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Operator
Good day and thank you for standing by. Welcome to the Cricket Q2 2021 earnings conference call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone keypad. If you require further assistance, please press star 0. I would like to hand the call to Stacey Clements, Investor Relations, the Blue Shirt Group. Please go ahead.
Stacey Clements
Thank you, operator, and good afternoon, everyone. Thank you for joining us on Cricut's second quarter 2021 earnings call. Please note that today's call is being webcast 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, prepared remarks, and accompanying slides used on today's call will also be posted to the investor relations section of the website, investor.cricut.com. Joining me on the call today are Ashish Arora, Chief Executive Officer, and Marty Peterson, Chief Financial Officer. Before we begin, I 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 factor section of Cricut's most recently filed Form 10-Q. Actual events or results may differ materially. All non-GAAP numbers referenced in today's call are reconciled in the press release or on the slide presentation on our investor relations website. This call also contains time-sensitive information that is accurate only as of the date of this broadcast, August 12, 2021. Cricut assumes no obligation to update any forward-looking projection that may be made in today's press release or call. I will now turn the call over to Ashish to begin.
Ashish Arora
Thank you, Stacey, and welcome, everyone. We had a solid second quarter with revenues increasing across all three categories, connected machines, subscriptions, and accessories and materials. Total revenue for the second quarter was $334.5 million, an increase of 42% over an exceptionally strong Q2 last year. Strong revenues, coupled with a profitable business model, led to a $68.5 million in EBITDA, a 39% increase over the second quarter last year. We also continued to see growth in our user base and healthy engagement and monetization. We added over 430,000 users in the quarter last bringing our total user count to nearly 5.4 million. We saw continued healthy engagement levels at 59% in the second quarter, down modestly from the stay-at-home engagement levels of the prior four quarters. As a result of healthy user growth and engagement, 3.2 million users were engaged on our platform in Q2. This is 1.1 million more users engaged in Q2 compared to Q2 of the previous year. The large influx of users from 2020 and the first half of 2021 provide a powerful flywheel effect to our business with ongoing modernization opportunities as well as fuel momentum through word of mouth referrals. I continue to be amazed by all the projects and creativity from our users. As expected, we are seeing many projects centered around events such as weddings, parties, family reunions, and vacations, just to name a few. As users create, they inspire other users to create. And the more they create, the more Cricket benefits from network effects that ultimately drive new user acquisition and inspire additional engagement. One of the many ways we are able to monetize engagement is through our subscription service, Cricket Access. We ended the quarter with nearly 1.8 million subscribers to Cricket Access, up from 1.6 million at the end of Q1. We continue to focus heavily on increasing the value proposition of our subscription. We now have over 175,000 images in Cricut Access, an increase of over 40% from Q2 2020. In the coming quarters, we will continue to aggressively add content as well as additional software features that will be available exclusively to Cricut Access members. Another important pillar of our growth strategy is international expansion. Revenue from international markets grew 179% year-on-year in the second quarter and continues to grow into a greater proportion of total revenue. Our top markets include Australia, France, Germany, and the UK. The international markets are especially promising given our observations that the motivations and behaviors that are driving growth internationally are very similar to those that have grown domestically since 2014. We recently introduced our new direct-to-consumer e-commerce site in the UK, giving our users a complete Cricut branded shopping experience. We anticipate that more direct-to-consumer sites will be launched in additional geographies in the coming quarters as we see significant synergies with our omnichannel strategy. We also welcomed our first sales team members in Italy and Mexico in Q2 and continue to expand our retailer footprint in markets such as Germany, France, Spain, South Africa, and Southeast Asia. As we think about future investments in international markets, you will see us continue to increase our sales and marketing efforts, including adding key influencer relationships across the globe to help raise awareness and drive conversion. We will also continue to diversify our content offerings, invest heavily in language and currency localization, as well as foster and support international markets with cricket team members in those geographies. We plan to grow international markets using the proven cricket playbook, invest in delivering great experiences to users that they will then show and tell to others. We had some very exciting new product launches during the second quarter. From the onset, we have focused on building an innovative and expandable platform for our community of users to drive long-term growth. In June, we launched the new Cricut Explore 3 and Cricut Maker 3 machines, significant undertakings which included new physical hardware as well as new software features, content, and a line of innovative materials. I'm very pleased with the new products and the improved user experience that they provide. Designed to cut up to twice as fast, users can also cut longer runs of materials. Now, this is especially useful when creating things like wall decor, large size of banners, or multiple copies of the same project. In connection with these machine launches, we also launch a line of smart materials designed to increase creative use cases and improve ease of use. Smart materials are especially engineered to keep materials perfectly aligned and on track from start to finish without the need for a cutting mat and for cuts up to 12 feet in length. These smart materials create a frictionless experience for our users, whether they're cutting a small single image or very long or repeated cuts. We will continue to innovate in this area where quality and seamless integration helps build a moat across our accessories and materials business. Now coming on to software. Our cloud-based software enables us to update features and functionality of existing physical and digital products. This kind of platform extensibility is a clear differentiator in the market, while also enabling us to rapidly innovate and add features to improve the user experience. For example, during Q2, we added the long-requested kerning feature in Design Space, a feature that enhances font usage and encourages engagement by saving time and effort. Additionally, users can now like projects inside Design Space and more easily organize their personal library with our newly redesigned bookmark feature. We also continued our ongoing search optimization, among many other things. We take great pride in listening to feedback from our community, constantly enhancing the platform and the overall user experience. And you will see us continue to invest heavily in these areas. As noted earlier, I love the passion of our users. Many of our users share a love of our brand, products, and mission. In other words, they are the heart and soul of Cricut. Approximately 43% of new customers first hear about Cricket through word of mouth, providing a powerful, viral, and cost-effective marketing engine for new user acquisition. We now have over 5.2 million social media followers and 2.4 billion views on hashtag Cricket on TikTok, which are almost entirely organic. We will continue to foster these communities, amplify their voices, and share their amazing work. Overall, I'm really pleased with the quarter and our progress to date. The products we've launched and the lives we impact create a tremendous opportunity for us to continue scaling our user base. We estimate our serviceable addressable market in the U.S. and Canada is roughly 85 million individuals. Including our SAM internationally, we believe our opportunity is roughly 130 million individuals when adding just Australia, France, Germany, and the UK markets. With a user base of nearly 5.4 million, we have penetrated just over 4% of our SAM. As we continue to expand our offerings, drive continued user engagement, and fuel our viral marketing engine, we believe there is an even greater opportunity for creatives everywhere to join the cricket platform. I will now turn the call over to Marty for more details on the financials.
Stacey
Thank you, Ashish, and good afternoon. Our second quarter's performance was fueled by strong fundamentals in the business and our powerful community of engaged users. Additionally, Q2 benefited from the new product launches that Ashish mentioned earlier. For those of you who are newer to our story, let me quickly touch on the financial drivers of our model. Dating back to 2014, Cricket has a proven track record of strong revenue growth and profitability. Our sales are diversified across categories and give us revenue streams that are largely predictable. The user journey generally starts with the purchase of a connected machine. The gross profit from that purchase mostly covers our customer acquisition cost. The purchase then triggers a flywheel of engagement, which in turn drives ongoing revenue from subscriptions, and accessories and materials. With that as a backdrop, I'll now walk through the financial highlights. We continued to see organic adoption. Word-of-mouth marketing drove strong connected machine sales and increased user acquisition. Our new and existing users continued to be highly engaged, which drove ongoing monetization through subscriptions and accessories and materials. Revenue in the quarter was $334.5 million. an increase of 42% over Q2 last year, representing strong growth relative to a tough comp of 149% year-over-year growth in Q2 of 2020 at the onset of the pandemic. Strength in the quarter came across our business, including our ability to replenish lower-than-normal retail inventory levels and the success from our new product launches. Breaking down revenue in the quarter even further, revenue from connected machines grew 29% over Q2 last year, even while comping extremely strong sales in Q2 2020 at the beginning of the pandemic. Connected machine revenue was driven in part by the launch of our new Maker 3 and Explorer 3 machines during the quarter. Strong machine sales and new user acquisition, as well as healthy engagement, of our growing base of existing users for the past five quarters helped drive 111% revenue growth in subscriptions in the quarter and 40% growth in accessories and materials. In terms of geographic breakdown, international revenue continued to outpace growth in North America, increasing 179% in the second quarter over the same quarter in 2020. As a percentage of total revenue, International represented 8.5% in the second quarter, up from 4.3% in Q2 2020 and 7.4% in all of 2020. We anticipate the investments we made in 2020 and ongoing future investments will continue to expand consumer reach and brand awareness internationally. The Cricut community of users drives healthy engagement on our platform and is an important variable in building our long-term business with sustainable growth and compelling margins. In the second quarter, the number of users engaged in our platform for the prior 90 days increased by 1.1 million versus the same quarter last year, further demonstrating consistent, healthy engagement on our platform. As a percentage of total users, this translates to 59% engagement, which is a slight sequential decline on a percentage basis given that Q2 is typically a seasonally softer quarter. As we move deeper into the summer months, we have also seen pandemic reopenings amplifying some of our normal summer seasonality. As a result, we could see slight pressure on engagement in Q3. We continue to rapidly grow our user base in Q2, ending the quarter with nearly 5.4 million total users, or 64% year-over-year growth despite a tough comp from the spike in user growth at the beginning of the pandemic. Ending paid subscribers grew nearly 1.8 million, up 77% over second quarter 2020. 33% of all users were subscribed at the end of Q2, which is equal to Q1, and up from 30% in Q2 2020. We continue to invest heavily in our subscription business, including strengthening and expanding the value proposition and leveraging user data in our targeted marketing efforts. User monetization from subscriptions and accessories and materials remained healthy in Q2. We measure that monetization through ARPU in those segments. We calculate average revenue per user for subscriptions by dividing total subscription revenue by our entire average user base within that period. ARPU for subscriptions in the second quarter was $9.83, up from $7.91 in Q2 2020. We calculate ARPU from accessories and materials by dividing that portion of revenue by our average user base for the period. ARPU from accessories and materials in Q2 was $26.67 compared to $32.23 at the beginning of the pandemic in Q2 2020, when we saw a surge in accessories and materials sales. We anticipate the new smart materials launched in the quarter will support accessories and materials monetization over time. Moving into gross margin, total gross margin in the second quarter was 39%, up from 31% in the second quarter of 2020. as we primarily benefited from lower tariffs associated with moving the bulk of our connected machine production from China to Malaysia and a slightly more favorable product mix in the quarter. Additionally, starting in Q2, we effected a prospective accounting change where we reclassified approximately $4.8 million of cost of revenue to sales and marketing. In Q2, the impact to gross margin from this change was an increase of approximately one percentage point to gross margin with a corresponding increase in operating expense. Looking to the second half of the year, and as we noted last quarter, we may choose to be more promotional in order to optimize user acquisition and product mix as demand and supply normalize, particularly on connected machines. Before I move farther down the P&L, I want to talk for a moment about inventory and supply chain. We and our retail channels are now in a healthy inventory position due to our manufacturing strategies put in place over the last few years, and we feel good about where we stand today. We continue to aggressively manage what is within our control. We do, however, see some risks to the supply chain, similar to what many others companies are experiencing. For example, we are subject to chip shortages and have been securing chip inventory well into the future to help mitigate these risks. We have also seen upward pressure on the cost of commodities such as resin and sheet metal and shipping related costs. There could also be possible shipping delays due to local port challenges and shortages of containers and ships. As a precautionary measure, we have a long-standing strategy of holding generous levels of onshore inventory in our accessories and materials SKUs. In order to further mitigate supply chain risk, we are in the process of building inventories above our customary levels on accessories and consumables or materials, and particularly on connected machines. And we intend to carry higher inventory levels into the future until we are comfortable the supply chain risks have improved. These dynamics, along with any increased level of promotions in the second half, could put some pressure on margins. Moving on to operating expenses, we continue to take a strategic approach to spending in order to gain efficient business growth long into our future. Total operating expenses in the second quarter were 66.1 million, an increase over Q2 2020 of $38.6 million. Of the increase, $8.1 million was related to stock-based compensation expense in the quarter, and $4.8 million, which I previously mentioned, from the reclass of cost of revenue to sales and marketing expense, and relates to the accounting treatment for payment processing fees and certain point-of-purchase displays. Our total operating expenses as a percentage of revenue was 19.8%, higher than the prior year as we have leaned into investments in sales and marketing and R&D to help build out the platform and drive future growth. We have always focused on building a long-term durable business model that delivers solid profitability while allowing us to grow the top line and invest for our future. Q2 represents the 10th consecutive quarter of positive net income. Net income in the second quarter was 49.1 million, up 41% from the same period last year, and diluted earnings per share was 22 cents. Note that Cricut did not have a comparable EPS history prior to the reorganization at the time of the IPO. Turning to EBITDA, which includes 8.1 million of stock-based compensation expense, we delivered EBITDA of 68.5 million or 20.5% EBITDA margin in the second quarter, compared to $49.2 million, or 20.9% margin in the second quarter 2020. As a reminder, we have been EBITDA positive since 2014. Turning now to the balance sheet and cash flow, we ended the quarter with $314 million in cash and cash equivalents. Our credit line of $150 million remains untapped. Cash used in operations for the second quarter was $54 million, reflecting payments for replenishing our inventory position and building additional inventory reserves to help mitigate supply chain risk mentioned earlier. Although we are not providing quantitative guidance at this time, I'd like to provide some color. Q2 outperformed our internal expectations. benefiting from two primary factors that I mentioned earlier, the replenishment of retail channel inventories to more healthy levels and the initial channel fill as we launch two new machines and a new portfolio of smart materials. As a result, products sell in during Q2 materially exceeded sell-through. These tailwinds will not continue in the second half. At the same time, we also began moving into our typically softer summer seasonality. As we emerge from the pandemic, the seasonality has been amplified as people spend less time at home, and we believe this dynamic could extend into Q4. Looking at the year in total, we still expect to add at least 1.8 million new users in full year 2021, equivalent to the number of new users added in full year 2020. We've made tremendous progress with a little over 1 million new users already added in the first half of the year. Nonetheless, in light of the uncertainties, we are not ready to update this target further at this time. This foundation of new users fuels future growth and profitability. Our platform provides for increased user monetization through higher margin subscriptions and accessories and materials revenue. This larger user base will also drive our viral marketing engine, resulting in new user acquisition and engagement. We will continue to run our business for the long term. Our singular priority will always be to deliver superior experience to our users throughout their crafting journey. Due to both uncertainty and logistical difficulties caused by the pandemic in 2020, our spending levels were restrained despite our growth. Therefore, we entered 2021 trying to catch up to our user growth in more operational areas and expect our increased spending levels to reflect these efforts. With the large base of users coming onto the platform, we plan to increase operating investments for the full year and into next year to drive continued growth in new users and healthy engagement as we lean into channel expansion opportunities, product development, and international growth. Nonetheless, we still expect to operate within our long-term EBITDA target range for the full year as disclosed previously. In conclusion, we have aggressively and consistently grown the business for many years. With only 4% of our SAM penetrated, we have a large runway for growth and extensible platform for continued innovation and a compelling financial model that drives growth and profitability. With that, we'll turn it back to the operator for questions.
Operator
Thank you, presenters. At this time, for the participants to ask a question, please press star 1 on your telephone keypad. We will pause for just a moment to compile the Q&A roster. We have our first question from Rod Hall from Goldman Sachs. Your line is open.
Rod
Yeah, hi, guys. Thanks for the question. I guess... what I wanted to dig into a little bit was the engagement number. And I mean it, you know, you juxtapose a little bit lower engagement maybe than we anticipated, maybe than you did too. I'm not sure against really good numbers here. What I'm curious about is whether you think you've learned anything incremental about user behavior that, you know, informs you on how this might play out in the second half of the year. I know, You know, some of the commentary sounded pretty cautious there, but I'm just curious what you guys feel like you've learned or have you really learned anything? Are we still kind of waiting to see how consumers behave as we move into the fall? And then I have a follow-up.
Ashish Arora
Okay. Well, Rod, let me take that question. This is Ashish. So just to provide context, let me kind of remind people how we calculate engagement. So engagement is calculated by the number of people that cut in the last 90 days divided by the entire user base. So we never churn users out, right? So in Q2, we had, like Marty said, 3.2 million users that were engaged in the last 90 days. That is about 1.1 million more users that were engaged this year than they were last year, right? So the user growth in terms of engagement was pretty significant. However, as you rightly pointed out, the engagement percentage number, 59, was down from Q1. And the reason was, again, the most important learning was that, I mean, clearly with the extended and amplified seasonality, we saw people taking vacations and getting out of their homes. Now that did influence the types of projects they were making. So we saw people making projects for weddings and parties and getting out for trips. But at the same time, the overall engagement probably was because of lesser home improvement and stay-at-home projects, the net impact of that was declined. So I think the biggest learning was clearly user behavior is changing. We have tried to offset that with a number of, ramping up a lot of our engagement activities by segmenting our users, giving them more inspiration, trying to get them, we've launched education programs, so we will see You know, while we will see a continued trend in that decline, at least, you know, past the summer months, we think we'll be able to offset some of that because of the additional insights and learnings we have. And just to give one more comment, you know, we had a tremendous program lined up for back to school. And just in the last week, you know, week and a half, we've seen a significant uptick in engagement because of that back to school activities. So I think, you know, it's a lot going on in the world out there, and, you know, we are keeping pretty vigilant in terms of understanding user behaviors, trends, and trying to offset some of that, you know, as we go into Q3.
Rod
Okay, that's great. Thanks, Ashish. Great color there. And then, Marty, you talked about margin, some expected margin pressure, you know, in the second half due to supplies and freight and so on. Could you maybe – do anything there to quantify for us, like what scale of pressure we're talking about, just so that we can all kind of level set what we should be anticipating for margins in the second part of the year?
Stacey
Yeah, I think that mainly what I was referring to at that time was leaning into more spending on operations investments that we had foregone. or should I say didn't keep up with in the early part of 2020. And so we came into 2021 working to catch up with those investments. And so I think that if you look at the year as a whole, we continue to expect that our EBITDA margin will remain in our long-term target model range, of 17% to 20%, but the quarters can obviously fluctuate.
Rod
Okay, and so what we should be thinking is kind of gross margins holding maybe roughly steady in the second half, but then OpEx, as you say, some of those OpEx investments coming back in, and that's the way the model roughly moves in the second half of the year.
Stacey
Yeah, I think that's a fair comment. It will be more on the OpEx side.
Rod
Okay. All right. Thanks a lot. Appreciate it.
Operator
We have our next question from Kay Huberty from Morgan Stanley. Your line is open.
Katie
Yes, thank you. Good afternoon. Marty, you mentioned the strategic decision to hold more inventory. Can you just clarify, is that – on Cricket's balance sheet or is it also in the channel or a combination of both of those? And then can you help us size the contribution to 2Q revenue from rebuilding retail channel inventory and selling in the new products just so that we can understand what was more one-time versus reflecting real sell-through?
Stacey
Yeah, so as far as inventory goes, My comment was primarily focused on our balance sheet. We don't really have control over, obviously, the channel inventories. But, you know, as I mentioned earlier, we have had a strategy of keeping a little higher balances of our accessories and materials, but we're extending that to machines, especially right now. just because of the supply chain challenges that exist today. That being said, we do feel good about the progress that we made in building channel inventories or refilling, let me say, channel inventories from where they were earlier. You'll recall that over the past year we've been light on inventory in terms of being able to meet demand for the channel and we have caught up on that and we did that in Q2 and so we feel pretty good about our position on inventories today but we continue to build that and will continue to build it into the future. As far as Q2 and the impact of the channel fill from the product launches and the inventory replan, it's obviously a little challenging to determine exactly what those numbers are because with the channel inventory fill, You've got phase-in and phase-outs that are implemented by some of the retailers, and it's a little bit challenging to define it exactly. But our estimate is about 8% to 10% attributable to the channel fill for the launch and about 5% to 8% for inventory replan.
Katie
And are those numbers on total revenue or just for device revenue?
Stacey
On total revenue.
Katie
Total revenue. Okay. And the refill was both for accessories and materials and devices or mostly just on the machine side?
Stacey
Yeah, more on machines. We were in a better inventory position earlier on accessories and materials. And so in Q2, it was really mostly machines.
Ashish Arora
And, Katie, I just want to add to Marty's color, which is, you know, and part of the reason it's really hard to estimate is that especially going into the quarter, we still had, you know, retailers that were out of product. So we, you know, we had to kind of net out the sales loss because we didn't have enough inventory in the channel. So really hard to, both from a phase-in, phase-out perspective, because there's a slowdown in the existing products while new people are waiting after the announcement for the new products. So, again, we just have to take that with a grain of salt.
Katie
Okay. That's really helpful. And then just a follow-up on the discussion around engagement. You mentioned that quarter to date you're seeing a bit of a downtick. Should we expect that that looks similar to the downtick from last from March to June, which was about three points. And then any view yet on whether you would expect to see the normal sequential uptick in the December quarter, the holiday season?
Ashish Arora
Yeah. So I think there are two numbers, right? One is that the, you know, what other companies would define as active user growth. I mean, we talked about engagement numbers. So the absolute numbers will increase quarter over quarter year on year, right? Because we have a much larger install base this year. and that's what we saw in Q2. Now, in Q3, as summer came and even as we've gone in the last few weeks and months, we've clearly seen that engagement, some headwinds for engagement. What's interesting is that we haven't seen similar headwinds, at least to date, on subscription, which we can kind of look at those two data points in tandem. One of the comments that I was making specifically about our
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