iRobot Corp (IRBT) 2019 Q2 法說會逐字稿

Good day, everyone, and welcome to the iRobot Second Quarter 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 Elise Caffrey of iRobot Investor Relations.

Please, go ahead.

Thank you, and good morning.

As many of you know, today is my last earnings call at iRobot.

My successor, Andy Kramer, joined the company about a month ago, and we have been working together to ensure a smooth transition.

I greatly value the relationships I've built with our analysts and investors over the years.

I'll now turn the call over to Andy.

Thank you Elise, and thanks again for all your help since starting at the company.

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 may pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements are subject to risks and uncertainties and involve many factors that could cause actual results to differ materially from those expressed or implied by such statements.

Additional information on these risks and uncertainties can be found in our public filings with the Securities and Exchange Commission.

iRobot undertakes no obligation to update or revise these forward-looking statements whether as a result of new information or circumstances.

During this call, we may also disclose non-GAAP financial measures as defined by the SEC Regulation G, including adjusted EBITDA, non-GAAP gross profit, non-GAAP operating income, non-GAAP income tax expense, non-GAAP net income and non-GAAP net income per share.

Our definitions of these non-GAAP financial measures and reconciliations of each of these non-GAAP financial measures, to the most directly comparable GAAP measure, are provided in the financial tables at the end of the second quarter 2019 earnings press release we issued last evening, which is available on our website.

On today's call, iRobot Chairman and CEO, Colin Angle will provide a review of the company's operations and achievements for the second quarter of 2019; and Alison Dean, Chief Financial Officer, who will review our financial results for the second quarter.

Colin and Alison will also provide our business and financial expectations for fiscal 2019.

Then we'll open the call to questions.

At this point, I'll turn the call over to Colin Angle.

Good morning, and thank you for joining us.

We had another strong quarter with revenue growing 15% over Q2 2018.

Our growth was led by Japan with more than 25% growth followed by EMEA with 18% growth and 12% growth in the United States.

Our Q2 operating income and EPS results were higher than anticipated in large part due to our very carefully managed spending.

Year-to-date segment growth in EMEA and Japan was generally in line with our expectations.

The U.S. segment did not accelerate in the second quarter as we had expected, but we had maintained our segment share in this region and are not seeing any share erosion due to competition.

We are, however, navigating the U.S. market segment that is growing more slowly than we had originally anticipated, driven by the direct and indirect impacts of the ongoing U.S.-China trade war and related tariffs.

So although we achieved our Q2 U.S. revenue target, we are lowering our second half expectations for this region.

Nevertheless, we view tariffs as a short-term impediment to more robust U.S. segment expansion.

We remain optimistic that the category will ultimately return to stronger growth over the medium and longer term and that iRobot will be well positioned to benefit whenever that occurs.

As a reminder, in February, our expectations for 2019 were based on 10% tariffs that we did not think would materially impact segment growth.

In April, we affirmed those expectations.

Today, following the implementation of increased tariffs to 25% on May 10th and the resulting slower-than-expected segment growth in U.S., which represents roughly half of our revenue, we now expect full year 2019 revenue of $1.2 billion to $1.25 billion, our year-over-year growth of 10% to 14%.

To mitigate the impact of lower-than-expected revenue and increasing gross margin pressure, we have begun to recalibrate spending in ways that we believe will help preserve near-term probability without compromising our ability to innovate, expand the business and create long-term value for all our stakeholders.

We now anticipate operating income of $75 million to $100 million, and EPS of $2.40 to $3.15 in 2019.

Now I'll take you through some of the quarterly highlights and our business expectations for the rest of the year.

In May, we successfully launched 2 revolutionary new cleaning robots in the U.S., the Roomba s9 and s9+, the most intelligent, powerful, deepest cleaning Roomba to date, and a Braava jet m6 robot mop, which can tackle multiple rooms and large spaces with advanced navigation and mapping capabilities.

Together, these 2 robots can use imprint link technology to talk to each other, automatically vacuuming and then mopping without any effort from the user.

We have talked for some time about robots working together in your home, leveraging our mapping and navigating technologies as the next step toward realizing the dream of the smart home.

Following the launch, I was a keynote speaker at re:MARS, Amazon's AI and robotics event, where I presented our vision for robotic automation in the home.

The s9+ and m6 as well as our soon-to-be-launched robot mower, Terra, we're working in conjunction with other smart home products, the Alexa and iRobot smart home.

We are continuing to demonstrate how our digital product architecture is increasingly a differentiator.

The proprietary software on our robots is the key to enabling spatial understanding that is fundamental for harnessing the full power of the smart home ecosystem.

The re:MARS event raised our visibility as part of the smart home ecosystem and the support we're getting from partners like Amazon in making the smart home a reality is very gratifying.

I will share some details about our Amazon Prime Day success in a moment, but it is worth noting that Amazon sold millions of smart home devices that day and specifically cited Roomba as one of the event's top-selling deals in the smart home category.

By the end of 2019, we expect to have sold over 9 million connected robots, and we have begun a developer program that enables third parties to leverage iRobot's home understanding with the homeowner's permission.

This progress demonstrates that we are building a strong foundation for our growing role in the smart home.

Now turning to the second quarter performance by region.

We delivered 12% year-over-year revenue growth in the U.S. while international revenue increased 18%.

In the United States, we believe that we have maintained segment share year-to-date that is comparable to last year, even as the category's estimated growth did not increase at the rate we had expected.

We believe that higher tariffs, compounded by a lack of competitive investment rather than market saturation, are creating a speed bump in the category's growth trajectory.

Our fifth consecutive invitation into and performance on Amazon Prime Day earlier this year helps validate our perspectives.

Amazon included 3 SKUs for this year's Prime Day versus only one entry-level SKU in prior years.

For the U.S., Prime Day event, our Roomba 980, the most expensive SKU we've ever promoted on Prime Day sold out on the first day, which, we believe, demonstrates continued consumer interest and demand for our premium priced Roomba robots.

In total, the U.S. event yielded a 90% increase in retail revenue with a 50% increase in units versus last year's Prime Day.

Internationally, where it was our second consecutive invitation into Prime Day, retail revenue grew by 35% with units increasing by nearly 45%.

We are thrilled with these results, but it's still too early in the year to know how this performance may influence current retailers' holiday buying expectations.

Nevertheless, our success on Prime Day illustrates that underlying demand for RVCs remains vibrant similar to how it was before tariffs.

In other news, we remain on track to begin our closely controlled U.S. beta program for Terra, our robot mower in Q3.

The timing is expected to coincide with the limited launch program for Terra in Germany.

Interest from potential beta participants and buyers has been overwhelming, and we are very excited to be launching this new category of robots for the home.

In EMEA, revenue grew 18% year-over-year in the second quarter, driven primarily by enthusiasm for the i7 and i7+.

The RVC segment is growing robustly in the region which is attracting more competition.

We are responding to a shift in landscape with more pricing and promotional programs.

Looking ahead the s9 and s9+ and m6 robots are launching in EMEA this quarter, which, we believe, will further increase our product differentiation.

And in Japan, we delivered another strong quarter with revenue up versus Q2 2018 by more than 25%, driven by the i7 and i7+ and the e5, all of which are performing better-than-expected.

The m6 is launching in July and the s9 and s9+ are scheduled for introduction early next year.

iRobot continues to gain share in this market segment, and we believe that our upcoming launches can help us build on our momentum.

Globally, we continue to expect full year double-digit revenue growth domestically and overseas.

New products, which include i7 and i7+ in international markets are on track with our target of 15% of total 2019 revenue.

A couple of additional notes on tariffs.

As some of you may have seen, iRobot has formally applied for exclusion from the tariffs.

And I have appeared in Washington several times to present our case.

We believe that our position to gain an exemption from tariffs is compelling.

However, given the nature of the process, it is unclear when a decision on our application will be forthcoming.

We raised prices on select products earlier this week to partially offset the impact of higher tariffs.

Higher tariffs are also impacting order timing from certain retailers and Alison will provide some further detail on that front.

We are making excellent progress with our 2019 manufacturing initiatives.

We continue to diversify manufacturing in China across our various contract manufacturers, and we are also tracking well against our plans to move our initial line of robots to Malaysia, where we expect to be manufacturing product by the end of 2019.

In summary, although, we are experiencing more impact from the worsening tariff situation than we originally anticipated in the U.S., 2019 is still shaping up to be a remarkable year.

With our new product launches proceeding on track, we are driving significant innovation that is resetting the bar for competition and laying another piece of our smart home foundation.

Even as we operate in a higher tariff environment, we still expect to generate very healthy, double-digit topline growth for the full year 2019 and fortify our substantial global segment leadership.

Our progress and achievements over the coming quarters will pave the way for us to capitalize on the many exciting medium- and longer-term opportunities for the company's products and our role in the evolving smart home.

With that, I will turn the call over to Alison to review our second quarter results in more detail.

Thank you, Colin.

Our second quarter performance was strong.

Quarterly revenue of $260 million, an increase of 15% from Q2 last year, was driven by 18% growth overseas.

Revenue was slightly below our quarterly expectations due to relatively small shortfalls in EMEA and Canada.

Operating income for Q2 was $5 million compared with $13 million last year.

EPS was $0.25 for the quarter, which included a net discrete tax benefit of $1.6 million or $0.06, driven by the release of a tax reserve along with additional stock compensation windfall.

This compares with EPS of $0.37 last year, which included a net discrete tax charge of $2 million or $0.07.

The charge last year was driven by an exit charge reserve in conjunction with the establishment of our U.K. principal company.

For the first half, revenue was $498 million compared with $443 million in the first half of 2018, operating income was $28 million compared with $39 million last year and EPS was $1.03 compared with $1.08 last year.

Our Q2 2019 effective tax rate was a negative 6.3% due to $1.6 million of discrete benefits.

Our Q2 tax rate before discrete items was 18%, and we still expect our full year tax rate before discrete items to be between 19% and 21%.

Revenue growth of 15% for Q2 included domestic growth of 12%, EMEA growth of 18% and Japan growth of more than 25%.

We still anticipate roughly 60% of our annual revenue to be generated in the second half of the year.

The reduction in our full year revenue expectations is primarily driven by U.S. RVC segment growth that has not accelerated at the rate we originally expected.

As a result, we now anticipate that revenue growth in the U.S. is likely to be in the low double-digit range versus the high teens we previously expected.

The initial launches of the Roomba s9, s9+ and Braava jet m6 are going well and are consistent with our previous expectations.

However, the slower-than-anticipated growth of the U.S. segment overall is weighing on the Braava category, the 380t in particular, such that we now expect to fall short of the 10% of total company revenue target before the Braava family in 2019.

Nevertheless, we still expect significant year-over-year growth in the range of 20% to 25% for the Braava category globally, driven by the m6, which, we believe, can take our mopping category to the next level.

Gross margin was 45% for the second quarter compared with 52% in Q2 2018.

The 600 basis point decrease from last year was due primarily to pricing and promotional activity as well as the impact of the tariffs we did not have last year.

Due to our increased pricing and promotional activity in EMEA that Colin discussed, coupled with the increased tariffs to 25% for the second half of the year, we now expect gross margin for the year to be approximately 45% to 46%.

Due to the tariff increase, we now expect that the direct tariff cost for the full year will be in the range of $35 million to $40 million versus our previous estimate of $20 million to $25 million.

The price increases that went into effect on July 22, in the U.S., are expected to only partially offset the incremental tariff costs.

Q2 operating expenses were 43% of revenue, down from 46% in Q2 last year, primarily due to the actions we began implementing to recalibrate our spending.

We ended Q2 with $157 million in cash, down from $162 million at year-end, as we built inventory to support our 2019 product launches as planned.

Q2 ending inventory was $192 million or 123 days compared with $115 million or 97 days last year.

Recall that our U.S. inventory value now includes the impact of tariffs, and we expect that the May increase of tariffs to 25% will further increase U.S. inventory value in the second half.

Given our global rollout cadence for new products and our supply chain diversification strategy, we expect elevated inventory levels for the next quarter before declining at year-end, as we discussed on the April conference call.

We still expect that average DII for 2019 will be higher than the previous 100-day average.

Now I'd like to provide you with additional detail and some of the underlying assumptions for our full year 2019 financial expectations and some quarterly color.

As Colin has discussed, we are experiencing a disruption of our U.S. market that is resulting in slower growth for 2019 than we anticipated.

The tariff situation remains fluid, and while it's possible that we could see some positive impact from continuing trade talks or an iRobot exclusion, neither is assumed in our revised expectations.

For 2019, we now expect full year revenue of $1.2 billion to $1.25 billion, which is year-over-year growth of 10% to 14%.

Consistent with top line trends during the past several years, we expect revenue will be more heavily weighted in the second half of the year.

Our revenue expectations contemplate yen and euro exchange rates roughly in line with current rates plus or minus 5%.

For the full year, we now expect operating expenses to be roughly 38% of revenue, a 300 basis point improvement over 2018, as we scale back spending to mitigate the impact of lower revenue and gross margin.

We now expect full year operating income of $75 million to $100 million and EPS of $2.40 to $3.15.

As we have discussed on prior calls, we manage our business from a full year perspective.

Likewise, our annual financial expectations should be viewed on a full year basis as quarterly year-over-year revenue growth rates and overall results can vary greatly by region due to a number of factors including new product introductions and product transitions.

The changing tariff environment is exacerbating this further, and our current financial expectations reflect our best estimate today of the impact of tariffs as well as the costs of our manufacturing diversification plans.

From a quarterly perspective, the anticipated second half order activity from certain retailers, most notably Amazon, is shifting as part of their efforts to navigate potential tariff exposure.

For example, last year, approximately 2/3 of Amazon's domestic second half revenue came in the third quarter with a large percentage of those orders being directly shipped to and imported by Amazon from our contracts manufacturer.

This year, we expect 20% of second half revenue from Amazon's U.S. operations to be generated in the third quarter as the timing and sourcing of second half orders have been further complicated by tariff concerns.

As a result of these shifts, we expect Q3 revenue to show a slight year-over-year decline.

Since substantially more of Amazon's expected second half orders are now expected to ship in the fourth quarter of this year, we now expect Q4 year-over-year revenue growth to be even more substantial than in prior years.

Gross margin in Q3 is expected to be comparable to Q2 as we continue to rollout our new products and respond to competitive pressures overseas.

We now expect Q4 to be our lowest gross margin quarter at approximately 44%, which would result in a full year gross margin between 45% and 46%.

As it relates to our longer-term 2020 targets, it is important to point out that those were last updated in a 10% tariff environment.

Due to the recent tariff increase to 25% and our updated 2019 expectations, those targets are no longer current and will be updated in conjunction with reporting our full year 2019 results early next year.

In summary, all regions delivered double-digit Q2 revenue growth and are expected to do so for the full year as well.

Our new product rollouts continue as does our strategic initiative to diversify our supply chain, and we are pulling the levers within our control to deliver continued profitable growth.

Outside of the uncertain U.S. market, we continue to execute well against our 2019 plan.

I'll now turn the call back to Colin.

Thank you.

I'm excited about the year ahead, as we address the current challenges in the U.S. market.

Our strategy to strengthen Roomba leadership extend the portfolio beyond vacuuming, widen our competitive mode, diversify our supply chain and advance our smart home goals continue to drive our planning and decision-making processes.

As we navigate choppier market conditions, we believe that consistent execution of this strategy is the most effective way to drive sustainable growth and build the shareholder value.

Although, the playing field is not as optimal today as we would otherwise prefer, we remain confident in our strategic direction and believe 2019 will be another successful year for iRobot.

Finally, on behalf of Alison and all of us at iRobot, I'd like to publicly thank Elise for her hard work and many contributions to the company over the past 13 years and wish her well in her post-iRobot endeavors.

With that said, we will now take your questions.

(Operator Instructions) Our first question comes from Frank Camma of Sidoti.

Thanks for taking the call.

I'd like to thank Elise to lots of help over the years.

First question is just -- I am having a little hard time just in my head kind of rationalizing the impact of tariffs on demand.

I totally get how they affect your cost structure.

But can you just explain just how tariffs have impacted the category?

It sounds like more of a demand issue, I mean granted you're still getting a lot of growth here in the U.S. But how did that impact consumers' view on the category itself, I guess?

So there is an elasticity to demand associated with price.

And the tariffs have caused iRobot and others in the category to increase their pricing.

And that has slowed down the rate of growth in the industry.

So with classic price elasticity of demand and the success of Prime Day, I think it a very powerful compelling proof point to that where we subsidized pricing to a larger degree than what we're doing in regular market on Prime Day.

So prices were less tariff impacted.

And we saw the success of Prime Day in 90% growth in dollars and 50% growth in units, which, again, I think speaks volume to the fact that there is still vibrant and growing demand for robot vacuuming.

And if not for tariffs, North America would be a much more healthy place.

We're all currently seeing -- go ahead.

No, I'll just add, totally buy that, and talking about the discretionary spend here for a while.

Do you think some of it's also perhaps that consumers are now, given this now the 5th year of the Prime Day, it was pretty well-publicized, a 2-day event, that consumers are almost trained to realize that they're going to get products like your own at a much better deal if they just wait a month or 2. Do you think that, that could have pulled some of your -- granted the sales where -- I think in the June number, but do you think that could have impacted some of your actual units that you would otherwise sold earlier in the year?

So I think that the success of Prime Day and the growth of Prime Day is what resulted in having a growth rate on that day of 90% in dollars.

So we're not saying that without tariffs the demand for Roomba, in 2019, would have grown 90%.

No, I think that we had given far more modest expectations at the beginning of the year for growth in the region.

But I do believe that the success of being one of the top products on Prime Day suggest that there is still vibrant demand for robot vacuuming as a category.

And that we're seeing is a price elasticity impact as well as we've seen some change in behavior of North American competitors who went completely dark on demand generation spending in Q2.

And we are expecting -- and so it did not drive market growth like they did last year.

And that's clearly attributable to the different tariff situation as well.

Frank, I think it's also important to recognize that consumers are facing price increases on many products, not just RVCs.

And it's our belief as well that, that is also a factor.

Yes, no, I buy that.

And Andy, just to be clear.

So the Prime Day sales, even though, it was in July, that was accounted for in your Q2.

I just wanted to make that abundant very clear.

Is that correct?

Yes.

Yes.

Okay.

Which is -- brings me to -- just to my next question on the cadence for your guidance.

I mean you explained it pretty well.

But so that alone -- so Amazon alone, which, I assume, is mostly a U.S. issue, is enough to drag your Q3 year-over-year revenue number negative -- or breakeven.

Am I correct on that?

I'm just trying to sort of grabble with that a little bit.

Yes.

Yes, it is.

So Amazon is a significant customer for us overall.

And certainly, the second half component of their purchases is very significant and how that timing breaks down between Q3 and Q4 can be substantial.

So it is enough to make that kind of a swing over what we previously would've expected would be a growth quarter.

I mean there is a huge shift from 2/3, 1/3 to 20:80s.

That moves a tremendous number of dollars.

Sure.

Okay.

And last follow-up to that.

Is Amazon for you an international customer as well?

Yes.

It is.

It was only in the last few years that Amazon has become more important internationally.

It was subsequent to our acquisition of the 2 distributors that became more of a focus for us overseas.

And our next question comes from James Ricchiuti of Needham & Company.

This is Mike Cikos, on for Jim Ricchiuti.

I'll apologize in advance for any background noise.

But the first question following on from the last speaker.

I wanted to understand that sequential ramp we're seeing from Q3 to Q4 I think is the largest sequential growth you guys have seen on record.

And I just wanted to get a better understanding, that growth, as we're talking about Amazon, is that all from their movement within the supply chain?

I guess you've already had customer conversations that have been able to instill the confidence in that steep Q4 sequential ramp?

So the timing and the ramp Q3 to Q4 is driven by the conversations that we've had with our retailers and distributors regarding their expected timing of orders and the shipments that would follow.

So that's our best view as we sit here today as to how the 2 quarters will play out.

Yes.

I think that it helps.

Without this extraordinary shift for our top customers like Amazon, Q3, Q4 would look quite similar to prior years.

And so that we're not seeing an extraordinary ramp in the retail behavior or our customer purchase behavior.

This is a disruption driven by tariffs causing our retailers to be more back-end focused in when they want product to arrive.

So we're not expecting anything unusual beyond the guidance as far as customer demand goes.

This is how our retailers are choosing to purchase in anticipation of the holidays.

And just as a reminder, last year, we faced the exact opposite phenomenon in Q3 and Q4.

So our Q3 growth rate last year was much higher than it normally was because Amazon had decided to take a direct shipment from one of our contract manufacturers and do it in Q3.

And we talked about that last year when it happened.

Okay.

Thank you for that, that's helpful.

And then the follow-up question I had, can you guys I guess discuss further the gross margin erosion that we have seen?

I understand the impact you guys are feeling from tariffs, but I also see the promotional pricing environment that you guys are in right now.

And just wanted to get a better understanding of where we are in that environment?

Do you guys feel like you can regain or recapture some of that lost margin down the road?

Or is this promotional environment you instated at this point?

Well for 2019, it's certainly here based on the guidance I've provided, we expect fairly flat gross margins Q3 to Q2 and then a slight further decline in Q4, which is our typical heavy promotional period.

So that environment we certainly expect will be here in 2019.

The second half of the year also has us putting more promotional programs in place in Europe specifically as that competitive environment there stays quite strong.

I would say that the other thing that is impacting gross margins is that a lot of our revenue is coming from recently launched products.

And we have a history of when we launch a product initially, the gross margins typically lag the more mature products they're replacing and then improve over time.

So that we have a little bit of a stack up of a lot of new products desire to go and act a little more aggressively in Europe and tariffs combining to impact the gross margins.

I think that the tariffs and product maturity both improve over time.

And the competitive position is something that is a little bit of a -- competition is not going to go away.

So I think that we will have some more aggressive situations at lower price points in our product portfolio.

So with the launch of our new products, we do expect that we will be creating more distance between us and the competitors as these products rollout on a global basis.

And our next question comes from Troy Jensen of Piper Jaffray.

Maybe a couple of quick ones here for Colin.

So Colin, I think with -- to me, just with the tariffs here, it really forced the price of some of your vacuums above a $1,000, right?

And I think that's been a threshold or a ceiling that you -- historically, you've may wanted to avoid.

So I would just like to get your thought on just kind of growth in the industry in a sub $200 market?

Are you still seeing that there with the -- obviously, there's been less price increases because of tariffs in the robot's category?

So that -- I am certain that s9 will be doing very well despite the fact that they've broken that $1000 price barrier, which to me, is not that it's great to have higher prices, but definitely the demand and the features of those products are being successful and I could only dream and imagine what we'd be doing if we could have those robots below $1000.

But that's not the world we're living in right now.

Relative to the market below $200, to be clear, this is not a focus of iRobot's.

We're focused on the premium and occasionally, due to some promotions, below $200, but, in general, are operating above that price point.

So we've talked share and it's all above $200.

Below $200, there is very little opportunity to make the types of margins that we are interested in pursuing.

That said, we do continue to see growth in the vacuuming industry below $200.

In much of the world, the growth in that particular segment is higher than the growth in the more premium price points.

It's a relatively new price category and there've been -- the past couple of years, as there have been an availability of product down there.

And so to some extent, it's catching up.

Where that price point has been present longer, which will be in China, we're actually seeing a deceleration of the growth at these low price points as the market is recognizing the value of the features available only on products at higher price points.

So we're still and it won't be below $200 price.

Our segment of robot vacuuming is pretty dynamic right now.

But it is a volume-healthy place, but a margin very unhealthy place.

Right.

Okay.

Thank you for the detail.

And just correct me if I'm wrong, but I think you guys have not raised prices because of tariffs for the 690, the 960 and the e5?

And then just would you -- do you intend to in the future, I guess, will be my question?

So we originally only increased the price when it was 10% tariffs on the i7, i7+.

Earlier this week, we did increase prices really across-the-board.

We didn't further increase the i7, i7+ price, but we did increase prices across the remainder of the Roomba products.

You did.

Okay.

Perfect.

So and it is safe to assume just the s9 and s9+ and the m6 already have kind of higher tariffs baked in, right?

Even though, there were never a first price and then an increased price because of tariffs?

No.

We increased the price on the s9 and S9+ and m6 robots as a result of the 25% tariffs.

And our next question comes from Mike Latimore with Northland Capital.

This is Pavan, on for Mike.

I have 2 questions.

Coming to the EMEA market, which competitors were most aggressive?

And when did they do so?

Were they aggressive in June or starting May?

It's really been this year.

So it's primarily been Chinese competition that has been particularly aggressive, Roborock, Ecovacs and companies like that.

Okay.

And my second question was like, you recently raised your prices, are there any other players to do it as well?

We expect other players in the marketplace in North America will also raise their prices.

The other players either operate on very, very thin margins or also are structures where premium margins -- premium healthy margins are critical to their business model, so in either case for the company absorb a 25% increase in COGS without impacting their price and market twice.

So this will be across-the-board.

And our next question comes from Jed Dorsheimer of Canaccord Genuity.

Two.

But the first, I also want to throw my head into the ring in terms of thanking Elise, have been quite helpful over the years from pre-IPO to now.

I guess first question, maybe I could just rephrase and tell me whether or not I'm looking at this and thinking about it correctly.

It looks as if you're having a bit of a mix shift to I guess some of the midrange or higher volume products by virtue of the success with Amazon Prime.

It would seem that in the greatest margin, it is kind of on the high end direct sales.

So is that what is contributing mostly to the contraction of the profitability for a full year guide?

Is that mix shift from high end to sort of the higher volume midrange?

No.

There really hasn't been a significant change in our mix expectations through the first half of the year and baked into our guidance.

We're seeing kind of reductions in the U.S. across all 3 categories from where we were originally expecting volumes to be for the U.S. We actually have a pretty healthy mix in Q2, which is very similar to Q1.

We had about 45% of our revenue coming from the 900 series and up in the range.

We had about 30% at our entry level and the remaining 20% was in our sort of e5 price category.

And that's been pretty consistent so far this year.

And Jed, given our premium strategy, we are very focused on continuing to drive demand at the 900 series and above level.

But we are seeing, because of the new product introduction, product margin phenomenon, which we do believe will improve over time, some reduction in profitability on a unit basis from those premium SKUs.

So that is again the trifecta hitting our gross margin in Q2 2019 is the promotional investment in EMEA, the new product launches and the tariffs.

But I think -- I'm actually quite happy with the current mix.

Got it.

That's helpful.

Second question.

Colin, this one is probably directed for you.

It is sort of a higher level strategy.

As you look at Terra, it has a lot of the same attributes as Roomba, to be successful for, is kind of what I'm getting at.

You've got a high price substitute product that you're replacing.

It's a chore that most people don't enjoy doing.

Whereas with the Braava, you have a very different set of dynamics.

So my question is more of a resource allocation and sort of redeployment, if you will, at what point -- what metrics are you looking at and what point do you to kind of put the eggs in Terra basket instead of the Braava basket?

So as iRobot has scaled, our ability to go launch and grow new products improves.

So for many years, the web category has failed to be the second coming of Roomba, partially because we didn't have systematic navigation and frankly mopping is more sensitive and benefit more from being able to say, that's the kitchen, just mop the kitchen.

So there is some technical hurdles that the m6 overcomes.

But there is also simply the -- when you look at the dollars available to go build the markets and get markets to the point where we have a very, very positive ROI and dollar spent, takes time and investment.

And I think that Braava has suffered not getting that full level of investment, while we're continuing to build the Roomba franchise globally.

In 2019, we believe, we have the product and we believe we have the marketing resources to drive m6.

And my -- the favorite quote so far post m6 launches, "It's selling like a Roomba," which makes me very happy.

As Terra gets to a point where it is in market and we have gotten through the betas and these initial launches, I think you will expect us to move our willingness to invest in market growth from Braava to Terra.

And our hope is that the m6 and the Braava mopping segments will have reached this escape velocity and can continue to profitably grow without the need for investments like marketing.

So it's a very planful sequential launch strategy where we want to drive our product to profitability and then move to the next product that we're investing and bringing up the demand curve.

And our next question comes from Charlie Anderson of Dougherty & Company.

And best of luck in everything, Elise.

I wanted to just kind of start with a multilayer question, the tariff situation.

So Colin, first, could you maybe walk us through the dynamics of the petition for exclusion?

It looks like companies that have applied for that have a decent batting average.

When are you expecting to hear back on that?

And then secondarily, has there been any conversations with the retailers in terms of them participating in any release here?

Obviously, they want to move a lot of product too as well?

And then you'll have a follow-up.

Sure.

So that imports from China were divided into 3 -- sorry, 4 groups.

Group one, the first group to have tariffs imposed had an exclusion -- has an exclusion process and is granting exclusions.

So -- and you are correct that it is reasonably good batting average.

List 2 has an exclusion process and there are many applicants.

And that's currently been in process.

No list 2 approvals as of yet.

So that when I talked about being unsure as to when we're going to, even if we are successful, get judgment, this is not a fast process.

And list 2 closed its window for application for exclusion in December.

So 7 months, we haven't gotten any list 2 approvals yet.

But I think we expect to see them and hopefully, the batting average will continue.

List 3 is now taking exclusion requests as of the beginning of July.

And so we're -- and we have submitted.

We believe we have a very good case.

But again, I think it could easily be reasonably into 2020 before we see progress.

We know that the USTR is hiring more people to work these issues so that there is some reason to believe that list 2 could be less indicative of the timing we take, but that would be putting an optimistic head on.

And it's worth noting that if we're excluded, it will be retroactive.

And so all of the money spent expanded on the tariffs that we have talked about would be refunded back to iRobot, which would be certainly a nice outcome.

But that's the sense of the timing.

Okay.

And then on the retailers?

So retailers are getting hard hit.

And so that on all sides with price increases and challenges and so that it is a common request and I think the retailers try to do what they can.

But that is not translating into them suddenly deciding that they're going to move and give back significant numbers of margin points because they are facing the resultant of slowdown in volumes as a result of higher prices.

So it's sort of a -- has not been a well that has been material for us.

Got it.

And then for my follow-up.

You've obviously been on those very low gross margins in Q4.

You have talked about Malaysia coming online backup.

But next year, you also have products that are going to be a little bit more mature.

I guess I'm curious how we should think about the margin trajectory from here?

When you do cutover to Malaysia, can we get back to some of the gross margins we have before?

Or is there incremental cost to Malaysia, when do you be thinking about that we did have in China?

Just kind of margin trajectory from here, how we should think about that?

So I'm not going to be giving comments about margins beyond 2019 and what I've already said for this year.

But I will remind you that we did communicate earlier that at least initially products coming off the line in Malaysia, like-for-like basis, will actually be more expensive than the same products produced in China, at least initially.

The labor rates -- the line labor rates are a little bit less expensive, but the management labor rates are a little bit more.

And more importantly, a lot of our -- most of our component supply is in China and we will have additional cost to get those components to Malaysia for production.

So at least, starting off, it's going to be more expensive.

More expensive meaning still better than 25% tariffs, just to be clear.

But rough order of magnitude on par with the 10% tariffs is sort of neutral-ish depending on volumes and so forth to sort of bound that a little bit.

And our next question comes from Ben Rose of Battle Road Research.

I wanted to echo my thanks to Elisa as well and wish Andrew luck in his new role.

Question for Colin.

Looking at the second half of the year with the newer products i7, i7+ just hitting the international markets and not having the constrain of the tariffs, could we see a higher product mix in favor of the newer products because you won't have to price them as high as you do in the U.S.?

You know our models for international sales are unchanged relative to the beginning of the year.

I think that we're excited to be launching these new products.

We are counting on them to deliver on the growth targets that we've communicated.

And so that I think that outside of North America, things are good, things are stable, they're behaving likely we had wanted them to.

If you're asking about risk of great marketing from Europe back to North America or something like that, I don't think we believe that is going to be material.

Okay.

And question for Alison.

Could you maybe cite some areas that the company is scaling back in from a cost standpoint in order to -- at least from an operational standpoint mitigate the impact of the tariffs?

Sure.

It's really across-the-board.

We're focused mostly on discretionary type spending that we don't think will sacrifice our longer-term strategic plan, but it's really across all of the different functional groups that we're looking for those reductions.

And our next question comes from Asiya Merchant of Citigroup.

I just had a couple of quick questions.

One, just on the revenue cadence that you have talked about.

I just wanted to understand that, I know a lot of questions have already been asked, but I would have assumed that given price increases are happening, not just for iRobot, but across other products, consumer products as well.

They would have called in some of that demand into the third quarter ahead of anticipated price increases that are likely to impact the second half.

That would have -- and just given the strength that you saw in Prime Day, I would've thought Amazon would have tried to replenish some of that inventory into the third quarter and before sort of price increases really take foot.

So that was my first question.

And then just on gross margins and the trajectory of gross margins.

The guide for the tariff that are impacting, it seems like that's only partially for this year.

So if we kind of then extrapolate that to the remainder of -- and going forward, is it fair to assume that the full impact of that would be felt most likely in 2020, offset by some price increases, of course, but is it fair to assume that from hereon, the margin unlikely to go up, but more likely to see some downside pressure as we get into 2020?

So relative to buying cadence and thus the revenue cadence of our retailers, the prices have already gone up.

So that there is no anticipation of initial price increases and inventory they would be taking in would carry with it that 25% tariff.

And so that what you're seeing is retailers holding out some hope or at least acknowledging that in the current environment, the only certainty is what exist today.

So that what we're seeing, for example, with Amazon is more tariffs to go away.

They would -- if they had already brought in products, they would be holding product at a higher cost basis than they would be if they had deferred that decision and took that inventory in post-tariffs.

So that said, as a retailer, you are advantaged to hold inventory levels lower than -- and balance that risk against supply chain risks, which drive companies to want to have inventories of exciting, hot product in hand to avoid the risk of not having access to those products.

And so that's the calculus.

But there is no benefit to a retailer at this point of loading up in Q3 ahead of the price increases because they have already happened.

Okay.

And then on gross margins?

Yes.

On your second point, Asiya, as I said before, I'm not really going to make any comments beyond 2019 from a gross margin perspective.

You're right that 25% tariffs are impacting half of our year and our price changes have been structured to hopefully offset part of that incremental tariff cost.

But what we have to do in entire full year 2020 plan once we understand better what that environment is going to be like before we can make any comments about anything relative to 2020.

Okay.

And then just one more if I may on the market share.

Some of the surveys that I've done as well clearly point to the strength that iRobot and the brand that you guys have.

But is there any data that you have, whether it's sales for data, et cetera, that suggests that market share was pretty much flat in the region for iRobot?

Yes.

What we've said earlier on the call is that in the U.S., we've held our share based on the data we are seeing.

The competition doesn't seem to have taken anything in the first half of the year.

So we look at that as a good sign, particularly in light of the segment itself rolling more slowly than we had anticipated.

And our next question comes from Mark Strouse with JP Morgan.

So you guys have applied for exclusion from the tariffs and Colin you talked about a compelling case for -- you believe that it's a compelling case for why that will be granted.

Can you just give a high-level overview of why you think it is a compelling case?

Sure.

I think it is appreciated in Washington that the consumer robot industry is a strategically interesting industry to the United States.

And so that they do believe that they would like consumer industry to prosper.

iRobot is the only non-China source of robots and so that there is not -- so we are a company of particular interest in leading this emerging opportunity.

And it's recognized that we are at a moment in time when winners and losers are determined.

So that this is a rapidly growing industry where growth is particularly important relative to competition.

And so that under those circumstances, iRobot, which has over half of its revenue in the U.S. and our -- while our competition has most of its revenue in China, which is not impacted by tariffs, the imposition of tariffs disproportionately slows us down relative to our competition.

And so that fact pattern leads to a compelling case of exclusion.

So if you want to help iRobot, don't slow us down on our primary market relative to our competition.

I think that's the gist of it.

Got it.

Okay.

That's helpful.

And then just in Malaysia, you talked about the output from that facility and maybe not by SKUs, but maybe just breaking it down some high-level, mid-level or entry-level, what's going to be coming out of that factory?

And can you kind of talk about the scale of that relative to what the demand for those products might be in the U.S.?

So Mark our current plan for 2019 is it's one of our entry-level SKUs that it will be -- is targeted to be produced in Malaysia by the end of the year.

So it's very limited volumes this year, as we look to just stand that line up and all the associated processes.

As we see how that goes, we'll determine how much volume we try to put through that line in 2020.

So that will be part of our guidance we give for 2020 early next year.

Okay.

That make sense.

And just real quick if I can.

Terra, where will that be manufactured?

That is manufactured in China and we don't have any plans of moving out of China.

And ladies and gentlemen, this does conclude our question-and-answer session.

I would now like to turn the call back over to Andy Kramer for any closing remarks.

Thank you.

That concludes our second quarter of 2019 earnings call.

We look forward to speaking with you and seeing many of you over the coming months.

We certainly appreciate your support, and we plan to talk to you again with our -- in October to discuss our Q3 results.

That concludes the call.

Participants may now disconnect.

Goodbye.