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Fool on the Street: iRobot Is Mutating

Here at the Fool, we know you've got a life. Between working while the sun shines and catching Z's when it doesn't, you may find it hard to keep up to speed on Wall Street events -- corporate "investor conferences," for instance.

These meetings ostensibly benefit investors, but the companies behind them rarely transcribe their proceedings and file them with the SEC. As a result, unless you can attend in person, you're often left out in the cold. That's where our "Fool on the Street" series comes in. We listen to the conferences, so you don't have to.

Without further ado ...
Today, we'll recap the news from iRobot's (Nasdaq: IRBT  ) Aug. 7 presentation at the Canaccord Adams 27th Annual Global Growth Conference, where CEO Colin Angle and CFO Geoff Clear made the company's case to Wall Street. As presentations go, this was a short one. Today, we'll make it shorter still by focusing on the two key points from this Motley Fool Rule Breakers recommendation, and one bonus.

Benevolent mutation
Is change good or bad? iRobot thinks that's the wrong question to ask: Change is clearly good, and the only question is how quickly can it be accomplished. Accompanying the executives' presentation was a slide show that graphically illustrated the evolution taking place in iRobot's product offerings -- putting into pictures Angle's assertion that "we are increasing the pace of new product launches at the company":

  • In 2004, iRobot had one domestic robot: the Roomba.
  • In 2005, it introduced the floor-scrubbing Scooba, bringing total product offerings to a grand total of two.
  • After taking a breather in 2006, iRobot now aims to have a total of six types of domestic robot on the market by the end of this year.
  • And according to Angle, we should expect to see this acceleration of new product offerings continue "in 2008 and beyond."

It's a similar story with the firm's military business. In 2007, it had four government and industrial types of robot, including three versions of the PackBot, and the R-Gator jointly developed with Deere (NYSE: DE  ) . Next year, management intends to have a total of 10 products -- including its second-generation PackBot, a "510" model that can be equipped with TASER (Nasdaq: TASR  ) stun-guns, the new Warrior (which looks like a PackBot on synthetic steroids), and the new Small Unmanned Ground Vehicle (SUGV) being developed with Boeing (NYSE: BA  ) . iRobot describes the variations we should be expecting simply as "many" in the years to come.

The key to going from one or two models to "many," says Angle, is that "all of these robots have common software, common interfaces, common controllers, so that if you develop for one, you know how to develop for all of the weight classes." Essentially, it seems that the business plan is to build one robot and then tweak it to perform whatever tasks are necessary. Need more payload capacity? Take your PackBot model, scale it up, and call it a "Warrior" (oh, and charge a premium). Want it to not just carry stuff, but shoot stuff, too? Let the PackBot pack a TASER, and voila, you've got yourself a combat droid.

The scalability and flexibility of this model, says Angle, are what permit the "acceleration of these robot platforms into the marketplace" -- an acceleration of iRobot's lead over the competition and, as a result, "further esconc[ing iRobot] as the de facto standard" in robotics.

More sales, and more profitable sales
The news out of iRobot's recent second-quarter earnings report was not entirely good. Thanks to a drawdown (and discounting) in inventories of domestic-servant robots -- Roombas and their ilk -- margins declined significantly. Of course, the rationale behind the drawdown was sound. Management wanted to clear out old inventories at retailers such as Sears Holdings' (Nasdaq: SHLD  ) Sears stores, Best Buy (NYSE: BBY  ) , and Target (NYSE: TGT  ) to make room for these retailers to stock up on the company's latest toys: the third-generation Roomba, and second-generation Scooba.

Even so, the 410-basis-point decline in gross margins on domestic robots (to 30.8%) has to hurt -- even though lesser margin compression on the military side of the business held overall gross margins to a 240-basis-point decline (to 30.5%.) Considering that iRobot spent 44% of its revenues on operating expenses, that's an unacceptably low gross, and it resulted in a net loss for the first half -- and a bigger one than last year.

Fortunately, as the new models roll out this year and in years to come, and iRobot gains scale, management expects better margins to roll in -- perhaps 36% at the gross level, with 7% spent on in-house research and development, and 28% on sales, general, and administrative expenses. In four years, it hopes to be grossing closer to 40% and spending 7% of that amount on R&D still, but bringing SG&A down to about 18% -- for a 15% operating-margins yield.

Sound good? It does to me, but it also tells us that two items will be the keys to success:

  • Upward progress towards 41% gross margins.
  • Downward progress towards 18% SG&A.

What about R&D, you ask? Honestly, I would not mind at all if iRobot spends more than 7% of its own funds on R&D. This is a tech shop, Fools. And in tech, you need to innovate to maintain market dominance. I'd rather see it spend too much on tech and remain the undisputed robo-king than pinch pennies and lose out to an upstart.

Act right now, and you can get a bonus paragraph free!
Let's close with perhaps the most interesting part of the presentation. Remember how I was talking about the Scooba a moment ago? Well, if you liked what you heard, tune in to the Home Shopping Network, and you can spend the next half-hour watching an infomercial hawking the gizmo. That's right, folks. iRobot is now selling on HSN. It may sound corny, but according to Angle, the response has been tremendous.

Hey, whatever floats your ro-boat.

Fool contributor Rich Smith owns shares of iRobot, which, along with TASER. is aRule Breakers recommendation. The Motley Fool's disclosure policy is autonomous and self-aware.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 12, 2009, at 3:28 PM, petersig wrote:

    Thanks for the scoop on SCOOBA, et al. You are right on that 7% is too low for R&D -- even with the reusable, reformable basic robot from which to work.

    IRBT looks fairly attractive, to my techie bent in investing. The problem, though, is that the volume of trading is very low, < 500,000 shares daily.

    I am now very wary of such stocks, having been bitten badly on the purchase of shares of ABD (Acco Brands). Its volatility was attractive, and I never checked the volume. Since there was so much change in price, I figured a lot of shares were being traded -- not so.

    So my caution on IRBT is that while it looks very attractive as a tech stock that's going places, the trading volume level is still too low.

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