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iRobot Thanks the Tax Man

Riddle me this: What does it mean when a company announces that it will exceed Wall Street profit estimates by 70%, yet the stock price doesn't budge an inch?

Answer: It means Wall Street doesn't expect the outperformance to be repeated -- and it's right.

On Tuesday, floor-sweeping andTASER-toting  robot maker iRobot (Nasdaq: IRBT  ) preannounced its fourth-quarter 2007 earnings news (the actual report will come out Feb. 19). The company expects to report about $99 million in Q4 sales, and perhaps $0.80 per share in profits.

This should have come as a shocker to Wall Street, which at last report had iRobot pegged for just $91 million in sales, and $0.47 in earnings. But what's this I see on my ticker feed? iRobot is actually down for the day? This bear's examination ...

... but not a lot. Because the answer to investors' lack of enthusiasm seems pretty clear to me, and it comes in three parts:

  • First, retailers like Best Buy (NYSE: BBY  ) , Sears (Nasdaq: SHLD  ) , and Target (NYSE: TGT  ) apparently did their part this Christmas season, helping iRobot to sell more of its new 500 Series Roombas than many people thought. Unfortunately, it seems iRobot made less money on the sales than it thought. (I'll get to how that worked out to higher profits in a moment.) According to CEO Colin Angle, this quarter's sales brought "lower than expected gross margins."
  • Second, iRobot incurred significant legal costs in the process of vaporizing upstart rival Robotic FX this year, and this quarter. Those will have siphoned away some of iRobot's hoped-for operating profits. (On the plus side, with the litigation now finished, it's unlikely that continuing legal costs will derail iRobot's plan to hit 15% operating margins three years from now.)
  • Third and finally, the "earnings beat" that headlined today's story is only one part hard work by iRobot, but two parts tax arcana. Predicting a figure somewhere north of $12 million in pre-tax profits this quarter, Angle added the caveat that $8 million of these profits come from an "income tax valuation reversal," a one-time event.

Granted, Angle ended on an optimistic note, promising "strong revenue growth and improved profitability across the company in 2008" -- and as I explained earlier this month, the accelerated delivery schedule for iRobot's SUGV military robot (developed in cooperation with Boeing (NYSE: BA  ) and SAIC (NYSE: SAI  ) ) should help with that. But the simple fact of the matter remains that today's announcement consisted of three pieces of good news, and three caveats:

  • We sold more stuff ... at lower margins.
  • We won our lawsuit ... but now the lawyers' bills are coming due.
  • We beat earnings ... thanks to a tax credit.

Hardly the stuff that dream investments are made of.

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