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iRobot Corporation (NASDAQ:IRBT)

Q3 2012 Earnings Call

October 24, 2012 8:30 am ET

Executives

Colin Angle – Chairman, Chief Executive Officer

John Leahy – Chief Financial Officer

Elise Caffrey – Investor Relations

Analysts

Jim Ricchiuti – Needham & Co.

Josephine Millward – Benchmark

Adam Fleck – Morningstar

Paul Coster – JP Morgan

Patrick Wu – (Unknown)

Brian Ruttenbur – CRT Capital

Operator

Good day everyone and welcome to the iRobot Third 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’d like to note that statements made on today’s call that are not based on historical information are forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties and involve a number of factors that could cause actual results to differ materially from those expressed or implied by such statements. Additional information on these risks and uncertainties can be found in our public filings with the Securities and Exchange Commission. iRobot undertakes no obligation to update or revise these forward-looking statements, whether as a result of new information or circumstances.

During this conference call, we will also disclose non-GAAP financial measures as defined by SEC Regulation G, including adjusted EBITDA, which we define as earnings before interest, taxes, depreciation, amortization, merger and acquisition expenses, restructuring expenses, net intellectual property litigation expenses, and non-cash compensation. A reconciliation of GAAP and non-GAAP metrics can be found in the financial tables at the end of the third 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 third quarter of 2012, our business outlook for the rest of 2012, and the preliminary revenue expectations for 2013. John Leahy, Chief Financial Officer will review our financial results for the third quarter and provide our financial expectations for the full year 2012 and the fourth quarter ending December 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. Last night we reported total revenue of $126 million for the third quarter driven by impressive growth in our home robot business. Earnings per share of $0.54 and adjusted EBITDA of $29 million for the quarter both far exceeded our expectations. During the quarter, there were a number of adjustments, the positive net impact of which was $7.7 million in revenue, $0.10 in EPS, and $5.2 million in adjusted EBITDA. John will provide additional details.

Our home robot business unit had an outstanding quarter. Total home robot revenue increased 33% year-over-year fueled by strong growth in both international and domestic markets. Our defense and security business had its best performance of the year, delivering revenue of $30 million. U.S. government funding and program delays, however, continued to negatively impact our near-term expectations for this business unit. With home robots accounting for more than 80% of the company’s total revenue, iRobot’s financial performance will be driven by growth in the consumer business and less impacted by the ups and downs in the defense business.

During the third quarter, we made a number of moves which we expect will extend our market-leading position. We announced an acquisition in support of our home robots business unit, hired key senior leaders across the organization, and began to implement significant strategic initiatives in our D&S business. Each of these actions will have a financial impact on Q4 and full-year 2012 results, as well as on 2013 results. We have revised our full-year 2012 expectations to reflect these actions and now anticipate full-year 2012 revenue between 434 million and 438 million, EPS between $0.44 and $0.50, and adjusted EBITDA of 47 to $49 million.

For the fourth quarter, we anticipate revenue of 98 to $102 million, loss per share of between $0.39 and $0.33, and adjusted EBITDA loss of 4 to $2 million. Both Q4 and full-year expectations include the impact of Evolution Robotics, which we acquired on October 1, 2012.

Now I’d like to take you through some of the details of the third quarter and our expectations for the rest of 2012. Expanded retail distribution of Roomba 700 domestically fueled total home robot revenue growth of 33% in the quarter. In the third quarter, our domestic revenue was up 85% over 2011 and 39% if you exclude the positive impact of a returns adjustment. Total EMEA revenue growth was 33% in Q3 and comprised almost 50% of home robot revenue in the quarter. Overall, international home robot revenue increased 16% year-over-year.

In addition to successful expansion of the Roomba 700, we introduced our Roomba 600 robot into select worldwide markets. Revenue from the Roomba 600 and 700 comprise more than 60% of home robot revenue in the third quarter. Our home robot business will grow between 25 and 30% in 2012 and we expect continued growth in 2013.

On September 17, we announced the signing of a definitive agreement to acquire Evolution Robotics. ER’s Mint products will expand our automated floor care offerings while we expect its technology deployed in future iRobot products to deliver even greater customer value. I am pleased to report that we closed the transaction on October 1 and we are working to quickly integrate the business. Paolo Pirjanian, ER’s former CEO and iRobot’s new Chief Technology Officer is on board and assisting in the process. Our domestic sales team is in discussions with iRobot retailers regarding the addition of Mint products to their floor care lines. Our operations team is working with ER contract manufacturers and (inaudible) suppliers to explore savings opportunities resulting from our combined purchasing power. Expectations for the financial impact of the acquisition remain unchanged at this point for 2012 and 2013. Underlying those expectations are the assumption that full integration of the acquisition will be complete by the end of 2013 and we will achieve higher revenue growth and improved margins in 2014.

In our defense and security business, shipments of the SUGV robots and software to upgrade the existing fleet of PackBot robots drove revenue of $30 million for the third quarter; however, our 2012 expectations for this business have declined further and at this point our outlook for 2013 is weaker. In addition to better size the organization with our revenue, we have taken several actions. First, our Maritime business which operated in North Carolina as part of the D&S has both product and research components. While we think there is a future for unmanned underwater vehicles, the product market has not materialized as quickly as we expected; therefore, we closed the Raleigh Durham and moved the research activities to Bedford. Secondly, we have taken actions to reduce costs across the entire D&S organization, allowing us to efficiently serve our current customer base and invest in our core products and technologies. We will record a 4 to $5 million restructuring charge in the fourth quarter as a result of these actions.

In August, Frank Wilson joined iRobot as Senior Vice President and General Manager of Defense and Security to lead this business unit and help map its strategic direction. To support this effort, he has reconstituted his management team. Frank, who was previously Vice President of Business Development and Mission Applications for Electronic Systems at BAE Systems, has extensive experience leading a business, driving business development, and transforming organizations in both favorable and declining defense budget environments. We look forward to his contributions and leadership as iRobot develops new technologies to address the growing role robots have in special operations and infantry missions.

On the last earnings call, we discussed the new RP-VITA Telemedicine robot which was built with InTouch Health on iRobot’s Ava platform. We recently hired Youssef Saleh as Vice President and General Manager to lead our remote presence business unit. Youssef comes to us with a tremendous depth of experience in new product development with a focus on telepresence. Formerly a VP at Polycom, he started their high-end telepresence business and grew it into a major business unit. Youssef combines entrepreneurial and product development skills to recognize opportunities that build markets and grow revenue. He has responsibility for supporting RP-VITA while exploring adjacent remote presence market opportunities.

During the third quarter, we made several strategic decisions to strengthen our business. Our home robot business has had an outstanding year and we expect continued growth in that business as we further penetrate our markets, expand our footprint, build brand awareness, and add ER’s Mint products to our family. Home robot revenue will account for more than 80% of total iRobot revenue in 2012 and 2013. Our near-term outlook for our defense and security business is weak. Our unmanned ground robots have become part of the U.S. military doctrine; however, the current macro environment is limiting sales to the government. We have scaled back D&S to allow it to succeed as a business unit and not negatively impact the overall company’s financial performance or our commitment to profitable growth, and we will continue to invest in remote presence. For the past three years, we have been exploring and investing in this market because of its significant potential, and we are now poised to access those opportunities under Youssef’s leadership.

I will now turn the call over to John to review our third quarter results and our Q4 and full-year expectations in more detail.

John Leahy

Thank you, Colin. Revenue for the third quarter was 126 million compared with last year’s 120 million. Earnings per share and EBITDA for the third quarter both exceeded our expectations. Earnings per share for the quarter were $0.54 compared with $0.50 last year, which included last year a $0.12 per share one-time tax benefit. EBITDA for Q3 was 29 million, up from 20 million.

In Q3, we adjusted our accrual rates for home robot product returns resulting in a benefit to revenue and earnings. Our returns experience continues to improve as a result of our sustained investment in product quality. We also booked reserves relating to slow-moving D&S inventory. Revenue, EPS and EBITDA would have been 118 million, $0.44 and $24 million respectively without these adjustments.

Home robot unit shipments grew 24% while revenue of 96 million increased approximately 33% from a year ago. International revenue increased 16% in the quarter to 63 million and comprised 66% of home robot revenue. Total domestic revenues were up significantly, nearly 85% in Q3 following a 40% increase in Q2. Domestic revenue grew 39% excluding the returns adjustment.

Sell through at our top five domestic retailers was up 17% year-over-year, reflecting the impact of our advertising campaign in Q2 and expanded distribution of products launched last year. Defense and security revenue of 30 million decreased from a year ago due to both lower contract and product revenue. D&S product revenue was 25 million in the third quarter compared with 38 million last year. Product lifecycle revenue was 15 million. Backlog at the end of the quarter was 12 million.

For the total company, gross margin was 43% for the quarter. Home robots had a gross margin of 51% and 47% without the benefit of the returns adjustment. Gross margin in our D&S business improved from last quarter due to higher revenue.

Operating expenses decreased to 25% of revenue in Q3 compared with 35% last quarter and 29% last year. The sequential decline was due primarily to the timing of the advertising program we kicked off in April. The first part of this campaign occurred in Q2 and the second part is scheduled for the fourth quarter to coincide with the holiday season.

At the end of Q3, we had cash including investments totaling $190 million compared with 145 million last year. Operating cash flow is $12 million on a year-to-date basis. Our Q4 ending cash balance will reflect the $75 million cash outlay for Evolution Robotics.

As Colin mentioned, there have been a number of material adjustments this year. In Q2, we adjusted our product returns accrual, which had a $3 million positive impact on revenue and EBITDA and an $0.08 positive impact on EPS. In Q3, we booked an additional product returns accrual adjustment which had an $8 million positive impact on revenue and EBITDA and an $0.18 positive impact on EPS. We also booked D&S inventory reserves, which had a negative impact of $2.5 million on EBITDA and $0.08 negative for EPS.

In Q4, we will be realizing for the first time the impact of the Evolution Robotics acquisition with a 4 to $6 million positive impact on revenue, a 5 to $6 million negative impact on EBITDA, and an $0.18 to $0.22 negative impact on EPS. We will also be incurring $0.09 to $0.11 negative EPS impact from restructuring our D&S business.

In 2013, we continue to expect the impact of the ER acquisition to be a 22 to $24 million positive impact on revenue, a 2 to $3 million negative impact on EBITDA, and a $0.22 to $0.26 negative impact on EPS and to be accretive by Q4. Inclusive of these items, we expect Q4 revenue of 98 to 102 million, a loss per share in the range of $0.39 to $0.33, and EBITDA loss of negative 4 to negative 2 million.

Our full-year revenue expectations are 434 to 438 million with home robot revenue growing more than 25% to 355 to 360. We anticipate D&S revenue in the range of 75 to 80 million for the full year. Our full-year expectations for EPS are $0.44 to $0.50 and EBITDA 47 million to 49 million. For 2013, our preliminary expectations are for revenue to increase 5 to 10% with 425 to 435 million in our home robot business, offset by a further decline in D&S revenue to 45 to $55 million.

Now I’ll turn the call back to Colin.

Colin Angle

Thank you. Our results for the third 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 invest in the tremendous growth opportunities for our home robots and our Ava platform while working to seamlessly integrate the Evolution Robotics acquisition. The current military climate is disappointing; however, the longer term drivers remain intact for our D&S business.

More than 80% of our annual revenue will be generated by home robot business and we expect continued growth in that unit. We have scaled back the D&S business to ensure that it does not negatively impact our commitment to profitable growth, and we will continue to invest in and pursue opportunities in our remote presence business unit.

With that, we will take your questions.

Question and Answer Session

Operator

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

And our first question comes from Jim Ricchiuti from Needham & Company. Please go ahead.

Jim Ricchiuti – Needham & Co.

Hi, good morning. I have two questions – one on the home robot business in Q4, and the second just with respect to the preliminary guidance and the outlook for the D&S business. First on the Q4 guidance for home robot – it looks like you trimmed a guidance a bit, which I guess isn’t all that surprising given the current economic environment. But I’m wondering if you could just a little bit more color on what you’re seeing. It appears that your business in Asia has slowed. Is that true, and what’s going into the guidance you’re giving for Q4 in that part of the business?

Colin Angle

Sure. As you know, Jim, the dividing line between Q3 and Q4 is often a little bit difficult to divine, and I think what we saw in Q3, the unexpectedly strong performance in home was driven by some retailer enthusiasm to get their hands on new products, which pulled some of the orders that might more normally have happened in Q4 into Q3. And then, we’re also seeing some impact in Europe in particular by retailers taking a more conservative approach toward inventory, which will mean that a successful Q4 ends with the channel in Europe very, very clean based on what we’re seeing in demand. So it is the new product introductions driving the over-performance in Q3, and Q4 takes a bit of a hit as a result.

I don’t think we’re seeing anything worthy of report as far as Asian demand for the product. It has been strong all year, and the ups and downs in inventory are making Q4 play out as we had described. But we don’t see a trend in that arena.

Jim Ricchiuti – Needham & Co.

Got it. And then just with respect to the 2013 guidance, if we go back to the last call, it sounded like the way you were characterizing the D&S business is you felt that you might be entering 2013 with better visibility than you had a year ago. So first, what are the changes that you have seen, and to what extent is this outlook for the D&S business just conservative or is it just a realistic view of the business as you see it?

Colin Angle

You know, I think what we’re seeing is a continued lack of visibility. Definitely the DOD has not been giving us clear signals as to the time frame under which they are going to go and continue or ramp-up their acquisition for the SUGV product, and certainly has pushed to the right the acquisition programs associated with First Look. And so it is very frustrating for us to try to plan, and thus what we’re giving you in our outlook for 2013 we think is the best estimate of expectations for 2013, given the data that we have today. We feel like we are very well positioned and that there is a very, very strong intermediate and long-term demand for ground robots in the military, very strong messaging on that regard. But on the flipside, we’re also seeing a lack of a strong demand signal for near-term purchases that have traditionally driven higher revenues. So what you see in our outlook for 2013 is our best guess based on the information that we have in hand today.

It’s a little bit of a tale of two cities – home robots with our technology leadership position is great guns. We’re seeing tremendous growth in that rapidly maturing business. On the defense side, it’s a little bit more of a wait and see, and our commitment was to make sure that we did not over-invest and over-spend on the defense side, so that we’ve taken some actions to allow us to appropriately continue to play in that market, appropriately continue to generate profit in that market as well as sensibly invest in our core products. So some of the type of outlook for next year and as I mentioned, defense is going to play a smaller role in driving our financial results in 2013.

Jim Ricchiuti – Needham & Co.

And John, just on that point about profitability, would you be willing to give any color with respect to where operating margins might go, given the revenue range that you’re talking about for next year in light of the restructuring moves?

John Leahy

Jim, we’re just not ready to do that. Normally, as you know, we would not even be projecting revenue at such an early point, but we did think it was important to try to level set given what we’re seeing in D&S. But we’ll still going through our internal planning process, and so we’re just not ready to guide you on margins or the bottom line.

Colin Angle

But I will emphasize that our commitment to profitable growth, as evidenced by our taking significant action to right-size the defense business, remains completely committed so that there is not a change in our business model around profitability – far from it.

Jim Ricchiuti – Needham & Co.

Okay, thanks Colin. That’s helpful.

Colin Angle

You bet.

Operator

Our next question comes from Josephine Millward from Benchmark. Please go ahead.

Josephine Millward – Benchmark

Good morning. Hi Colin. I know you have a lot of uncertainty with the government business with the elections, but are you just de-risking there by setting expectations very low for government next year, because it seems to me that you should be able to do a lot better based on SUGV funding from the ’12 budget and what’s been requested for ’13 on top of contract R&D and spares and parts. Can you comment on that, and do you still think the Army is committed to fielding the SUGV within the force structure over the long term, or in the coming year?

Colin Angle

What I would say is that yes, I believe that the DOD is committed to fielding the SUGV. The time frame and rate at which the monies that were in the budget are allocated is the thing that we have mixed signals, and so that we think taking a realistic view of how those monies are going to flow in 2013. The demand signal is there; the elections certainly have slowed things down. Sequestration has had a substantial impact on the ability to get commitments from the Pentagon, and I think that there are also some questions around how the SUGVs are going to be brought in and on what time frame, whether it’s the current approved configurations or whether they would like to see some additional features incorporated into the robots.

So there’s some real uncertainty, and I think that what you see in our numbers is our best guess at this time. I think that we are all disappointed by those numbers and feel like there is tremendous need in the military today for this type of equipment, but Washington is a challenging place and there are many struggles that impact the visibility and the rate of these procurement programs.

Josephine Millward – Benchmark

Can you give us a rough breakdown of your expectations for the 45, 55 million in terms of SUGV, robots and contract R&D?

John Leahy

Josephine, about half of our projected revenue is the First Look product and the contracted R&D, and the balance of the revenue is spread across small SUGV orders, small PackBot orders, and upgrades. So the key to that number being hit or perhaps exceeded is what happens with the First Look and the contract revenue. Those are the two largest parts of the plan.

Josephine Millward – Benchmark

Got it, thanks. Shifting gears to home robots, can you talk about your expectations from Latin America and expansion to China next year? Is that included in your outlook for ’13, and also your outlook for other telemedicine robots? Thank you.

Colin Angle

So the answer is yes, the expectations for Latin America and China are included in our current guidance. I think that we are on track with our plans in China. We talked about this year being not material and next year making material contributions. In Latin America, the performance of Latin America in 2012 was one of the rare weak spots in our performance, and we have made some changes in Latin America and believe that it will begin to perform to expectations next year, so that we had some distribution issues in Latin America which have been addressed.

So Latin America underperformed, China was on plan, both are included in our 2013 plan as material contributors, and we’re excited to see growth in those areas for many years to come.

Josephine Millward – Benchmark

Colin, why are you projecting a growth deceleration in home robots with the geographic expansion and the new products? I’m just trying to understand whether this is iRobot being conservative or is there something else going on that we should know about?

Colin Angle

You know, I think we’re very excited about the growth we see next year in home robots. I wouldn’t view it as sending any type of message other than it’s a vibrant and healthy market. We’ve included what we think are prudent estimates as far as how quickly we can roll Evolution into our product line because of the complexities of taking a product which was focused on the U.S. domestic market and making sure that we can meet the commitments and all of the product issues of internationalizing that product base. We do have growth over 20% modeled, which is what I think is a very exciting figure to be laying out there. I think that there is a lot of growing room for many years to come, and we’re very comfortable and pleased with the 20% growth number at this time.

As John mentioned, this is quite early for us to be commenting on 2013, but given the challenges that we’re anticipating next year in defense, we wanted to get a number out there. Certainly when we give more formal guidance for 2013 in February, we’ll have better numbers; but this is what we think is prudent and appropriate given the information we have at this time.

Josephine Millward – Benchmark

By the way, I see the Roomba everywhere in Paris. I think it’s very popular here!

Colin Angle

We continue just to defy the economic malaise in Europe and we hope to continue, so thank you for that feedback.

Josephine Millward – Benchmark

Thank you, Colin.

Operator

Our next question comes from Adam Fleck from Morningstar. Please go ahead.

Adam Fleck – Morningstar

Hi, thanks. Good morning. I had a quick follow-up on the discussion about home robots. ASPs showed much slower growth this quarter year-over-year than in some previous periods. How do you think about pricing – you know, the roll-out of the 700 is nearly complete, the roll-out of the 600 is just beginning albeit sounds like replacing the 500, but you’re also including the Mint next year. So should we expect this metric to continue to see somewhat flat performance?

Colin Angle

Well what you’re seeing right now, remember, is anniversarying of some of the higher price point products that we put into the market last year, so that there is some natural slow-down in the ASP growth just because of the comparable. We have seen the 700 series perform very well and the higher end robots particularly strong relative to expectations, so that has allowed our ASPs to increase.

You make a good point about the Evolution acquisition. Those products tend to have lower price points, so it’s building out quality product offerings at opening price points which we think customers will find very affordable and bring new segments of the customer base into the iRobot franchise. So I think that ASPs—we’re not giving guidance at this point as to what we expect to see in 2013, but you will some deceleration because of those very natural impacts of Evolution and anniversarying a high-end price point strategy that we launched last year.

Adam Fleck – Morningstar

Okay, fair enough. Thanks. And then just shifting back to the whole company, it looks like R&D came down pretty sharply sequentially and as a percentage of sales. Is this how you’re thinking about R&D going forward on a quarterly run rate? Maybe you can help us out with that a little bit.

John Leahy

Adam, what you’re seeing in Q3 is that we’re coming off of a peak level of R&D relative to the remote presence product, the Ava product; so that peaked in Q2 as we were working to finish some product delivery relative to our relationship with InTouch Health. We think that internal R&D will continue to run at 7 to 8% of revenue as it has been over the last couple of years, and then if you combine that with external R&D running in total about 13 to 14%.

Adam Fleck – Morningstar

Okay, great. Thanks.

Operator

Our next question comes from Paul Coster from JP Morgan. Please go ahead.

Paul Coster – JP Morgan

Thank you. Colin, as the R&D has been reined in, I assume that it’s more tilted towards the sort of D now as it tilts towards the consumer products rather than the defense products, for reasons of timing at least. Is that true, and does that kind of undermine in any way your sort of long-term prospects, because there was some really creative stuff happening in that defense segment previously.

Colin Angle

First off, the 7 to 8% IR&D has been our target for IR&D for many years at this point, so I think that we did have a burst of IR&D spending earlier in the year, as John said, to help us get a couple projects across the finish line, but there is no change in iRobot’s long-term commitment to IR&D with the absolute dollars increasing on year-over-year bases as revenue increases and as a percentage of revenue, holding that steady.

The question about technology and our investment in technology, it’s more significant than ever. The acquisition of Evolution Robotics has allowed us to put even more energy into visual navigation, which is a technology which is going to allow our robots to use low-cost cameras to build maps and allow our robots to perform more sophisticated tasks based on that information about it environment. And the cool thing is that the investments we’ve made in low-cost processing and the code base allows this technology to be applied across product lines. So while the absolute amount of dollars that is focused on research and development solely to benefit of D&S is probably down. The amount of IR&D that is working on cross-cutting technologies has been increased, so the technology that was being developed for D&S now has applicability in our remote presence business unit and also is being used in the development of future home robot products.

So we’re definitely a company that is able to better leverage our IR&D investments that we were just a year ago, so it’s actually a very exciting situation to be in where whole company R&D benefits all of the products. It’s one of the ways that we will stay and extend our leadership position in the defense arena despite the fact that the product sales have been disappointing and we anticipate continuing to be disappointing in the short term.

Paul Coster – JP Morgan

Okay. I’d like to revisit Josephine’s line of questioning as well regarding the home robotics business. I mean, the way we look at it here is that you’ve got—you’ve had this fabulous organic growth rate year-to-date. You quote market slowdown entering the fourth quarter and then it reaccelerates in 2013 to round about the 20% organic growth rate from 5% in the fourth quarter. Can you just kind of help us again understand this dip, and why you have such confidence that the dip is temporary in nature?

Colin Angle

Sure. Again, the retailers are—with a very substantial amount of our sell-through happening in the fourth quarter, the question is always when do the retailers order? Is it in Q3 to stock in advance of sales, or is it in Q4 to more conservatively, just-in-time order? And because (audio interference) products that we put in the market place, this year we have seen more activity that falls on the Q3 line of the ledger rather than on the Q4 line of the ledger, which means that the—you know we had growth rate for home above 30% in Q3 and excluding the Evolution impact down in the high single digits in the fourth quarter. But if you group those two quarters together, then we’re up in that 20%-plus growth rate that we’re more accustomed to seeing.

So I don’t believe that it is any way a deceleration, and I provide additional color that in Europe we’re seeing a little bit of a barbelling effect where they ordered early and then are holding off with a little bit of a wait-and-see attitude to look at sell-through, and thus the early Q4 that we typically see are being pushed further and further into the quarter. And as I mentioned earlier, that’s okay. It means that we’re likely to see inventory levels at very nice low, healthy levels exiting the year, which makes for a nice Q1. So every year has a little bit of a different dynamic. I think 2011 saw more in Q4, and for various reasons in 2012 we’re seeing the shift into Q3.

John Leahy

And Paul, I would just add a little color in terms of the strength of the business. In Q3, the domestic business excluding the impact of the returns adjustment grew about 39%. In Q3, EMEA grew over 30%. On a year-to-date basis, Japan is up over 50%, so we continue to see considerable strength really around the globe now, and as Colin pointed out, I think you’re seeing some timing anomalies with what we’ve said about Q4 but it should not change—it certainly does not change our perspective in terms of the strength of the business, now and going forward.

Paul Coster – JP Morgan

Okay, thank you.

Operator

Our next question is from Patrick Wu from (Inaudible) Research. Please go ahead.

Patrick Wu

Good morning guys. Thanks for taking my question. Quick question on the D&S – can you guys possibly provide a breakdown in terms of the 76 units sold? Just the distribution will be fine, actually, for the quarter.

John Leahy

Well, for Q3 the bulk of our product sales would have been both SUGV and PackBot, and then like always, we have some level of development research work. But both PackBot—you know, we had sales across PackBot, a small number of sales of First Look, and then SUGV. SUGV actually made up the bulk of the product sales in Q3.

Patrick Wu

Is it reasonable to assume that the SUGV and PackBot robots constitute 80% at least there?

Colin Angle

Yes.

John Leahy

Yeah, for sure, of the units.

Colin Angle

First Look is still at the beginning of its product life cycle. The majority of the robots that we’ve sold to date are an operational test. The procurement contracts that we had hoped to see in 2012 are now pushed out into 2013, and so they are still there waiting for us but part of the reason that we’ve had weakness against our estimates in 2012 has been the pushing to the right of the First Look.

Patrick Wu

Okay.

Colin Angle

But you’re absolutely correct that SUGV and PackBot represent the lion’s share of our product sales.

Patrick Wu

Okay. How much inventory and backlog is attached to the Maritime business?

Colin Angle

The Maritime product business has been shut down so that our estimates for the remainder of this year and next year have zero sales associated with Maritime product, and we have fully written down the inventory associated with that, and that’s included in the charges that we’re taking in Q4. So we’re out of the product business and have fully taken all of the financial hits for that exit. We believe that there is an exciting future for the Maritime business. We are continuing to perform funded research in the Maritime business and have a number of exciting contracts along that, and have moved those activities to Bedford so that they can benefit from the infrastructure and employee base up here in Massachusetts as well. So it’s a way of efficiently continuing to pursue it in a cost-effective fashion.

Patrick Wu

Okay. So the write-down should all happen in Q4 and not extend to 2013?

Colin Angle

All included in the guidance that we have just given. All included in the Q4 guidance that we’ve just given, so yes, you are exactly correct.

Patrick Wu

Okay. Just one more, if I may. It seems like there was a 35% sequential growth to accounts receivable for the quarter. What is this a function of, and in terms of product line where it is largely attributable to?

John Leahy

It’s really timing. We had the bulk of our revenue come towards the end of the quarter, particularly in the D&S business, which is not unusual. But that is timing and you’ll see that DSO number improve as we report Q4. Our collections in terms of current accounts are something like 97 or 98%, so that is strictly timing.

Patrick Wu

Okay, all right. Thank you. That’s all I had.

Operator

Our next question comes from Brian Ruttenbur from CRT Capital. Please go ahead.

Brian Ruttenbur – CRT Capital

Yes, thank you very much. The first question I have is a financial for 2013. You’ve given revenue. Can you give us some kind of trend in terms of gross margin by division? Do you expect gross margins—you know, which trend up or down from 2012 levels directionally? Can you help us out?

John Leahy

Brian, as I said to Jim earlier, it’s early to talk about operating margin so I won’t get very specific, but clearly in the home business where we’ve had terrific gross margin expansion over the last couple of years, we would not expect to back off of that trend. So gross margins will be at least where they are today and hopefully continuing to improve. D&S has been much more of a wild card, as you know, this year with gross margins being impacted by the lumpiness of the revenue this year, but as Colin mentioned, we’re in the process of taking significant action in Q4 to take costs out of that business, and we are doing that in part to try to improve the margin picture and the profitability of that business unit. So I can’t be real specific, but we are taking the actions to try to at least maintain the margins that we’ve had this year in D&S.

Brian Ruttenbur – CRT Capital

Okay, that’s where it’s a little confusing. On D&S, your gross margins this year have been anywhere from a negative to a positive. I assume they’re going to be in the positive range. That’s the way you’ve modeled it going forward with this restructuring?

John Leahy

Yeah, that’s what I meant earlier with the margins have bounced around quarter by quarter based upon the revenue, but I would expect as we go into the new year, we’ll be back to more normalized margins for what we have seen in that business historically.

Colin Angle

The gross margins are so tied to revenue that with the volatility in revenue this year, we had difficulty maintaining traditional margins. By changing our cost structure, we’ll be able to put that back into the right domain based on, we think, very achievable revenue figures that we’ve included in our outlook.

Brian Ruttenbur – CRT Capital

Okay. And so on the D&S, you expect to be—not to have big spikes in your revenue, more of if we did the middle of your range – roughly 50 million – that would be 13.5, so let’s call it 13 million a quarter or something like that. You expect that to be kind of flattish from quarter to quarter for 2013, or do you expect fourth quarter is going to be a big spike, it’s going to be back-end weighted? Do you have any idea how that’s going to look?

John Leahy

Well Brian, we’re not ready to talk about the quarters for next year, and unfortunately just the way we do our accounting in that business unit, the gross margin does fluctuate with revenue because of the absorption of overhead. And so next year if we do have lumpy quarters, you will see volatility in the gross margin. But for the full year, we’re working towards—to get those margins back to what we’ve done historically.

Brian Ruttenbur – CRT Capital

Okay, thank you. The next question I have on the other division is about your distributors. Is there a certain level of inventory that your distributors by agreement have to keep?

Colin Angle

No. In fact, we actively keep our distributors at an inventory level that tends to be below what they would ideally like. We have learned lessons over the last 20 years that suggest that allowing inventory levels to rise at the distributor just causes many, many different challenges, and so we aggressively manage our distributor inventories. We’re very, very conservative in how much rope we give them and make them come to us with their marketing programs, and we’ll work to make sure that they have adequate inventory to support their marketing programs. But again, we’d rather resupply them frequently than risk them owning too much product and being tempted to take any price action that would hurt the overall global franchise.

This is a very, very healthy, very exciting global franchise that we are actively managing very, very tightly to ensure control over the investment in our products, the price points in our products, and there is no need for anyone to have a glut at this time. There is great demand globally.

Brian Ruttenbur – CRT Capital

Great. Thank you very much.

Operator

We have a follow-up question from Josephine Millward. Please go ahead.

Josephine Millward – Benchmark

Hi Colin. I see a lot of other robotic vacuum cleaners here in Europe from Hoover and Samsung. Are you seeing more competition in home robots, and is that putting pressure on your ASP?

Colin Angle

We certainly are seeing remarkable growth in the overall robot vacuuming industry. I think that this is an industry which has gone mainstream, represents the second-largest growth driver in the small domestic appliance industry, and so it is something that customers are flocking to as they make decisions around how they are going to clean their floors.

Our growth speaks for itself, and there are other entrants into the marketplace in some markets, so that Samsung and LG, for example, do have competitive products out there. We believe strongly about our competitive position relative to those markets, but they are certainly getting some traction from the perspective of sales. So as I’ve mentioned a number of times, our growth rates are very attractive.

But their products tend to be priced quite high, and so that this is not putting downward pressure on us. We believe we have both better value pricing—sorry, better performance and a good value on our pricing. Our target is not to chase them down. We have the performance lead, we have a premium positioning strategy in the marketplace, and it is our intent to continue that trend; and certainly our acquisition of Evolution Robotics just adds to our very exciting IP portfolio around navigation technologies and gives us technology for next generations of home robots to come.

Josephine Millward – Benchmark

Got it. Can you give us an update on the Scooba roll-out? Have you completed the new Scooba U.S. and international roll-out, and how the ramp is going, because I think that’s exciting.

Colin Angle

I would say it’s not fully complete at this point. We’re again taking it relatively carefully. We’re very excited about the product, but it is not fully rolled out in Europe. It is not rolled out in Japan in any way to a full extent, so there’s a lot more to come on Scooba.

Josephine Millward – Benchmark

Okay. Do you think Scooba has the potential to become—you know, the size of the market, to rival the Roomba?

Colin Angle

You know, our expectations are that when both product lines are mature, Roomba will be larger than Scooba. I think in our models, the Scooba market will be more than 50%. Whether it’s 50 or 80 or 95% of Roomba, that is something that time will have to tell; but we believe that it is a market of great significance, and our testing shows that the desire to buy associated with Scooba rivals and even exceeds the desire to buy for the vacuum cleaners because scrubbing your floor is a much more hated task than vacuuming your floors because of the dirt and grime involved. And so as our products become increasingly easy to use and convenient, we see ourselves capturing more and more of the customers’ attention and allowing that new business area to grow.

Josephine Millward – Benchmark

And right now, the Scooba is about 10 to 15% of your home robot sales, right?

Colin Angle

That’s correct.

Josephine Millward – Benchmark

Okay, great. Thank you. That’s helpful.

Colin Angle

Okay, that concludes our third quarter earnings call. We appreciate your support and look forward to talking to you again in February to discuss our Q4 and full-year 2012 results, as well as a complete discussion of our expectations for 2013.

Operator

That concludes the call. Participants may now disconnect.

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