ROKU, INC quarterly report, Q3 FY2017

Business context and reporting period

Roku, Inc.’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2017, compared with the periods ended October 1, 2016. Roku operates a Player segment, selling streaming devices, and a Platform segment, generating advertising, subscription and transaction revenue shares, and licensing fees. The filing was made shortly after Roku’s October 2, 2017 IPO.

Financial performance and key metrics

• Q3 revenue grew 40%; platform revenue rose 137% to $57.5m, while Player revenue increased 4% to $67.3m. For the nine months, revenue grew 29%, with Platform up 108% to $139.9m and Player revenue nearly flat at $184.6m.
• Gross margin was approximately 40% in Q3 (29% prior year) and 39% for nine months (30% prior year). Platform supplied 89% of nine-month gross profit. Player gross profit fell 38% in Q3 and 31% year to date, reflecting lower selling prices and sales incentives.
• Active accounts reached 16.7m, up 48%; hours streamed were 3.78bn in Q3, up 58%, and 10.52bn year to date, up 60%. Trailing-four-quarter ARPU was $12.68, up 37%.
• Cash was $66.9m at September 30, versus $34.6m at December 31, 2016. Total assets were $225.5m; current assets $197.5m and current liabilities $145.5m. Deferred revenue totaled $69.6m.
• Nine-month operating cash flow was positive $31.2m, versus cash used of $12.9m in the prior-year period. Investing used $9.6m and financing provided $10.8m. Operating cash flow benefited from working-capital movements and noncash adjustments, including the warrant remeasurement.
• Debt obligations were $25.0m gross at September 30, with a $23.0m carrying value after discounts and issuance costs; there were no revolver borrowings. The company reported compliance with its debt covenants.

Material changes versus the prior comparable period

• Platform growth materially shifted revenue and gross profit mix: Platform was 46% of Q3 revenue versus 27% a year earlier, while Player’s share fell to 54% from 73%.
• Player unit volume grew 35% in Q3 and 37% year to date, but average selling prices fell 23% and 27%, respectively. Player gross profit consequently declined despite higher sales volume.
• Operating expenses increased 44% in Q3 and 26% year to date, led by research and development investment and increased staffing.
• Net loss widened substantially, principally because the fair value of preferred stock warrant liabilities generated noncash expense of $37.7m in Q3 and $40.3m for nine months. These warrants converted to common-stock warrants after the IPO.

Outlook, risks, contingencies and unusual items

• Management expects continued investment and increases in research and development, sales and marketing, and general and administrative expenses. It plans to prioritize active-account growth and Platform monetization, including accepting lower Player margins; it cautions that profitability may not be achieved or sustained. No numerical forward guidance is provided.
• After quarter-end, the IPO raised $134.8m net of underwriting discounts and commissions, before approximately $4.0m of offering costs; the filing elsewhere reports approximately $130.8m net after total expenses. Preferred shares converted into Class B common stock.
• On October 31, 2017, Roku repaid and terminated its subordinated term loan. The repayment is expected to result in a $2.338m debt-extinguishment loss; certain warrants tied to future borrowing were cancelled.
• Roku had $87.2m of manufacturing purchase commitments, primarily with a major vendor, and relies substantially on a single contract manufacturer. Changes in demand could leave the company with excess inventory or supply shortfalls.
• A temporary Mexican court order banning import and sale of Roku devices remained in effect; Roku was not named as a defendant in the underlying case and was challenging the ban. The filing cites a $0.9m inventory write-down related to the restriction.
• Content concentration is significant: the top five channels represented about 70% of streaming hours, with Netflix about one-third. Roku reported that Netflix revenue was not material and its distribution agreement was in its final year, with renewal anticipated. The company also noted that it earns no revenue from YouTube, its most-viewed ad-supported channel.
• Other key risks include competition, reliance on advertising inventory and content partners, privacy and cybersecurity, intellectual-property claims, seasonal sales, and evolving regulation. Management said it was not aware of ordinary-course disputes expected to have a material adverse effect, while noting potential litigation costs and disruption.
• The September 2017 launch of The Roku Channel adds advertising opportunity but also content and operating costs; Roku receives no subscription fees from users of the channel.

Important facts for investors to verify

• Whether Platform growth and ARPU gains continue, and whether they translate into durable gross profit and operating profitability.
• Player pricing, unit volumes, and margins, including whether lower device prices deliver sufficient active-account growth.
• The composition and sustainability of operating cash flow, particularly the effects of working capital, deferred revenue, and noncash warrant remeasurement.
• Post-IPO cash and share-count effects, and the final accounting for IPO costs, debt repayment, and the extinguishment loss.
• Exposure to manufacturing commitments and supplier concentration, and the status and financial impact of the Mexico restriction.
• Renewal terms for major content agreements, especially Netflix, and the ability to monetize viewing hours and ad inventory.