Cricut, Inc. (NASDAQ:CRCT) Q4 2022 Earnings Call Transcript

Cricut, Inc. (NASDAQ:CRCT) Q4 2022 Earnings Call Transcript March 7, 2023

Stacie Clements: Thank you, operator, and good afternoon, everyone. Thank you for joining us on Cricut’s Fourth Quarter and Year Ended 2022 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 a 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 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-Q. 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, March 7, 2023.

Cricut assumes no obligation to update any forward-looking projection that may be made in today’s release or call. And with that, I will now turn the call over to Ashish.

Ashish Arora: Thank you Stacie, and welcome everyone. I want to acknowledge up front that we expected 2022 to be a much better year for Cricut than the results we discuss today reflect. Entering the year, we expected to sell more connected machines and accessories and materials. That said, we added 1.5 million new users in 2022, ending the year with nearly 7.9 million total users on the Cricut platform, just shy of our initial expectations at the beginning of the year of 8 million users, boosted in part by strong connected machine sales in Q4 2021 and the first two months of 2022. Subscriptions also continued to grow notwithstanding the headwinds for our physical products. Despite my disappointment in our 2022 financial performance, I’m extremely proud and grateful for the team’s focus and all we accomplished over the past year.

Let me explain why. We significantly grew our subscriptions business. We ended the year with 2.6 million paid subscribers, up 28% over 2021. New features and functionality drove an increase in attach rates over the year, a particularly noteworthy highlight that suggests we are not just converting new users into Cricut Access but also reclaiming existing users. The number of engaged users who cut on the platform increased sequentially in Q4, as expected with typical holiday seasonality. We also saw a significant increase in user interactions like bookmarks and shared projects across the Cricut platform after rolling out multiple new user touchpoints and enhancements. Earlier in 2022, coming off a high-growth pandemic period, retailers reset inventory targets, which put additional pressure on our Connected Machines and Accessories and Materials revenue.

We worked diligently with our retail partners to better adjust those levels to their new targets and managed down channel inventory over the second half of the year. As a result, we started 2023 in a much healthier position. We also moved quickly to re-focus investments towards higher impact initiatives and tightened operating expenses, delivering our 6th consecutive year of net income profitability. We will continue to operate the company in a fiscally disciplined way. The opportunity for growth and international expansion has never been stronger. As we enter 2023, we will intensify our focus around new user acquisition and platform expansion in order to drive engagement, subscriptions and increased monetization. We are also on a focused two-year path to re-accelerate growth in Accessories and Materials.

Let me walk through each of these. We acquire new users when someone buys a connected machine. We believe that we are in the early days of market development and have only penetrated 6% of our serviceable addressable market from our top six markets, including the U.S., Canada, UK, France, Germany and Australia. This is up from 3% two years ago, as Cricut has become a more widely recognized global brand. In 2022, we launched in five new countries and now partner with a network of distributors in over 50 countries. Our international growth remains a key priority in 2023 as we deploy the same playbook that has grown our business in North America. In addition, the investments we make today in new user acquisition, engagement and monetization can be leveraged across all markets.

We believe our focus on industrial design, innovation, and our platform approach, along with our connected integration between design space, content, materials and our connected machines, positions us well in the market. Over the past year, we have conducted numerous research studies to understand our consumers and their purchase journey. Our research shows that we have a healthy top-of-funnel today with significant opportunity to drive consumer interest and shorten the path to purchase. There are several strategic initiatives in progress today to help simplify the journey from discovery to research to purchase. Our research also shows that we are reaching a broader and more diverse demographic, with nearly 50% of new users identifying as beginner crafters, almost double the rate of 2019 users.

And, even as we reach less experienced crafters, these new users are as likely to purchase our high-end machines and ultimately engage similarly to more experienced new users. We are also broadening our reach as we attract more Gen Z and Millennials. Going forward, we’ll plan and design our marketing use cases to appeal to a broader audience, while still providing the right tools and resources for the more advanced user. A majority of new users are introduced and interact with Cricut at multiple touch points prior to actively researching the brand. Word-of-mouth through friends and family and social channels, YouTube, TikTok, Pinterest, Facebook, and Instagram continue to play a key role as the initial touchpoint for nearly 80% of our new users.

Earlier in the year, we improved our audience targeting, launched new creative assets and refreshed content on Cricut.com. We continue to expand our influencer partnerships with greater focus around microinfluencers that have the ability to increase brand presence and impact social engagement across video platforms like TikTok and YouTube. Beyond the initial touchpoint, we are also focused on a more simpler €“ on a simpler more streamlined purchase journey as we continue to roll out several new creative assets and tools that bring relevant information to consumers more quickly across all channels. Last month we launched improved product comparison charts and are developing a new, simple quiz to help consumers decide which machine is right for them.

We are making changes to our website and digital marketing execution to pull users through the funnel to conversion. Many of these updates will be rolled out across our retail channels and global markets. We believe this strategy will help bring more users into the funnel as well as shorten the typical purchasing path for consumers. By investing in these initiatives now, we will position the Cricut brand for growth and accelerate the purchase decision for when consumer spend returns. We’re also focused on increasing user engagement, which starts the moment we acquire a user. Our data shows that the first few weeks of a new user’s experience is often indicative of their engagement over time. In Q4, we introduced a new onboarding process. We have been testing a series of lesson plans for Explore 3 and Maker 3 with a small population of our users, and are pleased with the initial results.

We plan to scale our learnings, expand these initiatives over more machines and continue to refine our approach. Once onboarded, our focus turns to frequency of engagement. Over half of our user base cut on our platform in Q4, and 74% of users cut a project in 2022. We have embarked on a number of initiatives to help increase user engagement. In line with that, I’m excited to announce that we have appointed one of our senior leaders to a new role entirely dedicated to user engagement. She previously was responsible for our connected machines portfolio and is one of our most seasoned leaders. Two years ago, we took a similar approach to our Subscriptions business, which resulted in revenue growth and higher attach rates. Both of these leaders will work in tandem, with expanded decision rights to drive strategic plans and roadmaps across several cross functional groups and are ultimately responsible for delivering results for engagement and subscriptions.

Inspiration drives engagement. Our research studies show that 16% of users get their project inspiration directly from Design Space and 25% from all other social media. This gives us significant opportunity to increase traffic sooner in the creative process, offering users thousands of ideas to help inspire and accelerate cutting. We believe that our investments in mobile experiences and other platform enhancements will play a crucial role in this strategy. In the fourth quarter, we saw a significant increase in bookmarks over Q3. We ended the year with over 150 million total bookmarks, an increase of nearly 30 million sequentially, making it easier for users to save ideas for later use when they come back. Subscribers are the most valuable members on our platform and drive increased engagement activities versus non-subscribers.

We ended the year with 2.6 million paid subscribers, a 28% increase year-over-year. This growth is the direct result of investments we’ve made over the past 12 to 18 months as we better communicate the value proposition to users in more places throughout their Cricut experience. For example, in Q4 we used the onboarding process to optimize messaging around the benefits of Cricut Access. We also added more merchandising touchpoints within the engagement journey, giving us the ability to advertise annual subscription plans more effectively. This latter effort is already showing promising improvement to the mix of annual versus monthly plan sign ups, without impacting attach rate. We also continued to expand new content and exclusive Cricut Access features, including automatic background remover, monogram maker, editable images, expanded collections and more.

In many cases, these robust, highly requested features become an important part in converting users to subscribers. We’re also seeing increased engagement from our Contributing Artist Program, which has accelerated our efforts to bring new, relevant and diverse content to Cricut Access. Another increasingly important source of content for subscribers comes from community projects. These are projects users create with Cricut images, which sometimes include instructions, a list of materials to use and suggestions on design layout. These community projects pass-through Cricut’s curation process to ensure authenticity of content and makeability. When subscribers find a community project that inspires them, they can instantly personalize it or make it as is, saving them the design time of starting from scratch.

This is an example of our community adding value to the platform that subscribers benefit from. Our goal is to make it even easier for Cricut users to share their projects and hence, increase the number of community projects, and significantly increase the value proposition for subscribers. And finally, we are increasing our focus on accessories and materials where we believe we have the right to play and to win. We are uniquely positioned to build innovative, high-quality, connected products that integrate with our hardware and our software. Our smart materials are a great example of this. This segment has experienced headwinds since exiting the pandemic as a result of a few consumer dynamics converging at once, including increasing price sensitivity, slower machine sales and less frequent engagement.

First, we have seen increased price sensitivity from users, particularly as the current economic situation continues. As consumers become more price sensitive, shopping habits for materials are increasingly shifting from bricks-and-mortar retail to online, third-party marketplaces, where we have seen an emergence of lower cost, lower quality materials. In response, we have started to work with our retail partners to develop differentiated product configurations and promotional strategies by channel to meet the needs of their customers, whether in-store or online. Our goal is to simplify SKUs, reengineer and repackage materials, and drive greater supply-chain efficiencies to regain healthier margins, while competing and driving share gain across all channels.

Some of this will take time to execute while we move through existing inventory. In the meantime, we will focus on being cost competitive for consumers and take a more deliberate and analytical approach to promotional strategies to maximize margins while capturing our share of the market. Second, the pressure we’ve experienced in new machines sales has also affected our Accessories and Materials segment. A portion of our Materials business is generated through the sale of machine bundles, which is an effective way to deliver to new users the materials they need to quickly start their journey with Cricut. Third, our Accessories and Materials segment is influenced by how much our users cut. The intensity of engagement has been lighter since exiting the pandemic.

The strategies we are building to drive engagement and subscriptions should work in parallel with our efforts to build a more robust online channel with our retail partners and together, will reignite growth in Accessories and Materials. We believe all of these things together €“ increased user engagement, combined with new product bundles, pricing and cost structures €“ will be a two-year journey to re-accelerate this segment of the business. In summary, we are creating greater alignment within the organization to drive our key priorities: acquiring new users globally, driving increased engagement and subscriptions, and structuring our Accessories and Materials business for long-term success. We have in-depth knowledge of our user base and have identified multiple opportunities to grow and increase monetization over the long term.

Our focus on strengthening every facet of the platform will help enable long-term sustainable growth and further enhance our defensible moat, with recurring monetization opportunities that are more characteristic of a platform business. Although the current macro environment will impact overall growth in the short term, the initiatives we are deploying now will position us well for when consumer spend returns. I’ll now turn the call over to Kimball for the financials.

Kimball Shill: Thank you, Ashish, and welcome everyone. Although consumer spend continues to be soft, Q4 delivered typical seasonal strength in connected machine revenue, new user growth, subscriptions revenue and user engagement. In the fourth quarter, we generated revenue of $280.8 million, a 28% decline compared to prior year Q4 and generated $10.9 million in net income as we continued to invest in our key priorities. Full year revenue was $886.3 million, a 32% decline over 2021. Keep in mind most of 2021 reflected unusually high growth due to the pandemic. Breaking revenue down further, revenue from connected machines for the year was $252.6 million, down 54% over 2021, reflecting softer consumer spend and excess channel inventory levels throughout most of the year.

In mid 2022, retailers began initiating lower inventory target levels in preparation for a weaker economy. As such, Connected Machine revenue doesn’t necessarily align with the increase in new user growth over the year. In working with our retail partners, we prioritized channel inventory and entered 2023 with healthier alignment between sell in and sell out. Revenue from Accessories and Materials for the year was $361.4 million, down 35% over 2021. Similar to connected machines, we entered 2022 with heavy channel inventory, making a tough year-over-year comparison. We continue to see pressure in Accessories and Materials from the dynamics Ashish mentioned earlier, which contributed to the decline in revenue and ARPU. Our strategy for reacceleration in this segment is focused on cost reductions over time, sound promotional strategies for increased market share, more machine and materials bundles across more diverse channels, and driving an overall increase in user engagement.

Subscriptions revenue for the year was $272.3 million, a 32% increase over 2021 and benefited from targeted investments in Cricut Access and the expansive improvements made over the last several quarters. In terms of geographic breakdown, international revenue was $142.3 million, compared to $148.5 million in 2021. As a percentage of total revenue, international was 16%, compared to 11% of total revenue in 2021. Turning to users and engagement. I’m pleased to share we ended the year with nearly 7.9 million total users, or 23% growth over 2021. Despite softer consumer spend throughout the year, this was just shy of our 8 million total user expectation at the beginning of 2022. We ended the year with over 4 million users who cut a project on a machine within the last 90 days.

This is up 6% from 2021. To put this in perspective, in 2022, 74% of total users cut a project in the last 12 months. Through the initiatives Ashish outlined, we have a significant opportunity to reach these users, which is three quarters of our total user base. We ended the year with over 2.6 million paid subscribers, up 28% from end of 2021. Attach rates were strong at 33%, up from 32% last year. ARPU for Subscriptions for the year was $38.09, slightly down from $38.37 in 2021. For context, three factors generally explain variability in subscription ARPU from one period to the next, when subscribers are growing and attach rates remain high: timing of signups; mix of new versus renewals subscriptions; and the increasing mix of international subscriptions.

Accessories and Materials ARPU was $50.54 for the year, compared to $102.91 in 2021. We believe with renewed focus, we can re-accelerate accessories and materials revenue over time. Moving to gross margin. Total gross margin in the fourth quarter was 30%, an improvement compared to 27% in Q4 2021. As a reminder, Q4 has seasonal pressure due to increased revenue contribution from connected machines. Breaking gross margin down further. Gross margin from connected machines was 2.8%. This compares to a negative 1.5% in Q4 of last year, when we elected to take price protection on Air 2 and Maker units in channel. For the full year, Connected Machine margin was 3.3%, down from 11.7% in 2021, and was primarily impacted by higher fixed costs as a percentage of revenue in warehousing and operations expense, along with increased warranty expense and promotional activity.

Looking at 2023, decreasing inventory levels along with fixed costs on warehousing and operations expense will continue to put pressure on margins. Partially offsetting this, we expect end-of-life machines to become a smaller part of machine mix, with small incremental improvements to machine margins. Subscriptions gross margin for the full year was 90.3%, up slightly compared to 2021 of 89.3%. Gross margin from Accessories and Materials was impacted by increased promotions, as well as fixed operating costs amortized over lower volumes both for the quarter and the full year. Full year gross margin for Accessories and Materials was 26.5%, compared to 37.9% in 2021. Going forward, we’ll continue to be competitive on price. Turning to operating expenses.

We continue to operate the business with discipline and flexibility to navigate current trends. In March, we began to see consumer spend softening and started to reprioritize investments. As a result, we eliminated $50 million of planned spend and investments throughout 2022 and held operating expenses relatively flat year-over-year. Total operating expenses for the year were $269.9 million and included $40.2 million in stock-based compensation expense. This was up less than 2% from $265 million in 2021. Operating income for the year was $80 million, or 9% of revenue, reflecting lower revenues compared to 2021 of $192.4 million, or 14.7% of revenue. Despite the challenges we faced in 2022, we continued to prioritize net income and cash. 2022 was our sixth consecutive year of positive net income.

Net income for the year was $60.7 million, or $0.28 per diluted share, compared to $140.5 million, or $0.64 per diluted share in 2021. Turning now to the balance sheet and cash flow. We continue to generate healthy cash flow on an annual basis, which funds annual inventory needs and investments for long-term growth. For the year, we generated $117.7 million in cash from operations, ending with a balance of $299.2 million. This strength allows for a flexible, yet purposeful approach to capital allocation, including returning capital to shareholders. During the year, we repurchased 2.35 million shares of our stock at a cost of $18.5 million. We have $31.5 million remaining in the repurchase program. In addition, on February 15th we used $77 million to pay a special shareholder dividend.

As we look ahead to 2023, we continue to see softer consumer spend patterns and are thus taking a conservative approach in our planning. We will continue to take a prudent and prioritized approach to investments, while managing for small, incremental operating margin improvements and healthy cash generation in 2023. In terms of new user growth, we expect to add fewer new users in 2023 than we did last year. For comparative purposes, user growth in Q1 of 2022 benefited from strong machines sales in Q4 of 2021 and early 2022. Conversely, Q1 2023 will see pressure from softer Q4 holidays sales. In addition, we started 2023 with softer-than-expected Connected Machine sales in January and February. While we have a positive outlook on Subscriptions, lower new users will put pressure on our subscriber growth rate and attach rate.

From a revenue standpoint, we entered 2023 with healthier channel inventory levels and revenue should be more directly linked to consumer demand. In other words, in 2023, Cricut could sell more Connected Machines than in 2022 and yet add fewer new users. As a reminder, Q1 of 2023 will be a tough year-over-year comp and we expect it to be materially below Q1 of last year. We expect year-over-year comps to improve starting in Q2. Gross margins will continue to be pressured. On physical products, higher fixed costs as a percentage of revenue in warehousing and operating expense will continue to be a factor throughout 2023. Accessories and Materials will also continue at a similar promotional cadence to remain price competitive, and we will likely have reserves for aging inventories as it relates to materials, particularly in Q2.

As a result, we expect full-year Accessories and Materials margins will be similar to Q4 2022 results. Machine gross margins should improve incrementally as machine mix shifts more to our newer machines in the second half of the year. We remain focused on managing our profitability, while investing in areas with the highest impact. For 2023, we anticipate small incremental operating margin improvement on an annual basis, with small upticks in the second half that align with stronger seasonality. Should macro conditions worsen, we will continue to manage with the flexibility to make adjustments as needed, just as we demonstrated in 2022. We expect to continue generating healthy cash flow from operations and remain committed to our long-term operating margin targets of 15% to 19%.

Our proven model has demonstrated that when we operate at scale and drive topline growth, these margins are achievable. With that, I’ll now turn the call over to the operator for questions.

Q&A Session

Operator: Thank you. The first question we have is coming from Mark Altschwager of Baird. Your line is open.

Mark Altschwager: Good afternoon. Thank you for taking my question. As we look at the gross margin profile of the Machine segment and the Accessories and Material segment in these recent quarters versus a few years ago, yes how much of the compression is structural, whether related to cost inflation or efforts to drive better affordability versus some more temporary factors? I guess, that’s another way, could you sort of rebase, the gross margin expectations for those segments medium to longer term after you’ve moved past some of these kind of temporary factors?

Kimball Shill: Yes. Mark, thanks for the question. So, I’ll talk about Machines and Accessories and Materials separately, all of our physical products are being influenced by kind of the cost of peak inventory and the cost of our, physical plant footprint over smaller volumes. And that is I think, pressure that continues with us through the year, going through 2023 in terms of magnitude that and our promotional impact, the impact of our promotional strategies and promotion loss we’ve spent on machines are about equal. And, we were less promotional, on the annual basis of machines than we were last year. But still, it’s a fairly significant portion of our gross margin. We expect machine gross margins to improve incrementally this year as we have our mix shift more towards, our newer machines.

On the Accessories and Material side, we called out that we will be more promotional and that we were in Q4 in particular, but we were more promotional than people that were for the full year. And we saw share gains from that in our mass and craft channels where we have data, we don’t have perfect data every place, but where we do, we saw that, margins are going to be pressured for 2023 and probably beyond as we go through a journal, our accessories materials business. Why don’t I stop there and I you can follow-up.

Ashish Arora: Yes, Mark, let me, thanks for asking the question. I’ll just add to Kimball’s point. I just want to go back to the machines and just kind of, build on what Kimball said. One is, clearly a lot of our margins were compressed because of the existing or the legacy machines. If you will, as, we come into 2023 with a much cleaner portfolio and as our portfolio mix improves, right, I think that’ll be positive for our margins. So, I feel good about that. The second, which we kind of hinted on in the prepared remark is, our promotional, we’ve, in the last probably 12 months, even though we’ve been less promotional in Q4 in general, we focus a lot on the bottom of the funnel and done a lot of POS dollars. I think going into 2023 we will be, less promotional and reallocate some of those dollars to top of funnel, in terms of driving awareness.

So, I think between, at least, especially on machines, between the portfolio mix and our promotional strategy, we’ll see some positive improvement in margins for machines.

Mark Altschwager: Great. Thank you for all that color. And then Ashish, I think you mentioned earlier that, you’re really doing a nice job attracting kind of more beginner crafters to the platform, and I think you said your studies suggest that they’re as likely to buy the larger machines as well as things like the Joy. I guess I’m a little bit surprised by that. I thought maybe the Joy would over index to some of those beginner crafters. So just curious if you could expand upon, your learnings there and just maybe some of the implications as we think about some of the, the mix impacts on machine revenue over time. And then kind of a related question, but the subscription attachment continues to trend nicely. Is it fair to think that could continue to edge higher as more of those beginner crafters enter the platform?

I would think that, some of the benefits of Cricut access would be, potentially higher for those newer crafters that wouldn’t otherwise know how to create some of the designs. Great, thank you.

Ashish Arora: Yes, so Mark, first of all, as Kim, as we said, we were pretty pleased with the fact that we added 1.5 million users, so came up to 7.9 million and that’s just like less than 6% or 6% of our SAM. And as you pointed out, a lot of these are beginner users and Gen Zs, and specifically when it comes to beginner users, we kind of studied the data and we were pretty positively surprised that they did not €“ they didn’t differ from other cohorts, both in terms of engagement as well as in terms of the kind of machines they bought. So that was, we were also very pleasantly surprised with that. We still do think that, affordability is going to continue to be key for our user base. So, I think products like Cricut Joy will play a role, but I think it’s very hard to draw correlation that is just the bigger are getting bigger our user users just with those, entry level machine price points.

I also think that some of the improvements that we’ve made, user will definitely the starting price point is really important because the user comes into the category and they basically to enter the category, it’s it has to be a lower price point. But as we do a better job in helping people understand and figuring out their use cases, I think we have an opportunity to continue to improve, users to get the right product, which may or may not be the entry level price point. So we are actually pretty pleased and excited about that, although we still think that, driving affordability and lower price machines is beneficial to the whole category. One thing I’ll just highlight is that we did, we kind of have a little notation in our presentation is that as we are looking at our data, a pretty good percentage of users is actually even beyond our SAM.

So these are people that we would not categorize as people that would’ve qualified to be in our SAM. So, we are actually really excited about the breadth of penetration that we are seeing both inside our SAM and outside. I let Kimble talk about the subscriptions.

Kimball Shill: Yes. Thanks for the question, Mark. We’re really excited about our subscription business and we think the team has done a great job this year in activating our user base and in growing the subscription of the business. And we’re in the very early stages of our roadmap. And we’ve heard us talk about features like automatic background remover and editable images and we have a long roadmap of features that will continue to add to the value proposition of subscribers. We’ve talked about our contributing artist program that is adding new and diverse content that’s getting a lot of traction. We’re doing a better job of merchandising Cricut access throughout the platform and we’re seeing results from that as we create more touchpoints.

An example of that is we’re having an uptick in the number of annual subscriptions as we’ve advertised it, as opposed to monthly subscriptions. And so we think we have a lot of room for improvement as we get better and better there. That said, we called on our prepared remarks that we expect to add fewer new users in 2023. And so that naturally is going to put pressure on our attach rate and on our growth rate because the largest portion of new subscribers come from adding new user to the platform, but as we get traction on some of these acquisition initiatives that Ashish mentioned and also an engagement, we think that that will help us reaccelerate growth in the subscription category.

Mark Altschwager: Thank you. I’ll pass it on.

Operator: Thank you. One moment while we prepare for the next question. Our next question will be coming from Jim Suva of Citi. Your line is open.

Jim Suva: Hi, thank you so much for the details so far. Separately on the machines versus the accessories when do you, it sounds like you mentioned January and February we’re also facing challenging inventory work down in the channel. When do you kind of expect that to be more normalized? Are we talking another quarter or so or kind of further out and then I’ll probably have a follow up.

Ashish Arora: So, Jim, thanks for the question. Actually, we entered the year with much healthier channel inventory. And what we were calling out in our prepared remarks is we had our forecast of what we expected for the quarter and we saw softer demand than we expected in the quarter, but that’s not related to unhealthy channel inventory levels. We ended the €“ we have a target range of forward-looking weeks on hand for our channels and we ended in those ranges. So this was more a consumer demand impact related to I think discretionary spend more than it was channel inventory issues.

Jim Suva: Okay. That was very useful. And so just to clarify, it sounds like what your channel, not what you calculate, but what your channel feedback is, that they’re also comfortable with the inventory levels in the channel. Because the reason why I ask is it seems like the channel is working down inventory to levels that pre-COVID maybe or even lower pre-COVID. But if you could comment on the feedback you’re getting there?

Ashish Arora: So I mean, the channel is continuing to focus on inventory, but we are in continuous dialogue with, on channel inventory plans and we’re aligned on those plans with our retailers. I think there’s a general level of conservatism but overall, like as Kimball said, we feel good about inventory coming into 2023. We had a healthy on plan weeks in hand inventory and I think we are just kind of watching the consumer spend very closely in terms of discretionary products, but I think there’s generally a good balance at this point overall.

Jim Suva: Great. Then my last question is focused on research and development that you’re doing internally there at Cricut. Are you kind of keeping same levels and same roadmap or given the macro uncertainties, do you need to do some adjustments?

Ashish Arora: Yes, so thanks, Jim. I think a couple of comments. I think about six, maybe two quarters ago we had kind of shared, two or three quarters ago we had shared that we are going to really lean in and double down on connected machines, right. So focus less, at least in the shorter term on accessories, but really kind of build out our connected machines portfolio. So I think that’s we take a very long view on that and we continue to innovate. We continue to do exciting things in that category. So I think you’ll see some great innovations from us over time. The thing that I would say that we have really kind of focused in on is building out the software and the platform. You see the benefit of that in subscriptions already.

I think we’ll see a number of initiatives around engagement and even more so I would say, the company is really going to become a €“ I mean, we were always a platform company, but you’ll see more and more investments in the software platform and we are really excited about that. But we’ve taken a very balanced approach to our R&D and feel that, we’ve kind of streamlined our R&D approach to what our strategy is and our priorities are.

Jim Suva: Great. Thank you so much for the colors and congratulations and for all the details.

Ashish Arora: Thank you.

Operator: Thank you. One moment while we prepare for the next question. The next question is coming from Adrienne Yih of Barclays. Your line is open.

Adrienne Yih: Great, thank you very much. Ashish, I wanted to get some more details on kind of your target, your customer. Do you have good data on sort of the target household income? It sounds like the new users are more beginners or more Gen Z. Does that mean that maybe your more seasoned users are kind of coming out of the kind of active user base and then of the 74% that cut this year, can you tell what proportion of them are heavy users versus sort of one-time users? And for the one-time users, is there an active method of reaching out to them and being more personalized to engage them more? Thank you so much.

Ashish Arora: Yes. So thanks Adrienne for the questions. There’s a number of questions there and if I don’t get to all of them, please feel free to follow-up or we can follow-up in our call. So I think one of the things I feel really good about, we are so early on in the cycle, right? And even though we added 1.5 million users and we have 7.9 million in total, at the end of the day, it’s less than 6 €“ close to 6% of our SAM. And like I said, we’ve even broadened outside our SAM. I would say that the €“ I don’t think our market is shifting. I think our market is expanding, right? And what I mean by that is we are definitely continuing to attract the big €“ the advanced crafters and the engaged crafters, but we are also broadening.

So the way to think about it is we are kind of flattening the bell curve, if you will, right? So the long tails are getting fatter. So we think that we are €“ as we expand the market, which is what our strategy is, as our products become easier to use, more affordable and there’s still a long ways to do that. We are keeping the current engaged customer base. We are getting to the crafter, but also we are getting to a user base that we’ve always wanted to. And like I said, the good news about attracting big crafter is that at least at this point, we don’t see that cohort doing anything different from our more engaged cohorts. So that’s kind of my overall remark on the acquisition piece. I think from an engagement perspective, we have gotten better and better at understanding the various cohorts.

So we haven’t kind of €“ the data’s not mature enough to share outside. But the way we look at engagement is we are able to differentiate between subscribers and non-subscribers. We’re able to classify people who are monthly users and quarterly users, occasional and semi-annual. And the one good thing that when we ask our customer base, even the people like who’ve not engaged with us for 12 months, right, as to what’s their experience being at Cricut and what drives them to Cricut, we see a very high percentage. We’ve shared this number in the past, like over close to 80% of people really say, wow, these are people that have actually not used the platform in nine to 12 months. And they will say, I love using the platform. And I think that’s when we get into the question and saying, well, why didn’t you, right?

And typically what we hear is, well, I just ran out of time or life got in the way. And what they’re probably saying is that, we have an opportunity to make the experience even simpler, better and as we build in mobile strategies, et cetera, we have an opportunity to attract €“ to bring back that user. Having said that, and I’ll end it there. We clearly want to go after. If you think about the folks that are engaged and specifically subscribers, our number one focus is on engaged subscribers, right, which is these are the people that we want to keep engaged, we want to keep subscribed. Having said that, we do have an opportunity to go after the folks that are not as engaged or not subscribed and we have a number of strategies in place to go after them.

But I would say in terms of the pecking order, our number one focus is let’s keep our engaged users engaged and let’s keep our engaged subscribers engaged and subscribed.

Adrienne Yih: Okay. That’s super helpful. Just a couple of follow-ups. I guess, the community aspect of it that was kind of front and center. I think the machine sales have sort of co-opted that in terms of the story discussion. And I’m just wondering, content creation, you did talk about it. But can you talk about kind of the community development in that aspect of it? Has that €“ I mean, it’s seemingly kind of taken a backseat in the mind of the user. Is that not the case? And for Kimball, you talked about a two year horizon and I wanted to make sure that I understand this of pressure on sales. And if I got €“ if that’s correct, how are you thinking about managing the cost side of the P&L under that circumstance? Thanks.

Ashish Arora: So Adrienne, let me take the first half of the question and then I’ll let Kimball answer the second half. No, I think what drove the category in terms of the network effects, in terms of the community, they’re stronger €“ they’re as strong as they have ever been, right? We continue to have very high percentage of users coming from friends and family. Over 80% of users come to know about Cricut through some kind of social media or friends and family or some kind of demos that somebody did for them. So that aspect, even outside the platform, and then I’ll talk about the platform continues to be very healthy and very robust, right? So nothing has changed from that standpoint. As far as the focus on community itself, I would say, and I made this comment to when Mark asked the question €“ actually when I think Jim asked the question about R&D.

We are building the community right inside the platform, right? And the community is creating projects that subscribers are able to benefit from and that helps them save over time, right? We’ve created other high value actions where people are able to follow each other, people are able to bookmark. So all of that we think that takes an expanded view of our lens in engagement. So I would say, in summary, both outside our platform and inside our platform, community plays a massive role. And I think those network effects will continue to drive that. I think as the consumer spend returns over time, we think that we will benefit from the funnel that we are building and the network effects that we are driving. But also as I said, community is a front and center part of our platform.

And I think we’ll see the benefit of that in terms of content that the community will generate and contribute to the platform.

Kimball Shill: Yes. Adrienne €“ sorry, I didn’t mean to cut you off. Thanks for the question. When I talked about two year acceleration, I was really talking about the accessories materials, not machines, right? And so let me talk about what we’re seeing and what we’re doing as additional context to Ashish’s prepared remarks. We’re seeing a price sensitive consumer, right? We’re also seeing cheaper, inferior materials showing up in the market, especially online, right? And so our strategy there is to be cost competitive. So over the last year and for the next couple years, you’ll see us being more promotional, right, in the short-term, because we want to make sure that our products are affordable to consumers. And as I mentioned that when we are closer to price parity, we win our fair share, right?

We were more promotional in Q4, and where we have data to measure, we saw that we actually improved our share position. Over the medium term, we’re going to be reconfiguring our supply chain to drive cost out to help improve our margins even as we’re being more promotional, and price competitive. Secondly, we sell a lot of materials through bundles. When we sell a new machine, we bundle it. And when we had fewer new machine sales, that also translates into fewer material sales. And as we work with our retail partners, you’ll see us being leaning into bundles with better value propositions both in brick-and-mortar and online. And then, the third factor is lower engagement, right? Even though our engaged users are up 6% year-over-year, we’re seeing since the pandemic people cutting fewer projects, right?

And so that drives the amount of material usage. And so that’s where the engagement initiative machines reference really come into play. And this is a space where our materials work seamlessly with our machines and we believe we have a right to win. And so it’s going to take some time. We’ve got inventory that we have to work through, and so between supply chain reconfiguration and working through inventory, that’s why we think it’s kind of a two year journey. But I just want to highlight that we’re very focused on managing our costs and being responsible, and I think we demonstrated that in last year with how we’re responsible were to how the year played out for us. And we will continue to be flexible based on what we see, but overall €“ for the overall business, we do expect to improve margins incrementally over the course of the year.

Adrienne Yih: Okay. Thank you so much. That’s all very helpful detail. Best of luck. Thanks.

Operator: Thank you. One moment while we take a follow-up question. We have a follow-up question coming from Jim Suva of Citi. Your line is open.

Jim Suva: Hi, I have a couple follow up questions. I believe it was Kimball mentioned some changes to the supply chain. Are you referring more to like those bundles like when Jim Suva bought the premium bundle with the machine the first time? Is that what you mean by reconfiguring the supply chain for those packages? Or are you talking about reconfiguring the supply chain, like how you make the machines? Where you make the machines? Where you do your distribution centers? Or what did you refer by changes to your distribution? Thank you €“ your channel.

Kimball Shill: Yes. So again, my comments are most on the reconfiguration, mostly directory towards Accessories and Materials, and it involves everything from looking at how we package, how we differentiate across different channels with configurations of product along with machines, and where some of those activities take place. So, we may look at nearshoring different materials over time, how we can serve the market more effectively, and frankly do it with less inventory.

Jim Suva: Okay. And then my second follow-up is on cash flow and what your plans are there? It sounds like you mentioned work down inventory still some more, is that correct? And if so, how should we think about your cash flow and what you’re going to use?

Kimball Shill: Well, so we do expect to be cash flow accretive for the year. We are starting to work through our inventory positions back to more pre-pandemic levels, but it will take us some time to get there.

Jim Suva: Great. And my last question is seasonality. With COVID it’s been tough to earmark what is normal seasonality, but I kind of would assume that second half of the year are stronger than the first half and probably Q4 is the strongest of the quarters. Is that the seasonality we should expect? Or are all these moving parts something I should be aware to calibrate a little bit more correctly for seasonality?

Kimball Shill: We’re expecting normal seasonality as we look to 2023. I mean, we acknowledging that Q1 is going to be particularly difficult quarter for us. If you recall last year it was in March, so we saw kind of the March shift in consumer behavior. And so I think Q1 will be challenging, but we expect improvement starting in Q2, but we think normal seasonality is how we’re looking at the year.

Jim Suva: Great. Thank you so much for the follow-up.

Operator: Thank you. I will now like to turn the call back over to management for closing remarks.

Ashish Arora: Thank you, Operator. And thank you all for joining us this afternoon. We’ll actually be at the Morgan Stanley conference tomorrow and looking forward to seeing everyone then. So thank you again.

Operator: Thank you all for joining this evening. You all have a great day. You may now disconnect.