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Q2 2008 · Earnings Call Transcript

Jul 25, 2008

Executives

Colin Angle – Co-Founder and Chief Executive Officer Helen Greiner – Co-Founder and Chairman John Leahy – Chief Financial Officer Elise Caffrey – Investor Relations

Analysts

Paul Coster – JPMorgan Alex Hamilton – Jesup & Lamont Securities Corporation James Ricchiuti – Needham & Company Brian Gesuale – Raymond James Josephine Millward - Stanford Group

Operator

Welcome to the iRobot second quarter 2008 financial result conference call. (Operator Instructions) At this time for opening remarks and introductions, I would like to turn the call over to Elise Caffrey of iRobot Investor Relations.

Elise Caffrey

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 provision 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, operation, demand for the Company's products and services, 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 these 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An archived version of the broadcast will be available on the same web page shortly.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, August 7 and can be accessed by dialing 719-457-0820, access code 4007782.

On today's call, iRobot CEO Colin Angle will provide a review of the Company's operations and achievements during the second quarter of 2008. Helen Greiner, Chairman of the Board, will discuss the impact on iRobot's recent development in the Army's Future Combat Systems program and our Seaglider licensing arrangement and John Leahy, Chief Financial Officer, will review our financial results for the second quarter.

Then we will open the call for questions. At this point, I will turn the call over to Colin Angle.

Colin Angle

First, I would like to formally welcome John Leahy to the iRobot team. As we have mentioned on our last call, John is a seasoned public company executive with more than 25 years of experience at PepsiCo and Keane, Inc.

I am excited to have him on board and you will be hearing from him in a few minutes. Last evening, we reported our 16th consecutive quarter of year-over-year revenue growth despite increasing economic headwinds.

We continue to execute against our plan, delivering first-half revenue of $124.5 million and pre-tax of $15.2 million; results that are substantially better than the guidance we provided for the period. I remain cautiously optimistic that we will deliver revenue of $295 million to $305 million and pre-tax income of $5million to $7 million for the full year as we discussed last quarter.

The second quarter and first-half results demonstrate the resiliency of our business in an unstable economic market. However, continuing uncertainty about the second-half compels us to remain cautious.

Our Home Robot division had a very strong second quarter; driven by the Roomba 500’s continued penetration of both domestic and international markets. We expect sales of these robots in both the United States and abroad to drive second-half growth as well.

Strong demand for our PackBots robots from the US military is fueling our Government and Industrial division’s growth. Orders received and anticipated for the PackBots with FasTac kits provide us with excellent revenue visibility in G & I for the remainder of 2008.

The Company delivered excellent results in a difficult environment. During the second-half, we will continue to drive top line growth while managing operations and costs to ensure that we deliver our earnings commitment.

Now, let us look at the results in more detail. iRobot’s 43% revenue growth was driven by more than doubling the revenue in our Home Robot division.

We see continuing strong demands from our retail partners, both domestically and abroad. International revenue was up more than five times the level of Q2 2007 and comprised approximately 40% of total Home Robot revenue in the quarter.

Sell-through statistics, the through is the most important measure of demand for our home products are not as readily available for our international retail customers; but we are regularly monitoring our Distributor Stock and gathering data from key customers. Based on the level of re-orders across the board and discussions with our partners, we believe that sell-through is strong there.

There has been a hundred of response for promotional activities being launched in some European countries and our partners are investing in in-store demonstration efforts, PR, display and promotional activities on a regular basis. We started to look at expansion in the Central and Eastern Europe and are currently evaluating several offer options for collaboration.

But the impact for 2008 is expected to be minimal as we focus on tier-one markets in Spain, Italy, France, Germany, Belgium and the United Kingdom; we have increased our retailer base and expected to continue. We also launched direct sales buy in the United Kingdom and Germany during the quarter.

On a domestic front, Roomba sell-through were up in the second quarter more than 40% over a year ago largely resulting from Mother's Day and Father's Day in the second quarter. Our retailers are very pleased with the customer demand for our products given the over-all weakness in our economy and store inventories are at appropriate levels going into the second-half.

Chinya, our Roomba 500 manufacturing partner, is entering the second season of production with a full year of experience and we do not expect issues producing or fulfilling second-half customer orders. We are beginning to receive holiday orders from our retail customers and initial indications are that orders will track consistently with our expectation.

Direct sales grew 5% in the second quarter year-over-year and comprised 19% of total HRD revenue. In the first-half, direct sales grew 24% over last year.

In 2007, direct revenue was exceptionally strong in the second quarter due to the infomercial-supported launch of the Scooba 380. Excluding this favorable impact, comparable year-over-year Web sales, were up 40%.

Our direct business is important and one in which we expect continued growth; especially as we introduce new and derivative products business channel and continued to add direct capability to the international market. The majority of Home Robot revenue derived from the sales of our Roomba 500 series; our other Home Robots are also selling well.

Based on excellent response to the introduction of our own Verro pool-cleaning robot last year, we expanded the line and added a cleaning robot for above ground pools. We continue to see further demands for these as well as Looj, which was a very popular Father's Day gift.

Now, let us turn to Government and Industrial Robots. We delivered 170 iRobot PackBots in the second quarter and a total of 326 in the first-half, up 31% over the first-half of 2007.

One hundred of the units shipped during the quarter for PackBots with FasTac kits. As we discussed on the last call, we expected to receive several large orders for FasTacs which would initially drive an increase in backlog and then generate revenue on the second-half of the year if we delivered against the orders.

The first orders of these were received in May and we begin fulfillment in late Q2. We received a second order for robots last week and have been informed that additional orders are forthcoming prior to year-end.

To date, we have received total orders of US$44.5 million for more than 500 FasTac robots plus spare parts under the US$286 million ID/IQ contract. We have excellent revenue visibility into the remainder of the year and we have already captured more than 75% of government and industrial division annual revenue as contemplated by our 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 US$22 million at the end of Q2, this level increased from US$30 million at the end of Q1 as we anticipated and discussed on our last call.

Not reflected in the Q2 backlog data is the US$17.5 million order for the 227 new FasTac robots just received. Other exciting news includes the acceleration of the Future Combat Systems program.

One of the questions we get most often is what will happen to your G&I business as the war in Iraq winds down. There is no doubt that the wars in Afghanistan and Iraq accelerated the acceptance of the robots in the military but there is a fundamental modernization going on in the Army which will continue independently and after the conclusion of the current war efforts, the acceleration of the Future Combat Systems program and the creation of other programs like xBot to deliver leading edge technology to the infantry is proof of an ongoing transformation in the military's thinking.

Unmanned Ground Vehicles are here to stay given the reality of today's asymmetric warfare versus the force-on-force combat of the past. Our robots provide unique value wherever our ground troops operate as validated by the Army's acceleration division.

Our customers will buy our products whether for fighting or for training. As the Iraq war winds down, more dollars will flow to the development program such as the FCS that will modernize our forces and there’s bipartisan support for tools that keep soldiers out of harm’s way.

I will provide additional details on new development programs and our full licensee agreement with the University of Washington commercializing Seaglider in a moment. As we look to the second half of the year we expect to deliver top and bottom line results within the estimates we discussed in our last call, despite the challenging macro environment.

The total robots for the full year, we expected a modest increase in units sold year-over-year, higher ASPs and lower return rate, all driven primarily by further market penetration of our Roomba 500 robots. For the first half, unit sales were up approximately 80%, ASPs increased 15% and to date Roomba 500 returns have been lower than Roomba 400 return rates at the same point in the product life cycle.

The division is ahead of plan year-to-date. Our overall orders were projected for Q3 were received in Q2.

Our full year revenue expectations are unchanged. In our G & I business for the full year, we expect a significant increase in unit shipped year over year, lower ASPs resulting from higher volume orders in a larger installed base from which we will generate more product life cycle revenue or PLR.

For the first half unit shipped were 31% higher, ASPs were 23% lower and PLR was 11% higher. This division is on track to deliver as expected.

In summary we are successfully executing against our plan. The top line is tracking ahead of our expectation and I am optimistic that we will deliver revenue within our estimated range despite the negative sentiments in the customer consumer sector.

Last quarter we discussed several factors on putting pressure on gross margins. We have made good progress in our initiatives to reduce product cost through engineering and the use of alternate materials in the Roomba 500 but we are finding it difficult to fully realize all of the expected cost-savings due to rising cost of raw materials, labor and freight.

Additionally, while we have seen improvement in return rates in the Roomba 500 series across the board there is one customer which we have modeled better return rate than we are experiencing and as a result we have made an adjustment to the rates in the second quarter which negatively impacted gross profit margin. John will discuss these factors further.

With that said, we are focused in managing our operating expenses in a fashion to deliver the bottom line consistent with our guidance. The second quarter and first half results demonstrate our ability to grow during a difficult market.

We are proving that our operations are scalable and that we can leverage our expenses. While there is uncertainty about second half conditions, I am committed to delivering top and bottom line performance consistent with previous guidance.

I will now turn the call over to Helen.

Helen Greiner

Thank you, there have been much discussion about the Army’s recent announcement regarding acceleration of the Future Combat Systems program and I wanted to clarify some local points as to the light to iRobot. It is important to note that our conversations with the lead system integrator and Army planners are ongoing and based on that I will not be able to answer all of your questions today.

As a background, in January of this year we announced that the US Army has accelerated its testing schedules for evaluating the Small Unmanned Ground Vehicle (SUGV) with COTS equipment. The updated plan called for iRobot to deliver accelerated SUGV robots in the second quarter of 2008.

Robots were delivered and we have been undergoing testing at Fort Bliss. Following testing this summer we expected a production decision to be made by the government in the fall of this year.

The Army’s announcement on June 26, 2008 concerned our SUGVs formal inclusion in SpinOut 1. This action constitutes the production decision on SUGV.

The timing of production for all the elements of SpinOut 1 has been pushed out by three quarters from the Army’s prior plan. The common plan calls for SUGV Block 1 to go into production Q4 of 2009 and continue into 2010 and beyond.

Until now we have been engaged with the system design and development phase of the FCS SUGV program. To date $48 million has been spent under the US$64 million FCS contract.

With this decision a calculation of the SUGV called SUGV Block 1 has been pushed forward to the earliest production and deployment for FCS. We will now begin to work in parallel with the FCS SpinOut 1 organization responsible for production of all SpinOut 1 systems to define cost, schedule and [Inaudible 25:49] required to facilitate and achieve the Army’s objective.

This organization is already engaged with the earlier defined elements of SpinOut 1. Now there will be additional scopes in the SpinOut 1 effort beginning in October 2008 to get SUGV Block 1 ready for production.

We will also continue working on the original FCS system design and development program. When complete, the product will be an SUGV with network C4 ISR for command, control, communications, computer intelligence surveillance, and reconnaissance capabilities compatible with the entire FCS system of systems.

This means that in addition to revenues from production facilitation phase we will also receive contract revenues as we further develop SUGVs capabilities. This development program will be completed in 2013.

Demand for SUGV outside the FCS program but within the US Armed Services is strong. The international demand for these robots is also strong and we will ready to deliver these robots to meet demand in early 2009.

In another exciting development, we announced that iRobot had finalized its selling and licensing agreement with the tech-transfer office at the University of Washington to commercialize autonomous underwater vehicle Seaglider technology previously supported by the Office of Naval Research and The National Science Foundation. The University of Washington developed and proved the Seaglider’s long endurance, autonomous underwater robot over several years and has started to receive regular orders from the US Navy and Oceanographers exceeding their charter and capacity.

After a competitive review, they concluded that iRobot has the right skills to transition the Seaglider to production and to put sales to these customers in the underwater military and commercial market. We are in the process of the technology transfer of the Seaglider and pursuing market opportunities.

We believe that underwater unmanned systems and unmanned search systems represent a significant opportunities not only for stand-alone unmanned systems but for common control and for a software architecture that is able to accommodate autonomy across the full spectrum. Unmanned Aerial Vehicles led the way in unmanned systems and the market penetration there is well over a billion a year.

Unmanned Ground Vehicles are enjoying a fast reduction than the GYVs [ph] in part because the missions are so dangerous. Underwater systems will certainly follow.

We have a strong track record of transferring new technology from research initiatives into products that support military missions and licensing the Seaglider from the University of Washington with robot conquering a new underwater frontier. Right now there are about 70 Seagliders in the field, mostly used by oceanographers for research but few are being used by the US Navy and we see them as a potential customer going forward.

As you can see, not only are we executing against our plans but we have a number of exciting opportunities that fuel our continued growth. I will now turn the call over to John for a review of our financial results.

John Leahy

Thanks, Helen and good morning everyone. As Colin said I joined the Company in early June and look forward to getting out and meet many of you in the coming months.

Our financial performance for the second quarter exceeded expectations above the top and bottom line despite weakness in the economy. Revenue grew 43% over the second quarter of last year to $67.2 million driven by Home Robot Division revenue which more than doubled year over year.

For the first half total revenue increased to $124.5 million against first half guidance of $109 million to $112 million. The pre tax loss in the second quarter was $8.8 million compared with $4.8 million a year ago.

For the first half, we reported a pre-tax loss of $15.2 million compared with $10.2 million a year ago in first half guidance of a loss of $17 million to $19 million. Net loss per share was $0.18 for the second quarter and $0.35 for the first half compared with guidance of $0.42 to $0.45 net loss per share.

Higher revenue and savings in operating expenses drove this significant favorability. A change in our tax rate, which I will discuss later, also favorably impacted EPS.

Looking first to Home Robots, we shipped 237,000 robots and generated revenue of $42 million in the second quarter compared with 99,000 robots and revenue of $17 million last year. We expected revenue for the division to be higher than last year due to the Roomba 500 product transition that we affected in the second quarter of 2007.

However, our revenue was fueled by greater than expected growth in the international market which totaled $18 million or 44% of revenue in Q2 compared with $3.5 million or 20% last year. In the G&I division, as we expected, total revenue declined 14% due to lower product revenue.

Contract revenue increased 15% due to increased work on the FCS program. G&I product revenue was $19 million in the second quarter compared to $24 million a year ago.

We shipped 170 robots during the quarter, a hundred of which were PackBots with FasTac kits. Last year’s Q2 was favorably impacted by the delivery of 88 PackBots with ICx Fido kits which carries substantially higher ASPs.

We received a FasTac order during the quarter for $16 million and recently received another order for $17.5 million. These two orders and at least one additional order which we expect in the third quarter will drive second half G&I product revenue.

For the total Company, gross profit margin for the second quarter was 24.5% of sales down from 32.4% last year. Home Robot gross margin declined 5.5 percentage points while G&I gross margin declined 10.5 percentage points.

The most significant factor impacting Home Robot margins was revenue mix. A higher percentage of international revenue and lower percentage of direct revenue accounted for 4.5 percentage points.

Net returns for select Home Robot customers accounted for an additional 2.5 percentage point decline. These were favorably offset somewhat by improved warranty and overhead costs.

Increased overhead as a percentage of revenue impacted G&I margins by about 11 percentage points. Increased revenues and increased investments to drive scalability accounted for five of those points, facility costs for three points and lower Q2 revenue for three points.

In the second quarter, we continue to closely manage operating expenses which were $26 million or 38% of revenue compared with $21 million or 44% of revenue a year ago. The 6 percentage point improvement reflects our increasing scalability and focus on expense management.

Included in the Company’s result for the quarter were approximately $800,000 in costs associated with the relocation of our headquarters which was allocated to both costs of revenue and operating expenses. The Company’s effective tax rate has increased from 37.3% in the first quarter to 43.9%.

Accumulative rate change was booked at 48.8% in the second quarter. A higher rate reflects the impact of the lower pre-tax profit estimate for the year we provided last quarter, higher FAS 123 (R) expenses and an increase in the estimate of state taxes for new state jurisdictions in 2008.

This increase will negatively impact after tax result and EPS calculations in the second half of the year as we will be booking to the 43.9% rate. At the end of the second quarter, we have cash and investments totaling $30 million compared with $38 million at the end of March.

Included in the Q2 balance was $14.8 million of auction rate securities or ARS compared with $15.4 million in the first quarter reflecting further discounts booked to other comprehensive income on the balance sheet. At the end of the quarter, we had 8 ARS investments.

On July 7, the issuer of one of the investments refinanced and redeemed the note at par. That investment of $1.2 million was classified as short-term at the end of the quarter.

Day sales outstanding were 36 days down from 39 at the end of the first quarter. These expect the DSO trends for the remainder of the year to increase somewhat as our retailers begin stocking for the holiday season.

Inventory was $43 million down from $46 million at the end of the first quarter and inventory returns were approximately four times. We expect inventory levels to be flat, or slightly up in Q3 and then decrease in Q4.

Finally, during the quarter we recorded a $4.7 million long term liability associated with the Company’s office move. This reflects the portion of resold improvements paid by the landlord that extends beyond one year.

To summarize, the second quarter was stronger than expected in a tough environment indicating the attractiveness of our business model. For the balance of the year, we will continue to aggressively manage operations and costs to ensure that we deliver our commitments.

Now, I would like to turn the call back to Colin.

Colin Angle

Thank you, John. In conclusion, we successfully executed against our plan, despite economic headwinds in the US, exceeding expectations at the top and bottom line.

While there is a great deal of our uncertainty about the economy for the rest of the year, we are committed to deliver in the second half the results in full year revenue of $295 million to $305 million, a pre-tax income of $5 million to $7 million consistent with our previous guidance. We will now open the call for questions.

Operator

(Operator’s instruction) We will take our first question from Paul Coster from JPMorgan.

Paul Coster – JPMorgan

Thank you. Helen, first I would like to start with you.

I got a little bit lost in the days sales on FCS and I probably take you offline but am I correct in thinking here that the sort of the formal FCS program has kind of shifting out a little bit but your COTS program allows you to sell in parallel to other potential customers in the military? Is that the right interpretation here?

Helen Greiner

Yes. Just to keep it clear, that version we call SUGV early.

Paul Coster – JPMorgan

Okay, got it and then any news on Warrior?

Helen Greiner

We have, as we said last time, we expect to sell off just a small amount by the end of the year, it is on track in its development.

Colin Angle

We also have some near term positive development that we did not want to talk about on this call but we expect to do so very soon as our policy is to sort of wait till things are really sautered and blued [ph 39:24] so perhaps hang on a bit for more news on Warrior but it is on track.

Paul Coster – JPMorgan

Okay, got it. The international sales, what percentage of it was sell-in versus sell-through?

What is the revenue recognition policy there for new distribution channels?

Colin Angle

We recognized our international revenue on a sale-in basis. We wanted to say something about sell-through despite the fact it is difficult to collect internationally so that is why I spoke to the fact that we are really reaching out to our retailers and monitoring inventory level so that we can ensure that we are seeing something far more than just channel sale for new retailers.

Paul Coster – JPMorgan

Okay, got it. Nickel prices, what’s happened there and have you locked-in or not to the costs there?

Colin Angle

Nickel prices on the market have actually declined throughout the year but as you might recall, the Company locked-in to fixed prices for batteries at the beginning of the year, so the day to day or the month’s movement of nickel has been really not a factor for the Company this year.

Paul Coster – JPMorgan

Okay, got it. Last thing, John, I was still a little bit troubled in my mind about the gross margins for the businesses so it feels like it should be a higher gross margin business in the aggregate.

I am not just talking about this quarter, I am talking about long-term. Do you have a view as to what the long term business model will look like here or whether it can be improved dramatically from the current level?

John Leahy

Well, I will be careful with what I will say here being only about six weeks but I would say that we are clearly all focused on growing gross margin overtime. It is obviously important.

Over the last several quarters, it seems like there has been something in each quarter that comes along such as nickel last year that hurts gross margins. So, it is something we certainly focused on in terms of growing the various elements of gross margin both price and class.

In this quarter it was interesting because margins were more heavily impacted by revenue mix shift both in the Home division and G&I but leave it to say that it is obviously important for us to grow margins in our model overtime and we are focused on that.

Paul Coster – JPMorgan

Okay, thanks very much.

Operator

Moving along, we will take our next question from Alex Hamilton from Jesup & Lamont.

Alex Hamilton – Jesup & Lamont Securities Corporation

Hi, good morning everybody. There is a big shift obviously in the business mix between Home Robot and Government and Industrial.

Do you think that is going to change expectations going out or should we still expect of something 60-40 mix Home Robot to G&I?

Colin Angle

The shift that we saw in the second quarter was something that we saw coming and actually tried to message last quarter. It is just the lumpiness inherent in our Government and Industrial business model that means it is out of our hands when the bulk of the orders come in.

So that as expected, we saw some significant stock orders come in that do not tap our backlog from where they were at the end of the first quarter and will be shipping against that increased backlog in the back half. So this is not a trend, this is just the way 2008 is playing out so that our expectations for overall mix remained unchanged, I think 60-40 should be something closer to 55-45 on the year but again the back half, uncertainty in the economy keeps us from making some stronger basis for what is going to happen back there but we are in very good shape going into the back half.

Alex Hamilton – Jesup & Lamont Securities Corporation

Okay and then just secondly, in your closing, at the end of what you had just said, you are talking about the uncertainty in the consumer. It still seems to me that you can stand on that, you had a terrific quarter.

It looks like your G & I is going gangbusters. Can you talk about, actually with the background of the growing or the robustness of those international sales?

Specifically, if there are specifics as to what the concern is on the consumer side or the temper or the caution?

Colin Angle

Okay. Well, the concern is really just the macroeconomic environment; the consumer confidence is at a low since 1980.

There is a lot of anxiety out there in the marketplace but clearly from our Home sales product, we are not seeing it. We had a great second quarter that is showing strong momentum moving in the back half so we would be, we are just trying to be respectful and mindful of what we are hearing in the marketplace, trying to anticipate the fact that our retailers in the back half maybe less aggressive than they have been in the past years placing the early orders and again we want to manage the expectations but we had a great first half and we are carrying that momentum in to the back half.

Alex Hamilton – Jesup & Lamont Securities Corporation

I think that is an important point. The fact that I think the Roomba is probably considered somewhat of a luxury item and given the Mac rap and all those concerns.

You guys have been doing well.

Colin Angle

We are sharing to you the data that we have thus far. It is the macroeconomic anxiety which cause us the cautiousness.

Alex Hamilton – Jesup & Lamont Securities Corporation

Thank you.

Operator

Moving along, we will take our next question from James Ricchiuti from Needham & Company.

James Ricchiuti – Needham & Company

Thank you. John, you gave quite a bit of information on gross margin and I may have missed this but I wonder if you, I thought you have alluded to earlier in the call to some higher cost associated with labor, materials, can you give us some sense as to how much that impacted your margins in the quarter?

You may have given it, I may have missed it.

John Leahy

So, let me just recap. In terms of the impact, the fresh fund margins that came on several fronts so they set in the script.

Revenue mix have the largest impact on the Company, about 4 ½ percentage points and that was driven by the shift in Home with lower direct mix and higher international and then from G&I, just with the nuances of this quarter, G&I product making up the lower percentage of mix than normal versus last year certainly. The other significant impact on gross margin which I alluded to was returns and in particular with one of our key clients which has a very liberal return policy.

Returns have been higher than the Company had modeled earlier in the year so we had to make an adjustment in Q2 for that. So, those are the large items.

On the flipside, as you know, we have had an initiative to take class out of the Roomba product in particular and we have made good progress across the first half of the year in doing that. However, there are now some headwinds which we were referring to which have pushed back some of those cost-savings largely driven out of the production facilities in China where we are experiencing or the manufacturers are experiencing some pressure on labor, somewhere on materials but probably most significantly freight now, in terms of the shipment costs to send stuff across the ocean.

And so, those items have served to somewhat mitigate the cost initiatives that had been underway in the first half of the year.

James Ricchiuti – Needham & Company

Those issues, I would assume are going to be something you are going to have to deal with on an ongoing basis particularly in the second half of the year with the mix shift particularly in Q4 where the Home Robot is.

John Leahy

Yes, that is right and particularly freight is what we are keeping our eye on. With the cost of fuel, freight charges have been going up.

We built into our forecast for the balance of year some assumptions around higher freight costs based upon what we are seeing but that is an area that we are watching very carefully.

Colin Angle

I just want to make the point that the Roomba 500 series is still quite a new product and the costs to that initiatives are ongoing and so that the inflationary pressure on raw materials, the increasing cost of transport is being passed as a negative driver and the continuing efforts to continue to reduce product costs and work aggressively on Home Robot margins of our products across the board is working in our favor and so it is going to be a bit of a foot race in 2008 but something that we see going forward, a race that we can significantly win.

James Ricchiuti – Needham & Company

Now, you have alluded to an order, I think some orders in the Home Robot business that you had projected to see in Q3. You saw those I think in Q2.

I wonder if, I think in the last call, you may have given us some senses that how you thought the Home Robot business would grow in the second half of the year somewhere if I know I think I have some 25% to 30%. I wonder if that is something you might be able to update first.

Colin Angle

Is that the full year figure that we gave? So, some of the upside that we saw in both in Q2 is due to this shift of orders from Q3 in the Q2, important that we are reiterating our commitment to our original full year guidance.

Obviously the growth that we have seen, extraordinary growth that we have seen in the Home Robot division in the first half allows for others to be more conservative in predictions of growth in the back half for the reasons that we have already given.

James Ricchiuti – Needham & Company

What drove that figures? What might have driven that the order is being pulled in?

Was that more of an international issue?

Colin Angle

No, those are domestic orders that were pulled in and I would be speculating as to whether or not the business reasons behind the retailers for accelerating the orders, all I can do is tell you that it happened and certainly not, it seems not to be bad move, acceleration tends to be good in the consumer business.

James Ricchiuti – Needham & Company

And last question for me is I wonder if we look at your backlog which worked nicely in the quarter and then with the additional orders that you announced yesterday. I wonder if you can give us some sense as to how much of that backlog in G & I you expect to recognize revenue in 2009?

Colin Angle

Again, we are reiterating our full year guidance and I think that our backlog that we currently have in the books that squeezed in to that figure we shared with you earlier that we have 75% of our year sort of books are already shipped and so it is the backlog is in 2008 backlog that should be viewed as such.

James Ricchiuti – Needham & Company

Okay, thanks very much.

Operator

Moving along, we will take our next question from Brian Gesuale from Raymond James.

Brian Gesuale – Raymond James

Guys, nice job on the quarter, I am wondering if you can give us an update on what you are doing with the Linens ‘n Things in terms of the target update of the last quarter and how are negotiations maybe going to getting paid?

John Leahy

There are a couple of things with Linens ’n Things. First of all, we did take the charge in Q1 and there has been no change in terms of that charge and we will just have to see what happens in the quarter in terms of what kind of pennies on the dollar could possibly comeback on that but we are not banking on that in our forecast.

Secondly, we have resumed shipping to Linens ’n Things by under very closely watched terms and tight payment terms and with the limit to the dollar sides of the shipment. So we are limiting our exposure quite a bit, ensuring that no new shipments go out until the payments is received on the previous shipment.

It is unfortunate because there is a volume opportunity there because they would take far more product than we are delivering, if we allow it, but we are taking a very conservative approach in terms of our exposure.

Brian Gesuale – Raymond James

Okay, great that is helpful. Colin, you mentioned that you thought, I cannot remember the exact word you used, but inventory levels were good or reasonable or something to that effect in your prepared remarks.

Can you give us a little bit more color to that maybe compare it to a prior period at some point and any more detail you can give us there?

Colin Angle

I guess what I can say is that the brisk sell-through that we reported would give good color to whether or not our retails are over inventoried as with the fact that we are seeing some retailers accelerate some of their orders so that when sell-through is slow, you will not worry about its inventory being stocked up in the warehouses that would maybe a challenge on a go-forward basis and clearly that is not the case. The orders continue to come in, sell-through is brisk and our inventory, we anticipate a normal cycle of Q3 ordering.

Brian Gesuale – Raymond James

Okay, terrific. I guess final question, looking at the sales and marketing spend in the first half of the year.

It seemed to be pretty brisk. I imagine some of that or a large degree of the growth there was to support the international expansion.

Was any, I guess is that true and then was any of that one time in nature should we see a continued second half pickup from that first half run rate on sales and marketing?

Colin Angle

We did a little bit more aggressive spending on advertising in the first half of the year relative to 2007 so it bring you back on the direct front and we do cut shipping and some commissions on sourcing of inquiries so that as direct continues to grow, we will see some additional increases in the absolute dollars spent on sales and marketing line.

Brian Gesuale – Raymond James

Okay, terrific. Thanks a lot.

Operator

Moving along, we will take our next question from Josephine Millward from Stanford Group.

Josephine Millward - Stanford Group

Good morning. Hi, I just wanted to confirm your backlogs for G&I, the $22 million, does that include the $70 million export order?

Colin Angle

No, it does not. That is incremental to the $22 million.

Josephine Millward - Stanford Group

Okay, great. In terms of, you said this early, when you get the production decision from the Army and the [5701], do you expect to begin production, is it positive?

Do you expect to begin production some time in early 2009 and how do you think this would impact demand for your FasTac robot?

Helen Greiner

Okay, beyond the news announcement on June 26, great news where in this SpinOut 1, that is the earliest possible deliveries of SpinOuts under the FCS program. They will start at the fourth quarter of 2009; there has been a three quarter delay in the FCS SpinOut portion of the program.

Colin Angle

The earliest, I would say, is available and ready to be shipped earlier in 2009 and I would not speculate on whether such early shipment would be cannibalistic under I guess the FasTac program. FasTac has a substantial ID/IQ in place and we are seeing continued demand for that product as we had hoped for so there would really be speculations and likely the early sales would be outside of the FasTac contract perhaps different customers.

Josephine Millward - Stanford Group

Okay, just so am clear, so you could start shipping in the beginning of 2009 but the earliest production for the Future Combat Systems probably would in Q4 of 2009, is that right?

Helen Greiner

That is right so although the FCS deployments are really later than we anticipated. The demands for SUGV outside this FCS program but within the US system are strong and we can start delivering on those in 2009.

Josephine Millward - Stanford Group

Great. Since, first, your margins in the first half are lower than I guess you anticipated.

Can you help us think about how margins will improve in the second half because I think they need to do a lot better than what happened during the first half of the year.

John Leahy

I do expect we will see margin improvement in the second half which is the typical seasonal trend for the Company and given the fact that there were some nuances as I described earlier that affected gross margin in Q2. We do expect that margins, we will see a margin lift in the second half and I…I am sorry?

Josephine Millward - Stanford Group

Is that from increasing volume or..?

John Leahy

Yes.

Colin Angle

The drivers of the G&I side of business is definitely volume related and then also on the HRD side, we look at our prior third and fourth quarters from previous years and you will see our gross margin substantially improve in the back half and we should expect to see similar impact this year. Thank you and that is going to conclude our second quarter earnings call.

We greatly appreciate your continued support and look forward to talking with you again following our third quarter.

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