Cricut, Inc. Q2 FY2024 Earnings Call

Good day, and thank you for standing by. Welcome to the Cricut Q2 2024 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, Jim Suva, Senior Vice President of Finance and Treasurer. Please go ahead.

Thank you, operator, and good afternoon, everyone. Thank you for joining us on Cricut's second quarter 2024 earnings call. Please note that today's call is being webcast and recorded 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, 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; and Kimball Shill, Chief Financial Officer. Today's prepared remarks have been recorded after which Ashish and Kimball will host a live Q&A. 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 strategies, business expenses and results of operations in response to your questions. These statements do not guarantee future performance and therefore, undue reliance should not be placed upon them. These statements are based on current expectations of the Company's management and involve inherent risks and uncertainties, including those identified in the Risk Factors section of Cricut’s most recently filed Form 10-K or Form 10-Q that we have filed with the Securities and Exchange Commission. Actual events or results could differ materially. This call also contains time-sensitive information that is accurate only as of the date of this broadcast, August 6, 2024. Cricut assumes no obligation to update any forward-looking projection that may be made in today's release or call. I will now turn the call over to Ashish.

Thank you, Jim, and welcome everyone. We are pleased with strong Q2 profitability and early signs that our acquisition and marketing strategies with retailers and consumers are starting to bear fruit. Connected machines revenue grew for the second consecutive quarter from increased sell into retailers, while sellout to consumers was flagged in the quarter compared to a decline in Q1. Remember, our flywheel begins with the purchase of a connected machine, which then presents the opportunity to monetize our customers through subscriptions and accessories and materials. Operating margin dollars grew significantly up 37% or $7 million driven by higher platform revenue as a percentage of total revenue and benefits from inventory impairment related items, despite a 6% year-on-year drop in overall sales. International sales grew 3% year-on-year. In Q2, platform revenues increased slightly on paid subscriber growth. Products revenues declined 10%, as connected machines units and revenue growth were more than offset by a decline in accessories and materials. Paid subscribers grew 3% to over 2.8 million. We ended the quarter with over 5.9 million active users who crafted in the past year slightly up from a year ago. Our 90-day engaged users declined 3% year-on-year, and I would like to give you some examples of our effort to improve this important KPI. Engagement is a key focus for our company, both in terms of onboarding as well as stimulating ongoing engagement for all users. Onboarders are a particular focus because the more they interact with our platform early, the more likely they are to interact with our platform over time. We made progress in delivering a simpler, more delightful experience to our onboarders. We introduced several improvements during the quarter. Starting with the out-of-box experience, we made it simpler to connect your machine and work through guided steps to connect with the platform. Along with other improvements, this led to a year-on-year increase in the share of members who complete a project during the first day and who complete several projects in their first week. These are leading indicators for longer-term engagement. In Q2, we further expanded our content library, which has now surpassed 1 million high-quality makeable images within Cricut Access. We continued with our increased investment in marketing. Some highlights include a partnership with the Jennifer Hudson show to support Teacher Appreciation week; a featured story on the evening edition of CBS News on Mother's Day; additional broadcast segments focused on seasonal themes throughout the quarter; and expansion of our digital marketing campaigns to reach consumers on streaming television, and a continued focus on the expansion of influencer marketing partnerships. Initial results are promising, measured by driving traffic to cricut.com, which plays a central role in pulling consumers through the funnel regardless of where they purchase the machine. Our deeper promotional strategy that we started in late 2023 is working. In Q2, we saw growth in connected machines selling to retailers, as well as improving trends in sell out to end consumers. This is a healthy positive indicator, despite retailers holding below-optimal inventory levels, which resulted in missed sales opportunities. Our discussions with retailers regarding our plan deeper promotion and their on-hand inventory levels are constructive with the goal of returning to total sales growth. Accessories and materials declined 27% year-on-year. Our materials are engineered to work seamlessly with our machines to create the best user experience. We launched a Cricut Value line of materials in late Q1, which we designed to compete in online marketplaces, and we are optimistic about this product, but it's still early given it represents a small portion of our portfolio. We have additional innovation products and cost reductions coming in the quarters ahead. The areas where we could do better are straightforward. We need to attract more new users to buy our connected machines. We need to reverse weakening engagement trends and reinject enthusiasm among our users. We need to be more effective competitors in accessories and materials. We are intensely focused on the overall customer experience and we are motivated to work with those retailers that help us create a great experience both on shelf and for the actual use of our ecosystem. It is our fundamental belief that when we give people more reasons and inspiration to make things that are appealing to them and we make it easier to create things affordably, we will see a lift in materials consumption. We are driven to continue to innovate while exhibiting both longer-term focus and current discipline.

Thank you, Ashish. In the second quarter, we delivered revenue of $167.9 million, a 6% decline compared to the prior year and in line with our expectations. We generated $19.8 million in net income, which is a 23% year-over-year increase, marking our 22nd consecutive quarter of positive net income as we continue to invest in our key priorities. Breaking revenue down further, Q2 2024 revenue from the platform was $77.6 million, slightly up year-over-year. While paid subscribers increased 3%, platform revenue was up less as the mix shifted more to annual versus monthly subscriptions and the geographic mix shifted more international compared to a year ago. Both shifts are targeted efforts. Platform ARPU increased 5% to $52.61. Revenue from products was $90.3 million, down 10% compared to Q2 2023. Connected machines increased 18% driven by higher units sold and positive makeshift, while accessories and materials decreased by 27%. Some retailers started to restock inventory levels on connected machines partially in Q2, unlike in 2023 when they were destocking more broadly. However, during key sales events, we found retailer shelves to be light on inventory to capture the opportunity fully. In terms of geographic breakdown, international revenue was $33.5 million, or up 3% compared to $32.6 million in Q2 2023. As a percentage of total revenue, international made up 20% in Q2 2024 compared with 18% of total revenue in Q2 2023. Turning to active users and engagement, we ended the quarter with over 5.9 million active users, a slight increase from a year ago. We ended the quarter with over 3.5 million 90-day engaged users, which was a 3% decline from Q2 last year. As Ashish mentioned, we are encouraged by improvement in leading indicator metrics for onboarders, but have more work to do to improve engagement. We ended the quarter with over 2.8 million paid subscribers, up 3% from Q2 2023 and up marginally sequentially. As discussed in earlier calls, there is some natural subscriber attrition, so subscriber growth will be muted until we increase the pace of machine sales and new user acquisition. Moving to gross margin. Total gross margin in the second quarter was 53.5%, an improvement compared to the 49.3% in Q2 2023. The improvement reflects higher platform revenue as a percentage of total revenue and benefits from excess and obsolete and other inventory impairment related items compared to the prior year. Breaking gross margin down further, gross margins from the platform were 88.6% compared to 89.7% a year ago. The slight decline in platform gross margins was primarily related to higher amortization of capitalized software costs, which we expect to continue. Gross margin from products was 23.3% compared to 18.2% in Q2 a year ago. The increase in gross margins was primarily due to positive impacts from excess and obsolete and other inventory impairment related items compared to the prior year. Total operating expenses for the quarter were $63.4 million and included $10.2 million in stock-based compensation. Total operating expenses decreased 7% from $68.4 million in Q2 2023, driven primarily by fewer reserves this year versus last year and the timing of some expenses that will be larger in Q3, as well as the unwinding of some prior reserves, which will not recur next quarter. As we mentioned last quarter, we increased our marketing plans for 2024, and you will see this in our higher sales and marketing spend. Operating income for the quarter was $26.4 million, or 15.7% of revenue, compared to $19.3 million, or 10.8% of revenue in Q2 last year. This represents a 37% increase in operating income despite the decline in sales for the reasons discussed previously. Our tax rate of 33.6% increased from 30.2% a year ago, primarily due to the tax impact of stock vesting at a lower price. Net income was $19.8 million or $0.09 per diluted share, compared to $16 million or $0.07 per diluted share in Q2 2023. Turning now to balance sheet and cash flow, we continue to generate healthy cash flow on an annual basis, which funds inventory needs and investments for long-term growth. In Q2, we generated $35 million in cash from operations, compared to $64 million a year ago. We ended Q2 with a cash and cash equivalent balance of $299 million. We remain debt-free. Inventory decreased by $102 million from a year ago to $192 million at the end of Q2 2024. During Q2, we used $9.3 million of cash to repurchase 1.5 million shares of our stock, resulting in $41.2 million remaining on our $50 million authorized stock repurchase program. In July, we paid approximately $108 million in dividends for the special one-time dividend of $0.40 per share, plus our first recurring semiannual dividend of $0.10 per share. These capital allocations are possible due to past profitability and our confidence in the sustainability of our future profitable operations. We want Cricut to always have ample liquidity to sustain and grow our business, but not to hold excess cash. We do not anticipate the need for any debt or utilization of our credit line in the near term. Now onto our outlook. Recall, we do not give detailed quarterly or annual guidance, but we do want to offer some updated color on our outlook for 2024. Given our first half performance, you can expect some incremental improvement in operating margins, while the remaining outlook remains generally unchanged. We expect continued sales pressure on our product segment, especially in accessories and materials, and accordingly, total company revenue may be down in Q3 year-over-year. We will continue to accelerate marketing to generate consumer excitement, but given ongoing retailer conservatism and pressure in our accessories and materials segment, as well as year-to-date performance, it is too soon to call an inflection point; hence, we may even see a decline in full-year company revenue. We expect paid subscriber count and subscription revenues to grow slightly and may become a larger portion of total company sales and profits for the full year. Lower new user growth rates will put pressure on our subscriber growth following a similar pattern to 2023. While Q2 paid subscribers grew, it was modest compared to Q1. Like last year, Q3 may see negative growth in paid subscribers in the quarter, but not enough to change our full-year view. We continue to expect growth in platform revenue and paid subscriber count for the full year. In 2024, our operating expenses will increase modestly as we increase our marketing spend to reinvigorate excitement in the category. Given first-half performance, we expect some incremental improvement in operating margins in 2024 compared to 2023. Remember, we typically sell more machines in the second half of the year and especially in Q4, which will naturally put pressure on margins. We also benefited in the first half from the unwinding of some reserves, which will not continue in the second half of the year; hence, the operating profits in the first half of the year will not fully carry to the second half of the year. We expect to be profitable each quarter and generate significant cash flow during 2024. We paid approximately $108 million in cash in July for the dividends after Q2 closed. So, we remind you that our cash balance and associated interest income should be adjusted accordingly. Our long-term financial model remains unchanged with operating margin targets of 15% to 19%. Our proven model has demonstrated that when we operate at scale, which we define as revenue above $1 billion and drive top-line growth, these margins are achievable. With that, I'll turn the call over to the operator for questions.

Our first question comes from the line of Eric Woodring with Morgan Stanley. Eric with Morgan Stanley, your line is open.

Eric, if you're asking a question, we can't hear you.

Can you hear me now?

Yes.

Sorry about that. I was just handling multiple calls. I apologize guys. Ashish, you spent a fair amount of time as we go back a few quarters, talking about stabilizing and improving customer engagement. And I know you do have a long-term vision, but the reality is, engagement remains a challenge in the near term. And I guess, it's a question whether investors are willing to be patient to get to that point of stabilization or inflection. So, can you maybe just help us understand why, but then also when, you believe your efforts to drive engagement will begin to materialize? And then I have a follow-up. Thanks so much.

Thank you for the question. As you mentioned, we've discussed this for several quarters now. Engagement is a significant focus for us. We've seen some positive trends, which we've mentioned during this earnings call, and I'd like to elaborate on those. The user cohorts we acquired in 2020 and 2021 are experiencing a natural graduation curve, which is increasing the pressure on engagement, especially since we are acquiring fewer users compared to those periods. We've divided this into two areas. First, regarding onboarders, we want to make sure that the users we bring in 2024 have a better engagement trajectory over time so they remain active and the engagement curve flattens. We've noticed key improving metrics that are promising for the overall business. Specifically, we’re getting users connected to the platform via Bluetooth, completing their first test card, and starting a few projects shortly after joining. This is crucial because our data shows that users who engage in their first few weeks are more likely to stay engaged long-term. So, that's a leading indicator that improving engagement for new cohorts should benefit the business as they grow over time. Now, for the existing user base, they tend to be set in their habits. We have several initiatives aimed at inspiring them to return to the platform, facilitating easier searches, and ultimately helping them bring their projects to life. These efforts will take more time to show results, and it’s challenging to pinpoint when we might see a turning point. However, I’m very optimistic about the initiatives we've identified and the projects our team is pursuing. To summarize, the key indicator is how well we can engage the new users we onboard and ensure they maintain their activities at a more stable level. Combined with our improved acquisition strategies, we believe this will help us turn the situation around. While it’s tough to predict an exact timeline, I am confident that we're working on the right efforts.

Okay. No, that detail is really helpful. Maybe the second question for Kimball, I have to commend you guys on consecutive quarters within your operating margin model. We did see what seemed to be maybe a little bit of cost rationalization this quarter and positive makeshift towards platform versus product. I realize you will ramp costs a bit in the second half, but does this type of leverage in the model imply that when you return to growth? We should expect to see even more operating leverage in the model, and maybe margins move to the higher end of your 15% to 19% range, or maybe just what's the right way to think about the relationship between growth and operating margins as we look forward, just given some of the performance you have amid the declining revenue base? And that's it for me. Thanks so much.

Eric, thanks for the question. First of all, it's important to acknowledge the impact of scale. Today, we're operating below a billion dollars, and so you see us leading into marketing investments to reinvigorate enthusiasm in the category both among consumers and retailers. You can expect that level of investment to continue as we are successful in getting back to a billion plus in revenue; you'll see that percent of revenue come to be a smaller percentage of revenue. I also kind of want to comment on the incremental improvement in margins that we talk about in the prepared comments, because we expect to see about a point of improvement as we move through the year and not everything moves to the second half. Let me break that down. We sell more machines in the second half than we do in the first half, and machines have naturally more margin pressure. And especially as we lean into our deeper promotional strategy, particularly in Q4 with the holidays, we expect to see more margin pressure in the second half compared to the first half. There are also some one-time and periodic things that occurred in the first half that won't carry on in the second half. For example, a year ago we were accruing bad debt reserves and this quarter we were able to unwind some of those reserves. That was about a $7.2 million impact to the quarter on a year-over-year basis.

Eric, any further questions?

Yes, that should be it. He had to hop.

All right, please stand by for the next caller.

The next question comes from Asiya Merchant with Citigroup. Your line is now open.

This is Mike Gaddis for Asiya at Citi. My one question is on international. Congratulations that it was up 3% after a couple of quarters of decline. I'd like to get a little bit more color on that, trying to see if it was broad based or maybe country specific. I only ask because, we want to calibrate it going forward and to see if maybe there's any upside to that as your initiatives gain more traction.

Mike, thanks for the question. We're really excited that we were able to return to growth in the international business. As we've talked over the last couple quarters, there are markets where we have seen pressure. We continue to see that pressure similar to North America, but we're active in over 50 countries. And so, in the quarter, there was enough goodness in some of the newer markets that it overcame the headwinds that we continue to experience in Western Europe, the UK, and Australia as we talked about last quarter. From an overall perspective, international we think continues to be a huge opportunity and a very important vector of growth for us, but like I say, we're pleased this quarter to get back to growth.

And let me just kind of add to that one is that the acquisition efforts that we are talking about in the U.S. we've basically been using that model across the world and it seems to be working. As a CEO, I get to travel in a lot of these markets every quarter. Like in Q1, I was in Europe in some of the larger markets. Earlier this month, I was in Latin America. In early Q4, late Q3, I'll be in Asia. What's always fascinating for me as we get to these markets, as I talk to users, as I see our influencers and the passion for the brand, the passion for creativity and for the Cricut brand, and some markets are more mature than others or at least, I don't believe any of our markets are mature, but we've been in some markets for a longer time than others. The same level of passion, the same level of trends on personalization, the trends on wanting to make things for your family or for yourself and capturing those moments, it's so consistent worldwide. So, we strongly believe that we are in the very early days of the Company, and all parts of the world and many of these 50 markets that Kimball talked about represent a really big opportunity for us over time.

Please stand by for the next question. The next question comes from the line of Adrienne Yih with Barclays. Your line is now open.

Hi, this is Angus Kelleher here on for Adrienne Yih. Thanks for taking our question. How did the Cricut Value materials offering do during its first full quarter? I understood it's still very early days, but perhaps you could speak to where you see that going in the future, the amount of material categories that could eventually touch, and the channels you see that in. And then I have a follow-up. Thank you.

Okay. Angus, thanks for the question. As I mentioned in the prior remarks, we designed Cricut Value materials specifically to compete well in online marketplaces, where we have to get the right value proposition and price point to make it effective to also be able to ship direct to consumers. We saw that play out very well, even though, again, very early days, but it's performing as we expected, and we think we're very optimistic as we look forward.

And I think, Angus, I'll add to that, which is that as we talked about, we've launched a set of materials. They're still a small part of our portfolio. We're going to continue to expand categories, price points, value propositions, etc. So, we're in the early days of that product line. But the signal so far, as Kimball said, has been very positive, and we're very excited about it.

My second question is, how do you feel about inventory levels at the retail partners? Sounds like you spoke to restocking being underway slowly but surely as we approach holiday, how do you see the order books shaping up?

So, if I can contrast the last quarter versus last year, last year we saw destocking more generally across channels. This quarter, we saw partial restocking related to connected machines, and as we've seen the growth in machine revenue. We still saw inventory light on shelves to fully capture the opportunity. So, when we had some larger promotions in the first half, we saw missed opportunity because there wasn't enough inventory to fully activate those opportunities.

And I think, let me just talk about some of the fundamentals, right? We see an increase and then I'll lead into your question again. With our marketing, and I believe that our marketing is working, we are seeing a positive increase in traffic and seeing those trends improve pretty significantly from Q1 to Q2. We don't generally report on sell through, but we've made some comments in our script, which is that our sell through and our registrations, while they were down in Q1, were largely flat year-on-year in Q2. And that was a very positive and improving sign. That's despite the fact that many of our retailers didn't have enough inventory on the shelf. So, the consumers either switched to online or they just kind of deferred that purchase to a later date. I think as we head into the second half, we're going to continue to ramp our marketing, we're going to continue to drive traffic; we have a solid plan for the end of the year. As we talked, we are working with retailers to ensure they are adequately stocked up. We saw some of the missed volume by retailers be leveraged by online channels. We think that we definitely missed some sales. Our partnerships with retailers are very positive and productive. We've been showing the data in terms of the enhanced marketing, increased traffic, and we hope that they get excited and committed to the category, which we think they will. Hopefully, they'll be able to capture some of these missed sales that they saw in the first half.

At this time, I'm showing no further questions. I would now like to turn it back to Jim Suva, Senior Vice President and Finance and Treasurer.

Thank you, Elizabeth, and thank you everyone for joining us this afternoon. We have a large opportunity over the long term to drive new user growth and increased engagement. The Cricut platform continues to not only strengthen but also provide increased value to our users. We will continue to manage our business for sustainable, profitable growth and generate healthy cash flows. I'm excited about the opportunities ahead of us. We will be presenting with investors at the following event, the Citigroup Global TMT Conference in New York the first week of September and the Goldman Sachs Global Communacopia and Technology Conference in San Francisco the second week of September. We hope to see you there. If you have additional questions, please e-mail me at jsuva@cricut.com. This now concludes this earnings call and you may now disconnect. Thank you.