Roku Inc

NASDAQ:ROKU

Earnings Call Transcript 2017-Q4

[Operator]

Good day ladies and gentlemen and welcome to the Roku Fourth Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct the question-and-answer session and instructions will follow at that time. This conference is being recorded.

I would now like to hand the floor over to James Samford, Vice President, Investor Relations. Please go ahead, sir.

[James Samford, IR]

Thank you and good afternoon, and welcome to Roku's financial results conference call for the fourth quarter ended December 31, 2017. I'm pleased to be joined on the call today with Anthony Wood, Roku's Founder and CEO; Steve Loughton, our CFO. And Scott Rosenberg, the GM of our platform business, who will be available for Q&A.

Please be sure to review our shareholder letter which contain much more details and we will cover in the introductory remarks. The following discussion including responses to your questions reflects management's views as of today February 21, 2017 only and we do not undertake any obligation to update or revise this information.

Some of the statements made on today's call are forward-looking and are based on our current expectations, forecasts, and assumptions, and involve risks and uncertainties. These statements include, but are not limited to, statements regarding the future performance of Roku, including expected financial results for the first quarter and full-year of 2018 and the future growth of our business.

Our actual results may differ materially from those discussed on this call for a variety of reasons. Please refer to today's shareholder letter and the company's filings with the SEC for information about factors which could cause our actual results to differ materially from those forward-looking statements.

You'll find reconciliation of non-GAAP measures to the most comparable measures discussed today in our shareholder letter which is posted on the company's Investor Relations Web site at ir.roku.com. I encourage you to periodically visit our IR Web site for important content. Finally, unless otherwise stated, all comparisons on this call will be against our results for the comparable period of 2016.

Now, I'd like to turn the call over to Anthony.

[Anthony Wood, CEO]

Thank you, James, and thanks everyone for joining our fourth quarter earnings call. First, let me start by saying how pleased we are with the fourth quarter and the full-year. The world continues to move to streaming which is great for Roku. Our mission is to be the streaming TV platform that connects the entire TV ecosystem as all TV viewing moves to streaming.

We connect consumers with the content they love. We help content publishers and owners build audience and make money. We give advertisers the ability to reach millions of consumers who don't watch conventional TV and provide them with more effective tools like targeting and measurement, and we partner with TV brands and service operators, so they can thrive in this rapidly changing world.

In 2017, revenue exceeded $500 million and we ended an exciting year with a fantastic quarter. Active accounts grew 44% for the year. We acquire accounts by selling and licensing players and by our Roku TV program. We're competing effectively and each of these ways of acquiring accounts made an important contribution to increasing our base to more than 19 million accounts.

I want to take a second to highlight Roku TV for both the year and the quarter. Our Roku TV program had exceptional performance, one in five smart TV sold in the U.S in 2017 were Roku TV. Our investment and being the leading TV OS is paying off. We plan to continue making Roku TV not just a great streaming experience, but an incredible TV that is part of the users connected home.

For example, at CES, we announced plans to make it easy for consumers to wirelessly add great audio to their Roku TV and to enable our users to build home entertainment network around their home with the TV at the center. We made significant progress growing our platform gross profit, especially through advertising.

We're increasingly tapping into the $70 billion, to the U.S advertisers spend on TV as the TV ad ecosystem moves to streaming. More than half of the Ad Age's top 200 advertise on the Roku platform. Our investments of being the leading streaming ad platform are paying off.

The shift to streaming is creating huge opportunities for Roku. We plan to reinvest our increasing gross profit into areas we view as growth drivers during this time of transition to OTT. We also plan to operate the overall business at or near breakeven in 2018, as we did in 2017 and continue to strive the right balance is investing in future growth and minimizing losses. We are in the early stages of a major trend and Roku is well-positioned. It’s a great time to be in the streaming business.

I will now turn it over to Steve to comment on the results and outlook.

[Steve Louden, CFO]

Thanks, Anthony. We have a strong quarter and a strong year indeed. We saw robust active account growth of 44% to $19.3 million with over a half of the new accounts coming from licensed sources, primarily Roku TV. ARPU increased 48% year-over-year to $13.78 on a trailing 12-month basis with more than two-thirds of ARPU coming from advertising.

The largest driver of ARPU growth is video advertising. But we are also seeing very rapid growth from our audience development ads which are endemic display ads. Total Q4 revenue increased 28% year-over-year to $188.3 million bringing the full-year revenue to $513 million, up 29% year-over-year.

Platform revenue in Q4 grew 129% to $85.4 million with the largest contributor coming from our advertising. In fact, advertising made up roughly 75% of platform revenue in the quarter and was more than two-thirds of the $225 million of platform revenue for the year.

Our platform segment represented 45% of our total revenue in Q4, up from 25% last year. Both video and audience development advertising grew even faster than the overall platform revenue this quarter as we saw the number of advertising deals continue to grow and the average deal size increase as well.

Q4 gross profit increased 64% year-over-year to $73.5 million, driving full-year gross profit up 65% to $200 million. Platform gross profit grew 120% year-over-year to $63.7 million and represented 87% of total gross profit in Q4, up from 65% last year. Gross margin expanded approximately 9 percentage points to 39% in the fourth quarter.

Adjusted EBITDA more than doubled year-over-year to $14.4 million in Q4, up from $6.7 million last year and the full-year 2017 adjusted EBITDA loss came in just below breakeven at $3.3 million, a significant improvement compared to the loss of $29.9 million in 2016.

I would like to provide you a little more detail on our Player segment results for Q4. And as a reminder, Players are part of our active account growth strategy. We optimize our retail player business around unit growth, not revenue or gross profit. The combination of Roku TV, retail player sales and player licensing resulted in 44% active account growth for the year and quarter. Q4 player retail unit sales grew 8% year-over-year, while average pricing declined 14% year-over-year resulting in a 7% revenue decline.

Player units were up 25% for the year as a whole. Q4 items of note include the launch of our highly successful $29.99 Roku Express for the holiday season in 2016, opened a new price point for Roku consumers and we comp this lunch in Q4 of this year. We also lowered the MSRP [ph] for the ultra to 99.99 down from 129.99.

Operationally, during the quarter. we experienced some supply disruption that impacted player availability for certain models as well as drove higher airfreight charges. We enter 2018 with strong momentum and are very encouraged by the trends we're seeing in our platform segment. Based on what we see today, we now expect platform revenue to exceed player revenue in 2018.

Full-year total net revenue is expected to be between $660 million and $690 million, representing 32% growth year-over-year at the midpoint. We expect gross profit to grow even faster than revenues to between $275 million and $295 million, up 43% year-over-year and 42% gross margin at the midpoint. These figures include our preliminary estimate of the impact of ASC 606 adoption. We will have more disclosure on ASC 606 next quarter, but I wanted to highlight some initial thoughts.

The new revenue recognition standards change the way contracts are assessed. How value of the deal is assigned to individual performance obligation, and how noncash elements are treated. We've chosen to implement 606 with the modified retrospective approach. And thus, we anticipate that we will have a significant portion, approximately $35 million of our existing deferred revenue balance that will be attributed to prior period and recorded as retained earnings. And thus will be a headwind to revenue in 2018 and beyond.

It is the primary driver of the negative impact from 606 adoption to 2018 gross profit of approximately $10 million. In 606, we will need to book revenue and COGS related to noncash elements in our contracts. Most notably advertising inventory split, which will have a positive impact on revenue, but will also increase COGS. So we do not anticipate any long-term benefits to gross profit.

There could be quarterly differences depending on the revenue and COGS recognition time. In 2018, this revenue increase largely offset other negative 606 revenue impact, such that we do not anticipate that revenue will significantly change from a 605 basis.

W anticipate that 606 adoption will increase quarterly variability based on the size and timing of signing of new agreements or modifications with content partners and licensees. Our profitability goal for the year is to operate our business at or near breakeven on an operating cash flow basis, while we reinvest gross profit into areas that can drive continued long-term growth.

On a 606 adjusted basis, we anticipate an adjusted EBITDA loss of $10 million to $25 million. However, on a 605 basis, adjusted EBITDA would also be at or near breakeven in 2018. In terms of Q1 outlook, we expect Q1 to be our seasonally lowest quarter of the year from a revenue perspective. As in past years, we expect significant seasonality in our business with Q4 remaining the highest quarter of the year. For example, Q4, 2017 total net revenue was just under 37% of 2017 revenue.

Overall, we are very encouraged by the traction we're seeing in our platform segment as a key long-term driver of robust revenue growth and margin expansion, which gives us confidence that the business is continuing on a compelling trajectory.

With that, let's turn the call over to for questions. Operator?

[Operator]

Thank you. [Operator Instructions] And our first question comes from the line of Laura Martin with Needham & Company.

[Laura Martin, Needham & Company.]

Hi. Great job in the fourth quarter, guys. So Netflix is valued a $120 billion today, and it [indiscernible] at a big revenue multiple premium to Roku in part because it has some international growth runway Anthony, could you talk about whether international is in your blueprints for 2018? And then, one of the things that you said last quarter is that on your licensed TVs you had a bunch of ways to monetize that you don't have on your streaming sticks. Could you actually talk more granularly about that?

[Anthony Wood, CEO]

Hey, Laura, thanks for the question. Yes, so international, our primary -- the primary numbers that are in at our plan for international in 2018 are around Roku Powered, that’s historically in our primary path forward with international active account growth. So to remind you, Roku Powered is a licensing program for players. So players, we distribute players through retail. We also distribute players through large local in-region partners such as Sky in the U.K and Telstra in Australia. In terms of monetizing Roku TVs, yes, I mean, Roku TVs have very high connect rate. They have very high usage. They're great TV and I think importantly with the Roku TV when you turn on -- when a customer turns on the TV, they see the Roku home screen. So the home screen is where we start our relationship with the customer for that viewing section, they see things for example like display ads, [indiscernible] through the content that’s on the home screen, the applications are on the home screen. So it’s a great way -- its great for the consumers, but it also gives us a lot of [indiscernible] on what customers consumers ultimately end up viewing. So that’s one sources of monetization. Also I think in the past we’ve mentioned ACR, which is another -- which is a -- probably a longer conversation, but it's another way to monetize linear [ph] viewing. And I think importantly TV is at the center of a customer's living room experience. I mean, it's a great position to be in to control the software on a TV and to be a trusted partner for the consumer on what time they’re going to watch.

[Laura Martin, Needham & Company.]

Super helpful. My last one is for Scott, Roku Channel, your favorite subject, could you -- you talked last quarter and I’m interested in your breakout on this. I know it's mostly discovery mechanism for sort of high quality content that you’ve aggregated from a lot of your long tail apps. But you said last quarter that you’ve -- there is a lot of published content being published directly on Roku through that mechanism called Roku Direct Publisher. Could you sort of more granularly talk about who is publishing directly on Roku and monetizing through you that actually don’t have a app?

[Scott Rosenberg, General Manager and SVP, Advertising]

Hi, Laura, thanks. The Roku Channel had a great quarter. We launched it in September, you will recall and since that time its already become the number three ad supported channel on Roku. It's exceeded our expectations and is already material contributor to the video inventory that we sell through our advertisers. It's been a great success. It's also importantly an experience that we fully control and fully program. So that means we can bring to bear all the great ad products that we’ve built into our platform. Today we have major studios dedicating content into the Roku Channel directly, but also as you referenced we have a program called the Roku Direct Publisher program, which allows content owners in a codeless way to produce an app in the Roku Channel store. That content can also then be syndicated and shown up inside of the Roku Channel. So Roku Channel in that sense acts as a way to drive additional traffic, additional audience past content partners content.

[Laura Martin, Needham & Company.]

Got you and monetize it too right?

[Scott Rosenberg, General Manager and SVP, Advertising]

That’s right. Roku sells all of the advertising in the Roku Channel and then shares revenues back with the content providers.

[Laura Martin, Needham & Company.]

Super helpful. Thanks guys. Great quarter.

[Operator]

Thank you. Our next question comes from the line of Ralph Schackart with William Blair.

[Ralph Schackart, William Blair]

Good afternoon. A couple of questions please. I think last quarter you talked about Q4 platform gross margin has been around maybe 70% due to -- maybe some shifts in inventory sources. However, you had a much stronger than anticipated quarter there. Just curious what drove that outperformance? And then, second question relates to ARPU continues to show very strong reacceleration, if you grew around 49% year-over-year, which I think is a strongest growth you’re seeing since Q3 '16. Just curious what the primary drivers you're seeing there and how you -- how we should think about ARPU trends going forward? Thank you.

[Scott Rosenberg, General Manager and SVP, Advertising]

This is Scott. I will take the first question and I will let Steve Louden answer the second. In any quarter, the margin that we see in the platform business is a mix of a couple of factors. One is the cost basis or the revenue that we share with publishers for inserting video ads into their channels. It's also a function of the contribution of our audience development and sponsorship businesses both of which are extremely high margin. All three categories, video ad sales, sponsorships, and audience development showed really strong growth in Q4 and so that's what accounts for the margin shift that you mentioned. Steve?

[Steve Louden, CFO]

Yes, hi, Ralph this is Steve. So just on your ARPU question, ARPU growth was very strong. It has been accelerating. Just a reminder to everybody that ARPU metric is on a trailing 12-month basis. So if we just look at what it was each in the last three years at the end of the year, 2015 incurred 22% year-over-year, 2016, 43% year-over-year and then 2017, 48% year-over-year. So that has been on a nice start of acceleration. ARPU doubled over last couple of years and a lot of what Scott talked about are the drivers. And what I would say is advertising has been a key growth driver for us and the key investment area in capabilities. And we really start investing in the advertising business 3, 4 years ago. And what you're seeing is bearing of that fruit in terms of incremental capabilities on the platform around video advertising, the audience development business, sponsorships, and so we think this is still early days and there's a lot of great runway ahead.

[Ralph Schackart, William Blair]

Okay, great. Thank you.

[Operator]

And our next question comes from the line of Mark Mahaney with RBC Capital Markets.

[Mark Mahaney, RBC Capital Markets]

Thanks. Two questions on the platform side. Just broadly could you talk about traction you're having with different advertiser verticals -- advertising verticals and any notable wins there? And in secondly, just in terms of ad content partnerships any -- also signs of traction there, and maybe if you can include in any comments about YouTube or Google TV and whether that -- any of that’s becoming materially -- material for you ? Thank you.

[Scott Rosenberg, General Manager and SVP, Advertising]

Sure. Scott Rosenberg, here. The -- when I say about our ad businesses it is now very broad-based. Over half of the Ad Age top 200 national advertisers are now clients. We are seeing strength not from any specific vertical, we are doing business across all major ad verticals whether that’s CPG, retail, financial services, auto. And as [indiscernible] just an indicator that the product that we sell is the TV advertising product. So it's really an opportunity for any TV advertiser who is moving money out of linear TV into OTT. Some exciting developments that we began to see take traction in Q4 or for example the Roku Channel as we just talked about, because we fully program, the Roku Channel. It creates opportunities for us to craft, brand, integrations. We had a launch sponsor. When we launch the Roku Channel and we’re creating bespoke sponsorship opportunities for brands within the Roku Channel, we also saw good progress from the use of ACR which Anthony mentioned earlier, ACR is interesting technology because it gives us visibility into what's happening on the linear side of viewership and we're able to use that technology for example to show TV advertisers, the incremental reach that they would achieve by buying advertising from Roku over a linear only TV ad plan. I would also just say that our deal volume has increased significantly, the overall business has more than doubled. We are seeing very high return rates from our ad clients.

[Anthony Wood, CEO]

Hey, this is Anthony. I’m just going to add a few things about -- you had asked about YouTube and other content. I mean, there is a large secular shift happening as consumers move their -- from traditional linear TVs streaming, and that’s causing a lot of positive trends for us. We're just a great platform for distribution of streaming content. We are very well-positioned. We ended the quarter with over 19 million active accounts, but that was growing 44% year-over-year. I mean, if you would think about that as sort of a traditional U.S MVPD, that will put us in the top three of MVPDs, but unlike MVPDs which are flat are declining in growth, we run 44% year-over-year. So as content moves to streaming, we're a great platform to distribute that content and we have a lot of tools to help the volumes for those content partners.

[Mark Mahaney, RBC Capital Markets]

Thank you, Anthony. Thank you, Scott.

[Operator]

Our next question comes from the line of Jason Helfstein with Oppenheimer.

[Jason Helfstein, Oppenheimer]

Thanks. I will ask a few. Just to start with [indiscernible], it seems like most of the upside in the quarter did come from monetization, and it look like the bulk of that was either higher pricing or more time spent, but streaming hours kind of looked about what we’re looking for. So can you just talk about how much of that came from the Roku Channel versus other sources of inventory and kind of relative to your expectations going to the quarter where did you find more inventory, if it wasn't the Roku Channel? And then on 606, Steve, that $10 million should we be thinking about adding that back to 2019 and 2020, just because that spread out over time with respect to gross profit? Thanks.

[Anthony Wood, CEO]

We did see a significant expansion of the ad business in Q4 that owes in part to pricing which we continue to be able to drive as we layer in more capabilities. But frankly, it's mostly the results of just selling more and expansion, not just our video ad sales, but also sponsorships and our audience development business. The Roku Channel is already a material part of our inventory mix. It's important to us because it really is a best-in-class ad experience from both the consumer perspective as well as the ad products that we can provide to our publishers. But our publisher mix in terms of the inventory we sell remains important as well as part of achieving an advertisers reach goals for example. And the one other thing I would say is that the ad supported vertical remains our fastest growing vertical and that's really a function of just this appetite that consumers have for free ad supported content. Its ultimately a validation of the original thesis behind the Roku Channel, which is that ad supported viewing is going to be a huge component of OTT or ship [ph] long-term. Steve, do you want to tackle the situation.

[Steve Louden, CFO]

Sure. Hey, Jason I will tackle 606. So -- and just to know we will have more disclosure on 606 next quarter as well, but some additional thoughts on that. One, 606 is a different way of valuing contract assessing the different -- the value of the different performance obligations, and then also there's the valuing of non-cash pieces. That’s so -- there's a lot of things going on. One of the biggest items to know with 606 and that was in the prepared remarks was that our deferred revenue balance which at the end of '17 stood at $83 million. Our initial estimate is roughly $35 million of that will effectively go away with the 606 adoption. It will -- we're doing a modified retrospective which means it will -- that will not pass-through the P&L, it will go kind of straight to retained earnings. So, in terms of your question, a lot of that value is basically getting attributed to prior periods with the adoption of 606 and that’s really pulling out of revenue that we otherwise would have recognized on a 605 basis. 606 can also pull revenue in from 2019 and beyond or in some cases push it out, so there is really a lot of factors. But I would say the biggest factor of that gap is really the 606 revenue -- deferred revenue that have been flush back into prior periods. Yes, the $10 million.

[Jason Helfstein, Oppenheimer]

And then just a follow-up, Anthony, I think a lot of people, investors [indiscernible] are trying to figure out how to think about how you benefit again from the shift to skinny bundles and etcetera to your point, I mean, 19 million active accounts, growing 44%, is there a point and I'm not asking for a number, but do you conceptually think there's a point where you become big enough that you got leverage to demand more economics?

[Anthony Wood, CEO]

Well, I think, the way we think about it is that as more and more content comes to streaming, it's just creating better experiences for our customers as well as better economics for our partners. And as our scale grows, we are becoming increasingly important to partners at the way they plan to distribute their content. Not just our scale, I mean our scale obviously is really important, but also we built a platform with a lot of tools that can proactively build audience for content partners. So those are all very valuable to our partners and our business model is [indiscernible] economics with that content exchange to our distribution in building audience as well as advertising as an important part of our business model as well. So, yes, as our scale grows, I think that we're in a better positions to get a fair share of the economic for the content distribution.

[Jason Helfstein, Oppenheimer]

Thank you.

[Operator]

Thank you. [Operator Instructions] Our next question comes from the line of Ben Swinburne with Morgan Stanley.

[Benjamin Swinburne, Morgan Stanley]

Thank you. Good afternoon. Just a follow-up on 606, I think just to make sure I got it clearly. The gross profit adjusted EBITDA headwinds you called out in the letter and in the prepared remarks, that is the gross profit and EBITDA associated with the revenue that’s being as you described flush back into prior periods to have that right?

[Scott Rosenberg, General Manager and SVP, Advertising]

Yes, largely. So the impact of the flush is actually bigger than that, which could be partially offset by pulling in revenues that we otherwise would have recognized in 2019 or beyond. So, but the net effect is that. So for most of 606's impact, it's a negative to revenue to gross profit and down to EBITDA. There is one factor and this is around valuing the non-cash elements of the deal, most notably the inventory split that we get where you now need to value the revenue and the associated COGS with that inventory split. So that would be a positive to revenue as well as a -- an increasing COGS and hence no gross profit. So when you look at the net impact to the outlook that we're providing, revenue stays relatively flat from a 605 to 606 basis, but the gross profit we're estimating would be negatively impacted by about $10 million for 2018. And that’s a noncash peak, right.

[Benjamin Swinburne, Morgan Stanley]

Right. Okay.

[Anthony Wood, CEO]

This is Anthony. Just -- and also just to remind folks that the results of 606 accounting treatment is in our guidance. That was taken into account in our guidance.

[Benjamin Swinburne, Morgan Stanley]

Right. Anthony, I was wondering if you look at your plans for 2018, you laid out a lot of stuff in the letter about what your focus, but what are the one or two kind most important investment areas that you’re focused on for the year that you [indiscernible] overly drive the business longer term to that system that we can make sure we are paying attention to the right stuff?

[Anthony Wood, CEO]

Well, there's just a tremendous amount of opportunity. So it's hard to narrow down to what are the most important areas that we're focusing on, but I would call out, I guess, Roku TV is a very powerful way for us to build active accounts. It's being very successful. It has been very successful and we think will continue to grow an important one in five Smart TV sold in 2017 were Roku TVs, so that -- that’s an area we’re going to focus on building just a great TV and a great TV platform. Advertising, of course, is fueling our monetization efforts and we still believe there's lots of ways to innovate in our advertising platform and advertising business. Half of the Ad Age top 200 advertisers were clients on for Roku last year, which is amazing. There's $70 billion of standby advertisers in U.S on television advertising and that $70 billion is going to move to streaming, and we think there's a huge opportunity to capture a big part of that. So advertising Roku TV, but the Roku Channel is the big initiative for us. Our entertainment networks are a great way to make our TVs better. There's just a lot of areas that are driving our growth and that will ultimately contribute to continue to ARPU growth.

[Benjamin Swinburne, Morgan Stanley]

That’s helpful. And just lastly, and you guys don’t disclose the ad hours as a percentage of total, but I know you believe that will grow. Can you just tell us qualitatively if you look at Q4 of 2017, was it up year-on-year and are you seeing trends that suggest 2018 where you kind of see an uplift in the mix of hours towards ad supported and if there's any seasonality we should be thinking about in that mix, please let us know?

[Anthony Wood, CEO]

It continues to be our fastest growing vertical. And so, we remain very bullish on it becoming a bigger and bigger share of viewership on the platform.

[Benjamin Swinburne, Morgan Stanley]

Okay. Thank you.

[Operator]

Thank you. And that concludes our question-and-answer session for today. I'd like to turn the floor back over to Anthony Wood for any closing comments.

[Anthony Wood, CEO]

Thanks everyone for joining our earnings call. The fourth quarter and 2017 -- sorry, the fourth quarter was a great quarter for us, it was fantastic and 2017 as a year was also an incredible year for us. This was made possible through a lot of efforts. It's been a team effort both Roku employees, but also of course our partners who I want to thank, our employees and our partners. We never did more excited about the future of our business. It's a huge transition that’s happening as TV moves to streaming, its changing a lot of behavior and moving a lot of economics around and it's a big opportunity for us. We are looking forward to continue having these calls over the next months and years. Thank you.

[Operator]

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may now disconnect. Everyone have a great day.