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Operator
Good day, and thank you for standing by. Welcome to the Cricut Q1 earnings conference call. At this time, all participants are in a 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 1-1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1-1 again. please be advised that today's conference is being recorded. I would now like to turn it over to our speaker today, Jim Suva, Senior Vice President of Finance. Please go ahead, Jim.
Jim Suva
Thank you, Operator, and good afternoon, everyone. Thank you for joining us on Cricut's first quarter 2023 earnings call. Please note that today's call is being webcast and recorded on the investor relations section of the company's website. A replay of the webcast will also be available following today's call. For your reference, accompanying slides used on today's call, along with a supplemental data sheet, have been posted to the Investor Relations section of the company's website, investor.cricket.com. Joining me on the call today are Ashish Arora, Chief Executive Officer, and Kimball Schill, Chief Financial Officer. Today's prepared remarks have been recorded, after which Ashish and Kimball will host live Q&A. Before we begin, we would like to remind everyone that our prepared remarks contain forward-looking statements, and management may make additional forward-looking statements, including statements regarding our strategies, business, expenses, and results of operations in response to your questions. These statements do not guarantee future performance, and therefore, undue reliance should not be placed upon them. These statements are based on current expectations as 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-K. Actual events or results could differ materially. This call also contains time-sensitive information that is accurate only as of the date of this broadcast, May 9th, 2023. Cricut assumes no obligation to update any forward-looking projection that may be made in today's release or call. I will now turn the call over to Ashish.
Ashish Arora
Thank you, Jim, and welcome, everyone. As we mentioned last quarter, we expected Q1 revenue to be materially below prior year. Even with that, revenue in the first quarter was softer than we expected for connected machines, down 45% year-on-year, and accessories and materials down 39% year-on-year, as retailers continue to take a conservative approach to inventory commitments and softer consumer spend. These trends continue quarter to date. Subscriptions revenue, on the other hand, grew 16% year-over-year and 6% sequentially. Despite these mixed results, the strength of our financial profile allows us to deliver positive profits and strong cash flow. We will continue to operate in a fiscally disciplined way, making focused investments that will deliver increased user engagement and growth over the medium term. The Cricket platform now has over 8.2 million total users, up 19% over Q1 last year. 3.7 million users, or 45% of total users, have cut a project at least once within the first quarter. This creates a tremendous opportunity for us to build deeper user engagement on our platform. Our goal is to bring a majority of our users into design space monthly to be inspired. We believe increasing visits to design space and improving our ability to serve relevant, makeable content that matches the interests of each user will lead to higher engagement and an increase in paid subscribers. We also want to broaden user engagement activities such as liking, bookmarking, and sharing projects. As users increasingly drive growth in shared community projects and our platform more effectively matches content tailored to each user, These mutually reinforcing effects will create value in our platform for all users. As we outlined last quarter, we have intensified our focus around new user acquisition and platform expansion in order to drive engagement, subscriptions, and increase monetization. We also laid out a two-year path to re-accelerate growth in accessories and materials. These investments are also leveraged across international markets where the opportunity for growth has never been stronger. In fact, as of the end of Q1, we have crossed a milestone with over 1.1 million international users outside of North America. We continue to simplify and streamline the consumer purchase journey. Last quarter, we rolled out several new creative assets and tools that bring relevant information to consumers more quickly across all channels. We will continue to iterate on these experiences and add to the growing content on our website and social media channels. We previously launched a new homepage along with comparison tables to help users compare various machines. By way of example, we have since seen an increase of time on our pages for our machine comparison tool of over 50%. Last month, we also added a new simple machine quiz to help consumers decide which machine is right for them. Given the success and positive feedback from these assets, we plan to leverage them broadly across all consumer touchpoints, including several retail and e-commerce destinations. We have already begun to roll out improved in-store retail merchandising to enhance the consumer shopping experience. For example, we work with Target on a redesign planogram that has been deployed across 80% of store locations. This new redesign will improve in-store branding and better communicate the value of the cricket ecosystem. We're also better optimizing our marketing efforts and audience targeting. As part of this, we are rebalancing some of our investments over the year from bottom of funnel to top of funnel activities, such as digital and influencer marketing across proven channels, as well as increased PR coverage. For example, we're very excited about the PR coverage we are receiving going into Mother's Day, as cricket being the perfect gift for moms in our lives. We believe this strategy will bear more long-term fruit and have greater lasting branding effects than what our promotional plans during the course of the year. We're also focused on creating greater upfront value for consumers. One way to do this is through more machine bundles, which can include digital content materials, and accessories. These bundles enhance the out-of-box experience and ensure users have all the things they need to make initial projects and get them quickly on the path towards user engagement. As I mentioned last quarter, we are putting a great deal of focus on user engagement, which starts the moment we acquire a user. Our data shows that the first few weeks of a new user's experience are often indicative of their engagement over time. Our current focus includes improving our onboarding process and driving users to design space early in their user journey. We are seeing early signs of success and are expanding our onboarding initiatives, like expanding lesson plans over the coming quarters to cover a broader set of machines. Content drives inspiration, which drives engagement. We think of content both in terms of images and makeable projects. which include images plus design layout work, photos of the finished project, and can include instructions and lists of materials. We are creating more effective ways for users to find relevant content while further reducing friction between designing and cutting projects. For example, we recently introduced visual-based search, which lets users find similar images. We're constantly increasing our image library. A contributing artist program also known as CAP launched just one year ago. The CAP program represents an increasingly significant portion of new images on Design Space. Sourced from diverse artists around the world, CAP also helps meet the need for localized content in many markets around the world. Community projects will increasingly be a fresh source of inspiration and makeable content for our subscribers. These projects are created and designed by our community of users, and in addition to the design layouts and photos of the finished project, may also include instructions and a list of materials to use, making it easier for others to create. These projects can be shared inside the platform and on other social media using links, thus inspiring other users to make and creating network effects. This user-generated content drives incremental value to design space and is becoming an increasingly important way to add content to the platform. As we grow our library of makeable content on our platform, we are also improving the ways we deliver personalized and curated experiences to our members to find the most inspiring and relevant content to them. We are beginning a number of projects across our marketing technology, commerce, and design platforms to significantly improve this experience. We see this as an important pillar in our journey to drive greater engagement. We ended the quarter with 2.7 million paid subscribers, a 17% increase year over year. We benefit from strong attach rates and are increasingly leveraging design space touchpoints to better communicate the benefit of our subscription services. We continue to execute against our roadmap of Cricut Access exclusive software features. Warp is our latest addition. Warp enables creative effects on any text object. This is an impactful tool, given that over 50% of projects made on our platform contain text. In many new cases, new features we launch coincide with increased subscriber growth, highlighting our visibility to develop valuable, highly sought after features. Our priority is to ensure subscribers continuously discover and use the content, features, and functionality available to them. We have an opportunity to increase user awareness of our many features through touch points and advertising on and off our platform, which will help us attract and retain subscribers. We're still in the very early days of our roadmap. Subscribers are our most valuable customers. The primary reason subscribers stop subscribing is that they don't use Design Space often enough to justify the cost. So one of our highest engagement priorities is to drive subscribers to engage more frequently. Closely related is gaining more subscribers. We capture more subscribers early in their quicker journey, making our onboarding improvement another source of future value. Turning to accessories and materials. As I mentioned, we are in the early days of rebuilding this business. We continue to hold market share when we compete on price, but overall, users are cutting fewer projects and therefore needing less material, which we believe is influenced, at least in part, by softer consumer discretionary spend. Longer term, we believe that accessories and materials will re-accelerate as we focus on cost reductions over time, sound promotional strategies for increased market share, more machine and materials bundles across more diverse channels, and increased user engagement. We acknowledge the pressure that muted discretionary consumer spend continues to put on connected machines and accessories and materials. Subscriptions continues to be resilient, and we are excited about our international opportunities. We are more focused than we've ever been and are taking the right steps to grow our business for the long term. Our focus on new user acquisition, which starts with the purchase of a connected machine, and platform expansion to drive engagement, subscriptions, and increase modernization, will help us navigate the current uncertainty and position as well for when consumer spend returns. I will now turn the call over to Kimball for the financials.
Jim
Thank you, Ashish, and welcome, everyone. In the first quarter, we delivered revenue of $181.2 million, a 26% decline compared to prior year. We generated $9.1 million in net income as we continued to invest in our key priorities. Breaking revenue down further, revenue from connected machines was $34.1 million, down 45% over Q1 2022. As we said in our last call, we ended 2022 with healthier channel inventory levels, and anticipated that retailers would replenish inventory within the quarter. Retailers, however, continued to be cautious in rebuilding inventory due to softer consumer discretionary spend. They continued to purchase, but below our expectations. Revenue from accessories and materials for the quarter was $72 million, down 39% over Q1 2022, and was impacted by retailers' conservative stance on rebuilding inventory levels. Also impacting revenue in this segment is lower engagement discussed above. Subscriptions revenue for the quarter was $75.1 million, a 16% increase over Q1 2022, reflecting targeted investments in cricket access and the expansive improvements made over the last several quarters, as well as an uplift from Q4 seasonal strength in machine sales. In terms of geographic breakdown, international revenue was $33.5 million compared to $36.5 million in Q1 2022. As a percentage of total revenue, international was 18% compared to 15% of total revenue in Q1 2022. Turning to users and engagement. I'm pleased to share we ended the quarter with over 8.2 million total users, or 90% growth over Q1 2022. As we increase engagement through the initiatives Ashish outlined, we have a significant opportunity to bring new users through the Cricut experience. This includes onboarding them more effectively and getting them to engage more quickly on Design Space. We ended the quarter with over 3.7 million engaged users. This was flat over Q1 last year. We ended the quarter with over 2.7 million paid subscribers, up 17% from Q1 2022. Our subscription attach rate matched Q1 2022 at 33%. Moving to gross margin. Total gross margin in the first quarter was 42.3%, an improvement compared to 40.5% in Q1 2022. breaking gross margin down further. Gross margin from connected machines was 3.1%. This compares to 2.7% in Q1 of last year. Looking at 2023, amortizing fixed costs on warehousing and capitalized operations expense across lower volumes will continue to put pressure on margins. Offsetting this partially, end-of-life machines, which carry lower gross margins, are becoming a smaller part of our machine mix, as expected, which is helping machine margins. Subscription's gross margin for the quarter was 89.8%, down slightly compared to 2022 of 90.3%. Gross margin from accessories and materials was impacted by an excess inventory write-down, fixed operating costs amortized over lower volumes for the quarter, and a consistent cadence in promotions. First quarter gross margin for accessories and materials was 11.3%, and included a write-down of $8.6 million of excess inventory primarily related to bulk configurations of smart iron-on and vinyl materials. Excluding this write-down, A&M margin would have been 23.2% in the quarter. This compares with 33% in Q1 2022. Turning to operating expenses, we continue to operate the business with discipline and flexibility to navigate current trends. Given the pressure we saw coming into Q1, we implemented cost reductions, including an 8% reduction in force, resulting in a $1.2 million charge in Q1. As a result, we expect to produce gross savings of $6.7 million for the full year. Total operating expenses for the quarter were $66.1 million and included $9.8 million in stock-based compensation expense. This was down 2% from $67.6 million in Q1 2022. Operating income for the quarter was $10.5 million, or 5.8% of revenue. compared to $31.4 million, or 12.8% of revenue, in Q1 last year. The decrease is related to lower revenue and an $8.6 million inventory write-down. Excluding the inventory write-down, operating margin would have been 10.5%. We delivered our 17th consecutive quarter of positive net income. Net income was $9.1 million, or 4 cents per diluted share, and 7 cents per diluted share, excluding the inventory write-down and related tax effect. compared to $23.5 million, or $0.11 for diluted share in Q1 2022. Turning now to the balance sheet and cash flow. We continue to generate healthy cash flow on an annual basis, which funds inventory needs and investments for long-term growth. For the quarter, we generated $95.2 million in cash from operations, ending with a balance of $307.3 million, and we remain debt-free. During the quarter, we used $3.2 million of cash to repurchase 347,000 shares of our stock. We have $28.3 million remaining in the repurchase program. In addition, in Q1, we used $75.5 million to pay a special shareholder dividend. Consistent with our commentary last quarter, we continue to see softer consumer spend and retailers taking a conservative approach to inventory commitments and are thus taking a prudent and prioritized approach in our planning as we look ahead to 2023. We expect operating margins to be slightly down for the full year given Q1 performance. From a revenue standpoint, we entered 2023 with healthier channel inventory levels and revenue should be more directly linked to consumer demand. But as already noted, retailers continue to be conservative on inventory commitments in the current environment. However, we expect typical second half seasonality and year-over-year comps should improve in the second half. In terms of new user growth, we still expect to add fewer new users in 2023 than we did last year. And we started 2023 with softened and expected connected machine sales in Q1, which puts further pressure on new user growth. While we have a positive outlook on subscriptions, lower new users will put pressure on subscriber growth rate and attach rates throughout the year. And paid subscribers may be flat for the year or even down if current trends worsen. Gross margin will continue to be pressured. On physical products, higher fixed costs as a percentage of revenue in warehousing and operations expense will continue to be a factor throughout 2023. Accessories and materials will also continue at a similar promotional cadence to remain price competitive. As a result, we expect full-year accessories and materials margins will be similar to Q4 2022's gross margin of 15.9%, inclusive of the write-down this quarter. We remain focused on managing our profitability while investing in areas with the highest impact. Should macro conditions worsen, we will continue to make adjustments as needed, just as we demonstrated in 2022. We expect to continue generating healthy cash flow from operations and remain committed to our long-term operating margin targets of 15% to 19%. Our proven model has demonstrated that when we operate at scale and drive top-line growth, these margins are achievable. With that, I'll turn the call over to the operator for questions.
Operator
Thank you. At this time, we will conduct a question and answer session. As a reminder, to ask a question, you'll need to press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again.
Mark
Please stand by while we compile the Q&A roster.
Operator
All right, our first question comes from the line of Mark Auschwager from Baird. Go ahead, Mark.
Mark Auschwager
Good afternoon. Thank you for taking my question. Maybe just first off, a quick clarification. When you say that the trend in connected machines and materials sales continue quarter to date, are you referencing a continuation in the year-over-year growth rate that you saw in Q1? I guess the comparison gets quite a bit easier, Q2 versus Q1, so I just want to be clear about what you're referencing there.
Jim
So, Mark, thanks for the question. As we called out, we were below our expectations for Q1, and we had called out that Q1 would be down year over year, but we saw demand even softer than we expected. Those are the trends that we're referring to as we move through Q2 so far. So we're seeing, just for the point on it, demand is softer than we expect still.
Ashish Arora
Mark, I'll just jump in. This is Ashish. I think there are two things to consider. One is that we clearly had a sell-through on a new user acquisition which is lower than what we expected. It's a lot more exaggerated for the sell-in, right? Because the point that Kimball made in his prepared remarks that the retailers took a conservative approach and were consolidating inventory which had an exaggerated impact on sell-in. So we took more inventory out of the channel. And at some point, we believe that that will reverse in terms of they will have to order inventory going into the holidays as they expect regular seasonality.
Mark Auschwager
Thank you. And on the retailer front, I mean, the hesitation regarding inventory is understandable. But I'm wondering, do you have a sense of what the sell-through rates look like with your channel partners? And I guess specifically with materials and accessories, I'm curious how the new pricing strategy and the promotional strategy is hitting the mark and any learnings you have over the last few months.
Jim
So as Ashish pointed out in your last question, sell-through tends to be healthier than sell-in. And on materials specifically, when we are more promotional and closer to cost parity with competition, that we are holding share or even gaining share. And we have maintained that promotional cadence and see that going forward so that we can be price competitive, especially when consumers are so cost conscious in the current environment.
Mark Auschwager
Great, and maybe just finally, curious if you could expand upon some of the marketing strategies you talked about with respect to new customer acquisition and refilling the funnel. Any particular tactics or areas where you're seeing the best results?
Ashish Arora
Yeah, so let me kind of spend a couple of minutes on this, Mark. Again, as we said before, we believe we have a large SAM and we're in the early days of that category, right? And one thing that gives me a lot of confidence and comfort is and we've talked about this previously, is that we are attracting Gen Zs and beginner crafters, which really kind of speaks to the breadth of the category, right? Now, when you look at the trends that especially drove growth prior to COVID, you know, these are secular trends like personalization and, you know, access to digital tools, etc. Now, clearly, in the shorter term, we are being impacted by some of the headwinds that we've talked about in terms of inflation, economy, consumer sentiment. But, you know, our job and what we think we have more control over is, you know, how do we add people to the funnel? And one of the things that I know you look at Google Trends, if you look at the specific search term on what is cricket, right, that tends, and if you compare it to a regular year like 2019, it shows the amount of interest. If you compare April over April or March over March over the few years, it basically shows that the interest exceeds what we are seeing in terms of sell-through. So there's clearly pent-up demand that we believe exists, the funnel. As far as the funnel is concerned, the way we are approaching, and I'll speak to all three stages of the funnel, from the top of the funnel perspective, we are focusing on digital media, social media tools, network effects, and we believe that works very well for our brand, word-of-mouth marketing. As we pull people through the funnels, which is, this is where you heard me talk about the assets that we are developing in terms of comparison tables, product quiz, and anything that would help address the user's questions and purchase barriers. And I think you'll see us continue to do that. And finally, when it comes to the bottom of the funnel, that's where we've been less promotional. We think it's the best thing for the brand. Instead, what we have done is we focus on affordability and value, which is where we've been offering bundles and that will continue to be a big part of our strategy. At the end of the day, we think that us focusing on those things, us continuing to build the funnel, just like what happened right at the start of COVID, we saw there was a funnel, it converted quickly. We think the same phenomena is going to exist as and when some level of normalcy returns. And in the meantime, we need to continue to build this infrastructure around the marketing funnel that we believe will ultimately pay off as the world returns back to normal.
Mark
That's great, Tyler. Thank you and best of luck. All right.
Operator
Again, if you would like to ask our speakers a question, please press star 1-1 on your telephone and wait for your name to be announced.
Mark
Please stand by as we compile the Q&A roster. All right.
Operator
That is all we have today. I would like to turn our call back over to Jim Suva for closing remarks.
Jim Suva
Thank you, Haley. Thank you all for joining us this afternoon. We have a large opportunity over the long term to drive new user growth and increased engagement. We believe the initiatives we are deploying now will position us well for when consumer spend returns. We will continue to manage the business for sustainable, profitable growth and generate healthy cash flow. I'm excited about the opportunities ahead of us. We will be at the Baird Global Consumer Technology and Services Conference in New York on June 7th and look forward to seeing everyone then. This now concludes this earnings call. If you have additional questions, please email me at jsuba at cricket.com. Thank you.
Operator
Thank you for participation in today's conference. This does conclude our program.
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