A Tale of 2 Tech Companies' Earnings

Snap (SNAP 4.95%) and Roku (ROKU 1.04%): two tech companies, alike in products, but so different in strategy. On this episode of Industry Focus: Tech, host Dylan Lewis and Fool.com contributor Evan Niu dive into the recent quarterly reports from both, and explain what it all means for the long term.

Snap finally gave some guidance! Investors can look forward to less volatility following every earnings report, but unfortunately, this doesn't change the company's long-term prospects. Roku, on the other hand, has managed to pivot away from the cutthroat and low-margin world of hardware to the much more appealing platform model. Tune in and find out more.

A full transcript follows the video.

This video was recorded on Aug. 10, 2018. 

Dylan Lewis: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Friday, August 10th. We're talking Roku and Snap earnings. I'm your host, Dylan Lewis, and I'm joined on Skype by senior tech specialist Evan Niu. Evan, what's going on?

Evan Niu: This earnings season will not end.

Lewis: No, it's the gift that keeps on giving. We're getting toward the tail end of it, although I will say Snap and Roku, two earnings takes that I always hotly anticipate. These are pretty interesting companies to me.

Niu: One's bad and one's a good. It'll be a nice contrast there.

Lewis: Why don't we start with the bad. We're going to talk Snap here, of course. [laughs] Snap did surprise Wall Street when it reported earnings. They beat revenue estimates by 5%. The company's top line came in at just a bit over $260 million, which is good for 44% year over year growth. Really the story here is ads. That's how this company is making all of its money, Evan. 

Niu: Right, we're not hearing too much on the hardware side, unlike six to 12 months ago when they loved to talk about hardware. 

Lewis: You know, it's funny, I was reading through the conference call. I see Evan Spiegel mention Spectacles somewhat early on. He's like, "We're really encouraged with what we got with this new launch of Spectacles." I'm like, "Alright, great. An analyst is going to ask a question about Spectacles." Didn't happen. No one asked a question about it. [laughs] 

Niu: No one cares! [laughs] 

Lewis: I know it's inconsequential to their business, but for them to keep focusing on it, I just think some analysts should ask that question at some point. If I ever get on a Snap conference call, I'm going to ask them about Spectacles. In the meantime, we'll focus on the ad revenue.

Niu: It shows you how distracted and misguided they are strategically in some ways. It's not super important the business, so I wouldn't expect too many questions about it. It's not moving any needles. But it's just an example of how this company does not know where it's going. 

Lewis: That's all to say, $262 million in revenue, $260 million coming from ads. That's where the business is going to be for a while, and that's why the analysts are asking questions about the ad business. The nuts and bolts of the ad business: impressions were up 191% year over year, 26% sequentially. Pricing down over 50% year over year, 9% sequentially. I think these are all of the dynamics you'd expect to see with a platform that is still making the switch over to programmatic ads.

Niu: I mean, they've been working on this for roughly two years, getting away from a really labor-intensive direct sales force and getting into this automated, programmatic platform where you can scale much better. At this point, I think they said something like 75% of ad purchases this quarter were sold programmatically. Definite improvement in progress on that front.

Lewis: A couple of analysts were asking about ad load on Snap. They were basically saying, "How much more room do you guys have to increase the number of impressions?" That's been a great lever for them. That's where a lot of this growth is coming from. What does that look like for the foreseeable future? I don't think management gave a super satisfying answer. They were being all cagey about that. But, in my anecdotal use of the platform, I think that they still have quite a bit of a ways to go with increasing ad usage. They are not beating people over the head with ad spots yet. That's certainly a lever they can pull. 

Niu: Right. The other question is, when you turn to user growth... this was the first-ever decline for daily active users that we've seen on a sequential basis. They were down to 188 million compared with the 191 last quarter.

Of course, they blame this whole redesign. As they're trying to become more mainstream and approachable to everyday consumers, they're putting off a lot of the core users, which is an ironic dynamic that's happening.

Lewis: That dip that they saw in DAUs, that happened in every single geography -- North America, Europe, rest of the world. It's not something that was limited to GDPR. Some people are saying, we're seeing this with Twitter (TWTR), we're seeing with this with Facebook, maybe it's increased sensitivity to privacy. I think the reality is that it has to do with their platform more than anything else. 

Something that was also concerning on the user side -- management emphasized that Q3 growth rates are generally lower both year over year and sequentially than Q2. If you're trying to work through what that might mean, from a year over year perspective, that means they're expecting growth to be lower than 8%, which is what it was recently; but, they also posted a sequential decline this quarter. My thought here is, OK, maybe they're going to be flat sequentially. There might even be another decline coming in Q3. 

Niu: I think that's what's really bothering investors. The stock fell on this earnings release. You want to grow the user base as much as you can while you're growing this ad business. Not only are they still in the process of growing the ad business, but now, the fear is that the user base is already hitting a ceiling when Facebook's Instagram's Stories alone, that one feature has over two times as many daily active users as the entire Snapshot platform. Instagram continues to execute and continues to soar in terms of usage, daily active users, Stories users hit a billion monthly active users recently. And now, there are more signs that Snap is already peaking. 

Lewis: We got another look at what's going on the user side with Snap. They gave us a glimpse of monthly active users. I think this is the first time that we've seen anything like that. I went back through all of the recent transcripts and saw no mentions of monthly actives. Imran Khan said they have "more than 100 million monthly active users in the U.S. and Canada." The company has 80 million DAUs in North America, which includes some other countries, just to give you a sense of engagement in those geographies. 

They also said that DAUs were up 8% year over year and monthly actives were up to their highest rate ever. Again, hard to know exactly what that means. The obfuscating here is a little frustrating, frankly. It reminds me a little bit of how Twitter handles the DAU number.

Niu: This is definitely the first time they've ever mentioned the number. We've talked before, they have never given this number before. Comparing the ratio of DAUs to MAUs is a really useful metric for investors to gauge engagement. Up until this quarter, they have never given us this number. And even now, they're only giving it in one geography. I mean, it's better than nothing. But again, like you mentioned it's still limited in how useful it is. 

Lewis: We got another major milestone from Snap management this quarter, and that's that we're finally getting guidance. I think that this might be the influence of new CFO, Tim Stone. This is the first time that we are getting a look at what Snap expects for next quarter. In Q3 2018, they're expecting the top line to be somewhere between $265-290 million, which would be good for somewhere between 27-39% growth year over year, a slight deceleration from where they were this quarter. 

Niu: I do think you're right. I think the new CFO, Stone, who's replacing outgoing CFO Drew Vollero. He's probably what's driving this. Obviously, investors want guidance. He's coming from Amazon. Amazon is a very mature, large company. That was always one thing that was so frustrating. They had never given outlook before. Now that they are, I think that's a big win, in terms of investor transparency. 

Lewis: It just gives everyone a better sense of what's going to be going on with the business. You're not going to have these massive swings, maybe, to the same extent, in stock price that we've seen in the past when they've reported earnings, because Wall Street is basing a lot of their estimates on the same type of stuff, the same inputs, that Snap is basing their internal estimates on. 

Niu: It's all based on the expectations. Guidance sets not only investor expectations, but also analyst expectations. That's how the market trades. 

Lewis: All told, looking at Snap, this report and where the company is going going forward, I think that we're at a point where they're getting close to maybe where Twitter was a year or two ago. We're seeing the stalling active users. They're going to be able to continue to grow revenue by increasing impressions, but at some point, if there's no floor for what happens with price declines, they're going to find themselves struggling to grow their top line. 

Niu: I think that's a good comparison. You could see Twitter's user base peaking a couple of years ago. The real challenge was, then, how can they improve monetization. They've done a pretty good job over the past one or two years, I would say. So, if Snap is peaking, in terms of users, now it's all about, can you improve monetization. It's too early to call at this point. It could very well play out very much like Twitter, like you're saying. But we just have to wait.

Lewis: What we saw a lot with Twitter's turnaround story was cost cutting. There was some slowing of price declines in ads, which absolutely helped revenue growth a ton. But they really got a lot more conservative in what they were spending. I think we're already starting to see Snap make some adjustments on headcount. They shuttered their drone ambitions and some of the crazier, more out-there things that the company is doing. Maybe this is an early recognition by management that this is what they're going to need to do to ultimately become a profitable business down the road. 

Niu: I wonder. Part of Twitter's engagement has really been helped by this political engagement, and the environment that we're in. I don't see President Trump getting on Snapchat anytime soon, though.

Lewis: [laughs] You don't think so?

Niu: [laughs] We'll see. You never know what he's doing. 

Lewis: Today, we're talking about the good and the bad here with earnings, Evan. We talked Snap. Why don't we talk about the good, and that is Roku? This is a company that has really surprised both of us with how successful they've been in going from conventional consumer tech to platform company.

Niu: I'm definitely impressed. This quarter, they put up some really solid numbers. As a result, the stock has jumped to basically all-time highs. They've done a really good job moving away from this consumer hardware space which used to dominate the business. It used to be all about these cheap, affordable hardware streaming media players. That is not at all where the future of this company is anymore. 

Lewis: Why don't we talk briefly about how they're making money on the platform side before we get into the specific numbers? People that aren't as familiar with this company may not really understand it

Niu: Historically, hardware revenue has always been the bulk of the business. They've been growing this platform, which has, historically, been these third-party channels where people will sell things à la carte, you charge a subscription fee, or you're ad-supported. Roku gets a cut out of all of that. The big change recently was, they launched the Roku Channel last September, which is their first-party channel of content. It's their channel, so they get 100% of ad inventory as opposed to just 30% of any ad inventory from a third-party channel. This has already become, according to the company, one of the top five channels on their platform, in terms of the active account reach, how many people are watching this channel.

Lewis: That was a major concern for us when we were looking at this business and their ability to make the platform work. We saw the active users primarily using Roku as a way to stream Netflix (NFLX 0.46%). We were saying, if Rokus are effectively a Netflix machine, then their ability to monetize users is pretty much nonexistent. Them going out there and saying, "We have a Roku Channel. We're going to own and operate all this ad inventory," that really changed the game for them.

Niu: Yeah, absolutely. Netflix is a huge part of it, and they get basically no money from any Netflix usage on the platform. And Netflix is one of the top three channels. The fact that, in less than a year, the Roku Channel is now one of the top five, it's to the point where it's at least remotely comparable to Netflix users, is a huge positive development.

Lewis: To get a feel for how that plays out in the financials, this most recent quarter, revenue was up 57% to $157 million. Of that, platform revenue $90 million, which grew 96%. That's pretty incredible. Player revenue also grew 24%. But, this company is doing something that is incredibly rare, incredibly hard to do in the consumer tech space, and that's making the platform play work. We've seen so many companies try to do that and just fail miserably. 

Niu: Right. And with this platform, which is much more profitable, we're seeing massive margin expansion. The gross margin was almost 12% over a year ago, and it's now almost 50%.

Lewis: That type of transformation as a business is practically unheard of. The numbers outside of the pure financials, the operating metrics, the key business metrics, also look pretty good for this company. 

Niu: Active accounts, they added about 1.2 million during the quarter on a sequential basis. They're now at about 22 million active accounts. They streamed 5.5 billion hours. Average revenue per user was up to $16.60, which is basically a trailing 12-month measure of platform revenue divided by active accounts.

Lewis: All told, this led to the company actually being slightly profitable in this quarter. Looking forward at what management expects, though, they're probably going to be losing money for the coming quarters. 

Niu: Right. Third quarter outlook, expecting revenue of about $164-172 million, gross profit of $71-76 million. Still going to lose a little bit of money, $13-18 million.

But they were able to raise their full year guidance to $710-730 million. Basically, they're raising the forecast. They're doing things pretty well here. 

Lewis: Thinking about this company, now at all-time highs coming off pretty solid earnings, the big benefit for them in this space was that they were somewhat platform agnostic. They weren't tied to any individual ecosystem. Do we see the growth there? Do you see a pretty long growth runway for them? Does it still exist? Or have they captured a lot of the consumer market that they're already going to reach?

Niu: In terms of expanding beyond their platform, that's where this is heading. Yesterday, they announced that for the first time, they're going to be bringing the Roku Channel to the broader web and mobile devices. Up until now, all of it's been within their own platform. The fact that they're now wanting to basically bring the Roku Channel to everywhere, which, earlier this year, they said they were going to bring it to Samsung's smart TVs, which is now out there. But even outside of smart TVs, just to have it on the internet has a lot of upside potential. You could think of it like Netflix, but a free, ad-supported version of Netflix with maybe not as good of original content, maybe a little bit of older material. But if they can really grow that audience, I think it sounds really promising. 

Lewis: That's the kind of thing also that could theoretically lead to device sales. If they have this owned and operated channel that's distributed, people can access it on browser, some companies have struggled doing that. This is the plan for them, though. They could get people to then buy Rokus, build the installed base out, and it becomes this virtuous cycle for them.

Niu: It's also worth pointing out, they're not the first company to try this strategy. You and I were talking about this earlier. Sony actually launched a service called Crackle 11 years ago, which is the same idea. You take this old content, you put it on the internet for free, any you monetize it with advertising. You had never heard of this service, even though, 11 years! [laughs] That's the problem. Sony completely failed with the execution of this strategy because their ad load was ridiculously aggressive. You can't skip the ads, they're really long, they're really obnoxious, and the content is not really that great. 

I think the real question is, can Roku take that idea, balance out these considerations, and deliver a better user experience that's more compelling?

Lewis: I'm actually a little embarrassed that I didn't know Crackle before we were doing the prep for the show. [laughs] I consider myself a reasonably sophisticated internet user. I'm pretty good at finding stuff that's streaming and avoiding paying for things when I can. But, yeah, to your point, I'm someone that consumes quite a bit of media online and had never used Crackle before. We loaded it up on both of our browsers before taping the show. I found that, with adblock, the ads were not nearly as intrusive as without adblock. But, yeah, this is something that Roku is going to have to figure out and learn from the mistakes that Sony Crackle has made. 

Niu: I'll admit that I have not used the Roku Channel quite yet because I don't have a Roku. But once it's available on the broader web, I'm very interested to see what that experience is like to really get a sense of how they're balancing their financial needs with the user experience. I think that's really going to be critical to how this plays out in the long run. Again, it's literally just starting. They announced this yesterday or the day before. We can't say for sure how it's going to play out, but given their execution so far, I would be a little optimistic.

Lewis: Yeah, this is one of the most impressive pivots I think I've seen a company make in this space. Everything that I see from this earnings report -- the thesis is intact, and management is executing on what it needs to execute on. 

Niu: Yeah. I was really impressed. This was a really solid quarter. 

Lewis: Well, I think we're going to close it there, good and bad. [laughs] Snap and Roku. We'll update as there's more to talk about with these companies. Evan, anything else before I let you go?

Niu: I think we're good.

Lewis: Listeners, that does it for this episode of Industry Focus. If you have any questions, or if you want to reach out and say hey, you can shoot us an email at [email protected], or you can tweet us at @MFIndustryFocus. If you're looking for more of our stuff, you can subscribe on iTunes or check out The Fool's family of shows over at fool.com/podcasts. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for all his work behind the glass. For Evan Niu, I'm Dylan Lewis. Thanks for listening and Fool on!