Cricut Inc

NASDAQ:CRCT

Earnings Call Transcript 2021-Q3

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Cricut Q3 2021 Conference Call. At this time all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Stacie Clements, Investor Relations at the Blue Shirt Group. Thank you. Please go ahead.

[Stacie Clements, Investor Relations-Blue Shirt Group]

Thank you, operator, and good afternoon, everyone. Thank you for joining us on Cricut's Third Quarter 2021 Earnings Call. Please note that today's call is being webcast on the Investor Relations section of the company's website. A replay of the webcast will also be available following today's call. For your reference, prepared remarks and the accompanying slides used on today's call will also be posted to the Investor Relations section of the company's website, investor.cree.com. Joining me on the call today are Ashish Alora, Chief Executive Officer; and Marty Petersen, Chief Financial Officer.

Before we begin, we would like to remind everyone that our prepared remarks contain forward-looking statements, and management may make 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-Q. Actual events or results could differ materially.

All non-GAAP numbers referenced in today's call are reconciled in the press release or the slide presentation on our Investor Relations website. This call also contains time-sensitive information that is accurate only as of the date of this broadcast, November 10, 2021. Cricut assumes no obligation to update any forward-looking projections that may include – that may be made in today's release or call.

I will now turn the call over to Ashish.

[Ashish Arora, President and Chief Executive Officer]

Thank you, Stacie, and welcome, everyone. We are pleased with the results in the third quarter. Total revenue grew 24.4% year-over-year driven by growth across all three categories: connected machines, subscriptions and accessories and materials. We delivered an EBITDA margin of just over 16.4% while at the same time increased investments in connected software, subscriptions, new product developments and international expansion.

We remain focused on our mission to help people lead creative lives. Our user base grew to over 5.7 million users at the end of the third quarter, up 56% year-over-year. Over 2 million of these users were acquired over the last 12 months. One thing I love is that our corporate cohort of users is engaging very similarly to our pre-COVID cohort of users. This means that we have an opportunity to fuel our viral marketing engine as these 2 million new users make and share projects.

Our job is to continue to provide a superior experience and drive engagement from existing and new users. Of the 5.7 million users, 3.2 million used their connected machines within the last 90 days, an increase of 37% from the same quarter last year. One of the many ways we monetize this engagement is through our subscription service, Cricut Access. The number of subscribers and subscription ARPU over time are important indicators of our success. We ended the third quarter with over 1.8 million paid subscribers or an attach rate of 32%, consistent with the accelerated attach rate seen last year due to the pandemic.

Since 2018, attach rates have grown nearly 10 percentage points, a testament to the success of our investments and in driving increased user monetization over time. As we expand the use cases of our connected platform, we expand our potential user base or serviceable addressable market. For example, the launch of Cricut Joy last year enabled us to reach a more mainstream user base like small business owners and teachers. The Cricut Joy gave us an opportunity to expand our retail partnerships with mass merchant retailers like Target, Walmart and specialty retailers such as the container store. We also expanded into new verticals such as office supply and consumer electronics retailers around the world. These users may start off using our platform for one or two use cases such as label-making reorganization, but we have a significant opportunity to expand their level of engagement over time.

We continue to aggressively add content to Cricut Access, now with over 200,000 images up from 175,000 images at the end of Q2. We added new genres, projects for new use cases, relevant content for international markets and more. We also continue to improve the user experience adding new features and functionality exclusive to Cricut members – Cricut Access members. For example, in October, we launched a feature called Automatic Background Remover, eliminating the need to manually clean and uploaded image.

Our passionate community of users provides a flywheel. The more they create, the more Cricut benefits from the network effects that drive new user acquisition and engagement. These communities around the world are organic by nature and serve as a competitive moat for us. Our users are at the center of everything we do, and we take great pride in fostering these communities.

By aligning our value with those of our users, great things can happen. Through our Make It Forward program, we partner with organizations to help inspire and spread joy to others. Most recently, we partnered with the Birthday Party Project, challenging users within our community to make 5,000 projects in five weeks for donation to help underprivileged kids celebrate their birthdays. Projects included cards, water bottles, banners, T-shirts, puzzles, stickers and coloring pages for kids to receive on their birthday. I’m proud to say that we exceeded expectations with over 11,000 projects made and donated. There is no doubt that our community continues to deliver above and beyond.

Our users inspire us every day to do our best for them so they can do their very best. This summer, we also saw amazing projects for outdoor events such as weddings, vacations, family reunions, baby events and, of course, back-to-school. As we head into the fourth quarter, our seasonally strongest quarter, we are already seeing inspirational projects focused on holiday decor and gifts from our growing user base.

As I mentioned earlier, over 40% of new customers first hear about Cricut through word of mouth, providing a powerful and cost-effective marketing engine for new user acquisition. We now have over 5.3 million social media followers and 2.8 billion views on #Cricut on TikTok, which are almost entirely organic. We will continue to foster these communities, amplify their voices and share their amazing work.

In addition, we’ve created an expanded set – suite of tutorial videos how to guide live online classes and inspirational ideas for projects and use cases to help drive engagement. For example, our back-to-school classroom organization how-to provides a list of ideas to beginner-level users. We include a list of materials and supplies needed and step-by-step instructions for each project. Earlier this year, we launched our live online classes. And to date, more than 20,000 users have already participated with very high satisfaction rates. More recently, in October, we launched Cricut Learn, a comprehensive resource featuring short expert-led video education as well as live interactive virtual classes. We are very excited about this new tool to help onboard users and drive engagement.

Revenue from international markets continues to outpace revenue growth from North America, growing approximately 110% year-over-year in the third quarter. I’m excited to have officially entered the Middle East and Hong Kong markets. We also made significant investments expanding our international retailer footprint. We entered partnerships in newer markets such as Germany, the Nordics, Benelux, Spain, Mexico, South Africa and Singapore. In more mature markets such as the U.K., Australia and France, we continue to diversify retail relationships, allowing us to reach new audiences and use cases in these markets. In Q2, we rolled out our e-commerce site in the U.K. In Q3, we expanded the strategy, bringing a direct-to-consumer branded experience to users in Ireland, France and Germany.

We are really excited about our international opportunity. Our observation is that the motivations and behaviors driving international growth are very similar to those that have driven growth in North America since 2014. The proven Cricut playbook invest in delivering great experiences to users that they will show and tell to others can be executed across the globe.

With this large opportunity in front of us and our momentum to date, we plan to increase investment to accelerate our international expansion.

We also continue to invest heavily in our platform, including new features and functionality within our design apps. For example, our new Restore Brush feature enables users to selectively restore any part of an image that may have been accidentally removed. We have also introduced a featured images ribbon on the home screen of design space that highlights our freshest and best content. Coupled with the new ability to book [park] images, we are focused on providing increased visibility and easy access to our ever-growing library of images. We have made major strides in improving our mobile apps with ongoing work to migrate both our iOS and Android apps to all new technology stacks that will provide the foundation for richer design experiences. They are currently in public beta with our new iOS app and be launched broadly in the coming weeks with the new Android version coming soon. We continue to accelerate investments in our software platform, mobile experiences and data to drive the best user experience possible.

Before I conclude my remarks, I want to highlight the incredible work from our operations and product teams who have worked tirelessly to help mitigate supply chain risks. Their work to secure components in advance and rewritten firmware to accommodate real-time component substitutions were necessary. These teams have delivered their Cricut values, always finding a way to serve our customers.

Overall, I’m very pleased with the quarter and the momentum of the business. We continue to add users onto the platform. We are investing in new products, improving the user experience and growing the number of engaged users. Cricut is gaining worldwide visibility in new retailers and markets, and I couldn't be more thrilled about the opportunities in front of us. We continue to invest, drive growth, deliver profits and delight users around the world.

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

[Marty Petersen, Chief Financial Officer]

Thank you, Ashish, and good afternoon, everyone. Our third quarter's performance was driven by strong fundamentals in the business, a diversified revenue stream and our powerful community of users. To understand the health and trajectory of the business, we focus on annual trends, which normalize for seasonality. Normalizing for the effects of the pandemic, we believe looking at financial performance on a two-year stacked basis is helpful.

Revenue in the quarter was $260.1 million, an increase of 24.4% over Q3 last year, and 131% since Q3 2019, a solid performance off a tough comp last year and a continuation of our long history of consistent revenue growth. Revenue from Connected Machines grew 35.7% over Q3 last year. As a reminder, the gross profit from Connected Machine purchases mostly covers our customer acquisition cost. The purchase then triggers a flywheel of engagement which in turn drives ongoing revenue from our higher margin categories of Subscriptions and Accessories and Materials.

Strong machine sales and healthy attach rates from our growing base of users helped drive 70.8% revenue growth in Subscriptions in the quarter. Accessories and Materials revenue grew 2% over a tough comp last year when engagement on the platform was quickly rising due to the pandemic and stay-at-home orders at the time.

In terms of geographic breakdown, international revenue growth continued to outpace growth in North America, increasing 109.7% in the third quarter over the same quarter in 2020. We’ve made significant investments to grow our opportunity and foster a global community of users. As a percentage of total revenue, International represented 12% in the third quarter, up from 7.1% in Q3 2020. As Ashish mentioned, we continued to rapidly grow our user base. As of the end of the third quarter, we have added 1.4 million users in 2021, bringing the total users on our platform to 5.7 million.

In the third quarter, the number of users engaged on our platform for the prior 90 days increased by almost 900,000, up 37.4% over the same period last year. As a percentage of total users, however, user engagement was 56%, down from a COVID-aided 63% in Q3 2020. As we said last quarter, we anticipated engagement on the platform to be softer than normal and to last longer than normal as people spend more time out of the home. Since late September, we have seen user engagement levels trending up.

Ending paid subscribers kept pace with user growth, growing to more than 1.8 million, up 55.8% over third quarter 2020. This equates to an attach rate of 32%, up slightly from Q3 2020 and up significantly from pre-pandemic levels and is a result of the investments we’ve made in subscription services to further monetize our growing user base.

We measure user monetization through ARPU 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 third quarter remained healthy at $9.60, up from $8.97 in Q3 2020, and reflected the relatively high attach rates I just mentioned.

ARPU from Accessories and Materials in the third quarter was $18.79. This compares to Q3 2020 APRU of $29.41, which benefited from higher-than-normal engagement levels related to the pandemic and some catch up on channel inventory in 2020. Accessories and Materials ARPU closely relates to engagement. As expected, the number of engaged users increased in the quarter, but the general project activity was lower than normal, putting some downward pressure on Accessories & Materials ARPU. We expect engagement and ARPU to improve sequentially, especially around the holidays at year-end.

Moving onto gross margin. Total gross margin in the third quarter was 39.2%, down from an unusually high 42.8% in the third quarter of 2020. The decrease was primarily due to higher freight costs and significantly lower promotional activity in 2020 associated with lower inventory levels from the pandemic surge in demand. In Q3 2021, we returned to a more normal promotional cadence given that we were able to reestablish healthy inventory positions. We also benefited this quarter from the highest proportion of subscription revenue in our history, which commands high margins.

We expect gross margin in Q4 to come down on a sequential basis, which is typical due to more promotional activities with the holiday season.

I want to take a moment and talk about the tremendous progress we have made to enhance our supply chain. We are subject to the same dynamics that are affecting companies all over the world. As Ashish mentioned, in the face of these global challenges, our teams have worked hard to strengthen our inventory positions and helped mitigate future risks. Over a year ago, we began making key investments to accelerate the purchase of long lead time components, including chips.

We also increased inventory levels in connect machines and accessories and materials and positioned onshore inventory to mitigate shipping delays. We’re in a strong position – we are in a strong inventory position today, particularly as we head into the holiday season. And as discussed previously, we’ll continue to carry higher inventory levels into 2022 until we are comfortable that supply chain risks have improved. On the cost side, we are experiencing inflationary pressure just like other importers. To offset these costs, we will continue to take a proactive approach in managing margins, including possible price increases.

Moving on to operating expenses. Total operating expenses in the third quarter were $64.3 million and included $8.1 million in stock-based compensation. This was an increase over Q3 2020 of $32.5 million when spending was unusually low or paused as we navigated the uncertainties of the pandemic.

Total operating expenses as a percentage of revenue were 24.7%. This is higher than the prior year figure of 15.2%, reflecting increased investments in sales and marketing and R&D to help build out the platform and drive future growth, including international growth. About 1/3 of the overall increase was attributed to personnel, a little more than half of which was in the form of stock-based compensation, which increased as a result of our IPO in March with the balance coming from adding to our talent pool, especially in R&D.

Roughly 1/4 of our total operating expense increase came from advertising and marketing, where we leaned into international expansion and continue to foster influencer relationships. Most of the balance was catching up to unusually low spending across all categories during the pandemic. We delivered our 11th consecutive quarter of positive net income. Net income in the third quarter was $30 million, down 33.6% from the same period last year, in part due to the increased investments I just mentioned. Diluted earnings per share was $0.13. Note that Cricut did not have a comparable EPS history prior to the reorganization at the time of the IPO.

Turning to EBITDA, which includes $8.1 million of stock-based compensation expense, we delivered EBITDA of $42.7 million or 16.4% margin in the third quarter just shy of our long-term annual EBITDA target of 17% to 20%. Q3 2020 EBITDA margin of 29.2% was unusually high, benefiting from strong pandemic dynamics. On a two-year stack basis, EBITDA has grown 256% over 2019.

Turning now to the balance sheet and cash flow. We ended the quarter with $224 million in cash and cash equivalents. Our credit line of $150 million remains untapped. Cash used in operations for the nine months ended September was $130.8 million, reflecting payments for building inventory reserves to help mitigate the supply chain risk mentioned earlier.

Overall, we’re pleased with the quarter and our progress to date. With our base of over 5.7 million, we – users, we have a large market opportunity in front of us. We have taken a long-term approach to our growth strategy and are choosing not to give short-term guidance. However, I would like to provide some color as we head into Q4 and our typically strong holiday season.

For the full year 2021, we are now increasing our expectations to add approximately 2 million new users, up from 1.8 million new users added in 2020. We have already added 1.4 million in the first nine months. This foundation of new users acquired through connected machine purchases fuels further growth and profitability. Most importantly, engagement from the users we’ve acquired during COVID remains very similar to the engagement patterns of users acquired pre-COVID. With the upcoming holidays approaching, we are seeing increased engagement across our platform, up from the trough we saw in late September. For the fourth quarter, we expect the number of engaged users to increase year-over-year, but the percentage of users engaged to be down from the tough year-over-year comp.

On a sequential basis, accessories and materials ARPU will likely increase from Q3. With increased engagement leading into the holidays – with – however, on a year-over-year basis, we expect accessories and materials ARPU to decline significantly. Last year, we benefited from strong engagement related to the holiday season and significantly higher sell-in from replenishing depleted channel inventories. Subscription ARPU in Q4 will likely remain relatively consistent with Q3.

Our EBITDA margins are on pace to fall within our long-term EBITDA target range of 17% to 20% for the full year 2021. The fundamentals of our business remain sound. We continue to drive new users and healthy engagement. We have a durable business model with a seven-year track record of driving both revenue and profits and remain focused on running our business for the long-term.

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

[Operator]

[Operator Instructions] Your first question comes from the line of Rod Hall from Goldman Sachs. Your line is now open.

[Unidentified Analyst]

Hi, thanks for taking my question. This is Bala on for Rod. Ashish, I want to start with the engagement rate metric? So, it’s down again materially this quarter, and it sounds like it is somewhat worse than what you had expected. But then it is good to hear that from September, it sounds like engagement metric – our engagement rate is improving. So, I just want to understand how you’re thinking about the December quarter. I know holiday season is really late November and into the month of December, so you’re not probably seeing the full extent of trends. But any initial thoughts on how you’re thinking about the December quarter and I got a follow-up.

[Ashish Alora]

Yes. So, thanks, Bala. I know the question was on engagement, so let me just start off by first – start with the acquisition, because I think that’s the pool of people that we use to engage. So, as we said, we’ve added 1.4 million users through the end of Q3 and expect to add up to 2 million users this year, which is up from 1.8 million that we had said previously. So that’s a good starting point for us to drive more engagement. The second thing, one of the things that we focus on inside is we are looking at the total number of engaged users and how that number is increasing year-over-year. And that number, we saw increased 37%, which, again, is a very positive sign.

From a standpoint of engagement as we look forward, I want to kind of highlight a few things. One is that we’ve acquired a very high-quality customer during COVID, right? So, the 2020 cohort was very similar to the pre-2020 cohort, which means that we have an opportunity to engage them as activity levels pick up. The second is that the trends that – including personalization that drove people to the cricket platform prior to the pandemic are still intact. Even though we saw an exaggerated summer where people doubled down on things that they hadn’t done for 2020, we see that number increasing and the engagement increasing. Like we said, we’ve already seen engagement rise since the end of September.

And when they do come back, right, because people will always still want to create, they want to make things, they want to do the projects, similar to what they wanted to do before the pandemic, and when they come back when they are starting to get engaged, we believe that there are very few, if any, substitute platforms for them to go to. And our job is to continue – is going to be to get them to our platform, get them more engaged and having them make more projects. So, we are really taking a very holistic long-term approach, and we think that there’s lots of the positive things that were in place, leading up to the pandemic are still in place, and we have a good opportunity to attract those users.

[Unidentified Analyst]

That’s helpful. On the picking up in this engagement rate, any color on maybe user behavior in different cohorts or different use cases such as maybe in education or holiday or events-related, et cetera? Any color there, Ashish?

[Ashish Alora]

Yes. So, I think there’s a couple of things that we mentioned in our remarks. One is that, as I said, the cohorts are behaving very similarly in terms of engagement, right? Another thing that we mentioned was that engagement was not only were the number of people that we engage is down, but also the total engagement was somewhat lower across the board. But like we had a great run up to Halloween. People are making the same kinds of things. And we believe that with all the efforts that we are putting in place like the typical holiday behaviors of making gifts, making projects that are in the holiday spirit, we don’t see anything unusual. In fact, if anything, we see the number of use cases broadening. We’re very excited about some of the new apps and new functionality we’ve created. So no, I don’t think there’s anything unusual that I want to highlight

[Marty Petersen, Chief Financial Officer]

Just one clarification. Ashish said that the number of users engaged was down. That’s actually – he’s referring to the percentage of total users that engages them. The actual number of engaged users is up quarter or year-over-year by about 900,000 or 37%. Just wanted to make that clarification.

[Ashish Alora]

Thanks for clarifying that, Marty.

[Unidentified Analyst]

Got it, Marty. And one follow-up, if I may. The ARPU here for the access and materials is down significantly even if I adjusted the lower engagement rate. On the other hand, subscription attached rate is still very strong. I guess my question is, how do you juxtapose those two metrics? So, it sounds like more people do want to keep subscribed whereas they’re engaging lower. I guess I just wanted to understand better how you are juxtaposing those metrics. Is there anything to read there are, how you’re thinking?

[Marty Petersen, Chief Financial Officer]

Yes. So, let’s take the accessories and materials ARPU question first. So, Ashish touched on an important link that we need to identify as we talk about this answer, and that’s the link between Accessories and Materials business measured in this case by ARPU and engagement, is when people are engaging, it means that they’re making things, they’re making projects. And when they make projects, they use accessories and materials, and so they’re buying accessories and materials. And so, the fluctuation in engagement generally correlates with the fluctuation in accessories and materials ARPU.

Now Bala, you correctly identified that ARPU is a little bit further down than the percent engaged. And where that comes from is while the percentage of our total users engaged is down to 56%, the – those who were engaged were less active. In other words, they’re making – those who remain engaged were making fewer projects. And so, what we point to here is that as we entered the summer – we talked about this last quarter that we’re a seasonal business, summer is our soft season. As we began entering the summer season this year, we saw exaggerated softness, so to speak.

And we saw that as pandemic opening up, people making up for lost vacations or other things that they hadn’t been able to do for a while, and that is reflected in both the engagement number and the Accessories and Materials ARPU number, and we believe that explains both the engagement and Accessories and ARPU.

Now you also asked about subscriptions. Now subscriptions is not a seasonal metric like the other two are. And the reason for that, there’s a couple of things going on. So, one, our subscriptions are sticky just by nature. We do have some subscribers who are seasonal. They come in and subscribe and craft during holiday and then leave and then come back for Valentine’s Day or something. However, in generally especially, the larger the user base grows the less fluctuation we’ve seen in that.

The other point to note is that while we experience the bump in subscriptions ARPU at the beginning of pandemic, seeing it rise significantly. It’s held pretty strong throughout the pandemic and as we’re beginning to emerge from the pandemic. And the reason for that is, coincident with that happening, we were really focusing heavily on increasing the value proposition of the subscription itself. We began adding dramatically to the content, quality, quantity, relevance. As well, you’ve seen us here recently start to add design functionality that is exclusive to subscribers.

And so, while we benefited as we went into the pandemic, as we were emerging from the pandemic, we have been watching for some sort of normalization as people exit their homes and do other things. But we think that this additional effort that we’ve been focusing on to increase the value proposition has really helped keep that ARPU up. And we still watch for some sort of normalization that may occur, but we haven’t seen that yet.

[Ashish Arora, President and Chief Executive Officer]

And I’ll just make one quick point. The fact that subscriptions are staying flat and the Accessories and Materials are down, one other thing that we think is happening is that as people are preparing to make things, they’re going to come back to craft for the holidays. And so, we think that the subscriptions are more indicative of that future engagement, if you will, because they’re designing projects, they want to cut those projects. And to come in and out of subscriptions, probably that we don’t see that much happening.

[Unidentified Analyst]

Very helpful.

[Operator]

Moving on to our next question, we have Mark Altschwager from Baird. Your line is now open.

[Mark Altschwager, Baird]

Great. Good afternoon. Thanks for taking my question. Maybe just sticking with the Accessories and Materials ARPU for a moment. Understanding that there are some exaggerated seasonality this year, I was hoping you could give us a better sense of the level of acceleration you’re seeing quarter-to-date or that you would expect to see in Q4. I guess, I’m trying to get a better sense of what normalization might look like post COVID and perhaps this fall, and these last couple of months is the first kind of clean look we’ve had at that. So just any more color you can share there would be helpful.

[Marty Petersen, Chief Financial Officer]

Yes. So, in the prepared remarks, we talked about the fact that we expect ARPU – well, ARPU fluctuates with engagement, and so we talked about the fact that both of those on a sequential basis will be up so in Q4 I’m talking about specifically. But the metrics in Q4 last year were just very strong, very tough comp. As people were very active in making a number of projects and engaging. And so, we don’t expect that we will equal that. In fact, that was abnormal and so we think will be significantly down from Q4 last year as we end Q4 this year.

[Mark Altschwager, Baird]

Okay. That’s helpful, Marty. A separate topic, I was hoping you could speak a bit about the, I guess, the pricing strategy and assortment strategy with the machine portfolio. You rolled out the upgraded machines earlier this year, but a lot of the prior models are still quite prevalent on both your site and your retail partners at lower prices. I guess what have been the learnings here thus far as you’ve had the new models and the older models coexisting in the marketplace? And how should we think about maybe the gross margin progression as those older machines sell through in the coming months? Thank you.

[Ashish Arora, President and Chief Executive Officer]

Yes. So, I’ll let Marty comment on the gross margin, but let me just talk a little bit about high-level strategy. So, I think one of the things that we wanted to do is, we wanted to make sure that we had enough overlap between our existing models and the new models because supply chain was in such a flux. Part of it was something that we do every time, and some of it was pretty characteristic to this year.

Our goal is to still continue to, I would say, carry most of the models. Of the two machines that we have, the three machines that we have, our goal is to phase out one of them and also use the other as to – as we diversify and broaden our channel base as an opportunity to do some channel differentiation. So, we can put the right product in the right channel. But other than the supply chain comment, the phase-in/phase-out strategy this year is not very different from what we’ve typically deployed, and the only thing that makes a difference is that we wanted to make sure we had a healthy overlap between the two models. I think from – I’ll let Marty comment on the gross margin mix and how it will impact.

[Marty Petersen, Chief Financial Officer]

Yes. So, one just point to note that when we went into COVID, we elected to retain some of our older products a little longer in market just because we – because of supply chain and other challenges, we didn’t know exactly how things were going to play out. So, we chose not to end of life some things that we – some products that we normally would have. So, you have more products coexisting today than we normally would have. So – but each of our products has kind of a life cycle in terms of promotional cadence, and the older machines typically carry deeper discounts from MSRP than the newer machines. And so, we do have more older machines in market today for the reasons I mentioned before. We elected to retain them, then – so we have more – a greater proportion of those today. So, there could be a tiny bit of pressure on margins as a result just of that mix and the election that we made to retain some of those older machines longer.

[Ashish Arora, President and Chief Executive Officer]

So, Mark, I just want to recap a couple of points for your benefit. Again, of the five models, more or less, right, there was permutation combination of it, four of them will be ongoing and one will be phased out. The second is, unlike a disconnected or a machine does not connect to a consumer electronics product that’s not connected, in our case, these platforms live for years and years, right? So, even to the extent that we have products that are continuing, our ability to differentiate them by new software feature and continuing to enhance them is very high. So, we are not too worried about having that overlap as well as having some of the older models continue as we continue to diversify our channels.

[Mark Altschwager, Baird]

That’s great, and best of luck over holiday.

[Marty Petersen, Chief Financial Officer]

Thank you.

[Operator]

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

[Jim Suva, Citigroup]

Thank you so much. And I think you all know as well as investors that I'm quite a crafty person, and I was actually making some custom mugs for my kids' school teachers and some neighbors and stuff. But then I noticed on your website, a lot of the mugs were sold out and supplies were sold out. So, I wanted to talk to you a little bit about supply chain management. And is there a bit of restocking that's about to come in front of the holidays? Because otherwise, it seems like T-shirt blanks, a lot of them were sold out, mugs are sold out, supplies are sold out and accessories because I know demand is really going to be high here in the next 60 days or so. So, can you talk about supply chain and maybe it's just simply coming in the boat in L.A. or San Francisco and about to be restocked? But I was kind of surprised that I couldn't order more mugs and T-shirts?

[Ashish Arora, President and Chief Executive Officer]

Thanks, Jim. But I'm actually really happy that you're – it seems that you're excited about our mug presents press and you're going to be making a lot of mug as gifts for this holiday. There are actually a lot of people like you that are also doing the same. So, you're absolutely right. The mug present has done well and exceeded our expectations. The attach rate of mugs to the mugs presents are also very high because, again, initially, when we are launching this product, we were not just focusing on personalizing mugs. We were actually focusing on redefining the gift market, right, making it easy for people to make affordable gifts.

So, we have been trying to keep up with demand. Again, that is one of the product lines that has been impacted by some of the supply chain, mostly because of demand and less about supply, but it is something that we are pretty aware of, and we will continue to bring more supply, and we have made some good progress. I don't know if you also noticed, but we want to expand the portfolio of mugs, et cetera.

Overall, and I'll allow for Marty to chime in. we feel like we – when you look at the Materials and Accessories portfolio, at a portfolio level, I think we feel pretty good about our inventory situation.

[Martin Petersen]

Yes. We feel like our inventory situation is good. Obviously, there's pockets of products that for one reason or another were not as strong as we would otherwise want to be. And the mug press is one of those. It's been – the demand has been very, very strong for us, and that's been – and it's a new product, and so it's been hard to keep that one in stock. But I think overall, our teams have just done a phenomenal job in terms of accelerating purchases of long lead time components in terms of rewriting firmware and reconfiguring board so that we have substitution parts, planning for worst-case scenarios and then operating to those worst-case scenarios so that we can have inventory where we need it, when we need it. And that doesn't obviously work when we have nearly 3,000 active SKUs, but we feel pretty good about overall where we are on most everything.

[Jim Suva, Citigroup]

Great. Yes, I've been very pleased with the mug press and the outcome. So, thank you so much and for making our holidays, really an enjoyable situation. Thank you.

[Operator]

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

[Paul Kearney, Barclays]

Hey, guys. Thanks for taking my question. First, I think relative to what we were expecting. We were expecting the step-up in expenses, it looks like sales and marketing has increased more than we had previously expected, and there's a little bit of a step-down in R&D. Just first, on the sales and marketing, can you talk about how the results you're seeing that give you confidence to step up that spend and how you're allocating that between adding new users to the platform and driving engagement?

[Ashish Arora, President and Chief Executive Officer]

Yes. That's a really good question. As you pointed out, our sales and marketing for this quarter was 11.6%. Last quarter, it was about 6.5%. So, it's significantly up, and part of it was that it was unusually low for all the factors related to the pandemic and supply chain and we didn't have enough inventory, so it was unusually low last year during this quarter. I think fundamentally, our approach to marketing has been changed. We have a very efficient marketing flywheel, and we benefit from strong network effects in our category.

Just to recap some numbers, over 40% of our customers first hear about Cricut through word of mouth, and the gross profits on machines more or less cover the customer acquisition cost. And since 2014, we've been leveraging the same playbook, and we will continue to do so, which is creating great experiences for our members.

Our category also is very unique because when people make things, they're very proud, they feel very accomplished, they give gifts to people, and that lends itself to a lot of word of mouth. And even to just make it very personal, they actually shared it on their networks when they've made it, right? And to make it very personal, my wife often makes T-shirts for my niece. And invariably, people will ask, well, where did you buy it, and that leads to a Cricut conversation. If you look at our Facebook page, for example, we get tremendous engagement every time we share a user project. And you compare it to other brands, it's pretty amazing.

One thing that I do want to point out is that as we continue to scale, we understand each of these social network. We do performance advertising like other folks. We don't do long-form advertising on TV, et cetera, but we feel like we have a very good sophisticated understanding of how to leverage each of the social platforms like YouTube and Facebook and Pinterest and Instagram, and we do that with a variety of organic as well as paid mechanisms. So again, I think our approach to marketing hasn't changed. Our cost of acquisition has not changed significantly.

One thing that I do want to point out is that as we accelerate our international expansion and as we add the number of countries, we do have to make some investment with a couple of key sales and marketing professionals and some upfront marketing investments. So, you will see, as we add more countries faster, that those numbers may put some pressure on the sales and marketing number. But overall, our approach hasn't changed, just that is unusually low last year.

[Marty Petersen, Chief Financial Officer]

Just one thing, a broader comment on all of the operating expense categories. You mentioned that R&D was down – there was a step-down. Actually, from a – both a dollar standpoint and a percentage of revenue standpoint, we increased that category meaningfully as well as sales and marketing and G&A. All categories are up. And much of what you're seeing is catching up from the pause in spend that we took in the COVID year 2020, but also leaning into some of these other activities that we've been talking about in investing for growth. And so – but R&D is one area that we have been investing in quite a bit.

[Paul Kearney, Barclays]

Okay. Thanks. Just a second, just my follow-up is, can you talk about the inventory levels and your end channel partners and the help there? Is this – are we at normal levels yet with your partners on both machines and accessories?

[Marty Petersen, Chief Financial Officer]

Yes. So given the market supply constraints and increased global supply lead times, we have seen what we would characterize as some defensive buying by a few of our retail partners, but not across the board. Just a few, we think, have bought maybe a little heavier just in defense of some of these challenges. So, we believe channel inventory may be a little bit heavy, but it's hard to say at this point.

One thing that I can say is that we've been awarded incremental shelf space from some retailers that we believe in some cases is because others couldn't fill the shelves and they knew we could, so they gave us that space. And so, it's hard to know exactly how all of that's going to play out. But we take a – from our inventory perspective, our view is we want to keep shelves full, and we want to be on the side of the coin of doing that rather than being on the side that doesn't have inventory and is losing shelf space because they can't keep shelves fallen.

[Ashish Arora, President and Chief Executive Officer]

And Paul, I just want to go back to – I think it's kind of also going back to Jim's question that he asked earlier, where some of the inventory, like the mugs were not available on Cricut.com. One of our goals is, first and foremost, to make sure we prioritize our retail partners to keep them in stock. So again, as we've taken that approach, we wanted to make sure that the products get to the shelves and the products available for consumers to come in and buy them in addition to our site.

[Paul Kearney, Barclays]

Thank you.

[Operator]

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

[Erik Woodring, Morgan Stanley]

Hey good evening, guys. Thank you for taking my call. Maybe to follow up on that question, just can you quantify what, if any, channel – excuse me, connected machine channel inventory fill there was in the third quarter? And then just going back to your earlier comment, Marty, is it safe to say or is it fair to say there's a greater mix of legacy products in the channel today than normal just because of the product cadence you've had over the last 12 months? And then I have a follow-up. Thanks.

[Marty Petersen, Chief Financial Officer]

So, on your first question, channel fill in Q3, I think you were asking about. From a machine standpoint, we were supply-constrained in Q3 on almost all of our products. Whether it be machines or accessories and materials. However, we started to catch up on channel inventory on accessories and material late in Q3. So, there is some channel fill impact in Q3 2020 that we saw on accessories and materials, not so much on machines. And then we continue to catch up on materials in Q4, which – that we were making good headway in catching up on that with accessories and materials. But machines, we were still light. And so, for all of 2020, at least the second half, I wouldn't characterize the machine channel fill is really a factor I'm sorry, Erik, I missed your second question. What was your second question?

[Erik Woodring, Morgan Stanley]

Yes. Just in terms of the composition of channel today. Is it safe to say or fair to say that there's a greater mix of legacy products in the channel today, just given the product kidding that you've had in some of the long life that you've had of some of the prior models that you've now refreshed over the last three months?

[Ashish Arora, President and Chief Executive Officer]

Yes. Actually, I want to clarify a comment that I made earlier. This probably addresses your question as well. First of all, our general goal is to – even though we have five models with three of them that were existing and two new models, our goal is not to do a broad phaseout of any of them, right? So, they are – we're going to use them to – for continued differentiation, whether in the North American markets or across international geographies. The capabilities of these platforms are somewhat unique, and we think that there's an opportunity for us to differentiate channels.

And then secondly, you – whenever we launch a machine, it lasts for four to seven plus years. We virtually have not phased out anything. Again, because they're connected, we can continue to expand the functionality with new features and new capabilities. So, we're not looking at it as a legacy issue that we are dealing with. As I said, how we decide to leverage the five models may vary on the model, but the fact is that those five models are going to stay in some form of fashion. And four of them are going to be broadly available, and the fifth one is also going to be available in certain channels. Is that helpful?

[Erik Woodring, Morgan Stanley]

Yes. Definitely. Thank you, Ashish and then maybe you mentioned an uptick in user engagement at the end of September. Just curious how does that compare to normal seasonality? I mean is that similar to past years? Are you seeing an uptick in engagement in September?

[Marty Petersen, Chief Financial Officer]

Yes. So, when we say normal seasonality, we started tracking engagement in mid-2019. And so, we don't have – and then 2020 was an odd year just because of all the dynamics of the pandemic. So, it's a little bit difficult to say what actual seasonality looks like from an engagement standpoint. But I mean, we know that people are more active – we've always known that people are more active in Q4 than any other quarter. And so, when we go back to 2019 and even 2020, we saw that play out. Now – and we expect that again this year. We think that engagement will be higher in Q4 than it was in Q3. We just think that Q4 of 2020 was just extraordinarily high, and we're not – we'll be significantly below that.

[Erik Woodring, Morgan Stanley]

Okay, super. Thank you, Marty.

[Operator]

I am showing no further questions at this time. This concludes today's conference call. Thank you all for your participation. You may now disconnect.