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

Good morning, everyone. Day 3 of Citi's Global TMT Conference. My name is Asiya Merchant, I'm a tech hardware, tech supply chain analyst here at Citi Research. Really happy to have Cricut's management with us. We have Kimball here, Kimball Shill. He's the CFO of Cricut. And next to him is Jim Suva. He's the SVP of Finance, Treasurer and Head of Investor Relations at Cricut. This session is obviously for Citi clients only. I have a bunch of prepared questions that I'm going to be talking to Cricut about. But before that, I just wanted to turn it over for some opening remarks.

Thanks. I just wanted to make sure that everybody realizes that we have a safe harbor statement, and you should please read the risks and uncertainties associated with our company as well as our Investor Relations site. Please have a look at our recent 10-Q and 10-K for additional information.

Great. Thank you, Jim. Kimball, let me start with you. I mean, I'm obviously familiar with the Cricut story because I've been covering you guys. But for those who are in the audience, online or in person, maybe they may not be as familiar with the Cricut story. And if you can just talk to us a little bit about the brief history about the company and where you guys are today with your product offerings.

Asiya, thank you for hosting us today. Cricut's original strength was in the scrap booking space, and we sold cartridges and cutting machines that people use for scrap booking. And the company had lots of debt and ran into some hard times. And that's the time when Petrus, which is owned by the Perot family, consolidated a lot of that debt. They brought in Ashish 12 years ago to right size the cost structure of the company and address the capital structure. But also, Ashish introduced the connected machine and the platform, where everything is in the cloud. And so we launched our first connected machine back in 2014, and we've been EBITDA profitable since 2014 and net income profitable since 2017. And so today, we provide our connected machine, the ecosystem around that, and the connected platform that drives all of our technology.

Okay. And then we've been asking this, I guess, all our companies. Just as you sit back and think about end demand here in calendar third quarter and if you reference kind of back to where you were maybe the start of the year, what surprised you? What's changed? What's different looking ahead?

So let me answer that more broadly. If I look at the macro trends that have driven our business since 2014, it's around the desire for personalization. It's the digitization of tools and social media that have been the long-term macro drivers of our business, and that's what we think provides lots of growth opportunity for us over time. In terms of your specific question on where do we see the fundamental drivers of our business, it's really around getting engagement with our core user base, and that's an area where we know we've had challenges over the last couple of years. But also, continue to grow our platform and our subscription revenue. And part of that is making sure that our platform is easier to use, and we're making significant investments and making progress there.

On the earnings call, you specifically do reference the platform segment, and that has been outgrowing, obviously, the product hardware segment in recent quarters as well. When you think about specifically the revenue drivers regarding that model, how are you thinking about the investments that you're doing to make sure that the platform revenue, which is the more margin profitable revenue, continues to outpace?

So clearly, the way people engage with us, right? And we define engagement, when somebody comes in and makes a project. So it's not just coming in and logging on to our platform, but they literally cut something. And so we're looking at how we improve that engagement over time, particularly among our subscriber base. And so ease of use is important. And also, we're investing heavily in the out-of-box experience. And let me explain how this works. Someone comes into our ecosystem when they buy a connected machine. And they register the machine and they have an opportunity then to take a trial subscription. And we want people to have a seamless experience or a frictionless experience when they come into our ecosystem. And the reason that's important is our data shows us that the way someone socializes with our platform in the early days of the experience is very predictive of how they will socialize with our platform over time. So if they come in, they have a good experience and they cut a number of projects, they're more likely to cut more projects over their life cycle as a consumer. And so as we invest in making our out-of-box experience better, we have specific metrics that we track internally, both looking at how many do a test cut in the first day that they open their box and register the machine, and then tracking within the first few days the number of projects that they're cutting. And we talked about in our earnings call that for the last 2 quarters now, we've seen those metrics improving. What we think that does for us over time is that, that ends up giving us a higher-quality user over the lifetime as more and more of these newly onboarded customers become a bigger part of the user base.

And Asiya, I would add on to what Kimball said is also for users, we've been putting in more value-enhancing things on the pay-wall side of a paid subscriber. For example, automatic background removal is one of our best features that paid subscribers use. So you take a picture and it automatically cleans up and removes the background to be able then to cut the image or put it on to a T-shirt or a greeting card. Other things such as monogram maker, warp, many different tools to enhance the experience to add for the paid subscriber that they get more value out of it. And that's been a really big focus for the company.

Engagement trends. Kimball, are you concerned about them declining more recently? Or how are you guys thinking about this trend? And what are you doing about that?

So clearly, that's been a headwind for us, right? As we moved through COVID, we had -- COVID was a tailwind for us. I mean, it didn't make our company. We were growing -- as I mentioned before, from 2014, we were growing at 40-plus percent CAGR. But as we went into COVID, we had a big, big boost as people who were in lockdown and were interested in being creative were very engaged, and that was obviously a big growth opportunity for us. Over the last couple of years, we have seen engagement decline, and so there's two things we're doing here. One is the out-of-box experience we're talking about, where we're working on making that more seamless for new users, so that they socialize with our platform and they learn how to use it, they build confidence, and we think they will cut over time. At least that's what our data suggests to us. The second thing that we're doing is making our platform easier to use overall for the installed base. And as Jim mentioned, we're continually growing both the content. So we have over 1 million high-quality images for our customers to make. We also have prepackaged projects that they can come and make with instructions, and then we have more and more premium design tools behind the pay-wall that they can use to kind of make that creative experience easier for them. And then the third thing that we're doing is making our search algorithm smarter so that when someone has a desire to be creative and they come in, they're not sorting 3 million images. We know that -- we understand that this person likes to make a paper project or an iron-on project to make a T-shirt, so that we're serving them, as their search content, things that match their interests, their stated skill sets, and so they can find something more readily to make.

Jim, you talked about deeper promotions at some point, when we talked on the call as well. Can you update us on where we are with promotional strategies for your products?

Well, the good news is, and I'll give you the conclusion to start, is it's working. We first started this in Q4 of last year, and the deeper promotions really caught the attention of the buyers. And in fact, so much so, we did see some stock-out at retailers. That's the good news is it's working. But to give you some historical context, it's very important to note that in 2023 as well as 2024, most retailers, the bricks-and-mortar stores, were de-stocking inventory. Consumers weren't spending a lot, and they wanted to make sure that they had enough cash flow. There was a large amount of de-stocking that happened. And so we're very pleased, Asiya, the deeper promotions are having a positive uplift, and we are very aggressively working in a constructive manner with our retailers to get them to restock to more adequate levels. But we're very pleased that it is working and seeing a positive uplift.

Okay. And then back on gross margins. There's a pretty big variance between the gross margins of your core segments, subsegments, I should say. And obviously, subscription revenues are very high margins and we've seen margins expand there. How does that inform your investment strategy? And how should investors think about the long-term -- or near-term and long-term gross margins for your company?

Yes. And you're exactly right, Asiya. The subscription models tend to think of it as high 80% margins. You should think about our company as kind of from a modeling perspective, 2 different segments, platform and products. On platform, high 80%. You've seen a small amount of pressure there as we've had added costs like some new developer and engineers, and those costs get amortized over a 3-year period as we continue to invest in the platform. But high 80% margins, we're very proud and pleased with that. On the product side, it's important to know, you have bill of materials, semiconductor chips, micro-controllers, metal, plastics that go into it, and also just the physical warehousing and logistics behind that. You do have a higher bill of materials. You also, on the product side, have seasonality. We sell a lot more products during the holiday period than during the non-holiday period, so you should model that appropriately. I would mention that we did see some onetime benefits that helped us this past quarter. And so if you look back to a year ago, those are some good reference points. As we enter the second half of the year, we did give some very granular guidance on operating margins and where they should be, around 10.1%. But I really encourage people to model it under 2 segments, platform and products.

And then just remind us the long-term target model, if you're -- if you have one on that.

So our long-term model is to be between 15% to 19% operating margin. But that comes into play for us when we're operating at scale, which for us is when we're at a revenue of $1 billion and back to growth.

Okay. And what does -- what target model have you guys shared on gross margins as well? The mix shift or the revenue split between product and platform?

So from a numeric standpoint, it's primarily focused -- I mean, we've only articulated as it relates to operating margin. I would call out that as we resume to growth in our connected machine segment or in our connected machines part of the business and physical products, you would expect gross margins to come down because as Jim highlighted, that part of the business carries lower gross margins than does platform side.

Okay. A little bit on marketing. I mean we've talked about the promotional strategy. But you're recently spending about 20%, I think, of your revenues on marketing expenses, which are higher than what it was a year ago and if I even dial it back a couple of years ago. Help us understand the rationale for that higher marketing.

Yes. So thank you, Asiya. As we've gone through the last couple of years and we've seen top line revenue decline, we've been very focused on managing our OpEx, and we've been -- and part of that was cutting back on marketing spend. We think we over-indexed on cutting back on marketing spend. And as the category leader, we have an opportunity to reinvigorate our consumers and our retailers with enthusiasm for the category. And so as we came into 2024, we have deliberately increased our marketing spend, especially in top of funnel and overall awareness marketing, to do just that. And you can -- and first, I would call out that we're seeing promising results from those efforts, and so you can expect us to continue leaning into that spend.

Can you be a little bit more -- can you double-click a little bit on the specific marketing initiatives? I know you guys talked about it on your earnings call, but just for the audience here.

Yes. So first of all, I know, Asiya, you've sourced many large, large cap companies. Our marketing is very targeted. We kind of know who our key market is. The majority of our users are female. And our key market is in the age group of 25 to 44-year-olds ballpark. And with various online social media ways of marketing, we can hone on -- hone into those pretty aggressively. For example, back-to-school. You saw a lot of marketing and promotions around that. Also, Mother's Day and Valentine's Day, we're really penciling that in. And today's technology and marketing allow us to focus on that as opposed to -- you won't see us at the Super Bowl or the Kansas City Chiefs football game broadcasting it to everybody. We're really focused on that type of demographics that we're looking at.

Sorry, a question back to the operating margin long-term range. You talked about you need to be at scale, at a particular revenue run rate level. How should I -- what are some of the building blocks to kind of get you to that revenue level? And if I think about the headwinds that you face there, is it just truly just revenue scale that gets you there? Or is there some mix shift as well between the segments that kind of gets you to your long-term target model range?

So I think there's 2 pieces. First of all is we talked about marketing being at 20% of revenue, right? That's a high watermark for us. There's some scale that will come into play of that will become a smaller percentage of revenue even as we lean into overall marketing dollars as we achieve higher revenue. If I look at the different pieces of the business in the product segment, our connected machines have grown for the last 2 quarters. So we're pleased to be back to growth with connected machines. But our accessory materials portion of the business continues to see headwinds and pressure, right? And so to get total company back to full growth, we need to turn that segment around as well. But we were -- in the most recent quarter, we were down still 27% on a year-over-year basis.

I will note, the operating margins we posted in Q2 were actually 15.7%. So someone might say, well, hey, you're already hitting your long-term goal of operating margins. I will note that there were some unique things that kind of helped us. We did benefit from selling some excess and obsolescent product. It's more of an accounting GAAP thing, where our accountants look at the velocity of how fast we're selling products. And sometimes, they make us reserve if we're not at a velocity that they feel is going to be adequate to absorb that inventory. We are fortunate to have some strong sales in some of those excess and obsolete products, which were previously reserved for, so you write those down in prior quarters. We are a company where the Board and management really doesn't do pro forma to GAAP adjustments. We report GAAP as is. We don't have adjustments. We don't reverse out stock comp. We don't reverse out all these charges. So previous quarters, we did take some reserves that we didn't call out or talk a lot about because we don't like to do a reconciliation of pro forma to GAAP. But then this quarter, when we were able to sell the excess and obsolescence, those came back to help us. So 15.7% this quarter was strong. But again, it was helped, so don't model 15.7% going forward. And kind of Kimball correctly stated 15% to 19% is where we see the company's business model of $1 billion sales per year and growing. For 2024, we gave some very specific commentary and that is we expect 2024 full-year operating income to be 10.1%. That compares to 9.1% in 2023. So you do see a nice improvement year-over-year in totality for it, and we're very focused on increasing that as well as sales.

Okay. When it is -- maybe if you can talk a little bit, you generate a lot of cash. There's no question about it. You guys are very profitable on that end. What is your capital allocation strategy? And how should investors think about your investments, maybe acquisitions, and returning cash to shareholders?

Jim, do you want to take that one?

Yes. Thanks, Asiya. Capital allocation, for us, we have a very disciplined manner of doing it, but I want to set the stage first. The company has no debt. And you correctly mentioned that we generate a significant amount of cash flow. We have no plans to take on any debt in the near term, but we're very fortunate to see very profitable operations. Our capital allocation framework, we're very clear with it. It's first and foremost, our top priority, underscored, double-click, bold, is to fund organic growth and organic operations. That is research and development, engineers, inventory, sales, looking at lead times to make sure our semiconductors are being ordered with adequate lead time as well as the shipping containers from Asia to the United States and supply chain as well. We don't want to stock-out and things like that. But first is to fund organic growth. That again includes inventory growth as well as R&D and internal needs. Second would be M&A, but we don't have an active pipeline there. And in fact, since our CEO, Ashish, who's absolutely brilliant and runs a very good company, he's been CEO for over a decade, about 12 years. We haven't done any acquisitions. So you can't -- you should not view us as a roll-up company who's looking in a tuck-in acquisitions. We may consider stuff. But so far, since he's been here, we've not made acquisitions. So I would kind of discount that one a little bit. But I would note that then, we don't want to hold excess cash just to hold excess cash. We understand shareholders out there that there's a marketplace where they can also invest in other companies or other diversified things. So we look at returning excess cash to shareholders. And on our Q2 earnings call, we made a very meaningful announcement. And just to remind people, at that time, we announced a stock buyback of $50 million of a stock buyback because we concluded our first $50 million buyback in calendar Q1. So this now brings back our next $50 million. We often get asked how quickly will we absorb or use that $50 million. We've said, expect about the same cadence that we did of the first $50 million, which was about over an 18-month period. And then we did announce dividends. We announced 2 specific dividends. First was a special dividend of $0.40. And then we announced a recurring dividend of $0.10 per share that will happen twice a year or semiannual. On the $0.40 dividend, Asiya, it's important to note, that is largely being funded not only from profitable operations but also a big part of us rightsizing our inventory. During COVID, when lead times were long, containers were very expensive to ship, semiconductors had 1- and 2-year lead times. We ordered a fair amount, and we are now rightsizing our inventory, and we've been drawing it down. Last year, we paid a special dividend of $1 in July, and then we also paid a special dividend of $0.35 in Q1. These special dividends are being funded a lot by the work-down of inventory to normalize it. The profitable operations definitely do help. But then the $0.10 dividend is what investors today and going forward should anticipate as a recurring dividend. So that would be $0.20 per year paid twice a year, July. And then if you add 6 months to that, assuming Board approval, that would be in the January time period. So you should look at $0.20 per share as a recurring dividend. Now sometimes, we get asked, why not just an annual dividend or why not a quarterly dividend. An annual dividend, we believe, doesn't reward investors for sticking around. It's kind of more episodic. But a quarterly dividend, there are administrative costs and burdens to the companies that do offer quarterly dividends and more administrative housekeeping. Given our shareholder base, we just felt it was more important to do it twice a year. And so we are very happy to say that we have very strong cash flows, no debt, and we're deploying that cash first to fund the company organically, and when there's excess, to return it to shareholders.

Okay. Great. Maybe just as we talk about, Kimball, when you talk to your investor base, both current investors, potential investors who call in to talk to IR, what's the key message that you are talking to investors about? And why should -- if you think about where your stock is trading, the valuation multiple relative to peers, relative to the broader industry, what's the key message for investors?

For Cricut, we're still in the very early days. We have a very large TAM. We're just beginning to address that. We're active in 50 countries around the world. We think international is a huge vector of growth for us over time. We've seen some of the same challenges in that part of our business as we've seen in our North American business over the last couple of years. But we're excited that in Q2, we returned to growth in international. And we think over time, that continues to be a very large opportunity. But large TAM, we still are early days, and we think we have lots and lots of growth ahead of us. We're a profitable company. No debt, as Jim has already highlighted. And we are growing our platform and our subscription revenue, and that drives a significant portion of our profitability. We're very focused on getting all segments of the business back to growth over time. And as we sell more connected machines and bring more users into our platform, we think that just has a virtuous cycle of helping us build our business in a very sustainable way over time. We are very focused on profitable growth, so we're not a growth-at-all-cost business. And so we're measured in the investments we take and the pace at which we move to make sure that we maintain our profitability as we grow.

Jim, any parting remarks?

I would just say, since being at the company and I used to be at Citigroup as a covering analyst, many people view Cricut as just a hardware company or just a cutting machine company. When you really get in and understand the value and power of the subscription model, and Kimball mentioned over 1 million makeable images that are there, with a couple of clicks, you can make them, and they're very professional, very good, it's very powerful. And when you think about going forward, the creativity that people can do is endless, whether it be for school, work, politics, church, sports teams, things like that. The creativity is endless. And I think gradually, as people start to use our product and see the value of the subscription business, it's fantastic. I'm excited for the future because I view creativity as personalized and endless. But also, as Kimball mentioned, we're at the very early infancy of a growing business, and I'm just so excited about that. And as people see us more and more as a platform company, we look to see and show the higher profitability and cash flows associated with more of a platform company than just a product company. But the future, I'm excited about it. And my family uses the product, as you know. And we used to use the cartridges. And now with it being connected, it's just really neat. And I'm very excited about the future. Kimball mentioned no debt and strong cash flow. It's an amazing blessing and fortunate place to be in this economy, with no debt and significant cash flow and giving cash back to shareholders in the form of stock buyback and dividend. And we're not constraining future research and development at all. We're still funding organic. So to us, the future is very bright out there and very creative for all of our user base.

Okay. Let me just make sure there aren't any -- are there any comments from the audience? Any questions? All right. Well, thank you both, Kimball and Jim. I appreciate you taking the time here to come to Citi's tech conference.

Asiya, thank you very much for hosting us.

Thank you.