Q2 2022 Cricut Inc Earnings Call
Okay.
Good day, and thank you for standing by and welcome to the cricket second quarter 2022 earnings Conference call. At this time all participants are in a listen only mode. After the speaker's presentation. There will be a question and answer session to ask a question. During the session you will need a press star one one on your Telus.
Phone you will then hear an automated message advising your hand is raised please be advised that today's conference is being recorded I would now like to hand, the conference over to Stacie Clements Investor Relations of the Blue shirt group. Please go ahead.
Thank you operator, and good afternoon, everyone. Thank you for anthem cricket corner of 2022.
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 a supplemental data sheet have been posted to the Investor Relations section of the company's website investor get Dot com joining.
Joining me on the call today, Ashish <unk>, Chief Executive Officer, and Kimball Shell Chief Financial Officer before we begin we would like to remind everyone that prepared remarks contain forward looking statements and management may make additional statements, including statements regarding our strategy business expenses and results of operations and.
To your question.
Please state not guarantee future performance or undue reliance should not be placed upon them.
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. Most recently filed Form 10-Q.
Actually the actual events or results could differ materially. This call also contains time sensitive information that is accurate only as of the broadcast August nine 2022.
Assumes no obligation to update any forward looking projection that may be made in today's release or call and with that I will now turn the call over to Ashish.
Thank you Stacy and welcome everyone.
Revenue in the second quarter was $182 8 million below our internal expectations.
We have three business segments are conducting machine exceptions are material on subscriptions.
Let me first discuss subscriptions.
Given the huge growth of users we have a deep focus on goodwill.
Describe for us coming into 2022.
This is the area that we would be a significant progress and ultimately result strategy going forward.
We had Peter.
A number of those subscribers could decline sequentially in Q2 due to the declines in connected machine sales this year.
Subscriptions related initiatives resulted in loss.
Nearly 60000 subscribers in Q2.
Strong growth strategy that we are executing on.
However, we think it is prudent to stay conservative subscriptions outlook in the short term.
On accessories, our materials businesses is being challenged minorities.
Competition and higher channel inventory.
Our engagement initiatives, which I'll talk about later.
Bear fruit in the medium to long term.
We believe that the channel inventory will continue to correct itself in the next few months.
We are focusing on improving the value proposition and affordability of our material.
Undertaking steps to communicate more effectively our compatibility and why consumers to choose cricket.
So let's talk about connected machines.
We leverage the opportunity in 2020 in 2021 to significantly grow our user base.
In 2022, it takes a very different environment the childhood Victoria has been high.
As a more cautious and prioritizing their spend on these items and.
On categories do unable to spend during COVID-19.
Our total inventory will work itself out in the next few months.
Strongly believes that we have.
Users to acquire and connected machines yourself.
We saw evidence of this during prime day sale, when we promoted pick the joy of $99 during the quarter.
Our strategy is to be patient and not impact the <unk>.
Long term health of the category. So I, just got a new machines too much.
Meantime, the steps we are taking to invest in the platform.
To improve engagement execute on our subscription strategy and become more competitive and material will help ensure that we fully exploit the opportunity connected machine in the future.
Despite these challenges we continue to operate a sound business model that.
Positions us well to come out of this tough environment in a position of strength.
We delivered a 14.
Quarter profitability with a history of generating cash, which allows us to continue to invest through the down cycle.
We also benefit from a significant opportunity to increase monetization from $7 2 million users already on the platform.
Robust subscription revenue stream and a strong balance sheet.
As I think about the second half of the.
The continued uncertain environment.
The other thing that will sustain our business in the short term.
Just as importantly position us for long term growth.
There are many levers within our control the primary visa quicker to the platform.
An important distinction that separates us from many other companies.
Because the other platform, we are able to interact with our users throughout the entire property journey.
Some initial onboarding to various levels of engagement and monetization.
We're able to rapidly innovate bring new content and features to our entire user base commute.
Communicate directly with our users through various touch points.
Leverage consumer behavior and data to drive further innovation.
I'm incredibly proud of the team and all they have accomplished over the past several quarters.
Operating in this environment has been challenging but it is also sharpened our focus on the initiatives that will be the most impactful to cricket.
Last quarter I outlined four key areas of investments improve user onboarding and drive engagement.
Focus on increased monetization through our subscription software service, who can access and accessories and materials.
Continued investment in the international market, leveraging our low cost of funds.
Marketing playbook.
And it's part of the platform.
We believe this work will position us to exit current macroeconomic conditions.
Explanations stronger with one to one connection deeper.
Deeper engagement on the platform and increased use of modernization.
Let me walk through each of these in more detail.
As the top priority of the team has been intensely focused on improving our user onboarding experience.
The faster they usually gets up and running the more we create engaging ship.
This process will be positive learning later this year, the combined content cricket materials and software experiences that hole that handholds of use it as they embark on their patient journey.
We're also focused in driving user engagement and creating habit forming experiences using cricket.
While the engagement metric only focuses on when a user centric customer into a machine, we think about engagement of the platform in a much broader way.
This includes all touch points, along the way discovery and exploration book box user connections and other aspects of exploration that you had in the design stage platform and community.
That in turn will drive user stickiness and ultimately increased monetization through content.
Scripture unacceptable material.
We are working to make the design process, even easier offering bold design tools and expanding our content library.
We believe these efforts will be able to drive higher levels of engagement over time.
In Q2, we added several new features and design space such as community to the notification.
Perfect sharing enhancements with <unk> capabilities.
Localized inspiration experiences at other design capabilities to the platform.
We're excited about the progress we've made so far.
Just as important to our business is turning engagement and to increased use of modernization.
We do this through our subscription business and accessories that material.
We made significant improvements to our subscription product at our <unk>.
It's already paying off.
Our subscription business is as strong as it has ever been including at the height of the pandemic.
Nearly $2 4 million paid subscribers.
Took a lots of subscribers at the end of Q2, an increase of more than 34% versus Q2 of last year.
Also the end of Q2, we had more trials subscribers than Q2 of last year.
Despite sluggish connected machine sales.
We saw broad existing users begin trials subscriptions for the first time.
We will continue to invest in this area is to improve the experience and bring new and innovative ways to convert cloud subscribers to paying subscribers.
In addition to increasing our content library that adding new premium designed to available only to critical access subscribers.
Positive results from our previously launched motto grabbed Baker at automatic background removal gives us confidence in our strategy for pick at axis.
In addition, we have expanded use of touch points with intricate design space.
To improve our merchandising marketing and promotional efforts.
Strong roadmap and are in the early days of executing on that road map.
Additional monetization opportunities exist within our accessory the materials business.
We continue to innovate in ways that uniquely leverage our platform.
In recent months, we have broadened our successful smart materials portfolio.
Our new use cases.
<unk> introduced a new cricket new card banking ecosystem and expanded into new sublimation blacks.
The Blackstone compatibility benefit derived from the integration so far.
These are material spin it up machine designs based software and digital content.
It resonates very well with our members.
Additionally, we are seeing significant competition, especially online as well as more placement of competitive materials.
Seo channel.
While our members realize that cricket materials work seamlessly with our machine and our software they are more price sensitive than they have ever been.
And we're focusing on making the products more affordable for our consumers via cost reductions in promotions.
International remains a key priority for us.
Key trends that have driven our business since 2014 also hold true internationally.
International continues to become a larger percentage of our overall business.
For relatively small initial investment levels.
Mona Stablish international markets like the UK and Australia are experiencing similar headwinds to our North American business.
Emerging countries.
Very quickly, giving us diversity in revenue growth, especially over the long term.
As we enter new markets.
Quite the same cricket playbook with a focus on key influential voices.
Wall Street community.
With key retailers and continuing to build out a robust platform to support our worldwide community of users.
Investments in international markets continued to deliver success.
<unk> significant progress on design space localization as well as new country launches and Thailand and Turkey.
India, Japan, South Korea, and Taiwan coming soon.
We will continue to build the platform localized products and expand awareness by leveraging our proven go to market model and network effects.
While these investments ultimately expand our platform.
It's adding new software features content personalized experiences.
It all enriches the community experience around the world.
For example, our contributor deposit program, which we launched in Q1 expands our platform drives engagement and creates opportunities to increase user monetization.
All the images from contributing audits on available for purchase a standalone images within design space.
Subscribers are included in our cricket access subscriptions.
Then in the early days of this program and are excited by initial results.
We've also been working on are very important and has been to a software and images architecture.
Today, when a damage contains text that pets treated graphically.
It is not an easy task if a user wants to customize the attacks.
<unk> retained the plants of the initial graphical image.
We are working on a new architecture, along with a new class of images cause editable images.
And a simple images will allow the users to easily modify the text and the image and customize it in a variety of ways.
This new class of edible images, along with the software features will be available later this year.
Cricket access members as part of their subscription.
We have a solid roadmap of features enhancements for editor limited.
Our focus of the platform has never been higher than it is today.
We are improving every aspect of the platform, including design tools community features.
Engagement related features data capabilities, such mobile specific initiatives cricket actress features and so much more.
I could not be more excited about the opportunities ahead.
Underscoring our confidence in our four key trends that demonstrate resilience to the market and that have driven our business forward since 2014.
First the desire for personalization.
The digitization of tools that make personalization easy and seamless.
Third technology has opened the door to a new generation of entrepreneurs.
And toward the proliferation of social media to drive community.
<unk> barrier to entry for others looking to enter the market.
Although there's a lot of uncertainty in the current macro environment as confident as ever about our medium and long term opportunity for growth.
I'm very optimistic about the foundation laid over.
Over the last 10 years and.
And excited about how laser focused the team on the most important thing we need to accomplish in the short term and long term.
Optimizing the tradeoff between current profitability and investment in our long term growth opportunities.
Notwithstanding the current environment puts us squarely on the accelerated path towards sustainable long term growth.
Many of our investments are showing signs of success.
Building confidence that what we are doing today.
To have lasting impacts for long term growth.
I will now turn the call over to Kimball.
More details of the financials.
Thank you Ashish and good afternoon, everyone.
Q2 was a challenging quarter for us we believe the macro trends that we've been navigating well more than likely continue into the back half of the year.
However, we are tightly managing what is within our control.
In the second quarter, we generated revenue of $183 8 million or 45% decline compared to prior year Q2, and generated $13 8 million and net income.
Breaking revenue down further revenue from connected machines was $35 $4 million.
Down 76% year over year against significantly difficult comps given the unusually high salary. We had in Q2 2021, and just to remind everybody sales of connected machines in Q2 last year were unusually high as retailers replenish inventory.
Stocked up on newly launched machine.
Excuse me Q2 was impacted by macroeconomic pressures softer consumer demand beginning in March and higher than normal channel inventory position that some of our retailers held as we entered the quarter. We anticipate retailers will continue to work down their inventory levels through the end of Q3, Ashish mentioned consumers are also priority.
Their spend on the central Maine, and other categories that they missed out on during the pandemic.
For context, one way, we have thought about the impact of channel inventory versus consumer behavior as it compare niesr adds for the quarter, which was down almost 34% year over year do.
These are AD is correlated with a machine sell through.
Revenue from subscriptions was $67 6 million up 33% over last year, and 4% sequentially a remarkable accomplishment given the pressure we saw in connected machine revenues and a demonstration of the durability of our business model for.
For several quarters now we have invested in cricket access and the success, we saw in Q2 validates our strategy.
Revenue from accessories, and materials was $80 7 million down 41% over last year and reflected similar pressure from increased channel inventory levels macroeconomic trends and competition.
Terms of geographic breakdown international markets grew as a percentage of total business, representing 13, 2% of total revenue compared to eight 5% in Q2 in the prior year.
Revenues from international on a year over year basis decreased by about 14% with softness in our most mature markets like the U K, although somewhat offset by growth in newer geographies.
On a two year basis international revenues have grown 140% compared to Q2 2020.
During the second quarter, we continued to fuel our monetization flywheel for long term growth. We ended the quarter with nearly $7 2 million total users, which is up $1 8 million users year over year.
The number of users engaged on our platform for the 90 day period, ending June 30 was $3 7 million up 17% year over year.
As a percentage of total users user engagement was 51% in the second quarter down from 59% in the prior year.
There are multiple factors influencing engagement, including seasonality post pandemic opening and macroeconomic factors historically summer is the lowest period for engagement, we believe that when trends normalize and consumers want to create theres no real alternative to the cricket platform in the meantime, we continue making it easier and faster to engage with us.
We also continue to see strong momentum in cricket access.
A number of paid subscribers grew by more than 600000 on a year over year basis, ending the quarter with nearly $2 4 million paid subscribers.
<unk> continued to be strong ending the quarter at 33% as a reminder, this is a significant increase from pre pandemic periods put our attach rates were in the mid twenties.
We measure user monetization through average revenue per user and both subscriptions and accessory materials by dividing revenue for the period in those segments by our entire user base.
<unk> for subscriptions in the second quarter was $9 59 down from $9.83 in Q2 2021.
Accessories and materials arpin closely relates to user engagement RFP from accessories and materials in the second quarter was $11 45.
This compares to Q2, 2021, <unk> $26 67, which.
Which was higher due to unusually high engagement trends during COVID-19 and also reflects retailers reducing purchases in 2022 as they right size inventory levels.
Moving to gross margin total gross margin in the second quarter, but 46, 5% an improvement of 70 575 percentage points compared to Q2, 2022, which highlights the benefit of.
Our diverse revenue streams.
Breaking gross margin down further gross margin for connected machines in the quarter was one 6% on a year over year basis connected machine margin is down compared to an unusually high 26% in Q2, 2021, which benefited from pandemic tailwind.
With elevated machine itself and less promotional activity.
Connected machine margin in the quarter was also impacted by end of life machines, which carry lower gross margins.
We expect end of life machines to affect gross margins through mid 2023, as we sell through the remaining inventory.
Our strategy is to preserve pricing being careful not to discount newer machines two months, while working through end of life inventory.
In addition, Q2 2022 included elevated freight warehousing and handling costs.
As we move through 2022, we anticipate increased commodity and labor costs.
Margin from subscriptions increased slightly in the quarter to 99%, reflecting leverage on our subscription business.
Gross margin from accessories materials in the second quarter was 29, 1% down from 39, 9% in the prior year, primarily driven by higher freight and handling.
Inventory reserves and higher sales incentives.
In Q2, we rolled out price increases with our retail and distribution partners across connected machine accessories that materials.
Mitigates the impact of the recent cost escalation.
We expect to materially benefit from these actions later in the year once retailer inventory levels are right sized and then they get placing larger replenishment orders.
Total operating expenses in the second quarter were $65 4 million and included $10 $3 million.
<unk> based compensation. This was a decrease from $66 1 million in Q2 2021.
Let me provide some context, we began slowing hiring significantly in late Q3 last year and then through 2022 with a cautious outlook on Opex.
In Q1, we re prioritizing investments to focus primarily on products that will launch in the next 12 months to 24 months. These products will expand our existing cutting machine category as well as new categories that create new subscription services and materials, we have all.
There's other investments that we believe are critical to driving growth in the medium to long term, including investments in international and in the platform, including data software affricate access.
Some of these investments are showing very promising early results like the increase in trial subscription from cricket access despite lower machine sales and the adoption of the contributing artist program went.
We intend to keep these investment plans in place given the focus nature and disciplined approach.
The fundamentals of our business remain sound and we believe that we have the resources to navigate the current macro environment and invest without sacrificing long term operating margin profitability or cash flow.
So the macro environment significantly deteriorate greatly bringing our internal forecast down.
We would look to re prioritize investments predominantly through variable cost reductions and other tradeoffs among the biggest impact time horizons and growth opportunities.
Operating income for the second quarter was $20 million or 10, 9% of revenue compared to $64 2 million or 19, 2% of revenue in Q2, 2021, and driven by lower revenues in the quarter and increased investments as we continue to navigate headwinds in the short term we remain focused on managing our resources.
And continuing to deliver healthy operating margin, even though in the short term they will likely be below the long term target range of 15% to 90% by a few points are.
Our business remains durable.
With the healthy profitability profile, we delivered our 14th consecutive quarter of positive net income.
Net income in the quarter was $13 $8 million down from $49 1 million in Q2 of the prior year and up 56% from Q2, 2019, which was pre pandemic.
Diluted earnings per share was <unk> <unk> compared to 11% sequentially and 22 cents in Q2 2021.
Turning now to the balance sheet and cash flow.
Our balance sheet is strong and enables us to navigate through these challenging macroeconomic times.
We ended the quarter with $231 $3 million in cash cash equivalents in marketable securities and our new $300 million credit line remains untapped. We continued to generate healthy cash flows cash generated from operations year to date was $13 million cash generated as the primary source of funding or annual.
Inventory and additional investments for long term growth this fosters a balanced and disciplined approach to capital allocation.
As part of this balanced approach cricket Board has authorized the repurchase of up to $50 million. Okay. Its class a common stock. This program allows us to put cash to good use without sacrificing flexibility to invest in attractive organic or inorganic opportunities.
Let me spend a few minutes talking about what we see as we look ahead to the rest of the year.
We continue to see soft consumer demand and expect that expect that most likely for the rest of the year, we anticipate a moderate lift in sales for the end of Q3 and have a weighted lift in Q4 as retailers fill new orders for holiday.
As you recall in our Q4 comments, we highlighted that second half of the year. It typically represents 60% of annual revenue given.
Given the current macro environment, we expect second half revenue to be slightly softer than the 60% historical pattern.
We remain committed to our annual operating margin targets of 15% to 19% over the long term we.
We anticipate operating margins for Q4 to start to improve however, we will likely be below our long term targets by a few percentage points for the full year.
Looking at the long term, we believe the trends that have driven our business over the last eight years remain intact.
We are confident in the unique value proposition that cricket brings to millions of users and to millions more around the world that we have an opportunity to bring to the break of platform.
The significant growth in our user base over the last few years also provides opportunities to further drive engagement and monetization.
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 Craig's access at our accessories and materials business.
With that I'll now turn the call over to the operator for questions.
Thank you as a reminder to ask a question you will need to press star one one on your telephone.
Our first question comes from the line of Mark Oswald her with Baird. Your line is open.
Hi, Thank you for taking my question.
So to start out just.
The number of engaged users I think it's up about 20% year to date.
Number of paid subscribers.
Up almost 40% on average year to date, yet that accessories and materials revenue is down about 27%. So I'm, hoping you can help us understand or unpack a bit more how much of this pressure on accessories revenue is channel destock versus.
<unk> users doing fewer projects or consuming maybe less per project I.
I think that there's maybe a mix and a price component going on and there are lot of moving pieces.
Just trying to better understand kind of what's happening when we might see that start to normalize.
Thanks, Mike So you know.
We'll give you a broad view of that and just kind of where the what the factors are that you've kind of outlined some of them. So the first thing is you know clearly engagement at the macroeconomic conditions.
Put significant pressure and we think that's a chunk of that bill.
<unk> drove the AVO down I do believe it was a significant contributor to that.
And we've talked about the post pandemic behavior than that Mike, but I think it's a combination of those two things the second.
But I've got to say this in sequence.
And by the pecking order the second of channel inventory.
The <unk> number is based on sell in obviously not setting in as much as we work through the inventory in the next few months.
And we think that that was the second contributor.
But you know less less compared to the engagement, one and last but not the least as competition, but perhaps you can talk about that because this is part of the business has always been the most competitive.
And we were kind of that's the world we have grown up in.
For many of our materials, we're able to differentiate those materials pretty well by through IP through software content et cetera, but there's a portion of our portfolio that is more.
There is more prone to competition, specifically the vital as the heat transfer vinyl category.
You know our approach there is going to be to promote our products more effectively.
Balanced out with similar cost reduction so we think that the.
The contributors without getting into the specific numbers, but mostly the fact that engagement was down not just from a seasonality perspective, but also across the board given that people are now outside and doing other things.
The second factor.
Channel inventory in the third track towards some.
Some of the competitive pressures that we've seen.
That's very helpful. Thank you.
Kind of switching topics heading into the back to school and holiday season.
Talk about your position in the retail channel relative to last year, I guess any metrics, you're able to share on maybe the number of doors retail doors, you're in today versus last year in the U S and internationally and then I know word of mouth has always been very powerful for cricket, but maybe talk about your plans to drive awareness with other.
Marketing activities as we enter this more important time for for your business.
Yeah. So one of the things that we've talked about before right, which is that you know as advance basically I think normalized right now you'll see the impact of seasonality and even though I know you didn't ask the question, but let me just kind of highlight that.
The drop from Q1 to Q2.
The pharmacy.
From a seasonality perspective that we saw last year.
But the exaggerated the fact that we had at a lower level is more because of the post pandemic opening compared to last year, but Q1 to Q2, dropping again, but it's very similar from a seasonality perspective.
Just wanted to kind of share that.
Retail perspective, you know our placement continue to be.
It's very strong, but unlike other categories, we know that when the consumer comes back in the alternative platform both twice so.
The platform that they're going to come through with us.
The the Kimball mentioned is that.
Even though our revenues declined by 76% our net user that was only down 34% and we think it's because the consumer sentiment and the macro economic conditions. So we feel really good about awareness.
And the reason I say that is we put a lot of effort in driving awareness and familiarity.
And we actually promoted cricket Joy and couple of other machines during Prime day, and we saw a significant uptick.
That to us toward lost but theres a lot of.
Pent up demand and the can do as it relates to jump in at the right price, but we don't want to use that lever too much. So we'll continue to see a patient.
The other big opportunity, we have and you kind of alluded to it.
A question of ill say 7 million customers and there's such a huge opportunity to drive engagement to get that customer.
Engaged.
Otherwise that actually create worried about.
And also we can monetize that so given our view of the trends given.
Our investment in our platform, we feel pretty good about how we can leverage our existing installed base and our awareness of initiatives to drive growth in the medium to long term, but from a retail perspective.
We have the.
We have not lost any.
Placement and be as many doors as we had before for the most part.
Thank you and just maybe one last quick one for Kimball just on the on the balance sheet inventory.
Any obsolescence risk in that number as it remains elevated here and then what should that normalization look like over the next 12 to 18 months, just what's a normalized level of balance sheet inventory for you as you work through some of that older product.
So yes, so so.
Thank you Mark.
So the first part of your question. So we have several machines that are end of life and so.
There may be pockets.
Hum.
Write offs related to specific skus or geographies, but but.
Not generally across the board.
And as it goes to our inventory strategy going forward. So I'll just call out as we went through the pandemic we intentionally.
Held more finished goods inventory than we normally would.
<unk>.
We've continued that strategy through this year as we haven't seen any of that.
The lead times significantly unwind as we move into next year, we're watching that.
That trend overlay with consumer demand very carefully and well.
We will end up.
Make sure that we are too heavy on our finished goods inventory.
Yes.
Okay.
Great. Thanks again.
Thank you.
Our next question comes from the line of Erik Woodring with Morgan Stanley . Your line is open.
Hey, guys. Thanks for taking my questions, maybe first one for you here.
You talked about entering India, Japan, Taiwan, and South Korea and in the coming months can you just talk about maybe what you've done in those markets to prepare for a launch and the reason I ask that.
Is obviously your biggest competitors are based out of that region, and so I'd imagine competition might be a bit more intense in those markets. So how are you getting the brand name out there how are you getting customers to think of cricket first and foremost.
As you prepare to launch and then I have a follow up thanks.
Yeah. So Eric Thanks for the question, we've had our Asian presence for quite some time, but ahead of Asia, even though we have a baseball team ahead of Asia Singapore.
I've spent a fair amount of time in those markets specifically.
Even though.
Correct.
Some of our competitors are in that region, that's really bought a major competitor that is in the retail space.
So we don't believe that that market has been subdued Verizon even to the extent that there is a competitor in Japan is mostly operated through the dealer channel and our approach in go to market are very different from the incumbent competitors. So we don't see too much of a retail presence for many of our competitors today as we go on.
Some of those markets our formula is very much the same formula of erythroid and bidding.
Many markets right, which is we have a small team that we've got.
Put in some of those companies not all of them and then we have quality. We have been recruiting influencers you have been talking to the community and really it's the same playbook that we've leveraged many many times which is.
Get get community members involved helping drive word of mouth and build the market organically.
While the investment at each of these countries is not massive.
When you kind of look at all of them together it adds up but I think our approaches that'd be very similar.
We were actually waiting for some certification and compliance et cetera, but we've been working on content. We've been working on Influencers and we feel that we will always be that we've been in those markets for quite some time, even though.
We have not really had our own team members, but we have a number of our influenza.
Typical cricket passionate users that are educated us.
Eager to get going.
Okay Super Thanks, Ashish I think you're right that that was really helpful.
Maybe if I don't know if I could phrase as to your to your Kimball, but you know what.
Last quarter, you guys had talked about how I think the excess channel inventory had felt that something like $28 million at quarter end I'd, just love to know where it is now because I thought if I interpreted your comment earlier about net new users down 34% that would mean, the kind of incremental 40% of declines and connected machines.
Was due to channel that it would imply like 60 62 ish million dollars of headwinds and so if you could just help me square that circle, and where channel inventory, where where does that excess channel inventory today and then how is it split between connected machines and accessories of materials that'd be helpful. Thank you.
Thanks, Eric This is Kevin I'll take that.
So as we talked about we ended the year with what we thought was about $35 million heavy in channel inventory.
Yeah that was based on historical trends that we saw retailers holding.
<unk> moved through the pandemic.
Yes.
As we went through Q1, we saw some retailers.
Through their positions or begin to work through their positions, while others were actually building their position.
What changed in Q2 is we saw retailers across the board.
Working through their inventory positions and in the last few weeks, we've even seen that focus intensify.
Yeah. So so to certain extent, we think we think the goalposts moved a little bit on what retailers are expecting as their optimal inventory levels.
That said with everything we know today watching sell through trends.
Looking at consumer demand and conversations with our retail partners.
Overlaying our expectations of holiday, we expect the channel.
To get to their target inventory levels towards the end of Q3.
And so we'll be in a position to place larger <unk> orders late Q3 and more into Q4.
Uh huh.
Inventory for holiday.
Let me, let me just jump in.
So just to build on what <unk> said I think the 34% user that has a lot more.
Correlated data to what's happening in the market. The one thing that I would say exaggerate and 76% is just to remind you that last year, we will launch a new machine that does a significant amount of inventory that was going into the channel. So I think that that.
Negative as well.
Okay. Thanks for that and maybe just last.
Last question for me is on the pricing side, you talked about rolling out pricing increases what has the demand response been I realize it's a tough market backdrop, but maybe just help us kind of juxtapose.
Your desire to increase prices with maybe the need to discount given some of the channel issues given some of the competitive pressures given some of just the demand pressures that you're facing.
Does that equate to net.
Kind of net pricing declines when you factor in the discount or maybe just help us parse parse out the pricing strategy as we think about it today and that's it for me. Thank you so much.
Okay.
On the price increases we implemented those.
The course of Q2 and and sell in was softer for the quarter as we've already talked about it. So we haven't seen really impact from that yet right. So we do see we do expect to see.
The benefit from price increases.
SLM resumes and then as Ashish talked about especially as it kind of goes to our R&M space. So we will we expect to see an improvement in margins from price increases, but we will also.
We work on being strategically promotional to make sure that we are.
Competing well against.
Other other competitors in the category, especially as it relates to vinyl and heat transfer.
Data is a little bit muddied also by the fact that.
With these end of life machine, maybe a working through so the average price they've got a hide some of that but in general we are not.
To use the price lever too much.
Just because we think it's the right thing for us to be patient on net impact may not.
It looks like that but it's really mostly driven by these end of life machine that we have but for most of our newer products, we're not being overly promotional.
Got it thanks, so much guys.
Thank you.
Our next question comes from the line of Rod Hall with Goldman Sachs. Your line is open.
Yeah.
Yes. Thanks for the question guys can you hear me.
Yes.
So I wanted to check.
If we were just kind of trying to figure out the inventory cash flow here it.
It looks like you've spent about $35 $7 million of cash and.
Cash outflow into inventory, but.
And then the inventory level on the balance sheet remained roughly stable and we see this other assets line moving up so just wasn't sure how that 35530 $6 million kind of materialized on the balance sheet. So I wonder if you could help us understand that a little bit better and then I've got a follow up.
Yes so.
We.
Classified.
Component inventory as non current inventory that showed up in the other assets and.
$35 million.
And as we went through the pandemic.
We.
We're ordering components at a 78 week lead time.
So as as we've now seen how demand plays out there is some of those components that we will be.
Story, and then using overtime.
I will hasten to add that there's not a risk of obsolescence.
As our new components that all go into our newly launched machines.
We won't be working through them in the next 12 months and has three glass.
Oh I see so it's occurring because their current inventory there'll be used in the next 12 months. That's why they go in other assets and not into inventory is that is that right.
Because they are components that we won't fully consumed in the next 12 months. So it will be months 13, and beyond and Thats, why I say that as well.
Kurt.
Got you, Okay, I got that and then the other thing I wanted to come back to this pricing.
Point and just ask you guys when I go online and I look at joys and other products out there, they're all being discounted by the retail channel, which makes sense right people are trying to move it out of inventory that we have.
Historically, we've seen that kind of discounting.
Get sticky when it comes to pricing so the company then.
Struggles to regain its prior pricing levels I know that you said that your intention is to raise prices in and so on but.
I just wonder how big of a risk do you think pricing is out there given you have got this channel clear, what's going on and how do you control for that.
Yes.
Couple of things one is we have a map policy that employers.
That'd be a pretty diligent about it.
There are two things that I think there'll be a little bit more on the vehicle and of night machines, but for the newer machines. We think that we wanted to do the same amount of price.
Stability.
For the most part I would say that stayed true, but one of the things that we've done and we have a lot of experience and given the implied EBIT also going forward.
Because we had a connected machine.
We actually feel that we don't have to launch a machine every year or two or three years.
We also don't have to keep the price per deadweight, let the point price point great.
I think given the investments that we're making in the platform we are increasingly going to leverage.
That platform to maintain the longevity and the price stability in the market.
We may actually increase the value proposition, but our relative turnover and phase in phase out the machine will actually slow down because we think that thats an opportunity we havent fully aware involved.
To date and again for the last six months, we've been working really hard which is the result of these slides subscriptions.
To basically create so much content and so much capability that we think that we will.
What is the lead on the price level year on year.
On just kind of.
Basically having to fees increased alcohol machine more frequently.
Okay. That's that's helpful. Ashish. Thank you and one thing I wanted to ask you a follow up to that comment you're making does that reduce the R&D load in the business over time do you think or do you. Just does that you just move R&D into some of these other things and away from machines maybe.
Yes.
That's a really good question.
First of all I think one of our main focus area is to invest in the platform. We think that that is something that we have the potential to leverage a lot more that we have done to date. So I would say that it has focus started about six to nine months ago, and probably will continue to ramp up over the next year.
Over the next few years.
From an R&D perspective.
We will continue to focus on connected machines <unk> got a few connected machines for the last couple of years and those will be launched over the next 12 to 24 months. In addition to that we are.
Being much much more strategic in.
Focusing on machines that allow us to go into new categories. So the number of products. We made do maybe less but we will probably do fewer bigger bets that have the potential to create large ecosystem. So I would say specifically in the hardware R&D roadmaps there'll be more and more focus on.
The connected machine category.
<unk> got.
<unk> got a brand new ecosystems.
Great. Okay. Thank you very much I appreciate that.
Okay.
Thank you.
Our next question comes from the line of Jim Suva with Citi. Jamie Your line is open.
Hi, My first question is you mentioned inventory I think you said exiting Q3 should be more in line. How should we think about that or is it more right sized as we kind of head into the holidays, because exiting Q3, let's call. It the end of October .
Isn't that far away from kind of a black Friday Thanksgiving.
Holiday season, so at that point are you stocked and ready for the holidays or is there going to have to be a key.
Quick replenishment after that which seems kind of interesting time.
So Jim.
When we're talking about towards the end of Q3, we're actually thinking mid to late September is when does replenishment orders normally would be coming in for holiday and about the same time that we see the trends crossing that retailers are hitting their target inventory levels and so we.
We think we think the uptick in sales will coincide with normal holiday buying.
Okay that makes sense and then the second.
Item I had and that's a bit of an observation from our family as we recently actually tried some other cricket knockoff vinyls and things and to be honest. It jumped up our machine I spent a lot of hours cleaning off the knives and all of this and all the decals and our dogs flaked and came off on the T shirts from a birthday parties and stuck with you.
The disaster now while you're smiling the opportunity is is how do you educate.
Consumers and customers about that because when you see something at a much lower price you kind of got to try it and don't blame the person but.
I have no knowledge slide tried it that it was going to result in a complete gum up disaster in waste of time and backs variance, but it seems like a knockoff Rams are are cheaper for a reason to quality, but how do you get it across to the purchaser about that.
This is Jim we strongly in the past I believe that when we.
Across our software and some of the <unk>.
Even like our machines and accessories that go with it the whole decline is due.
We have an end to end seamless experience than what you experienced in the consumer.
Is something that a lot of our consumers experience, but having said that.
ICEE and affordability has been a key factor so I think people onboard and will attempt to try those that so our approach is going to be to make our product more affordable having said that the question that you asked which is the right question. Matt is we have to do a much better job and.
This is one of the top initiatives of the company just below subscriptions and engagement.
We are doing a better job in communicating that story.
Both of them on our website.
In design space as well as in the on the retail shelf life. So I think the opportunities for us too.
Made sure the consumer understands the value and the Seamlessness of the peace of mind that they again, but I do think that you know.
That doesn't give us the license to.
B.
At a significantly higher price point I think there is some premiums to be charged. So what are you going to do is they're going to try to win.
Make sure that our products at affordable they don't have to be matched to the Donlin and then we will do a much better job at both bid and design space, where there's enough not pump as well as at retail channels as to what the value proposition.
A key differentiator of our materials.
We are working with our retail partners to do that this is a very important part of our business and I think we have the right focus on it.
And then my final question is it seems like the average of accessories and items per user that are being used is that an all time low even before COVID-19. It never reached.
Down into.
These levels and I'm talking we're talking about.
$11 45, it's never been that low before so does that mean the.
Current reported quarter in the next quarter may be kind of the worst you think and then people start to rebuy and replenish the channel Replenishes, Mark where do you think we're kind of at this level for a while about our Peru for accessories and materials around 11 to $12.
So I think the.
The two factors that I've mentioned that we won't be able to comment on exactly where this would go because there's still a lot of moving pieces would.
But we do know is that engagement, which again like I said.
Q1 to Q2 was a similar seasonality compared to last year, when we dropped about 3%. So the engagement of the macroeconomic conditions paid a big rule. The second is as you highlighted on the channel inventory.
John was heavy when it came to material then because this number is calculated on sell in.
We saw that we basically weren't able to sell it as many materials as we would've liked to.
And lastly, we already talked about competition. So we think you know.
As the channel inventory corrects itself as people start crafting board.
We still think there's.
Yes.
Our optimism and our positive outlook for that business I also think that from an engagement perspective, our initiatives on engagement and really getting the user involved.
Use of typically start thinking about labor materials by 50 days ahead of that to make the project I think there is a unique opportunity to educate our customers on the materials et cetera, and I think the early days of that so overall, we feel very positive about the initiatives. We are taking and we hope that this business will continue to.
To improve in the medium to long term.
Thanks, so much for the additional details and clarifications, it's greatly appreciate it.
Thank you.
Our next question comes from the line of Erik Woodring with Morgan Stanley Eric Your line is open.
Hey, guys. Thank you for taking the root of your question I just wanted to come back to one topic and that was you know I know last quarter. You had mentioned you know you might not expect to hit the 8 million users at year end can you just kind of update us on your latest expectations I know there wasn't anything in the prepared remarks.
And really what I'd love to hear that there is just kind of how you think about seasonality for for net new user adds as we move into the third quarter and the fourth quarter. Thank you.
So as we called out at the end of last quarter.
We thought we'd be shy of that and we think we're still going to be shy on that based on what we see.
Playing out.
That said I do think we will see.
More user growth in Q4, which is typically.
A higher quarter for us when it comes to machine sales and we expect that to communicate. This youre also so we do expect to see some uplift in <unk>.
New user ads driven by machine sell through.
In the second half of the year, but mostly weighted in Q4.
So let me let me just add to that so first of all we feel really good about all the things that we're doing to drive awareness and familiarity and we saw evidence of that.
During prime day.
The promotion of the machine the consumer stepped in so we feel that our job is to continue to build that awareness into bad and not over use the price lever. The second is I think there's a little bit up.
You can probably look into the number that we gave.
The second half of the contributes a certain about percentage of revenues.
<unk>.
I think there's.
You'd probably use that to model what the second half would look like again, while we believe that the customer sentiment would be more positive and there will be the holiday mode.
The creativity the trends Havent changed and now it's just a question of how the consumer is feeling about the economy and everything else that's going on.
We don't want to do that.
We have looked at.
Though I know you didn't ask the question is I think there is.
And the investment we've made in subscriptions.
Feel that while.
Waiting for that customer to come back there is an opportunity to continue to invest in both engagement and the subscriptions.
Put that amount of monetization.
And I think.
Because that's if that user gets more and more engaged.
Not only has the ability to monetize through subscription, but also there is an opportunity that they drive worried about so I think we have to grow topline awareness top of the funnel and we have to get our current customers more against which we have been able to do so.
The subscription data point that we shed.
Pretty strong roadmap that we're just going to stick to our knitting and do what's in our control.
Got it thank you for that color guys I appreciate it.
Thank you. This concludes today's conference call. Thank you for participating you may now disconnect.
Thank you. This concludes today's conference call. Thank you for participating you may now disconnect.
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