iRobot Corporation (NASDAQ:IRBT) Q2 2021 Earnings Conference Call July 29, 2021 8:30 AM ET

Company Participants

Andrew Kramer - Investor Relations

Colin Angle - Chairman and Chief Executive Officer

Julie Zeiler - Executive Vice President and Chief Financial Officer

Conference Call Participants

Ben Rose - Battle Road Research

Asiya Merchant - Citigroup

John Babcock - Bank of America

Derek Soderberg - Colliers Securities

Tyler Bailey - Needham

Operator

Good day, ladies and gentlemen and thank you for standing by. Welcome to the Second Quarter 2021 iRobot Corporation Earnings Conference Call. [Operator Instructions] At this time, I would like to turn the conference over to your host today, Mr. Andrew Kramer. Thank you. Sir, please begin.

Andrew Kramer

Thank you, Howard and good morning everybody. Joining me on today’s call are iRobot Chairman and CEO, Colin Angle and Executive Vice President and CFO, Julie Zeiler.

Before I set the agenda for today’s call, 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. 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.

Related to our financial disclosures during this conference call, we will reference certain non-GAAP financial measures as defined by SEC Regulation G, including non-GAAP gross margin, non-GAAP operating expense, non-GAAP operating income, profit and profit margin, non-GAAP effective tax rate and non-GAAP net income per share. We believe that our non-GAAP financial results help provide additional transparency into iRobot’s underlying operating performance and potential. Our definition 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 at the end of these prepared remarks and in the financial tables at the end of the second quarter 2021 financial results press release we issued last evening, which is available on our website at www.irobot.com.

Also, unless stated otherwise, the second quarter 2021 financial metrics as well as financial metrics provided in our outlook that we reference on today’s call will be on a non-GAAP basis only and all historical comparisons are with the second quarter of 2020. For today’s call, our agenda will be as follows. Colin will briefly review the company’s quarterly financial results and then share his perspective on the primary issues shaping our revised outlook for 2021. Julie will review our second quarter financial results and offer additional insight into our expectations going forward. Colin will conclude our commentary with some closing remarks. After that, we will open the call for questions.

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

Colin Angle

Good morning and thank you for joining us. We delivered solid second quarter results that were generally in line with the targets that we outlined for you in early May, as we navigated an increasingly challenging supply chain environment. We generated second quarter revenue of $366 million, an increase of 31% over the prior year. Our revenue growth was primarily driven by healthy demand from retailers in North America and from our retail and distribution partners in EMEA. We were pleased with this performance considering a COVID-related disruption to shipping activities in Southern China left us unable to fill $17 million in order at the end of the quarter. We converted our top line performance into an operating income of $9 million, an operating profit margin of 2%, and EPS of $0.27.

Our first half performance tells a very positive story, particularly as it relates to strong consumer demand for our products as well as increased customer engagement. Roomba robots occupied 8 of the top 10 best-selling RVC models in the United States, 6 of the top 10 in EMEA and 9 of the top 10 in Japan. For the seventh straight year, we participated in Amazon’s Prime Day event. Once again, Amazon cited Roomba as one of its best selling items.

We generated solid 42% growth from the mid and premium tiers of our portfolio, which we believe demonstrates the appeal of our floor-cleaning robots to provide their owners with personalized control over where, when and how the robot cleans. We also continue to expand our direct-to-consumer sales as reopening activities in the U.S. and rising online advertising costs moderated this growth.

Overall, we saw solid growth in the number of robots shipped and ASPs in our second quarter versus the same period last year. We finished Q2 with over 11.6 million connected customers, an increase of 67% from the same period last year. Customers are increasingly using our newest features like directed room cleaning. We are so increasingly using our AI-powered recommendations to clean by objects and adopting our new clean while I am away capability using geolocation services on their smartphones.

As we move through the second quarter, our commercial teams, retailers and distribution partners were increasingly bullish about the second half of the year, especially given our plans to introduce 2 new Roomba robots and deliver another major upgrade to our Genius Home Intelligence platform. Our new e-commerce and martech systems will soon start moving into production, giving us the capabilities to expand existing customer revenue effectively and efficiently. Even after raising our top line outlook in early May, we saw opportunity to exceed these targets.

Unfortunately, the reality of the current supply chain environment is forcing us to tell a different story for the second half of the year. Quite simply, the supply side of our business is not currently able to keep pace with demand for our products. Since our call in May, we have seen further deterioration in our ability to source the requisite volume of semiconductor chips used to manufacture our floor cleaning robots. We are not alone in feeling the pain of the semiconductor chip shortage as it impacts a range of industries from automobiles to medical devices to TVs, smartphones and many other consumer electronics.

Our robots rely on a wide range of integrated circuits from lower cost commodity-like devices to very sophisticated powerful processors. While there is tightness across the board, we have recently fielded calls from multiple chip suppliers who are now unlikely to fulfill their commitments to us either in volume, timing or both. These decommitments and push-outs will constrain our ability to fulfill all of the orders we anticipated during the second half of the year. Accordingly, based primarily on the assumption of lower unit volumes, we have reduced our 2021 revenue target to $1.55 billion to $1.62 billion, which still represents 8% to 13% growth over prior year. This range is wider than usual, reflecting limited short-term visibility into the availability of certain semiconductor componentry.

The impact of lower revenue on our anticipated profitability is compounded by having to increasingly source more semiconductor componentry in the aftermarket at a much higher price as well as grapple with rising raw material and transportation costs. Against this backdrop, we are working diligently to carefully manage channel and product mix, adjust promotional activities, qualify new alternate suppliers and optimize inventory levels. More specifically, with limited supply, we were working collaboratively with our strategic retailers in countries where our brand is strongest to support them while we also take steps to optimize our second half promotional activities and direct-to-consumer sales.

Additionally, we are evaluating potential price increases. We know consumers are excited about the way we continue to innovate. And with that in mind, we intend to defend our leadership position in the premium segment, while also investing in marketing activities to help us bring our next-generation Roomba robots to market later this year. We will also remain disciplined with our second half spending plans by recalibrating hiring activities and other discretionary programs.

At the same time, we move forward committed to advancing our strategy by continuing to fund the initiatives we believe are necessary to emerge from the short-term turbulence as an even stronger category leader. As we balance cost austerity with investing in our future as a technology and category leader, we expect that our second half profitability will be aided by tariff relief. Between recently passed legislation in the U.S. Senate and bipartisan urging from representatives about the reinstatement of the tariff exclusion process, we now believe it is more likely than not that iRobot will receive a tariff exemption. And as a result, we have incorporated this likely development into our updated 2021 outlook.

With that said, it is inherently difficult to forecast precisely when, or even if, the USTR would reinstate exclusions to the China Section 301 tariffs and establish a new process for importers to apply for exclusions since those activities are likely to be linked to the Biden administration’s ongoing reassessment of its overall policy towards China. Based on our ongoing dialogue with policymakers and elected officials, we anticipate that an exclusion, if reinstated, would cover all of ‘21 at a minimum and could extend through the end of 2022. Julie will share more details on the specific financial impact of tariff release in a moment.

Regardless of this potential positive development, diversifying our manufacturing footprint into Malaysia remains strategically important and we are making good progress on this front. We are now producing nearly half of our U.S. bound product out of Malaysia and remain on track to have Malaysia manufacturing at scale by the end of the year. Taking all these factors into account, we have also revised our operating income and EPS expectations. We now expect our 2021 operating income to range from $80 million to $110 million or 5% to 7% of revenue, with an EPS range of $2.25 to $3.15, which also factors in our recent and planned stock repurchase activities.

While the changes to our full year outlook are nonetheless disappointing, it is important again to emphasize that we believe the supply chain constraints and cost headwinds are temporary. Our operations teams are working diligently to preserve our supply chain resiliency as a high-priority strategic customer to many of our longstanding chip suppliers, we continue to put longer term supply arrangements in place that not only support our revised near-term volume requirements, but also position us to be at the front of the line when our partners begin increasing their output, which we expect will happen during the first half of next year.

Just as important, although qualifying new suppliers is time consuming, we expect that these ongoing efforts will also help further increase our supply during this period. Although visibility is limited right now, we believe these activities will help lead to improved availability of components starting in the beginning of next year and steadily strengthen as we move into the second half of 2022. While our performance in 2021 is now expected to fall short of our ambitious targets, we remain optimistic about our revenue and EPS growth potential for next year. I will share some additional thoughts on how we see 2022 evolving in just a few minutes. But at this point, I would like to turn over to Julie for her financial review.

Julie Zeiler

Thank you, Colin. As Andy mentioned earlier, my review of our financial results and outlook will be done on a non-GAAP basis. So unless stated otherwise, each mention of gross margin, operating expense, operating income and operating profit margin, effective tax rate and net income per share will mean the corresponding non-GAAP metric. All quarterly comparisons are against the second quarter of 2020, unless otherwise noted.

We reported a solid Q2 performance. Total second quarter revenue grew 31% to $366 million due primarily to strong retail and distributor orders in the U.S. and EMEA. A COVID-related shutdown of the shipping ports in Southern China in late June prevented us from fulfilling $17 million in orders. Most of those orders have since shipped and we expect to complete this activity over the next couple of weeks.

Geographically, revenue grew 40% in the U.S., 29% growth in EMEA and 7% increase in Japan. From a product mix perspective, Roomba robots and accessories represented 88% of our Q2 revenue mix, with Braava making up the remainder. We estimate that approximately two-thirds of total second quarter revenue came from e-commerce, which comprises our own website and app, dedicated e-commerce websites and the online arms of traditional brick-and-mortar retailers.

Our D2C revenue grew 36% to $45 million or 12% of total revenue. Although we saw very strong D2C growth in EMEA and Japan, sales in the U.S. moderated due to the more limited traffic arising from higher advertising fees and reopening events that diverted consumer spending into other categories. Given these dynamics, along with our supply constraints, we now expect D2C sales to represent approximately 13% of total full year revenue in 2021.

Our gross margin of 38% in Q2 was slightly below plan as favorable changes in promotional activity were more than offset by higher warranty costs and timing shifts associated with the purchase of certain componentry. Tariffs were the single biggest factor for the 12 point decline in gross margin from the second quarter of 2020. As you may recall, we received our tariff exclusion in the second quarter of 2020, which not only eliminated any quarterly tariff expense, but also resulted in a reversal of tariff cost of approximately $7 million from Q1 ‘20.

In this year’s second quarter, we paid tariffs of approximately $12 million. The net impact from tariffs from both periods was approximately $18 million, which represents nearly half of the decline. The remainder of the decline was split relatively evenly between pricing and promotional activity, supply chain headwinds, higher warranty expense and unfavorable channel and product mix shifts. I would also note that the company’s second quarter 2020 GAAP gross profit reflected the reversal of the full $47 million in tariffs that had been paid since they went into effect.

Second quarter 2021 operating costs of $131 million increased by 32% and represented 36% of revenue. The increase reflected higher working media to drive sales growth, increased personnel-related expenses primarily tied to headcount and higher R&D spending. Our Q2 2021 operating income was $9 million, or 2% of revenue. The impact of the delayed shipping of $17 million in orders to our operating income was approximately $7 million. Our Q2 2021 effective tax rate was approximately 12%, which reflects changes in our full year tax rate assumptions, primarily associated with lower expected full year operating income. Our net income per share was $0.27.

We ended the second quarter with $416 million in cash and short-term investments, a decline of $85 million from the end of Q1. The decrease primarily reflects share repurchases totaling $50 million and $27 million in operating cash outflows, mostly driven by changes in our inventory. Second quarter DSOs were 19 days, a 23-day decrease against the same period 1 year ago. The decrease reflects the timing of orders that were more weighted to the first half of the quarter versus last year when the pandemic resulted in most orders being shifted into the last half of that same quarter. Q2 ending inventory was $277 million or 112 days compared with $133 million or 86 days at the same time last year. The increase in inventory reflects the combination of our efforts to support our second half volume requirements as well as the impact of tariffs and the units that were stuck at port at the end of the quarter.

With the quarterly review complete, let’s move on to our 2021 outlook. As Colin detailed, the semiconductor chip shortage will significantly reduce the number of robots we had expected to ship in 2021. We now expect 2021 revenue in the range of $1.55 billion to $1.62 billion, which implies 57% to 59% of our anticipated revenue coming in the second half of the year and a 1% to 8% decline in our second half revenue versus the same period last year. While it is very challenging to forecast the timing of holiday orders between the third and fourth quarters, we currently expect low single-digit revenue growth in the third quarter. As a reminder, our revenue expectations contemplate yen and euro exchange rates roughly in line with current rates, plus or minus 5%.

In terms of our gross profit margin earlier on the call, Colin shared our rationale for why we expect an exclusion from Section 301 tariffs for 2021. We have factored this anticipated development into our updated outlook and removed $35 million to $37 million from our anticipated full year cost of goods sold. Without the burden of tariffs, we expect a full year gross margin range of 39% to 40%. If a tariff exclusion is not granted, our full year 2021 gross margin will be 2 percentage points lower. Assuming the exclusion is granted in the fourth quarter, we anticipate a third quarter gross margin of approximately 35% that will reflect anticipated tariff costs of $11 million to $13 million, as well as many of the same factors that also affected our Q2 gross margin in a more prominent way. This implies an expected tariff free fourth quarter gross margin of around 44%, which would include a reversal of all tariffs paid from the prior three quarters.

In terms of our 2021 operating costs, we expect full year operating costs in the range of $532 million to $535 million or 33% to 34% of sales. With that spend, we anticipate that our sales and marketing will range between 18% and 19% of total revenue as we begin moving our new e-commerce and digital marketing systems and tools into production and we direct our working marketing towards supporting our new product launches and strong sell-through during the holiday season. As a result, we expect an operating profit margin between 5% and 7%, with anticipated operating income between $80 million and $110 million. As we adjust our spending plans, we expect third quarter operating costs to be 28% to 29% of total revenue, with sales and marketing costs moderating from Q2 levels. We expect Q3 operating income margin in the mid single-digits.

In terms of other major modeling assumptions for 2021, we still expect other expense to be between $2 million and $3 million. We are now anticipating an effective tax rate between 16% and 17%. As a result, we anticipate a full year EPS range from $2.25 to $3.15, with an anticipated diluted share count of approximately 28.5 million shares. We estimate that the tariff exclusion will contribute approximately $1.05 to our 2021 EPS on an after-tax basis. We anticipate third quarter EPS in the range of $0.70 to $0.90.

We continue to expect our 2021 capital spending to be in the low $50 million range. On the use of capital front, as detailed in our earnings press release, we plan to execute an accelerated share repurchase agreement to repurchase an aggregate of $100 million of iRobot common stock subject to the terms of the ASR agreement. We expect to fund the ASR from cash on hand. We will share additional details via an 8-K when the ASR is executed. Our EPS outlook incorporates the effect of the upcoming ASR. We still expect that inventory, both in terms of dollars and DII, will fluctuate meaningfully from quarter-to-quarter as we continue navigating a challenging and fluid supply chain environment.

In summary, despite solid results over the past two quarters, our full year outlook has eroded as the shortage in semiconductor chips will leave us unable to completely fulfill anticipated second half demand. Despite this disappointing development, it does not diminish the tangible progress we are making to advance our strategy and position our business for substantially better performance next year as those constraints ease. Our upcoming share repurchase activity further demonstrates our confidence in our ability to capitalize on the opportunities that lie ahead.

With that said, I will turn the call back to Colin.

Colin Angle

Thank you, Julie. On our most recent quarterly conference calls, we detailed our strategy to build a more defensible, profitable enterprise with a compelling value proposition that resonates across a growing global base of loyal connected customers. By innovating to differentiate the iRobot experience, we will plan to continue winning more customers and keep them delighted at every turn to the point that they will buy more products and services directly from us over the lifetime of their ownership. We are optimistic that executing on our planes will drive substantial value creation over the long-term. We’ve also shared our preliminary view that further progress on this path in 2021 would support continued top line expansion that we can convert into substantially improved operating profitability and EPS expansion in 2022. Although the impact of constrained supply will make it more challenging to achieve our preliminary 2022 target of returning the business to our 2020 operating profit margin levels, we are confident that we can make considerable progress next year.

In terms of our 2022 top line assumptions, we anticipate more modest revenue growth in the first half of the year as we take proactive steps to increase our active – our access to semiconductor componentry amid fundamentally healthy demand signals from retailers and consumers. Assuming our suppliers steadily ramped their production, as expected, we will look forward to accelerating revenue during the second half of 2022, anchored by substantial restocking orders from retailers who will carry very lean inventory over the next several quarters.

In addition to executing on our product road maps and leveraging our unique home understanding, we are also excited about the potential of our iRobot select service. which we expect will begin to scale later this year as a growing recurring revenue stream. We also look forward to seeing the impact of our DTC infrastructure investments on growing existing customer revenue as we further personalize the online buying experience on our website and Home app and focus on delivering the right promotions to the right customers at the right time.

As we plan for next year, we anticipate that other transitory costs that have spiked in 2021, namely raw materials, oceanic transport and air freight should eventually revert back to more normalized levels at some point in 2022. These potential tailwinds, combined with expected tariff release, Malaysia manufacturing at scale and our ongoing efforts to our ongoing efforts to optimize our production and fulfillment costs will leave us well positioned to drive gross margin improvement next year. By remaining very disciplined with our spending, we believe that we’ll convert our top line expansion into strong operating profit gains and significant EPS growth next year.

As we move forward, we believe there’s a lot of opportunity in front of us. Household penetration remains low, we have an expansive and growing global connect customer base and their exciting new growth initiatives now underway or in planning stages. As a result, we believe that our exit trajectory for the second half of 2022, in combination with continued strategic progress, will set the stage for sustaining solid annual top line expansion that can be converted into improving double-digit operating profit margins, substantial EPS growth and robust operating cash flow generation.

Our confidence in our strategic direction and our ability to achieve our ambitions over the next several years is underscored by our upcoming plans to execute a $100 million Accelerated Share Repurchase Agreement. We will share greater insight into our business later this year when we host a virtual Investor Day event. In addition to highlighting our vision and strategy, our leadership team plans to share greater insight into many exciting initiatives that will underpin an updated set of long-term financial targets. Stay tuned for more details on this event.

That concludes our comments. Operator, we will take questions now.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question or comment comes from the line of Ben Rose from Battle Road Research. Your line is open.

Ben Rose

Good morning. First question for Colin, I know that you – excuse me, reiterated your plans to introduce two new Roomba models later on this year. Can you talk about how you plan to do that in light of the chip shortage that you mentioned? Is it a question of simply prioritizing the chips that are available or are there other factors at play that give you this confidence?

Colin Angle

It’s really about prioritizing the chips for these exciting new products. So that – There’s a lot of shared componentry across robots, and making sure that we are able to execute aggressively on these new product launches is something that we have taken on, so that we have great confidence that the chip shortage will not impact those plans.

Ben Rose

Okay. And with regard to the sales and marketing expenditures in Q2, I understand that, that is very strong quarter in terms of seasonal promotion, but were there any additional one-time charge costs in there and how do you, I know that Julie you provided some commentary on the expectation for sales and marketing, but could you maybe give a little bit more color on the extent to which those can decline as a percentage of sales over the course of the rest of the year?

Julie Zeiler

Sure. As we think and as we’ve gone through this year, Ben, we’ve been talking about the investments that we’re making in our direct-to-consumer capability, both in terms of systems and then in the talent to enable those systems. What you’ve seen this year are those thoughtful investments that we have been doing. And again, in Q2, we made some of those investments. What we’ve also been saying and continues to be true, as we look forward, a lot of those are foundational elements that will not scale as revenue scales. And so as we head into the back half of the year, there are two things that work here. One is the normal fluctuation in our working marketing aligned with promotional periods; and then the other is the – those investments starting to become fully in place, and we’re excited about the results that we should see there.

Ben Rose

Okay, thanks very much. Appreciate it.

Julie Zeiler

Sure.

Operator

Thank you. Our next question or comment comes from the line of Asiya Merchant from Citigroup. Your line is open.

Asiya Merchant

Great. Thank you for the opportunity. A couple of quick questions. Can you guys give us any commentary on sell-through versus sell-in into the quarter across your different regions? And then just given the dynamics with chip shortages and promo activity, etcetera, if you have any color on competitive dynamics, were you experiencing any share loss because of the unfulfilled orders? Were the unfulfilled orders largely domestic or were the international? Or is that more a global phenomenon? And then lastly, on inventory, obviously, you guys have the chip shortage situation but the inventory spike was pretty significant. Is that all components or planning ahead of the new Roombas that you plan to introduce here in the second half? Thank you.

Colin Angle

Okay. So the – three questions. The first question was on share – sorry, on sell-through, the – and inventory levels. So we definitely have been seeing an impact that in Q2 that will – that is increasing as we go through the rest of the year where demand from our retailers exceeds our ability to supply. That will drive down the retailer inventory levels. There is some impact in Q2, and that impact should be seen as growing significantly in Q3 and Q4. So as we exit the year, the inventory levels with our retailers will be unusually low relative to normal. The second question you asked was, do these chip shortages impact our competition equally and what is the impact on share? The – our competition tends to use a greater percentage of Chinese local componentry, which has slightly different availability dynamics. But it only takes one component to stop you from building a robot. And even our competitors’ designs require componentry, which will be hard to come by. So it’s difficult for us to truly model what – the extent to which they’re going to be impacted beyond. We know they will be impacted to some degree. So there’s a little bit of a wait and see as it relates to what a transitory impact in Q4 around share will be. If they’re impacted similar to we are, we don’t expect share to change from where it is significantly. If they have some additional availability, they might pick up a bit of share until we can reassert our in-stock capabilities. So there’s a little bit of TBD and transitory impact to share numbers that we’ll have to work through in Q4 and then move into next year as things start to normalize.

Julie Zeiler

And then your final question, Asiya, was around the iRobot inventory, which we ended our – with our own inventory at $277 million at the end of Q2. And we tried to lay out some of the factors year-on-year as we looked at that increase. Second half – our efforts to support our second half volume requirements, that inventory is tariffed as compared to a year ago. And then also those units that we were – those orders that we were unable to ship for the end of the quarter remained in our inventory. As we look forward, we expect our inventory will fluctuate as we go through the rest of this year as we navigate through these rather challenging environments.

Asiya Merchant

Okay, thank you.

Colin Angle

Yes.

Operator

Thank you. Our next question or comment comes from the line of John Babcock from Bank of America. Your line is open.

John Babcock

Hey, good morning. Thanks for taking my questions. I guess the first one, I was just wondering if you could talk about the iRobot Select service, how that’s progressing so far? And also what you’ve learned from the first few months that this has been available.

Colin Angle

Sure, I’m happy to. So we are in the preliminary stage of rolling out that service. I would say that we’re very optimistic with both the Net Promoter, the customer favorability of the service as we’ve rolled it out. We’ve seen very favorable low levels of churn. And that has led us to gain the confidence required to begin real scaling of iRobot Select, which we talked in the call about being increasingly visible through the balance of the year, and exiting the year at a rate that we believe in 2022, it’s going to be a material contributor that we will be able to talk about and starts to build our recurring revenue backlog. So all things – all systems green on iRobot Select thus far. It’s definitely one of the exciting tests that we began last year and now we’re at a point of scaling.

John Babcock

Got it. That’s helpful. And then next question, just – are there any signs that the semiconductor chip shortage is getting better lately? I mean, obviously, it sounds like it’s perhaps more challenging now than 1Q. But I mean, has that, at least so far in 3Q, shown any signs of lessening or does it seem like we are still kind of on the downward slope here?

Colin Angle

I think that it is certainly more well understood at this moment in time by both the suppliers themselves and the manufacturers who rely on the componentry. So we went from a situation of not really understanding how bad it was going to be to, okay, we think we understand it now. And the suppliers are working to try to make sure that the components they’re able to produce are going efficiently to the manufacturers that they are choosing to support. And so that’s kind of an intermediate step while investments are being made to bring more production capacity online as the suppliers recognize the bump in demand is not transitory and capital investments in increased manufacturing capability are good business decisions for them. So I won’t say we’re out of the woods, but we’re at a period of fewer surprises and concrete action to improve.

John Babcock

Okay. And then you also talked about considering price increases. Obviously, you considered this back in 2019 and did take price increases on some of your products back then. Do you believe the market is sufficiently different now versus back then that the price increases might be better received?

Colin Angle

I think that price increases, we mentioned it because it is one of the tools that we are considering. I think we learned a lot from last time we did it. And should we decide to execute and take action with that tool that will be done in a way that captures those learning. So it might be more tactical and strategic or certainly being done in a way that we have more confidence in its success. So – but it is only one of the tools we have in our cadre to ensure continued financial performance. And I would iterate that the backdrop against applying these different tools is a conviction that the supply chain and raw material cost disruptions we’re currently facing are transitory.

John Babcock

Okay. And then just last question before I turn it over. I was just wondering if you might be able to provide some more detail on the different factors impacting gross margins relative to the 2020 levels? Ideally, I mean, it would be nice if you provide some color on how much is from raw materials, how much of the lower guidance is from raw materials, transportation, tariffs and price mix, recognizing you might not want to get too specific. Any color you can provide would be useful?

Julie Zeiler

Sure. And I will be speaking both in 2020 and in 2021 in an assumption of a tariff-free comparison. And so if you’re looking in 2020, we were at approximately 45% gross margin. And our outlook for 2021, assuming tariffs exemption, is 39% to 40%. Certainly the headwinds, and you have named a number of them, are significant in terms of increasing costs for ocean transportation, sourcing materials on the open market, increased raw material costs, as well as increased air freight to make sure that we can get our products to our customers when they need them. That’s a significant factor as – along with year-on-year pricing and promotional reductions, which we have been talking about, that then are partially offset by the good work that our supply chain teams continue to do to take product cost out of our products. And so it’s the net of all of that, that gives you the walk between last year and this year.

John Babcock

Okay, that’s great. Thanks. I will pass it over.

Operator

[Operator Instructions] Our next question or comment comes from the line of Derek Soderberg from Colliers Securities. Your line is open.

Derek Soderberg

Hi everyone. Thanks for taking my question. Just want to get a bit more color on your view around tariffs, Colin. I guess I am wondering what’s changed in the Biden administration on trade policy. My understanding is that the U.S. trade representative, Katherine Tai, is more or less enforcing existing trade policy. Has the office under Biden picked up the pace of exemptions, I guess, since January or is this the first time they are considering them? I just want to get a bit more color on what you are hearing and what’s informing your view? Thanks.

Colin Angle

So, what’s informing our view is the fact that the Senate passed a legislation that called for the reinstatement of exemptions for companies that had previously received exemptions for all of ‘22 and all of ‘21. That bill is being taken up by the House, and there is strong support for exemption language in the House as well. We just can’t guarantee when that legislation is going to be taken up. And the USTR is – could also up to act unilaterally independent of this legislation. And so that in general, there is broad-based support, though the timing is uncertain. So, we are kind of in a little bit of a wait-and-see, but we felt like it was – it behooved us to include an assumption of an exemption based on our analysis that it was more likely than not, and that would convey the most accurate view on our financial performance.

Derek Soderberg

Got it. And then is the exemption, is that part of a larger bill with other stuff that could potentially muddy the waters in terms of bipartisan support or is that more of a standalone bill?

Colin Angle

Yes. It would be part of a larger legislative package, which would contain other things. That is correct.

Derek Soderberg

Okay. Got it. Thanks.

Colin Angle

You bet.

Operator

[Operator Instructions] We have a follow-up question from Mr. John Babcock from Bank of America. Your line is open.

John Babcock

Hi guys. Just figured I would jump since there aren’t any other questions, I guess. Just first of all, what drove the higher warranty expense in the quarter?

Julie Zeiler

So, our warranty expense is a look at the trended amounts that we are paying as we see those costs come back. The – some of the issues that we have been talking about in terms of higher costs and logistics costs are things that would impact our warranty expense. So, it’s a number of factors.

Colin Angle

Just to give you a little bit of a feeling for pain, there are some situations where we previously could affect or repair with – by sending a part. And because of supply chain challenges, we actually have to send a robot. So, it’s a multi-factor issue, but again, something we feel good about driving back to more historical levels.

John Babcock

Got it. And then just relative back when you reported 1Q earnings, has inflation situation changed that positively or negatively for raw materials and transportation?

Colin Angle

Raw materials have grown dramatically in cost, particularly resins. And we expect those raw material prices to maintain elevated for the balance of the year. And we expect them to normalize at some point next year. But definitely, that’s a headwind.

John Babcock

Okay. And transportation, no big changes there, I guess?

Colin Angle

And transportation as well. Very similar.

John Babcock

Sorry, I don’t mean to interrupt. Yes. And then I guess, just my last question. I mean it sounds like demand from retailers is going to exceed your ability to supply it in the back half of the year. Are you able to charge more to help offset that? So in other words, while not raising the price of robots, perhaps increase that spread with the retailers to help deal with that demand? I don’t know if that’s an option or not, but just kind of curious on that front.

Colin Angle

We did mention price as one of the levers that we are looking at as we try to optimize the back half of the year. There may be some situations where that could work. But we have – we are predicting very – 8% to 13% growth. There is still a tremendous amount of robots to move. And it’s a complex year. But that’s one of the reasons why we wanted to mention price as being on the table, that’s something we would consider.

John Babcock

Okay. So, it sounds like that basically the price will be driven by the end market price that the consumer is paying instead of a change in the price that the retailers might pay.

Colin Angle

Certainly, something we are considering and we will try to thoughtfully use along with other levers to ensure that we are extracting as much profit out of the robots that we sell.

John Babcock

Okay. Alright. I appreciate it. Thank you for all the details.

Colin Angle

Yes.

Operator

Thank you. Our next question or comment comes from the line of Jim Ricchiuti from Needham. Your line is open.

Tyler Bailey

Hi everyone. This is Tyler Bailey filling in for Jim today.

Julie Zeiler

Hi Tyler.

Tyler Bailey

Hi. Thank you, guys for taking questions. One question, I guess, just looking at historicals, did you see sort of, I guess, relatively similar bump from prime days as in past quarters?

Colin Angle

The Prime Day – it’s a difficult question to precisely answer, because last year Prime Day happened much later in the year. And the year previously when Prime Day was similarly timed 2 years ago, and the market has – and our – the size of our Prime Day has grown substantially from there. So, I would say that we had a very successful Prime Day and we are called out as one of the top performers on Prime Day. But there is no normal or at least normal is changing every year. So, I am not sure how to give you a good answer there.

Tyler Bailey

No, I appreciate that insight, though. And then another question for me, I just wondering how, I guess, maybe you can just provide some additional color on your iRobot as a service model? I know you talked about that last quarter a little bit. Just wondering if you can provide any additional color or customer feedback, it seemed like it had been going well. I just wanted to get an update there?

Colin Angle

Sure. What we can say today is that the tests that we have run have been very successful, and we are going to be significantly scaling our Select program in the back half of this year and believe it to be an important part of next year. So, we are not quantifying the numbers yet, something that, again, as it grows, we will be providing more color there. But it’s all systems go, and we are actively scaling the numbers of customers that we are targeting in with our Select program. So, customer satisfaction is good. Churn is low and well within our target ranges. This is a good thing.

Tyler Bailey

I appreciate that. Thanks. That’s all for me. Thanks for taking the question guys.

Colin Angle

You bet.

Operator

Thank you. Our next question or comment comes from the line of Ben Rose from Battle Road Research. Your line is open.

Ben Rose

I just wanted to ask one follow-up question for Colin. A number of the competitors over the last number of months have been introducing vacuum robots with some new capabilities, including remote monitoring. I am encouraged to get your thoughts on just at a high level, whether you think features like that are sort of something of a Swiss Army knife approach or whether they make sense to incorporate into a vacuum robot?

Colin Angle

It’s a great question with a long answer, because it all has to do with whether or not the features that are being added can be effectively used by the customer, whether the customer would value that feature and – or whether it’s just more unusable complexity. People that put security cameras on robots before with no success. Is it a bad idea. I think we can say it was a bad idea executed as it was executed when it was tried before. So, I think people are wondering what is – what can they do, how can they go and further differentiate their robots. And our competitors like to just add stuff. Our strategy is really around how do we make the experience of owning the robot one where you feel like you are more in control and you are able to get the robot to do what you wanted to do, when you wanted to do it and have it operate the way you wanted to do it intuitively and effectively, so you feel like the robot is your partner in cleaning your home. I would tell you, blindly adding stuff to the robot is going to have a negative impact in people’s interest in the robots. So, you would really have to do it thoughtfully as part of a larger strategy that would bring customers along with you in order to succeed. So again, not a simple answer, but there is a lot of bad ways of just adding stuff to your product.

Ben Rose

Okay, that’s helpful. Thank you.

Colin Angle

Okay.

Operator

Thank you. I am showing no additional questions in the queue at this time. I would like to turn the conference back over to management for any closing remarks.

Andrew Kramer

Thank you, Howard. That concludes our second quarter 2021 financial results conference call. We appreciate everybody’s support, your participation today. We certainly look forward to talking with you over the coming weeks and months. Thank you again.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This concludes the phone call. You may now disconnect. Everyone, have a wonderful day.