unaffordable. The solution is taking advantage of the massive capital investment in one's own home and instead of centralizing the people and sending the services to that centralized location, using technology, mobile computing, robotics to bring the service to the people where they live.

So what do you need to do? You'll first need to care of the home, that's the Roomba, that's the Scooba, that's all of the other devices that we're creating. Then you need to bring services into the home, well first you start with this. This is revolutionary and wonderful for the robot industry because this solves place and video over IP, it solve touchscreen user interfaces, it solves speaker independent voice reorganization, it solves all of these things that used to be robot problems in an incredibly affordable mass manufactured easily programmable form. So then you just have to make this mobile and able to navigate around the home. So that's what our Eva project, Eva is one of our research platforms, it's basically a navigating robot that uses the technology I described earlier to bring this to where it needs to be to allow a nurse or a doctor or a loved one to interact with that elder and I think I am out of time, else I'd tell you more about it. But that's the big vision. That's how we're going to change the world in a more profound way than we've done thus far. And I think there are good and profitable steps along the way which we're trying to take.

Paul Coster – JPMorgan

Good. Thank you very much Collin. Appreciate you making the long trip here and everyone else as well. Thank you.

Colin Angle

Thank you very much.

Question-and-Answer Session

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