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Paul Coster: My name is Paul Coster, I'm the senior analyst covering applied technologies here at JPMorgan. Welcome everyone to the iRobot session, we have the founder and CEO of iRobot, Colin Angle - and also a movie star. As we have just been discussing, he appeared on the movie 21, is that correct?
Colin Angle: Yes, I had a big part on 21.
Paul Coster: Apparently, one more movie appearance and you have got your screen actor's [inaudible] account, which would be good. You get job security at that point, don't you?
Colin Angle: I'm not sure.
Paul Coster: Anyway, let's talk about iRobot, and, you know, I really think this is a big deal. But it's taking a while, isn't it? So, Colin, talk just a little bit about the start of this year and just give us kind of an overall picture where iRobot stands [inaudible].
Colin Angle: Sure. This year - at iRobot we have two main areas of business, one on the military side and one on the home side - and this year so far has been one where we've had a good strategy, we had an issue with one of our retailers going bankrupt, which was a bit of a frustrating event, that's the bad news off the top, but other things have been going in a very exciting direction.
Specifically, it has been our long term strategy to position our military robot division to sell robots to the infantry.
This is, in our mind, the largest market for unmanned ground vehicles. And we've had success to date selling to niches in the military - the explosive ordnance disposal teams, the military police and to less extent the combat engineers - but the infantry is really where the volume is and the action is. And there's two main contracts that we've been pursuing: The Future Combat Systems (FCS) Soldier Unmanned Ground Vehicle (SUGV) and then the infantry unexploited ordnance disposal robot, that's the xBot competition. So 2008 is the year where both of these major infantry procurement contracts are starting to play out, thus far, at the end of 2007 we won the xBot contract and are now delivering robots under the xBot contract, this is the infantry unexploited ordnance robot, and we are just ramping up, we got 101 robots delivered to date and are expecting more orders. And we delivered the first 25 of the Future Combat Systems Soldier Unmanned Ground Vehicles and they are at battle labs being tested and we anticipate a (hopefully) favourable decision in September and we'll see procurement contracts for those vehicles beyond the 25 beginning at the end of the year and running into 2009. So we have our legacy business in the military and onto that the xBot business in 2008 and then we will layer on the Soldier Unmanned Ground Vehicle, this is in 2009, and then we're well positioned and will continue growth in 2010 with the Warrior robot. So, really, 2008 sees our long term strategy on the military side playing out.
On the consumer side, this is the first full year of the 500 series of the Roomba robotic vacuum cleaner. We went through our startup issues last year at its introduction and we have that rolling out now. Unfortunately we had the issue with the supplier (Linens and Things) and we are in a weak economy. But we are still one of our retailer's stronges selling items and we are achieving the type of selling and sell-through that we had modelled for the year I think that it's been a beginning of the year with a fair amount of [inaudible] but we're excited, this is a big year for us.
Paul Coster: For those people who are unfamiliar with the story - what proportion of revenues are coming from these two segments and please talk as through the seasonality of that for a little bit.
Colin Angle: Sure. For 2008, we should expect maybe 55 percent of revenue coming from the home side, primarily driven by the Roomba robotic floor vacuum, and about 45 percent coming from the military side. The military side has been closing the gap with the consumer side over the past few years, but it's still weighted about that as I described. And both of our businesses are actually seasonal, but for different reasons. The home robot division's strongest periods are around mother's day and than around the holiday season and the holiday season is being larger than mother's day which means our sales are back-end loaded, we see 60-65 percent of our revenue in our home side happen in the back half of the year. And the G&I (Government and Industrial) side is also seasonal, but due to growth. It is an area of business that has been growing very strongly for us and so, January, by definition, is bigger than December. So, both of our divisions contribute to seasonality.
Paul Coster: Ok. And long term, do you feel this is to stay as a fairly balanced business or do you think that in time there will be a twist in favour of one or the other of these divisions?
Colin Angle: I think both of the divisions represent extremely large opportunities. On the home robot side, we have about 2 percent market penetration in U.S. homes and we are just getting the math right as how to best pursue the international markets. In Q1 2007 to Q1 2008 we saw a 5X increase in international sales so that represents an emerging new marketplace for us. We see that as a division with large spans and a long distance to cover before we start to saturate the marketplace.
On the military side, we are seeing a transformation of the military, Senator Warner of the armed service commitee, has set out a target that by 2015 one third of all the military's ground vehicles are unmanned, which is a tremendous upside from where we are today. So I'm really somewhat agnostic as to which side of the business is going to roll more rapidly over the long term. In fact, we may see other branches of iRobot to develop over time and grow very, very healthily as well. So, I don't want to predict the future on that side.
Paul Coster: Alright. In terms of gross margins, what are we seeing at the moment and how do think that will revolve for those two businesses are there similar gross margins?
Colin Angle: The consumer side of the business has higher gross margins but also carries higher selling expenses and higher IR&D expenses. On the government side, the selling is easier, we have a smaller set of customers and much of the IR&D is paid for through government contracts. So, despite having higher margins [in the home robot division], both divisions have the capability of delivering similar operating margins. And as we grow in scale and are winning these contracts and delivering these contracts to supply the infantry robots we see volumes and revenues increase, we may see some decreases in gross margins - as you might expect - having to give price breaks for high volume orders. But the bottom line should continue to improve with revenue giving us the ability to more fully absorb our indirect costs on the military side and monetizing through that operating leverage.
Paul Coster: I'm sort of thinking at the moment that for this year, it is a 35 percent gross margin business and a 10-15 percent operating margin business, is that correct?
Colin Angle: I think that taking an aggregate you are looking at about 35 percent on the top line and our pre tax which is one of the metrics we guide to is in the sort of 2 or 3 percent of top line revenue.
Paul Coster: In my sense, the gross margins, if I was coming to this fresh, with all of your intellectual property that you have at your disposal I would be kind of surprised that the gross margins aren't higher than this. Can you explain what the dynamics are that you have a 35 percent rather than perhaps a 50 percent gross margins structure?
Colin Angle: I think that, again, when we take this and talk about the businesses seperately, on the Home Robot side we do have a high IP content that has been tested, but our mission to date is to drive penetration of the products. To put these products at prices where our target demographic can afford them and then, over time, get them the value of the products to a much higher degree. Sort of like how the PalmPilot was originally entered into the marketplace, it was made to be accessable, and then as people found that this was a device they valued then they too would value more functionality and features in the robots. So that, from where we started, where ASPs were around 200 dollars retail, we are now up at 300 dollars to 350 dollars with our new generation 500 series robots and our sales have increased. So, it really took an aggressive pricing strategy to get people to try the product, now, 3.5 million Roombas later, we're having consistently increasing ASPs. That should yield higher margins over time as well.
Paul Coster: And the military side?
Colin Angle: On the military side, there we are operating in a very constrained business. The price you pay for having the government pay for the R&D is having the government also participate in looking what they consider a fair price for the product as well. And you succeed and win the contract by having a relatively aggressively priced product. But also with every robot we sell there's service, training, support - what we call product lifecycle revenue (PLR), which can have much higher revenues. As well as fees on integrating third party equipment and sensors onto the robots, so the model is to achieve an installed base, achieve an acceptance of our robot operating system, both of which we are successful at accomplishing, and will yield higher margins over time and also will scale to leverage our operating model and drive profatibility that way.
Paul Coster: Are 40 percent gross margins attainable over, say, the next two or three years?
Colin Angle: I'd rather say that mid-teens pre-tax net income as percent of revenue is achievable over the next three or four years, because I don't think iRobot should be judged if we are increadibly successfull selling these xBots and SUGVs to see our gross margins decline, but see the improvement on the bottom line, that's more important to us.
Paul Coster: You have a rather difficult job, because not only are you trying to achieve returns for shareholders, you also have to invest in growth, and doing this under the scrutiny of being a public company. Maybe you shouldn't have gone public when you did? How do you answer that question and what is the tradeoff that you see, what should investors be thinking in terms of the payback?
Colin Angle: We went public for a reason. And we went public because we wanted to lead an industry, we didn't want to be an also-ran in the robot industry, we think that this is a multi billion dollar fantastic opportunity. And in order to lead the military side of the business, it was necessary to provide the type of transparency that only a public company can give to allow our sponsors the confidence that iRobot is capable of both receiving and executing on hundrets of millions of dollars of government contracts. As well as - to the process of going public - seeding the industry with lower cost of capital, so that small companies could find VC money, grow and then ultimately become aquisition targets for iRobot. So, I don't regret the idea, it is a balance, but we're on a mission to build not just a company, but an industry and then lead that industry. And to do so in a less than transparent way would have been a mistake and would not have been a winning strategy.
Paul Coster: Fair enough. So let's talk about how big these opportunities are. [...] and penetration. I think you don't see this as vacuum cleaning versus iRobot. You have a different way of thinking about it. Can you talk us through that and can you talk about what the ultimate penetration level can be?
Colin Angle: Ok. When I think about robot vacuums in the home, really we're talking about something different than the type of periodic cleaning with an ordinary upright vacuum. What Roomba offers is the potential to come home every single day and have a freshly vacuumed floor. This is, every day, vacuuming for an hour, go back, plug itself in and recharge. So, maintaining your floors as opposed to dealing with a spill. And through that process, that big upright vacuum cleaner gets put back into the closet and comes out every time you knock over a plant as opposed to every weekend when you feel guilted into making your home look cleaner.
And, I think that's a big difference, and if I look for analogies: when the microwave came out, what did that do to help people who thought about cooking? Originally, it was positioned as a replacement for the stove. Well, the microwave isn't, we do all know that the microwave isn't a replacement for the stove, and it didn't succeed as a product. I wasn't until people started thinking about the microwave as a very convenient way to heat water, make popcorn, and reheat food that it started to take off. The Roomba requires people to think about vacuuming differently and realize that it is a convenience that can allow them to feel better about their homes on a routine basis.
So, 2 percent market penetration, it's clearly, clearly just getting started. The types of people that buy Roomba are not just the financial elite, in fact, if you have a lot of money you probably hire someone to clean your home for you. This is for mainstream Middle America. This is 30, 40, 50 percent of the households out there where we want to focus our marketing efforts on and so, the 2 percent penetration, that's nothing, that's almost none on the way to where we want to be. It's 10 percent, 20 percent types of penetration numbers of U.S. households that represent the opportunity domestically, and then similar percentages internationally. And that's an area where we scratched the surface even more lately, although we are seeing some good traction.
Paul Coster: And of course in a much longer term perspective you believe there are other applications in a home that can be addressed?
Colin Angle: Right, if you want to think about where we are going long-term, the real idea is that homes can take care of themselves to a larger degree to allow the occupants of homes to have reduced physical abilities to care for their own homes or have basically more time to do other things. And if you take this one step further, you look at the greying of America, the fact that over the next 15 years the number of people over 65 is going to double. They don't want to go into nursing homes, which is good, because nursing homes is an industry currently in decline, it's not adequate for today's population of elder people. So, the robot industry is being looked to and will be counted upon to allow people to live independently for longer periods of time, allowing homes to take care of themselves, allowing doctors and nurses to visit those people at homes, because, frankly, Middle America can not afford the doctors and nurses to make housecalls and that's one of our current challenges. So the robots like the ConnectR, which is our virtual visiting robot and allows you over a laptop to project a physical presence anywhere in the world to where one of these robots is located is the type of technology, which, used in conjunction with the Roomba-like technology, can give you a home that takes care of itself and cares for the people that are in the home.
Paul Coster: Ok, sort of a big vision. And the military side gets just as exciting pretty quickly, doesn't it? I think the thing that quickly got my attention was last year's analyst day, when admiral Dyer said that we will see a ten-fold increase of the addressable market within three to four years. And so far it seems to be playing out. Can you talk us through that and what's behind it?
Colin Angle: Well, the biggest challenge is that the United States can't truly afford the military it has today much less than the military it wants to have. And yet the number of crisis response days, the number of days that we put soldiers in action around the world to address our interests has grown steadily over the last 60 years in a very consistent monotonic path. And that's independent of conflicts like Afghanistan and Iraq. So if we are to maintain our position in the world, we need to find more efficient ways to intervene and to perform missions.
And the cost of a soldier on the Ground for the United States military is growing rapidly. I think a year and a half ago that was estimated to be around 4 million dollars for a single soldier over his ten years in the military. So when we talk about sending another thousand soldiers into the field, calling them up and putting them into action, you know, do the math, that's 4 billion dollars for just a 1000. And typically, when you hear the news it's 40,000 or 100,000 soldiers. These are incredible dollar figures. So it's really economics that drive the use of robots.
And we've been able to demonstrate in exercises that not only can robots save lifes, we get that data back from Iraq, but that robots are able to dramatically increase the pace of operations. If you imagine you are a soldier in a squad and that squad is supposed to clear this building, that requires enter the rooms without getting killed, getting upstairs and so forth. In exercises like experiment 1.1 which was conducted last year the robots where shown to dramatically decrease the time that takes a single squad to clear a building. From, literally, time measured in hours to time measured in minutes. So, if it just doubled the (available) time, it effectively doubles the number of people for your missions. So, this is a critical technology, that will be driven very hard, that will be driven very hard regardless which administration wins the next election and something that you are going to see long term growth in.
Paul Coster: Can you give us or share with us some statistics around the size of the addressible market.
Colin Angle: We estimate that the number of robots to be procured by the infantry over the next 3 to 5 years to be between 10,000 and 20,000 robots. To date, iRobot has sold about 1400 robots. So you can see a step change as the capabilities and programs that are in place today start to play out.
Paul Coster: All right, and I think the FCS program states that by 2013 there should be 30 percent of vehicles unmanned.
Colin Angle: 2015, so that's near upon us. And I think that makes sense, you can look at the unmanned airial vehicle industry for comparable performance and you see that industry is now high single digit billion dollars and growing rapidly. We are just getting to the point now where unmanned armed airial vehicles are starting to be talked about and tested and so forth. Until today, the unmanned reconnesance missions where paramount.
Paul Coster: Right, UAVs are already attracting billions of dollars, UGVs, whether armed or not, are attracting just hundrets of millions, why is there such a big difference there and is it good or bad news for UGVs?
Colin Angle: Well, it's much earlier for unmanned ground vehicles than for unmanned airial vehicles. From a robot perspective, flying is actually easy compared to driving, there's not a lot of things to hit - assuming that you can land. Radar works really well, sensors work really well, so you just follow your GPS waypoints and you will be ok. So, that industry has been around for several decades and thankful for us, because they have paved the way to a large degree. On the ground, you have lots of things to avoid, autonomous navigation is much harder and before the PackBot, there were no examples that were sufficiently capable, cost effective and rugged enough to give the kind of performance that soldiers where going to count upon count upon in order to do their jobs. And now that's changed, there's good exemplars it's taken from Afghanistan to September of this year to really see the major procurement programs started to be put in place.
Paul Coster: Ok, so there's a go-no-go decision on SUGV in September of this year. And if it gets the go-ahead, than I understand you have a pretty sizeable commitment already from the FCS program, is that correct?
Colin Angle: We don't have a exact figure at this point but the program of record talks about 3600 units, that was set back a number of years ago and certainly the interest in unmanned ground vehicles has only risen since then. So we would be expecting a sizeable, probably IDIQ contract, and then production orders that would follow. And that's what we are talking about, to get all this in place, talking about 2009 revenue as opposed to October, November revenue.
Paul Coster: In the meantime, xBot came through, and it seemed really urgent. [inaudible] You've seen the first 100 of these, correct?
Colin Angle: First 100 have already shipped and we are continuing to build into 2008 and well into 2009.
Paul Coster: So a little bit of frustration on my part was that, yes, ok, so you ran into some problems in the consumer side - no big surprise, really, why wasn't it offset and then some by the military side. It really felt like this year was going to be what you described previously as an inflection point and you'll be hustling to keep up with demand.
Colin Angle: I think that the military's definition of urgent need and your and my definition of urgent need may not be exactly the same. But the size of these contracts and what they mean strategically to the military is absolutely valid and accurate. Our philosophy for giving guidance and communication is to be as transparent as possible and when we looked at what we understood the size of the xBot orders to be and played out the challenges that we've had in the marketplace and took the hit from the Linens and Things bankruptcy, we did not have confidence at this point to say anything other than ok, based on what we know today, we are going to revise our guidance for the earnings side down somewhat. And as I stand here today I don't know of any contracts of xBot that would more than make up for losses we've had on the consumer side. The future is an interesting place and we know that there is a strong demand and need for these robots that is playing out, but it's the prediction of timing for contracts for the Government that is problematic and that leads me to be very reluctant in speculating that it's all going to work out.
Paul Coster: Things could suddenly go very much in your favour. Let me paint a picture here, ok. These xBots are going to ordinary infantry squads, they aren't going to specialists anymore who would be called in to clear a road, these are young people who are being asked to clear the road themselves. And, presumably, without the robots, they will have to go up to these unattended boxes and use a FIDO sniffer, a handhold one. That sounds pretty damn scary to me, I can't imagine now, that the genie is being let out of the bottle, and some of these squads are actually getting access to these things, that the other hundrets and hundrets of squads are going to be very pleased about the fact that they have to engage in an old-fashioned way of sniffing out bombs. I mean, it sounds ridiculous.
Colin Angle: Well, it is ridiculous. And the soldiers should have this technology. And I think that what you are saying is what has played out on the EOD side, where, when we first sent our explosive ordnance disposal team over to Iraq, they didn't have robots. It was some of the robots we've sent to Afghanistan being dragged over there and put to work, that created a half-and-half [inaudible] and led to the rapid procurement of explosive ordnance disposal robots. So what you are saying is entirely plausible and makes rational sense and as someone who believes very strongly that we should be doing whatever we can to protect our soldiers...
Paul Coster: Do you think that there is a ground swell of activism amongst the infantry themselves to get this technology deployed or is it all top-down stuff?
Colin Angle: This, the xBot, the robot that you are describing, that program was formed based on ground soldiers saying we need this type of technology. Now it's the top-down contracting challenges and where's the money coming from, and the administration's ability to free up dollars to pay for this which puts the speed limit on how fast these products can get over. And whether, like there was with body armor, some politicalization for the process that's sort of what it would take in order to accellerate the procurement of the xBot beyond the rate we are seeing today. I think it is possible, I don't feel it's my duty as a public company CEO to speculate on that type of outcome, but we certainly could see that happening.
Paul Coster: Ok. Does it matter to you who becomes the next president of the United States?
Colin Angle: No, it doesn't from the perspective of iRobot. I think we see Iraq and Afghanistan demonstrating to the world that the current way of conducting military operations is inefficient, ineffective - or less effective than we would desire - and is in dire need of some new technologies to face these evolving threats. So, that lesson has been learned, that die is cast and we are seeing a bipartisan resolve to bring robots into the military. So that if we stay in Iraq, we would see probably more spares and services and support type of revenue, if we pull out of Iraq over time we are going to see more ressources available to equip our armed forces with this type of equipment and see probably more research dollars associated. So, we certainly will see the color of money change and the type of procurement contracts that we are seeing as we go forward, but we are in a very very exciting position leading a transformation of technology in the military. It creates an opportunity to be a tier 1 defense contractor because the Boeings, the Raytheons, the Lookheed-Martins, and the GDs missed small robots in their strategic planning. iRobot was there, we won the major contracts and we are building ourselves out into the major player in small robots.
Paul Coster: In 2006, you had a strong end of the year. You kind of disappointed investors a little bit by plowing millions back into R&D to accelerate development of the Warrior platform which is like the Packbot on steroids. But we haven't seen any sales since, or just a couple. What happened there, what is happening there.
Colin Angle: What's happening there is the Warrior platform is a larger version of our Packbot robot. It's a 250 pound robot. The philosophy behind it is: the Packbot is a tool that a soldier might use to go into a building ahead of himself. The Warrior is a soldier replacement. This is a robot that is small enough to operate inside buildings, strong enough to lift 150 pounds nine feet in the air with its manipulator, and stable enough to be weaponized and carry a variety of payloads effectively. So this is a robot which is a real game changer once again for how our military operates. So, we had to develop it and had support from the U.S. Government to to so and we augmented that with some of our own dollars in 2006, now the robot is going into the battle labs, documents are going to developed around on how this robot should be used and then we should see low rate initial production in 2008 and then we should see that grow the year after. I think it's going to be very material as far as one of the drivers in the 2010 timeframe and we also see some benefit next year on that platform. So we really do take a long term view and things in the military go through different gates and take some time to be rolled out, so xBot this year, add on top of that SUGV in 2009, and add on top of that Warrior in late 2009, 2010 as far as selling and delivering these robots in sufficient volume to be material to the company. What was material in 2006 is perhaps not so material in 2009 and 2010 based on our growth rates.
Question from the audience: What about competitors coming out of Asia in the home robot division?
Colin Angle: Since we launched the Roomba, there have been competitors. There was competition from Electrolux, there was a competitor coming out of some of the factories in Asia trying to knock-off the Roomba and so far nobody has had any measurable success in the marketplace outside of South Korea. So we have well over 95, 98 percent marketshare everywhere in the world other than South Korea where we are sort of in the 60-70 percent marketshare category. In South Korea where I would say is the hotbed outside of the United States of practical robotics we see both Samsung and LG having entrance into the marketplace. These are robots at substantial price premiums to the Roomba, and I think that it would be interesting to see what Samsung or LG would do to the marketplace if they in fact wanted to spend some real money and help us with the development of the credibility of this new market. So it would be interesting.
Paul Coster: I have one last question. You are changing your leadership team at the moment, quite a lot, in fact, what's going on there, can you just sort of tell us what's happening.
Colin Angle: Well, my CFO and I have been talking the last year about making a change. His love is smaller companies - a couple million dollars up to around where we are - and so he is leaving us to pursue that passion and in his place we are very excited to bring John Leahy who has 17 years international experience with Pepsi and for seven years was at [inaudible] as their CFO and so he brings experience that we need to move the company forward in this 300 million to a billion dollar space and beyond. So that's been a long plan and exciting. The other change that we announced was that we changed leadership in the home robot division where Sandra Lawrence had been with us for about a year. Her speciality is on the marketing front and as we had the launches of the Roomba 500 series and the Looj and the broadening of the portfolio of Scoobas that sort of played out. Then we found ourselves to be needing more of top level leadership on the operations front and decided to make a change to better meet the needs of the company.
Paul Coster: Thank you.
Colin Angle: You bet.