Roku, Inc. (ROKU) Earnings Call Transcript & Summary

Ready? Okay. Please note that all important disclosures, including personal holdings disclosures and Morgan Stanley disclosures appear on the Morgan Stanley public website at morganstanley.com/researchdisclosures or at the registration desk. My name is Ben Swinburne, Morgan Stanley's media analyst, and we're thrilled to welcome back to the conference, Roku. And to my left is the CFO of Roku, Steve Louden. Steve, thanks for coming back to the conference.

Yes. Thanks for hosting.

Absolutely. I want to talk to you about sort of the quarter you reported, the outlook for 2020, sort of where you guys are focused on the business, but I think we should at first just talk about everyone's focused on, which is all the volatility in the market and sort of the coronavirus implications, if there are any for your company and how this may impact business. If you could just hit that one first, and then we can dive into some more interesting topics.

Yes, I hadn't noticed the volatility, so you have to tell me more about that. But no, thanks to everybody for joining. I'm not sure if you guys are the smart ones or the tough ones, but I appreciate everybody being here today. Yes, in terms of coronavirus, what we mentioned is, today, we've only seen minor impacts, largely around supply chain in manufacturing. We had moved our Player manufacturing into Vietnam in the fall as a result of the potential tariff situation. But like the rest of the industry, a lot of the component supply chain runs in part through China. And so to the extent there's continued disruption or significant disruption of the supply chain, so that can impact our ability to replenish our inventory. We had a great holiday season, so now is the time of the year where you usually replenish your Player inventory. And a similar situation occurs with our TV partners, although they each have their own strategies. So something we're continuing to monitor closely.

Okay. And on the platform side, then, I guess, it sounds like no real implications. Is it the time...

Yes, to date, correct. But again, we'll monitor it.

Okay. So you ended last year, I think, 37 million active accounts. Your platform revenues have more than tripled in the last 2 years. What are the priorities for you and the Roku team as you guys look into 2020?

Yes, sure. Yes, just as a primer for folks, if you're less familiar with Roku, Roku's business model is basically in 3 phases. So first, regards to where we're at, we need to build scale. We measure that by active accounts. Secondarily, we want to drive engagement on the platform. We measure that by streaming hours. And then Phase 3 is the monetization of the platform, and we measure that by ARPU. So in terms of priorities, certainly, in the U.S., we're continuing to build out our monetization. The trends towards streaming continue to accelerate on a consumer side, and then the video advertising budgets are moving over, but more slowly. But in general, we've had a great track record of growing the active account basis, like you said, 37 million. We had 40 billion streaming hours last year, which was a new record and a great milestone, and then our ARPU was over $23 last year, which continues to move up over time. So all those different key operating metrics are moving nicely in the right direction.

You guys invested behind -- I mean you did a lot last year, but sort of 4 specific initiatives, the ad business, the Roku Channel, Roku TVs and then international. I'm wondering if you could just touch on sort of the most important things you think you accomplished last year in those areas and how they set you up for the future.

Yes. So certainly, one of the biggest value creators at Roku now and in the long term is the ad business. So we made significant progress on the ad business, both organically and then we had the acquisition of dataxu near the end of the year. So we continue to invest in the -- what we consider the leading OTT advertising platform in terms of driving video advertising. We have best-in-class audience development capabilities. So that's marketing opportunities with on the platform. And then with the inclusion of dataxu near the end of the year, we're in the process of integrating, but that allows us to shift the conversation from buying on -- buying Roku inventory specifically to a broader OTT-wide conversation and also being able to target folks on Roku as well as retarget them off-platform using the omnichannel capabilities of dataxu, so following them to mobile and desktop. So advertising, we made a lot of progress in 2020. We said that our Roku monetized video ad impressions will continue to double. They did last year. And we've, as part of our outlook, said that we expect that to continue. So that's advertising, first and foremost. Roku TV, another strategic investment area. We made very good progress in '19. So we were 1 in 3 smart TVs sold. We're running the Roku operating system. We had a great milestone on the Roku TV side. We passed Samsung as the #1 smart TV operating system in the U.S., which is amazing considering that program is only 5 years old. We continue to sign up OEMs, get more share from -- more share of models from OEMs, and our OEMs continue to gain share for folks that have kept their proprietary operating systems. So in that -- and then we'll talk more about the international side, but there's a lot of great opportunity for Roku TV international. The Roku Channel as well made really good progress. Roku Channel is only 2.5 years old, and it's already a top 5 app in terms of reach. And we continue to add to the depth of the content as well as broaden the category. So last year, we created premium subscriptions, which is adding SVOD subscription services within the Roku Channel. Historically, the foundation of that has been free ad-supported TV, so we added SVOD services. We added linear feeds within that. So we now have 55-plus linear feeds. And then later in the year, we added the kids and family category as well. And so that's been very successful. And we continue to move Roku Channel into other geographies as well. And then international, which we get a lot of questions about. We're just starting to really push on international. Job 1 at Roku has always been to win in the U.S., and we've been able to maintain and grow our lead in the U.S., and that's because the U.S. is well ahead of the rest of the world in terms of its adoption of streaming, it's also the most lucrative ARPU market, but we do believe that a lot of the same differentiators in the U.S. port to international, right? So the fact that we have a purpose-built operating system for TV is critical. That manifests itself in -- it's cheaper to build a Roku Player and a Roku TV, which is important globally. Our neutral positioning is really important. As we compete with Apple, Amazon and Google, a lot of the retailers, a lot of content publishers are wary of getting too close to them. And then the fact that we're experts and free ad-supported TV is even more important internationally. So we made some good progress. We announced Brazil recently. We announced a TV with Hisense in the U.K. We continue to make progress in markets like Canada, which is farther along. We're 1 in 4 TVs sold there now run Roku. We added the Roku Channel there. And now we're starting to light up ad sales. In Mexico, we've made great growth as well on the account side.

That's great. That's a great overview. I think we'll talk more about all of those things. Maybe just going back to advertising and your dataxu acquisition, which has been probably the biggest acquisition certainly recently that you guys have done. How do you plan on deploying that business as a platform inside of Roku? And what does it do for you guys from a customer perspective?

Yes, sure. Yes, historically, most of our growth has been organic. Anthony, our Founder and CEO, is a true innovator in the space. And so a lot of what -- of our growth vectors have been largely internally driven. But the dataxu acquisition is really a nice add-on to an already robust set of skills we have in the OTT ad space. And I think there are 3 things I would point to for dataxu. One is it helps us broaden the conversation from how do you buy advertising on Roku to how does Roku anchor a broader conversation about OTT advertising and the ability to target segments in OTT and then go find them in other channels as well. And so dataxu being a DSP allows us to broaden that conversation out, which we had gotten a lot of feedback from advertisers, agencies as well as content publishers that OTT is so new, and there's such a disconnect between the capabilities on different platforms and with different people in the ecosystem that they look to Roku as a leader, but they weren't -- we weren't able to help them with having an OTT buy or if they're a content publisher, sell some impressions that they had on another platform. So that first and foremost helps shift that conversation. Secondly, we look at the dataxu not as buying a book of business, but buying the technology and the team, they're really -- their automated buying and planning tool set is really advanced and their team, especially around the engineering side and the data science side, are really well developed. It's a great group of folks. And so we are in the process of integrating them into the various Roku departments and then focusing more on a consolidated sale. And then thirdly, for dataxu, and I think this one will take longer to manifest itself is we had historically been focused on talking to large advertisers and the agency holding companies to bring their budgets over. Those are the big pools of money that need to come over to follow the viewership from traditional TV to streaming. But dataxu's focus was on the small- to mid-sized advertisers, which we had not looked at at all. And if you think about scale digital platforms, most notably, Facebook and Google, what you see is a surprising portion of their revenues are actually from that small to midnight -- mid-sized segment.

Sure. Got it. That all makes sense. And you talked a lot about the international expansion, 9 OEMs -- partnerships announced in Mexico, some more in Europe and Brazil. How are you feeling about the progress you guys have made in terms of adding partners overseas, since I think you announced international about a year ago, as sort of a key strategy for you guys?

Yes. So our international expansion has been around longer, but frankly, it's very opportunistic. When we were smaller, we were focused on the U.S., as I mentioned. And so we basically put some players in different markets largely via third-party distributors and really didn't spend a lot of time on the other aspects of creating a thriving Roku ecosystem in different markets. So yes, last year, we announced that that was going to be one of our strategic investment areas. And we were putting more and more efforts. I think we feel pretty good about it. It's definitely a focused approach. And so we've been looking at how do we bring the differentiators in Roku to bear in terms of being able to drive accounts, ideally through both Players and TVs, being able to sign up relevant local content providers, and then over time, build scale so that we can light up ad sales and add things like TRC. So good progress in '19. I think we're going to continue to emphasize it in '20, and there'll be more to come on that front.

As you guys have continued to drive impressive top line, you've opted to reinvest that gross profit back in the business. What's the time line for starting to show maybe some operating leverage? How should we think about your appetite to reinvest back in the business versus sort of drive some profitability over a certain period of time?

Yes. So I mean the long-term goal is to drive a fast-growing, profitable business over long term. Given the -- how fast the business is growing, given how quickly the OTT ecosystem is evolving, it's hard to give a specific number. But what I would say is each year, and we kind of revisit this throughout the year, is that we look ahead and we say, "Okay, what are the investment opportunities we have, how does the road map look?" And when we talk about investment, largely, we invest in our people, and the people are able to drive forward on the road map. So our investments are largely more engineers and more salespeople. And so that's where we look at it. So for us, it's very clear that it's early days. We have a commanding position in the U.S. We think a lot of those differentiators port nicely to international, and there's a lot of growth in these other core areas like the Roku Channel, Roku TV and ads. And so we think that is the value-maximizing play at least for 2020.

And on that gross profit reinvestment, Steve, is -- are the gross margins we've been seeing and that you're guiding to this year sort of high 50%, 60%, you see that as a sustainable long-term gross margin for the company?

Yes. So just to clarify, those are the Platform gross margins. The overall gross margins are in the kind of mid-40s range. Yes, so in terms of Platform gross margins, what we said is that, over time, as the video ad piece becomes a greater share of Platform, then the margins will tick down over time. The video ad business runs at roughly a 50%-plus gross margin. There are other pieces within Platform, such as the rev shares, SVOD and TVOD rev shares, which are much higher margin. And then you have other pieces within advertising, audience development as well as the sponsorships that are high margin. We also have some areas that are lower margin because of the accounting treatment, like the premium subscriptions, which is SVOD services within the Roku Channel. We're the wholesaler there, so that's a gross treatment. That business is great for revenue and gross profit dollars, but because of the treatment, it's lower gross margin. So over time -- that platform gross margin will trail down over time, but we're focused on driving gross profit dollars, and we're very happy with the growth of the overall company and specifically platform, which is the key engine.

Got you. I promise we're not going to ask about ASC 606 or 605 in this stage, for that matter. Let's shift to active accounts. So you mentioned before, you guys have -- I think around 1 in 3 smart TVs sold last year were Roku Powered. Why have the OEMs adopted Roku as their operating system? And what do you see is the sort of competitive landscape, when you guys look at it at the TV OS landscape?

Yes, sure. So yes, certainly, there is a transformation on smart TVs over to license operating systems. We're the primary driver of that. But I think a quick analogy is really helpful. If you look back to what happened to phones and the handset manufacturers, there was a situation where they all had their proprietary operating systems and Android OS for phones came on the market, and it was a better mousetrap. And so what you had is some of the TV handset manufacturers adopted that, they tended to get better reviews, and they started to gain market shares. And then you had some of the larger companies, the incumbents that held on to their proprietary operating systems, and they lost market share over time. That exact phenomenon is happening with TVs right now. So the main competitive set that we are facing with Roku TV is actually getting the TV operating -- or the TV OEMs to actually switch from their own proprietary operating systems. Now we -- the value proposition of Roku TV operating system is actually very strong. It's cheaper to build a Roku TV because of the purpose-built operating system. We have way more content, an easy to use UI. We can get them differential retail replacements. Because of the UI and the OS itself, there's actually lower return rates, which is really important to the thin economics in that business. And then we actually do the software updates as well. So the actual value proposition is really compelling. And so you see a lot of OEMs -- we're now up to 16 OEMs, and you see that we've gained 0 -- from 0 market share 5 years ago to 1 in 3, and that's starting to replicate elsewhere, right? We mentioned in the last shareholder letter, that we were 1 in 4 TVs in Canada. And as you mentioned, we're signing up more -- we've gone from 2 to 9 OEMs in Mexico.

And for those major OEMs who have resisted the value proposition, is that simply inertia and sort of wanting to have everything in-house because of a sense of ownership? Or what do you think is keeping them from moving over faster?

Yes, I think that's part of it. What I would say is, and I think it's -- again, this is a similar situation to history is, if you have a strong market share, you usually have pricing premium. And as a result, you want to stay differentiated. And so I think the concern is if you adopt the license operating system that reduces your differentiation and, hence, does that have an issue for your pricing premium. So a couple of the bigger traditional TV OEMs have stuck with their proprietary operating systems, and as a result, they've lost significant share. When we started the program in the U.S., Samsung had over 1/3 of the market share 5 years ago. They're now under 1/4. LG has lost, I think, almost half their market share. So I think it is a true innovator's dilemma. So I'd rather be on our side of that equation.

Are there things that Roku can do to help the OEMs sell more TVs beyond just having the sort of best OS out there in order to drive their business? I mean TCL has been an unbelievable share gainer partnered with Roku.

Yes. Certainly, they have and kudos to their U.S. team. I mean they went all-in on Roku from the get-go 5 years ago. Most of the other OEMs, because there are a lot of internal constituencies, have dabbled. They start with a small subset of Roku OS models, and they realize they sell very well. We get them differential placement with retailers and so we get more models over time. But certainly, that -- many of our OEMs have increased their market share, but most notably, TCL because they went in for the get-go. Certainly, the Roku operating system itself is the core, having a TV that's better, that's cheaper to build is important. The other thing we do, whether it's Players or TVs, is we work on making sure the product is the best it can be because we don't do any brand marketing for Roku. Our brand marketing equivalent is we win consumer and professional reviews, and we get the PR from that. And so the fact that there's a Roku co-brand on the TV is important. We leveraged our Player relationships with retailers to get our TV OEMs placement at key retailers that they wouldn't -- they haven't been able to get on their own. And then the fact that these TVs are winning CNET Editors' Choice awards gives it a good brand halo, and they're well reviewed by the consumers on different websites is really important as well.

Sure. And do you think -- last question on this topic. But do you think the economic relationship between Roku and OEMs evolves over time. Or maybe not just Roku, but in the industry between OS and OEM, if you think there's a big change over time. Obviously, a lot of focus on rev share and things like that in the market.

Yes, there's certainly a lot of swirl about rev-sharing economics. I mean the important thing to remember is when we start with a -- discussion with an OEM, we don't start at 0. We start at giving them a big gift of a way better TV that's cheaper to build and getting them retailer placement that they likely couldn't get on their own. So certainly -- we're a public company. People can see that our ARPUs are increasing. And certainly, people would love to participate in that, but it's very, very important to us. We don't pay rev shares. I haven't -- I've heard a lot of rumors of other rev shares in the industry. I don't have any credible evidence of that personally. But I think it's important to understand how much value Roku is bringing to the table, both in terms of the actual TV sale, but then we're the ones that do the software updates. We've got all the functionality on the monetization side as well.

So we've been talking at this conference about streaming nonstop. A lot of media companies, like Viacom this morning, talking about their house of brands and what they're going to be doing. What are people watching on Roku? Can you tell us a little bit more about sort of subscription versus ad-supported? General entertainment versus -- I think there's over 7,000 apps on the service. So there's a lot going on in engagement.

Yes. So overall, the world is moving to streaming. What's great to hear about everybody talking about streaming is when I showed up at Roku 5 years ago, we spent most of our time trying to convince folks in the -- some of the folks in the audience here that streaming was a real thing. So now, we don't have to sit and talk about that anymore, so that's good. But in general, like the overall trends for streamings are increasingly apparent and accelerating, right? Cord cutting is accelerating. A lot of the media companies that were a little bit wary of getting into streaming have now gone in full boat. So that is great. In terms of the behavior on the platform, what's interesting is that over time, the viewership continues to broaden out. And one of the biggest trends that has been consistent on the platform a couple of years, but I think a lot of the industry has really underestimated is the power of free ad-supported TV viewing. And so as a platform owner, we have this data years ago, and we did a lot of research, and that's why we created The Roku Channel, 2.5 years ago. At the time, the entire industry was seemingly SVOD-focused and chasing Netflix. And everyone thought that why would anyone watch ads in OTT when you can just pay a little bit more. Well, the behavior suggests and the research confirms that most people come to OTT for choice, everyone gets that. But a close second is value. They're fleeing their overburdened cable bill of $80 to $100. And they don't want to stack SVOD services one on top of the other to get back to that. And so they have a certain amount of SVOD services that have a permanent spot, and they have a rotational spot as well. Game of Thrones is on over at HBO, so I'm going to light that up for a month or 2. Okay. Great. Billions is over here on SHOWTIME. New season, I'm going over there, and then I'm going to Hulu next month for Handmaid's Tale still coming back. And so I think that's one of the things that's underappreciated is how the pricing aspect and just wanting to keep a reasonable bill drives consumer behavior. So certainly, that ad-supported trend has been really big for us. And then I think within that, you're starting to get more of the viewership, not only on to on-demand, but live streams and other things. And that's -- a lot of the reason why The Roku Channel not only has gotten deeper content but also broader categories of content.

Before we spend more time on The Roku Channel, what is your -- give us the pitch you make to publishers, both on the subscription side in terms of the content distribution, and on the advertising side to work with you to sell inventory? What does Roku bring to the publishing community?

Yes. Well, I think, first and foremost, it brings the largest, most-engaged streaming base in the U.S. 37 million active accounts, as we talked about, the vast majority of those in the U.S. Last year, as I mentioned, we passed 40 billion streaming hours in the year, which is just an amazing amount. And so I think if you're a publisher and you want to monetize your content, regardless of the model, you need to be where the people are streaming, right, and where the biggest potential lies. Secondarily, our pitch to them is unlike other streaming platforms, we -- our -- all of our revenue models are built so that we create value for the content publisher, and then we share a fair economic portion of that versus their inherent conflicts, either competing with content or having their own play stores or things like that. And so for us, that's another important part on neutrality. And then on the ad side, we have the best-in-class ad capabilities. And then increasingly, we talk to folks about The Roku Channel. Everyone is certainly welcome to put a stand-alone app on the platform, and for certain content publishers, that's a very successful strategy. Largely, that's around having a critical mass of original exclusive content to become a true destination. For a lot of the other folks, The Roku Channel is maybe a better, more efficient way to monetize because as the platform owner, we know who's watching versus if you have a stand-alone AVOD app, you don't know who's watching. Hence, because we know who's watching and we have a lot of data on behavioral trends and interest, we can customize the content that shows up in The Roku Channel, hence, the content recommendation algorithm for us, is more efficient. And then because we know who's watching, we can sell that same ad impression that might show up in a stand-alone AVOD for a premium CPM. And hence, even if you're getting a rev share from Roku, you likely will be making more per hour than you could on your own. Plus, you have a multiple of traffic because we can drive more traffic through The Roku channel.

Got it. If there's questions in the audience, please raise your hand and wait for a microphone. And while we wait, just one more from me, Steve. On The Roku Channel. Are you interested in at all directly licensing content from studios or even maybe getting into the production business? Or do you look at this much more as a way to aggregate publisher content in a rev share model, which has been the historical approach?

Yes. So in terms of licensing, we're definitely interested in licensing. Our predominant model is the rev share, roughly a 50-50 rev share. Although we have, since the get-go at The Roku Channel done some fixed licensing fees. Largely, it's because there are certain studios out there that haven't embraced the rev share model yet. We think it's a better model for both parties. It obviously keeps our costs more variable, and we can dial it up and down with viewership. But we do that. In terms of original content, we don't have any plans for original content, notwithstanding the article that came out this morning that said we did. It included a nice quote that we don't have any plans for original content.

Right, right. Okay, we've got time for maybe one question, if there is one out there, if you have a question for Steve. Yes, right here in the middle? Is there a microphone? Yes.

[indiscernible] call it, 2 or 3 minutes -- sorry, distributors getting 2 or 3 minutes of ads to sell on cable, content owner keeps the rest. How's that split with you guys?

Sure. Yes, so in case folks didn't hear, the question was the traditional cable deals, they get 2 minutes on the hour out of the ad load, and so how does that compare with Roku. So there's a couple of different models on Roku. If there's a content publisher with a stand-alone app on the platform and it's ad-supported. We get an inventory split of that. The click-through agreement standard is 30%. Although some of the other bigger deals are -- they're part of our broader negotiation. And then within The Roku Channel, that runs a 50-50 -- roughly a 50-50 rev share split similar to other digital distribution models like YouTube.

We can do one more. There's a microphone. I can also repeat it if -- let's take the last question.

There seem to be brewing sort of new-age carriage fights. You guys have been involved in a couple of those lately with publishers who believe their content is powerful on its own and you guys believe your distribution is powerful. Over time, do you believe you'll be able to hold on to the rev share and never see it go to a -- flip the model where they might be able to charge you to distribute their content?

The -- I think the primary difference is there are a lot of legacy media companies that come to OTT with that traditional cable mindset where the cable companies are charging the users, and then they're basically negotiating or fighting over kind of the user fees and how much they should push those up. OTT has a very different model in terms of -- we don't charge the consumer anything. So it'd be hard for us to pay something that we don't charge for. And so our model is basically -- we can create a best-in-class streaming platform, the best-in-class audience development, basically marketing tools for content publishers, we can help you make a bunch of money, and we want a fair economic value of that. Now we have thousands and thousands of apps. We tend to sign shorter deals because as our scale has been growing significantly, in general, we're getting better economics. We've become a more essential partner over time for the ecosystem. And now in the U.S., if you want to have a legitimate OTT offering, you need to be on Roku, right? We're the biggest and most engaged base. And so we're happy to do deals with folks, but we also want to have fair economics. And so that's important for us.

All right. We're out of time. Steve, thank you so much.

Okay. Thanks, everyone.

Thanks, everybody.