"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.