Cricut, Inc. Q4 FY2021 Earnings Call

Good day and thank you for standing by. Welcome to the Cricut Q4 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Stacie Clements with the Blue Shirt Group. You may begin.

Thank you, operator, and good afternoon, everyone. Thank you for joining us on Cricut's Fourth Quarter and Full Year 2021 Earnings Call. Please note that today's call is being webcast on the Investor Relations section of the Company's website. A replay of the webcast will also be available following today's call. For your reference, the accompanying slides used on today's call, along with the supplemental data sheet, have been posted to the Investor Relations section of the Company's website, investor.cricut.com. Joining me on the call today are Ashish Arora, Chief Executive Officer; Marty Petersen, Chief Financial Officer; and Kimball Shill, Executive Vice President of Operations and incoming CFO. Before we begin, we would like to remind everyone that our prepared remarks contain forward-looking statements, and management may make additional forward-looking statements, including statements regarding our strategy, business, expenses, and results of operations in response to your questions. These statements do not guarantee future performance, and undue reliance should not be placed upon them. These statements are based on current expectations of the Company's management, involve inherent risks and uncertainties, including those identified in the Risk Factors section of Cricut's most recently filed Form 10-K. Actual events or results could differ materially. All non-GAAP numbers referenced in today's call are reconciled in the press release or the slide presentation on the Investor Relations website. This call also contains time-sensitive information that is accurate only as of the date of the broadcast, March 8, 2022. Cricut assumes no obligation to update any forward-looking projections that may be made in today's release or call. I will now turn the call over to Ashish.

Well, thank you, Stacie, and welcome, everyone. Before I get started with my comments, I wanted to take a moment to acknowledge the devastating events in Ukraine that are on our minds. As part of our virtual team, we have software partners that we work with in Ukraine. My team and I have been in contact with these team members and their leadership and have expressed our concern and support for them. We also know these events impact many people across the global teams, user communities, friends, and families. Our hearts and prayers are with all of them. While these events are clearly top of mind for us all, let me now shift to talking about our latest updates at Cricut. 2021 was an exciting year for us with strong momentum across our business. 2021 was also a complicated year as Cricut, our retailers, and our customers navigated the ups and downs of a global pandemic. Total revenue for the year grew by 36%, a remarkable performance on top of a very tough comp in 2020, driven by growth across connected machines, accessories and materials, and subscriptions. We delivered a 16% EBITDA margin for the full year. Our profitable business model enables us to fund significant investments towards our long-term growth strategy. In addition, we successfully navigated through some tough supply chain challenges. And as a result, we benefited from a strong inventory and cash position that continues as we enter 2022. 2021 represented a second year in a row that we accelerated our growth in two key areas. The first was the expansion of our consumer base, adding nearly 2.1 million new users in 2021. And the second was the growing revenue contribution from our international efforts. In 2021, international revenue grew by nearly 110% compared to the prior year and represented 11% of total revenues. We added new use cases, entered into new markets, expanded our retail footprint, and fostered a growing global community that will continue to fuel our engagement flywheel. Revenue in the fourth quarter was strong as anticipated in the holiday season. Our gross margin pressures resulted in much lower EBITDA margins in the fourth quarter than anticipated, which Marty will talk to in a few minutes. In 2021, we added more than 2 million new users, an increase over the nearly 1.8 million users added in 2020. At the top of our engagement funnel sits 6.4 million users, total users on our platform. As anticipated, engagement as a percentage of total users in the fourth quarter increased sequentially, consistent with typical holiday seasonality. As a percent of total users, engagement in the fourth quarter was 60%, up significantly from the 56% we saw in Q3 at our trough. At the end of 2021, we had 1 million more users cutting in the last 90 days compared to the end of 2020. As we've discussed before, the engagement metric on a percentage basis will fluctuate as we expand our market opportunity and acquire new customers. We're expanding beyond our traditional craft consumers by broadening our use cases and growing partnerships with various retail channels. Our goal is to drive engagement with these users by offering seamless connected experiences, relevant content, community, and value-added services. This increased engagement in turn drives modernization through subscriptions and materials. Our passionate and engaged users fuel our marketing pie, where over 40% of new users come to know about Cricut through word of mouth. This user acquisition engagement and sharing cycle powers our business from machines, subscriptions, accessories, and materials. These businesses are symbiotic with each other and the user experience. At the core of this user experience, we ensure compatibility between our connected machines, software content, accessories, and materials. We then work actively with retail partners who are passionate about telling this compatibility story, showcasing the entire Cricut brand, and delivering a great experience for our consumers. Our growth from our international expansion was one of the highlights for the year. This past holiday season, we significantly expanded our retail footprint across a broad range of retail channels around the world, beyond crafts, including home office, home organization, and consumer electronics. Since the end of 2020, we've introduced Cricut products in 60 new markets, making Cricut products now available for purchase in over 45 countries. Our user acquisition approach is driven by our organic word-of-mouth marketing. Based on our experience to date, these international investments will pay off over time and typically take a few years to achieve critical mass in each country. At the heart of Cricut is our passionate community of users. We curate our Facebook, TikTok, Instagram, and Pinterest pages from projects that our users share across their social channels. Our goal is to amplify their great work and inspire others around the globe. Our community provides a powerful competitive moat while driving organic engagement and new user acquisition. More than 5.7 million social media followers actively engaged with Cricut across relevant platforms. The #Cricut alone has more than 3.1 million posts just on Instagram. On YouTube and Pinterest, video views of Cricut content more than tripled compared to 2020. We now have over 3.3 billion views on TikTok, up from 2 billion at the end of 2020. Our international communities continue to grow as well, fueled by hundreds of active influencers outside of the U.S. with a combined reach in the tens of millions. In October, we launched Cricut Learn, showcasing a beginner's drive with live Zoom workshops and short searchable on-demand instructions covering everything from popular materials to how we use design space. As of today, we've posted over 80,000 members with introductory courses making up 40% of content consumed. At the same time, we hosted more than 40,000 new members in our live workshops. We see member education as a significant opportunity to provide members of tools and resources early in their Cricut journey so that they can create more often and with confidence. We continue to drive engagement through Cricut Access, our subscription service. We ended 2021 with over 2 million paid subscribers, a 56% increase over the prior year. This equates to about 32% of our total user base, a strong attach rate that speaks to our continued investment in subscription services. We will continue to add new features, functionality, and content as we continue to increase the value proposition of Cricut Access. One of the things I want to highlight is our new contributing artists program. Currently in beta, this new marketplace enhances our content library, enabling artists to upload their artwork to Cricut design space and get compensated as their artwork is used by Cricut members for their projects. For millions of our users, they can access new authentic and diverse content from their favorite designers. This marketplace strategy lays the foundation for more to come as we look for ways to further engage with our community globally and for the community to further engage each other. Our ability to extend the platform as we introduce new machines, smart materials, tools, and accessories expands use cases and categories, which further drives user engagement. Just yesterday, we introduced an exciting new lineup of heat presses. The Easy Press 3 is our newest model that includes Bluetooth technology along with the new Cricut Heat app, to perfectly monitor the heat setting to any project via a connected platform. Our new Cricut Hat Press enables us and our users to create high-quality hats. We also launched our flagship heat press, the Cricut Auto Press. The Cricut Auto Press is designed for enthusiasts who love making t-shirts and other heat crafting projects as well as for prosumers who are using their Cricut machines for making heat press products to sell. We also recently launched the Cricut Bright 360 floor lamp and the desk lamp. These lamps are designed specifically for every Cricut user and every crafter. The lamps are designed to reveal accurate colors and light up your entire workspace. We're very excited about all of these launches. Our plan enables us to constantly enrich the experience for the entire installed base of users and machines as we roll out software updates across desktop and mobile. These software updates allow users to benefit from new features and capabilities when coupled with new content materials and tools. This is very unique to our platform and allows us to drive engagement by giving users the ability to make new types of projects and expand on their creativity. For the holidays, we released new destination pages on the desktop version of Cricut design space. These pages allow us to feature targeted content, projects, and images to support key themes and engage users in a rich and inspiring way. We also plan to build on this and give our international markets to create their own flavor of destination pages for each of their respective markets. The underlying trends that drive our business, a personalization and digitization of tools, are healthy and intact. As we further penetrate our SAM, we are excited to see a broadening of demographics among our user base. We see a growing number of beginner crafters joining the platform. We are seeing younger generations of crafters, including more Gen Zs and millennials, as well as a greater percentage of men becoming Cricut users. One of our old mantras is proud but hungry, and we'll continue to innovate around the platform and create additional value for the user experience within the Cricut ecosystem. Over the last two years, we have acquired nearly 4 million new users, and we've significantly grown the business. As we head into 2022, we are focused on cultivating this larger user base and creating the best experience we can for them. These investments will drive further monetization and profitability, ultimately fueling more investment in growth for the long term. Our key focus areas this year include: First, we will continue to enter new markets and expand across retail channels; second, we want to simplify the onboarding process and drive engagement across our entire installed base. This is fundamental to our user acquisition strategy and the marketing flywheel; third, we want to monetize our user base and this enhanced engagement. We plan to do this with the launch of new materials, accessories, content, and enhance the value our users get by subscribing to Cricut Access. Our focus on compatibility across the entire ecosystem is key to driving this. Balanced with these shorter-term objectives, we will continue to invest for the medium and long term. We are expanding our platform and investing in new types of connected machines that will serve us well for 2023 and beyond. Before I conclude my remarks, I would like to thank the entire Cricut team for their amazing and tireless work. I also want to thank Marty for his countless contributions and leadership that has helped build the company to over $1 billion in revenue. We've built a tremendous team, and I'm grateful for the dedication and passion for our company culture, our mission, and our users. He's been an incredible part to me over these past 10 years, and I wish him all the best in his retirement later this year. I'm also thrilled to introduce you to Kimball Shill, who is joining us today on the call for the first time. He's served as part of the executive team for the past three years, and his deep operational expertise and proven leadership at Cricut makes him the ideal person for the CFO role. Three years ago, Kimball was tasked with building a team that could reimagine our supply chain for greater scale and flexibility while also serving our growing international market. Kimball and Marty both were tightly integrated, and we are lucky to welcome Kimball's expanded leadership role within the company. I'll now turn the call over to Marty.

Thank you, Ashish, and good afternoon, everyone. I want to take a moment to express my gratitude to the entire Cricut team. It has been a privilege to be part of this team for the past ten years. I am thankful for the incredible experience we have had in empowering so many lives around the world, and I feel honored to contribute to someone's creative joy and inspiration. For today's call, I will briefly summarize our annual financials, but most of my time will focus on providing details about our fourth-quarter performance. As a reminder, we have made a supplemental data sheet available on our Investor Relations website with historical numbers for your reference. We had a strong year, achieving $1.3 billion in revenue, which is a 36% increase following last year's 97% growth. This growth has been driven by a diversified revenue stream, with all three segments experiencing significant year-over-year growth in 2021. We increased our total revenue costs by 35% for the year but maintained our gross margin at 35%, the same as last year. The rise in sales costs was primarily due to higher promotional levels compared to last year when promotions were unusually low and also due to increased freight costs. These costs were somewhat offset by both the revenue increase and our revenue mix. Our strong business model allowed us to invest significantly in several growth initiatives that Ashish mentioned. Our total operating expenses for the year were 20% of total revenues, up from 14% in 2020. In absolute terms, we doubled our operating expenses in 2021 compared to lower levels in 2020 when spending was paused due to pandemic uncertainties. We have a resilient business model, and 2021 marked our fifth consecutive year of GAAP profitability, delivering $140.5 million in GAAP net income compared to $154.6 million in 2020. Our EBITDA margin for the year, which included $38.1 million in stock-based compensation, was 16.2%, slightly below our expectations for the fourth quarter. This compares with a 22.4% EBITDA margin in 2020, buoyed by lower promotional activity and paused spending earlier mentioned, along with nominal stock-based compensation expenses. Overall, 2021 was a year full of achievements; we experienced strong revenue growth, made significant investments, replenished our inventory, maneuvered through a challenging supply chain environment, and continued to generate profits. Now, moving on to the quarterly numbers, I will delve into specific factors influencing our Q4 financial results. This behind-the-scenes look is crucial for evaluating Q4 performance and framing our outlook for 2022. To assess the health and trajectory of the business, we concentrate on annual year-over-year trends, which adjust for seasonality. To account for the pandemic's effects, we find it useful to view financial performance on a two-year basis. Fourth-quarter revenue was $387.8 million, a 5% increase year over year, and on a two-year basis, revenue increased by 123%. We observed standard holiday strength in Q4, as expected. Additionally, our Q4 revenue benefited from certain retailers ordering more vigorously and building defensive stock in anticipation of potential supply chain disruptions, estimating an impact of roughly $20 million on Q4 revenues from connected machines and accessories and materials. This revenue was likely pulled forward from the first half of 2022. Revenue from connected machines totaled $158.1 million, representing a 7% decline from the previous year. It's important to note that we are comparing against an exceptionally strong Q4 last year. Furthermore, Q4 2021 revenue was influenced by the atypical retailer behavior I mentioned earlier. Subscription revenue was $55.7 million, up 51% year over year, driven by strong machine sales and attachment rates throughout the year. Revenue from accessories and materials reached $174 million, a 7% increase over last year, as we grew our engaged user base sufficiently to offset the decline in engagement percentages. This revenue also benefited from increased retailer buying during the quarter. When we look at geographic growth, international revenue continues to outpace growth in North America, rising by 53% in the fourth quarter compared to the same quarter in 2020. In Q4, we added a record 676,000 new users, contributing to a total of more than 6.4 million users by the end of 2021. Engagement in Q4 increased sequentially, as it is typically our strongest quarter for engagement due to seasonal trends. Year over year, the engaged user count for the 90-day period ending in December grew to 3.8 million, an increase of over 1 million or 36%. By the end of 2021, 5.2 million of our total 6.4 million users had used their connected machines within the past year. The engagement rate for the fourth quarter was 60%, an increase from the low point in Q3 but down from the unusually high 65% from the prior year. In annual terms, the number of paid subscribers grew by 735,000, or 56%, closing the year with over 2 million paid subscribers. Our attach rates stayed strong at 32% at the end of Q4. We measure user monetization through average revenue per user in subscriptions and accessories by dividing revenue from these segments by our total user base during that period. ARPU for subscriptions in Q4 was $9.18, down slightly from $9.23 in Q4 2020. For accessories and materials, ARPU was $28.66, an increase from $18.79 in Q3 2021, yet below the $40.76 peak from Q4 2020 due to elevated engagement levels related to the pandemic and inventory catch-up that year. We are committed to monetizing our expanding user base through subscriptions and accessories. Historically, we see softer gross margins in Q4 due to higher sales concentrations in connected machines and increased holiday promotions. Total gross margin in Q4 was 27%, down from 33.6% in Q4 2020, mainly due to significantly lower margins in our connected machines and accessories. The Q4 2021 gross margin was impacted by several factors. Connected machines had a gross margin of negative 1.5%, which is unusually low; last year's Q4 margin was 14.4%, boosted by low promotional activity during the pandemic. Typically, pre-pandemic Q4 margins on connected machines fall within mid- to high single digits. This decline was primarily driven by nonrecurring factors and cost pressures that may continue to affect our machine gross margin in 2022. Our support for promotions from retail partners was higher than expected. In Q4, we faced challenges in managing the promotional activities in the channel, which led us to align and support our retail partners with additional promotional funds, accounting for about 5 percentage points of the decrease in connected machine gross margin. We have established new structures and policies to enhance management within our retail channels and will collaborate with retailers who align with us strategically to avoid future challenges. Additionally, Q4 2021 experienced greater reserve levels related to pricing changes for certain end-of-life products, contributing an extra 3 percentage points of margin impact. Furthermore, inflationary pressures across our supply chain continue to affect the gross margins for connected machines. Our teams have effectively navigated this landscape to ensure we maintain adequate inventory levels. In 2022, we anticipate ongoing inflation-related challenges in freight, warehousing, and commodity costs. To counter some inflationary pressures, we plan to increase prices and adjust our promotional strategies for connected machines and accessories. The gross margin for subscriptions was 88.4%, slightly down from the previous year due to rising hosting costs needed to support our applications' functionality and scale for future growth. The gross margin for accessories and materials in Q4 was 33.3%, decreased from 41.3% the previous year due to tighter unit costs, driven by increased freight expenses and changes in product revenue mixes. On operating expenses, total expenses in Q4 amounted to $79 million, which included $10.1 million in stock-based compensation, a significant rise from $45.2 million in Q4 2020 when spending was paused due to the pandemic. The operating expenses relative to revenue were 20% in Q4, up from 12% the previous year, reflecting heightened investments in sales, marketing, and R&D for future growth. The increase was primarily driven by advertising and marketing expenses related to our international expansion and a growing headcount in R&D following our IPO. Operating income for Q4 was $25.8 million, or 6.7% of revenue, lower than $79.6 million, or 21.5% of revenue in Q4 2020. This decline was driven by reduced gross margins and increased investment and stock-based compensation expenses. On a full-year basis, operating income in 2021 was $192.4 million, equating to 14.7% of revenue, compared to $200.5 million or 20.9% in 2020. We recorded our 12th consecutive quarter of positive net income, with Q4 net income at $11.9 million, down from $61.4 million in the prior year's Q4. This quarter included a tax true-up of $6 million due to increased sales across more states with higher tax rates and taxes stemming from higher stock-based compensation, leading to a notably higher effective tax rate. Moving forward, we expect our ongoing effective tax rate to be around 25%. Diluted earnings per share were $0.05, noting that Cricut did not have a comparable EPS history before last year's IPO. Q4 EBITDA was $31.8 million, an 8.2% margin, including $10.1 million in stock-based compensation, compared to an unusually high $83.5 million or 22.5% in last year’s Q4. On a two-year basis, EBITDA reflects a growth of 122% since 2019. We maintain healthy operating margins and will provide year-over-year EPS comparisons starting in 2022. Moving forward, management believes operating income and earnings per share are the primary metrics for measuring profitability and managing the business long term. Therefore, we will no longer highlight EBITDA as a key metric. Operating income closely aligns with our previous 방식 of calculating EBITDA, and investors interested in EBITDA can easily derive it from our financial statements. We will focus on long-term operating margin targets of 15% to 19%, with unchanged long-term targets for gross margins and operating expenses. For reference, our historical operating margins and long-term target ranges can be found in the data sheet and appendix of our earnings presentation on our Investor Relations website. Regarding our balance sheet and cash flow, we concluded the year with a strong balance sheet, including $241.6 million in cash and cash equivalents, along with healthy inventory levels. Our $150 million credit line remains untapped. Cash used in operations for the year was $104.9 million, primarily for rebuilding depleted inventories. As we’ve communicated in recent quarters, we intend to continue reducing our higher-than-normal inventory levels to mitigate supply chain risks. We are monitoring known risks and plan to adjust inventory levels accordingly. In summary, 2021 marked two consecutive years of phenomenal revenue growth, with revenue growing over 165% on a two-year basis and nearly 4 million new users added to our platform. We also grew our operating income by over 255% during the same two years. While maintaining a flat gross margin, we navigated a complex supply chain environment and made significant business investments. I believe we are currently a stronger organization than before the pandemic, and we will continue to effectively manage what we can control. As we approach 2022, it's important to remember that the first half of last year was unusually strong. Had 2021 followed a typical seasonal pattern, the quarterly revenue distribution would have looked quite different, making first-half 2022 comparisons challenging. Additionally, we estimate that retailer inventories entering 2020 were about $35 million above typical levels, including approximately $20 million from increased buying in Q4. These factors may present headwinds in the first half of 2022, which we are already observing early in the year. As we move into 2022, we expect to benefit from traditionally stronger seasonal trends and easier comps in the second half of the year. However, we remain cautious about macroeconomic uncertainties surrounding inflation and consumer spending. We expect to end 2022 with at least 8 million total users, and the substantial growth in our user base over the past two years offers additional opportunities to enhance engagement and monetization across a larger user base. Our commitment to driving profitable growth remains steadfast, and we aim for an annual operating margin target of 15% to 19% over the long term. Given the uncertainties present as we enter 2022, we anticipate some pressure on operating margins that could temporarily push us below this range. We believe the trends that have supported our growth since 2014 will continue for years to come. Our history of maintaining profitability while effectively managing financial resources positions us well in this dynamic macro environment. The tremendous growth we have experienced provides a strong foundation for further scaling and growth ahead.

Our first question comes from the line of Mark Altschwager from Baird. Please go ahead.

Just to start out on gross margin, could you talk a little bit more about the levers that you have within your control to help stabilize the machine margins and the materials gross margin through 2022? Just what are the puts and takes there? And if you could say, I guess, net of the price increases and promotional changes, how are you thinking about sort of the gross margin in those segments of the year?

Let's quickly recap a few points regarding the gross margin, specifically for machines. The machine gross margin was lower than usual, primarily due to three factors. First, there was an unusually high level of promotional activity during the quarter, which contributed about 5 percentage points to the decline in gross machine margin. Second, we took end-of-life reserves because we had delayed phasing out certain products, particularly machines, during the pandemic. This was a precaution since we were uncertain about our production capabilities. In Q4, we felt confident about our supply chain and decided to end the life of those machines in 2022, resulting in a reserve that accounted for about 3 percentage points. If we exclude these nonrecurring items, machine gross margins would have been close to the levels we observed in Q4 of 2018 and 2019, before the pandemic. Additionally, inflationary pressures in the supply chain, especially concerning freight and warehousing, have further affected margins. Moving forward, we noted that freight and warehousing costs peaked in Q4, with no expected relief through at least the first half of 2023. However, we are planning price increases to help mitigate some of these pressures, which we anticipate will mostly take effect in the second half of the year.

Let me add to that, Mark. I want to emphasize our promotional strategy and why it resulted in an anomaly. We have a strong partnership with all our retail partners, and we plan our promotions six to nine months ahead of the holiday season. This past holiday season, one major retail partner was more engaged than we had anticipated. Given the highly competitive market, we decided to support our retail partners with additional point-of-sale dollars to remain competitive. However, we have implemented processes to help prevent similar situations in the future. This was an unexpected event that we had to manage during the quarter. A couple of other points that Marty mentioned will be beneficial. We are adjusting pricing both for our retailers and for consumers, which will help improve our gross margins. As we move into the second half of the year, our product mix, especially in machines, will shift towards higher price points and products with better margins. We believe that these changes will help restore our long-term margins. What we observed in Q4 was the bottom point.

To follow up, Ashish, we noticed the announcement yesterday and some of the new products. How much of this innovation is aimed at increasing monetization of your current users, specifically your power users, as opposed to attracting new users to the platform? Additionally, could you share any details about the innovation pipeline for 2022 beyond those announcements?

I appreciate your insight regarding our strategy with recent launches, including the lamps we announced earlier this quarter. My primary focus is on supporting our existing Cricut users and enhancing monetization of our current customer base. We believe that, over time, a portion of our users will seek to sell their creations, alongside the enthusiasts and hobbyists. Some of these users may also draw in new customers who approach our products from a commercial angle. It's likely a mix of both scenarios. We're excited about these launches and have seen strong consumer interest and demand around them. From an innovation standpoint, as a platform company, we will keep investing in our platform, which encompasses data, content, community, services, and software across both desktop and mobile. This investment will be ongoing. We believe that we are still in the early stages of our category, particularly in connected cutting machines, and we have significant potential for growth in that area. We also plan to invest in different types of machines outside of our current offerings, which is an exciting prospect for us. However, these initiatives will be medium to long-term investments.

Our next question comes from the line of Jim Suva from Citi Group. Please go ahead.

It's Jim Suva. I have a question I think it was Marty mentioned that inventory levels were a little bit higher than normal to the neighborhood. I remember right around $35 million. I might be wrong or right on that? What was the reason for higher inventory levels? Was it retailers were expecting another kind of COVID growth here, or they were concerned about supply chain issues and kind of double order? And the reason I ask is a lot of societies see shortages of inventory; it sounds like you're talking about extra inventory. So if you could help us with that, that would be great.

Yes. Sure, Jim. So let me just address a distinction between our inventory and channel. The comment that you're talking about is channel inventory. Just very quickly, we've been talking over the past few quarters about our own intention and practice of carrying higher levels of inventory than we normally would to mitigate against supply chain challenges. And we ourselves ended the year about on target with where we planned to be. We watch metrics very closely. We have pre-designated metrics to look at relative to certain risk factors. We mentioned in last quarter's call that we had seen defensive buying similar to what we were doing on the part of a few of our retailers. And we saw that buying continue all the way through the end of Q4. And we estimated the pull forward of that defensive buying into Q4 from future periods of about $20 million. But then as we look at the balance, the channel inventory balances that existed at the end of the year looking forward into 2022, we saw about $35 million in additional inventory that was being carried.

Perfect. And just to clarify, the $20 million that you mentioned and $35 million, the $35 million, that includes the $20 million, I assume? Or is it uniquely different?

Yes, it does. I'm sorry, I should have clarified that. The $20 million is within the $35 million.

That's what I thought. Okay. And then the last question is, if we compare to, say, two years ago, again, taking out the COVID year a little bit, accessories, how should we think about why accessories are trending what they are versus accessories and materials versus two years ago? Is there some type of trend we should extrapolate? I don't want to compare it to one year ago because I think that's an unfair relationship. But what are your thoughts about versus two years ago for accessories and materials in the direction of such?

Yes. So we agree with you that comparing to a year ago is not valid just because of so many things going on last year. And so I'm talking about accessories and materials ARPU specifically. If we look at accessories and materials ARPU at the end of 2019, pre-pandemic relative to accessories and materials in 2021, ARPU declined about 7%. Now ARPU is, for us, is a measure and a yardstick of our production and profitability of every person who has ever registered a machine, whether they put it in the closet or not. Because that's the denominator, and so we look at revenues from accessories and materials divided by that entire user base. And so over that same period, we increased our user base by 153% or 4 million people. And so we feel pretty good about that 2021 ARPU number because increasing the numbers that quickly and on declining 7% feels pretty good.

Thank you for the details and clarification. And yes, indeed, all our Christmas Mug Presses did come out for all of our family members in a great manner.

Jim, I'd like to add a comment to Marty's statement. One thing that informs your question is that we are seeing many beginner and intermediate crafters, particularly Gen Zs and millennials, which is exactly what we want. This is about broadening the market and reaching highly engaged enthusiasts. As we expand retail channels and use cases, we are noticing a wider demographic participation. Initially, engagement levels from these new demographics may not match those of die-hard crafters, but the overall number of engaged users will significantly increase. Although engagement per user might increase over time, leading to some pressure, we see this as an opportunity to guide them further along the engagement funnel and boost monetization. I believe your question touches on the broader demographic changes, which highlight our market potential, but these shifts will have an effect on the average revenue per user for materials.

Your next question comes from the line of Erik Woodring from Morgan Stanley. Please go ahead.

I guess we have the guidance for 8 million users at the end of 2022. Is there any way that you can put additional kind of framing of how 2022 might look either from an ARPU perspective, or margins, OpEx? Really, what I'm just trying to get at is you've left 2022 a bit open. And I'm just trying to give you a chance to help guide us as to how we might think about 2022 across any of those metrics? And then I have a follow-up.

So I'll let Marty talk about one of the other key concepts that we introduced with seasonality, but let me kind of give you my perspective on the $8 million. If you calculate the numbers that basically means that we're going to add another 1.6 million users in 2022. Given the promotional strategy and the pricing, we feel really good about that number. Just to give you some context, that will be twice as many users that we added in 2019, and it builds on the roughly 3.8 million or 4 million users that we acquired in 2020 and 2021. So you take the 3.8 million users that we acquired in the last two years, plus the 1.6 million. We think that's a wonderful platform for us to further monetize with subscriptions, industries, and materials. I do think that, again, I want Marty to comment on the other aspects of your question, but one other thing that we are seeing is reverting back to seasonality that we hadn't seen in the last couple of years.

Yes. So, on the seasonality point, and I highlighted this a little bit in my prepared remarks, we're a seasonal business. Year in, year out, pre-pandemic, it was pretty consistent that about 40% of our revenues would come from the first half and about 60% in the second half. The pandemic kind of turned everything upside down. Specifically, 2021 was a front-end loaded year with about 50% coming from the first half and 50% in the second half. Now as we exit the pandemic and we are moving back to a more normal seasonality pattern, what that means is that we're moving from 50% revenues in the first half last year to 40% as our expectation this year. When we're looking at comps or year-over-year growth rates by quarter, it means that the first quarter are difficult comps for us to meet. The second half, though, if you're looking at that, the comps will be a bit easier. So I just want to make sure that you're thinking about that in your analysis as well as the additional channel overhang that we believe will probably work itself out in the first half of the year.

Okay. That's helpful. And then one just clarification question on the channel inventory, Marty, you talked about the $35 million, $20 million of which was estimated pull forward. What's the incremental $15 million from? Just so as a better understanding of how we get to that $35 million total.

Yes, that would have been prior to Q4. In other words, we have seen some defensive buying in advance of Q4.

So just to clarify, essentially, the channel was elevated going into Q4 and now with that defensive buying, you add up to the two quarters and you get to that $35 million.

Your next question comes from the line of Rod Hall from Goldman Sachs. Please go ahead.

This is Bala on for Rod. I want to kick it off with linearity through the quarter, in the December quarter and also in the months of January and February, both in terms of engagement and also the user additions. And I got a follow-up.

So let me elaborate on what I think you're referring to. We are looking at how the first quarter is developing so far. It's important to remember that there are a couple of key factors affecting the first half: one is a return to typical seasonal patterns, and the other is channel excess. When we assess consumer demand compared to the first quarter of 2020, which was before the pandemic, we feel optimistic about it. The demand remains robust. From this viewpoint, along with search trends and other indicators, we are confident that consumer demand is strong.

Okay. I guess what I'm wondering is some companies in the space here kind of flagged the slowdown especially last month in February. I'm just wondering. What are you seeing in terms of new user activations? In the context of your full year user growth of 1.6 million users, I'm just wondering, comparing back last year, I understand last couple of years, there was this COVID work-from-home impact, but given the addressable market is so huge, I'm just wondering if the slowdown in user additions in '20 '21? Is the dynamic of maybe what you've been seeing lately over the last couple of months?

Yes, I think the trends that influence our business remain strong. Personalization and digital tools that have driven our growth are stable, and we don't anticipate any significant changes in that regard. We are comfortable with our projection of 1.6 million new users for the year, considering the current market dynamics. Additionally, what we observed last year was atypical in terms of seasonality, and regarding the comments made by Marty about the usual seasonal trends we saw before the pandemic, we are confident about the demand. However, we are not providing any further guidance at this time.

And I got one follow-up if I may. On price increases that you're planning, I guess I'm wondering how you're thinking about these price increases potentially impacting user adds in the context of this normalization on demand. Because I was thinking, I suppose your goal would be to prioritize user acquisition or profitability, especially in the medium term. Is that still the right thinking? Any color there?

I would like to refer back to the addition of 1.6 million users. The market has many dynamics at play, making it difficult to quantify the effects of higher prices or reduced promotions. Considering this, we expect to finish the year with 8 million users, which represents an addition of 1.6 million. Regarding our promotional strategy, we have always maintained a long-term view of the business. Moving forward, we believe our promotional approach aligns well with our strategic goals for user acquisition, profitability, and desired margins. Our aim is to restore our margins to where they should be. Although inflation is unpredictable at present, we feel confident about reaching the 8 million target. It's essential to remember that our business model relies significantly on user engagement, which is a top priority as mentioned in our release. Our objective is to enhance engagement and increase monetization through subscriptions, accessories, and materials.

Our next question comes from the line of Paul Kearney from Barclays. Please go ahead.

I wanted to go back to one of the things you said was the competitive environment contributing to the need for increased promotions. I'm wondering what you're seeing competitively in the market? Are you seeing promotions from some of your competitors? Or has anything changed on how you view your position? And then I have a quick follow-up.

Let me clarify. We are the category leader with a significant market share. I would say that our competitors that we do have are experiencing inventory shortages. This is mainly based on observations from our teams examining the shelves. The competitive environment I mentioned was primarily at the retailer partner level. We wanted to ensure that our strategic partnerships with all our retailers were maintained, so when one major retailer became more aggressive with their promotions, we decided to support other retailers to help them compete in the market. This approach was more about enabling our partners rather than being in direct competition with other players in our space.

My second question is about gross margin, which has shown the biggest variance compared to our estimates and consensus for this quarter. How should we approach modeling gross margin for the next few quarters, particularly regarding connected machines and accessories? When will the price increases you mentioned start to be reflected in the model? Should we anticipate some pressure on this line in the near term?

Yes. I explained the nonrecurring items; if you exclude those on an annualized basis, we were at the low end of our long-term target range for EBITDA. We are still experiencing pressures from freight, warehousing, and other inflationary factors. We're beginning to notice a rise in raw material costs, which is why we are planning a price increase. We are currently collaborating with our retailers to determine the specifics of this price increase and its effective date, with the expectation that the main impact will be in the second half. It's difficult for me to provide further comments beyond that.

Our last question comes from the line of Jim Suva from Citi Group. Please go ahead.

As a follow-up, is it fair to assume that the margins in 2022 will be lower than 2021 due to all the myriad of things that you're referring to? Or any color because as Rod Hall and I kind of mentioned that there is a lot of concern about gross margin. So any color you can give there? And if not, then I may have a follow-up on a different topic.

So, we're not giving specific guidance on where we expect margins to be for 2022. But what we will say is our long-term target model remains something that we feel good about. Where, long term, we expect gross margins to be in the 37% to 38% range and operating margin to be in the 15% to 19% range.

Okay. And then my quick follow-up. The Hat Press, light, these additional things you've launched, are they consistent with corporate average profitability or above or below? Or do they need volumes to really help out? Or how should we think about your kind of flurry of recent product announcements?

Yes, I believe they are generally aligned with our expectations. We have priced them accordingly to ensure that we are in a good position. The materials and accessories category features a blended margin, encompassing a variety of products which are healthy and offer good margins. We have just announced them, and they are not yet available in retail; it will take a few weeks.

That concludes our Q&A session, and that concludes today's conference call. Thank you all for participating. You may now disconnect.

So, thank you, operator.