iRobot CEO Discusses Q2 2012 Results - Earnings Call Transcript

Jul.25.12 | About: iRobot Corporation (IRBT)

iRobot Corporation (NASDAQ:IRBT)

Q22012 Earnings Call

July 25, 2012 8:30 am ET

Executives

Colin Angle – Chairman and Chief Executive Officer

John Leahy - Chief Financial Officer

Elise Caffrey - Investor Relations

Analysts

James Ricchiuti - Needham & Company

Josephine Millward - The Benchmark Company

Adam Fleck – Morningstar

Alex Hamilton – Early Bird

Paul Coster - JPMorgan

Brian Ruttenbur - CRC Capital

Operator

Good day, everyone and welcome to the iRobot second quarter 2012 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 would like to note that statements made on today’s call that are not based on historical information are forward-looking statements made pursuant to the Safe Harbor Provisions of the Private Securities Litigation 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 and acquisition expenses, restructuring expenses, net intellectual property litigation expenses and non-cash stock compensation. A reconciliation of GAAP and non-GAAP metrics can be found in the financial tables at the end of the second quarter 2012 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 the Company's operations and achievements for the second quarter of 2012, as well as our business outlook for rest of 2012 and John Leahy, Chief Financial Officer, will review our financial results for the second quarter and provide our financial expectations for the full year 2012 and the third quarter ending September 29, 2012. 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. I am pleased to report that the company’s second-quarter performance was very good given the challenging environment. Total Q2 revenue of $111 million was at the high end of our expectations for the quarter while Adjusted EBITDA of $16 million and EPS of $0.26 for the quarter, both far exceeded our expectations.

Our continuing investment to improve Home Robot product quality resulted in an adjustment to our product returns accrual which positively impacted revenue and profit by approximately $3 million. Yesterday we announced, with InTouch Health, the unveiling of the RP-VITA telemedicine robot. The robot combines InTouch Health’s state-of the-art telemedicine solutions with iRobot’s autonomous navigation capabilities, mobility, interactive communication and situational awareness from the Ava program. It’s the first commercial robot based on our Ava technology and our most significant technological system since SUGV.

Our Home Robot business unit had an outstanding quarter and the outlook for that business is excellent. Strong growth in both our international and U.S. markets fueled a 50% year-over-year increase in Home Robot revenue. We are successfully expanding our distribution of new products and increasing our market penetration. In both the third and fourth quarters, expanded product distribution and strong demand both domestically and overseas will drive year-over-year revenue growth of more than 20%.

U.S. government funding and program delays, however, continue to negatively impact our expectations for the Defense & Security business unit. We have received notification of contract delays for both FirstLook and the two BCTM combat brigades which we expected to drive second half revenue in that business unit.

Our steadily increasing Home Robot global reach is enabling us to substantially offset the impact of U.S. government spending issues on our Defense & Security business. Therefore, we are reaffirming our expectations for full year 2012 revenue, which we provided in February and affirmed in April and are increasing our expectations for full year 2012 EPS and Adjusted EBITDA.

We anticipate full year 2012 revenue of between $465 million and $485 million, EPS of between $0.90 and $1.00 and Adjusted EBITDA of between $59 million and $63 million. For the third quarter we anticipate revenue of $125 million to $130 million, EPS between $0.30 and $0.36 and Adjusted EBITDA of $17 million to $20 million.

Now, I would like to take you through some of the details of the second quarter and our expectations for the rest of 2012.

In Home Robots, expanded distribution of our Roomba 700 domestically and very strong demand overseas, particularly in Japan, continued to fuel revenue growth. Asia Pacific grew more than 85% in the second quarter and totaled approximately 30% of Home Robot revenue in Q2. Our business continues to thrive in Europe despite the negative news that has dominated the headlines. Total EMEA revenue grew 42% in Q2 over last year and Western Europe, which comprised approximately 30% of Home Robot revenue, grew 40%.

Overall international Home Robot revenue increased 56% year-over-year. We have partnered with distributors who understand their markets and our products well and we expect international Home Robot demand to contribute significantly to revenue for the remainder of 2012.

I am particularly excited to report that our plans to revitalize our U.S. business are succeeding. Domestic revenue grew nearly 40% over second quarter last year following an impressive 21% increase in Q1. These results were driven by expanded distribution of Roomba 700 into U.S. retailers. Our continued investment in marketing to reach our target customer, the modern professional, was increased in the second quarter to support the expanded distribution.

Proof that our efforts, in particular the Q2 advertising campaign, have been effective is evidenced in higher Roomba and iRobot awareness scores as measured by an independent sources as well as significantly stronger sell through as reported by our domestic retail partners. During the six week campaign, the daily average of home robots sold to consumers in the U.S. increased approximately 50% from the daily average sold during the 15 weeks preceding the campaign.

Over the past year we have talked about the importance of investing in brand and marketing support to drive our growth plans and we saw the positive impact of our investments in the first half and expect our programs to drive even greater awareness in the U.S. market in 2012.

In addition to successful expansion of the Roomba 700, we continue to see demand for our Scooba 230 product, which is being sold on our website and in select European markets. Revenue from the Roomba 700 and Scooba 230 comprised more than 50% of Home Robot revenue in the second quarter. Expanding our distribution of both products throughout the rest of 2012 will continue to drive increased revenue.

Since our last call, we have announced new contracts totaling approximately $27 million for SUGV and PackBot robots, spares and software upgrades that we will deliver over the remainder of 2012. We are currently performing work under the BCTM bridge development contract and expect to sign a direct contract with the government later this year.

In June, the FirstLook robot was the top performer in the Ultra Light Recon Robot competition at the Joint IED Defeat Organization’s first challenge-based acquisitions event at the U.S. Army Robotics Rodeo. Among the participants were our three competitors in the operational assessment underway in Afghanistan and not only did we win the competition, but none of the other companies’ robots finished in the top three.

The event’s main objective was to use robotics to discover new methods that will enable creating better speed and flexibly to maneuver in the counter-IED environment. The FirstLook robot’s performance positions us very well for the upcoming contract competition in this weight class. Unfortunately, the solicitation for this robot has been delayed until October of this year and it is currently unclear whether the government will place any significant orders for FirstLook robots prior to contract award.

In addition to orders that we expected for approximately 76 SUGVs for BCTM brigades 4 & 5 have also been delayed. We expect to receive them in the fourth quarter and fulfill them in the first half of 2013.

Given leaner military budgets, there is an intense focus on doing more with less. Unmanned ground vehicles enable efficient achievement of mission objectives with fewer troops and we are well positioned with our SUGV and FirstLook robots to enable the government to meet its objectives. Limited visibility in our Defense & Security business presents near term challenges but we are working our way through them and hope to exit 2012 in a more positive position.

Finally, at the end of February we announced the management and structural realignment of the company for our next stage of evolution which we discussed on last quarter’s call. After combining the divisional engineering, operations and finance organizations into a shared service model to more effectively serve the business units, we identified a number of redundancies and inefficiencies and we took action in early July.

I will now turn the call over to John to review our second-quarter results and our Q3 and full-year expectations in more detail.

John Leahy

Thank you, Colin. Revenue for the second quarter was $111 million compared with last year’s $108 million. Earnings per share and EBITDA for the second quarter both exceeded our expectations. Earnings per share for the quarter were $0.26 compared with $0.29 last year, and EBITDA for Q2 was $16 million, flat with last year.

In Q2, we adjusted our accrual rates for Home Robot product returns, resulting in a positive benefit to revenue and earnings. Our returns experience has gradually improved as the result of our sustained investment in product quality. Revenue, EPS and EBITDA would have been $108 million, $0.18 and $13 million respectively, without this positive adjustment. For the first half, revenue was $209 million compared with $214 million in 2011; EPS was $0.28 compared with $0.56 last year and EBITDA was $22 million compared with $31 million last year.

Home Robot shipments grew 30% while revenue of $96 million increased approximately 50% from a year ago. International revenue increased to 56% in the quarter to $65 million and comprised 67% of Home Robot revenue. Total domestic revenues were up significantly, nearly 40% in Q2, following a 21% increase in Q1.

We now expect domestic revenues to grow more than 25% for the full year, our best domestic performance in several years. Importantly, sell through out of top 5 top domestic retailers was up nearly 35% year-over-year reflecting the impact of our advertising campaign in Q2 and expanded distribution of products launched last year.

Defense & Security revenue of $15 million decreased from a year ago due to both lower contract and product revenue. Defense & Security product revenue was $12 million in the second quarter, compared with $34 million last year. Product lifecycle revenue was $5 million. Backlog at the end of the quarter was $18 million. However, as of today the backlog totals approximately $28 million, the highest level since Q3 of 2011.

For the total company, gross margin was 44% for the quarter, compared with 39% last year. This improvement was largely driven by Home Robots which had a gross margin of 52%. As Colin mentioned earlier, improved product quality benefited our product return accruals. Excluding this impact, Home Robot gross margins would have been 50%, compared with 44% last year.

Product mix, lower warranty costs, and operating efficiency also contributed to the increase. Gross margin in our Defense & Security business improved from last quarter, despite lower revenue, as a result of cost reduction initiatives. We expect total company gross margin to be 41% to 42% for the full year.

Operating expenses increased to 35% of revenue in Q2 compared with 29% last year. The increase was driven by a 50% increase in sales & marketing for the quarter, reflecting the multi-media advertising program we kicked off in April. The second half of this campaign is scheduled for the fourth quarter to coincide with the holiday season.

Internal R&D grew 20% in Q2 as we accelerated development on Ava for the delivery of product to InTouch Health which Colin discussed earlier. For the full year, we expect operating expenses to be approximately 33% to 34% of revenue. At the end of Q2, we had cash, including investments, totaling $177 million compared with $123 million last year and operating cash flow is breakeven on a year-to-date basis.

In Q3, we expect revenue of $125 million to $130 million, a slight increase over the last year, driven by strong growth in Home Robots. We expect EPS in the range of $0.30 to $0.36 and EBITDA of $17 million to $20 million. Please keep in mind that in Q3 2011 we recorded a one-time tax benefit which impacted EPS positively by $0.12. Our full year revenue expectations of $465 million to $485 million remain unchanged, however we now expect Home Robot revenue to grow more than 30% to $365 million to $375 million and comprise almost 80% of total company revenue.

We anticipate Defense & Security revenue in the range of $100 million to $110 million for the full year, with sequential growth in both Q3 and Q4. We have increased our full-year expectations for EPS to $0.90 to $1.00 and EBITDA to $59 million to $63 million for the full year.

Strong domestic sales growth, the expanded distribution of new products, and further penetration into long term international markets will drive the Home Robot business. Orders for SUGV robots from the U.S. military and block software upgrades of D&S robots will support that business in the second half.

I’ll now turn the call back to Colin.

Colin Angle

Thank you. Our results in the second quarter exceeded our expectations due to strong performance by our Home Robot business unit. As we look at the rest of the year, we will extend our presence in existing markets and continue expansion in new geographic markets.

Beyond this year, we see tremendous growth opportunities for our Home robots and are very excited about the prospects for Ava. While the current military climate is disappointing, the longer term drivers remain intact for our Defense & Security business, and we are well-positioned for those markets.

With that we’ll take your questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question and answer session. [Operator Instructions].

The first question is from James Ricchiuti from Needham & Company. Please go ahead.

James Ricchiuti - Needham & Company

Thank you and good morning. First question I had Colin is, you noted in your presentation that 50% of the Home Robot revenues is now coming from the 700 and the new Scooba 230. Can you give us a sense as to where you might see that going by the end of Q4 because clearly there is a mix shift here that’s helping your gross margins?

Colin Angle

Right, I think that the 700, we are seeing very strong performance and we are not fully rolled out with the 700 at this time. So I think that that’s going to be an area of strength whether it increases from its current mix. I wouldn’t expect it to change dramatically from what we are seeing but certainly good reason to think we can maintain Roomba 700’s sales throughout the balance of the year from a mix perspective as we roll them out more fully. So the gross margins and the ASPs that we have reported, we think are sustainable through the remainder of the year.

James Ricchiuti - Needham & Company

Is the 700, just in terms of geographies, you said Japan was particularly strong. For example, is the 700 available widely now in Japan?

Colin Angle

Yes, and in fact the Japan was the region where we most aggressively rolled it out. It was a very good fit for that product and so that was an early launch market for the 700.

James Ricchiuti - Needham & Company

Okay, John, maybe you could help us understand that if we think of that 600 basis point improvement that you saw in Home Robot gross margins, excluding the accrual benefit, how much of that is coming from mix and how much of that is coming from the lower warranty rates and the operating efficiencies. Is there a way for us to get a sense as to how that’s breaking out?

John Leahy

Yes, so excluding the benefit of the returns, gross margins were about 50%, so about 600 basis point improvement year-over-year and it is split roughly by thirds. About a third of it benefitted by lower warranty costs, about a third benefitted by the mix impact and as you pointed out earlier, that’s really driven by the 700, and about a third driven by lower cost of goods and transport costs.

James Ricchiuti - Needham & Company

Got it, thanks very much.

John Leahy

Sure

Operator

Thank you, and the next question is from Josephine Millward from The Benchmark Company. Please go ahead.

Josephine Millward - The Benchmark Company

Good morning.

Colin Angle

Good morning.

Josephine Millward - The Benchmark Company

Congratulations, Colin. Can you talk about visibility for the government business in fiscal year ’13? Do you see it stabilizing or growing in light of the accrual on the increase for the SUGV so far from the three out of four defense committees on the hill?

Colin Angle

We are not going to comment much about ’13. I think that certainly is good news and creates the beginning of a basis, as we said, we build our estimates for 2013. We believe that we will exit the year with more visibility going to ’13 than we had going into ’12, though that’s a low bar but certainly we view as a positive and something that we can build on.

Josephine Millward - The Benchmark Company

Thank you. Switching gear to consumer. When do you expect the Roomba 700 to be fully rolled out in the U.S. and around the world?

Colin Angle

Our roll out plans, they have different stages. When we first launch a product, it’s in the specialty high end retailers only. We are past that. By the end of this year, you will see the 700 fully rolled out into the belly of our strategy which is the mass market retailers. Certainly, you wouldn’t see the 700 in the later stage discounting channels at this point.

That would be something that would happen in upcoming years, but it will be fully rolled out into our major mass market channels by the end of the year.

Josephine Millward - The Benchmark Company

Thank you very much.

Colin Angle

You bet.

Operator

Thank you, and the next question is from Adam Fleck from Morningstar. Please go ahead.

Adam Fleck – Morningstar

Hi, good morning. Thanks for taking my questions.

Colin Angle

Good morning.

Adam Fleck – Morningstar

I had a couple of questions about Europe really quickly. U.S. sell through was, again, really strong during the quarter. Like I said, two questions. How does that compare to what you have seen in Europe on the sell through and also, John, I appreciate the walk through on the improved gross margins but is there a substantial difference in profitability between your U.S. sales and your international sales?

John Leahy

Let me take the second part of that, Adam. In years past, as you recall, there was a quite a gross margin difference between international and domestic but with the good work that the home business unit has done in resetting our business in the U.S. and the rationalization that was talked about on profitable excuse and customers. The gross margins have improved significantly in the domestic business. So now, the margins are pretty close. International is slightly higher but domestic has improved so much that it is not a big gross margin mix impact now between domestic and international.

Colin Angle

For the questions on sell through, in Europe and in the U.S., we have a very uneven degree of reporting as far as the accurate sell through numbers are. Some retailers give us great data. Some don’t give us any data. So as a surrogate we track extremely carefully what the inventory levels at or retailers are and I will tell you that they are at a very comfortable two to three months of inventory at this point, both in the U.S. and in Europe.

So that would suggest that our distributors where we track their inventory levels, and so that gives us confidence that sell in is a valid surrogate for sell through. So we see no signs that inventory levels are doing anything unnatural. We believe that the sell in and the power of the growth we have seen in Q2 is completely representative of what’s going out the doors of the stores/

Adam Fleck – Morningstar

Okay, great, thanks, and if I could just sneak one more in on just a quick housekeeping. John, does the new EPS guidance include the one time gain from this quarter? The accruals?

John Leahy

You mean the adjustment from the returns?

Adam Fleck – Morningstar

That’s right.

John Leahy

Yes, it does.

Adam Fleck – Morningstar

Okay, great. All right, well thanks, guys.

Colin Angle

You bet

Operator

The next question is from Alex Hamilton from Early Bird. Please go ahead.

Alex Hamilton – Early Bird

Good morning.

Colin Angle

Good morning, Alex.

Alex Hamilton – Early Bird

From the strategy side, as you have gone throughout the course of the year and visibility in defense has gotten worse and visibility on consumer has gotten better. How has that changed in the boardroom of your strategy towards those products, either existing or what you are trying to develop going forward?

Colin Angle

Well, the reorganization of the company that we performed at the beginning of the year, gave us the flexibility to shift resources so we could select investments for the company that we felt were the most promising on a full company basis rather than strictly on a divisional basis. This has had some very positive effects in where we see the company placing its bets moving forward.

Clearly, on the military side, we have great future in a number of our products like SUGV and FirstLook and we continue to make substantial investments there. We also, on the home side, have seen tremendous growth and we are making sure that we are investing commensurate with the opportunities there.

As far as the more speculative work, that is further out as far as generating revenues go. Certainly it would be appropriate to imagine we are putting our money into programs like EVA, programs that we think are going to leave us in good stead to maintain our market leading position on the home side and so forth.

Alex Hamilton – Early Bird

Great, thank you.

Operator

Thank you, and the next question is from Paul Coster from JPMorgan. Please state your question.

Paul Coster - JPMorgan

Yes, good morning, and thanks for taking my question. Maybe perhaps start with the currency changes that are happening, obviously the dollar strengthening against the Euro. How has part of that risk passed on to your distributors in Europe and ultimately to the consumer?

Colin Angle

Our arrangements with our distributors in Europe have, we sell product to them in dollars and we have a band of exchange rates where the pricing is valid as the dollar strengthens, were to stay outside of that band for a long period of time, they would negatively impact our distributors ability invest in marketing programs and we may wish to supplement those marketing programs with some additional resources but we don’t change our transfer pricing for distributors based on currency.

Paul Coster - JPMorgan

The guidance for the full year, does that assume that you step in on the marketing programs or not.

Colin Angle

The guidance, we view it as all in set of guidance and we think that there are hundreds of different puts and takes that go into making that. Certainly we have probability weighted the notion that we might need to put a little bit of money and that would push our guidance into a slightly more conservative place but we have other factors that we believe that offset and that’s how we are able to get comfortable. There is some risk that we may see a prolonged disparity between currencies.

Paul Coster - JPMorgan

Okay, generally you see a sequential dip in the first quarter in your defense segment, your D&S segment revenues but it sounds like this year it might be a little less pronounced starting to the shift of the BCTM business out into the beginning of next year. Do you concur?

Colin Angle

Defense has always been lumpy. Certainly starting off 2013 with BCTM 4 and 5 would be a great way to start next year and would bolster first half sales but I would push back at any deep systemic pattern to the ordering of the government other than the fact that Q4 tends to be good because we have benefitted from year-end dollars that are obligated in September.

So that would be the only systematic seasonality to defense business, but certainly you are correct. It should help next year first half.

Paul Coster - JPMorgan

Okay, got it. My last question, Colin, is very exciting with the introduction of the health care robot. Can you talk a little bit about your assessment of the addressable market? Whether you have got any customers already? What the near term demand is? How are you going to develop that channel? All that good stuff.

Colin Angle

Okay. We are very excited about this. This is a major product launch and we do think it will contribute to our revenue next year and in some way to our back half revenue this year. What we have as an unveiling of the robot later this week. The exact date when we start taking orders is not yet set though it will be in the back half of this year.

From an addressable market perspective, we think this is a very substantial trend that with hospitals meaning to look at ways to control costs and to provide expertise of care across large geographic areas. So we think that this is an important market as well as being in a very important first start for EVA technology in general. We think that healthcare is one of a number of important markets that will be served by this technology.

So it is the first step in creating the next major business unit for iRobot and I look forward to being able to talk more about it as we start incorporating our expectations for performance into our revenue guidance with more fidelity.

Paul Coster - JPMorgan

All right, thank you.

Colin Angle

You bet.

Operator

Thank you, and the next question is from Brian Ruttenbur from CRC Capital. Please go ahead.

Brian Ruttenbur - CRC Capital

Thank you, a great quarter, congratulations. You had incredible growth in Europe and Asia on the Home Robot side. Can you talk about, maybe, your long term projections in these markets and maybe talk about what’s driving this growth? Is it existing distributors? Is it new distributors? Can you, I may have missed it, talk about the number of new distributors that you have added in Asia and Europe in the quarter and if that’s driving or it’s the existing distributors? Thank you.

Colin Angle

It’s primarily being driven by existing distributors. The major new area for growth in Asia is China and we have been saying all this year that that is something that is going to be material next year not this year. So 2013, we are excited about starting to tell the China story with more detail but what’s driving growth in Europe and Asia this year is the rollout of the 700 and the rollout of Scooba 230 through primarily existing distributors and those distributors are increasing their number of doors so that same number of distributors and increase in doors but primarily better sell through, same store sales, elevated price points and then with the distributors with some amount of new doors as the kicker on top of that but it’s the story we have been telling for a while toward the end of 2012 about growth drivers for ’13 and its gratifying to see that playing despite all of the negative economic news that we have been getting out of Europe.

Brian Ruttenbur - CRC Capital

Great, thank you very much.

Colin Angle

You bet.

Operator

The next question is a follow up question from James Ricchiuti from Needham & Company. Please state your question.

James Ricchiuti - Needham & Company

Yes, just a follow up to Paul’s year question about EVA. This is more of a housekeeping. Where will you be including the revenues for the telemedicine robot? In which pocket?

John Leahy

Well, to date, Jim, the cost we have been capturing within the home business unit but likely with the re-org that we announced we talked earlier about and merging BU and so as the revenue gets to be material and the cost of goods obviously, we will break it out at some point but to date, the cost have been in the home business unit and largely just showing up in our R&D spend.

James Ricchiuti - Needham & Company

Got it, and Colin, is it fair to assume that you will take the platform in to some markets outside of healthcare in 2013? Is that something we can anticipate in the early part of the year or is that more in the second half?

Colin Angle

At this point, what we have announced is bringing the platform in partnership with InTouch Health into the telemedicine space. I certainly will be excited to let you know when we are ready to take our next step but I make no timing promises at this time.

James Ricchiuti - Needham & Company

Okay, thanks very much. Congratulations on the quarter, by the way.

Colin Angle

Thank you so much. Well, that concludes our second quarter earnings call. We appreciate your support and look forward to talking with you again in October to discuss our Q3 results.

Operator

That concludes the call. Participants may now disconnect.

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