iRobot Can't Rest on Its Laurels in This Competitive Market

iRobot Corp (IRBT), now a familiar name in the robotics arena, designs and develops residential, industrial, and defense (U.S. Government) robots. Its products are marketed both organically and along with their partners. Manufacturing is turnkey from China for residential robots and indigenous for defense products, as U.S. Defense contracts mandate it for their industrial and governmental robots.

iRobot was founded in 1990 by Colin Angle, Helen Greiner, and Dr. Rodney Brooks who were roboticists at Massachusetts Institute of Technology [MIT]. The initial robots were limited use, special purpose robots, which included the Genghis for extraterrestrial exploration and the Ariel with crab-like legs that detected and eliminated mines in surf zones. The year 1998 proved to be defining for iRobot as it received a DARPA contract for the tactical mobile robot program which was responsible for the development of the PackBot. The PackBot had three major achievements in the 2001-2002 timeframe that ushered in popularity for the company in the robotics field:

• September 2001 – Searched the rubble of the World Trade Center in New York City after the September 11 terrorist attacks.
• June 2002 – Searched caves in Afghanistan for ammunition and hostile forces.
• September 2002 – Searched the Great Pyramids of Egypt. The live event was televised globally.

The company entered the residential space with the introduction of Roomba - the vacuuming robot in September 2002. Sales of Roomba pushed one million units in the first two years. The 2^nd generation Roomba (Discovery series) was introduced in 2004 and the Roomba 5-series in 2007. iRobot has sold more than two million of their residential robots and 1200 of their industrial and governmental robots to date. Majority of the residential sales are for the Roomba vacuuming robots while on the industrial and governmental side, PackBot took the lead. The PackBots are installed in the war zones of Iraq and Afghanistan. The pace of new products has picked up recently both in the consumer and defense areas.

Business Issues

The company had its IPO on 11/8/2005 for 4.3 million shares (roughly 20% of the total shares outstanding) priced at $24 valuing the company at $480 million. The stock closed at $26.70 on the first day of trading. Revenue climbed from around $15 million in 2002 to $142 million in 2005 and at the time of IPO, the YOY revenue growth stood at 70% and gross margin at 29%. Profitability has been elusive for the company because of very low margins. Below is a summary of the company’s financials over the last three years:

Year	2007*	2006	2005
Revenue	240M	189M	142M
YOY Revenue Growth	27	33	49
Gross Margin	37	33.5	28.8
Net Profit Margin	1.25-2.0	1.9	1.8

* 2007 figures are projected.

A few factors that contributed to the anemic levels in the net margins over the last few years are:

• Increase in head-count.
• Litigation and other legal expenses.
• Product mix and customer relationship management related expenses.

Management should rein in expenses to ensure that it lags the annual revenue growth rate as compared to the current inverse scenario. iRobot’s product mix also leaves a lot to be desired. Though Roomba is a success story, most other consumer products notably Looj and Verro cater to a much smaller market. For an infrequent chore, consumers show a preference for outsourcing the job or renting a tool over owning a robot. There are already plans in the offing for products that can rake leaves, shovel snow, mow lawns, and wash windows, and it pays to research the potential market and the competitive environment.

iRobot’s strategy of configuring the PackBot product successfully for multiple purposes should be extended to its consumer suite of products too. By combining the functionality in various products, iRobot can definitely bring a versatile product to the market. For example, a base consumer robot with configurable options enabling it to function as the Roomba, the Scooba, the Dirt Dog, and possibly others would be well received by the market. The company could see margins improve and the customer could be spared the agony of amassing products. The company should consider this shift as early as the next generation of Roomba. This will position the company to realize the vision of these robots making the switch from an early adopter type product to being the smart assistants for “chief household officers”.

The significance of iRobot’s fairly large patent portfolio came into play in the pre-IPO days in 2005 when it successfully swept its rival Koolatron out of the U.S. Koolatron’s “smart” vacuum under the KoolVac brand was termed a complete knock-off of the Roomba. Recently, the company successfully sued against Robotic FX, a rival in the military space. Robotic FX had managed to pocket a large military contract by underbidding iRobot. Ultimately military negated the order. The company needs to continue being aggressive on defending its intellectual property, as building knock-offs is not complicated.

The 3^rd quarter saw the company disappointing Wall Street as results came in well below expectations. The delay in manufacturing the 5-series Roomba robots as a result of switching the manufacturing partner from Jetta to Kin Yat, both in China, was the root cause. The company has justified this as a diversification move. Management has to be diligent on avoiding such negative surprises as the effects can linger on for a while. The defense side has its own challenges when competing in the global marketplace. Strong partnerships along with a diversified and flexible manufacturing base are what the company should aim for going forward.

Outlook

iRobot has a number of new products scheduled both in the consumer and defense market. The big positive is that many of the defense related announcements involve partnerships with bigger defense contractors. It also has several research initiatives, of which some are bound to fetch returns in the long run. The consumer side of the business has explosive growth potential. Good execution is chiefly dependent on building brand awareness and doing away with the perception of an early adopter type product in the market space. Partnerships in the consumer space that parallel the defense space approach, should facilitate the company getting there in a higher gear.

The competitive landscape is crowded with more powerful rivals even though the company has a head start in some areas. Below is a list of its primary competitors taken from its annual report:

• Developers of robot floor care products such as AB Electrolux (ELUXY), Alfred Ka¨rcher GmbH & Co., Samsung Electronics Co., Ltd., LG Electronics Inc., Infinuvo/Metapo, Inc, Matsutek Enterprises Co Ltd. and Yujin Robotic Co. Ltd.;
• Developers of small unmanned ground vehicles such as Foster-Miller, Inc. —a wholly owned subsidiary of QinetiQ North America, Inc., Allen-Vanguard Corporation, and Remotec — a division of Northrop Grumman Corporation; and
• Established government contractors working on unmanned systems such as Lockheed Martin Corporation, BAE Systems, Inc. and General Dynamics Corporation.

The valuation is high on a going forward basis – the company is expected to earn 37 cents per share next year and hence is trading for a PE ratio of above 50. It is justified if the company is able to grow both revenue and profitability at an accelerated pace going forward. Given the potential for explosive growth in the consumer sector and the relatively low market capitalization, iRobot should be a very good fit in the small-cap aggressive growth area of a diversified portfolio.

Disclosure: The author has a long position in iRobot.