How Roku Makes Its Money

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Roku has now filed its S-1 Registration Statement with the SEC, officially signaling its intention to go public in the near future. The company's brand is synonymous with streaming set-top boxes, but has also expanded into other hardware products like its streaming HDMI stick as well as partnering with smart TV manufacturers that integrate Roku TV. Roku operates a platform for TV content that is available to content creators, offering a variety of monetization options.

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With a glimpse at Roku's financials, investors can now get a better sense of the business and how Roku makes its money. The two main parts of the business are player sales and platform revenue.

Players

The most basic streaming player that Roku offers is the $25 Roku Express, with more full-featured player products like the $100 Roku Ultra. The Roku Streaming Stick costs $40, while smart TVs that integrate Roku TV start at $140.

Roku relies primarily on third-party distribution channels like electronics retailers to sell its players, in addition to selling players directly on its site. This part of the business is fairly straightforward.

As far as profitability goes, Roku is consciously sacrificing profitability in an effort to sell more players and grow the number of active accounts it has. Player gross margin fell to just 6.4% in the second quarter, the lowest level since the beginning of 2015 (as far back as Roku discloses financial results in the filing). On a trailing-12-month basis, Roku has generated $292.1 million in player revenue for a gross profit of $38.6 million (13.2% gross margin).

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Roku does not disclose unit volumes or average selling prices (ASPs) for its player business.

Platform

The platform side of the business is where it gets both more interesting and more complex. Perhaps more importantly for investors, Roku's overall financial success will largely hinge on whether or not it can execute on the platform front.

Platform revenue comes from fees received from advertisers and content creators, as well as licensing fees that Roku earns when service operators or TV manufacturers integrate its service. Channels have three options to monetize their content: selling ads, selling subscriptions, or selling content on a transactional basis (i.e. a la carte). These are the main sources of platform revenue.

Just as you would expect from a platform operator, Roku gets a cut of all transactions. Ad-supported channels may have to share up to 30% of video ad inventory so that Roku can sell ads for itself. The company often doesn't do this for channels with small audiences. For paid channels, including both subscription and transactional content, Roku keeps 20% of revenue (net of credits and refunds). This was lowered from a prior revenue sharing level of 30% back in late 2015. Roku only recognizes its net share in its financial statements.

The platform business is much more profitable than the player business, and it also offers the opportunity for ongoing content purchases or recurring subscription revenue, which is why Roku is looking to shift its focus to growing the platform. Platform gross margin was a healthy 74.4% in the second quarter. On a trailing-12-month basis, Roku has generated $144 million in platform revenue for a gross profit of $108.6 million (75.4% gross margin).

For the platform business, investors then need to look at active accounts and average revenue per user (ARPU). At the end of the second quarter, Roku had 15.1 million active accounts, up from 6.8 million active accounts in Q1 2015. ARPU, which Roku measures on a trailing-12-month basis, was $11.22 at the end of the second quarter, up from $5.40 in Q1 2015. Roku is definitely making progress both growing its active account base while improving monetization through increased viewership and engagement. The company streamed 3.5 billion hours in the second quarter, up from 1.2 billion in Q1 2015.

Here's a breakdown of Roku's revenue:

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