Roku, Inc.

Hope you guys are ready for this.

Anyone got an accordion? What can I say?

I'm full of surprises.

Good day, and thank you for standing by. Welcome to the Roku second quarter 2022 earnings conference call. At this time, all participants are in a listening mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one one on your telephone. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Conrad Grodd, Vice President of Investor Relations. Please go ahead.

Thank you, operator. Good afternoon and welcome to Roku's second quarter 2022 earnings call.

I'm joined today by Anthony Wood, Roku's founder and CEO. and Steve Loudon, our CFO. Full details of our results and additional management commentary are available in our shareable letter, which can be found on our investor relations website at roku.com forward slash investor. Our comments and responses to your questions on this call reflect management's views as of today only, and we disclaim any obligation to update this information. On this call, we'll make forward-looking statements, which are predictions, projections, or other statements about future events such as statements regarding our financial outlook, our investments, future market conditions, the shift of ad spend from legacy pay TV to TV streaming, and macro environment headwinds, such as global supply chain disruptions, recessionary fears, and inflationary pressures. These statements are based on our current expectations, forecasts, and assumptions, and involve risks and uncertainties. Please refer to our share letter and our periodic SEC filings for information on factors that could cause our actual results to differ materially from these forward-looking statements. We'll also discuss certain non-GAAP financial measures on today's call. Reconciliations for most comparable GAAP financial measures are provided in our shareholder letter. Finally, unless otherwise stated, all comparisons on this call will be against our results from the comparable period of 2021. Now, I'd like to hand the call over to Anthony.

Thanks, Conrad, and thank you all for joining us today. In Q2, we saw a significant slowdown in TV advertising spend due to the macroeconomic environment, which is pressuring Roku's platform business growth in the short term. However, Roku's business and strategic fundamentals are stronger than ever and growing stronger. Our TV advertising market share continues to grow, and our active accounts continue to increase. In light of the current macroeconomic environment, we started taking actions in Q2 to significantly slow OpEx growth. That said, we expect to keep investing into our streaming leadership. While downturns are difficult, it's important to keep in mind that temporary economic cycles do not change the significant long-term opportunity in TV streaming. Roku is founded on the belief that all TV and all TV ads will be streamed, and we continue to see this unfold. In the first half of this year, TV streaming passed the tipping point where reach and engagement for adults aged 18 to 49 exceeded that of legacy pay TV. However, marketers are expected to spend just 22% of their TV ad budgets on streaming in 2022. The ultimate driver of our success is the continued shift of viewers to streaming around the world and the closing gap between viewership and ad budgets. The current economic state is causing TV advertisers to pause and reconsider spend. which is painful in the short term. But it also causes them to seek greater efficiency and ROI, which will benefit Roku in the mid and long term. This reminds us of when advertisers paused spend during the 2008 recession, but it became a catalyst that accelerated the shift of ad spend from print publishing to digital. We believe a similar opportunity exists now for advertisers to accelerate their shift from legacy pay TV to TV streaming. We're already seeing this in the upfronts, where we continue to take share from broadcast networks, and where we surpassed the milestone of $1 billion in commitments recently. Active accounts were a bright spot in Q2. We added 1.8 million incremental active accounts to reach 63.1 million, and we maintained our market leadership. We remain the number one selling TV OS in the U.S., and we are the number one TV streaming platform in the US, Canada, and Mexico by our stream. Roku remains differentiated by our unique assets, our proprietary Roku TV OS, the Roku channel, and our innovative ad platform for connected TV. We are more confident than ever in our strategy, market position, and growth potential, and we remain focused on the significant opportunity ahead. With that, let me hand the call over to Steve.

Thanks, Anthony. Despite the challenging macroeconomic environment, Roku continues to grow, adding 1.8 million active accounts in Q2 and ending the quarter with 63.1 million. In the quarter, retailers temporarily lowered US TV prices to manage through elevated inventory levels, which resulted in a short-term increase in overall TV unit sales, including Roku TV models. Going forward, we expect less promotional activity and lower inventory levels in retail channels, which we believe will continue to keep overall U.S. TV sales below 2019 levels. Roku player unit sales remained above pre-COVID levels in the U.S., and the average selling price decreased 5% year-over-year. We have continued to insulate consumers from our cost increases in our player business based on our growing ARPU, which enables us to prioritize account acquisition. Streaming hours were 20.7 billion. This was up 3.4 billion hours year-over-year, but down 0.2 billion hours from Q1, which was as expected due to normal seasonality. In Q2, total net revenue increased 18% year-over-year to $764 million, coming in below our expectations. Recessionary fears and elevated inflation caused advertisers to significantly curtail or paused spend in the scatter market, and consumers to moderate discretionary spend. This adversely affected our Q2 platform revenue growth, which was still up 26% year-over-year to $673 million. Going forward, we expect reduced consumer discretionary spend to pressure Roku TV and players' unit sets. We therefore reduced our unit forecasts and revised our 606 models, which had a disproportionately negative impact on Q2 platform revenue. Q2 player revenue was down 19%, while player unit sales were down 16% year-over-year on a sell-in basis. Total gross margin was 46% in the quarter. Q2 platform gross margin was 56%, which was down 9 points year-over-year. This reflected a shift toward a greater mix of video advertising compared to a year-ago period, which benefited from significant growth of higher margin M&E and content distribution due to the launch of new services, as well as weakness in the ad market in the quarter. Q2 player margin was negative 24%, which was down roughly 18 points year-over-year, as we chose to prioritize account acquisition and insulate consumers from higher costs caused by supply chain disruption and inflationary pressures. The year-over-year compression in platform and player margins, in addition to a negative 6.06 adjustment, based on our expectations for lower Roku TV and player unit sales, resulted in gross profit growth of 5% year-over-year versus the 18% year-over-year growth for total net revenue. Q2 adjusted EBITDA was negative $12 million, and we ended the quarter with nearly $2.1 billion of cash in short-term investments. As we look ahead to the third quarter, we are facing an increasingly difficult and uncertain environment, Recessionary fears, inflationary pressures, rising interest rates, and ongoing supply chain issues will continue to impact both consumers and advertisers. We believe consumers are going to continue to moderate discretionary spend, and the ad scanner market will remain pressured. As a result, our third quarter outlook is for the following. Total net revenue of $700 million, up 3% year-over-year. Gross profit of $325 million. with a gross margin of 46% and adjusted EBITDA of negative 75 million. These estimates reflect our viewpoint that the second half operating environment will be increasingly challenging. We expect roughly stable platform margin on a sequential basis. Our player margins will continue to be pressured as we insulate consumers from cost increases caused by ongoing headwinds from supply chain disruptions and inflationary pressures. In anticipation of ongoing macroeconomic challenges, we took steps in Q2 to significantly slow both operating expense and headcount growth. We have reduced our OpEx growth rates down from the rates that underpin the full-year color that we provided on our Q1 fall. We reduced our Q2 OpEx year-over-year growth rate by 10 percentage points, and we plan to reduce Q3 by 10 percentage points and Q4 OpEx by 25 percentage points bringing Q4 OpEx year-over-year growth rate roughly in line with that of Q1 2022. We will continue to prudently invest in our business, given the long-term potential we see. We plan to manage our content spend on the Rota channel based on both the scale of the channel and the macroeconomic factors. We are closely monitoring macro conditions and will continue to be flexible with our OpEx and content spends. Given the volatility and uncertainty of the current macroeconomic environment, we are withdrawing our previous full-year revenue growth outlook for 2022. Our outlook has always been based on our assessments of both our business and the broader macroeconomic environment. And at this point, we feel that there is too much macro uncertainty for us to provide a full-year outlook. Before we get to questions, I want to say one last thing. The significant and long-term opportunity in streaming is not changed by the current economic cycle. We remain confident in our business model and the secular trends that support it. We're in a strong position as a market leader and have a strong balance sheet, and we have the right strategy. And with that, let's take some questions. Operator?

Thank you. As a reminder, to ask a question, you will need to press star 11 on your telephone. Please stand by while we compile the Q&A roster. Our first question comes from Corey Carpenter with JP Morgan. Your line is now open.

Hey, thanks for the question. Hoping you could expand a bit on what you're seeing in the ad market. It sounds like you saw a pretty dramatic broad-based pullback, but any color on when you started to see the market turn or what verticals perhaps were most impacted would be helpful. Thank you.

Hey, Corey. This is Anthony. I'll take that and then turn it over to Steve to add some more color. At a high level, of course, we are seeing advertisers worried about a possible recession. We're seeing them reduce their spend in places that are easy for them to turn off and turn back on. For example, the scatter market, which is an important source of ad revenue for Roku, is an easy market for advertisers to turn off and turn back on. That's one of the big factors we're seeing from the macroeconomic environment. And that's impacting the growth rate in the short term in terms of, but I mean, I guess another, another important point there isn't even though advertisers are pulling back on the growth of their spending or pulling back on their ad spend in places like the scatter market, they are continuing to invest more into streaming than traditional TV. So for example, you know, a couple of the verticals that we saw that were particularly impacted recently, uh, are, are, um, CPG and auto. And if you look at CPG and auto, you know, they were down in traditional TV, they were down 9% in the quarter. But we saw double digit growth as, you know, as advertisers continue to prioritize streaming for their ad dollars. So that's the macro environment. But in terms of, you know, if you just kind of peel back the onion, I think super important is that if you just look at the business fundamentals for us, they're very strong. I mean, we're in an economic cycle where advertising is trending down, it'll turn around and things like ad market share will become very important when that happens into the size of the rebound. So for example, we are growing our share of the advertising market as advertisers continue to move dollars to streaming and platforms like Roku. So for example, even though the scanner market we're seeing softness, we had a robust upfront recently where we closed over a billion dollars in commitments for the first time. And the upfront, you know, is sort of the opposite of the scatter market. And the scatter market is sort of quarter by quarter, short term. Upfronts are where advertisers commit dollars for the next year. And so, you know, the billion dollar plus in commitments in the upfront shows continued faith in advertisers for streaming as a place for them to place their advertising bets. So good robust upfront recently. We also, in the quarter, added 1.8 million active accounts. So active accounts continue to grow. Our share of ad dollars continues to grow as paid TV dollars shift over as advertisers continue to move their dollars to higher ROI environments like streaming. So that's a few thoughts on the impact of the macro environment. I know, Steve, would you like to add some thoughts?

Yeah, just adding some color on the advertiser pullback in the scatter market overall. Certainly, that was a significant factor in the quarter and progressed as the quarter went on. But an advertiser perception survey noted that almost half of advertisers in Q2 made pauses on their ad TV spend on TV streaming, which was similar to the amount that paused on digital video and traditional TV. So this is definitely a broad-scale significant pullback that happened within the quarter itself, and one that's pretty similar to other historical times of a degree of uncertainty or advertisers worried about impending economic downturns. For example, at the start of the pandemic, this is very similar to when A lot of advertisers paused or greatly curtailed their spending. And then once they got a better handle on which way the world was going, they added those budgets back. Like Anthony mentioned, the scatter market is a very flexible market of close-in timing. And so it's usually one of the first things to be dialed back on when there's uncertainty or a negative outlook, but it's also something that comes back. And when that money comes back, it generally comes back disproportionately into the you know, more demonstratable, higher ROI markets like TV streaming.

Yeah, and I think just to add, I think that is a silver lining here that's important to note, which is that, you know, stress on TV budgets causes people to evaluate how they're spending their dollars, looking at more effective ways to spend those dollars. You know, 22% of TV budgets spent on streaming in 2022 versus about half of all TV hours on streaming. So there's a big opportunity to accelerate the transition from traditional advertising dollars from traditional TV to streaming. And this event will have a positive impact on that acceleration.

Thank you. Our next question comes from Jason Helfstein with Oppenheimer. Your line is now open. Jason, your line is open. Please check your mute button.

Oh, thank you. Sorry. Two questions. Steve, can you just go back and unpack the 606 impact on the quarter? Just specifically, how are you thinking about the drag versus a year ago? And then maybe give us an update on OneView. It doesn't really seem to be generating any material revenue tailwind, at least from our perspective. So just how are you thinking about the programmatic impact on your business going forward? And are you considering, especially maybe during harder times, allowing other DSPs to bid on Roku inventory? Thanks.

Steve, do you want to take the first question? I'll take the 1B question.

Okay, sure. Yeah, hey, Jason. Thanks for the question. So, yeah, in terms of the 606 models, you know, just a reminder to everybody that every quarter we go through a process where we're, looking at the assumptions that underpin our material deal contracts, and we're updating those as necessary. This is a quarter where certainly with the macroeconomic headwinds, not only we saw the advertiser pullback, but also we saw in the economy that many verticals of consumer discretionary spending were getting hit. We mentioned in the letter and some of the remarks that You know, the TV size of the overall US TV market and sort of overall player sales in the US, you know, are being impacted by, you know, that pullback and spend. And our expectation is that that, you know, that that continues in the foreseeable future. As a result, in the short and kind of midterm, we updated our unit forecast to reflect the lower a lower or kind of smaller market size, and that had a impact, a broad impact on most of our 606 models, you know, most acutely around expected button revenue value in some of the deals. So, anyway, that has an overall view on the portfolio. As a reminder, in the past, we've had, you know, most quarters we have some deal values go up, some go down, many don't stay the same. When you have a change to input that's common across all the deal models for good or bad, you tend to get a significant impact on the portfolio. In this case, we did with the lowering of the unit sales. That has a disproportionate impact in the quarter you do that, so we did see a hit to expected platform segment revenue in Q2, and that will have an ongoing impact in subsequent quarters as well based on the lifetime of the deal, the various deal models that are impacted.

And then on OneView, I guess a couple thoughts. One is that in the quarter in Q2, we saw spending on TV streaming inventory from agency holding companies in OneView quadruple year over year. So it is growing, but it is also still a fairly small part of our business compared to just TV media streaming, streaming TV media generally. I mean, we're, you know, we just closed a billion dollars plus in upfronts. We're seeing TV dollars continue to shift in greater share in greater proportions from traditional pay TV to streaming. That's the biggest driver of our TV ad business. But one view is a contributor is growing. And it's also, I think, strategically important. You know, over time, we expect more and more of TV advertising to move to programmatic, and so having a robust one-view solution as DSP is something we think strategically important.

Thank you. Thank you. Our next question comes from Matthew Thornton with Truist. Matthew, your line is now open. Matthew Thornton, your line is open. Please check your mute button.

Yeah, thanks for taking the question. Sorry about that. Hey, guys, as we go to the back half of the year, I'm kind of curious how you're thinking about a few things contributing. I guess one would be are you thinking about international launches having any impact as we kind of roll through the year? Similarly, political, I know is new for you guys, probably starting small, but I'm kind of curious how you're thinking about that contribution as we move through the year. And then finally... late this year into next year obviously we have a couple of very high profile uh avod service launches and i'm curious if you expect those to be uh net accretive to to roku and any thought there would be would be helpful thank you uh this is dancing i'll take that there was a lot of questions there so uh the first first question on international uh you know international is going well for us just as a reminder

Obviously, streaming is a large global opportunity. Over a billion broadband TV households around the world, they're all going to switch to streaming. Roku is the number one streaming platform in the United States, but also in Canada and Mexico. We're growing fast in Brazil and Latin America generally, doing well, starting to make good progress in the UK. And we just recently launched in Germany. So we are focused on global expansion. I'm happy with the results there. We're going well, generally. Our business model is to focus first on scale and then second on monetization. Most international companies, we haven't started monetization yet. So that is something that will come in the future, primarily focused on scale, at least for now, on international. Let's see. And then you had asked about political. You know, political is a good vertical for us. It's an area that's growing, obviously. The political season is coming up. You know, streaming is mainstream. Roku is America's number one TV streaming platform by hours. So political is an important part of that, of our ad business. But it's, you know, so I'd say it's an important, it's a good business, it's growing, but it's not a huge business for us. It's not yet become, you know, a primary growth driver. And I think that's for various reasons, but one of the reasons is, you know, the political advertising tends to be in certain very high demand localized markets. And so even though we have a lot of scale in a particular market, we'll reach caps fairly quickly. And so that's one of the one of the limiters on growth. But we expect political to continue to grow and continue to be an important vertical for us. And then AVOD. So, yeah, I mean, this is, you know, an important trend in the industry, which is that we're seeing SVOD services continue to add ad-supported tiers. I mean, the most recent, obviously, is Netflix. Disney Plus also announced they're going to launch an ad-supported tier. All the other SVOD services already have ad-supported tiers, Hulu, HBO Max, for example. And I think if you just think about the high level, what's the impact of this? Well, ad-supported tiers and SVOD services have the primary impact of lowering the cost of streaming for viewers, which increases the amount of streaming that consumers do. So it's good for engagement. As the US's leading streaming platform, more engagement in streaming is good for our business overall. You know, we like it when people watch more TV. So that's one big factor. Another big factor is with companies like Netflix and Disney moving into ads, it makes streaming ads even more mainstream. I mean, they're already mainstream, but it makes them even more appealing to advertisers. And, you know, I think we'll continue to accelerate or drive the trend from advertisers buying ads and traditional TV to moving those ads over to streaming. So it'll grow the industry. Uh, we have a lot of tools, you know, for partners as well as for ourselves and for advertisers to help make ads more effective on our platform. So it's, you know, it's obviously an area we're leaning into and have a lot of ways you can partner and help help our service partners. Uh, another, I think interesting trend driven by advertise in the rise of advertising is that if you're an S5 service, historically you're just focused on active accounts or the number of subscribers you have. But if you have ads in your service, then you're also focused on engagement more so because the more people watch TV, the more ads they see. And we've built obviously a lot of tools in our platform to help drive engagement. Ways to promote services and content on our home screen, throughout our platform. And that's one of the keys that drives our M&E business. So I think the rise of ads is going to continue to be a positive influence for us. It'll make ads more mainstream. It'll move dollars over faster. It'll drive our M&E business. And it creates partnership opportunities for us and our key partners.

Thank you. Our next question comes from Shweta Kajoria with Evercore ISI. Your line is now open.

Okay, thank you very much. Let me try one on expenses and one on gross profit, please. So could you please talk a little bit about how much flexibility do you have in terms of pulling back on your expenses, not only this year, but how you're thinking about it just overall at a high level as we even think about next year without, you know, you don't have to officially guide, but just help us think through the potential here in terms of expense control, and where would you be slowing down most of your expenses? So would it be original content, international expansion, product? Could you please provide color on that? And then the second question is on gross margins. Just help us with how we should think about the stability of gross margins for the platform segment, please. You guided to Q3, but how should we think about the long-term potential of gross margins for platform? Thank you.

Steve, do you want to take that?

Yeah, hey, Sweta. Yeah, I'll hit that OpEx and LEND gross margin. And in terms of OpEx, you know, just a reminder, when we look at our OpEx, the single biggest bucket is headcount growth or headcount-related expenses. And so, you know, one of the significant actions we took is to slow that headcount growth in Q2. along with slowing down variable OpEx or non-headcount growth as well. In addition, what we wanted to do is make sure that the Roku channel content spend is commensurate with the scale and the growth trajectory of the Roku channel. We've lived within this ad-supported TV model since the inception of the Roku, and so certainly making sure it reflects the economic realities of the short-term um you know disruptions around the macro economic factors is important so you know when we think about that um and i mentioned this in our remarks uh the opex growth rate is gonna be lower than what we had originally talked about on the q1 call you know just the actions in q1 or q2 apologies that lower that growth rate that otherwise would have been higher by 10 percentage points. We think it'll be a similar level of about 10 percentage points in Q3 and 25 percentage points by Q4. That will take the year-over-year growth rate back down to, you know, closer to the Q1 range. And so we'll continue to manage that as things handle. But the biggest thing we can do while still maintaining you know, the right amount of balance between investing in the long-term opportunity that we're still convinced is there and we're in a leadership position to go deliver against, as well as the short-term realities is to bend that cost curve down, you know, on the OpEx side. Again, CRC is a bit of a different angle. As a reminder there, when we talk about content spend, the majority of the content spend and the foundation of the spend from the Roku channel from day one has been third-party licensing. There's two models there. The predominant one is RevShare, so that kind of variable-izes things on its own in third-party licensing. And then you have the Roku Originals, which is obviously the newer piece and one that gets a lot of attention, but that's the minority of spending. And so the Roku Original program is important for consumers to help drive incremental reach and engagement, and then also it helps deepen the relationship with the advertisers, you know, as part of the value proposition in our successful upfronts that we just completed where we surpassed over a billion dollars. But we're going to make sure that we're keeping that content in line with the revenue outlook. So that's how we think about that. Obviously, there's a lot of uncertainty out in the world, so we'll remain flexible as we get a better handle on which way the world's going. In terms of the gross margin, You know, again, we mentioned that the world's very uncertain, and we are providing specific guidance past Q3 at this point. Certainly, the margins, especially on the platform side, you've seen some year-over-year degradation. That largely has to do with the mix shift toward more video, as we had some, you know, kind of one-offs around media and entertainment spend. and content distribution revenue being a higher percentage mix as some of the new tier one services came online at the end of 2020 and early 2021. And then also obviously some weakness in the ad market. So we anticipate that, you know, some of the pressures on the macro environment will continue in the short term and that that will have, you know, knock on impacts around not only the revenue growth rate, but also the margin structure.

Okay. Thank you, Steve.

Thanks.

Our next question comes from Nicholas Zengler with Stevens. Your line is now open.

Yeah. Hey, guys. I'm curious if there's any specific forces that you could point out that are serving as a potential offset to the industry headwinds in the near term. You kind of talked about political. I know you just turned on the advertising engine in Mexico. And then you launched the What to Watch home screen in April. I'd love to know if that is a monetizable product. It seems like it, but I'd love to get clarification there. But just any near-term catalyst to kind of go through it.

Hey, this is Anthony. I would say maybe one important factor there is if you just look at the general advertising industry versus TV advertising industry, especially in the scatter market, versus Roku's ad business, which is obviously streaming, we are still seeing, as advertisers decide how to invest more limited amounts of dollars, they do, they do look favorably on platforms that are growing as opposed to platforms that are shrinking. And so, you know, it is causing, it is causing dollars to shift to streaming at a faster rate. And I think a good example of that was that stat I said before, where, you know, we saw. CPG and auto, uh, you know, down, uh, in the mark down in the overall TV ad industry, uh, 9% in the quarter. but grew double digits on our platform. So we are still the beneficiary of advertisers starting to follow viewers and starting to follow higher ROI to streaming. And there's a big opportunity for that to continue to happen. I mean, like I said before, about half of TV hours are now streaming, but only 22% of the TV budget. So I think one bright spot is that you know, pressures on budgets cause people to get more serious about how they spend their budgets, causes them to change their behavior, and that behavior change is permanent. So, I think when we come out of this, we'll be in a better position. And then, like I said, you know, sorry, go ahead.

I was just going to add, if you don't mind.

I was curious also, if we could get a status update. on enabling like small and mid-sized brands and performance advertisers to promote via targeted ads on Roku. I know you guys had, you know, within the last year and a half announced a partnership with Shopify there, but just curious because it seems like it's a growing priority now. We've heard recent announcements from the Trade Desk, Amazon, Peacock, all catering to this type of demand. And I know you guys were pretty early on starting to set this up. So any update there would also be appreciated. Thanks.

Sure. You also had asked about more ways to watch other factors in our UI that's causing more engagement. And I think it is worth noting that we have been putting a lot more emphasis recently on driving engagement on our platform. We have created a whole new team. We hired a new executive that's focused on improving engagement, and there's a lot of low-hanging fruit there. So that is an area that we are also continuing to focus on. In terms of performance advertising, yeah, that's still a focus for us. I mean, we think that a lot of advertising is in the process of moving to performance space. We have a lot of tools to do that. We're good at it. We're getting even better. So it is an area that we're continuing to see growth in. I mean, if you look at digital budgets, they are a factor for us. And this is a budget that we're starting to tap into that we didn't historically tap into. But it's still a fairly small part of our sales. It's growing. But still, by far, the biggest source of revenue, ad revenue for us is traditional TV budgets moving to streaming. And that's a $70 billion opportunity in the US alone. So that's our primary focus. And some of those budgets are becoming more performance-based as well.

Thank you very much.

Thank you. Our next question comes from Benjamin Swinburne with Morgan Stanley. Your line is now open.

Thank you. Good afternoon. One for Anthony and then a question for clarification for Steve. I think back in April you guys launched the dynamic linear ad product, at least in the beta, which I think was something that came out of your Nielsen acquisition and something we've heard ad buyers and national networks are excited about. Do you have any update on how that's trending and whether that can turn into a revenue or driver in sort of the next, you know, six to 12 months. And then, Steve, just wanted to better understand the six of six adjustment. I apologize for going back to that. But I think you said it was tied to your outlook for player sales. I just want to confirm that was true. And also just make sure, I don't think you said that impacted the third quarter guys. I just wanted to just confirm that. Thank you, guys.

Thanks, Ben. Yeah, so just a Quick update on dynamic linear ads. It's going well. Still early days. For those that aren't familiar, dynamic linear ads or DLA is a technology that allows publishers with Roku's help to replace linear TV ads in real time so that they're targeted. So it allows for higher CPMs and better targeting of ads. We're in beta with partners like Discovery and AMC. It's going well. but still fairly early. We did in Q2 release it broadly to buyers in OneView so that OneView buyers can now target ads to DLA partners as well as traditional streaming ads. So it's rolling out more broadly, still early. It looks promising, but still early. Then Steve.

Yeah, in terms of the 606 side of things, Ben,

Yeah, just to clarify, I mentioned that the changes in 606 model were primarily related to change in assumption that the size of the US TV market and player markets would be lower than prior expectations. That would translate into lower estimates of active accounts, which then funnel through various models. explicit connection to that would be a lower expectation of button revenues in certain deals where we've sold those deep link buttons on the remote. So that's the primary thing. So it's not necessarily just a player thing. It's a macroeconomic wind largely tied to lower consumer discretionary spend expectations in a recessionary environment. And then you mentioned the question on Q3. Whenever we change the 606 models and you have a broad scale assumption like this that it's the majority of the portfolio 606 model, you have a disproportionate impact from that change in the quarter. So, in this case, Q2, but you do have an ongoing impact in subsequent quarters, including Q3. There is a negative impact of that 606 call down that's contemplated in the Q3 outlook.

I see. Thank you so much. Sure.

Thank you. Our next question comes from Tim Nolan with Macquarie. Your line is now open.

Hi, thanks. so could you help us understand how you're adding 1.8 million active accounts which is more than you did in q2 last year and it followed a 1.2 in q1 if your player sales are down as much as they are um that implies smart tv operating system sales good but i have the 606 markdown so i'm just wondering if you could help illuminate where the account growth is coming from and if i'm right that it's more the smart tv side Operating system side, how much of that, if you could help us break out between U.S. and international, if that's possible. Thanks.

This is Anthony. I'll start and then turn it over to Steve for some more detail. So I would just say at a high level, you know, people are still buying lots of Roku streaming players. I mean, we have great products. People love them. Streaming players are available at very low prices. Our TVs are a great value. Lots of content, lots of super easy to use. you know, the Roku OS, the only purpose built OS for TV. So all of these have resulted in people liking Roku products and buying, continuing to buy Roku's products and our strength of our brand continues to grow. So, I mean, I think that's a big factor. Um, and both, both streaming players and TVs are, are doing well for us. Uh, but maybe Steve, do you want to talk about some of the details?

Yeah, sure. So the, um, In terms of the kind of net ads in Q1 versus Q2, the biggest factor there that we talked about in the shareholder letter was on the TV side. So, you know, a lot of retailers are feeling like they have over inventoried right now and they're trying to lower their overall inventory levels in part due to the recessionary fears and also some of the consumer discretionary spend across a number of verticals that they're starting to see weakened. As a result, especially on the TV side, which tends to be, you know, kind of costly inventory, they temporarily reduced the price of that, you know, kind of basically put more aggressive promos on the TVs in order to get rid of excess inventory. That had a short-term boost on the number of TVs sold in the market, including Roku TV models. which is the kind of thing, the biggest part of the fact that net ads increased on a quarter-over-a-quarter basis. We think that's a temporary blip. You know, a lot of retailers have said that they're looking to kind of lower their inventory levels in general and become more cautious, you know, as the recessionary fears continue and inflationary pressures continue. And so we look at that as more of a temporary phenomenon. Like I said, in general, with the 606 answer, you know, the expectation out there in the market is that the, you know, many of the consumer discretionary markets, including consumer electronics in general, will be smaller during, you know, the near term because of these pressures.

Okay. And any help on maybe qualitatively breaking out U.S. versus international? No.

We haven't provided that before, so yeah, nothing to add there. Okay. Thanks, Steve. Thanks, Anthony.

Sure.

Thank you. Our next question comes from Alan Gould with Loop Capital. Your line is now open.

Thanks for taking the question. Anthony, can you tell us, was there any big difference in the various verticals in terms of advertising, or did it all slow down at the same time? And specifically, how did the media and entertainment vertical do?

Yeah, I mean, well, definitely different verticals were – some verticals were more impacted than others. I mean, I mentioned that CPG and auto were particularly impacted, you know, declining 9%. for traditional TV generally, but growing double digits for us, which is good growth, but we would have expected stronger growth in the absence of the macroeconomic problems we're seeing. And then in terms of media M&E, I think it's a good business for us. And like I said before, I think that the fundamentals are in favor of that business continuing to do well, particularly You know, for example, just one example, you know, subscription publishers of SVOD services tend to just focus on subscriber acquisition type promotions, but we are seeing them now start to do promotions designed to retain customers, not just to acquire new customers. And so, as the industry matures, it'll start spending more promotional dollars on retaining customers reducing churn as well as acquiring customers. And then, like I said before, I think the trend to offer more advertising supported tiers is going to result in services wanting to drive engagement because, you know, the more engagement, the more ads people see. And so, and we have a lot of tools in our M&E business for helping to drive engagement. And I think we'll start to see them used increasingly. So I think, you know, M&E is going to be a big and growing business for us.

If I could just ask one follow-up. You say you're targeting most of your ad gains from traditional TV, not digital, but these trends sound a lot more like the digital players. When Comcast reported this morning, they talked about the scatter market being choppy, but having the whole business pause sounds a lot more like the digital guys. Wondering where the discrepancy is coming from.

Well, it didn't pause. I mean, our, our platform business, uh, grew nicely in the quarter. You know, I was saying that we had, uh, like I was talking about that one vertical CPG and, uh, auto, you know, down, uh, down in the industry overall, but up double digits for us. So we are, we are seeing, uh, we did see in Q2 growth in our ad business, just not as strong as we had initially expected. So I think, I think, um, We are starting to access digital budgets as well, but they're still relatively small compared to the overall TV ad business, which is a $70-plus billion business and has got a lot of reasons to transition to streaming at the moment. I think that the overall business is growing, just not as strongly as it would have if advertisers weren't pulling back. Another factor, I guess, in our business is we do traditionally over-index on scatter versus upfronts. I mean, that's starting to change. Our upfronts are getting bigger and bigger every year. You know, this year we passed a billion dollars, but we do traditionally have a lot of scatter business, more than a traditional TV network. There tends to be more of their business in the upfronts. Okay. And the scatter market's easy for advertisers to pause on and then restart.

Thank you. Our last question comes from Michael Nathanson with Moffitt Nathanson. Michael, your line is now open.

Great. Thanks. Can I just ask two? One, Steve, I wanted to come back to System 6. What I wanted to know is are you seeing a material change in either top-of-funnel gross additions to streaming services or churn dynamics, right? on the economics of streaming that makes you come back and look at your assumptions. And then the bigger question is, there was a group M study back in June that talked about a lot of ad impressions on sticks and dongles were running when the TV set was off. And I wonder if you guys have a point of view on the group M study and what you're doing to maybe address that. And do you think is that a legitimate concern about maybe the the quality of impressions that come through SNCCs and Dynos. So, thanks.

Yeah, Steve, do you want to take that? I can take the impression question if you want, but go ahead.

Sure. Yeah, I think in terms of the 606 piece, the material change is, like I said, around the sort of market sizing of overall TV players and the player, sorry, TV sales as well as player sales. kind of on the market level, which then filters down into units, sales, estimates, and then active account numbers. Certainly we update the assumptions for the specific deal models. What I would say on that in terms of kind of the funnels within the SBOT services, there's certainly more competition in the SBOT space. And so there may be changes that we make in different models over time, but it's certainly not a macro factor like what we've seen with the material impacts of the 606 model. So I would say that's more of a competition-related set of changes potentially that we look at every single quarter as opposed to a broad-scale change in the market size of TVs and players. That's really what's driving the change in the 606 model this time.

Okay. Anybody else?

And then on the ad impressions, I would say Roku is the leader in advertising quality. I mean, so on the point you raised, specifically, I'll just talk about a few of the things we do and then maybe talk about the big picture. So in terms of specific things, when a Roku player goes inactive, sorry, a Roku player will go inactive when they get a signal from the TV that the TV inputs are no longer being watched. A lot of TVs, most TVs send out that signal, but not all. You know, obviously, if it's a Roku TV, then we know when you turn off the TV and we stop, we don't continue to play. And then to catch the edge cases, in 2019, we rolled out a feature called Are You Still Watching? You know, where we, if there's a period of inactivity, we ask the user if they're still there. So we take a lot of steps to make sure our inventory is high quality. And I think we're, I mean, we're confident that it is generally. And I think the proof is in the numbers. If you just look at, we do lots of, We do lots of analysis on ad campaigns that run on linear and then also run on Roku. And we see consistently that the campaigns are higher performing on our platform versus traditional linear TV.

Thanks.

Thank you. This concludes the question and answer session. I would now like to turn the conference back over to Anthony Wood for closing remarks.

Thanks. I want to thank our employees, customers, and partners for their focus and commitment in a very difficult operating environment. But we expect to emerge from the current advertising downturn stronger and better positioned than ever to capture value in the transition of TV to streaming.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.