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

Okay. So, I think in the interest of time, we're going to get going with our next fireside chat. There we go. I'm actually going to kick it over to Jim Suva first. Jim is going to read a safe harbor. Jim, why don't you go ahead, and then maybe I'll do the intros and get us started.

Thank you, everyone. It's great to see you. My name is Jim Suva. I'm the Treasurer, Senior Vice President, and also, over Investor Relations. And joining me on the stage is Kimball Shill. I will reference our safe harbor statement. Please have a look at the Cricut Investor Relations website for forward-looking commentary as well as risks and uncertainties, and have a look at our recent 10-Ks and 10-Qs. Eric, back to you.

Okay. Great. Well, Kimball, Jim, thanks so much for being part of the conference. Great to have you here. Kimball, I'm going to start with you. For those in the audience that are less familiar with the Cricut story, why don't you talk a little bit about what you're trying to build, the unlock towards the opportunity the company is trying to scale against, and how you think about that over the longer-term?

Okay. Thanks for the question. If you go back in history, Cricut was really a scrap booking company that was very paper-focused and with cartridges, and a very hardware-centric company. About a decade ago, in 2014, we launched our first connected machine and our platform. And so, today, we sell connected machines, subscriptions on our platform, and then also accessories and materials. And so, it's an ecosystem that works together. And as we've grown over the last many years, the platform has become an increasingly important part of our business. So today, it represents 80% of our profitability and is a very stable foundation for the business, even as we continue to bring people into our ecosystem by selling connected machines and then giving that opportunity to monetize them.

So, in recent years, we have seen the platform segment outpace product revenue. So, when you think long-term, how do you think about the key revenue drivers and aligning investments behind where you want to go against the opportunity?

So, we believe we have a huge opportunity in front of us, both domestically, as well as in rest of world, right? So, international will continue to be a vector of growth for us. We think we have an opportunity to sell millions of more machines, right? So today, we have roughly 4.5 million active users, but we think we have opportunity for millions of more, and that will continue to grow over time and build that base even as the platform over the last couple of years, as we have sold fewer machines than we did during COVID, we've seen the mix of our business tilt more towards platform. But we think as we kind of navigate kind of the current economic headwinds that we've seen and we're successful in bringing more in, that we will accelerate both pieces of the business. So, you should expect to see hardware pick up over time. And that will also give us more opportunity to grow the platform.

One more, before I sort of try to bring Jim into the conversation. One of the questions we get a fair bit because you're such a unique company is what is the competitive landscape? So, when you look at all the different product offerings you have, how do you guys think about the competitive landscape, who you compete with? And how to think about some of the differentiation points from your company versus that competitive set?

So, we view ourselves as a platform company. That is our core business, our core value driver. I know some people view us as a hardware company. Some people don't quite know how to classify us. So, we don't see anyone else taking the same approach to how we provide a creative solution. And our platform really is our moat. So, there are other cutting machines out there, but we have the vast majority of market share. And the approach that we see competitors from the cutting machine segment don't really overlap with what we have to offer. And so really, it's about how do we gain creative mind share for people who want to create. And our platform is the moat -- I'm stumbling a little bit on this one, but it's really about the platform is that moat for us. Let me hold it there.

Jim, I want to bring you into the conversation. I think there's been a couple of big debates here at the conference over the last couple of days. One of them anchors very much around the macro environment. So, when you look at the broader macro environment and your business, can you provide investors with a bit of an update about how you guys are thinking about end demand?

Yes, that's a great question, Eric. I'll tell you, our average customer or user represents your typical American household, not necessarily over-indexed on affluences or those who are struggling. It's very much your typical average American household. That being said, I wanted to mention, a couple of years ago, when interest rates were going up, fuel prices of a gallon of gas here in San Francisco, $5, and it used to be $3, rent and food escalating. A lot of households were adjusting to a new normalcy, and they had to do an adjustment for it. And so, the past few years have been really challenged for us, and our sales have been down. Now that being said, I do want to note a couple of things. Compounding this is also, historically, we should look at the retailers and what they've done. You mentioned there's been a lot of uncertainty from some of the traditional retailers, and that's true. And in 2022, we saw retailers destock their shelves. Instead of carrying 5, 10 of our cutting machines, they cut it down to a few. And then in 2023, the big surprise is we were hoping they would restock, and Eric, they actually destocked even more, and that hurt us more. Now we did additional promotions, and we saw some uplift from that during the holidays, specifically in Q4 of last year. So, our discussions, Eric, have turned now to be more positive, proactive and constructive with the retailers to get them to carry a more adequate amount of supply. So, to be honest, when we talk about the overall economy, it's been challenged with the inflationary environment. However, we've continued to innovate our platform and give more features, and we're looking forward to the average customer being able to come back and spend and buy our products.

So, sticking with that theme of the customer at the anchor of the platform, we've seen engaged users showing some declining trends in recent quarters. Can you discuss the actions and investments you've made to stabilize engagement? And when are you expecting a return to growth?

So, let me take that one. So, we have seen engagement decline over the last few quarters. And part of that is, if you look at the company growing pre-pandemic, right? We are growing at a 40-plus percent CAGR. But we are adding -- in 2019, we added about 1 million new users. As we went through the COVID years, that really turbocharged the growth even more. And so, we brought in roughly 4 million users in general terms over the course of 2020 and 2021. And then post-COVID, we're growing back at about that 1 million user rate a year, right? And we're using general numbers here. There's a natural attrition curve that you see. When someone first comes in, they're very engaged and then they kind of, as with any hobby, you kind of have some natural falloff. And so, there is an element of these extra-large cohorts of the COVID years going through their natural life cycle, and we're not adding enough new users to fully offset that. So that is a headwind that we face, and that's just one of the dynamics that we have to deal with. So, what are we doing about it? One, we are very focused on onboarding. And onboarding for us is when a new user buys a machine and they come into our ecosystem and how they engage with it. And our research shows us that the way someone engages with us in the very early days of their journey is very predictive of how they engage over time. And so, we are working to take friction out of that process and make it easier. And there's some internal metrics that we've talked about on our last call, where we are looking at how many people, what percent of users come in, register their machine and do their first test cut in the first day. And then we look at how many projects they're creating in that first week. And because, again, we think that's predictive of the quality of that user over time. And so, we're actively trying to improve that metric. And we talked about how in the last couple of quarters, we have seen that improvement in that leading indicator over time. Now it will take time for these new higher-quality users, if I can use that term, to become a larger portion of our user base. But we're very focused on that, and that's a current area of focus. The other thing that we're doing to address engagement is speaking to our current installed base and making it easier for them to come in and find content, and match that content with their interest, with their time ability, with their skill set, so that when they come in and they want to make something, it's easier to find something. Today, we have a database of over 1 million high-quality images that they can come in and combine into a project. But how do you feed that and make it efficient because someone may have 20 minutes to come and do something. They don't want to spend hours browsing and then figuring it out.

Understood. I want to pivot back and maybe, Jim, you talked a little bit earlier about end demand environment. Talk a little bit about in the product revenue segment, the health of the promotional activity that you're seeing. How is the promotional strategy continuing to evolve? And how does it sort of interact with both, not only connected machine unit sales, but also accessories and materials?

Sure. Starting in calendar Q4 of last year, so we haven't lapped it yet. We started to do some deeper promotions during some key selling seasons that are important for our core customer base. You think about holidays, Thanksgiving, Christmas. You think about Valentine's Day, Mother's Day. We did some deeper promotions. The good news, Eric, is they are working. We are seeing a positive uplift. This has then helped us have more constructive discussions with our retailers. For example, if one of our machines like the Maker 3 went on sale, and Kimball or his wife or family purchased it on Friday, and I went in on Saturday or Sunday, sometimes the retailers would be stocked out and they would lose that sale. So, we are working proactively with the retailers to stock to more adequate levels. But we're very pleased that the promotional -- deeper promotions are having a positive uplift, and it is helping us have more positive constructive discussions with the retailers. So, as we approach this holiday season, we're optimistic, but we haven't lapped a year yet.

One of the things you've been going down a road of in the last sort of 12 months is more partnerships, creators, e-commerce platforms. How do you think about an array of partnerships you've done or what the partnership road map might look like as an element of stimulating user-growth or monetization looking forward?

One of the important partnerships for us this year has been partnering with Pinterest on the weddings trend. And that's one example where people tend to use our platform to create around key moments in life. So, birthdays, anniversaries, weddings, back-to-school. And so, our marketing plans this year are very much focused on 6 or 7 different key events and helping provide inspiration around those to work with people. And so, like I said, we've worked with Pinterest. We're active on all the social media platforms. And we've talked about how we are leaning into our marketing spend. And so that involves really getting mathematical in how we allocate spend across the different platforms based on where we're seeing results.

Sticking with you, Kimball, I just want to talk a little bit about the international opportunity, array of markets internationally. Talk a little bit about where you're seeing pockets of strength or weakness, or the relative performance of markets in the international portfolio, what some of the key learnings might have been from your international scope?

Okay. No, I appreciate the question. We're really excited about the international business. We're excited that we got back to growth last quarter. Many of the pressures that Jim was talking about that we've seen in our North American business, we see that in some of the larger markets where we've been longer in our international business. So, U.K., France, Germany. U.K. in particular, we see the same kind of economic headwinds. But we're active in 50 countries around the world. And so, we see some of the goodness of those smaller markets overcoming some of the headwinds we've seen in some of the Western European countries and even Australia.

Jim, come back into the conversation here. You've seen very healthy levels of gross margin expansion when you look back over the last couple of reporting periods. How does that inform your investment strategy? And how should we be thinking about gross margin as an evolution of revenue mix over the medium- to long-term?

It's very important that investors and those who model the company think about it kind of under 2 segments. And let me dive into each of those. First, on the platform segment. That's where we sell subscriptions, and we also have digital content. Those gross margins are in the high 80%. And that's for a very big reason, it's a paid subscription model. You're not selling bill of materials such as chips, hardware, plastics, resins, metals, vinyls, and such. It's a software offering. So very high 80% margins. There's been a very small little bit of pressure on that recently as we've been amortizing additional investments that we've been doing organically and internally, such as additional engineers who are working on that. And the way the GAAP treatment is, is you capitalize that cost and spread it over 3 years. So, as we invest more in that, there's a small amount of pressure on it, but you should model the platform as high 80%. The second segment is products. That's where we have both the machines, as well as you asked about accessories and materials. This past quarter, we actually saw that we posted 23%, and that's very impressive. But there were some unique things that helped that quarter. Under GAAP, we had to previously reserve some items that were called excess and obsolescence, and we are able to successfully sell some of those products into the marketplace where the GAAP said the velocity or the turnover wasn't strong enough. So, we weren't making judgmental calls or managing earnings. It was more the GAAP said that they weren't selling enough. And prior quarters, we took some reserves and then the consumer actually purchased them, and those are higher gross margins. I mentioned that it was 23% this past quarter. Keep in mind that a year ago, it was 18%. So that's the big difference between products and platform, but you should really be modeling it into the 2 different segments. And then it depends upon your weight allocation when we sell more machines, which have higher bill of materials, higher metals, plastics, semiconductors, microchips, Bluetooth chips or vinyls, those have lower margins than simply the platform or higher subscriptions. So, I would model it under those 2 segments, and the weighting will determine your overall company gross margins.

Okay. Very clear in terms of the signals on gross margin. I want to turn to marketing. How do your views continue to evolve in terms of marketing investments, both in terms of the revenues -- the sort of relative returns you're ready to generate in terms of revenues from those marketing dollars? And how are you thinking about scaling marketing investments over the medium- to long-term?

So, as we moved through the last couple of years and we saw our top line declining, we were managing OpEx, and part of that was we pulled back on sales and marketing spend. We think we over-indexed on that pullback. And so, for the last few quarters now, we have been leaning more into marketing and have been very deliberate this year and talked about that we are doing more to generate awareness, right? We're the category leader, and we think we have an opportunity to reinvigorate both consumer excitement, but also retailer excitement for the category. And it's still fairly early on, but we're seeing positive signs from where we're leaning into marketing. And I mentioned that we're trying to be very data-driven on our mix of where we allocate that spend. And that changes month-to-month as we run our models and we see where we're getting traction, where we're not. But if we look at -- and the kinds of things that we're tracking are how successful are we driving traffic to cricut.com? Because regardless of what channel someone purchases their machine or their materials through, coming to cricut.com as part of the research journey is an important point. And so, we are seeing success with kind of the leading indicators that we are tracking on marketing that give us confidence that we will continue to lean into marketing and scale it as long as we see that return on investment coming. And from a modeling standpoint, you should expect sales and marketing to be more in the second half of the year than it is in the first half.

Jim, you've continued to talk about your long-term operating margin target, 15% to 19%. Can you frame a little bit of the key building blocks to get to that range or that target range of margin and how current year headwinds are impacting margins when you think about the trajectory towards the longer-term goals?

You bet. Our margins are actually stronger than investors and consensus expected for the first couple of quarters of this year. A lot of that had to do with the unwinding of some of those reserves. The way to think about it is in 2023, we posted full year margins of 9.1%. And we don't give a lot of guidance, but we did give some color and guidance in commentary, where for 2024, we expect that 9.1% to increase to 10.1%. Now, you notice that still is below our 15% to 19% goal. The way we get to our 15% to 19% goal is we can get there. And historically, you can see we have achieved that pretty consistently when our sales are at a run rate of annually $1 billion and also growing. So, we're below that rate right now, but we still do see margin expansion from 2023 of 9.1% to 10.1% in 2024. But we do expect to hit our goals of 15% to 19% when sales are above $1 billion and also seeing positive growth.

Jim, maybe last one for you. Can you bring it all together for us. Can you provide an overview of your capital allocation strategy, maybe breaking it into a couple of pieces. You've got long-term investments you want to make in the business. There's always the potential to speed some of those up with acquisitions and inorganic growth. And the third bucket would be returning capital to shareholders. So, Jim, maybe how are those are your priorities? How are you thinking about the general philosophy around capital allocation?

Your framework is spot on, Eric. First, we want to really allocate money for organic growth internally. That means funding R&D. That means funding inventory. That means international growth. Our first priority is to fund that growth organically. We have no debt. We have no immediate or near-term plans to even get any debt. We actually have the situation of generating very profitable operations. So, priority number one is to fund internal operations. Number 2 would be if there's any acquisitive, nothing transformative, but I do want to note so people can kind of balance this. Our wonderful CEO, Ashish Arora, joined the company in 2012. And since that time, we haven't made any acquisitions. So, we're not like a serial acquirer as some of the other companies that you may follow who are always bolting on lots and lots of companies every year. So far, we haven't made any acquisitions, and we don't have a very active pipeline. But the third thing is when there's excess cash, you will see us very disciplined return it to shareholders. And we do that in 2 manners. First is stock buyback and the second is dividend. In May, a couple of months ago, we actually made an announcement of a new $50 million, 50 stock buyback, and that was because we concluded the prior one, which took about 18 months. We also announced a very important change to our dividend. When we were here on stage last year, we had announced a dividend in calendar Q1, which was $0.35 and then another $1 in July of last year. Those were special unique dividends, and they are primarily funded from the work down of inventory that we had ordered and had built up during the COVID years, because as you know, lead times were very long, and we wanted to make sure we had enough product. So, our inventory went up, and we've been working it down. So, we've been returning that cash to shareholders. This year in May, we announced 2 dividends. A special dividend of $0.40 and then a recurring semiannual $0.10 dividend that is payable in July, and we expect to anticipate to pay that every 6 months, another $0.10 pending Board approval. But that recurring dividend, Eric, is being funded by our profitable operations, and we see no need to tap the debt markets. We are a very profitable company and very pleased with that. And when we generate excess cash, first, we want to, of course, fund internal operations, which we're blessed to have more than sufficient in organic growth and inventory, and then we'll look to return it to shareholders as needed. And those current investors who own the stock in July, they got a $0.50 dividend, $0.40 onetime and $0.10 recurring. And for those in the audience who hopefully will become new shareholders after this meeting, you should anticipate every 6 months an additional $0.10 per share dividend after that.

Kim will bring us home. We've got a few minutes left. We're trying to end on sort of forward-looking questions for folks. So, when you think about the big milestones or the goals you'd like to achieve as a company over the next year, what would those be? And the second part of the question would be, if we were sitting here and having this conversation a year from now, what do you think -- and maybe Jim will weigh in as well, what do you think investors are either missing or not thinking about thematically with respect to the company or the industry that it sort of competes in?

Okay. Thanks, Eric. So, one of our biggest priorities is focused on improving engagement, right? And engagement for us is defined as when someone comes in and makes a project. So, it's not just come visit the platform, come to our website. It's actually design and create, and cut and make a project. And we've seen our average project cuts per user decline since COVID. And I mean, when people are locked at home and they like to be creative, but it was an outlet that we really saw engagement spike during that time frame. But we also see that as an opportunity to inspire our users, to bring them back to get inspired on the platform and then -- and to make more projects. We haven't really talked about our accessory materials business, but that's one that has been under pressure. And that in part, because engagement has been less. And therefore, when people make a project, they use materials, right? They're making a T-shirt, or they're cutting vinyl, or they're cutting paper for cards, right? And so, the more projects' people make, the more they need to buy things. And so, we are focused on how do we get our user base more active and more engaged. And we continue to invest in that. Again, we see leading indicators that are trending positive, but we haven't seen the overall public metric improve yet. We are focused on acquisition. How do we bring more users into our ecosystem? How do we sell more machines and have them begin that journey. And so, those are very important areas of focus for us, and that expands to our sales and marketing. There's an element, as we talked about earlier, of kind of macroeconomic headwinds that we're trying to overcome. Hopefully, a year from now, we're talking about how these investments that we are 12 and 18 months into making, to turn our business around, seeing those bear fruit in a way that is manifested in our public-facing KPIs.

Jim, anything you want to weigh in on?

Well, I used to sit in your seat, and I can tell you, I'm very pleased that you kind of look at us from a platform ecosystem standpoint. A lot of other investors think of us as a hardware-only company or a retail company. So, while we may make very professional or allow our users to make very professional things like this coffee mug, which my 12-year-old child made for me, it's dishwasher safe and everything. I'm excited because when we think about creativity, it doesn't matter what language or country you live in. We have a very profitable company, and we just crossed a wonderful milestone of 1 million high-quality makeable images. You can just simply swap out Jim and put in Kimball's name. It's that easy to make. And I'm very excited about that, and I think we're in the very early infancy stages, and the value of our paid subscribers and platform is tremendous. And I think that's the biggest thing that investors miss. We're not a hardware company. We're not necessarily a retailer. We're kind of a tweener, but we view ourselves as very much of a platform company as you do correctly.

Okay. Well, Kimball, Jim, first of all, thanks for the opportunity to have the conversation this year. And for those in the audience, please join me in thanking Cricut for being part of the conference.