iRobot Faces Temporary Headwinds, But The Thesis Is On Track

Summary

• iRobot reported their Q2 2021 earnings recently, on July 28, 2021.
• Their profitability tanked during the most recent quarter due to tariffs, and they were constrained due to the semiconductor chip shortage that has affected many business recently.
• However, these short-term headwinds do not pull iRobot off the main investment thesis, which is why iRobot is a Buy for long-term investors who will hold longer than three years.

Onfokus/iStock Unreleased via Getty Images

The Thesis for iRobot

iRobot's (NASDAQ:IRBT) recent quarter was a mixed bag for many investors. iRobot was one of the few pandemic plays that weren't hit hard by the reopening, yet iRobot faced many tough macroeconomic obstacles that will likely continue to affect them into the near-term future. However, long-term investors should not focus much on these headwinds, for they are only temporary. Aside from these short-term headwinds, iRobot executed well on what is critical: growth, product expansion, and their software. Because of their execution and success in the things that matter most, iRobot is still a very strong company that is deserving of long-term investors' money today, despite the strong headwinds they will face for the next six months.

Short-Term Headwinds Ahead

After reporting strong, 31% revenue growth Year-over-year, iRobot investors were slightly concerned over the temporary headwinds they cited about future growth for the next six months.

Data by YCharts

Thirty percent revenue growth is strong for iRobot, but during the pandemic, investors got used to seeing larger growth. Management also expected strong growth in the previous quarter, while gave investors high hopes. One of the reasons that investors were disheartened by 30% revenue growth was due to the supply constraints that iRobot suffered from in the recent quarter.

Supply Chain Shortages

Due to weakness in their supply chain, iRobot lost $17 million in orders that were not fulfilled due to COVID-related disruptions to shipping activities in southern China. Although this order volume would have only represented an additional 5% in revenue from this quarter, which reached $366 million, the shortages clearly resulted in iRobot failing to meet the demand for its product.

Management also noted that they experienced chip shortages, which partially resulted in the inability to fully meet the demand for their product. For the coming quarters, Angle said that while the continuation of this shortage remains uncertain, iRobot will be focusing on prioritizing the chips they have for the new products that they will be launching.

Tariffs

While growth was still strong, the profitability of iRobot's quarter was where they were hit badly.

The company's second-quarter 2021 GAAP operating loss was $3.0 million, compared with GAAP operating income of $70.3 million in the second quarter of 2020. Second-quarter 2021 non-GAAP operating income of $9.0 million compared with non-GAAP operating income of $40.5 million in the same period one year ago.

Source: Q2 Press Release

Earning per share was hit hard, resulting in $-.10, compared to $2.07 one year ago.

Data by YCharts

This profitability was largely hit by tariffs that were enacted right after the second quarter of 2020. The strong demand was able to grow Q3 2020 EPS, but iRobot was forced to pay nearly $12 million in tariffs this quarter. Combined with $7 million in tariff exclusions in Q2 2020, iRobot's profitability was affected by nearly $18 million by these tariffs.

This resulted in guidance being significantly lowered for FY 2021:

Metric	GAAP Guidance From Q1 2021	GAAP Guidance From Q2 2021	Difference (from midpoint)
Revenue	$1.67 - $1.71 billion	$1.55 - $1.62 billion	($10) million
Gross Profit	$642 - $672 million	$609 - $642 million	($31) million
Operating Income	$69 - $79 million	$37 - $67 million	($12) million
EPS	$1.85 - $2.10	$1.02 - $1.89	($.52)

Click to enlarge

Source: From Q2 and Q1 Press Releases

However, there is good news. iRobot management expects that these tariffs will be released by the end of the year. They will continue to affect Q3, but CEO Colin Angle believes that there will be significant financial betterment by the year's end.

While the tariffs and supply chain malfunctions remain a problem for the coming quarters, these problems will work themselves out within 6 months. These headwinds will remain headwinds for the next quarter, and it severely dampened the profitability of this quarter, but long-term investors in iRobot should not be too worried. Rather, long-term investors should focus on what went right in this quarter, and many things went right. When looking at some of these areas where iRobot's growth will likely come from, investors can see that the investment thesis in iRobot is still intact, and they are still running well.

What's Going Right With iRobot

When investors look at the results of the quarter with a new eye, investors can see that iRobot had a strong quarter, and they announced exciting news about the future of the business.

Competition Put Out By iRobot

iRobot continued to dominate the leaderboards when it came to robot vacuum sales. This is primarily due to the wide variety they offer, along with the innovative software and learning capabilities of the vacuum and mops.

• For the 7^th consecutive year, Roomba was a featured product in Amazon's Prime Day event where the Roomba was cited by Amazon as a top-selling product.
• Roomba and Braava were cited as best-in-class floor cleaning robots in Consumer Reports (North America), Fortune (North America), TechRadar (EMEA – United Kingdom), Xataka (EMEA – Spain), Lee (Japan), and Story (Japan).

When asked about the competition that has been flowing into the market on the earnings call, Angle had this to say:

So, I think people (competitors) are wondering what is – what can they do, how can they go and further differentiate their robots. And our competitors like to just add stuff. Our strategy is really around how do we make the experience of owning the robot one where you feel like you are more in control and you are able to get the robot to do what you wanted to do, when you wanted to do it and have it operate the way you wanted to do it intuitively and effectively, so you feel like the robot is your partner in cleaning your home. I would tell you, blindly adding stuff to the robot is going to have a negative impact in people’s interest in the robots.

Source: Q2 Transcript

Clearly, while there are many competitors for iRobot, few are actually succeeding in taking market share from them. While they are trying to make differentiated products, they are doing so in an ineffective way, which is actually taking away from the quality of their product.

iRobot creates their products differently, and they are slow and meticulous to create and innovate products, which is something that their competitors are not doing. This perfectionist mentality is delivering strength over the long term and is thus locking out the competition and solidifying iRobot's spot as the market leader in this industry.

Competition is fierce, and if any of its competitors were to take the approach that iRobot does to try to perfect their robots, they could phase into popularity. However, iRobot has remained one of the strongest brands in this space, and thus created a strong brand reputation. It would be very difficult for a competitor to displace this strong reputation that iRobot has created for itself. If a competitor were to do so, however, this could pose a threat to iRobot's business. One way they are fighting off competition is through the strategic, consumer-focused integration of services and technology.

iRobot Select Service

iRobot's Select Membership is also growing fast, although still in the early stages of its life. The product, which allows for subscribers to receive accessories for their robot, while also getting access to damage protection, management support, and robot upgrades, has only recently opened to the public. Despite its freshness to the market, management noted that it has seen high satisfaction and it seems to be growing at a fast rate.

Source: iRobot Website

Even though it has not been broken out by itself in the financials, iRobot's Select Service is expected to scale quickly, and it could even become a material contributor in just 1 year.

While this product is immensely young, it has lots of potential. The recurring revenue is wonderful for iRobot, and the customization and benefits that are given to the consumer create a strong value proposition for iRobot users. Churn levels for the service are low and meeting expectations, and as this service scales, it would be reasonable to expect the churn to remain low as long as the customer satisfaction stays as high as it currently is.

Bringing iRobot users into this service only deepens the switching costs associated with iRobot, which is another benefit of this service. It will also differentiate the product, for the technology, robot, and service combined is something that few other competitors offer. This service has lots of room to grow, and it could be a strong growth runway for the business if execution is done well.

Product Launches

iRobot also announced plans to introduce two new Roomba robots during the next quarter. They also announced updates to their Home Intelligence platform.

Source: iRobot Website

Their Home Intelligence and app experience for consumers is one that is relatively unmatched by competitors, and it allows for consumer customization and perfection. Growing and maximizing the utility from this app and the robot's knowledge of the consumer only creates a strong value proposition for consumers, thus strengthening the consumer loyalty.

As I previously mentioned, iRobot management is slow to add new products to the market, so two additional products will likely show new, innovative technology. Adding these new products will not only bring in new customers, but it will also strengthen iRobot's brand reputation as the best robot vacuum company.

If these robots were to flop, however, and have no significant changes, this could end up hurting their brand reputation, which would be bad. If this were to happen, I would get concerned. However, management usually errs on the side of caution when implementing new products, and they only release them when they are very confident, so I believe that these products will show strength in the coming quarters and years.

Key Takeaways

While the financials on the surface looked rough for iRobot, the key pinpoints are still on track for their business. They are keeping competition back by integrating unique technology and robotics into their products. Their product has truly become unique and differentiated, and they are continuing to do this by becoming more technology-centric. Implementing their Select Service and their Home Intelligence brings a value proposition that is strong for consumers, and this pushes back any form of real competition.

While there are tough temporary headwinds, iRobot will likely be able to come out stronger than ever, and these headwinds will only be temporary setbacks. Long-term investors should realize that this will impact the next quarter or two, but recognize that the thesis for iRobot is still on track, and they are executing quite well. Because of their strong implementation of technology and durable expansion of products, long-term investors should consider investing in iRobot, and investors who already have a position could increase their position at today's prices.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of IRBT either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[ValueStockInvestor]

Great article! I remember all the negativity around Ford in 2019 when I bought that stock for $8. When a company got a great product and undervalued, it will always come out with flying colors. One thing that I don't understand is, iRobot got many patents. Many companies are copying iRobot design including Samsung, are they succeeding on this legal battles? Technically, the more companies get into robot vacuum space, the better for iRobot because their competitor will do the job of educating the customer and convincing them why they need a robot vacuum. When customer tries to buy one, they will most go for the best in the market which is iRobot (same thing happened with Telsa).

[Diesel]

This company is most likely an acquisition target more than anything.

[Niko Theodoridis]

I am invested with about 3 % of my Portfolio. In my opinion home automation will be a huge trend. So many people already using the robotic vacuumcleaners and almost everybody is complaining. But for many brands. This technology is far from finished and has only started.
I assume IRBT is in a great position to launch future products. Hopefully they can create a good platform for managing a few home robotics. This will create additional exit barriers for existing users.

I dont fear temporary pricing headwinds due to chip shortage. I only fear cheap china copies.

Its not the easiest investment to make. But valuation is pretty low already and if they can manage to grow top level at 15% and get a net margin of 10 %. I am pretty sure we will see a different stock .

[Rizzi Capital]

@Niko Theodoridis Net margin of 10% ----- hahahahahahahahahahaha

[jk31]

While I am an investor, I don’t own IRBT stock nor puts/calls, nor am I short the stock. We do own their products and have owned them for years. So I thought perhaps our experience with IRBT products could be helpful to others at SA.

In short, IRBT’s latest flagship S9+ robot has been a disaster. We are on our 4th replacement and it looks like that will soon be 5. Check out Lowes customer comments. I think about 50% rate it in the 2 lowest quintiles (1 or 2 stars out of 5). These are accompanied by many comments stating they will never buy another Roomba.

I know these are anecdotal cases but this refers to the company’s most expensive product (the S9+) which, in our case, after a February software update, spends 3 to 6 hours vacuuming the same space it previously only required 90 minutes to clean. This seems to be due to it’s penchant for incessantly moving in random circles and losing its way. The unit also seems unable to deal with one of the very popular “home net wifi systems” we have.

In addition, all of the later replacement robots seem to be manufactured with material that attracts and holds pet dander and dust like glue requiring a tedious weekly cleaning of surfaces and sensors under the rollers (our first S9+ didn’t have that issue).

In our case, I have been spending many hours dealing with this on the phone with customer service, cleaning the robot, and 5 or 6 hours re-mapping our home each time we get a new unit.

Perhaps none of this is meaningful, but perhaps, Medium to long term, it could have an impact on the stock if IRBT loses reputation as more people experience issues with a very expensive product they have been unable to correct thus far.

[HPBunker]

@jk31

Thanks for the comment re: IRBT. It's nice to hear about a consumer experience with their products.

[jk31]

@jk31 just an update to my earlier post: iRobot put out a new software update and all the issues were solved.

However, there was no public or private mea-culpa, no apology for an expensive product that was essentially useless for 7 months, all the hours many customers spent on the phone with a customer service in denial of the issue, no admission re iRobot causing the problems nor the many hours trying to “fix” the disappointing product. Nothing at all. Zero.

It makes you wonder about the levels of competence in iRobot PR, CS and tech departments and, mostly, the executive suite.

[Rizzi Capital]

Competition is eating them alive. And in a tougher economy, the low end will see the most growth (i.e, their competitors). Their margins are atrocious because they are the IT department for the whole industry. Their leadership team is ancient. They buy back shares, but issue them just as fast (faster, in fact) - they have more shares outstanding now than in 2017 or 2018.

It's one mistake after another and wall street has lost all confidence in them. That is why IRBT can grow the top line at 30%, but the stock falls and is barely trading at 2 times net tangible assets. At $40 per share it is worth a chance, but at $85, you should not touch it.

[Lunch_Buffet]

@Rizzi Capital
Have you even looked at their income statement/balance sheet at all?

[Rizzi Capital]

@Lunch_Buffet Yes I have. What exactly is it about my statement that you disagree with?

[Jamie Louko]

@Rizzi Capital In a tougher economy, most people will be vacuuming their own houses, not buying a cheap, poor-quality Roomba knockoff. There is a reason why iRobot products are the most expensive: all the other products are poorly made and not worth a dime. And, looking at this quarter, shares outstanding have decreased the last year... Just about every growth-based company will have a higher share count today than in 2018, so that doesn't say anything about this business specifically. Other than the Terra (which was only delayed, not a flop or a mistake), execution and growth have been quite strong and impressive. Their software and app additions are really unique. I wouldn't say that iRobot has made many mistakes in the past few years...

[HPBunker]

What happened to Terra?

[Ben Brumfield]

@HPBunker Last year, Terra’s launch was paused in April 2020 to prioritize investment into other areas, namely to accelerate the buildout of our direct-to-consumer (DTC) capabilities and software-centric development activities. While Terra was close to launch, it also was at the earliest stages of commercialization with an extensive, multi-year roadmap for new features, enhanced functionality and better performance. The company also stated that "Progress in expanding our DTC capabilities will increase the likelihood that we can successfully and efficiently enter new product categories. Based on this approach, our efforts around the robot mower market are on hold for the foreseeable future. To the extent we restart our efforts in this area, we will do so in stealth mode and will not be providing updates on a quarterly basis."

Hope you found this helpful.

[HPBunker]

@Ben Brumfield

I appreciate your taking the time to respond. It's just that you're quoting the company, and what they've had to say hasn't been helpful.

What I find strange is that lots of other companies already sell robot mowers. IRBT is falling further and further behind the curve in this market. I have trouble understanding why they just gave up.

In the US especially, we've had this huge trend of people dumping their urban apartments and condos, and buying houses in the suburbs with... lawns!

I find lawns to be boring and ecologically wasteful. But robot mowers are surely a product worth manufacturing. Especially in hot, southern states, homeowners hate mowing their own lawns.

[Ben Brumfield]

@HPBunker They didn’t state that the project was dead. The focus has just shifted to growing and supporting the customer base. I think they are going to launch a mower that is better in every way. My guess is that they jumped the gun a bit announcing it before it was ready and combined with the pandemic, it made more business sense to switch gears a bit.

From my brief research I haven’t found a robotic mower that doesn’t require cumbersome boundary wire to be installed. Also, another challenge with current robotic lawnmowers is that they are all incredibly expensive.

If iRobot were to come out with an easy-to-use boundary free robot lawnmower and offer it on the select program, I think they would do quite well. I agree with their approach to invest heavily in supporting a strong customer base, so that when they come out with a refined robot mower, they will be met with a large customer base and a proven recurring revenue model to launch it on.

[alex352]

Thank you for your article Jamie!