In this Market Foolery podcast, host Chris Hill and David Kretzmann of Motley Fool Rule Breakers and SuperNova consider three unusually good earnings results. Beleaguered social-media giant Twitter (NYSE:TWTR) jumped by a double-digit percentage after its third-quarter report; better cost controls and some strategic shifts helped Buffalo Wild Wings (NASDAQ:BWLD) do the same.
But poor iRobot (NASDAQ:IRBT). Despite solid Q3 profits and raised guidance, the Roomba maker's shares got pummelled. Chris and David explain the stories behind the share prices, and they also finish up this week's discussion of overrated and underrated candy varieties with some great listener emails.
A full transcript follows the video.
This video was recorded on Oct. 26, 2017.
Chris Hill: It's Thursday, Oct. 26. Welcome to Market Foolery. I'm Chris Hill. Joining me in studio today, from Supernova and Rule Breakers, David Kretzmann. Happy Thursday!
David Kretzmann: Good to be here, Chris!
Hill: Big earnings day.
Kretzmann: Yeah, slightly.
Hill: We have, like, 10 different companies we're going to talk about, but we're not going to do that. We're going to talk restaurants, we're going to talk robots, and of course, we're going to wrap up candy week here on Market Foolery. We got some great email. Our listeners are the best. We got some great email --
Kretzmann: They really are.
Hill: -- on overrated and underrated candy. We have to start, though, with Twitter. Shares of Twitter are up 15% this morning. The third-quarter revenue came in higher than expected. They raised guidance for the fourth quarter. This has been a long time coming. If you're a Twitter shareholder, you're having a good day, and it's been a long time since you've had a day like this.
Kretzmann: Yeah. Honestly, I think part of it, going back to our IBM conversation last week, it really helps when expectations are low. You have a low bar to jump over. I think that's part of what Twitter is dealing with. Their sales were still down 4% this quarter, so they are still shrinking, but the pace of sales declines is slowing. So that's a plus. Last quarter was down 5%. That's improving. They're also really improving their expense management. Their GAAP expenses were down 16%. It's nice when you can cut costs more than your sales are dropping. They're getting closer and closer to GAAP profitability. They're still not quite there, but they think within the next couple of quarters they could hit that mark.
In general, a lot of things moving in the right direction for Twitter, although there's still a lot of room for improvement. But their daily active users are up 14%, so they're just finding ways to increase engagement on that platform, which is obviously what they need right now.
Hill: It absolutely is. When you think about what's driving the revenue, when you think about advertising, I think part of what helps them, part of why I think there's some optimism about the next six months, particularly if they get the profitability next quarter or the one after that, is, one of the things a quarter like this does is it makes people whose job it is to control large advertising budgets, it makes them think twice about skipping Twitter. There was a good stretch of time where Twitter was, if not outright ignored by a lot of ad companies and ad firms and major brands, that sort of thing, this keeps them in the conversation, particularly, as you mentioned, the growth users. When you can add a few million users, that makes it more likely that advertisers are going to come your way.
Kretzmann: Yeah, and ad engagement on the platform almost doubled this quarter. The cost per engagement was down about 50%. But still, in general, moving the right direction. The volume of engagement, people are seeing more ads, which is obviously the direction it needs to go. They are pushing more and more into live video. This past quarter, they streamed 830 events. For the life of me, I don't know where to go on Twitter to find the live video. And I feel like I'm a semi-smart guy. I can use Snapchat, which is supposed to be the most complicated social-media app out there. But Twitter, for the life of me, I can't figure out where they host the live video on their platform. And even people who are die-hard Twitter users, like Jay-Mo here at Fool HQ, even he has a hard time finding it. It's like, guys, discovering live video shouldn't be this hard on your platform when that's supposed to be a key tenet of your strategy.
Hill: Absolutely. I can't remember if it was on Market Foolery or Motley Fool Money, Jason has mentioned that recently, and it's absolutely true. And I am, in fact, reminded of the lack of visibility on their video strategy every time I open up Twitter on the desktop, because when I go to Twitter, it automatically opens up a video screen on the right-hand side of the page. And so, whatever is the thing you mentioned -- how many?
Hill: 830, OK. So when I open up Twitter on desktop, whatever is the one live video that they're promoting at that moment -- sometimes it's financial news; sometimes it's a sporting event if it's the evening -- if it's got my attention, I'll start watching it. But every single time, whether I watch it or not, I'm reminded of the fact that, there's still no central section for video where I can click through and say, I know you're streaming other stuff live; where can I find it?
Kretzmann: It seems like a no-brainer. They are testing other ways to increase user engagement, test different things around. They're testing longer character limits. It took them 11 years to figure out that people actually max out their 140 characters in Twitter when they have all sorts of numbers and symbols trying to squeeze as much as possible into 140 characters. So they're at least starting to test rolling out longer character limits, going up to 280 characters, essentially doubling the number of characters you can put in your quality Twitter posts.
In general, this is the most optimistic I've been about Twitter in a while. For a long time, this has been an easy company to hate on, but they are controlling their stock-based compensation, their other expenses, bringing their expenses in general into a better position, better contained. They have $2.5 billion of net cash on the balance sheet. They are more and more free cash flow positive, and that's not just due to stock-based compensation. And they are getting closer to GAAP profitability. So in general, I think the company is in a stronger position today, even though sales are still dropping. But I think there are better days ahead.
Hill: I'm glad you mentioned the compensation, because that was one pretty significant reason why, a year ago, two years ago, plenty of smart people looked at Twitter and thought that company is going to be bought, because they can't maintain the path they're on right now. And a big part of that was the stock-based compensation.
Kretzmann: And it's still high. Last year, it was about 25% of total sales that was made up of stock-based compensation, which is very high. Alphabet, for comparison, was 7%-8%. Facebook was 15%. I'm not sure where Facebook is at this year. But now, Twitter has gotten that number down to 17%. So it's still on the high end of the spectrum. The diluted share count is still almost growing 1% each quarter, but that number has, bit by bit, decelerated. So, moving in the right direction but still some work to do.
Hill: Buffalo Wild Wings' third-quarter earnings came in so much higher than anyone was expecting, possibly even them. The stock is up 20% today. They're doing a great job of cutting costs. I don't think Sally Smith is rethinking her decision to leave as CEO, which she announced on June 2. I don't know if this is her last full quarter in the corner office, but if it is, this is a hell of a swan song.
Kretzmann: At least a higher note to go out on rather than getting essentially booted out by Marcato Capital, the geniuses who have since driven the stock down 20%.
Hill: They didn't boot her out. They got seats on the board and she said, "I see where this is going, and I feel good about my resume, so I'm going to exit stage left."
Kretzmann: Right. I don't blame her. I think Marcato came in with a very short-sighted strategy. They essentially want to go to an almost 90% franchising model, which I think they tried to do with Applebee's a few years back, and they basically ran that into the ground. Didn't go all that well. So it's like, OK, your track record with restaurants is not all that great.
I think Buffalo Wild Wings here, similar to Twitter, is benefiting from low expectations. The stock was down well over 25% since June, when Marcato did gain those board seats and essentially gained more control over the future direction of the company. Buffalo Wild Wings is still seeing declines in same-store sales, seeing a lot of the headwinds that many casual diners in the U.S. are facing. Buffalo Wild Wings has an extra headwind in the form of traditional chicken wing prices, which makes up almost 30% of their total cost of sales.
Hill: Those are going up.
Kretzmann: Yeah, those are going up. Over the past year, up 26%. So when essentially your main cost item is going off at that pace, it's going to be hard to put up any decent numbers. So I think part of the issues that Buffalo Wild Wings has experienced, and part of the reason why Marcato targeted them, you can probably attribute some of those problems just to facing such high chicken wing prices. Because as soon as those prices go down, you're going to see an instant improvement in margins just about overnight.
But in the meantime, they are transitioning from a focus on traditional wings to boneless wings, which have a lower price point. Their Tuesday wing promotions are now focusing on boneless wings almost entirely, at least in their company-owned stores, and they're rolling that out to the franchisees soon. So they're trying to find different ways to keep customers coming back into the stores, but going toward some higher-margin products.
And they're also seeing strong improvements with takeout and delivery, that now makes up 19% of total sales. They have a Blazin' Rewards loyalty program, which has 3.5 million members. They're trying to push out more personalized offerings to those members. I do like how they are positioning themselves for when that time comes that chicken wing prices fall back to Earth and the restaurant sector in general actually has some tailwinds, rather than the constant headwinds of the past couple of years.
Hill: Where are you on the spiciness scale? I think, if I'm remembering correctly, on the menu at Buffalo Wild Wings, they have 21, I think it's 21, different sauces? And they range in how hot they are. Where are you? How spicy? If you're digging into wings -- well, you're not a chicken wing guy.
Kretzmann: I'm not. But I enjoy some spice.
Hill: When it comes to your palate in general, where are you, on a scale of 1 to 21?
Kretzmann: I feel like I always overestimate how spicy I like things. Realistically, I'm probably 10 or 11, but I would probably try a 15 and regret it instantly.
Hill: [laughs] Regret it instantly. Reach for the water and the bread and then dial it back.
Kretzmann: Yes. How about you?
Hill: I'm probably somewhere in the low teens. But I've certainly had experiences in my life where I have done that move, where it's like, yeah, I'll try that, and then instant regret kicks in.
iRobot's third-quarter profits -- help me understand this, please. Their third-quarter profits were up big. They raised guidance. They're growing revenue more than 20% year over year, and the stock is down 15% this week. What happened? Help us, America! What happened to iRobot?
Kretzmann: I'm still trying to figure this out. This is puzzling. I think part of it was a lofty valuation. In contrast to Twitter and Buffalo Wild Wings, which are beaten-down companies, low expectations, iRobot was trading for a P/E multiple of over 40. So the valuation was lofty. Expectations were high. And the company has been getting a lot more attention over the past year or two. Well deserved, but expectations went up as a result.
I think part of the issue here is growing pressure for the company in China, where they've only operated for a couple of years. China still makes up less than 5% of their total revenue. Revenue in China this year will be down 25%-30%. A large part of that is due to increased competition on the lower end of the robot vacuum price spectrum. You're seeing more and more Chinese manufacturers competing with those lower-priced robot vacuums. And you're starting to see some of that trickle into the U.S. as well. You have the SharkNinja -- came out this summer.
Hill: Great name.
Kretzmann: You got a solid name. I don't know it can match the brand power that Roomba has, because iRobot through that Roomba brand really has developed a nice brand following a lot of brand awareness. I don't think that will be easy to match right away.
Anyway, you're seeing some of that price competition trickle over from China into the U.S. Also, looking at the guidance, they raised guidance; they're expecting earnings per share to be between $1.60 and $2.00 for the full 2017 year, but right now their trailing 12 months EPS, earnings per share, is $2.10. So essentially, they're guiding for earnings to drop from where they are due to the fourth quarter.
At the same time, they're guiding for revenue to grow at least 45% in the fourth quarter. But they're also guiding for earnings to take a pretty substantial hit. I'm not entirely sure why that is. It could be R&D, a marketing expense, something else. But when you're guiding for earnings to drop from where they are, that lowers the floor on the stock, so that could be part of it. And that's a double ding for when you already have a higher valuation. So I think that could be part of what the company is dealing with.
But looking longer-term, this is a company that now is entirely focused on the consumer-facing brands. They used to have a military division, which, from a cultural perspective, just didn't work very well. I read an interview with the founder and CEO where he said the military and consumer divisions at iRobot, they're actually competing against each other in a way. From a culture perspective, not a very healthy way to go. But now they're entirely focused on that consumer-facing side. Still less than 10% market penetration in the U.S., which is their biggest market with the Roomba. As connected homes become more of a thing, as people look to automate more cleaning in and around the house. I think Roomba still is in a positive position. But how they compete against these lower price competitors, that'll be a key thing to watch.
Hill: Am I the only one who thinks that a military type of robot vacuum would just be better and stronger and more effective than a regular one?
Kretzmann: Military grade.
Hill: If it's a military-grade vacuum, maybe I'm wrong, but I think that's just going to do a better job of cleaning.
Kretzmann: Maybe. Maybe there was a tie-in there.
Hill: Let's go back to the guidance for one second. I was struck by the range that you mentioned that they laid out, $1.60-$2.00 a share. Put aside for a moment the fact that to hit that range, their earnings would have to drop. Let's just put that aside for a moment. Am I the only one who thinks that's a really wide range? You can't get more specific than that?
Kretzmann: I think they could get more specific. You have to keep in mind that this is a smaller company; they're operating globally. There are a lot of different variables here. Management teams will have different philosophies here. Some will guide down to the penny, and others will leave this large range. Ideally you under-promise and over-deliver with these kinds of results. But in this case, when you only have one more quarter, you think you would have a little bit tighter range than $1.60-$2.00. But, hey, management teams, they choose how they roll.
Hill: Our email address is firstname.lastname@example.org, and we've been doing overrated/underrated candy all week. And as usual, the listeners did not disappoint. From Dave Thomas, "The Oh Henry! bar is the most underrated, underappreciated candy bar on the market."
From Derrick Getz in Delaware: "I agree that, if introduced today, Twizzlers would not have a shot. It's trading on nostalgia. It instantly made me think that Twizzlers are the IBM of the candy world."
From Carol and Robin, who identify as two of the dozens: "Overrated: Starbursts. They're waxy blocks of tongue-curdling sweetness. Underrated: the U-No bar, a masterpiece of candy inventiveness with an unexpected crunch of salt embedded in a nougat that is somehow airy and satisfying at the same time, all dipped in a thin layer of very tasty chocolate. Minimalist, elegant, and truly underrated."
From Michael Palmer, "Overrated: Reese's Pieces. Fond memories of the movie E.T., so you think you enjoy the candy, even though they're just sad M&Ms." Which I just love.
To Michael's comment about, [laughs] he said the phrase "sad M&Ms," and Carol and Robin talking about "waxy blocks of tongue-curdling sweetness," I know there's a corrosive effect in American politics when it comes to negative advertising. And yet emails like this make me want to see candymakers take out negative ads on one another.
Kretzmann: Just go for it. Duke it out.
Hill: Yeah. If all of a sudden, the Mars Company, which makes M&Ms, if all of a sudden they just started putting out these negative ads about how Reese's Pieces were just sad imitators -- speaking of which, by the way, I should mention, this weekend on Motley Fool Money, our guest, just in time for Halloween, is Joel Glenn Brenner, who wrote a fabulous book called The Emperors of Chocolate. It's about the Mars Company and the Hershey Company and comparing the two. I taped the interview with her yesterday. It was really interesting stuff. Even though those two companies are in the same business, they are so different. One could not be more secretive, and the other is among the most public-facing public companies in America.
Hill: What do you have for overrated/underrated candy? I can't remember if I mentioned you by name yesterday, but I did mention Jerry Fulani, who sent us that fabulous box, and it included, for you, Smarties.
Kretzmann: I know.
Hill: Some people aren't fans of the Smarties.
Kretzmann: Smarties have been dissed a couple of times over the past week by fellow analysts at the Fool here. My feelings were a little hurt by that. Jerry, I appreciate it. Thanks for sending those in. That means a lot. I still enjoy Smarties. They're delicious. Don't hate on Smarties.
But for this year, I was thinking about this. I'm not a very active candy eater, but I think Milk Duds is one that I would say is underrated. They're kind of a similar texture to Starburst, where they just inevitably, half of them get stuck in your teeth and they kind of hurt to chew. But they taste good. It's a whole experience in itself, eating the candy. So I'll go with Milk Duds for underrated.
Hill: What about overrated?
Kretzmann: Overrated, I think it might have been Steve last week who said candy corn, and I totally agree with that. Those are things that I never go out of my way to eat, and whenever I do actually pick one up and eat it, I'm never pleasantly surprised.
Hill: See, I agree with that, although one of our listeners made the comment that candy corn, essentially making the argument that candy corn isn't overrated because it really only gets rolled out once a year. And so it's not being pushed on us all the time. It was a pretty compelling case. But my only push back to that would be the point that you just made, which is, yeah, no, that's true, it really only gets pushed to us in the fall, right in the lead-up to Halloween. And yet anytime I look and think, "It's Halloween, it's once a year, I'll just have one or two pieces of this tiny candy," I instantly regret it.
Kretzmann: Right. If it's only pushed out around Halloween, that's still being pushed out one time too many. [laughs] There are just better options out there. We've been talking about so much candy -- why would you go with candy corn?
Hill: That's true. And that's the thing. I don't think this came up in the interview, but maybe this happened before the interview when Joel Glenn Brenner and I were talking, but one of the points that she made was, candy is an indulgence, and it's an inexpensive indulgence. And that's one of the reasons why candy is popular. It's not just for kids. Adults will indulge in it as well.
Anyway, keep the emails coming, email@example.com. Not just about candy. You can send us questions about stocks as well. David Kretzmann, thanks so much for being here.
Kretzmann: Thanks, Chris.
Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of Market Foolery. This show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening. We'll see you on Monday.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Chris Hill has no position in any of the stocks mentioned. David Kretzmann owns shares of Alphabet (C shares), Buffalo Wild Wings, Facebook, and Twitter. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Buffalo Wild Wings, Facebook, iRobot, and Twitter. The Motley Fool has a disclosure policy.