Lookit That Roomba Go!

"What was that! Seriously when I read the eps I had to read it three times. Then I read that it was only so ultra gigantic because of a one-time tax benefit. 'Phew!' I thought, 'It's just some tax thing.' And then I kept reading. Without the tax benefit - they still hit it out of the park!"
-- Rule Breakers member "SarahGen"

That's how one member of our Motley Fool Rule Breakers service reacted to this week's earnings news from Rule Breakers recommendation iRobot (Nasdaq: IRBT  ) , and I must say -- I too had to read the release a few times before it finally sunk in: iRobot missed Wall Street's revenue estimates by a hair (pulling in just $94.2 million in revenues), but it absolutely killed on profits. Expected to earn $0.07 per share in Q3, iRobot instead produced per-share profits of $0.18 (or $0.27, diluted, counting the tax benefit).

With investors in large defense contractors like Raytheon (NYSE: RTN  ) and Lockheed Martin (NYSE: LMT  ) looking at a foreseeable period of flat defense budgets, could your defense portfolio use a boost from smaller players like iRobot?

How'd iRobot do that?
You can thank two things for iRobot’s beat: First, an abundance of dusty foreign floors (iRobot saw "strong demand" for Roombas overseas). Second, Boeing (NYSE: BA  ) , and the rump end of what remains of Future Combat Systems spending. Combined, these two factors helped tack on 15% to "government & industrial" sales as the Boeing-led, iRobot-built SUGV robot program booted up.

And one thing more: higher margins. iRobot added a full 400 basis points to its gross margin last quarter, grossing 35% of each revenue dollar it pulled in -- revenues that were, overall, up 20% year over year.

Disturbing beeps, and a red warning light
It wasn't all good news, of course. iRobot's international consumer strength only made its domestic weakness stand out in contrast, as U.S. home robot sales slipped 11%. As for the military and industrial business, the 15% sales improvement we saw there didn't translate into much more profits, as warbot gross margins slipped 210 basis points.

Most disturbing of all, iRobot may be losing its beartrap grip on inventories, which grew nearly twice as fast as sales in Q3, up 38% year over year. With more cash now tied up in unsold robot parts, iRobot's free cash flow (FCF) suffered a precipitous 33% drop in comparison to last year, tumbling to just $7.8 million for the quarter.

Granted, this still leaves iRobot tracking toward $36.5 million in FCF this year. Also granted, this values the company at a measly 13.5 times FCF -- even as analysts project 35% annual long-term growth. But management does need to clean up this inventory mess if it intends to keep the brushes clean, and the good times rolling. We'll be watching.

iRobot is a Motley Fool Rule Breakers recommendation and Fool contributor Rich Smith owns shares of iRobot. The Motley Fool has a disclosure policy.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.


Read/Post Comments (3) | Recommend This Article (6)

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 October 29, 2010, at 9:59 PM, jbl123 wrote:

    You say:

    "But management does need to clean up this inventory mess if it intends to keep the brushes clean"

    I'm not sure you are looking at the whole picture and I'm a little disappointed. You should have mentioned the idea that a large portions of their "past year" sales had been centered around Christmas. This year, due to unexpected growth, IRobot had projected a shortage at the holiday time. It' seems obvious that the company is planning ahead for Christmas. This may be incorrect, but the issue is Sooo important to require your consideration. By the way, If I was IRobot, I would be growing my inventory on the military side too. you cant sell what you don't got.

    A follow up from the Fools seems appropriate. Even if only to explain why I am off base and why you saw no reason to cover their cyclic nature and known short term sourcing problem in your analysis.

    Thanks

  • Report this Comment On October 29, 2010, at 11:43 PM, crca99 wrote:

    I appreciate the coverage - interesting company.

  • Report this Comment On November 01, 2010, at 10:27 AM, TMFDitty wrote:

    @jbl123:

    This is why we compare year-over-year numbers, rather than quarter-to-quarter. The problem is not that inventories are growing, period. The problem, in a nutshell, is that inventories are growing twice as fast as sales.

    As a one-off issue, it is not enough to scare me away from the stock. But if I see inventories continue to outgrow sales, it might be.

    Fool on!

    TMFDitty

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