Shares of iRobot (NASDAQ:IRBT) closed down 10.4% to $35.52 on Wednesday, following the company's release of its first-quarter 2014 earnings after the market close on Tuesday. The robot maker, best known for its home cleaning bots, beat analysts' estimates for both revenue and earnings, so why did the stock sell off to such a degree on heavy trading volume?

It's all about expectations
Most investors likely realize that iRobot routinely issues quite conservative guidance, which the company usually beats by a good margin. So, after a long enough period of this under-estimate and over-deliver scenario, investors are naturally going to hope for -- even expect -- more than a small beat on the top and bottom lines. That's what iRobot delivered this quarter: relatively small beats. iRobot earned $0.18 per share on revenue of $114.2 million, whereas analysts were expecting EPS of $0.16 on revenue on about $112 million.

More importantly, investors were surely hoping for a bump up in forward guidance, whereas the company merely reaffirmed its previous guidance, which, again, investors were likely considering lowball numbers.

I also think general market sentiment contributed to the stock's selling off, as investors have been more jittery in 2014 than in 2013.

Let's dig into the numbers to see if we can glean anything else.

The Q1 nitty-gritty
Here are the earnings highlights and some key metrics: 

  • Revenue increased by 7.5% from the year-ago period to $114.2 million.
  • Revenue for the core home robot segment rose 17% to $108 million.
  • Revenue for the defense and security business dropped 50% to $5.6 million.
  • Earnings per share fell to $0.18 from $0.30 in the year-ago period; however, the previous year's quarter included an $0.08 benefit from investment tax credits. So, on adjusted basis, EPS was down 18% from $0.22.
  • Gross, operating, and profit margins were 45.3%, 7%, and 4.6%, respectively, down from 43.8%, 8.4%, and 7.9%.
  • Cash flow generated from operations was -$7.8 million, considerably less than the reported operating income of $5.3 million, as well as down from $156,000 in the year-ago period.

iRobot's sales are essentially generated from two segments: its home segment, which accounted for nearly 95% of revenue in the quarter, and its defense and security business. The home business, which makes a wide array of cleaning bots for the consumer market, continues to perform well across the board, by region and product line. The segment's 17% revenue growth in the quarter is quite solid, given we're talking about consumer discretionary products that are priced mostly in the $300-$700 range; remember, much of the global economy, notably Europe, has only relatively recently emerged from the recession.

The company's defense and security business has struggled for several years, heavily because of the U.S. government budget cuts. While this segment only accounts for a small -- and shrinking -- portion of iRobot's revenue, it continues to act as a drag on the company's overall results. Most investors know this and so have (wisely, in my opinion) largely been focusing on the company's results in its core consumer business, rather than its overall results.

iRobot is in the early stages of developing and marketing its telepresence and videoconferencing assistance bots. In April, the company received the first orders for its Ava 500 video collaboration bot, which launched in March in North America and certain European markets through select certified Cisco resellers. Ava 500 is aimed at the enterprise market, whereas the company's previously launched RP-VITA is geared toward the health care industry.

This commercial business didn't contribute meaningfully to revenue in 2013, and is only expected to contribute about 3% to revenue in 2014. However, investors should look for this segment to make a more meaningful contribution to revenue in 2015 and beyond. I continue to believe that this business has significant long-term potential; that is, of course, if iRobot develops and maintains a high enough moat to keep competitors at bay. This segment's products have the potential to save companies huge amounts of time in travel costs -- and big time savings equates to big money savings.

As to the numbers above, it seems most of the negative comparisons to last year's period can be attributed to the anchor on results that is the company's defense business. Defense's gross margin plummeted to 37.2% from 47.5%, whereas the home segment's increased to 50.4%, up from 48.2%. Beyond the gross margin level, however, it's not possible to fully tease out the performances of the segments.

A yellow flag: cash flow generated from operations
There's a yellow flag that investors should monitor: cash flow generated from operations. iRobot's cash flow from operations was -$7.8 million in the quarter. So, from a cash standpoint, the company's core operations lost money.

It's a given that we'd like to see positive cash flow. Beyond that, however, we'd ideally like to see cash flow generated from a company's operations exceed its reported operating income; iRobot's operating income for the quarter was $5.3 million. At the least, we'd like to see the two numbers in the same ballpark. This is because operating income, like net income, is just an accounting measure, whereas cash flows are the real McCoys when it comes to money. All sorts of legitimate things can greatly affect a company's reported earnings and operating income. This isn't so with cash flows.

The reason this situation matters is because investors who are solely considering net income and operating income, and ignoring cash generated from operations, are getting a rosier-than-accurate picture of how the company's core operation performed in the first quarter. 

Cash flows can be "lumpy" on a quarterly basis for all sorts of good reasons, so not too much emphasis should be placed on just a single quarter. That said, this divergence between operating income and cash generated from operations -- which was heavily due to "accrued compensation" (compensation owed, but not yet paid) -- should be monitored going forward, as if it persists, it could be cause for concern.

Forward guidance
As previously mentioned, iRobot surely disappointed investors by merely reaffirming, rather than raising, its previously issued 2014 guidance. 

The company reaffirmed that it expects 2014 revenue in the range of $560 million-$570 million, and EPS within $1.00-$1.15. This guidance, at the midpoint, implies annual earnings growth of about 14% on revenue growth of 16%, as iRobot earned $0.94 per share on revenue of $487.4 million in 2013. 

The Foolish bottom line
I remain cautiously optimistic about iRobot as a long-term play. The stock remains a bit pricey for a relatively slow overall grower, as it trades at 25 times forward earnings. Positively, the company has a first-mover advantage in the consumer robotics market, a nascent market which looks to be on the cusp of a significant growth trajectory. Additionally, iRobot's new commercial business looks quite promising. 

My main concern remains the company's moat, as it needs to remain high enough to fend off competitors, as margins aren't fat enough to allow for heavy price competition. Investors should monitor the competitive landscape, which is heating up, as well as the company's cash flow generated from operations.