Roku (ROKU -1.04%) reported third-quarter earnings after the market closed on Nov. 3. The stock is down 11% since the announcement as the company highlighted how supply chain issues continue to hinder its operations. To make matters worse, it expects these issues to persist.
The difficulty is hitting Roku in two ways: Supply chain bottlenecks make it costly to produce and deliver its players. And with short supplies of products affecting broad swaths of the economy, companies are reducing how much they spend on advertising -- less reason to advertise if you're out of merchandise to sell.
Businesses may pull back advertising if their inventories are low
In the third quarter, revenue increased 51% year over year. The platform segment made up 86% of the top line as Roku shows ads to people watching content through its platform and earns fees from streaming services for distributing their content. Revenue increased on both of those fronts during the quarter.
Since the pandemic onset, several new streaming services have launched as media and entertainment companies are increasingly shifting their focus to connected TV, a trend that has benefited Roku's platform business overall.
However, advertising revenue, while still growing, is also seeing the fallout from worldwide supply-chain disruptions. Businesses are having a hard time securing enough inventory to meet customer demand. If customer demand is already exceeding supply, there is less incentive to advertise: Why tell customers to come to your store if they are going to find empty shelves?
There was evidence advertisers are pulling back in the third quarter, and Roku's management is expecting this situation to continue at least through the end of the year.
Roku is paying up to secure production and delivery
Roku brings people into its ecosystem by selling players or licensing its platform to TV manufacturers, making Roku the default operating system.
The company has more control over the manufacture and distribution of its own players, and it has taken aggressive, proactive steps to ensure supply can meet customer demand. Here's CEO Anthony Wood describing some of the actions taken:
We are paying more for expedited shipping for -- to get chips, get in front of the line for chips. So the results of all that is our costs are going up. But we haven't sold out yet. We've just been paying for air shipping, and we've been spending money to insulate the retailer and the end customer from pricing issues and supply issues. So far, we've been doing that relatively effectively.
Collectively, those actions led Roku's player segment gross profit to fall from $20.2 million in the year-ago period to a loss of $14.6 million last quarter as player revenue fell 26%. Roku is willing to sell players at a loss, because as viewers join its platform, they fuel a business that boasts a gross margin of 65%.
Still, the losses in the player segment are unsurprisingly concerning investors, as are the other effects of continued supply-chain bottlenecks. The stock, which was up nearly 50% earlier this year, is now down 16% in 2021 and may continue going lower if macro operating conditions don't improve over the next few quarters.
But these are short-term issues, and the company has excellent prospects as more and more people stream their entertainment. Investors can put Roku on their watch list and even consider the latest sell-off an opportunity to buy shares.