Streaming TV platform Roku (NASDAQ: ROKU) reported Q2 FY2023 results topping Consensus expectations, with revenue up 10.8% year on year to $847.2 million. The company also expects next quarter's revenue to be around $815 million, roughly in line with Consensus. Roku made a GAAP loss of $107.6 million, improving from its loss of $112.3 million in the same quarter last year.
Roku (ROKU) Q2 FY2023 Highlights:
- Revenue: $847.2 million vs analyst estimates of $774.5 million (9.38% beat)
- EPS: -$0.76 vs analyst estimates of -$1.26 (39.8% beat)
- Revenue guidance for Q3 2023 is $815 million at the midpoint, above analyst estimates of $808 million
- Free cash flow of $129 million is up from -$208 million in the previous quarter
- Gross Margin (GAAP): 44.7%, down from 46.5% in the same quarter last year
- Active Accounts: 73.5 million, up 10.4 million year on year
Spun out from Netflix, Roku (NASDAQ: ROKU) makes hardware players that offer access to various online streaming TV services.
Roku was originally founded by Anthony Wood in 2002 – the name Roku means six in Japanese – it was Wood’s sixth company he founded. He would eventually go to work at Netflix tasked with developing a Netflix branded streaming player. Days before launch, Netflix decided it couldn’t release its own hardware player that would put it into competition with other hardware distribution partners like Sony or Samsung, so instead it spun Roku out.
Roku’s streaming content operating system runs on either Roku TV models or as the OS on a range of smart TV models. The company owns and operates the Roku channel, a collection of content offered for free. Its business is built on scaling the number of active accounts to grow the number of hours of viewing throughout its ecosystem, and then monetize through a combination of advertising and commissions from sales of subscription services.
The Roku ecosystem offers benefits to each of its stakeholders, ranging from consumers, content publishers, advertisers, Roku TV brand partners, and other partners. Consumers can discover and access a wide variety of streaming content, content publishers have access to a large base of over 50 million customers, while advertisers can leverage Roku’s data to serve targeted and measurable ads to TV viewers who increasingly don’t watch TV through traditional channels.
Consumers today expect goods and services to be hyper-personalized and on demand. Whether it be what music they listen to or what movie they watch, or finding a date, online consumer businesses today are expected to delight their customers with simple user interfaces that magically fulfill demand. Subscription models have increased usage and stickiness of many online consumer services.
Roku (NASDAQ: ROKU) competes for streaming TV subscribers with Apple (NASDAQ: AAPL), Alphabet (NASDAQ:GOOG.L), Amazon (NASDAQ:AMZN), and competes with Disney (NYSE:DIS), Netflix (NASDAQ: NFLX), AT&T’s Warner (NYSE:T) and ViacomCBS (NASDAQ: VIAC) for streaming audiences, and a range of streaming advertisers notably YouTube and Amazon.
Sales Growth
Roku's revenue growth over the last three years has been very strong, averaging 37.1% annually. This quarter, Roku beat analysts' estimates but reported mediocre 10.8% year-on-year revenue growth.
Guidance for the next quarter indicates Roku is expecting revenue to grow 7.04% year on year to $815 million, slowing down from the 12% year-on-year increase it recorded in the same quarter last year. Ahead of the earnings results, analysts covering the company were projecting sales to grow 8.46% over the next 12 months.
Usage Growth
As a subscription-based app, Roku generates revenue growth by expanding both its subscriber base and the amount each subscriber spends over time.
Over the last two years, Roku's monthly active users, a key performance metric for the company, grew 16.8% annually to 73.5 million. This is solid growth for a consumer internet company.
In Q2, Roku added 10.4 million monthly active users, translating into 16.5% year-on-year growth.
Revenue Per User
Average revenue per user (ARPU) is a critical metric to track for consumer internet businesses like Roku because it measures how much the average user spends. ARPU is also a key indicator of how valuable its users are (and can be over time). 
The company's ability to increase prices while maintaining its monthly active users shows the value of its platform. This quarter, ARPU declined 4.85% year on year to $11.53 per user.
Pricing Power
A company's gross profit margin has a major impact on its ability to extert pricing power, develop new products, and invest in marketing. These factors may ultimately determine the winner in a competitive market, making it a critical metric to track for the long-term investor. Roku's gross profit margin, which tells us how much money the company gets to keep after covering the base cost of its products and services, came in at 44.7% this quarter, down 1.8 percentage points year on year.
For internet subscription businesses like Roku, these aforementioned costs typically include customer service, data center and infrastructure expenses, and royalties and other content-related costs if the company's offering includes features such as video or music services. After paying for these expenses, Roku had $0.45 for every $1 in revenue to invest in marketing, talent, and the development of new products and services.
Roku's gross margins have been trending down over the last 12 months, averaging 44.8%. This weakness isn't great as Roku's margins are already far below other consumer internet companies and suggest shrinking pricing power and loose cost controls.
User Acquisition Efficiency
Unlike enterprise software that's typically sold by dedicated sales teams, consumer internet businesses like Roku grow from a combination of product virality, paid advertisement, and incentives.
It's very expensive for Roku to acquire new users as the company has spent 66.2% of its gross profit on sales and marketing expenses over the last year. This inefficiency indicates a highly competitive environment with little differentiation between Roku and its peers.
Profitability & Free Cash Flow
Investors frequently analyze operating income to understand a business's core profitability. Similar to operating income, adjusted EBITDA is the most common profitability metric for consumer internet companies because it removes various one-time or non-cash expenses, offering a more normalized view of a company's profit potential.
Roku reported negative EBITDA of $17.8 million this quarter, resulting in a -2.1% margin. The company has also shown rather mediocre profitability for a consumer internet business over the last four quarters, with average EBITDA margins of -6.73%.
If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills. Roku's free cash flow came in at $129 million in Q2, turning positive year on year.
Roku has burned through $166.4 million of cash over the last 12 months, resulting in a negative 5.85% free cash flow margin. This below-average FCF margin stems from Roku's continuous need to reinvest in its business to penetrate the market.
Key Takeaways from Roku's Q2 Results
Although Roku, which has a market capitalization of $10.1 billion, has been burning cash over the last 12 months, its more than $1.8 billion in cash on hand gives it the flexibility to continue prioritizing growth over profitability.
We were impressed by how significantly Roku blew past analysts' revenue expectations this quarter, partly driven in a beat in Active Accounts and partly by revenue per Active Account. Additionally, adjusted EBITDA beat expectations. The only minor negative we found was that revenue decelerated. Overall, we think this was a really good quarter that should please shareholders. The stock is up 8.52% after reporting and currently trades at $74 per share.
Is Now The Time?
When considering Roku, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We cheer for everyone who is making the lives of others easier through technology, but in the case of Roku we will be cheering from the sidelines. Its revenue growth has been impressive, and that growth rate is even expected to increase in the short term. But while its growth in monthly active users has been healthy, the downside is that its sales and marketing spend is very high compared to other consumer internet businesses and its gross margins make it more difficult to reach positive operating profits compared to other consumer internet businesses.
Roku's price/gross profit ratio based on the next twelve months is 6.2x. While we have no doubt one can find things to like about the company, and the price is not completely unreasonable, we think that at the moment there might be better opportunities in the market.
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