iRobot Corp (IRBT) 2007 Q3 法說會逐字稿

Good morning, everyone, and welcome to the iRobot third-quarter 2007 financial results conference call. This call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Ms. Elise Caffrey of iRobot Investor Relations. Please go ahead, ma'am.

Thank you and good morning. Before I introduce the iRobot management team, I would like to note that statements made on today's call that are not based on historical information are forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. This conference call may contain expressed or implied forward-looking statements relating to the Company's financial results, operations and business conditions. These statements are neither promises nor guarantees but are subject to a variety of risks and uncertainties, many of which are beyond our control which could cause actual results to differ materially from those contemplated in the forward-looking statements.

In particular, the risks and uncertainties include those contained in our public filings with the Securities and Exchange Commission. Investors are cautioned not to place undue reliance on forward-looking statements which speak only as of the date hereof.

Please note that a live audio broadcast of this conference call is available on the Investor Relations page of iRobot's website at www.iRobot.com. An archived version of the broadcast will be available on the same web page shortly.

In addition, a replay of this conference call will be available through Thursday, November 1 and can be accessed by dialing 719-457-0820, access code 548-4379.

On today's call iRobot CEO, Colin Angle, will provide a review of the Company's operations and achievements for the third quarter of 2007 and the outlook for the rest of the year. Helen Greiner, Chairman of the Board, will provide an update on our litigation activity, and Geoff Clear, Chief Financial Officer, will review our financial results for the third quarter of 2007 and comment on our financial guidance for the year. Then we will open the call for questions.

At this point I will turn the call over to Colin Angle.

Hello and thank you for joining us. Last evening we reported our financial results for the third quarter of 2007. Because of delayed shipments of the new Roomba 500 series, product transition and end of life return rate adjustments and unanticipated legal expenses, our results were lower than our expectations in July. Our top and bottom lines were consistent with those reported in the preliminary earnings release we issued on October 10.

Production ramp by our new contract manufacturer was slower than our initial targeted projections, and revenue and earnings that we anticipated achieving in the third quarter will now be realized in the fourth quarter. Despite these issues, I'm confident in our ability to deliver pretax profits for 2007 in the range of 3 to $5 million on revenues of 240 to $250 million, the revised guidance range we announced last evening.

On this call my goal is to provide three things. First, additional detail as to why our third-quarter results have differed materially from expectations we set during the second-quarter earnings call in July, particularly with respect to profitability.

Second, support my confidence in our ability to execute and generate fourth-quarter revenue and profitability that will meet our full-year revised financial guidance.

And third, reaffirm commitments to increase profitability in 2008 with continued investment in our future.

Our 13th consecutive quarter of year-over-year revenue growth was driven by a 21% increase in our government and industrial division for the third quarter. We continue to see strong demand for our robots in the US military and in international markets. During the quarter we delivered 114 robots plus spares and made important development progress on several projects significantly to expand our product offering.

In 2008 we will deliver two major new platforms, Warrior and SUGV, the small unmanned ground vehicle. During the quarter we announced two Naval Sea Systems Command, NAVSEA, delivery orders totaling $19 million for 128 additional bomb-disposal robots. These latest awards bring the total value of the NAVSEA orders placed to date to $94 million. There remains $170 million available under the previously existing indefinite delivery, indefinite quantity ID/IQ contract.

We recently announced an $8.8 million order for the U.S. Army Program Executive Office for stimulation simulation training and instrumentation -- that is PEO STRI -- for 40 iRobot PackBots plus spare parts and equipment. PEO STRI placed this order for a range of iRobot systems, including PackBot with ICx Fido kit, as well as the Army's first orders for the PackBot 510 robot and more than 300 new high-performance radios that will be retrofitted onto existing iRobot PackBots in theater.

These radios increase the operational range and flexibility of the PackBot system to achieve mission success in a wider range of tactical environments than previously possible. The robots will ship with iRobot's new game-style hand controllers for faster training and easier operation in the field.

In our home robot division, we successfully launched our new generation of Roomba floor vacuuming robots, the Roomba 500 series. We've positioned our Roomba 400 line and introduced two non-floor cleaning robots, the Looj, our gutter cleaning robot, and ConnectR, our virtual visiting robot. The Roomba 500 developed over the past three years incorporating feedback for many of our more than 2 million customers is smarter, more powerful and more efficient than its predecessors.

With this introduction, we diversified our manufacturing base by adding another manufacturing partner in China. In the long run, we feel that it is important for the Company to have multiple manufacturing sources to mitigate the risk inherent in full source arrangements.

We did, however, incur initial production issues with our new partner to cause our ramp-up to be slower than we had anticipated. Bringing a new manufacturer up to speed to build a sophisticated product such as the Roomba 500 has had its challenges. We believe based on past experience with new manufacturing partners that we have built sufficient leadtime into the process, but we are off by a couple of weeks.

The delayed shipments caused revenues and earnings we expected in the third quarter to move to the fourth. The production issues have been addressed, and we're currently seeing production at the levels needed to meet holiday demand and timetables. As we have said in the past, it is very difficult to accurately predict the timing of home robot systems shipments for the holiday season between the third and fourth quarter, even without a production issue, which is why we provide financial guidance in six-months increments.

Direct revenues increased 174% in the third quarter year-over-year and comprised 23% of total home robot revenue this year compared with 9% a year ago. This increase was driven primarily by the sale of Scooba 380s through our infomercial and the sale of Roombas, both 400s and 500s, on our website. We shipped 229,000 home robots in the third quarter, approximately 38,000 fewer than we had anticipated, primarily Roomba 500s, and that compares with 222,000 for the same quarter last year.

Because the robots that were not shipped were high margin units, the delayed shipments have impacted our profitability for the quarter in addition to reducing revenues from our original expectations. The other factors that negatively impacted profitability in the third quarter were product transition and end of life return rate adjustments that Geoff will address and legal expenses associated with litigation we initiated to defend our intellectual property. Helen will discuss these actions further in a minute.

Our outlook for the fourth quarter in both divisions is very positive. The Aegean I division is successfully executing against plan. We have significant revenue visibility into the remainder of the year and have already captured 100% of the government and industrial division's annual revenues that is contemplated by our new full-year guidance. This captured revenue is in the form of shipped products, services rendered, executed contracts to be performed and product backlog expected to ship this year. Product backlog was $36 million at the end of Q3, an increase of 87% from the end of Q2, which positions us well for both fourth quarter and early 2008.

On the international front, our G&I sales force continues to deliver and has recently secured orders in multiple countries including Israel, Australia, Sweden, Thailand and South Korea. International revenue for the third quarter was approximately 10% of total G&I revenue, and we anticipate increasing demand in this market in the fourth quarter and beyond.

In home robots we're extremely optimistic about sales for the holidays. We are still early in the season, and Roomba 500 is just setting in stores. But preliminary data for the past five weeks indicates an increase in year-over-year total (inaudible) Roomba sell-through of 26%. In stores that have been selling Roomba 500 for three weeks, total Roomba sell-through increased by more than 50% year-over-year. We believe this validates the health of the Roomba franchise, the Roomba 500 has been well-received and the channel is eager for the product.

Demand for Roomba 500s is there, and we're currently seeing production at the levels needed to meet holiday demand and timetables. That gives us enough comfort to raise the revenue guidance for the full-year. As we look to 2008 and beyond, we are well positioned to deliver continued growth and increasing profitability in both divisions.

In addition to our PackBot family of robots, we will have two new platforms ready for delivery in 2008. Our SUGV platform continues to build momentum. Due to our partnership with Boeing for the development of SUGV early, we anticipate sales of this robot to contribute materially in 2008. We expect to see demand from the US military and foreign customers, as well as opportunities in new markets, including swap teams, special operations, chem-bio specialists, and infantry to name a few.

The Future Combat Systems SUGV development program is also progressing well and heading to preliminary design review in February of 2008. Pre-prototype SUGVs have been featured by Army Secretary [Garren] and Army Chief of Staff General Casey. In testimony to Capitol Hill and various Senate and congressional committees, momentum to accelerate SUGV continues to build. Our role in FCS was recently expanded through a multiyear subcontract agreement or $3.9 million with Lockheed Martin for the development of a centralized controller, which will contribute to revenues beginning in 2008. The centralized controller will consolidate what traditionally would have been numerous disparate controllers into a single integrated system simplifying logistics and empowering the soldier. iRobot's role is to develop controls, display and interface design for this centralized controller.

Our Warrior robot development continues on track for a mid-2008 delivery to developers and early adopters. We recently received positive feedback from potential customers in Europe, following an extensive tour and interest continues to grow in the military, engineering, chemical detection and combat medical communities, as well as the state and local first responders.

Successful bidding on multiple opportunities in our G&I research division also positions us well to deliver in 2008. The new research programs include initiatives in strategically important areas such as unmanned air and ground vehicle coordination, novel mobility designs and sensor-based navigation. These research efforts continue to provide the innovation and strong technology foundation required to support our product lines in 2008 and beyond. These products, in addition to our PackBot family of robots with payloads for explosive sniffing, sniper detection, advanced communication and electric control devices will provide the basis for increasing growth in the G&I division next year. We have been aggressively marketing our current products, as well as actively demonstrating prototypes of products we expect to deliver to the market in 2008.

Not only do we have battle-proven products, but we have demonstrated the capacity to develop, test, produce and deliver products that meet our customers' changing needs. As the number of robots in the field continues to grow, we have seen an increasing need for spare parts, service support and training, what we refer to as product lifecycle revenue or PLR. We expect that over time PLR will be sustainable at a rate of 25% of our G&I product revenues. Margins on PLR are higher than on our other G&I product revenue.

In 2008 and beyond, we expect profit margins to expand to growth in PLR. We also see opportunity for margin expansion through leverage in our operating models. Because we outsource our manufacturing, we expect our internal cost to increase at a lower rate than revenue. We do, however, expect that as order volumes increase, there will be some pressure on pricing.

I'm equally optimistic about the outlook for a home robot division in 2008. Sandy Lawrence joined as President of the division in May of this year, and I'm happy to have her onboard setting and executing on the strategy of continued growth and increased profitability in 2008 and beyond. Her efforts to develop a more effective media strategy have already made a positive impact. She is focused on increasing product demand, while decreasing customer acquisition costs through better targeted broadcast media and direct program, and she will continue to focus to an even greater degree in 2008. Our holiday TV media campaign was kicked off with our Animal House advertisement targeting the Chief Household Officer showing Roomba as a maintenance tool as the first example.

Now at the risk of sounding like a vacuum cleaner salesman, I have not had the opportunity to describe the importance of the Roomba 500 to iRobot. With this product we are delivering on the original vision of the robot vacuum cleaner, which is one that can reliably maintain your floor everyday for years. It features a 100% more effective vacuum, better brush design, debris and particle filtering, advanced cleaning coverage and navigation, plus new scheduling capabilities and significantly improved reliability. Roomba 500's improved performance and greater reliability should lead to lower return rates, which in turn will result in higher revenue, increased gross profit margins and earnings.

There are two additional opportunities for us to improve home robot gross margins in 2008. The first is nickel. We have spoken at length about the negative impact that increasing nickel prices had on our 2007 margins. We estimated that higher prices would reduce second-half and full-year gross margins by $5 million. Since June of 2007, nickel prices have fallen substantially. While we were not able to take advantage of that decrease in 2007, we do expect to substantially improve our 2008 home robot gross margins as a result of this decline.

The other opportunity for margin expansion is through increased sales generated through our website. Our investment in our direct sales channel continues to yield excellent results. As I mentioned, direct revenues were up 174% in the third quarter year-over-year. We expect this trend to continue and actually accelerate as we add direct capabilities to the international market.

Our direct business offers the highest gross margins but also gives us the best understanding of and connection to our customers and provides the channel for our entire product line. I remain committed to improved profitability and have discussed several of the drivers for improved gross profit improvement for each of the divisions in 2008. This should in turn drive improved operating margins. We will continue to leverage the investments we have made to scale to a global organization and focus on improving our business processes. As we realize increased growth in 2008 and beyond, we will drive more profit to the bottom line.

In summary, we experience a delay in home robot production, which shifted revenue and profit across a difficult to predict boundary between Q3 and Q4, the reason we provide financial guidance in six-months increments. We have 100% revenue visibility in our G&I business for the year. There is tremendous demand for our home robot product, and we are currently seeing production at levels needed to meet holiday demand and timetables, all of which gives us confidence in our ability to deliver second-half and full-year 2007 results within our revised guidance. We expect the momentum we achieve in the fourth quarter to continue in 2008 and beyond.

I will now turn the call over to Helen.

Thank you. There has been a lot of discussion and speculation about our litigation with iRobot's former employee and the Company he founded, and I wanted to spend a minute bringing you up-to-date on the outstanding legal actions.

In August we filed a lawsuit against Robotic FX and its founder, Mr. Ahed, in Massachusetts for trade secret misappropriation, breach of contract and other related issues. Based in part on evidence uncovered after the complaint was filed, iRobot has filed a motion for a preliminary injunction, and we are currently awaiting a ruling.

To be clear, a preliminary injunction is extraordinary belief, and regardless of the outcome, we will aggressively pursue a permanent injunction on this matter.

In addition to the trade secret case in Massachusetts, we filed a lawsuit against Robotic FX in the US District Court for the Northern district of Alabama alleging infringement of two US patents where we are seeking damages and a permanent injunction. As is the case with most litigation, it is difficult to assess either the time it will take or estimate the total cost impact on the Company. It will put pressure on our earnings in the near-term. But defending our position is vital to maintaining our competitive position in the industry. There is nothing more we can say about any of the ongoing litigation at this point.

On September 21 we filed a bid protest with the GAO regarding the xBot competition. For those of you who have not been following this process, xBot is a joint urgent operational need program for the procurement of multiple portable robots for the infantry improvised explosive device community. The Army announced on September 14 that it was awarding this contract with a $280 million ceiling to Robotic FX after technical trials and a reverse option. We did not include any revenues or costs associated with winning this award in our 2007 financial projections.

A bid protest is an auction offered to companies bidding on government contacts to challenge certain aspects of the contract award process. On October 23, 2007, we were informed by the U.S. Army Legal Services Agency that they would seek a dismissal of our protests based upon the Army's intent to take corrective action as to the award of the contract. Specifically the Army will one, set aside the award to Robotic FX; two, conduct a reassessment of the Robotic FX responsibility to perform the xBot contract in light of information that was made available to the contracting officer after the award but concerned events prior to the award; three, if the contracting officer determines that Robotic FX is not responsible, she will refer the matter to the Small Business Administration Government Contracting area office for a certificate of competency in accordance with federal acquisition regulation; and four, if the SBA declines to issue a certificate of competency, the contracting officer will award a contract to the next lowest bidder, iRobot.

We have been informed that it is the frequent if not common practice of the GAO to dismiss as academic pending protests when an agency informs it of intended corrective action. Here the Army has specifically requested that the GAO dismiss iRobot's protests, including all supplemental protests as academic based on the announcement of corrective action. On both the litigation and bid protest fronts, we will continue to aggressively work to ensure that our interests are protected.

In our home robot business, we introduced two new non floor care products at DigitalLife, ConnectR and Looj. ConnectR is a virtual visiting robot that allows you to see what the robot sees, hear what the robot hears and drive the robot wherever you want to go no matter where you are.

In the next few months, we will begin a pilot program with a small group of consumers, which will allow us to do additional usage and satisfaction research prior to a mass-market launch. Our Looj robot, which was selected as best holiday gift for adults at DigitalLife, was designed to relieve homeowners of the dull, dirty and dangerous task of gutter cleaning.

To put the Looj opportunity in perspective, there were more than 70 million homeowners in the United States, the majority of whom have gutters serviceable by Looj. Our market research shows that approximately 50% of households within our target demographics clean their own gutters, and we believe that at a $99 entry price, Looj will provide these homeowners with an economical way to perform this shore more efficiently and safely.

Looj has been available on our website and through Brookstone and [Hamnika Shelmer] catalogs since the launch. In November it will air on Home Shopping Network and will be available at home centers next year.

I will now turn the call over to Geoff for a review of our financial results.

Thank you, Helen, and good morning, everyone. Our financial performance for the third quarter did not meet the expectations we had at the time of our second-quarter earnings call in July. During the last few weeks of the quarter, we were impacted by three unanticipated events -- delayed shipments of Roomba 500, higher-than-expected end of life costs related to the repositioning of our Roomba 400 line, and the essential but expensive legal fees that negatively affected our financial results.

I would like to walk you through the variances in our third-quarter results year-over-year, as well as the differences between our expectations at the end of July and the results we reported last night.

Let me start with the most significant variance, gross profit margin. Gross margin for the third quarter was 31.5% of sales, down 10.3 percentage points from 41.8% for the comparable quarter of 2006. There were several onetime events that contributed to the decline, and these negative items were partially offset by a favorable factor that we anticipate will continue to have a positive impact on gross margin going into 2008.

Exclusive of a onetime settlement last year on the UK MOD project, government and industrial gross profit had a favorable impact to Company gross profit of almost 4 percentage points. Thus, the decline in the Company's gross margin of 10 percentage points is due to last year's onetime factor in G&I and the following four home robot division factors -- end of life product transition costs, the cost of nickel, delayed Roomba 500 shipments and return rates.

The first three are unusual events that impacted the third quarter, and we expect that the Roomba return rates will be the favorable as compared to our historical return rates, thus benefiting our future financial results.

Let's look at the impact of each factor on the third quarter. First, we made a series of onetime adjustments for product transition costs associated with the repositioning of our Roomba 400 line. We anticipated that there would be an impact from generational transition, but we were unable to make a complete financial assessment until after the new Roomba 500 product was on the retail shelves, and the stores had made decisions with regard to remaining inventories of Roomba 400s. The financial impact of this transition should be behind us.

Second, unfortunately many of the Roomba 500 shipments that were delayed at the end of September were high margin units bound for several of our larger retail stores. The gross margins in home robots tend to vary widely by product and by customer. The mix of products shipped and the mix of customers to whom they are shipped can significantly impact gross margins quarter to quarter.

In the third quarter, the delayed shipments were primarily of higher margin products. The good news here is that these shipments were shifted to October and November instead, and thus they will positively impact Q4.

The third factor is the cost of nickel in the third quarter of 2007, which was 50% higher than in the third quarter last year, which further contributed to the gross margin decline as Colin described earlier.

And the fourth factor, Roomba and Scooba return rates, will be a key ongoing determinate of home robot gross margins. We regularly review the return product profile of our home robots. As we conducted our review for the third quarter of 2007, we determined that the return rate for Scooba infomercial sales was higher than the rate at which we had been accruing. That analysis resulted in a onetime rate adjustment in the third quarter that negatively impacted gross margins.

More than offsetting this, however, is a significant piece of good news. Based upon hundreds of thousands of hours of Roomba 500 product testing, our statistical analysis indicates that the quality of our new Roomba productline is significantly higher than our previous generation. And, therefore, our financial return accrual rate for the new Roomba 500 is lower than that of the previous generation of Roombas. Adjustments to return accrual rates either up or down based upon actual experience can significantly impact the gross margin in any given quarter, so we will keep a close eye on this metric in coming quarters.

After considering all of the negative events that occurred during the quarter, and especially after considering that several of them were timing issues, our outlook for the fourth quarter is for significantly increased gross margins, and we still expect gross margin for the year to approximate 35%, the low-end of our previously provided annual guidance.

Primarily as a result of the above described gross margin and also legal expense impacts, we reported a net loss for the third quarter of $1.4 million compared with a $10 million profit in the third quarter last year.

It is unusual for us to generate a loss in our third quarter, and in fact, during our second-quarter earnings call in July, we said that we expected to be significantly profitable in the third quarter. Clearly the lower gross margins which I just described, the revenue delays that Colin described earlier, and significant costs associated with the xBot and litigation activity, were all unanticipated and significant financial impacts.

Further widening the bottom-line gap between Q3 '06 and Q3 '07 was $2.5 million of favorable onetime settlement costs recorded last year as part of the UK MOD settlement.

Now I would like to talk about operating expenses. For the third quarter, total operating expenses were $22.3 million or 35% of revenues compared with $13.7 million or 25% of revenues last year.

Let's look at OpEx in more detail, beginning with R&D. For the quarter internal R&D was $4.7 million or 7.4% of revenues compared with $4.3 million or approximately 7.9% of revenues a year ago.

As I previously mentioned, this past quarter's R&D costs included unanticipated engineering costs associated with the xBot competition. We expect internal R&D for the full year to be approximately 7% of revenues consistent with our guidance.

Sales and marketing spending for the third quarter amounted to $11.1 million or 17.4% of revenues. This compares with $4.7 million or 8.6% of revenues in the year ago quarter, a substantial increase both on an absolute dollar and percent of sales basis.

The increase in sales and marketing spending as compared to last year is primarily the result of two factors. First, marketing and fulfillment costs for direct sales due to the significant growth in that channel. And second, the cost of our infomercial program for Scooba, which began in the second quarter and continued into September when we placed the program on hold.

I would like to emphasize that while we believe that an infomercial is an effective media mechanism for creating product awareness, revenues generated directly from infomercials tend to generate little to no operating margin net of the related direct media spend. Increased infomercial revenues are causing our 2000 revenues to grow at a faster rate than our pretax earnings. The focus of our media spending in the fourth quarter will be an infomercial featuring the Roomba 500 and, to a much lesser extent than last year, TV advertising. This spending is essential to create consumer awareness for our new Roomba 500 products.

Full-year sales and marketing investment will be approximately 19% of revenues as previously indicated. G&A expense was $6.5 million or 10.1% of sales in the third quarter of 2007 compared with $4.7 million or 8.5% of sales in the year ago quarter. The year-over-year increase was due primarily to the legal expenses discussed earlier and increased headcount. We are focused on tightly managing controllable operating expense, and we affirm our commitment to improving profit margins partially through leverage of our operating expenses. We expect the full-year G&A expense will be approximately 9% of revenues, including the anticipated legal expenses in the fourth quarter.

Our after-tax loss was $1.4 million in the third quarter compared with an after-tax profit of $10 million a year ago. This year's results include stock compensation charges of $1.2 million for the third quarter compared with $724,000 last year.

Turning now to our balance sheet, we continue to maintain a strong balance sheet with no debt outstanding. Cash and short-term investments at September 29 were $49 million compared with $70 million at the end of the second quarter. Our cash position should start to rebuild within the next several weeks as we expect -- and we expect that trend to continue through year-end.

Net Accounts Receivable were $35 million, and days sales outstanding were 54 days.

Before we take your questions, I would like to discuss financial guidance. There are three key risks that could impact our ability to deliver against our revised guidance for 2007.

First, economic uncertainty. As with any company who is dependent on trends in the retail sector, we face the uncertainty of the effects of consumer confidence and other economic factors on holiday buying. While we remain optimistic about buyers' enthusiasm for our products, a slow holiday season could nonetheless impact us.

Second, continued successful production of Roomba 500 to meet the retail demand. We are currently at the rate of production required to meet our customers' demands, and we must continue at this rate throughout the next few weeks.

And third, unanticipated legal expenses. Legal suits are expensive and hard to predict. We give guidance in six-month increments because of the challenge of predicting the precise split between shipments in September and October. This year's pattern of considerably higher revenue and profitability in the fourth quarter is consistent with the pattern we experienced in 2004 when we first introduced the Roomba 400 series.

This is the most difficult time of the year to predict our home robot results. We have evaluated all of the risk factors discussed today, and we firmly believe that we can deliver against our revised financial guidance. Our G&I backlog is solid, and we have excellent visibility in this business through year-end. All of our expected G&I revenue is now on order, in production and should ship by the end of December.

Current orders in home robots and strong expectations for reorders in the fourth quarter give us the confidence to increase our full-year revenue guidance to 240 to $250 million in revenue. That is a year-over-year growth rate of 27 to 32%.

Due largely to the factors which I mentioned earlier, we are revising our gross margin guidance to 35% from the previous range of 35 to 36%. We still expect our full-year pretax earnings to be in a range of 3 to $5 million in spite of the revenue guidance increase, primarily as a result of the reduced gross margin guidance.

In addition to the lower gross margins, lower margin infomercial revenues and unanticipated legal costs have put continued pressure on our pretax profit margins for the year. Despite this, our revised guidance implies significant second-half momentum for both revenue and pretax net income that we believe is sustainable into 2008. Second-half 2007 revenue is forecast to grow between 32 and 41% from the second half of 2006, and pretax net income is expected to increase 55 to 79%.

In summary, revenue and profit originally forecast for the third quarter has shifted to the fourth quarter. Several factors negatively impacted our gross margins, and we incurred unanticipated legal expenses that caused us to fall short of our third-quarter earnings expectations. We have excellent visibility in our government and industrial business. There is strong retail channel demand in our home robots supporting our increased revenue expectations for the year, and we expect a significantly profitable fourth quarter with earnings momentum to continue into 2008.

With that, Matt, we will open the call to callers' questions.

(OPERATOR INSTRUCTIONS). Paul Coster, JPMorgan.

On that last point, when you talk about earnings momentum into '08, you mean of course on a year-on-year basis, not on a sequential basis?

I do mean on a year-on-year basis, Paul. Thank you for the clarification.

Right. xBots, now I don't even understand why the Army sort of commissioned this program in the context of the PackBot programs and the SUGV. Can you explain to us what you think the objective was, and how important is that program and the contention to iRobot and why?

Well, the xBot competition was set up in response to what is called a joint urgent operational needs statement coming from the field. That is equipment that they want to get into the field in an extremely short timeframe. And you saw some very stringent delivery dates on the xBot. SUGV is a program of record for the development of the Next Generation of portable robots for the Army. It has a longer timeframe on it in the original conceived program, but as we have been telling you, it is a poster child for delivering on the program. It has been constantly highlighted by program officials as a prime candidate for acceleration to meet current needs in the field, and we are going to be ready to deliver the SUGV early in partnership with Boeing in 2008.

How important is the xBot win to you if you manage to overturn this decision?

We do not have the xBot in our financial projections at all.

The 3000s or even 1000 units that have been projected, do you believe that that is the size of this program?

As Helen described, the xBot is a stop -- it sort of is meeting a gap that has arisen out of the demand from the field for this type of equipment. The SUGV is the long-term solution which is being accelerated, and the xBot is designed to meet that need. So that it is inherently a temporary solution to some extent, and we have not included it in our forecast. So it would represent upside to our thinking about how our growth is going to progress.

Given your leadership in this space and the scale that you have already attained, how do you respond to the argument, well, surely iRobot should never be underbid given its formidable leadership already.

Well, the xBot acquisition strategy included both technical trials, which we competed in and passed along with Robotic FX, but it also contained a reverse auction. To be the lowest bidder, we would have had to go lower on price than we would have been comfortable with.

Okay. Nickel prices have come down. Colin, have you locked into some kind of forward contract there, or how are you going to make sure that we see predictable gross margins I guess in '08?

Yes, honestly we were caught a bit by surprise by nickel in 2007 absolutely. We did lock in prices to prevent further margin erosion in 2007, and we are evaluating what the best solution for 2008 will be. Right now if we believe that we are at a good price, we certainly would consider locking it in ensure stability. We are not going to watch it do what -- we are going to ensure we are not impacted like we were in 2007 again. But we have not taken definitive action to lock in nickel at this moment in time. We think that is premature.

My last question is, in the event that the xBot contract gets overturned and sent in your direction, are there any gating factors from a production capacity perspective at iRobot?

No, we're ready to deliver on this contract. Absolutely.

Alex Hamilton, Jesup & Lamont.

I apologize. I think I missed, what was the conversation -- and I apologize for asking you to repeat it on the call -- what was the conversation that is pressuring the gross margins?

There are a number of things that I referred to during the call. Some of them are onetime this past quarter. The most significant of that were end of life transitional issues with regard to the Roomba 400 product line. The other things that I referred to where the nickel that Colin just mentioned, and i also talked a bit about legal expenses.

That is what I figured. I know and I don't necessarily know how to ask this question the proper way, because I know you guys are kind of tied on what you can answer. I guess what I'm trying to reconcile here is that pressure on margin is continuing. There is a little bit of gross margin pressure as you talked about, which is why I wanted kind of the reiteration or the recap of what has happened. And also there's legal expenses going on. I'm trying to gauge how much greater were the legal expenses than potentially you had talked about.

And I guess the second part of the question is, how much visibility do you have into those legal expenses given your G&A guidance forecast of 9%? I mean we are kind of going into November. We're going into the sleepy period of the year. Do you predict or would you see a big spike in those legal expenses?

Let me start by explaining that the 9% figure that you referred to is our guidance including what we expect the legal expenses to be. Now there's a little bit of good news in there in that we predicted 9% before. So obviously what that means is some of the other costs in G&A are actually favorable, and yet the legal costs pushed us back to 9%.

You are correct that I cannot be very specific on how much the legal costs really are. I will tell you that we have spent time with our lawyers trying to understand the potential fees that would be incurred in the October/November/December timeframe, and that is what is reflected in the guidance. But, as I said and you know, legal suits are very difficult to predict, and something can always happen.

And just -- I will let somebody else go on -- but two quick questions. Can you talk about the cash drawdown and what occurred there? And then can you talk about the profitability on the international G&I sales?

Yes, I can. As far as cash is concerned, as I indicated in my comments, cash is down about $20 million. That was entirely due to a build in inventory. Most of that build obviously occurred in the home robot side of the business where we were building inventory for the holiday season. Much of the inventory in home robots that was on the balance sheet at the end of September has already been shipped in the first several weeks of October as we are obviously in our very peak shipment and delivery time now.

As far as the international question, were you asking about the -- which side of the business were you asking about there?

The G&I side business. On the G&I business, you're talking about an increase of international orders and kind of the momentum there. I just wanted to get an idea. My assumption -- I guess you can confirm or deny it -- is that that's a higher margin business than the domestic business, or is that not true?

No, I would describe the profitability or gross margin for our international business as similar to our US business. Sometimes the prices vary a little bit, but obviously freight and things like that vary. So I would describe them as very similar in the final analysis.

Jim Ricchiuti, Needham & Co.

I have a question on your contract manufacturing strategy going forward. My understanding was your original contract manufacturer has been handling the older Roombas, the Scoobas and I guess the Looj. Now going forward, do you see any changes in that? Will this contract manufacturer be doing any of the 500 series as well going forward now that the 400 is falling off?

We do try to make sure that both our contract manufacturers are well engaged. We have not made any decisions about how we would break up future build plans. Our new manufacturer is doing an excellent job producing high-quality robots, and we think that having the option of sending work to either factory gives us very good leverage and should help in the long-term.

But it would seem that with the ramp-up in the new robot Roomba that the unit volumes at the first factory would begin to fall off unless you're assuming that the Looj is going to be a big driver in '08. I guess that is what I'm also curious about.

I will make two comments. First, we believe that the Looj is a very exciting new product. Second, the Roomba 400 series, which is our low-cost market product, will continue in 2008. So that certainly they will have, even if nothing changes, a significant amount of work.

Okay. Can you talk about when you expect to be in some of the home centers, the major home center chains in 2008 with Looj?

We are taking a strategy of launching these new products more than we have in the past. We're on the Web now. We're in stores like [Hamnika Shelmer]. [Hamnika Shelmer] will be on the Home Shopping Network, and we're going to evaluate the customer response from that and let that dictate when we get to the home centers next year.

Okay. One final question. Just if I can switch gears to the G&I business, can you talk a little bit more in general terms as to how you see the margins in this business going forward? Clearly there is going to be a shift I think to lower-cost robots, and you should get some benefits from that with increased manufacturing efficiencies, but just in general terms on the margins there.

Jim, I will start to answer that, and Colin may add something towards the end. The margins in the -- the product margins in the G&I side tend to be in the low to mid 30s. They were actually up -- the product margins were actually up this past quarter as compared to the same quarter last year if you remove the effect of that one-time MOD adjustment,$2.5 million adjustment from the same quarter last year. So, on an apples-to-apples basis, they were up.

Now I would point out that as we enter new contracts in the future and as particular as volumes go up, that could have an impact on our ASPs, our average selling prices, in our G&I business, and obviously it is incumbent on us to make sure we stay ahead of the curve in terms of economies of scale on the cost side of the formula.

So qualitatively if you look at our G&I margins relative to other peer companies, we're pretty good. The positive things that can help us is manufacturing efficiency and steady-state achievement of this product lifecycle revenue. Going against is the fact that as we win increasingly large contracts, there is an expectation that prices will experience some pressure.

So I think that we're in a good place today relative to our peers, and we have forces going in both directions. Hopefully we can see some decent improvement from where we are today.

Is it fair to say that if there is upside, some of that upside could come from increased product lifecycle revenue? I would assume there is a fair amount --

Absolutely. That is a correct assumption.

Brian Gesuale, Raymond James.

This is [Matt] speaking for Brian. I guess the first question going on PLR is, can you tell us what that was in the third quarter?

PLR on the G&I side was actually almost 40% of our revenues, and just to remind everybody on the phone, when we have numbers that high, that is the reason G&I products were favorable, and the margins tend to be in the 50 to 60% for PLR and G&I.

Got you. And that is 40% of product revenue?

40% of G&I product revenue was PLR.

Something that has traditionally been lumpy quarter to quarter. If you recall back to earlier calls, it has been down, and this was an anticipated sort of catchup so that this 25% is the target for a blended full-year rate.

On a year-to-date basis, just to clarify, it was 23% on a year-to-date basis.

Okay. Thanks for that. I guess another question, just in general looking into the fourth quarter maybe into 2008, how do you see the breakout of government and home robot I guess differ or stay similar to I guess in the past in historical years?

Well, I would say that we're lucky enough to be enjoying substantial growth in both divisions. The introduction of the Roomba 500 series into the home robot product line has yet to really fully play out. But, as I mentioned, there is a lot of optimism there. And then clearly our government and industrial division has been riding a very strong growth wave for several years now when we see that continuing.

So I cannot predict whether our ratio between divisional revenues is going to change significantly in 2008. I'm excited not to have to.

Okay. I guess I can deal with that. Thanks very much for your time.

Jed Dorsheimer, Canaccord Adams. (technical difficulty). Paul Coster, JPMorgan.

I'm so fascinated by the Warrior and (inaudible) with next year in mind. Do you have any sense to what kind of unit volumes we're talking about for either of these products?

That sounds a bit like 2008 guidance, so we're not yet speaking on that. But we certainly will be giving indications as to what we think will happen on the next call. So sorry about that one.

That is fine. Thank you. Finished.

Jim Ricchiuti, Needham & Co.

Just a question on the progress you are seeing in the home robot business overseas. At what point do we really begin to see some nice traction in that business? Do you anticipate that in '08, and I wonder if you could just elaborate on where you stand there?

Sure. The new product line, first off, is going to be very beneficial to our international business because of the modular nature, and I think it fits the type of product that will do well internationally.

Also, we had to set up some improved distribution in Europe in order to see real traction there, and we have established a warehouse and are working as we mentioned in establishing a direct sales mechanism in addition to augmenting our distributor networks.

So definitely we have are putting -- have laid in much of the infrastructure we need to grow in Europe, and we think we have a stronger product line for it to drive growth in Asia. So I think that we're very optimistic as to what this all will add up to in 2008.

Can you quantify year-to-date how much of the home business is going to Europe?

Yes, I can, Jim. The international business on a year-to-date basis was about 16% in the home division.

Okay. Just a question on Scooba. It seems like you have seen some higher return rates there or maybe return rates that are a little higher than you would like to see, and it is not clear what the future is for that product. Can you talk a little bit about it?

Let me be clear. When we talked about increased return rates, those are increased return rates based on our infomercial selling, which is a different selling mechanism than selling through retail where people have buyers remorse that are multi-paid plans and things like that. And we had to change the way we accrue for a return slightly in order to match the economics of infomercial.

So it was not an inherent return rate increase on Scooba. It was a business model we just have to issue, and we have to factor that in as we calculate how much we want to invest in the infomercial spending, especially with Scooba having the retail presence it currently has.

Well, maybe just a more broader question. How satisfied are you with Scooba's results so far, the demand you are seeing for the product?

Well, it is a product which has very high satisfaction ratings, and it is a product that materially contributes to the consumer's business. It is not Roomba nor are most wet clean products. They are smaller in volume than vacuum planners. So

I think we have created a very sound and solid product which does what we designed it to do. And it is going to continue in the long-term to materially contribute to our results. However, I don't anticipate it is going to ever reach Roomba levels as it currently exists.

The final question and then I will jump off. There has been just some news on the supplemental budget request, and it looks like there is a fair amount allocated for protection against IEDs. I wonder if you could talk a little bit about the potential for maybe an acceleration of some of the business purchase orders against some of the ID/IQs you have out there?

Well, the xBot is a (inaudible) that comes from -- some of the funding comes from JIEDDO, which is the joint improvised explosive device agency. We have seen a lot of demand in the field for our products, and we did just announce an order for $19 million with NAVSEA for 128 additional bomb-disposal robots and $8.8 million from PEO STRI for 40 more PackBot robots. These will all be performing IED missions. That is what the big need is for today.

That is all the time that we do have for questions today. For any additional or closing remarks, I would like to turn the call back over to Mr. Colin Angle. Please go ahead, sir.

Thank you. That concludes our third-quarter earnings call. We appreciate your continued support and look forward to talking with you again following our fourth quarter. Thank you very much.

That does concludes today's conference call. We do thank you for attending, and have a great day.