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iRobot Corporation (NASDAQ:IRBT)

Q1 2008 Earnings Call Transcript

May 1, 2008 8:30 am ET

Executives

Elise Caffrey – IR

Colin Angle – Co-Founder and CEO

Helen Greiner – Co-Founder and Chairman

Geoff Clear – CFO

Analysts

Paul Coster – JPMorgan

Jim Ricchiuti – Needham & Co.

Alex Hamilton – Jesup & Lamont

Operator

Good day, everyone, and welcome to the iRobot's First Quarter 2008 Earnings Conference Call. This conference 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 provision of the Private Securities Litigation Reform Act of 1995. This conference call may contain expressed or implied forward-looking statements relating to the Company's financial performance and results, the Company's operations, liquidity, geographic expansion and growth, demand for and delivery of the Company's products, and business conditions.

These statements are neither promises nor guarantees but are subject to a variety of risks and uncertainties, many of which are beyond our control, which could cause actual results to differ materially from those contemplated in the forward-looking statement. In particular, the risks and uncertainties include those contained in our public filings with the Securities and Exchange Commission. Investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof.

Please note that a live audio broadcast of this conference call is available on the Investor Relations page of iRobot's website at www.irobot.com. An archived version of the broadcast will be available on the same web page shortly. In addition, a replay of this conference call will be available through May 15 and can be accessed by dialing 719-457-0820, access code 3518435.

On today's call, iRobot CEO Colin Angle will provide a review of the Company's operations and achievements during the first quarter of 2008. Helen Greiner, Chairman of the Board, will provide an overview of international initiatives and Geoff Clear, Chief Financial Officer, will review our financial results for the first quarter of 2008. Then we will open the call for questions. At this point, I'll turn the call over to Colin Angle.

Colin Angle

Hello and thank you for joining us. Last evening, we announced our 15th consecutive quarter of year-over-year revenue growth. We continue to see strong demand for our products in both divisions. Home Robot revenue was up 55% with international Home Robot revenue up more than five times from Q1 a year ago. G&I revenue grew 35% in the first quarter from the first quarter last year. That said, we faced some macroeconomic challenges during the quarter that impacted our bottom line. Due to the financial condition of one of our key customers, Linens 'n Things, we did not recognize revenue for $1.8 million of shipments made to them in Q1. Compared with the first quarter of 2007, this accounted for a 2.3 percentage point decline in gross margin and a $0.05 decrease in earnings per share.

Over the past two months since we provided our 2008 financial guidance on February 20, the overall retail environment has deteriorated. Two of our retail customers have experienced severe financial decline, one to the point of declaring bankruptcy. Customer confidence is at the lowest point since 2003, and there is unprecedented turmoil in the credit markets. We develop guidance built upon unit growth rates that we thought were reasonable in a recession, and we have seen sell-through performance that meets or exceeds that model. We did not anticipate that retailers with previously high credit would choose not to pay for the products they ordered from us. Additionally, in the current U.S. economic climate, we anticipate that it will be difficult for retail partners to buy as aggressively as they have in the past in order to fill shelves with products.

Based on the uncertainty in the consumer marketplace, particularly with respect to holidays in the back half of the year, we are maintaining our first-half guidance and modifying our guidance for the full year of 2008. When we spoke to investors at the beginning of the year, we outlined a plan for top line growth and improved profitability for each of the divisions. We are continuing to execute against that plan, and our revenue expectations for the year remain relatively unchanged. What we’ve found it’s easier to preserve revenue than to maximize bottom-line earnings in this environment, so based on our current view of the economy and its impact on our customers, we not expect full-year 2008 revenue to be $295 million to $305 million and pre-tax net income of $5 million to $7 million.

There are several key points that I'd like to emphasize on this call. First, demand remains strong. Demand for the iRobot Roomba contributed significantly to the Company's year-over-year growth. Sell-through continues to be robust and on plan. In our Government and Industrial business, we continue to see increasing demand for PackBots, both from the U.S. government and foreign customers. Second, our financial performance in the first quarter, coupled with the probability of receiving several significant orders in our government business, gives us a high level of confidence in meeting our revised full-year financial guidance.

There is no doubt that we are being negatively affected by overall weakness in the economy. We thought we had factored the impact of a weaker economy into our models, but depending upon the length and severity of the recession, we may have underestimated it. Interestingly, several retailers reported that despite widespread consumer pessimism the Roomba continues to be one of their best-selling products.

As I review the results of the quarter, I hope to provide you with sufficient detail to support my confidence in achieving our 2008 goals. The Roomba 500 Series is selling well. Our significant efforts are focused on reducing product costs while improving quality. Year-over-year quarterly revenue increase of 45% was driven by substantial growth in our Home Robot division, which represented 53% of total revenue for the quarter. HRD revenue of $30 million grew 55% from Q1 of 2007, primarily as a result of the retail demand for the Roomba 500.

Driven by retailers' orders to replenish reduced store inventory levels and to stock the shelves for Mother's Day and Father's Day, we shipped 169,000 units during the quarter, compared with 129,000 units a year ago, an increase of 31%. Sell-through for Roomba was strong, up 10% from last year. And we expect unit shipments in the second quarter to be at a level consistent with the first quarter, which again represents substantial growth over the second quarter of 2007.

Average selling prices for the first quarter were also up 16% year-over-year, consistent with our expectations. Direct sales continued to be strong, up 50% year-over-year, and comprised 26% of HRD revenue in the first quarter. While the growth was very significant, direct sales comprised a lower percentage of total Home Robot revenue than we had originally modeled for the quarter. International revenue was $10.4 million and comprised 35% of Home Robot sales compared with 9.5% of sales a year ago. The strong international market is clearly a bright spot in contrast to the weakening domestic market. We are making substantial progress against our international goals, and Helen will comment further on our strategy and execution to date in a minute.

Gross profit margins in our Home Robot business declined to 26.8% from 30.2% a year ago. The impact from Linens 'n Things accounted for the entire 3.4 percentage point decrease. To offset this negative impact on gross margins, we are reducing operating expenses in order to deliver first-half financial results in line with our February 20th guidance.

Turning now to our G&I business, we delivered 156 robots to drive revenue up 35% year-over-year to $27 million. 67 of the robots were PackBots with FasTac kits under the first xBot contracts deliver order for 101 systems. Since the end of the quarter, we have delivered an additional 31 systems and expect to deliver the balance of this order this week.

We received a second delivery order for 26 systems and we will deliver those in May. We've gotten positive feedback from the field. The training on the systems is very quick, and the robots are easy to use. The robots have been well-received in theatre and we expect to receive additional orders for FasTacs in the near term that will fuel second half 2008 G&I growth.

We have reasonable revenue visibility into the remainder of the year and have already captured 40% of the Government and Industrial division's annual revenue as contemplated by our full-year guidance. This captured revenue is in the form of shipped products, services rendered, executed contracts to be performed, and product backlog expected to ship this year. This visibility figure is expected to increase substantially within the next several weeks as we are expecting significant orders shortly. Product backlog was $13 million at the end of Q1. This level decreased from the end of Q4 as we anticipated and discussed on our last call.

Last week, we announced an increase in our Future Combat Systems contract. Over the past five years, this contract has grown from $23 million in 2003 to approximately $63 million. The most recent $6 million increase supports the program acceleration we announced in January of this year. There has been much discussion in the news about the restructuring – about restructuring the FCS program. Robots being developed under this program are critical to the Army's modernization, and as such has seen both funding increases and development acceleration. The contracted task order for the SUGV acceleration calls for the delivery of 25 units. Three were delivered in January to support the new equipment training of soldiers at Fort Bliss, which was accomplished in January and February. The balance of the 22 SUGVs with design improvements and updated data sensors began delivery this week and we will complete delivery in May.

Following testing this summer, we expect a production decision to be made by the government in September. A positive decision would not significantly impact our 2008 results, but would set the stage for meaningful growth in 2009. In anticipation of a positive production decision, we selected Benchmark Electronics to produce the SUGV robot in its Hudson, New Hampshire facility, following an extensive evaluation of potential manufacturers. Having a second manufacturing option in G&I will allow us to mitigate risks of production interruption and enable us to maintain a competitive cost structure.

As we look at the rest of 2008, I am confident in our ability to deliver first-half results consistent with the guidance we provided on February 20 and full-year financial results in line with our revised guidance. As we said on last quarter's conference call, we expect our second quarter to be the weakest of the year. For the second quarter, we expect revenues of $51 million to $53 million, and a pre-tax loss of $10 million to $12 million. HRD revenues will be flat in Q2, while gross margins will improve substantially, quarter-to-quarter, because Q1 was so negatively impacted by Linens 'n Things. G&I revenue and gross margins will be down quarter-to-quarter as anticipated.

Looking at the second half, I want to discuss the formulas and assumptions that underlie our financial projections. We expect Home Robot revenue to growing 25% to 30% over 2007. To do this, we have modeled a modest 10% increase in units sold, a higher ASP and lower return rates, all driven primarily by further market penetration of our Roomba 500 Series robot. In Q1, our units were 31% higher, ASP's increased 16%, and early indicators reflect a lower return rate on the Roomba 500, as compared with the Roomba 400.

Our current expectation is that pre-tax net income in Home Robots will fall below expectations we set in February for several reasons. First is revenue mix. Based on deterioration in the retail sector, we have revised our models to reflect less higher-margin domestic sales, less higher-margin direct sales, and more lower-margin international sales. The other two factors which will impact Home Robot results this year are the sale of discontinued products in the Roomba line and the full-year impact of Linens 'n Things.

We continue to make great progress on the cost out program on the Roomba 500, the initiative to reduce product costs through engineering and use of alternate materials. The cost-out actions will positively impact margins in the second half. However, the savings will not be significant enough in 2008 to compensate for the other factors I just discussed.

Looking now to G&I, our lower backlog going into the second quarter was expected and we are projecting a 20% to 25% growth rate over 2007. In that division, we expect a significant increase in units shipped, lower ASPs due to higher volume orders, and a larger installed base into which we will sell more spare parts, support, training, and service for product lifecycle revenue. In Q1, we shipped 156 units, compared with 97 last year, and ASPs decreased 8%, as expected. PLR was up 7% over the first quarter of 2007. As I said earlier, we are anticipating several large orders for FasTac, which will initially drive an increase in backlog and then generate revenue in the second half of the year as we deliver against these orders. We expect at least one of the FasTac orders will be received in the near term for fulfillment starting in Q2.

While we continue to expect significant order volume, product mix will impact gross margins in the second quarter and throughout the rest of the year. Based on the military's current need, we expect them to order a larger percentage of lower-margin FasTacs than higher margin robots under the MTRS program as we had originally modeled. This impact – this will impact our G&I margins despite the leverage in the back half of the year on the investments we made in 2006 and 2007.

In summary, we executed well against our plan but our results suffered in a challenging economic environment. We reported revenue growth of 45% year-over-year. There continues to be strong demand for our consumer and G&I robots in the U.S. and abroad. And we are confident that we will deliver financial results in accordance with our revised guidance. Before turning the call over to Helen, I'd like to comment on the other announcement we made last evening. On June 9, John Leahy will be joining iRobot as EVP and Chief Financial Officer.

Geoff Clear joined us six years ago as CFO when we were a 100-person Company generating less than $20 million in revenue. He led us through our IPO and into our new headquarters building just this week. He will remain with the Company as Senior Finance Advisor to the CEO for as long as needed to ensure a smooth transition.

With more than 25 years as a financial executive, John brings iRobot extensive experience from multinational companies in both technology and consumer industries. Prior to joining iRobot, he served for eight years as Executive Vice President and Chief Financial Officer at Keane, Inc., a $950 million IT business, consulting and outsourcing services company, which did significant business with the U.S. government. Prior to Keane, John spent 17 years at PepsiCo Inc., both domestically and internationally. His impressive track record of leadership and accomplishment will help strengthen iRobot, and he will be a significant contributor to the future success of the iRobot team as we continue to grow our global presence.

We thank Geoff for his dedication and many contributions over the past six years and wish him all the best in his endeavors to assist other emerging companies.

Now, I'll turn the call over to Helen.

Helen Greiner

Thank you. An essential element of our growth strategy is expansion in international markets, and we see tremendous opportunities, given strong international currencies. I wanted to update you on what we have done in both of our divisions to execute on this strategy and our expectations for 2008.

In Home Robots, international has been a growing part of the business. Last year, international revenues comprised 15% of our Home Robot sales. In Q1 of this year, the business grew to 35% of the division's total revenue, and we expect that it will be approximately 20% for the full year. One of the reasons we are excited about our international opportunities is that we now have a product, the Roomba 500 Series, which is better suited for international markets.

In January, I traveled to visit Home Robot distributors and customers in Japan. Sales to Japan have now exceeded those to Korea, and Japan now represents our largest market outside North America. Historically, individual markets like Japan and Korea were our largest. The people in these countries are typically enthusiastic adopters of technology and labor-saving devices. iRobot has invested in sales and marketing resources in Hong Kong to support this region's growth. We expect to see (inaudible) business continuing to grow as the result of the investments in people and the acceptance of our Roomba 500 products.

We are also seeing strong growth in European markets. Early in 2007, iRobot made some key strategic changes, which included the decision to change our pan-European distributor and replace it with iRobot resourced sales and marketing staff to work directly with our partners. Our one pan-European partner in 2006 has now been replaced with focused iRobot support in 17 different markets. This change has resulted in better pricing for the customer – for the consumer, enabled our staff to know our distributors better, and allowed us to get closer to the end users. This has set the stage for continued European growth as the potential of these markets continues to be significant.

During the second quarter, we expect to launch our direct business in Europe, allowing consumers in the UK and Germany to purchase iRobots from our website. GSI Commerce, the company we are using for our domestic Web business, will provide a Web technology platform solution to service the international e-commerce opportunities for us.

In the Government and Industrial division, we continue to pursue an ever-growing range of international opportunities. This year, we've seen strong sales in Australia and in Scandinavia, where we recently won a major new contract and have launched marketing initiatives in several new regions, including India, the Middle East and Latin America. Europe and East Asia continue to be our core international markets. The majority of our sales is direct to international customers. However, we are currently nearing completion of our first major sales to the U.S. government foreign military sales program, which we see as a future growth area.

Our direct sales are managed by three international sales managers and our network of more than ten international distributors. Our international customers have been quick to adopt the new, upgraded PackBot 510. Today, the majority of our PackBot 510 sales have been to international customers with sales in Australia, Scandinavia, and Singapore. International market interest has also remained strong for the reconnaissance versions of PackBot, Scout and Explorer, which accounted for a significant share of 2007 international sales and they are expected to be a major contributor in 2008 as well.

We have also begun to market the larger Warrior robot and the smaller Small Unmanned Ground Vehicle, SUGV, internationally with the first major international demonstrations of these vehicles this year. The SUGV is marketed jointly with the Boeing Co. and Boeing Australia Ltd. will be our distributor in Australia. In June, we will be demonstrating a wide range of iRobots at the Eurosatory Conference in Paris that is attended by most of the defense agencies from around the world.

The larger opportunity for us today is meeting the needs of the U.S. military. But the breadth of our product offerings and our extensive marketing efforts positions us well for future international growth.

In conclusion, we see tremendous international market opportunities for both of our divisions and further penetration of those markets will continue to be an important part of our ongoing growth strategy.

I will now turn the call over to Geoff to review the financial results.

Geoff Clear

Thanks, Helen, and good morning, everyone. Revenue for the first quarter was $57.3 million, compared with $39.5 million last year. The pre-tax loss in the first quarter was $6.4 million, compared with $5.5 million in Q1 a year ago, and net loss per share was $0.16, compared to $0.23 last year. In the Q1 press release we issued last evening, we provided extensive supplemental detail for your review and analysis. Rather than repeat all of those metrics, I am going to address the financial highlights, the issues we faced during the quarter, an explanation of their accounting treatments, and an expectation – and our expectations going forward. I'll begin by discussing the issues which negatively impacted the first quarter.

At the end of first quarter, we had cash and investments totaling $38 million, compared with $43 million at year-end 2007. Included in the $38 million at the end of March was $15.4 million of auction rate securities or ARSs. We reclassified our ARSs to long-term investments during the first quarter due to the uncertain timing of our ability to liquidate these securities in today's volatile credit markets.

I'd like to provide some background on our position in these securities, as well as an understanding of our investment objectives and policy. Within our investment policy, we have three principal portfolio management objectives – first, to maintain readily available cash to fund our daily operating requirements; second, to invest in only the most highly-rated, AAA securities; and third, to generate a reasonable investment return while keeping objectives 1 and 2 in mind.

We manage our investments through several banks who recommended that we invest in ARSs because their characteristics best matched our investment objectives. With the relatively short duration of these securities, 7 to 44 days, ARSs offered us maximum flexibility for funding our operating cash requirements. In selecting the highest-quality investments with reasonable yields, we chose ARSs that were all backed by student loans and were fully secured by the U.S. government. We currently have eight ARS investments and each has failed at auction at least once in the past few weeks. We are still receiving interest payments, and in fact we are receiving payments at the default rate of interest, which is frequently higher than the security rate.

During the quarter, we engaged a third-party valuation expert to provide us with data on the market and give us valuation assistance. We believe the value of this portfolio is not impaired on a long-term basis, but there has been a temporary decline in its fair value. As a result, during the first quarter, we made a balance sheet adjustment to recognize an unrealized loss of $2.1 million on these investments. Each quarter, we will do a market valuation of the securities and record any adjustments to our financial statements.

I want to emphasize that the Company does not have a liquidity issue, nor do we anticipate that the potential lack of liquidity on these investments in the near term will affect our ability to execute our current business plan, based upon our projected operating cash flow and other sources of cash, including our $50 million unused line of credit with Bank of America.

I'd like to take a minute now to discuss our position regarding Linens 'n Things, one of our top ten retail partners. Our retail partners are very important to us, and we carefully consider all of the elements relative to a customer's business before making a decision to deviate from agreed-upon shipping terms. During the first quarter, we shipped Linens 'n Things approximately $1.9 million worth of product in the ordinary course of business. All of our receivables from Linens 'n Things were current going into the quarter and continued to be current through the middle of March.

Throughout the first quarter, we had extensive conversations with the company's executives to assess the collectibility of our outstanding receivables in light of the market intelligence we were getting about their deteriorating financial situation. At the beginning of April, the Wall Street Journal reported that Linens 'n Things might declare bankruptcy. Linens 'n Things subsequently announced that it had reached a 30-day standstill agreement with its noteholders to give the management team time to negotiate a debt restructuring. Since then, we have been selected as a key vendor by Linens 'n Things, and we are working with them to ship product on a cash-in-advance basis as they manage through this challenging period.

At this point, we don't know the ultimate outcome for Linens 'n Things, but given the uncertainty, we were unable to recognize revenue on a majority of our first quarter shipments, a total of $1.8 million. Had we recognized that revenue, our gross profit would have been 29.1% for the quarter compared with the 26.8% we actually reported.

While we continue to make significant progress in reducing the effective cost of our products, our gross margin for 2008 should be approximately 35%, a decrease from the 36% to 37% estimate we provided on February 20, in part because of this first quarter Linens 'n Things charge. We are monitoring the financial condition of our other retail customers.

And while we don't feel that any additional reserves are warranted, we will take appropriate steps should we see any deterioration in any other customer channels. This is certainly a challenging time for consumers, and the retail sector in the United States and we will continue to closely monitor the economic indicators and assess their potential impact on our business.

Operating expenses for the first quarter of 2008 were $22.2 million, or 38.8% of revenue, compared with $17.5 million or 44.4% of revenue a year ago. The 5.6 percentage point decrease reflects our increasing scalability and our focus on expense management as we continue to seek improvement to the profitability levels in our business models.

In summary, for the first quarter, Linens 'n Things' financial condition accounted for a 2.3 percentage point decrease in gross margin and a $0.05 decrease in earnings per share. We have revised guidance that reflects our estimation of the impact of a challenging domestic retail environment on our customers. And we are pleased with continuing revenue growth, and we remain focused on programs to improve profitability.

Before taking your questions, I'd like to speak briefly about my long-planned change in role at iRobot. As Colin mentioned, John Leahy will become the Company's new CFO as of mid-June. I will stay with the Company until that time and as long after that date as needed to ensure a smooth transition. My interest and expertise lies in working with companies that are between $50 million and $300 million in revenue.

Over the past six years, I've helped iRobot grow to become the successful Company it is today, and I am now look looking to move on to do the same thing with similar-sized emerging companies. I've enjoyed working with the founders, taking the Company from startup throughout IPO, and I wish everyone at the Company success with their continued growth plans.

With that, Lisa, we will open the call to the audience's questions.

Question-and-Answer Session

Operator

Thank you, sir. The question-and-answer session will be conducted electronically. (Operator instructions) And our first question comes from Paul Coster with JPMorgan.

Paul Coster – JPMorgan

Good morning. Colin, I think last conference call, perhaps prior to that, you talked of this year as being the inflection year. Well, is it? If not, what's happening?

Colin Angle

Well, certainly right now we are seeing some uncertainty in the consumer marketplace, and it is our policy to try to get all the information out as clearly and early as we can and that was the main reason why we adjusted our guidance today. We anticipate that there is going to be some consumer weakness in the back-half of the year, and we've tried to build that into our model. That said, we are seeing strong sales of our consumer products according to our plan, so there is some challenge with predicting exactly how the back half is going to run. On the military side, we are strategically positioned exactly where we hoped to be. This year, as hoped, we are going to see a lot of activity under the xBot contract and that will be driving our revenue this year as well as the production decision in September on the SUGV program which, combined with the xBot contract, gives us that real beginning to ship volumes into the infantry. So it is an inflection year. This adjustment to guidance is something that is primarily trying to factor in the uncertainty on the consumer basis, and we like where we are.

Paul Coster – JPMorgan

The guidance that you previously issued for the military business, it felt like it was loaded with upside insofar as any additional SUGV or xBot orders would buoy revenues beyond the expectations. Now, that doesn't seem to be the case, yet you are seeing those orders coming through. So, am I correct in thinking here that it's essentially cannibalization of the PackBot higher ASP revenue by the xBot lower ASP business that's causing that kind of not to work out for us?

Helen Greiner

I wouldn't say that. The back half of the year will be driven by xBot, which is built on a PackBot platform. We call it the iRobot PackBot with the FasTac kit. The contract that it's ordered under is called xBot. The SUGV, there's a production decision in September, so orders will drive revenue growth in 2009. So that will be start of the inflection point at the back half of this year and into 2009.

Paul Coster – JPMorgan

About 18 months ago, you accelerated your R&D in order to try and get the Warrior to market, which you did. And probably it was a bit disappointing for investors, but there was going to be a payoff from it. What's happened, though, with Warrior? It doesn't feel like it's got any traction so far.

Helen Greiner

The Warrior is gaining a lot of traction in the military market. As we said, it will be a product in the back half of the year. We've already sold one to a DOE facility who is working on mine clearance for the military. And in addition, there is a $3 million plus congressional appropriation to support additional Warrior development. Our strategy is to get the Warrior into the hands of the military labs and then refine it based on their needs for many particular missions. We consider the Warrior a multi-mission platform that can attack the EOD, engineering, the route clearance and other military markets.

Paul Coster – JPMorgan

It's a much lower price point than any other mine-clearing robot out there. Is that this sort of proposition there, value proposition?

Colin Angle

I think that the Warrior is a multipurpose platform and using the experience that we have making cost-effective, practical robots, I think you should anticipate the robot being a platform which offers substantial advantages, both in performance and price, over older technologies. So you know, we are changing and helping the military bring practical robots into the field. I think that, going back to my earlier comment, with the Warrior, with SUGV and with the PackBot with the FasTac kit, we are strategically doing everything that we had hoped to accomplish, and now we are letting these large slow-moving government contracting process to play out. And so I don't see any change. There is no change in our strategy; there is no change in our optimism and our excitement about where we are in the government side. And so I don’t – this is – we are not on the phone talking about a deviation from our plan, nor trying to change any expectations about how this is going to work.

Paul Coster – JPMorgan

Okay. All right, I get it. Last point is, on the expense, on the cost of goods sold side, just can you give us your latest thinking on how you are locking in your margins and are able to sort of explore new cost curves down that perhaps might yield better margins in the future? I mean, the nickel issue is obviously the most recent manifestation of your sort of challenges there anyway.

Geoff Clear

Sure, Paul, I'm happy to. As you will recall from previous conversations, we have locked in our battery costs for this full year, not only by the way with regard to the nickel but also with regard to any potential exposure to the Chinese yuan, so that piece is in place. We've also had extensive conversations and have fixed the commitments from our manufacturing outsource partners in China, both of them. And then we have many programs ongoing to take costs out of our products in general and in particular take cost of the Roomba 500 platform. Those programs were started in late 2007. Most of them have now been completed and are actually being incorporated into the products that we will be manufacturing later this quarter and in the third quarter as we start to ramp up for the holiday season. So those should improve our margins, particularly for the HRD business, in the back half of this year.

Paul Coster – JPMorgan

Okay. Thanks very much.

Colin Angle

You bet.

Operator

And our next question comes from Jim Ricchiuti with Needham and Company.

Jim Ricchiuti – Needham & Co.

Hi, good morning. The question just with respect to the G&I business in the second half of the year, did you say that you are assuming 20% to 25% growth in the second half?

Colin Angle

That is correct. For the full year, we are expecting 20% to 25% growth.

Jim Ricchiuti – Needham & Co.

Okay, and maybe just for clarification, has that changed from your prior expectations?

Colin Angle

No, it hasn't.

Jim Ricchiuti – Needham & Co.

Okay, thank you. And just as we think about some of the opportunities that you might have for expense containment as the environment has changed, Geoff, are there any areas of OpEx that in particular we would see you guys making some savings initiatives?

Geoff Clear

Well, Jim, if you look at the numbers for the first quarter, you'll see that we got some operating expense leverage, about six percentage points worth. That came in two categories. The most traditional one of course is in the G&A area, where we dropped as a percent of sales by a couple of percent. As we start to grow, you'll probably see more leverage there. We also kept our R&D costs essentially flat, so obviously with the increase in revenue, that means some leverage there. The one area that was essentially the same as a percent of sales, roughly 20%, was the sales and marketing area. And we will continue to do the programs that are necessary to support our products, particularly in this challenging economic environment.

Jim Ricchiuti – Needham & Co.

And, Geoff, as we think about R&D going forward, can you give us any sense as to how you see that trending?

Geoff Clear

We modeled, in our long-term financial model, R&D at 6% to 8%. And we see no reason why that has to change in order to achieve our long-term model.

Helen Greiner

We also continue to win government-supported programs to do research and development and our research division is going extremely strong and we have recently been awarded some new DARPA initiatives for next generation of robot technologies.

Jim Ricchiuti – Needham & Co.

And just a follow-up question on the G&I business, it sounds like you feel fairly confident that you'll see an order soon, another order, follow-on order. You alluded to I think a second order. Is there a timeline around that second order?

Colin Angle

There is absolutely a timeline associated with how we model the back half of the year and what we see coming down the pipe, but there is some uncertainty, so we tend to be quite conservative in trying to predict when anything exactly is going to happen. So we do expect some orders to come down the road, and we will be very, very clear with all of you as soon as we have them in hand.

Jim Ricchiuti – Needham & Co.

Okay, Colin, last question, is there a – with respect to the September production order timeline, I guess go or no-go, how hard and fast is that? Can that slip? Do you see that? Do you anticipate that slipping or do you see the military making that decision in that September time frame?

Helen Greiner

Any government decision can slip, but I can tell you that right now we are going through the testing and checking all the boxes, and it is going extremely well and on schedule.

Jim Ricchiuti – Needham & Co.

Okay, thanks very much.

Colin Angle

Okay.

Operator

(Operator instructions) We will take our question from Alex Hamilton with Jesup & Lamont.

Alex Hamilton – Jesup & Lamont

Hi, good morning. First, let me state, Geoff, it's been a pleasure knowing you. I hope to bump into you sometime in the future and I definitely look forward to meeting Mr. Leahy. But let me ask this question. Your cash balance, obviously, you had to reclassify some of these auction rate securities. If I am looking at the cash balance properly, you have about as much cash on hand as you burned through last year. Has that become a concern or are there any contingency plans in there?

Geoff Clear

As I indicated in my text, Alex, we do not have a short-term liquidity problem. It is something, obviously, we look at regularly. We did consume a fair amount of cash in the back half of last year as you know, but keep in mind that was at least partially if not mostly as a result of the fact that we had to essentially rebuild our inventory position as we transitioned from Roomba 400 to Roomba 500. That will not be the case this year. We have sufficient inventory already at this particular point in time. We have about $40 million of Home Robot inventory. That doesn't mean that there won't be some cash requirements in the back half of the year, there undoubtedly will, but we do have a $50 million working capital line of credit with Bank of America. And if we have to draw upon that, we certainly won't hesitate to do that.

Alex Hamilton – Jesup & Lamont

Great, thank you. And then just lastly, obviously the consumer market is a little jittery. And I might have missed this so I apologize for having you rehash it, but you are talking about a deterioration in the retail business and the fact that there could still be some charge-offs, although we think not likely but are possible, obviously. Yet you are talking about higher ASPs. Can you get me comfortable with kind of the conflict there?

Colin Angle

Sure. The higher ASPs are based on the increased price and value associated with the 500 series Roomba. So the 400 series carried slightly lower on average prices, and the 500 series because it's a more sophisticated, higher functioning robot, commands slightly higher prices in the marketplace. That's a primary driver, and we have seen, as we've said, improvements in our sell-through as a result.

Alex Hamilton – Jesup & Lamont

Fantastic, thank you.

Operator

And there are no further questions at this time. I'd like to turn the conference back over to Mr. Angle for any closing remarks.

Colin Angle

Well, thank you all for join us, and we look forward to further communication through the quarter in our next call. Again, thank you and good morning.

Operator

And that concludes today's teleconference. Thank you for your participation, and have a good day.

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Source: iRobot Corporation Q1 2008 Earnings Call Transcript
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