Cricut (NASDAQ:CRCT) Q4 2021 Earnings Call

0:00 Good day and thank you for standing by. Welcome to the Cricket Q4 2021 earnings conference call. At this time, all participants are on a listen-only mode. After the speaker 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. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your first speaker today, to Stacey Clemons with the Boucher Group. You may begin.

0:33 Thank you, operator, and good afternoon, everyone. Thank you for joining us on Cricket's fourth quarter and four-year 2021 screens 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, the accompanying slides used on today's call, along with the supplemental data sheets, have been posted to the Investor Relations section of the company's website, investor.cricut.com. Joining me on the call today are Ashish Arora, Chief Executive Officer, Marty Peterson, Chief Financial Officer, and Kimball Shill, Executive Vice President of Operations and Incoming CFO. 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.

1:26 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 Session of Cricket's most recently filed Form 10-K. Actual events or results could differ most strictly. All non-GAP numbers referenced in today's call are reconciled in the press release or the slide presentation on the Express for Relations website. This call also contains time-sensitive information that is accurate only as of the date of its broadcast, March 8, 2022. Thank you, Stacey, and welcome, everyone.

2:15 Before I get started with my comments, I wanted to take a moment to acknowledge the devastating events in Ukraine that are on our minds. As part of a virtual team, we have software partners that we work with in Ukraine. My team and I have been in contact with these team members and their leadership and have expressed their concern and support for them. We also know these events impact many people across our global teams, user communities, friends and families. Our hearts and prayers are with all of them. While these events are truly top-line for us all, let me now shift to talking about our latest updates at Cricket. 2021 was an exciting year for us, with strong momentum across our business.

3:01 2021 was also a complicated year as Cricut, our retailers, and our customers navigated the ups and downs of a global pandemic. Total revenue for the year grew 36%, a remarkable performance on top of the very tough comp in 2020, driven by growth across connected machines, accessories and materials, and subscriptions. We delivered 16% EBITDA margin for the full year. Our profitable business model enabled us to fund significant investments towards our long-term growth strategy. In addition, we successfully navigated through some tough supply chain challenges and, as a result, benefited from a strong inventory and cash position that continues as we enter 2022. 2021 represented the second year in a row that we accelerated our growth in two key areas. The first was the expansion of our consumer base, adding nearly 2.1 million new users in 2021.

4:01 And the second was the growing revenue contribution from our international efforts. In 2021, international revenue grew by nearly 110% compared to the prior year and represented 11% of total revenues. We added new use cases and turned into new markets, expanding our retail footprint and fostering a growing global community that will continue to fuel our engagement flywheel. Revenue in the fourth quarter was strong as anticipated in the holiday season. Our gross margin pressures resulted in a much lower EBITDA margins in the fourth quarter than anticipated, which Mario will talk to in a few minutes. In 2021, we added more than 2 million new users, an increase of over the nearly 1.8 million users added in 2020.

4:51 At the top of our engagement funnel, 6.4 million total users on our platform. As anticipated, engagement as a percentage of total users in the fourth quarter increased sequentially, consistent with typical holiday seasonality. As a percent of total users, engagement in the fourth quarter was 60%, up significantly from 56% we saw in Q3 at our drop. At the end of 2021, we had 1 million more users cutting in the last 90 days compared to the end of 2020. As we've discussed before, the engagement metric on a percentage basis will fluctuate as we expand our market opportunity and acquire new customers. We're expanding beyond our traditional craft consumer by broadening our use cases and growing partnerships with various retail channels.

5:43 Our goal is to drive engagement with these users by offering seamless connected experiences, relevant content, community, and value-added services. This increased engagement in turn drives monetization through subscriptions and materials. Our passionate and engaged users fuel our marketing priorities where over 40% of new users come to know about Cricket from word of mouth. This user acquisition, engagement, and sharing cycle powers our business from machines, subscriptions, and accessories and materials. These businesses are symbiotic with each other and the user experience. At the core of this user experience, we ensure compatibility between our connected machines, software content, accessories, and materials.

6:29 We then work actively with retail partners who are passionate about telling this compatibility story, showcasing the entire Cricket brand and delivering a great experience for our consumers. Our growth from our international expansion was one of the highlights of the year. This past holiday season, we significantly expanded our retail footprint across a broad range of retail channels around the world, beyond craft, including home office, home organization, and consumer electronics. Since the end of 2020, we've introduced Cricket products in 16 new markets, making Cricket products now available for purchase in over 45 countries. Our user acquisition approach is driven by our organic word-of-mouth marketing.

7:15 Based on our experience to date, these international investments will pay off over time and typically take a few years to achieve critical mass in each country. At the heart of Cricket is our passionate community of users. Securing our Facebook, TikTok, Instagram, and Pinterest pages from projects that our users share across their social channels. Our goal is to amplify their great work and inspire others around the globe. Our community provides a powerful competitive mode while driving organic engagement and new user acquisition. More than 5.7 million social media followers actively engage with Cricket across relevant platforms. The hashtag Cricket alone has more than 3.1 million posts just on Instagram.

8:02 On YouTube and Pinterest, video views of Cricket content more than tripled compared to 2020. We now have over 3.3 billion views on TikTok, up from 2 billion at the end of 2020. Our international communities continue to grow as well, fueled by hundreds of active influencers outside of the U.S. with a combined reach in the tens of millions. In October, we launched Cricket Learn. showcasing a beginner's guide to live Zoom workshops and short searchable on-demand video instructions covering everything from popular materials to how to use design space. As of today, we've hosted over 80,000 members with introductory courses making up 40% of content consumed. At the same time, we've hosted more than 40,000 new members in our live workshops.

8:52 You see member education as a significant opportunity to provide members with tools and resources early in their Cricket journey so that they can create more often and with confidence. We continue to drive engagement through Cricket Access, our subscription service. We ended 2021 with over 2 million paid subscribers, a 56% increase over the prior year. This equates to about 32% of our total user base, a strong attachment that speaks to our continued investment in subscription services. We'll continue to add new features, functionality, and content as we continue to increase the value proposition of Cricut Access. One of the things I want to highlight is our new contributing artist program. Currently in beta, the new marketplace enhances our content library, enabling artists to upload their artwork to Cricut Design Space and get compensated as their artwork is used by Cricut members for their projects.

9:50 For millions of our users, they can access new, authentic, and diverse content from their favorite designers. This marketplace strategy lays the foundation for more to come as we look for ways to further engage with our community globally and for the community to further engage with each other. Our ability to extend the platform as we introduce new machines, smart materials, tools, and accessories expands use cases and categories to further drive user engagement. Just yesterday, we introduced an exciting new lineup of heat presses. The EasyPress 3 is our newest model that includes Bluetooth technology along with the new Cricut Heat app. It perfectly monitors the heat settings for any project via a connected platform.

10:36 Our new Cricut Hat Press enables us and our users to create personalized, high-quality hats. We also launched our flagship heat press, the Cricut AutoPress. The Cricut AutoPress is designed for enthusiasts who love making T-shirts and other heat caster projects, as well as for prosumers who are using their Cricut machines for making heat caster products themselves. We also recently launched a Cricut Write 360 floor lamp and a desk lamp. These lamps are designed specifically for every Cricut user and every crafter. The lamps are designed to reveal rich, accurate colors and evenly light up your entire workspace. We're very excited about all of these launches. Our platform enables us to constantly enrich the experience for the entire install base of users and machines as we roll out software updates across desktop and mobile.

11:30 These software updates allow users to benefit from new features and capabilities when coupled with new content, materials, and tools. This is very unique to our platform and allows us to drive engagement by giving users the ability to make new types of projects and expand on their creativities. Over the holidays, we released the new destination pages on the desktop version of Cricket Design Space. These pages allow us to feature targeted content, projects, and images to support key themes and to engage users in a rich and inspiring way. We also plan to build on this and give our international market to create their own flavor of destination pages for each of their respective markets. The underlying trends that drive our business, like personalization and digitization of tools, are healthy and intact. As we further penetrate our staff, we are excited to see a broadening of demographics among our user base.

12:28 We see a growing number of beginner crafters joining the platform. We are seeing younger generations of crafters, including more Gen Zs and millennials, as well as a greater percentage of men becoming cricket users. One of our core mantras is Proud But Hungry. and we'll continue to innovate around the platform and create additional value for the user experience within the critical ecosystem. Over the last two years, we've acquired nearly 4 million new users and we've significantly grown the business. As we head into 2022, we are focused on cultivating this larger user base and creating the best experience we can for that. These investments will drive further modernization and profitability ultimately fueling more investment and growth for the long term.

13:15 Our key focus areas this year include, first, we will continue to enter new markets and expand across retail channels. Second, we want to simplify the onboarding process and drive engagement across our entire install base. This is fundamental to our user acquisition strategy and the marketing flywheel. Third, we want to monetize our user base and this enhanced engagement. We plan to do this with the launch of new materials, accessories, content, and enhance the value our users get by subscribing to quicker access. Our focus on compatibility across the entire ecosystem is key to driving this. Balanced with these shorter-term objectives, we will continue to invest for the medium and long term. We are expanding our platform and investing in new types of connected machines that will serve us well for 2023 and beyond.

14:11 Before I conclude my remarks, I would like to thank the entire cricket team for their amazing and tireless work. I also want to thank Marty for his countless contributions and leadership that have helped build the company to over a billion dollars in revenue. He's built a tremendous team, and I'm grateful for the dedication and passion for company culture, our mission, and our users. He's been an incredible partner to me over these past 10 years, and I wish him all the best. in his retirement later this year. I'm also thrilled to introduce you to Kimball Shill, who is joining us today on the call for the first time. He served as part of the executive team for the past three years, and his deep operational expertise and proven leadership at Cricket makes him the ideal person for the CFO role.

15:00 Three years ago, Kimball was tasked with building a team that could reimagine our supply chain for greater scale and flexibility while also serving our growing international market. Kimball and Marty were tightly integrated, and we are lucky to have Kimball expand his leadership role within the company. I'll now turn the call over to Marty.

15:23 Thank you, Ashish, and good afternoon, everyone. I want to take a minute to thank the entire Cricket team. It has been a privilege to be part of this team for the past 10 years. I'm grateful for this amazing experience and to have been able to contribute. What we do and what we build empowers so many lives around the world, and I'm honored to be just a small part in helping with someone's creative joy and inspiration. For the call today, I'll quickly recap the financials on an annual basis, but we'll spend most of my time this afternoon giving additional color on our fourth quarter performance. As a quick reminder, we've posted a supplemental data sheet with historical numbers on our investor relations website for easy reference. We had a strong year, delivering $1.3 billion in revenue, or a growth of 36% on top of last year's 97% growth.

16:17 Driving this growth is our diversified revenue stream, with all three segments of 2021 significantly growing year over year. We increased total cost of revenue by 35% for the year, but held gross margins flat with last year at 35%. higher cost of sales primarily came from increased levels of promotions compared to the prior year when our promotional activity was unusually low and from higher freight costs. These costs were partially offset by the increase in revenue and revenue mix. The strength of our business model enabled us to significantly invest in multiple growth initiatives, many of which Ashish just mentioned.

17:03 Total operating expenses for the year were 20% of total revenues compared to 14% in 2020. In absolute dollars, we doubled our operating expenses in 2021 up from suppressed levels in 2020 when we had paused spending given the uncertainty of the pandemic. We have a durable business model, and 2021 marked our fifth consecutive year of GAAP profitability. For the year, we delivered $140.5 million of GAAP net income, compared to $154.6 million in 2020. EBITDA margin for the year, which included $38.1 million of stock-based compensation, was 16.2%, just shy of our expectation going into the fourth quarter.

17:52 This compares to 22.4% EBITDA margin in 2020, which benefited from the lower promotional activity and paused spending just mentioned. as well as nominal stock-based compensation expense. Overall, 2021 was a year of many accomplishments. We saw continued strong revenue growth, significantly invest in the business, grew inventory back to strong levels, successfully navigated the challenging supply chain environment, and continued to generate profits. Now on to the quarterly numbers. I'm going to dive more deeply into certain business factors underlying Q4 financial results. You'll need this behind-the-scenes tour in order to evaluate Q4 performance and to frame the outlook for 2022. To understand the health and trajectory of the business, we focus on annual year-over-year trends, which normalize for seasonality.

18:51 To normalize for the effects of the pandemic, we believe looking at financial performance on a two-year basis is helpful. Revenue in the fourth quarter was $387.8 million, a 5% increase year over year. On a two-year basis, revenue was up 123%. We saw typical holiday strength in Q4 as anticipated. Additionally, Q4 2021 revenue benefited from a few of our retailers ordering more aggressively and building defensive stock in Q4 2021 as they also navigated concerns about We estimate that this buying inflated Q4 revenues by roughly $20 million across connected machines and accessories and materials.

19:40 These revenues were likely pulled forward from the first half of 2022. Revenue from connected machines was $158.1 million, down 7% year-over-year. Keep in mind that on a year-over-year comparative basis, We are comping to an exceptionally strong Q4 last year. Additionally, Q4 2021 revenue benefited from some unusual retail behavior that I just mentioned. Revenue from subscriptions was $55.7 million, up 51% over last year, driven by continued strong machine sales and a tax rate throughout the year. Revenue from accessories and materials was $174 million, up 7% over last year as we grew our engaged user base sufficiently to offset the year-over-year decline in engagement percentages.

20:33 And these revenues also benefited from some higher retailer buying during the quarter. In terms of geographic breakdown, international revenue growth continued to outpace growth in North America, increasing 53% in the fourth quarter over the same quarter in 2020. In the fourth quarter, we added 676,000 new users, a record number for any single quarter, helping fuel our monetization flywheel for continued long-term growth. We ended 2021 with more than 6.4 million total users. As anticipated, engagement in the fourth quarter increased on a sequential basis, as Q4 is typically strongest are our strongest quarter for engagement due to seasonal trends.

21:24 Year over year, the number of users engaged on our platform for the 90-day period ending December was 3.8 million, an increase of over 1 million, or up 36%. Also, as of the end of 2021, 5.2 million of our total 6.4 million users had used their connected machines in the prior 365 days. As a percentage of total users, user engagement was 60% in the fourth quarter, significantly up from the trough we experienced in Q3. Engagement was down from 65% in the prior year, which was unusually high. Keep in mind this calculation will fluctuate over time as we broaden our user base and expand into new verticals and use cases.

22:14 On a year-over-year basis, the number of paid subscribers grew by 735,000, or 56%, ending the year with just over 2 million paid subscribers. Attach rates helped strongly at 32% as of the end of Q4 2021, an increase of 2 percentage points on a significantly higher total user base compared to Q4 last year. We measure our user monetization through average revenue per user in both subscriptions and accessories and materials by dividing revenue in those segments by our entire user base within that period. ARPU for subscriptions in the fourth quarter was $9.18, down slightly from $9.23 in Q4 2020.

23:00 Accessories and materials ARPU closely relates to engagement. ARPU from accessories and materials in the fourth quarter was $28.66. This was up sequentially from $18.79 in Q3 2021. This compares to Q4 2020 ARPU of $40.76, which was an all-time peak, benefiting from higher than normal engagement levels related to the pandemic and some catch-up on channel inventory in 2020. We have a strong focus on monetizing our growing user base through our subscriptions and accessories and materials. Keep in mind, we grew our user base by 3.9 million, or 154% since 2019. This fuels our monetization flywheel as we move forward by adding more beginner and intermediate users, which presents a significant opportunity for us to increase levels of engagement over time and drive these revenue streams Moving on to gross margin. As a reminder, historically, we see softer gross margin in the fourth quarter due to a higher revenue mix in connected machines and increased promotional activities around the holidays.

24:22 Total gross margin in the fourth quarter was 27%, down from 33.6% in Q4 last year, largely driven by significantly lower margins in our connected machines and accessories and materials. Q4 2021 was also impacted by a few items that resulted in lower margins for the quarter. Breaking this down further, gross margin from connected machines in the quarter was negative 1.5%, which was unusually low. Prior year Q4 connected machine gross margin was 14.4%, which was unusually high due to the lower level of promotional activity in the middle of the pandemic. For context, pre-pandemic Q4 margins on connected machines typically ranged in the mid to high single digits. The decrease was primarily driven by some non-recurring items as well as ongoing cost headwinds that will continue to impact our machine gross margin as we look into 2022.

25:24 First, our support for promotions and consumers by our retail partners was much higher than expected. We benefit significantly from strong, competitive retail partners who look to us to maintain order in the channel. In Q4, we stumbled in managing the channel and the promotional activity tightly enough. To address this channel imbalance, we chose to align and support all of our retail partners appropriately with additional promotional dollars, which showed about 5 percentage points of the decrease in connected machine gross margins. Going forward, we have put in place structures and policies to ensure stronger management across our retail channels and will partner with retailers who strategically align with us to prevent these types of issues in the future.

26:14 Second, Q4 2021 also reflected a higher level of reserves related to our pricing plan for end-of-life on certain products. These reserves resulted in an additional three percentage points of connected machine gross margin impact. Additionally, our connected machine gross margins continue to see inflationary impacts across all aspects of our supply chain. Our teams have been successful in navigating the environment to ensure we have sufficient inventory when and where we need it. As we move through 2022, we expect to continue to feel the impacts of elevated freight, warehousing, and handling costs, as well as increases in commodities. Going forward, to mitigate some of the continued headwinds from inflationary pressures, we intend to implement price increases and adjust our promotional strategies across connected machines and accessories and materials.

27:10 Gross margin from subscriptions in the quarter was 88.4%, down slightly year over year due to an increase in hosting costs to support increased functionality of our applications and to scale capacity for future growth. Gross margin from accessories and materials in the fourth quarter was 33.3%, down from 41.3% in the prior year due to tighter unit costs, including increased freight expenses as well as a change in the revenue next to product. Moving on to operating expenses, total operating expenses in the fourth quarter were $79 million and included $10.1 million in stock-based compensation.

27:55 This was a significant increase over Q4 2020 of $45.2 million when we paused spending as we navigated the uncertainties of the pandemic. Additionally, Q4 2022 had much lower stock-based compensation expense. Total operating expense as a percentage of revenue was 20% in Q4. This is higher than the prior year figure of 12%, reflecting increased investments in sales and marketing, and R&D to extend our platform for future growth. The main drivers of the year-over-year increase were led by increased advertising and marketing spending, particularly related to our international expansion. Additionally, we increased headcount, particularly in R&D and stock-based compensation as a result of our IPO in March.

28:45 Operating income for the fourth quarter was $25.8 million, or 6.7% of revenue compared to $79.6 million, or 21.5% of revenue in Q4 2020, driven by lower gross margins plus the increased investments and stock-based compensation expense I just mentioned. On a full-year basis, operating income in 2021 was $192.4 million, or 14.7%, We delivered our 12th consecutive quarter of positive net income. Net income in the fourth quarter was $11.9 million, down from $61.4 million in Q4 of the prior year.

29:34 In the fourth quarter of 2021, we recorded a tax true-up of $6 million related to higher sales across more states with higher tax rates as well as taxes related to higher stock-based compensation. This resulted in a significantly higher effective tax rate for the quarter. Going forward, we expect our ongoing effective tax rate to be about 25%. Diluted earnings per share was $0.05. Note that Cricket did not have a comparable EPS history prior to the reorganization at the time of last year's IPO. EBITDA in the fourth quarter was $31.8 million, or 8.2% margin in the fourth quarter, which includes $10.1 million of stock-based compensation expense.

30:25 This compares to an unusually high $83.5 million, or 22.5% in the prior year Q4. On a two-year basis, our EBITDA grew 122% over 2019. We generate healthy operating margins, and starting in 2022, we will be able to provide year-over-year EPS comparisons. Going forward, management believes that operating income and earnings per share are the key metrics on which to measure profitability and manage the long-term business. Therefore, this will be the last time that we highlight EBITDA as a key metric. Note that operating income is closely aligned to how we have calculated EBITDA, and of course, investors who are still interested in the EBITDA metric can easily calculate it from our financial statements.

31:16 To align to this framework, we will manage towards long-term operating margin targets of 15% to 19%. Our long-term target ranges for gross margin and operating expenses remain unchanged. For reference, our historical operating margins are included within the data sheet, and the long-term target ranges are included in the appendix of our earnings presentation. Both are available on our investment relations website. Turning now to the balance sheet and cash flow. We ended the year with a strong balance sheet of $241.6 million in cash and cash equivalents and healthy inventory levels. Our credit line of $150 million remains untapped. Cash used in operations for the year was $104.9 million, which was primarily used to rebuild depleted inventories.

32:10 Consistent with what we have said over the last few quarters, we plan to continue carrying higher-than-normal inventory levels to mitigate supply chain risks. We are carefully monitoring known risks and plan to manage down inventory levels to match as risks unwind. In summary, 2021 marks two consecutive years of hyper-revenue growth. On a two-year basis, revenue grew over 165%, and we added nearly 4 million new users to the platform. We grew operating income over 255% over the same two-year period. At the same time, we held gross margin flat while managing through a complex supply chain environment and have continued to significantly invest in the business.

33:00 I believe we are a stronger organization today than we were pre-pandemic and we will continue to tightly manage what is within our control. As we look to 2022, it is important to keep in mind the first half of last year was unseasonably high. If 2021 had followed our typical seasonality pattern, similar to years prior to COVID, the quarterly revenue distribution would have looked significantly different. So as we return to a more normal seasonality pattern, this makes first half 2022 costs very difficult. Moreover, while we don't have full visibility into the channel, We are operating on the belief that retailer inventories ended 2022 about $35 million above what retailers would consider normal levels.

33:49 This figure includes the roughly $20 million of defensive buying that occurred during Q4 by a few retailers. Combined, these factors create headwinds in the first half, which we can already see early in 2022. As we move further into 2022, we expect to benefit from traditionally stronger seasonality and easier comms over second half 2021. However, we are mindful of uncertainty around some of the macroeconomic pressures of inflation and consumer spending. We expect to end 2022 with at least 8 million total users. The significant growth in our user base over the last two years also provides opportunity to further drive engagement, and monetization over larger base of users.

34:40 We remain focused on driving profitable growth and committed to our annual operating margin targets of 15% to 19% over the long term. Given the uncertainties of the current environment as we enter 2022, we do see pressure on operating margins that may put us below the range in the short term. We believe the same trends that have fueled our growth from 2014 will continue for many years to come. We have a consistent track record of driving profitability while managing our financial resources. This dynamic macro environment plays to the strength of our disciplined approach we have cultivated since 2014. The tremendous growth we've achieved lays the foundation for us to scale and grow even further. With that, I'll now turn the time over to the operators for questions.

35:35 Thank you, sir. As a reminder, to ask a question, you would need to press star 1 on your telephone. To withdraw your question, please press the pound key. Please stand by while we compile the Q&A roster. I show our first question. It comes from the line of Mark Allschwager from Bayer. Please go ahead.

35:56 Good afternoon. Thanks for taking my question. Just to start out on gross margin, could you maybe talk a little bit more about the levers that you have within your control to help stabilize the machine margins and the materials gross margin through 2022? What are the puts and takes there? And if you could say, you know, net of the price increases and promotional changes, you know, how are you thinking about sort of the gross margin in those segments for the year?

36:28 So let's just talk really quick about just recap a couple of things on gross margin, specifically talking about machines. So the machine gross margin was lower than we would normally see, and this was due in part to three things primarily. The first was the unusually high level of promotional activity that we highlighted earlier. that occurred in the quarter. That represented about five percentage points of the decline. That's on machine gross margin. The second was the end-of-life reserves that we took. You may recall that we had elected to delay the end-of-life of certain of our products, particularly machines, as we went into the pandemic because we wanted to make sure that we could We didn't know exactly when and where and what machines and other products we would be able to produce, so we chose not to end of life those machines when normally scheduled.

37:37 And so in Q4, we were comfortable enough with our supply chain going forward that we elected to make plans to end of life those in 2022. And so we took a reserve on those plans. The final one, and that was about three percentage points. If you look at those two non-recurring items, machining gross margins would have been basically in the range for Q4, where we saw Q4 2018 and 2019 pre-pandemic. Add on top of that, though, the inflationary pressures across the supply chain that we're experiencing, particularly in freight and warehousing, and you get something closer to where we would expect it to be normally. That being said, if we look forward, we saw freight and warehousing levels peak in Q4, and we don't see any relief from that. at least through the first half and probably moving into 2023.

38:58 But we are implementing price increases to help offset some of that and we expect those to likely take effect somewhere around mostly in the second half.

39:16 Let me just add to that, Mark. I want to just double click on the and many others. So, you know, we have a great partnership with all our retail partners and we plan for these promotions six to nine months ahead of the holiday season. During the holidays, we had one major retail partner that actually was a lot deeper than we had anticipated. And we, at that point, you know, given the hyper-competitive environment, chose to support our retail partners with additional POS dollars. to make them competitive. But, you know, we put in place policies to help avoid or mitigate these in the future. So that is one event that, you know, was really kind of a surprise event that happened and we had to just manage it during the quarter.

40:03 There are a couple other things that Marty mentioned that I think will help. One is clearly, you know, changing, we're going to be impacting pricing both to our retailers as well as to the consumers that will help drive the gross margins up. You know, as we go into the second half of the year, our mix of the product, especially on machines, will gravitate towards the higher price points and the products with better margins. So I think those, you know, we think that all of those combined, you know, will start to gravitate back to the long-term margins in the longer term. So what we saw was a class increase workplace.

40:45 Thank you for all that detail. And maybe to follow up, Ashish, we saw the announcement yesterday on some of the new products. I guess to what extent is some of this innovation geared toward greater monetization of some of your current users, your power users? I guess I think the auto press has a $1,000 price point on it versus attracting new users to the platform. and then more generally, Ashish, any details you're willing to share on the innovation pipeline for 2022 beyond those announcements would be great. Thank you.

41:21 So, you know, I think you're very astute in terms of, you know, our first and foremost strategy with all of the launches, including the LAMP that we announced earlier in the quarter, I really gave first and foremost words to our current Cricket users, right, is to help drive monetization of the existing install base We do believe that, you know, over time, as you know, as you've said in the past, a certain percentage of our users like to sell. We believe that in addition to the enthusiasts and the hobbyists, there will be some of our users or we'll attract new users who actually come at it more from a commercial perspective. So I think it's probably a combination of both. We've had some, you know, we're really excited about all of these launches and we had some really good signals of consumer passion and demand around that.

42:12 You know, from an innovation pipeline perspective, you know, first and foremost, one of our fundamentals, because we're a platform company, you know, we continue to invest significantly in the platform, right, which is the data, the content, the community, the services, and the software across desktop and mobile. So that's going to be a continuing ongoing investment that we will pursue. I think, you know, we've kind of said we will continue to, we believe that the current category is still in the early days. So from our connected machines for cutting, you know, we still have a lot of runway ahead of that, and so we will continue to innovate in that area. And then finally, I alluded to this, that we will be, we are investing in, because we're a platform company and these connecting machines sit on top of the platform, we We are continuing to invest in other types of machines that are different than what we do today.

43:09 So we're really excited about that. But, you know, those are, again, medium to long-term investments.

43:16 That's great. Thank you. Thank you. I saw the next question comes from the line of Jim Suva from Citigroup. Please go ahead.

43:29 Thank you so much for the details. It's Jim Suva. I have a question. I think it was Marty mentioned that inventory levels were a little bit higher than normal to the neighborhood. I remember right around 35 million. I might be wrong or right on that. What was the reason for higher inventory levels? Was it retailers were expecting another kind of COVID growth year or they were concerned about supply chain issues and kind of double ordered? And the reason I ask is a lot of society is seeing Shortages of inventory. It sounds like you're talking about extra inventory. So if you could help us with that, that'd be great. Yeah, sure, Jim.

44:12 So let me just draw a distinction between our inventory and channel. The comment that you're talking about is channel inventory. And just very quickly, we've been talking over the past few quarters about our own intention of and practice of carrying higher levels of inventory than we normally would to mitigate against supply chain challenges. And we ourselves ended the year about on target with where we plan to be. We watch metrics very closely. We have predesignated metrics to look at relative to certain risk factors. and we mentioned in last quarter's call that we had seen defensive buying similar to what we were doing on the part of a few of our retailers.

45:07 And we saw that buying continue all the way through the end of Q4. And we estimated the pull forward of that defensive buy into Q4 from future periods of about $20 million. But then as we look at the balances, the channel inventory balances that existed at the end of the year looking forward into 2022, based on what we would estimate to be normal levels of inventory, we saw about $35 million in additional inventory that was being carried.

45:48 Perfect. And just to clarify, the $20 million that you mentioned and $35 million, The 35, that includes the 20 million, I assume, or is it uniquely different? Yes, it does. I'm sorry. I should have clarified that. The 20 is within the 35. That's what I thought. Okay. And then the last question is, if we compare to, say, two years ago, again, kind of taking out the COVID year a little bit, accessories, you know, how should we think about, you know, why accessories are trending what they are versus accessories and materials? versus two years ago, is there some type of trend we should extrapolate? I don't want to compare it to one year ago because I think that's an unfair relationship, but what's your thoughts about versus two years ago for accessories and materials and the direction and such?

46:39 Yeah, so we agree with you that comparing to a year ago is not valid just because of so many things going on last year. and so I'm talking about accessories and materials ARPU specifically and so if we look at accessories and materials ARPU at the end of 2019 so pre-pandemic relative to accessories and materials in 2021 ARPU declined about 7% and now ARPU is for us is a measure and a yardstick of our production and profitability of every person who has ever registered a machine, whether they put it in the closet or not, because that's the denominator. And so we look at revenues from accessories and materials divided by that entire user base.

47:45 And so over that same period, We increased our user base by 153% or 4 million people. And so, you know, we feel pretty good about that 2021 ARPU number because increasing the numbers that quickly and only declining 7% feels pretty good.

48:15 Thank you for the details and clarification. And yes, indeed, all our Christmas mug presses did come out for all of our family members in a great manner. So thank you for that experience.

48:25 Jim, let me just add one comment to Mari's statement. One of the things, and I think it kind of informed the question you asked as well, which is we are continuing to see a lot of beginner and intermediate crafters, Gen Zs and millennials, which is actually exactly what we want, right, which is broadening the market, going after the to highly engaged enthusiasts. So as we've added retail channels, as we've added use cases, we have seen the broadening of demographics. Now, what will happen is initially when those demographics will come in, the engagement will, you know, will not be as high as somebody who lives and breathes crafts. However, the total number of engaged users or basic lists can be higher, but on a per-user basis, that will put some pressure. And over time, we think that's, again, an opportunity for us to continue to bring them down the funnel and increase engagement and drive monetization.

49:17 But I do want to, I think your question, you know, there is an element of the broadening demographics which speaks to the market opportunity, but it will impact the odds and numbers of material going to exist.

49:31 Great. Thanks so much for the additional cover. Thank you. Ashish, our next question comes from the line of Eric Woodwin from Morgan Stanley. Please go ahead.

49:44 Hey, good afternoon, guys. Thanks for taking the question. I guess, you know, we have the guidance for 8 million users at the end of 2022. Is there any way that you can put additional kind of framing of how 2022 might look, either from an ARPU perspective, a margins, you know, OpEx? You know, really what I'm just trying to get at is, We've left 2022 a bit open, and I'm just trying to give you a chance maybe to help guide us as to how we might think about 2022 across any of those metrics. And then I have a follow-up.

50:20 So I'll let Marty talk about, you know, one of the other key concepts that we introduced was seasonality, and I'll let him talk to that. But let me kind of give you my perspective on the 8 million. So, you know, if you calculate the number, that basically means that we're going to add another 1.6 billion users in 2022. And, you know, given the promotional strategy and the pricing, we feel really good about that number. And, you know, just to give you some context, that'll be twice as many users that we added in 2019, and it builds on the roughly 3.8 or 4 million users that we acquired in 2020 and 2021. So, you know, you take the 3.8 million users that we acquired in the last two years, plus the $1.6 million. We think that's a wonderful platform for us to further monetize, you know, the subscriptions, accessories, and materials.

51:11 I do think that, again, you know, I want Marty to comment on the other aspects of their question, but, you know, one other thing that we are seeing is the wording back to seasonality that we haven't seen in the last couple of years.

51:25 Yeah, so on the seasonality point, and I highlighted this a little bit in my prepared remarks, but We're a seasonal business. Year in, year out, pre-pandemic, it was pretty consistent that about 40% of our revenues would come from the first half and about 60% in the second half. Pandemic kind of turned everything upside down, and specifically 2021 was a front-end loaded year with about 50% coming from first half and 50% in the second half. Now, as we exit the pandemic and we are moving back to a more normal seasonality pattern, what that means is that we're moving from 50% revenues in the first half last year to 40% is our expectation this year.

52:21 And so when we're looking at comps or year-over-year growth rates by quarter, It means that the first quarter are difficult comps for us to meet. The second half, though, if you're looking at that, the comps will be a bit easier. So I just want to make sure that you're thinking about that in your analysis as well as the additional channel overhang. We believe, we think that that will probably work itself out in the first half of the year.

53:01 Okay, thank you. That's helpful. And then, you know, one just clarification question. On the channel inventory, Marty talked about the $35 million, $20 million of which was estimated pull forward. What's the incremental $15 million from, just so I have a better understanding of how we get to that $35 million total?

53:20 Thank you. Yes, that would have been prior to Q4. In other words, we have seen some defensive buying in advance of Q4.

53:33 So just to clarify, essentially the channel was elevated going into 4Q and now with that defensive buy, you add up to those two quarters and you get to that $35 million.

53:43 That's right.

53:45 Okay, perfect. Thank you so much. Thank you. I think our next question comes from the line of Rod Hall from Goldman Sachs. Please go ahead. Hi, thanks for taking my question. This is Bala on for Rod. I want to kick it off with Linearity through the quarter, the December quarter, and also the months of January and February, both in terms of engagement and also the user additions. And I've got follow-up.

54:18 So let me ask what I think you're talking about. We're just looking at, I think you're looking at how Q1 is shaping up so far. and just keeping in mind that there are a couple of the two items that I mentioned that are the dynamics that I mentioned that are impacting the first half. One is a reversion to normal seasonality and the other one channel overhang. As we look at consumer demand and we look at it relative to 2020, the first quarter of 2020, which was pre-pandemic, we feel good about the demand. The demand is strong.

55:07 And so at least from that perspective, as well as search and other things, we feel good that consumer demand is strong. Okay, thanks for that, Mark. I guess what I'm wondering is some companies in the space here are kind of flagged this slowdown, especially last month in February. I'm just wondering, what are you seeing in terms of new user activations in the context of your full year user growth of 1.6 million users? I'm just wondering, comparing that last year, I understand last couple of years there was this COVID work-from-home impact, but Given the addressable market is so huge, I'm just wondering if the slowdown in user additions in 2022-21 is a dynamic of maybe what you've been seeing lately over the last couple of months?

56:13 Yeah, so I think, you know, Salah, let me take that. You know, one is, you know, we are clearly... So, first of all, you know, the trends that shape our business, we feel are very much intact, right? Personalization and digital tools and everything that's driven our business are very much intact, and we don't see anything changing dramatically there, right? We've given the number of 1.6 billion ads for the year, which, again, you know, at this point, given all the dynamics of the marketplace or the market, we just, you know, we have basically... comfortable with that 1.6 million ad number. The third is, which is, you know, like what we saw in the last year, or at least in 2021, was something that is uncharacteristically not seasonal, right?

56:58 And I think what we are, what Mari, the comment that Mari made is, relative to the seasonality that you see in a typical year coming into COVID, or prior to the pandemic, we feel good about the demand. But at this point, we are not giving further guidance or information on that at this point. Thanks, Ashish. And I got one follow-up for me. On price increases that you're planning, I guess I'm wondering how you're thinking about these price increases potentially impacting user ads in the context of this normalization and demand. because I was thinking, I suppose, your goal would be to prioritize user acquisition or profitability, especially in the medium term.

57:50 Is that still the right thinking? Any color there?

57:55 Yes. You know, I revert back to my, you know, 1.6 million ad, right? I mean, the environment is just, there's so many dynamics going on in the market that really kind of, isolating the impact on higher pricing or decreased promotions is hard to estimate. But, you know, given all of that, we basically wanted to, you know, we basically think that we'll end the year at 8 million users, which is roughly an add of 1.6. From a standpoint of, you know, whether we should be promoting more or less, we believe that, you know, we've always been very long in the business, right? And we believe that you know, going forward, our promotional strategy is more in line with what strategically we'd want to do, both in terms of user acquisition, but also in terms of where we want the, you know, relative margins to be.

58:47 So our goal is to, you know, definitely get our margins back to where they need to be. Now, you know, again, nobody can predict inflation right now, etc., but I think right now, given everything that we know, we feel good about the 8 million number. I appreciate it. Thanks, Ashish.

59:05 Yeah, and again, you know, the one thing that I want to make sure that we remind ourselves of the business model, right, which is that when we talk about user acquisition, right, a key part of what drives our business model is engagement, right? And I think, you know, that's one of the top priorities as we highlighted in our release, that it's one of the top focuses of the company. So our goal is to drive engagement and drive monetization with subscriptions, accessories, and materials. Got it. Thanks. Thank you. I saw the next question. It comes from the line of Paul Canney from Barclays. Please go ahead.

59:44 Hey, guys. Thanks for taking my question. I wanted to go back to one of the things you said was the competitive environment contributing to the need for increased promotions. I'm wondering what you're seeing competitively in the market. Are you seeing promotions from some of your competitors or Has anything kind of changed on how you view your self-position? And then I have a quick follow-up.

1:00:08 Okay. Well, let me clarify. You know, we are the category leader, right? And we have significant market share. And I would say that, in fact, if there are – the competitors that we do have all probably had, you know, lack of inventory and significant inventory shortages. At least, you know, again, this is anecdotal because we're just looking at the shelves that teams are going around. The competitive environment that I talked about was more at the retailer-partner level. So we wanted to make sure, given our strategic partnership with all our retailers, that when one major retailer kind of was more aggressive in the promotions, we took a decision for the benefit of our partnership with other retailers to support other retailers to compete in the market. So it was more enabling our partners rather than us being in a competitive environment relative to other competitors in our space.

1:01:07 Okay. Thank you. That makes sense. My second question is to harp on it a little bit, but on gross margin is clearly the biggest variance of where at least consensus and we were estimating for this quarter. How should we think about modeling gross margin, at least for the next few quarters, specifically on both connected machines and accessories? When do the price increases that you talked about come through into the model, and should we expect some pressure on this line in the near term?

1:01:41 Yeah, so I explained the sort of non-recurring items. If you remove those On an annualized basis, we were, from an EBITDA standpoint, we were at the low end of our long-term target range. But we still are facing pressures from freight and warehousing and other inflationary pressures. We're starting to feel more of an increase in raw materials. and that is the reason why we're working on a price increase. We are working with our retailers now on exactly what that price increase would look like and when it would take effect, but our expectation is the primary impact would be second half.

1:02:38 It's hard for me to comment anything beyond that.

1:02:43 Okay. Thank you. Best of luck. Thank you. Thank you. Thank you. I'm sure our last question comes from the line of Jim Suva from Citigroup. Please go ahead.

1:02:56 Thanks. As a follow-up, is it fair to assume that the margins in 2022 will be lower than 2021 due to all the myriad of things that you're referring to, or or any color because, you know, as Rod Hall and I kind of both, you know, mentioned that there is a lot of concern about gross margins. So, any color you can get there and if not, then I may have a follow-up on a different topic.

1:03:25 So, we're not giving specific guidance on where we expect margins to be for 2022. But what we, you know, what we will say is our long-term target model remains something that we feel good about, where long-term we've set gross margins to be in the 37% to 38% range and operating margin to be in the 15% to 19% range. Okay.

1:03:57 And then my quick follow-up. The half-press, light, these additional things you've launched, are they consistent with corporate average profitability or above or below or they need volumes to really help out or how should we think about your kind of flurry of recent product announcements?

1:04:15 Yeah, no, I think they're relatively in line with where we want to be. So, you know, we price them accordingly to make sure that we are in the, you know, and again, the materials and accessories are blended margins so there's a variety of things in there but those are healthy products with good margins.

1:04:34 Great. Thanks for the details.

1:04:36 I mean, we just announced them. They're still not in retail. It'll be a few weeks. Thank you. That concludes our Q&A session, and that concludes today's conference call. Thank you all for participating. You may now disconnect. So thank you, Operator.