Cricut Inc

NASDAQ:CRCT

Earnings Call Transcript 2022-Q1

[Operator]

Ladies and gentlemen, thank you for standing by and welcome to the Cricut Q1 2022 Earnings Conference Call. [Operator Instructions] I would now like to hand the conference over to your speaker today, Ms. Stacie Clements with Blueshirt Group. Please go ahead, ma’am.

[Stacie Clements, Investor Relations]

Thank you, operator and good afternoon everyone. Thank you for joining us on Cricut’s first quarter 2022 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, accompanying slides used on today’s call, along with the supplemental data sheet, have been posted to the Investor Relations section of the company’s website at investor.cricut.com.

Joining me on the call today are Ashish Arora, Chief Executive Officer; Kimball Shill, Chief Financial Officer; and Jason Dea, VP of Finance.

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 of the company’s management and involve inherent risks and uncertainties, including those identified in the Risk Factors 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 10, 2022. Cricut assumes no obligation to update any forward-looking projection that maybe made in today’s release or call.

I will now turn the call over to Ashish.

[Ashish Arora, Chief Executive Officer]

Thank you, Stacie and welcome everyone. Revenue in the first quarter was $244.8 million, a significant year-over-year decline, reflecting a tough comp from an exceptionally strong Q1 last year, which benefited from the pandemic. As anticipated, January and February followed a reversion to more typical pre-pandemic seasonal trends.

Starting in March, we began to see additional impacts of slowing consumer demand. Our sound business model and our ability to execute operationally continued, delivering our 13th consecutive quarter of profitability. As we enter Q2 and look ahead to the remainder of the year, we anticipate these pressures persisting in the near term and are highly focused on executing with a balanced and disciplined approach.

We continue to view our business through a long-term lens, optimizing the many levers within our control. We are focused on the business fundamentals that position us well for medium to long-term growth and profitability. We added more than 495,000 new users to the platform in the first quarter. Our subscription business was strong, with over 33% of our total users being paid subscribers at the end of Q1. We improved gross margins on a sequential basis, reflecting our diverse revenue streams and the work we have done to stabilize our pricing and promotions.

Our balance sheet and inventory levels remain healthy and we continue to operate with agility and discipline, all while delivering attractive profitability. Coming off a 2-year hyper growth period the Cricut brand is more mainstream and retailers have given significantly more shelf space to our growing ecosystem of connected products and materials. We have a strong and passionate user base, which will fuel our flywheel of engagement and increased user monetization for many years to come. We have invested in driving significant customer acquisition, adding more retail partners and influencers across the globe. At the end of Q1 2022, we had nearly 7 million users on our platform, a growth of more than 4 million users from 2 years ago with 54% of total users engaged over the last 90 days.

We continue to focus on building a robust engagement engine, which ultimately leads to greater monetization. This engine also fuels our flywheel, creating low-cost customer acquisition through strong word-of-mouth influence. Adversely energize and focus on everything we need to do to operate in the short-term, optimizing the trade-off between current profitability and investments in our long-term growth opportunities. We will continue to invest in international markets against a proven playbook of seeding the market long before revenue contribution.

Looking at our user base as a whole, we have a significant opportunity to drive growth in our Subscriptions and Accessories and Materials businesses, as we further strengthen user engagement and the onboarding experience. Our product roadmap is robust. We are focused on enhancing the value proposition of our subscription products. We are excited by the new things that we are launching over the next 3 to 6 months that will enable more content and functionality for our quick-access subscribers. We’re also making significant investments in our Accessories and Materials products, where we have an opportunity to expand the Cricut ecosystem. Ultimately, these are the drivers that will result in robust growth in the long term, as we continue to grow our user base.

For consumers looking for a seamless connected ecosystem for their projects, there is no alternative. It’s never been a better time to be a Cricut user. Underscoring our confidence are four key trends that demonstrate resilience in the market and have driven our business forward since 2014. First, the desire for personalization; second, the digitization of tools that makes personalization easy and seamless; third, technology has opened the door to a new generation of entrepreneurs; and fourth, the proliferation of social media that drives community a significant value for entry for others looking to enter the market. These key trends also bode true internationally where we have significant growth opportunity across new and existing markets.

Similar environmental challenges exist in our more mature international markets like the UK and Australia. Our newer markets like Germany and France continue to expand and thrive, as we add new stores at a high rate with existing retailers and add new retail and e-commerce partnerships. We look at things like user engagement levels, Google search terms, and brand familiarity, all of which have contributed to our success in these markets. As we enter new markets, we utilize the same Cricut playbook, with a focus on the same fundamental – same strong fundamental drivers of the business. We have just recently launched in Turkey and are very excited about our upcoming launches in Japan and South Korea over the next few months.

At the local market level, we drive continued growth by identifying influential voices, fostering community and partnering with key retailers. We are also investing heavily in user engagement, starting with how we onboard first-time users. We believe that a great onboarding process plays a strong role in driving long-term engagement and monetization. When a user first receives their machine, it is our goal to delight them at every turn, like the setup and the registration process should be seamless. We’re also developing product bundles and learning experiences, which we believe will help smooth the path for users, who are just starting out.

In addition to our focus on onboarding, we are investing significantly in our platform to help drive user engagement. This starts with Design Space where we have a unique opportunity to foster more user engagement. This year, we are focused on bringing more versatile and editable content along with expanding the amount of diverse content. We recently launched a new homepage for Cricut Design Space, creating a more dynamic experience and improving content discovery, both within our app and across our user of social media feeds. We are also focused on delivering greater parity between the desktop and mobile experiences, so users can have a consistent experience across all of our apps. We recently launched our Design Space app for Android in April, following a new and improved iOS launch at the end of last year. Our mobile apps are key to our overall engagement strategy and a critical pillar of our community efforts.

All of these efforts around onboarding and engagement ultimately drive more monetization opportunities on our platform. A little over 2.3 million paid Cricut Access subscribers at the end of Q1, nearly 700,000 more paid subscribers compared to prior year Q1. Our strategy with Cricut Access is to further expand our offering beyond simply adding more content to include enhanced software and services to further delight our user base and bring additional value to them. Investments in software and subscriptions are resulting in an expansive roadmap of new functionality for our Cricut Access subscribers.

One example is our Monogram Maker tool that we will be releasing soon and exclusively for subscribers. This addresses our popular use case. The tool now allows users to quickly create beautiful, personalized monograms from a wide variety of template designs and forms. Additionally, our Contributing Artist Program, which I mentioned in the last earnings call, has received great feedback from our beta users. We have made significant steps to extend the program to a broader audience over the next month, bringing more artists to the platform and a wide range of diverse content to our users. We have been increasingly advertising Cricut Access inside Design Space and now have the ability, capabilities to feature different messaging and upsell offers for Cricut Access and to measure the effectiveness of each of those placements inside Design Space.

Another opportunity for monetization is through Accessories and Materials with engagement as a key driver. The more users make the more materials they need. Our competitive advantage in Accessories and Materials is that we design materials to be seamlessly compatible within the Cricut ecosystem. This means that the materials are specifically designed with our software and Connected Machines in mind. This is an area of significant opportunity for us, 1 where we can differentiate from competitors. We will continue to work and partner with those retailers who will help bring these seamless experiences to the end consumer. We will continue to innovate and leverage our compatibility story to differentiate and drive demand for Cricut materials.

Although there is a lot of uncertainty in the current macro environment, we are as confident as ever about our medium- and long-term opportunity for growth. We continue to see a large opportunity to expand our nearly 7 million users over time, as we grow into new markets and retailers. Our focus is on driving deeper engagement, including improving the onboarding process, and making it easier for our new users beginning their journey.

Driving board engagement in turn leads to more opportunities to monetize the user base with Subscriptions and Accessories and Materials, we continue to invest in our future growth through continued innovation that will extend and expand our Connected platform. In turn, this will enable us to continue to deliver profits and delight users around the world. Notwithstanding the currently bumpy road, our foot is still squarely on the accelerator pedal of long-term growth.

I will now turn the call over to Kimball for more details on the financials.

[Kimball Shill, Chief Financial Officer]

Thank you, Ashish and good afternoon everyone. For those of you who haven’t met me yet, I have led Cricut’s operations and supply chain for the last 3 years. Our purpose-driven mission to help people lead creative lives is what inspires me and our teams every day. Our products foster mental health and wellbeing, entrepreneurship and community to millions of consumers around the globe. The diversity of our revenue streams and our proven track record of profitability allow us to operate Cricut through a long-term lens. I’m excited to be here today and look forward to meeting you all in the coming quarters.

In the first quarter, we delivered revenue of $244.8 million, a decline of 24% compared to prior year Q1, which benefited from a strong pandemic-related year-over-year growth rate of 125%. Looking at growth momentum over the long term, Q1 revenue was up 70% over the pre-pandemic comparative quarter of Q1 2020.

In our last call, we talked about our expectations for a reversion to historical seasonality as we emerge from the pandemic. In March, we also started to see softening in consumer demand, which we believe relates to current macroeconomic factors. That softness continues quarter-to-date. First quarter revenue was also impacted by higher channel inventory. As discussed on our last call, some retailers took a more proactive approach to manage their inventory and we entered Q1 with approximately $35 million in higher-than-normal channel inventory.

During the quarter, some retailers worked these inventory levels – worked down these inventory levels, while others continue to build their stocks. On a net basis, we estimate that these higher-than-normal channel inventory levels decreased by approximately 20%, but given current market conditions, this process may continue into Q3. We have no plans for additional promotional activity to move this inventory and believe higher channel fill is primarily a result of retailers own proactive approaches to managing inventory. We view these factors, tough year-over-year comps, softer consumer demand due to macroeconomic uncertainties, and higher inventory levels at retailers, as short term in nature. We continue to believe in our strong business fundamentals and our long-term growth trajectory.

Operating margins were up 70 basis points from Q1 2020 despite a nearly 250% increase in operating expenses over the same 2-year period. We delivered $23.5 million of net income in the first quarter, demonstrating a durable business model and our continued focus on profitability.

Breaking revenue down further, Connected Machines revenue was impacted by reduced consumer demand trends that began in March, as well as the higher-than-normal channel inventory positions that some of our retailers held entering the quarter. Revenue from Connected Machines was $62.4 million, down 56% year-over-year, compared to a pre-pandemic Q1 2020, Connected Machine revenues grew nearly 10% on a 2-year basis. Revenue from subscriptions was $64.8 million, up 40% over last year, and nearly 238% on a 2-year basis, driven by seasonally high machine sales in Q4 and prior investments made to increase the value in Cricut Access. Revenue from Accessories and Materials was $117.6 million, down 14% over last year, compared to the pre-pandemic Q1 2020 Accessories and Materials revenues grew 74% on a 2-year basis, reflecting growth in our engaged user base.

In terms of geographic breakdown, international markets grew as a percentage of the total business representing 15% of total revenues, compared to 10% in Q1 of the prior year. Revenues from international on a year-over-year basis increased by about 9%, with softness in our most mature markets like the UK, offset by growth in newer geographies. On a 2-year basis, international revenues have grown 285% compared to Q1 2020.

We continue to fuel our monetization flywheel for long-term growth. In the first quarter, we added over 495,000 new users and ended the quarter with more than 6.9 million total users. The number of users engaged on our platform for the 90-day period ending March was up 21% year-over-year climbing to 3.7 million engaged users. As a percentage of total users, user engagement was 54% in the first quarter, down from 62% in the prior year when we benefited from stay-at-home pandemic conditions. This was down on a sequential basis from 60%.

Typically, Q4 is our seasonal high and keep in mind, this calculation will fluctuate over time with seasonality and as we broaden our user base and expand into new verticals and use cases. We are increasingly attracting Gen Zs and beginner crafters, creating an opportunity for us in the medium to long-term, as we broaden the appeal of our products and our platform. Typically, beginner crafters will be less engaged at the start of their crafting journey, with significant opportunity for us to drive higher engagement over time.

As Ashish pointed out, onboarding and driving engagement is one of the top priorities for the company and we continue to invest in this area. We also saw a strong momentum with Cricut Access. The number of base subscribers grew by 696,000 on a year-over-year basis, ending the quarter with just over 2.3 million paid subscribers. Attach rates in the quarter rose to over 33%, up significantly from pre-pandemic periods when our attach rates were in the mid-20s.

Subscriber growth is fueled by Connected Machine sales and new user adds in the prior quarter, offset by a historically consistent level of churn against our now much larger user base – subscriber base, excuse me. Paid subscriber growth typically lags new user additions by about a quarter. As free trials end and users use a transition to pay subscription plans. As we look to the rest of the year, we expect pressure on subscriber growth, particularly in Q2 and Q3, as we navigate through the short-term environment of slower consumer demand and new user adds.

We measure 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 first quarter was $9.73, down slightly from $9.96 in Q1 2021. Accessories and Materials are proved closely relates to user engagement and channel inventory. ARPU from Accessories and Materials in the first quarter was $17.67. This compares to Q1 2021 ARPU of $29.45, which was higher due to unusually high engagement trends during COVID and also reflects heavier buying from our retailers, as they restocked depleted inventory levels at the beginning of last year. We have a strong focus on monetizing our growing user base through Subscriptions and Accessories and Materials. Keep in mind we grew our user base by 4.1 million users since Q1 2020.

Moving to gross margin, total gross margin in the first quarter was 40.5%, an improvement of over 13 points compared to Q4 2021 and up from 37% in Q1 last year. This represents the leverages in our business model associated with our diverse revenue streams, as a greater percentage of revenue in the quarter derived from Subscriptions and with new promotional strategies. You will recall comments during our last call regarding our efforts to improve our overall promotions policies, including new strategies to give us greater flexibility on a go-forward basis, enabling us to manage the business and support retail partnerships.

Breaking gross margin down further, gross margin from Connected Machines in the quarter was 2.7%. On a year-over-year basis, Connected Machine margin was down compared to 15.3% in Q1 2021, when we were at the height of the pandemic and saw elevated machine sales. The lower Connected Machine margin was the result of pricing on end-of-life machines and the impact of fixed cost was significantly lower unit volumes. In addition, on a year-over-year basis, Q1 2022 saw impact of elevated freight, warehousing and handling costs. As we move through 2022, we also anticipate the impact of increases to commodities and labor costs.

On a sequential basis, Connected Machine margins improved from prior quarter of negative 1.5%, as we took corrective actions through the promotional challenges during Q4. Gross margin from Subscriptions in the quarter was 90.2%, which is essentially flat year-over-year. Gross margin from Accessories and Materials in the first quarter was 33%, down from 41.7% in the prior year, primarily driven by higher costs, including higher freight and handling, as well as lower average selling prices.

Starting in Q2, we began to implement price increases. We are in the process of rolling these out with the retail and distribution partners across Connected Machines, Accessories and Materials, to help mitigate the impact of the recent cost escalations. We expect these actions to begin benefiting margins later in Q2 with a material impact in the second half of the year.

Moving on to operating expenses, we continue to significantly invest in the business with a disciplined focus, while making long-term improvements in operating margin. On a 2-year compare, we improved operating margin by 70 basis points, while more than doubling operating expenses. Total operating expenses in the first quarter were $67.6 million and included $8.9 million in stock-based compensation. This was an increase over the $55.6 million in Q1 of 2021, primarily reflecting continued investments that Ashish outlined. Total operating expenses as a percentage of revenue was 28% in Q1, an increase from 17% from a year ago, primarily due to lower revenues in the quarter.

Operating income for the first quarter was $31.4 million or 12.8% of revenue, compared to $64.7 million or 20% of revenue in Q1 2021, driven by lower revenues for the quarter and increased investments. As we navigate headwinds in the short-term, we remain focused on managing our resources and continuing to deliver healthy operating margins. Even though in the short-term, they will likely be below the long-term target range of 15% to 19%.

Our business remains durable with a healthy profitability profile. We delivered our 13th consecutive quarter of positive net income. Net income in the first quarter was $23.5 million, down from $49.4 million in Q1 of the prior year. Diluted earnings per share, was $0.11 compared to $0.24 in Q1 2021.

Turning now to the balance sheet and cash flow, our balance sheet is strong and enables us to navigate through periods of market volatility. We ended the quarter with $245 million – $245.7 million in cash and cash equivalents and healthy inventory levels. Our credit line of $150 million remains untapped. Cash generated from operations for the quarter was a positive $15.6 million. We plan to carry higher inventory levels to mitigate supply chain risks, as we continue to see long lead times for components and materials. We are carefully monitoring on risks and plan to manage down inventory levels to match as risks unwind.

Let me spend a few minutes talking about what we see as we look ahead to the rest of the year. As a reminder, Q2 is typically a softer quarter for us. Also, as we mentioned, we saw significant consumer softness starting in March, and that continues so far in Q2. Based on this, our target of reaching 8 million total users in this year will likely prove to be more challenging than we previously thought which will likely impact subscriber growth. As I mentioned earlier, new subscriber growth typically lags user growth. Therefore, we expect the number of paid subscribers in Q2 and Q3 to be flat or possibly decline, primarily related to fewer new user adds added to the platform.

We continue to see churn rates that are consistent with historical trends. We view this flat to decline in subscribers as short-term in nature. We remain focused on the user’s journey, which we believe will increase the value proposition and maximize user monetization. Looking at the long-term, we believe the trends that have driven our business over the last 8 years remain intact.

We are strongly confident in the unique value proposition that Cricut brings to millions of users and to the millions more around the world that we have an opportunity to bring to the Cricut platform. The significant growth in our user base over the last 2 years also provides opportunities to further drive engagement and monetization over a larger base of users. We are focused on managing our profitability while investing in areas with the highest impact, including improving onboarding, fostering higher levels of engagement, and innovating on our platform to drive growth in Cricut Access and our Accessories and Materials business.

We remain focused on driving profitable growth and are committed to our annual operating margin target of 15% to 19% over the long-term. In the short-term, as we continue to invest, we will likely be below this range by a few percentage points for the remainder of this year. We have a strong balance sheet, solid cash position and unique business model that enables us to navigate these uncertain times and remain focused on our long-term opportunities. We have a consistent track record of driving profitability, while managing our financial resources.

Our disciplined approach has been cultivated since 2014 and is ingrained in how we manage and operate our business model. The tremendous growth we’ve achieved, lays the foundation for us to scale and grow even further, and we are as focused as ever on optimizing the things that will truly drive our business forward.

With that, I’ll turn the call over to the operator for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Mark Altschwager from Baird. Your line is open.

[Unidentified Analyst]

Hello. This is [indiscernible] on for Mark this afternoon. To start off, could you give us a bit more color on what you were seeing with user engagement, what types of projects are consumers engaging in now versus 6 months ago? And we saw some amplified seasonality last summer. Do you expect that to play out similarly this year?

[Ashish Arora, Chief Executive Officer]

Yes. Let me take that, and Kimball could jump in. So I think when we look at engagement, I want to go back and make sure that we define what the – how we calculate the engagement percentage. So the way we calculate engagement percentage is the number of users that have cut in the last 90 days divided by all our user base, right? So to the entire user base, so we don’t graduate any user. In Q1, we – like typical seasons, we see a slowdown from Q4, because Q4 people are in the holidays. When we look at that engagement percentage number, we actually kind of look at two metrics in tandem, right? And we look at the total number of engaged users that are also engaged at that time. So just to give that number and just to kind of repeat that, at the end of Q1, we basically had 3.7 million engaged users, which is about 650,000 compared to the same quarter last year. So I think we expect an engagement to go down from a seasonality perspective. The range of projects that people are doing are – I mean, clearly, we had Valentine’s and more recently, we had Mother’s Day and Easter, we don’t see a big difference in the kind of projects people are doing, right? They are still doing cards and T-shirts and labels. And a lot of this also depends on what stories we tell. As Kimball talked about and I mentioned briefly, one of our core areas of focus is to drive onboarding and engagement. So we are working on a number of initiatives that we believe will help drive those numbers up. But again, it’s a very important metric for the company and we’re hyper focused on it.

[Unidentified Analyst]

Great, thank you for that. And then as a follow-up, how have you seen your customers respond to inflationary pressures in particular? You talked about bringing some more beginner crafters and Gen Z crafters into the network. Are you seeing any significant differences between the heavy users and those newer, younger customers?

[Ashish Arora, Chief Executive Officer]

Yes. So that’s a really good question. One of our core goals in this company has been to go beyond the super engaged enthusiast, right? And as we have launched retail partnerships, as we have partnered with influencers, our strategy has been to broaden and bring the creativity out in everybody, right? And so the fact that more beginners and intermediates are joining the platform, it’s somewhat by design and by strategy, where we believe that we want to make it easy and less time consuming for people to create things. So whether they want to organize their home, we want to bring creativity not just on special occasions, but in everyday life. The kind of projects that you would guess they are looking to do simpler projects. We have a lot of focus on helping people do things in 5 minutes or less. And then as they get engaged, to kind of bring them up the engagement curve over time. We will see a lot of innovation, as I talked about, in our software where we can bring these users on board. We have launched Cricut Learn as a platform for driving more education, as well as our platform itself basically will feature a significant amount of engagement.

I will give one more example. We recently launched our homepage, reduced with kind of one-dimensional right? And now the homepage is multi-dimensional where we have, we are featuring projects from the community. We are featuring projects for beginners and we see people bookmarking projects, saving projects, connecting with community members, etcetera. And we think that we are in the very, very early days of driving that rich engagement on our platform, which is even beyond cutting. And I think that’s something that is particularly helpful to – for new beginners. So as I said, we will stay very focused on expanding and bringing creativity in everyday life, and then complementing that with the infrastructure on our platform to help drive that. So if you talk about crossing the chasm, we’re really focused on that. And we are proud of what our teams have done, and I think we have long ways to go.

[Unidentified Analyst]

Alright. Thank you. I will pass it on.

[Operator]

Your next question comes from the line of Erik Woodring from Morgan Stanley. Your line is open.

[Erik Woodring, Morgan Stanley]

Hey, good afternoon, guys. Thank you for taking my questions. Maybe Ashish, I’ll start one with you. Obviously, without giving too many details beyond what you’d be comfortable sharing. Maybe can you just elaborate a bit on kind of what excites you so much about the 3 to 6-months product road map, meaning would these products be TAM expanders or maybe how can we think about their fit within your ecosystem? And then just adding to that, does the consumer demand environment impact the way that you are thinking about the product launch road map or what products to come out with or the price points to come out with? And then I have a follow-up.

[Ashish Arora, Chief Executive Officer]

How much time do you have Erik?

[Erik Woodring, Morgan Stanley]

As much as you want.

[Ashish Arora, Chief Executive Officer]

You ask a product CEO, what’s in the road map, and he can go on forever. I think there is a number of exciting things that I’m proud of. Our team just launched a number of products in the heat press category. We launched a Hat Press, which gave people the ability to personalize hats. We launched a consumer focused product at $1,000 that we can talk about the Auto Press and as well as we have upgraded our Easy Press line, and we have tons of innovation coming. I think the thing that excites me the most over the next 3 to 6 months is our platform. And again, what I mean by our platform is Cricut Design Space. It’s the mobile app. As I said, there is a number of things that we are doing that will help drive onboarding. There is a number of things that we are doing to make it easier for the community to connect with each other, to be inspired, to share projects with each other. And I think all of that will really lay the foundation for monetization. The next thing I would say, just building on that track is, we have massive amount of effort going on in helping improve Cricut Access. So we talked about the Contributing Artist Program that will massively expand the library of content and the diversity of content, the genres of content, not just within the U.S. but also globally.

We are – in addition to expanding the content library I briefly mentioned this word editable content. Well, what I mean by that is that the people will be able to manipulate content exponentially easier than what they can do today. And we are complementing that content with services such as a software tools such as Monogram Maker. Monogram Maker is a perfect example of matching that to a road map. As we have beginner crafters come in, how do you make it really easy for them to do something that they love doing, which is making a monogram. And they can do that within a couple of clicks. So that’s kind of a few of the examples of the road – of the platform, but I think as we achieve more parity between mobile and desktop, I think that will really enable us to not only enrich the products that are in the market today, but also allow us to introduce new products in new categories that are beyond cutting machines. So that product life cycle is a little bit longer, but we have been working on technologies and innovations that can really expand what Cricut means to people beyond the cutting machine. So those are all the things that I am excited about and I hope I answered most of your questions.

[Erik Woodring, Morgan Stanley]

Yes. No, no, no, that’s perfect. Maybe just as a follow-up, obviously, there is a lot of moving pieces, a lot of dynamics going on in the market. So just to kind of help level set and make sure we’re thinking about it correctly – 2Q correctly from a seasonality perspective. If we look back over the past few years, there is been quarters where June is up fairly strong. Obviously, during the pandemic last year, we were up kind of low single digits. Given the commentary that you provided, should we think about both net new users and total revenue being down sequentially? And just maybe any guidance you can provide on kind of the magnitude of that, again, just so we can kind of all level set where expectations might be for June to the best of your ability?

[Ashish Arora, Chief Executive Officer]

Obviously, we’re not providing any specific quarterly guidance, but let me kind of talk about the number that we have talked about and hopefully it addresses some of the aspects of your question. As we said in the last earnings call, we’ve basically talked about 8 million users at the end of 2022. And as you can see from Q1, we added 495,000 users, which is even higher than we expected. So it was a strong – and that was driven by a strong sell-through in Q4 last year. January and February looked very typical months from a seasonality perspective, and we are fairly satisfied with how those performed. Starting March, things slowed down and again, a number of factors that you probably are aware of from inflation, to sentiment, to pandemic opening, etcetera. One thing that I didn’t talk about in our prepared remarks as we saw Mother’s Day, Mother’s Day kind of brought a similar level of excitement that we have seen in the previous years, at least week over week, month over month, where whether it was people searching for our brand or excitement about the brand, there is a lot of that. And that gives me confidence that as we go into while we will see a continued slow growth in users for the next couple of quarters, we believe that as we head into Q4, the same kind of thing that drives Cricut every year, which is holidays and Halloween and Christmas and gift giving and home decoration, will be the growth drivers. Now that may not be enough to offset the slower growth in Q2 and Q3. One thing I want to highlight is that unlike other platforms, unlike other categories, where there is a lot of alternatives for people, I don’t believe that there is an expansive platform like us from a creativity perspective. So, when that demand does come back, because people are always going to make T-shirts and do guests and everything else, we don’t think that’s going to go away. We believe they will be the platform of choice, and that’s what gives me confidence. I know you asked me this question specifically in the shorter term, but I do want to address why I am very optimistic and confident about the medium to long-term, because again, as I have said before, the trends on personalization, on social media marketplaces, the fact that people want to sell things haven’t changed. And they are so early on in our brand awareness and familiarity. So, as we improve engagement as we help people make for projects, we think it will drive word of mouth. So, again, we just have to get past the short-term macroeconomic challenges, but we remain fairly confident with our strategy and what we need to do to drive growth going forward in the medium-term.

[Erik Woodring, Morgan Stanley]

Alright. Thank you for the color, Ashish. I appreciate that.

[Operator]

Your next question comes from the line of Jim Suva from Citigroup. Your line is open.

[Jim Suva, Citigroup]

Thank you very much. I have a first question, probably for Kimball. And that is when you mentioned the subscribers likely to be soft or going down, I think you mean on an absolute basis, not a deceleration basis like the numbers of subscribers actually going down, not deceleration, if I heard that right. And if so, I followed your company since IPO time and I don’t recall a quarter of subscriber growth actually going down. And maybe that’s because we would lived in a world of COVID for the past 2.5 years. But looking back historically more, are there normal periods of normally Q2 should be down, or are they just because of coming back to meeting with people out of society and out of COVID that now it’s kind of an abnormality that we see subscribers going down? Thank you.

[Kimball Shill, Chief Financial Officer]

Thanks for the question, Jim. So, really, there is three factors that go into overall subscriber growth. And the first and most important factor is machine sell-through that drives new user adds that leads to subscribers. Second is churn, which has been fairly consistent with the natural level of churn over the long-term. And then reactivations during the period, where subscribers will drop out and come back in. And the largest factor is just lower consumer demand and as we go through the next couple of quarters that will put pressure on subscriber growth. And just to be clear, we are talking about total subscribers as opposed to just the rate of subscription. Our attach rate remains very high. We are at our highest point with slightly over 33% attach rate compared to a pre-pandemic mid-20s in our attach rate. Looking forward, we do expect to return to growth in Q4, as we move into our more normal seasonal high and machine sales pick up. In the meantime, I just want to reinforce that we are continuing to invest in the value of our Cricut Access and subscription products and that’s manifested with the attach rates I talked about. But also we are starting to move the needle on reactivations, but it’s not enough to overcome just the drop in consumer demand and the impact of that.

[Jim Suva, Citigroup]

Right. But historically, have there been periods like pre-IPO works pretty normal, or is this subscriber going down, kind of just an abnormal bump that we should not consider to be a normal thing of the past and going forward?

[Kimball Shill, Chief Financial Officer]

This is – I call it, it’s a bump.

[Jim Suva, Citigroup]

Okay.

[Kimball Shill, Chief Financial Officer]

And part of it is I talked about kind of that natural level of churn. We have a much larger subscriber base than we did 2 years ago, right. And our churn rate hasn’t increased, but we still have a fairly consistent level of churn. And as growth moderates in this near-term – in the near-term, it just works out that way, but we expect to resume growth in Q4.

[Jim Suva, Citigroup]

Okay. And then a question for Ashish on more strategy, in your prepared comments, you mentioned your excitement for the next 3 months to 6 months. Is that more on like enhancements of software and enhancements to your ecosystem, or is that on new physical products as we think about your excitement?

[Ashish Arora, Chief Executive Officer]

Yes. So, I think for the – we have talked about building new types of technologies and innovations that will leverage our platform. But when I really talk about the next three months to six months, I am mostly talking about the platform. Because I think there is a significant opportunity to onboard users better, to drive higher levels of engagement and a fair amount of focus on driving Cricut Access, which is a subscription product. And so we have been working on a variety of software. We have been working with the contributing artists program. So, that’s what I would say we have definitely accelerated our efforts in driving those three things, because they are kind of all related. The more engage users we have, it will drive higher level of subscribers. So, I would say, for the next three months to six months, what we will be able share – what we will be able to share publicly is all in the software platform arena. I mean clearly, as hardware and new technologies take a lot longer, we are feverishly working on some exciting new things that we will be launching in the next couple of years. But at this point, I am talking primarily about our software platform.

[Jim Suva, Citigroup]

Great. Thanks so much for the details and right now, I’m actually drinking out of my Cricut Mug some hot cocoa. So, I figured out the onboarding and user experience at least. Thank you so much.

[Ashish Arora, Chief Executive Officer]

Thank you.

[Operator]

Your next question comes from the line of Rod Hall from Goldman Sachs. Your line is open.

[Unidentified Analyst]

Hi. Thanks for taking my questions. This is Bala on for Rod. I guess I want to actually start with softness in consumer demand in March. Could you maybe elaborate a bit more on it? It looks like you are seeing that weakness both in terms of new users, given that you lowered the full year user adds guidance. And also, it looks like engagement has come down too. So, is it more or less across the board, both in terms of engagement and also a new user onboarding? And I have a follow-up.

[Ashish Arora, Chief Executive Officer]

Yes. So I think Bala, as we mentioned, like new user adds are driven by machine sell-through, right. So, stuff that we stored in October, November, December, that has a certain lag that time people come off their trial subscriptions. So, in March, we didn’t necessarily see a slowdown in the number of user adds compared to our expectations. What we saw was a slowdown in machine sell-through, which will then impact Q2 and Q3. I think like I said, from an engagement perspective, we saw January and February similar to the typical seasonality we see coming off Q4. So, we didn’t necessarily see anything remarkably different. And we clearly saw, I think what we attribute to the effects of inflation, consumer spending, maybe even return to office and the stresses that puts on life, etcetera. One insight that we have that we not specifically talked about is, the feedback that we get when we talk about engagement and research our user base, is they have all intentions of engaging, they are just out of time, right. So, it’s something that we are focusing on heavily as to how do we make it easier and less time-consuming for people to do some of the things. But again, as I have said, the user adds stayed fairly healthy and consistent with expectations. That’s why we added 495,000 users in Q1. It’s the sell-through and maybe – and somewhat engagement that we saw slow down in March, that will then manifest itself in the next few months.

[Unidentified Analyst]

That makes sense. And for a follow-up, I guess I am wondering, in an environment like this where consumer demand is weakening. Do you plan to go after chasing new users by doing more promotions or do you just plan to continue to be disciplined and focus on profitability? I guess I better – I wanted to better understand your strategy, especially in an environment like this.

[Ashish Arora, Chief Executive Officer]

Yes. So Bala, that’s a really good question. And I will answer it slightly differently for our accessories and materials versus our machines. So, I think as we have talked about before, we have been very thoughtful about our promotional strategy. It’s a very challenging consumer spending environment. And we don’t believe that it’s the right thing for the long-term business to be highly promotional and leave money on the table. And it also kind of destroys like, to some degree, dilute the value of our brand. What we would like to do is, enhance the value, both in terms of functionality and the things that people can do with our products and also make it significantly easier, right. So, our goal is – and typically, that’s what you see with all major brands is that pricing and brand value can go hand-in-hand. And we think that our current strategy of being less promotional that we have talked about is the right strategy for us. What we would like to do is, we have 7 million users on our platform, right. And our goal is to help drive engagement and help improve the overall experience, because we know even though it’s not a short gun approach, we know that when those users are more engaged, they will make more projects and they will tell their friends and family, and as some of these short-term macroeconomic factors go away, that will help drive demand for the overall product. And again, we as a company have always taken a very long-term view of the world, and we think we are sound in our strategy, and we need to continue to execute on it in a very disciplined and profitable way. That’s just core to our ethos and how we grew up. On the material side, we are working very hard to improve the value of our materials, both in terms of how users perceive the value of our materials, but also in giving them value. Because everybody is worried about their gas bills and their food expenses, etcetera. So, we are being a little bit more promotional on materials and accessories in that category versus machines. And I think we are going to, at least for now, stay pretty strong – sound on our strategy of being less promotional and really kind of focusing on the basics of the business. It’s really a time for us to just get back to the basics, and we think is the right thing for us to do.

[Unidentified Analyst]

Very helpful, Ashish. And I got a follow-up for Kimball, if I may. Just want to touch base on gross margins. Clearly, they were better in the quarter. Mix helped a lot. Going through the year, how should we think about gross margins and a weakening consumer demand environment? Any color there would be helpful, Kimball?

[Kimball Shill, Chief Financial Officer]

Yes. So, as we mentioned in our prepared remarks, we remain committed to our long-term operating margins of 15% to 19%. We do think for the rest of the year, we will be a few points below that. And gross margins this quarter benefited, as you called out, from a mix of revenue. So, to the extent that accessories and materials, and subscriptions were a larger part of the mix, that actually helped our gross margins in the quarter. Overall, the machine revenue was about 25%, when usually – it’s usually using in the low-40s. And so – we expect gross margins to continue – I guess continue at current rates until we see the machine sell-through pick up. And so especially as we get to the fourth quarter, which is typically our highest season – our highest quarter for machine sell-through, that’s how we are looking at gross margin.

[Ashish Arora, Chief Executive Officer]

And our goal as a company is to continue to drive profitable growth. Now clearly, there is just a lot of uncertainty in the world out there. And a lot of it’s going to depend on just inflation and commodity costs and everything else. But our strategy is, as I said, we want to be less promotional on machines. We want to continue to drive subscription access product, and we want to give more value. So, how everything plays out, it’s really hard to predict in the shorter term, but our general strategy is to get back from an operating margin standpoint of 15% to 19%, but when that happens is a question at this point.

[Unidentified Analyst]

Got it. Thanks very much.

[Operator]

Your next question comes from the line of Paul Kearney from Barclays. Your line is open.

[Paul Kearney, Barclays]

Hi everybody. Thanks for taking my question. I was wondering if you can comment on quarter-to-date trends of engaged users. Are you on track to grow sequentially in terms of an absolute number of engaged users? And then also, longer term, how should we think about your targets for engaged user growth?

[Ashish Arora, Chief Executive Officer]

Yes. We haven’t really given specific guidance on the number of engaged users. As I said, we look at the two numbers in tandem with each other. One is the percentage engagement, which is again, where we divided by the total installed base. And the second is the total number of engaged users. So, I think it’s – for the year, given our focus that we are going to – and I think we will see some of these initiatives manifest themselves towards the later part of the year. Our goal is to look at that number as – probably even provide a more richer variation of that, right. So, today, we define engagement in a very narrow specific way, but our goal is to continue to drive engagement. Now from a number of users standpoint, like again, we obviously don’t graduate user base, so we will see the same – you will see user base continue to grow.

[Paul Kearney, Barclays]

Understood. And then you mentioned, I think there is pricing initiatives that are in place starting in 3Q. I was wondering if you can just provide more detail on that. Is it both in connected machines and accessories? And is it in all channels as well? And also, how do you kind of reconcile that with the promotions – the recent promotional activity?

[Ashish Arora, Chief Executive Officer]

So, we are in the process of rolling out price increases across all of our physical segments. So, machine – both machines, and accessories and materials. And that’s still a work-in-process. And so we will see some benefit of that in Q2, but that’s mostly going to impact the second half of the year.

[Paul Kearney, Barclays]

Understood. And is it like-for-like price increases, or is this through innovation in new products?

[Ashish Arora, Chief Executive Officer]

Well, so the price increases – so could you repeat your question again? Sorry.

[Paul Kearney, Barclays]

I am just – I am wondering, are the price increases, are they like-for-like, right? Price increases as in same product from last year, or are you introducing price more so through innovation and new products? Thank you.

[Ashish Arora, Chief Executive Officer]

Yes. So, I think, there is a couple of things going on. For – we are actually – when we are rolling out price increases, therefore, all our products across the board. What is going to change is the mix of the products. We have a couple of products that are end of life. And as we go through the year, some of those products will go away, that will actually have a positive impact on gross margins, but the pricing increase that we implemented are mostly across the board, but we are just trying to work through some of the inventories.

[Paul Kearney, Barclays]

Okay. Thank you.

[Operator]

Your last question comes from the line of Erik Woodring from Morgan Stanley. Your line is open.

[Erik Woodring, Morgan Stanley]

Hey guys. Sorry, I just wanted to ask one follow-up question to Jim’s question earlier, and that was when we are talking about the trajectory of subscribers. Those comments about flat to decline or growth in 4Q, those are on a sequential basis, correct, and not a year-over-year basis?

[Kimball Shill, Chief Financial Officer]

Yes, that is correct.

[Erik Woodring, Morgan Stanley]

Okay. That was just a clarification. Thanks.

[Operator]

There are no further questions at this time. Ladies and gentlemen, this concludes today’s conference. Thank you for your participation, and have a wonderful day. You may all disconnect.