Cricut, Inc. (CRCT) Earnings Call Transcript & Summary

Let's get started. Before I introduce my guest, let me just read the research disclosure here. For important disclosures, please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. My name is Erik Woodring, I lead the hardware research efforts here at Morgan Stanley. I'm very pleased to be joined by 2 members of the Cricut Team, Ashish Arora, CEO; Kimball Shill, the CFO. A lot to talk about today, but you guys reported earnings last night, but thank you guys for coming here early in the morning immediately post that. So great to talk to you.

Yes. Thank you for having us here.

So, Ashish, maybe I'll start with you, your second time at the TMT conference. I think most people in the audience know what Cricut does, but let's maybe just start off with a bit of a post-mortem just because you reported 4Q earnings last night. So really what my question is, is what were some of the more important points of the report as we look back over the last 12 months? What did you do well? Where did you leave room for improvement? And what's the message as we enter 2023?

Sure. Thanks, Erik. So we reported our results yesterday evening. And a couple of key takeaways that we had. First of all, we basically announced that we acquired about 1.5 million users, which is close to what gets our user base about 7.9 million. We're really excited about that. As part of that, one of the things that I'm particularly excited about is that we are able to penetrate our SAM, which is still only less than 6%, and we were able to acquire a lot of beginner users and Gen Zs. We basically reinforce that we have a large SAM ahead of us, and we're in the very early days of that acquisition. Our subscription business was a highlight. We had a very solid performance in our subscriptions business. And just we have a really strong road map there as well. I think a couple of things that we noted were the company is really kind of leaning in on building a platform, a platform that drives engagement. We had a couple of challenges and a couple of opportunities. And I think specifically, we talked a little bit about the margin compression and accessories and materials business. And also our plan, which we're very confident about to reinvent and reinvigorate that business over the next 12 to 18 months. So I think those are probably some of the key takeaways.

Perfect. And we'll get into all of that. But before we do the specifics, I want to kind of take a step back and think about the long-term drivers of this business, of this platform. While some things have definitely changed over the last 2 years since the start of the pandemic, I'd imagine a lot of the long-term drivers have stayed the same. And so what are they? What's most important? And again, how have they, if at all, kind of changed in the last 2 years in terms of driving the longer-term growth story for you guys?

Yes. So, Erik, our market, our SAM continues to be huge, and we're in the very early days of that. Our funnel is very healthy. We continue to add people into the funnel. We do believe that there's a little bit of reticence in terms of people really kind of getting to the bottom of the funnel and actually purchasing the product. Having said that, we have a number of initiatives in place. One of the things that makes our category very unique is, at the top of the funnel, we have a lot of network effects, right? So we actually are very efficient with our sales and marketing spend as we continue to bring more people through social media, through friends and families who network effects. So none of that has really changed, right? As a company, we have more insights about what it takes for people to get from a broader awareness to where they're starting to get familiar with the product. So we are working on tools that help address their questions. And then specifically at the bottom of the funnel, where you kind of drive purchase and conversion, one of the strategies we had to actually take -- in the last 12 months, we were generally a little bit more promotional than we'd like to be. We think that it's the best -- it's in the best interest of the company and more sustainable in terms of actually redeploying some of the dollars to the top of the funnel and driving awareness. And I think all of this is kind of vested in the fact that we have an ongoing relationship with our users, and that really creates a very sustainable moat and a sustainable profitable business over time.

Okay.

So I would also add to that, that the long-term trends, the macro trends that have driven our business since 2014 remain in place. And we're now in over 50 countries around the world, and we find the same motivators for creation and applicability of our business model in every one of those countries, not just in the U.S. market.

Okay. Okay. So let's talk about these users. Historically, your user base was very over-indexed to female, very over indexed to the U.S. You made some comments last night about the characteristics of new users being a bit different today. And maybe just expand on how that user base is really changing now.

Yes. So as Kimball pointed out, the trends that drive our business, which is around personalization, creativity, and that's really true for every part of the globe, right? We don't see any significant differences for that user. As you pointed out, over 90% of our users are female, we're really underpenetrated at this point in that user base, right? We continue to be in the very, very early days of that SAM. I think those are some of the things that we feel good about. One of the things that we talked about is that we have a lot of -- we're being able to attract a lot of beginner users and Gen Zs, and a comment that I specifically made in our prepared remarks, is that, that beginner doesn't show a difference in terms of the types of machines they buy and the type of engagement they have, which is really good news because as we are broadening our penetration in our SAM, we are able to attract a high-quality cohort of users, right? And I think that's really good. And the one last point I'd make is that a really healthy percentage of the users we are being able to attract is actually even beyond our SAP, right? And I think the quality of that cohort seems to be very, very similar to our historical cohorts to be acquired.

So you just answered my next question without me asking you. I was going to say, I think the initial concern that one could hear when you talk about onboarding beginning users is the monetization curve might look different. And I think what I took away from your comments last night and now is that, actually the engagement with the platform might not be different between cohorts.

Sure.

Post-pandemic, maybe engagement for the whole user base is a little bit different, but the cohorts are behaving very similarly. And I guess my question really is, kind of how do you leverage that knowledge to inform your product road map and kind of what you're doing with the platform as you think about the opportunities to go from 6% penetration to whatever that number might be in the future?

So about 74% of our users -- actually let me actually be back up. So the way we count engagement is actually the number of people that are cutting on our machine, right? And 74% of users ever since we started in 2014 actually cut in the last 12 months, right? The number of users, the number of people who actually cut on our machines increased 6% year-on-year. And we think there's a huge opportunity just across the board, right, not specifically to any new cohorts or anything, like we obviously could dramatically increase that number, and we are focused on a number of initiatives to actually help drive onboarding and engagement. So we talked a little bit about this, which is the user behavior in the first 4 to 6 to 8 weeks really kind of becomes predictive of how they behave over time. And we've been doing a lot of experiments with onboarding. We've had some really good results. We really actually planning to scale that, right? So the opportunity we have, Erik, if you think about the user journey, right, we actually cover the transaction saying when somebody cuts, but there's a huge rich journey that happens when the user decides that they actually want to make something, right? It's the early part of the inspiration. Our platform plays a key role, other platforms like Pinterest play a key role. And I think there's a huge opportunity to get the user early on in the cycle. So we are building a platform which has a ton of inspiration. We basically are really leveraging mobile. So think about this, right? Somebody could be on the road away from their machine for 10 days. They could be interacting with our platform. They could be book marking stuff. They could be creating projects. We don't count any of that as engagement, right? And that creates a huge opportunity in terms of really interacting with the user and creating other forms of monetization over time. So we're actually really excited about that.

Right. Okay. So I have 2 questions off the back of that. Maybe first just starting with engagement. I would say there are -- there have been temporary headwinds. But last night, you also talked about kind of making the journey less complex, make it simpler for your users. Help us understand what exactly that means and how that can translate into better engagement metrics, again, longer term over time.

Yes. So I think one is clearly the out-of-the-box expense and the initial first few weeks of engagement. And like I said, that becomes very predictive. So it's basically giving them the education, the tools, the out-of-box materials and helping hold their hand to lead them through the project. The other thing I would say is that, again, our platform enables, which is we have hundreds of thousands of pieces of inspiration. And the user -- we've got to get to a point where -- so somebody can just click on something they actually can make it, right? And I think we're in the early days of that. And I think as we do that -- no one actually interesting stat that I'll share, which is when we ask customers who haven't come on to our platform for 6 to 9 months, hey, what do you think about Cricut? Why haven't you come in the platform? There's a very high percentage of those users that would say, oh my God, like this is really good. I love using Cricut, right? I really enjoyed it. And then when you asked them saying, well, why didn't you? And they'll say, oh, well, I have just run out of time. Or life just got in the way. And what they're really saying is it's an opportunity to make those experiences frictionless, right? It's to help them do those things in less than 5 or 10 minutes. And again, I think mobile plays a key role, right? The platform plays a key role. Think about this, which is we want to generate personalized relevant triggers, right? So even if the user wasn't intending to do something, we just reminded them of a birthday project they made last year and say, hey, somebody's birthday is coming up. All of those possibilities exist, and that's where the platform is going, which is really leveraging user data to understand their behavior and giving them highly personalized, relevant nudges to do something. And I think we think that that will move the [indiscernible].

And that's the change you're saying?

Yes.

That's right. Okay. And then the other part of the comment that you made just prior to this one was the ways in which your users engage with the platform that potentially you don't monetize today. And so I guess my question is, you touched on some studies last night about different cohorts, different user engagement. What did the data show in terms of is there an opportunity to figure out maybe how to monetize engagement that doesn't necessarily get picked up by the metric you discussed earlier?

Yes. So we -- internally, we take a very broad view on that metric, right? And like I said, any time the user interacts. So I go back to the example, right? I'm on a vacation, and I'm creating projects for my classroom. Let's say I'm a school teacher. We don't count any of that is engagement. It's an opportunity to inspire them with relevant things. It's our opportunity to propose types of materials they can buy, what kind of projects they can make. So yes, there's a huge opportunity to monetize those eyeballs both in terms of -- and some of that we've already done today, we have some proof points, right, which is one of the reasons why our subscription products done really well is because we have -- as they -- there's a 150 million bookmarks that are created, right? And every week, millions and millions of bookmarks are created. And what that means is a user intent that they actually want to come back and make that project. Now we can start to propose, hey, these are the materials you need to buy. These are the things that you need in order to make this project. So again, as we help with this coverability and help people think about ideas to make things or even give them reminders to make things, it's an opportunity to not only create digital revenues, but also physical revenues in terms of materials, et cetera.

Right.

Well, and I think proof point you started to mention was we're advertising our access subscription service more frequently throughout the platform, and we're seeing increases in annual subscriptions just based on advertising that opportunity.

Right.

So we have 10 or 15 touch points inside our software that can basically reinforce the people as to the benefits they're missing. And one of the reasons Cricut access is the amount of users that come into the platform is overwhelming. I always tell people saying, those many users don't go into craft aisles every day and yet we interact with those users multiple times a day.

And that's really exciting. And I guess your point is helping educate them across multiple different fronts is something that you believe can help with the monetization curve, help with the engagement curve, again, help take the platform from where it is today into the future.

Yes, absolutely. And the community itself is playing a huge role in actually enriching the platform. So we said there's 80,000, 90,000 projects that have been made by the community. And what that means is that another user that comes up, basically, if they click on a project that is being built by community, in one click, they actually have all the design work. So that's basically saving them 60 minutes of time. So again, one of the things I talked about platforms is where the participants of the platform have created more value than the creator of the platform itself, right? So we believe that ultimately, the value proposition of subscription, the value proposition and the ease of use -- we will provide the enabling infrastructure, but it's the users that will make it easy for other people to do things. If the users that will inspire are the users to do things.

So that's an important point. And when we've gone through this process for multiple years now, and I think something that really stood out early on when you became public was just how engaged your user base is on social media, far in excess of, I'd say, your competitors, far, far in excess of your competitors, but even far in excess of other, let's call it, technology platforms. How can that translate into kind of maybe P&L efficiency for you guys? How do you leverage that to, again, drive profitability to the bottom line?

Yes. So let me kind of talk about that. So over 40% of our users come to know about our platform from friends and family. Over 80% of them become aware of Cricut and the platform through social media, through Pinterest, Instagram, TikTok, YouTube, et cetera. And even when you compare on TikTok, for example, as compared to really large brands -- they're some of the biggest brands in the world. It's pretty wild right, right, in terms of engagement. So I think there's a huge opportunity to drive network effects. And if you think about the nature of the category, when our users create projects, they're incredibly proud and they feel self-accomplished that they've made all these things and they advertise for us, right? And how that translates I think it's a huge opportunity for us to -- those network effects exist today. There's an opportunity for us to leverage them and even harness them even more so. And what that does is basically -- and I talked about the top of the funnel is that helps drive awareness and efficiencies that other brands are not able to achieve. So I think our opportunity in terms of -- even though our sales and marketing -- our sales and marketing expense is -- our long-term model is about 8% to 10%, if I remember, right? And we were up at 15% this year, and that's mostly because we are spending a lot of money on the POS dollars and promotions for conversion. And our strategy going forward is to actually leverage some of the top of line awareness effects rather than -- and be less promotional. That -- we believe we have a strong conviction that our funnel is very healthy. We have data that shows our funnel is very healthy. And we believe that the customer is coming through the funnel, but they are just stopping shy of that conversion. There's opportunities to improve that, but we believe that as consumer spend returns, we will be benefiting from that.

Okay. Okay. I'm going to get into the numbers. Kimball, don't worry. I just want to touch on international expansion first before we get to some of the segments. It's been an initial year for you guys. You just mentioned in more than 50 countries. Again, this has been a challenging last 12 months. And so if we take away kind of the noise, talk to us about the long-term international expansion. Where is your focus? What countries are you most focused on today? And maybe as we look out over the next 12 months, what new countries might emerge as more core to the story?

So I want to make a point on the international because -- our financials show that were down slightly, but on a constant currency basis, we actually would have been growing at kind of mid-single digits, right? And so we did have some currency fluctuations. As to the countries, I think we're in most of the countries we plan to be in for the next year or 2, and we're looking at deepening our footprint, right? The way we go to market is very organic, right? So we start small. We use social media effects similar to how we do in the U.S. and that takes time to build momentum. And so that process is in flight, and it will take a year or 2 for that to bear fruit. Our largest markets are the ones we've been in the longest. So if you look at U.K., France, Germany, Australia, that's where the bulk of our revenue comes from today. And we talked a little bit yesterday on the call about how economic headwinds, particularly in U.K. and Australia, really kind of weighed down that piece of our business. Even though we had growth in some of the less mature markets, it didn't fully offset what we saw happen in the bigger markets.

Right. Okay. And then maybe last question on international. It's just in terms of engagement and monetization. Is there any difference in takeaway currency and all of that? Any difference in the international user versus the domestic user?

Well, in terms of what motivates them to create, no. We see that very similar. We actually do see in some markets, higher attach rates to subscriptions than we see in the U.S. But it's also early days, early adopters. And so I mean it's too early to conclude trends from that.

We don't see any differences in terms of what motivates people. In some countries, especially in some of the developing markets, a user may come in because they want to start a business versus the hobby. But other than that, the underlying motivation and the intrinsic drivers are the same. Again, it's early to tell because even though some of the attach rates are higher, these may be early adopters. But overall, we think that they're demonstrating very, very similarly across the board.

Okay. So let's get into the segments. Connected machines, 2022, sell-in didn't necessarily match sell-through. You were working down channel inventory. What's the message for 2023? And then just as hardware guys, you don't need to open the kimono and tell us what's coming out, but how should we think about the cadence of new product launches? What should we get excited about on that front? Yes.

So let me talk about the margin piece because it's important to understand the portfolio nature of our business, right? We're talking about connected machines. We did see margin pressure over the last couple of years as we are transitioning from old generation to new generation of machines. But we do expect incremental margin improvements on machines as the mix tilts now more towards our newer machines. On our accessory materials business, we did talk about -- and maybe we'll get to that, but we just talk about how that piece of business is going to see pressure for the next couple of years. But that's not talking about entire business and that's at a gross margin level. We do expect to see operating margin improvement for the full year.

And I'll just add on the new products. When we look at our portfolio, especially around physical products and the hardware stuff that we do, we're very, very, very focused on connected machines. And we have a super exciting road map. I think you'll see a lot of innovation from us, not just within our existing category, but in new categories. And we're in the very early days of that. Having said that, the company has always had this vision of really evolving the platform. And we've really leaned in because we believe that the beauty about our business, Erik, is that a user buys a machine and then they go on a journey with us. We interact with our users every single day. Every time they use their machine, we can talk to them, right? So we believe that the platform plays a huge role in leveraging that machine. So we are very excited about our hardware road map. We're going to have some exciting new things coming but also we're very, very excited about our platform and where the company is going.

Good. Good. So then let's -- again, let's touch on the aftermarket stuff. Let's touch on subscriptions, let's touch accessories and materials. Kimball, you talked about accessories and materials. So I'm just going to take that and run with it, and that is it did see challenges in 2022. Talk to us about the competitive landscape. But really, I want the focus to be on Cricut and more so the actions that you're taking to really reinvigorate this business because you do have IP here. But again, perhaps there are tweaks that you need to make. And so what are those tweaks that you guys are making?

So we're seeing a price-sensitive consumer right now. And that clearly weighs on the business, and we're seeing on -- let me kind of take a step back, right? Accessories and materials for us is a very broad category of products. So we have a $1,000 heat press product called Autopress, and we have a $5 roll of vinyl and a whole bunch of stuff in between. And so things like vinyl there's a lot more competition for that. And so in vinyl iron on, we see cheaper inferior products come in, especially online, right? And so we're responding to that by being price competitive. You saw some of the pressure on margins related to our promotional dollars on materials. Over the long term, we're going to reconfigure our supply chain and focus on more efficient packaging and differentiating by channel, so that we can actually have healthier margins even as we compete and win our fair share. We sell a fair number of our materials as bundled with machines. And so as we sold fewer machines, that's impacted the A&M segment as well. But you'll see us leaning into a bundled strategy more broadly, both with brick-and-mortar and online to help accelerate that. And then Ashish has talked about engagement. And those engagement efforts as people begin to cut more, as you highlighted, all users are cutting a little bit less coming out of the pandemic, right? But we think we can help reverse that trend as we lean into engagement. But at the end of the day, our materials are designed to work seamlessly with our products. And so we believe we have a right to win in this space. But as we work through existing inventories and make some of these kind of medium-term changes to our supply chain, it will take us 18, 24 months to get there. And that's why we talk about kind of margin pressure, gross margin pressure on materials for that time period.

Okay. So let's go to subscription. It's a business that grew over 30% year-over-year in 2022. You ended the year with 2.6 million paid subscribers, attach rate that's around 33%. How do we think about that metric trending into '23? And really we kind of touched on this, but what changes are you making to the subscription offering to really enhance that value proposition to get your users to say, I want to be a subscriber?

Yes. So we're really excited about our subscription business. We think it's a huge opportunity for us over time. And the team has done a great job over the last 18, 24 months as we're just beginning our road map of improvement. So we have lots of premium design features like automatic background editable images. We have our Contributing Artist Program where we have third-party artists who create content that's diverse. It's an important part of our localization for content as we move around the world. And we're just getting started on those types of features. And as we look to '23, and we talk a little bit of the pressure we'll see here, is we get new subscribers primarily from adding new users to the platform. We do believe we're going to have lower new users this year than we did last year, but that's largely driven by as someone buys a machine and they register it, there's a time lag before when they actually come on to the platform. So in kind of Q4 of '21, we had a much stronger holiday season than we did this last year. And so we don't have that same influx of new users in Q1 to kind of boost our numbers. But that's short-term pressure. We believe as our acquisition efforts get traction that we will reaccelerate that business.

Yes. And Erik, I pointed this out last time, I'll do it again. which is our subscription product has a lot of stickiness in terms of -- our platform itself is very sticky, right? So for example, if a user on our platform has made 50 projects, while they're subscribed, so they've added like let's say, 100 hours of design time and they've uploaded photos, they've done a lot of edits, that product that they have now created value around, is not accessible if they stop subscribing. So in some ways we provide the raw ingredients, they created the derived work, and in order for them to access that derived work, they have to be a subscriber. And so we are actually really pleased about the long-term structure of that business and our focus on these incredible design software tools. So our entire value proposition as Kimball talked about is content is going to be king. Our community, the participants on the platform will add more value to that content become part of the subscription. Software tools will play a key role and then software -- and then services will play a key role. So our long-term outlook and a long-term viewpoint on that business is very optimistic.

And can you just on the software side, again, I know you mentioned mobile earlier, but outside -- there's clearly a focus on software and enhancing the cloud-based offering that you have. Again, you can't take your project with you elsewhere. It's on the cloud on the Cricut journey, but what else are you doing on the software side to, again, whether it's enhance the platform or enhance engagement or monetization, what's the priority to that?

Yes. So first and foremost, right? In fact, we have 2 leaders in our company. One is driving subscriptions, the other is driving engagement, and they actually work hand in hand, right? So the #1 focus of our software, which was when we started was to connect to make an incredibly cloud connected device. The #2 was, let's really invest in our subscription effort, and that's where we are about 12 to 18 months ahead. The third piece is the engagement piece, which is how do we get our users to come to a platform, 5 to 6 to 10 days? How do we get them to come to a platform that they didn't even have an intention, right? So the fact that people can follow other creators, the fact that people can on their mobile devices, bookmark things that other people have made, right? So the likes, the bookmarks, the follows. And then finally, I would say search and personalization is huge. We want to give people incredibly personalized, highly relevant content even when they didn't know that they actually needed it, right? So we are very much like how a content platform would behave. So I think those are some of the technologies that advanced machine learning, looking at something in other technologies that are coming up. So we think that there's an insane opportunity going forward.

Okay. So if we add this all up, we kind of talked about the top line stuff. We've touched on some of the cost side. Again, we're ramping up towards that target operating margin range, which is 15% to 19%. Again, what kind of takes us from where we are today? I think it was 9% in 2022, looking to incrementally increase that this year. What takes that from this year to that range? How do we get there?

So I think a lot of that is scale. If you look at the size we were in 2020, '21, we were in those operating margin ranges. And so part of this is reaccelerating business with some of the efforts that we've talked about. But in the interim period, we are very focused on managing profitability, right, where a business that generates cash. We paid a special dividend this year because we had more cash than after we fully funded all of our investments that we wanted to fund. And we expect to generate cash in '23 as well.

Okay. Okay. So just have a few seconds. I'm sure you're excited to put 2022 behind you and refocus the message on 2023, getting back to growth. And so just leave the audience with what's your final message that you want to tell everyone before you step off stage and why you should be interested why Cricut should be on their radars?

Yes. Erik, we believe that we have a massive SAM, 129 million people in just the top 6 markets, right? The underlying trends that drove our business from 2014 are largely -- in fact, are intact, right? And we believe our funnel is healthy. When COVID happened, we didn't -- all of a sudden, people didn't go on the web and start searching for what is a home device they can use, right? We had a healthy funnel and COVID just converted those people. We have a very healthy funnel today. And we believe we are being more efficient in bringing people down and as that consumer spend returns on discretionary products, we believe that we will be in the consumer's list. So we take a very long-term view and we are building our business. We're building a platform, and we think we have sustainable levers, and we're in the very, very early innings of the game.

Good. I wish you the best of luck. Thank you for your time here. Thank you guys for joining us. Thank you all.

Thank you.

That was great.