Streaming-video platform Roku's (ROKU +1.29%) first-quarter earnings report was a blowout, and strong revenue growth was again the focus of all the attention. User-growth metrics also played a big role in exciting investors. But hardly anyone is talking about Roku's expanding profit margins, and that's a shame.
Roku has entered an exciting phase in its long-term journey. Not only is it enjoying unprecedented adoption, but its gross profit margin is quietly ticking higher. And that's really good news for shareholders. Here's why.
What everyone is talking about
In the first quarter, Roku generated revenue of $574.2 million. Not only was this up an eye-popping 79% from the same quarter last year, but it also greatly outpaced expectations. For its part, management had guided for revenue of $478 million to $493 million. So results demolished the high end of guidance by 16%.
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For the second quarter, management guided for revenue of $610 million to $620 million. Of course, Wall Street analysts had already created their own models before this guidance came out. Their consensus estimates for the second quarter called for revenue of around $550 million. So management's guidance is outpacing expectations yet again. In short, Roku's revenue growth is superb right now.
There's a twofold reason for that. First, the company is gaining new accounts at an impressive rate. It ended 2018 with just 27 million active accounts. Just over two years later, it has roughly doubled to 53.6 million active accounts. And it's still growing at a 35% annual rate -- which would lead to another doubling less than three years from now if the pace continues.
Second, Roku is making more money from active accounts than ever before. This is tracked with a metric called average revenue per user (ARPU). As of the first quarter, ARPU was $32.14 -- up 32% year over year. In fact, ARPU has increased quarter over quarter ever since Roku went public in 2017.
Why is ARPU increasing? One factor to consider is that advertising dollars are shifting from traditional media to connected TV (CTV). Roku has one of the largest captive audiences in CTV, and its ad platform provides brands with good, measurable returns. So its ad slots are in high demand. And as more advertisers compete for these slots, monetization improves.
In short, Roku's top line is growing at a blazing pace. But there's more to love here than just that.
Image source: Getty Images.
An overlooked gold nugget
Roku's gross margin has expanded in four straight quarters, reaching 56.9% in the latest first quarter -- a record high. This profitability metric measures the company's revenue against the cost of goods sold. In other words, the goods and services it provides are getting cheaper for Roku.
Its revenue structure is changing over time, and this is the primary reason for its expanding gross-profit margins. The company has two operating segments. Its player segment generates revenue by selling streaming devices, and it's a low-margin business. Its platform segment monetizes higher-margin opportunities like displaying ads.
In the first quarter of 2020, Roku's platform-segment revenue was 72.5% of total revenue. In this year's first quarter, it was over 81% of total revenue. As platform-segment revenue keeps growing into a bigger part of the business, its overall gross margin is pulled higher.
And on top of boosting overall margins by becoming a bigger part of the business, Roku's gross margin for the platform segment is getting better as well. Last year its gross margin for the platform segment was 56.2%. This year it was 66.9%, a marked improvement.
Expenses keep growing for Roku as it tries to expand and capture its global opportunity. Management is intentionally spending big and consequently hasn't been guiding for bottom-line profits. That said, Roku has surprisingly reported net income in its last two quarters because its revenue is growing faster than anticipated.
Therefore, call Roku's net income of $77 million during the past two quarters an "accident" for now -- management intends to run closer to breakeven, guiding for net income of just $10 million to $20 million in the coming quarter. But with revenue growing as fast as it is, its profit potential is getting hard to hide.
Here's a simple way to combine the two things we looked at in this article: Roku's revenue is growing at an impressive pace and this revenue increasingly has higher profit potential. And that's a powerful combination that bodes well for shareholders in the years to come if these trends continue.
