Cricut, Inc. (NASDAQ:CRCT) Q2 2022 Earnings Conference Call August 9, 2022 5:00 PM ET
Company Participants
Stacie Clements – Investor Relations, The Blueshirt Group
Ashish Arora – President and Chief Executive Officer
Kimball Shill – Chief Financial Officer
Conference Call Participants
Mark Altschwager – Baird
Erik Woodring – Morgan Stanley
Rod Hall – Goldman Sachs
Jim Suva – Citi
Operator
Good day, and thank you for standing by. Welcome to the Cricut Second Quarter 2022 Earnings 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 Stacie Clements, Investor Relations of The Blueshirt Group. Please go ahead.
Stacie Clements
Thank you, operator, and good afternoon, everyone. Thank you for joining us on Cricut second quarter 2020 earnings. 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.cricut.com.
Joining me on the call today are Ashish Arora, Chief Executive Officer, and Kimball Shill, Chief Financial Officer.
Before we begin, we would like to remind everyone that our prepared remarks contain forward-looking statements, and management may make additional forward-looking statements, including statements regarding our strategy, business expenses and results of operations in response to your questions. These statements do not guarantee future performance or 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 most recently filed Form 10-Q.
Actual events or results could differ materially. This call also contains time-sensitive information that is accurate only as of this broadcast, August 9, 2022. Cricut assumes no obligation to update any forward-looking projections that may be made in today’s release or call.
And with that, I will now turn the call over to Ashish.
Ashish Arora
Thank you, Stacie, and welcome everyone.
Revenue in the second quarter was $183.8 million, below our internal expectations. We have three business segments, our connected machines, accessories and materials and subscriptions. Let me first discuss subscriptions. Given the huge growth in new users, we had a deep focus on converting users to subscribers coming into 2022. This is the area where we have made significant progress and also have a sound strategy going forward. We had feared that the number of subscribers could decline sequentially in Q2 due to the decline in connected machine sales this year. All our subscriptions-related initiatives resulted in us adding nearly 60,000 subscribers in Q2. We have a strong roadmap and strategy that we are executing on. However, we think it is prudent to stay conservative on our subscriptions outlook in the short-term.
Our accessories and materials business is being impacted by lower engagement, increased competition and higher channel inventory. Our engagement initiatives, which I will talk about later, will 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 materials and undertaking steps to communicate more effectively our compatibility and why consumers should choose Cricut.
Let’s talk about connected machines. We leveraged the opportunity in 2020 and 2021 to significantly grow our user base. In 2022, we face a very different environment where channel inventory is still high, consumers are more cautious and prioritizing their spend on need items and on categories they were unable to spend on during Covid. Channel inventory will work itself out in the next few months. We strongly believe that we have millions of new users to acquire and connected machines to sell. We saw evidence of this during Prime Day sales when we promoted Cricut Joy at $99 during the quarter. Our strategy is to be patient and not impact the long-term health of the category by discounting new machines too much. In the meantime, the steps we are taking to invest in the platform, improve engagement, execute on our subscriptions strategy and become more competitive in materials will help assure that we fully exploit the opportunity in connected machines 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 our 14th consecutive quarter of profitability, with a history of generating cash, which allows us to continue to invest through the downcycle. We also benefit from significant opportunity to increase monetization from 7.2 million users already on the platform, a robust subscription revenue stream, and a strong balance sheet. As I think about the second half of the year and the continued uncertain environment, these pillars of strength are the things that will sustain our business in the short-term and just as importantly, position us for long-term growth.
We have many levers within our control, the primary being that Cricut is a Platform. This is an important distinction that separates us from many other companies. Because we are a platform, we are able to interact with our users throughout their entire crafting journey, from initial onboarding to various levels of engagement and monetization. We are able to rapidly innovate, bring new content and features to our entire user base, communicate directly with our users through various touchpoints, and 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 has also sharpened our focus on the initiatives that will be the most impactful to Cricut.
Last quarter, I outlined four key areas of investment: Improve user onboarding and drive engagement; focus on increased monetization through our subscription software service; Cricut Access and Accessories and Materials Continued investments in international market leveraging our low-cost word of mouth marketing playbook, and Innovate and expand the platform. We believe this work will position us to exit current macroeconomic conditions exponentially stronger with one-to-one user connections, deeper engagement on the platform and increased user monetization.
Let me walk through each of these in more detail. As a top priority, the team has been intently focused on improving our user onboarding experience. The faster a user gets up and running, the more they create, engage and share. To help drive this process, we will be piloting learning kits later this year that combine content, Cricut materials and software experiences that hand hold the user as they embark on their Cricut journey.
We’re also focused on driving user engagement and creating habit forming experiences using Cricut. While our engagement metric only focuses on when a user sends a cut command to a machine, we think about engagement on the platform in a much broader way. This includes all touch points along the way — discovery and inspiration, bookmarks, user connections and other aspects of inspiration and sharing in the Design Space platform and community. That, in turn, will drive user stickiness and, ultimately, increased monetization through content, subscriptions and accessories and materials. We are working to make the design process even easier, offering more 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 in Design Space such as community-driven notifications, project sharing, enhancements to text capabilities, localized inspiration experiences and other design capabilities to the platform. We are excited about the progress we’ve made so far. Just as important to our business is turning engagement into increased user monetization. We do this through our subscription business and accessories and materials.
We’ve made significant improvements to our subscription product and our efforts are already paying off. Our subscription business is as strong as it has ever been, including at the height of the pandemic. We had nearly 2.4 million paid Cricut Access subscribers at the end of Q2, an increase of more than 34% versus Q2 of last year. Also at the end of Q2, we had more trial subscribers than Q2 of last year, despite slower connected machine sales, as we saw more existing users begin trial subscriptions for the first time. We’ll continue to invest in this area to improve the experience and bring new and innovative ways to convert trial subscribers to paying subscribers.
In addition to increasing our content library, we are adding new premium design tools available only to Cricut Access subscribers. Positive results from our previously launched Monogram Maker and Automatic Background Removal give us confidence in our strategy for Cricut Access. In addition, we are expanding user touchpoints within Cricut Design Space to improve our merchandising, marketing and promotional efforts. We have a strong roadmap and are in the early days of executing on that roadmap.
Additional monetization opportunities exist within our Accessories and Materials business where we continue to innovate in ways that uniquely leverage our platform. In recent months, we have broadened our successful Smart Materials portfolio to cover new use cases, introduced a new card making ecosystem, and expanded into new sublimation blanks. The platform compatibility benefit derived from the integration of our Accessories and Materials with our Machines, Design Space software and digital content resonates very well with our members.
Additionally, we are seeing significant competition, especially online, as well as more placement of competitive materials in our retail channels. While our members realize that Cricut materials work seamlessly with our machines and our software, they are more price sensitive than they have ever been. And we are focusing on making our products more affordable for our consumers via cost reductions and promotions.
International remains a key priority for us. The 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. While our more established international markets like the U.K. and Australia are experiencing similar headwinds to our North American business, emerging countries are growing quickly, giving us diversity in revenue growth, especially over the long-term.
As we enter new markets, we employ the same Cricut playbook, with a focus on key influential voices, fostering community, partnering with key retailers, and continuing to build out our robust platform to support our worldwide community of users.
Investments in international markets continue to deliver success, including significant progress on Design Space localization, as well as new country launches in Thailand and Turkey, with India, Japan, South Korea, and Taiwan coming soon. We’ll continue to build the platform, localize products and expand awareness by leveraging our proven go-to-market model and network effects. All these investments ultimately expand our platform, whether it’s adding new software features, content, or personalized experiences, it all enriches the community experience around the world.
For example, our Contributing Artists Program, which we launched in Q1, expands our platform, drives engagement and creates opportunities for increased user monetization. All the images from Contributing Artists are available for purchase as stand-alone images within Design Space and for subscribers, are included in our Cricut Access subscription service. We are in the early days of this program and are excited by initial results.
We have also been working on a very important enhancement to our software and images architecture. Today, when an image contains text, that text is treated graphically. It is not an easy task if a user wants to customize their text, as we don’t retain the font in the initial graphical image. We are working on a new architecture along with a new class of images called editable images. Editable images will allow the user to easily modify the text in the image and customize it in a variety of ways. This new class of editable images along with the software features will be available later this year to Cricut Access members as part of their subscription. We have a solid roadmap of feature enhancements for editable images.
Our focus on 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, search, mobile specific initiatives, Cricut Access features and so much more.
I could not be more excited about the opportunities ahead. Underscoring our confidence are four key trends that demonstrate resilience in the market and that have driven our business forward since 2014: First, the desire for personalization. Second, the digitization of tools that makes personalization easy and seamless. Third, technology has opened the door to a new generation of entrepreneurs. And fourth, the proliferation of social media drives community a significant barrier to entry for others looking to enter the market.
Although there is still a lot of uncertainty in the current macro-environment, we are as confident as ever about our medium and long-term opportunity for growth. I am very optimistic about the foundation that we have laid over the last 10-years and excited about how laser focused the team is on the most important things we need to accomplish in the short-term and long-term, optimizing the tradeoff between current profitability and investments in our long-term growth opportunities.
Notwithstanding the current environment, our foot is squarely on the accelerator pedal toward sustainable long-term growth. Many of our investments are showing signs of success, building confidence that what we’re doing today will have lasting impacts for long-term growth.
I’ll now turn the call over to Kimball for more details on the financials.
Kimball Shill
Thank you, Ashish and good afternoon, everyone. Q2 was a challenging quarter for us. We believe the macro trends that we have been navigating will 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, a 45% decline, compared to prior year Q2 and generated $13.8 million in 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 sell-in we had in Q2 2021. Just to remind everyone, sales of connected machines in Q2 last year were unusually high as retailers replenished inventory and stocked up on newly launched machines.
Q2 was impacted by macroeconomic pressures, softer consumer demand beginning in March, and higher-than-normal channel inventory positions 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.
As Ashish mentioned, consumers are also prioritizing their spend on essential needs and other categories that they missed out on during pandemic. For context, one way we have thought about the impact of channel inventory versus consumer behavior is to compare new user adds for the quarter, which was down almost 34% year-over-year. New user adds is correlated with 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 Machines revenue and a demonstration of the durability of our business model. For several quarters now, we have invested in Cricut 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, macro-economic trends, and competition.
In terms of geographic breakdown, international markets grew as a percentage of total business, representing 13.2% of total revenue, compared to 8.5% in Q2 of 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 macro-economic factors. Historically, summer is the lowest period for engagement. We believe that when trends normalize and consumers want to create, there is no real alternative to the Cricut Platform. In the meantime, we continue making it easier and faster to engage with us.
We also continued to see strong momentum with Cricut Access. The number of paid subscribers grew by more than 600,000 on a year-over-year basis, ending the quarter with nearly 2.4 million paid subscribers. Attach rates continued to be strong, ending the quarter at 33%. As a reminder, this is a significant increase from pre-pandemic periods, when our attach rates were in the mid-20s. We measure user monetization through Average Revenue per user in both Subscriptions and Accessories and Materials by dividing revenue for the period in those segments by our entire user base. ARPU for Subscriptions in the second quarter was $9.59, down from $9.83 in Q2 2021.
Accessories and Materials ARPU closely relates to user engagement. ARPU from Accessories and Materials in the second quarter was $11.45. This compares to Q2 2021 ARPU of $26.67, which was higher due to unusually high engagement trends during COVID 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 was 46.5%, an improvement of 7.5 percentage points, compared to Q2 2022, which highlights the benefit of our diverse revenue streams.
Breaking gross margin down further gross margin from connected machines in the quarter was 1.6%. On a year-over-year basis, connected machine margin is down, compared to an unusually high 20.6% in Q2 2021, which benefited from pandemic tail winds, with elevated machine sales 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 margin through mid-2023, as we sell through remaining inventory. Our strategy is to preserve pricing, being careful not to discount newer machines too much, 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 commodities and labor costs.
Gross margin from Subscriptions increased slightly in the quarter to 90.9%, reflecting leverage in our subscription business. Gross margin from Accessories and Materials in the second quarter was 29.1%, down from 39.9% in the prior year, primarily driven by higher freight and handling, excess inventory reserves, and higher sales incentives.
In Q2, we rolled out price increases with our retail and distribution partners across connected machines, accessories, and materials to help mitigate the impact of the recent cost escalations. We expect to materially benefit from these actions later in the year, once retailer inventory levels are right-sized and they begin placing larger replenishment orders.
Total operating expenses in the second quarter were $65.4 million and included $10.3 million in stock-based compensation. This was a decrease from $66.1 million in Q2 2021. Let me provide some context. We began to slow hiring significantly in late Q3 last year and entered 2022 with a cautious outlook on OpEx.
In Q1, we reprioritized investments to focus primarily on products that will launch in the next 12 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 also prioritized 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 and Cricut Access.
Some of these investments are showing very promising early results like the increase in trial subscriptions for Cricut Access despite lower machine sales and the adoption of the contributing artists program. We intend to keep these investment plans in place given the focused nature and disciplined approach.
The fundamentals of our business remain sound and we believe we have the resources to navigate the current macro environment and invest — without sacrificing long-term operating margins, profitability or cash flow. Should the macro environment significantly deteriorate, greatly bringing our internal forecasts down, we would look to reprioritize investments, predominantly through variable cost reductions and other trade-offs among biggest impacts, 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 margins, even though in the short-term they will likely be below the long-term target range of 15% to 19% by a few points.
Our business remains durable, with a healthy profitability profile. We delivered our 14th consecutive quarter of positive net income. Net income in the second quarter was $13.8 million, down from $49.1 million in Q2 of the prior year and up 56% from Q2 2019, pre-pandemic. Diluted earnings per share was $0.06 compared to $0.11 sequentially and $0.22 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 macro-economic times. We ended the quarter with $231.3 million in cash, cash equivalents, and marketable securities and our new $300 million credit line remains untapped.
We continue to generate healthy cash flows. Cash generated from operations year-to-date was $13.0 million. Cash generated is the primary source of funding toward our annual inventory needs and additional investments for long-term growth. This fosters a balanced and disciplined approach to capital allocation.
As part of this balanced approach, Cricut’s board has authorized the repurchase of up to $50 million dollars of its Class A Common Stock. This program allows us to put cash to good use without sacrificing flexibility to invest in attractive organic and 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 most likely for the rest of the year. We anticipate a moderate lift in sales toward the end of Q3, and a more weighted lift in Q4, as retailers fill new orders for holiday.
As you recall in our Q4 comments, we highlighted that the second half of the year typically represents 60% of annual revenue. Given the current macro environment, we expect second half revenue to be slightly softer than this 60% historical pattern. We remain committed to our annual operating margin targets of 15% to 19% over the long term. We anticipate operating margins in 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 Cricut brings to millions of users and to the millions more around the world that we have an opportunity to bring to the Cricut platform. The significant growth in our user base over the last two years also provides opportunity 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 Cricut Access and our accessories and materials business.
With that, I’ll now turn the call over to the operator for questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first question comes from the line of Mark Altschwager with Baird. Your line is open.
Mark Altschwager
Hi, thank you for taking my question. So to start out, just the number of engaged users, I think, is up about 20% year-to-date. The 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 users doing fewer projects or consuming maybe less per project?
I think that there’s maybe a mix and a price component going on in there. So a lot of moving pieces. So I’m just trying to better understand, what type [Technical Difficulty] we might see that start to normalize?
Ashish Arora
Thanks, Mark. So, you know, we’ll give you a broad view of that and just what the factors are, but you outlined some of them. So the first thing is, clearly, engagement at the macroeconomic conditions put significant pressure. We think that’s a chunk of that, that basically drove the ARPU down, and we believe was a significant contributor to that. And we talked about the post-pandemic behaviors and the like, but I think it’s a combination of those two things.
The second is, I’ve got to say this in sequence and by the perky order. The second is channel inventory. Since the ARPU number is based on selling, we’re obviously not selling in as much as we work through the inventory in the next few months. And we think that, that was a second contributor, but less compared to the engagement one. And last but not the least is competition and important for us to talk about that. This point of the business has always been the most competitive. And we are kind of — that’s the world we’ve grown up in. For many of our materials, we are able to differentiate those materials pretty well by — through IP, through software, content, et cetera. But as a portion of our portfolio that is more prone to competition, specifically providing that the heat transfer vinyl category.
And our approach there is going to be to promote our products more effectively and balance that with similar cost reductions. So we think that the contributor has been not coming to the specific numbers, but mostly in 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 was channel inventory and the third factor was some of the competitive pressures that we’ve seen.
Mark Altschwager
That’s very helpful. Thank you. Kind of switching topics, heading into the back-to-school and holiday season. Talk about how your positions 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 Cricut, but maybe talk about your plans to drive awareness with other marketing activities as we enter this more important time for your business?
Ashish Arora
Yes, one of the things that we’ve talked about before, right, which is that as and when — basically as things normalize — right now, we are seeing the impact of seasonality — and even though I know you didn’t ask the question, but let me just kind of highlight that, which is the drop from Q1 to Q2 is very [Technical Difficulty] from a seasonality perspective that we saw last year, right? The exaggerated — the fact that we are at a lower level is more because of the post-pandemic opening, compared to last year, but Q1 to Q2 drop in engagement is very similar from a seasonality perspective, right? So I just want to kind of share that.
From a retail perspective, our placement continues to be very strong, right? And unlike other categories, we know that when the consumer comes back, there is the alternative platform of choice. So the platform that they’re going to come to is us. One of the things that Kimball mentioned is that we are — even though our revenue declined by 76%, our net user adds were only down 34%, and we think it’s because of the consumer sentiment and the macroeconomic conditions. But we feel really good about our awareness, right?
And the reason I say that is we put a lot of effort in driving awareness and familiarity. And we actually promoted Cricut Joy and couple of our machines during Prime Day and we saw a significant uptick. So that too has told us that there is a lot of pent-up demand and the consumer is willing to jump in at the right price, but we don’t want to use that lever too much. So we’ll continue to stay patient.
And the other big opportunity we have and you kind of alluded to it in your question, we have, say, 7 million customers and there’s such a huge opportunity to drive engagement to get that customer engaged and they are the ones that actually create word of mouth, and also, we can monetize that. So given our view of the trends, given our investment in our platform, we feel really good about how we can leverage our existing installed base and an awareness of initiatives to drive growth in the medium- to long-term. But from a retail perspective, we have not lost any placement and we have as many doors as we had before, for the most part.
Mark Altschwager
Thank you. And just maybe one last quick one for Kimball, just 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?
Kimball Shill
Yes, so — thank you, Mark, on — to the first part of your question, we have several machines that are end-of-life. And so there may be pockets of write-offs related to specific SKUs and geographies, but not generally across the board. And as it goes to our inventory strategy going forward, I’ll just call out, as we went through the pandemic, we intentionally held more finished goods inventory than we normally would. And we’ve continued that strategy through this year as we haven’t seen any of the lead times significantly unwanted. As we move into next year, we’re watching that trend overly with consumer demand very carefully and we’ll end up make sure that we aren’t too heavy on finished goods inventory.
Mark Altschwager
Great. Thanks again.
Operator
Thank you. Our next question comes from the line of Erik Woodring with Morgan Stanley. Your line is open.
Erik Woodring
Hey, guys, thanks for taking my questions. Maybe Ashish, first one for you. You talked about entering India, Japan, Taiwan, and South Korea 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 Cricut first and foremost as you prepare to launch? And then I have a follow-up. Thanks.
Ashish Arora
Yes, so Erik, thanks for the question. We’ve had Asian presence for quite some time. Our Head of Asia — even though we have a very small team, our Head of Asia, Singapore, I’ve spent a fair amount of time in those markets specifically. And even though you’re correct that some of our competitors are in that region, but it’s really not a major competitor that is in the retail space. So we don’t believe that, that market has been consumerize, and even to the extent, there is a competitor in Japan. It’s mostly operated through the dealer channel, and our approach in go-to-market is 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 in some of those markets.
Our formula is very much the same formula we employed in different — in many markets, right, which as we have a small team that we’re going to put in some of those countries, not all of them. And then we have quality — we’ve been recruiting influencers, we’ve been talking to the community, and really it’s the same playbook that we’ve leveraged many, many times, which is, get — you get community members involve, help them drive word of mouth and build the market organically. So while the investment in each of these countries is not massive, when you kind of look at all of them together, it adds up, but I think our approach is going to be very similar.
And we were actually waiting for some certifications and compliance, et cetera, but we’ve been working on content, we’ve been working on influencers, and we feel that — we always feel 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 influencers and typical Cricut passionate users that have educated us and are eager to get going.
Erik Woodring
Okay, super. Ashish, thank you for that. That was really helpful. Maybe, and I don’t know if I should phrase this to you or Kimball, but last quarter you guys had talked about how — I think the excess channel inventory had fell to something like $28 million at quarter end. I 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 in connected machines was due to channel that would imply like $62-ish-million of headwinds. And so if you could just help me square that circle and where channel inventory — where is excess channel inventory today and then how is it split between connected machines and accessories and materials, that would be helpful. Thank you.
Kimball Shill
So, thanks, Erik. This is Kimball. 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, and that was based on historical trends that we saw retail is holding as we move through the pandemic years. As we went through Q1, we saw some retailers worked through their positions or begin to work through their positions, while others were actually building their position. What change 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.
So to some extent, we think the goalpost moved a little bit on what retailers are expecting is their optimal inventory levels. That said, with everything we know today watching sell-through trends, looking at consumer demand and conversations with the retail partners and then 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 large replen orders late Q3 and more into Q4 to have inventory for holiday.
Ashish Arora
Let me just jump in, just to build on what Kimball said. I think the 34% user adds has a lot more correlated data to what’s happening in the market. The one thing that, I would say, exaggerated to 76% is just to remind you that last year we were launching new machines as the significant amount of inventory that was going into the channel. So I think that, that factor playing in it as well.
Erik Woodring
Okay, thanks for that. And maybe just last question from 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 the — 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. Like is — does that equate to net — kind of net pricing declines when you factor in the discount? Or maybe just help us parse out the pricing strategy as we think about it today? And that’s it from me. Thank you so much.
Kimball Shill
Okay, so on the price increases, we implemented those over the course of Q2 and sell-in was softer for the quarter as we’ve already talked about it. And so we haven’t seen really impact from that yet, right? So we do see — we do expect to see a benefit from price increases as sell-in resumes. And then as Ashish talked about, especially as it goes to our R&M space, so we will — we expect to see an improvement in margins from price increases, but we will also work on being strategically promotional to make sure that we are competing well against other competitors in the category, especially as it relates to vinyl and heat transfer vinyl.
Ashish Arora
I think the data is a little bit muddied also by the fact that we have the end-of-life machine that we are working through, so the average price may going to hide some of that. But in general, we are not going to use the price lever too much just, because we think it’s the right thing for us to be patient. Now, a net impact may not look 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 are not being overly promotional.
Erik Woodring
Got it. Thanks so much, guys.
Operator
Thank you. Our next question comes from the line of Rod Hall with Goldman Sachs. Your line is open.
Rod Hall
Yes, thanks for the question, guys. Can you hear me?
Ashish Arora
Yes.
Rod Hall
So I wanted to check, we were just kind of trying to figure out the inventory cash flow here, it looks like you spent about $35.7 million of cash outflow into inventory, but then the inventory level on the balance sheet remained roughly stable and we see these other assets line moving up. So just wasn’t sure how that $35 million, $36 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.
Kimball Shill
Yes, so we classified some component inventory as non-current inventory that shows up in other assets and that’s $35.1 million. And as we went through the pandemic, we’re ordering components at a 78-week lead time. And so as we have now seen how demand plays out, there are some of those components that we will be restoring and then using over time. Now, I’ll hasten to add that there is not a risk of obsolescence. These are new components that all go into our newly launched machines, and it’s just that we won’t be working through them in the next 12 months and hence the reclass.
Rod Hall
Oh, I see. So it’s a current — because they’re current inventory that will be used in the next 12-months, that’s why they go into other assets and not into inventory. Is that right?
Kimball Shill
It’s because their components that we won’t fully consumed in the next 12-months, so it’ll be months 13 and beyond, and that’s why they classify as non-current.
Rod Hall
Oh, okay. Got you. Okay, I got that. And then the other — 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. But we have — and 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. And I know that you said that your intention is to raise prices and so on. But I just wonder how big of a risk do you think pricing is out there given you’ve got this channel clearance going on and how do you control for that?
Ashish Arora
Yes, so a couple of things, Rod. One is we have a map policy that we — in floors, that we’re pretty diligent about it. Now, there are a few things that I think there will be a little bit more on the maker and to around end-of-life machines, but for the newer machines, we think that we want to maintain a fair amount of price stability. And for the most part, I would say that it’s very true. Now, one of the things that we’ve done and we have a lot of experience in given the — in fact more so going forward, right, because we had a connected machine, we actually feel that we don’t have to launch a machine every year, two, three years, and we also don’t have to keep the price point degrade — let the point price point degrade. I think given the investments that we are making in the platform we are increasingly going to leverage that platform to maintain the longevity and the price stability in the market, right.
So we may actually increase the value proposition, but our relative turnover and phase-in, phase-out of machines will actually slowdown, because we think that that’s an opportunity we haven’t fully availed off to-date, and again, for the last six months, we’ve been working really hard, which is the result you saw in subscriptions to basically create so much content and so much capability that we think that it would lead on the price lever year-on-year on just kind of basically having to phase-in, phase-out more machine more frequently.
Rod Hall
Okay, that’s helpful, Ashish. Thank you. And one thing I wanted to ask you is 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 move R&D into some of these other things and away from machines maybe?
Ashish Arora
So that’s a really good question, Rod. First of all, I think one of our main focus areas is to invest in the platform. We think that, that is something that we have the potential to leverage a lot more than we have done to-date. So I would say that enhanced focus started about six to nine months ago and probably will continue to ramp up over the next few years.
From an R&D perspective, we will continue to focus on connected machines. We’ve been working on 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 may do maybe less, but we’ll probably do fewer bigger beds that have the potential to create large ecosystem. So I would say, specifically in the hardware R&D road maps, there’ll be more and more focus on the connected machine category where we can kind of bed new ecosystems.
Rod Hall
Great. Okay, thank you very much. Appreciate that.
Operator
Thank you. Our next question comes from the line of Jim Suva with Citi. Jim, your line is open.
Jim Suva
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 you said more rightsized. As we kind of head into the holidays, because exiting Q3, let’s call it, at the end of October, isn’t that far away from kind of the 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 quick replenishment after that which seems kind of interesting timing?
Kimball Shill
So Jim, when we’re talking about towards the end of Q3, we’re actually thinking mid to late-September is when those replenishment orders normally would be coming in for holiday, and about the same time that we see the trends crossing — the retailers are hitting their target inventory levels. And so we think the uptick in sales will coincide with normal holiday buying.
Jim Suva
Okay, that makes sense. And then the second item I had and it’s a bit of an observation from our family is we recently actually tried some of the Cricut knock off vinyls and things, and to be honest, it gummed up our machine, I spend a lot of hours cleaning off with knives and all this, and all the details and iron arms flake and came off on the T-shirts from the birthday parties and stuff we did. So was a disaster.
Now, while you’re smiling, the opportunity 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 had no knowledge, so I tried it that it was going to result in a complete gum up disaster and waste of time and bad experience, but it seems like a knock off brands are cheaper for a reason, the quality. But how do you get it across to the purchaser about that?
Ashish Arora
Yes, Jim, we strongly and passionate believe in that, right, when we work across our software and some of the — or even like our machines and accessories that go over the whole client as to have an end-to-end seamless experience, then what you’ll experience as a consumer is something that a lot of our consumers experience, right? Having said that, our pricing and affordability has been a key factor. So I think people are more and more tempted to try to those then. 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, right, is we have to do a much better job and we’ve — this is one of the top initiatives in the company just below subscription and engagement where we are doing a better job in communicating that story both through with our website, in Design Space, as well as in the — on the retail shop, right?
So I think the opportunities for us to make sure that consumer understands the value and the seamlessness and the peace of mind that they get. But I do think that doesn’t give us the license to be at a significantly higher price point. I think there some premiums to be charged. So what we are going to do is, we are going to try to win make sure that our products are affordable. They don’t have to be match to the dollar and then we will do a much better job, both within Design Space, both within our platform, as well as in retail channels as to what the value proposition and what our key differentiator are of our materials. And 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 that.
Jim Suva
And then my final question is, it seems like the average of accessories and items per user that are being used is at an all-time low, even before COVID 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 and the next quarter may be kind of the worst you think, and then people start to re-buy and replenish, and the channel replenishes more? Or do you think we’re kind of at this level for a while of ARPU for accessories and materials of around $11 to $12?
Ashish Arora
So I think the two factors that I mentioned that — we won’t be able to comment on exactly where this would go because there are still a lot of moving pieces. But we do know is that engagement, which again, like I said, from Q1 to Q2 was a similar seasonality compared to last year where we dropped about 3%. So engagement and the macroeconomic conditions played a big role.
The second is, as you highlighted, channel inventory, the channel was heavy when it came to materials and because this number is calculated on sell-in, we saw that we basically weren’t able to sell-in as many materials as we would have liked to. And lastly, we already talked about competition. So we think as the channel inventory connected itself as people started crafting more, we still think there is optimism and a positive outlook for that business. I also think that from an engagement perspective, our initiatives on engagement and really getting the user involve from — a user typically start thinking about materials five, 10, 15 days ahead of activating the project. I think there is a unique opportunity to educate that customer on the materials, et cetera, and I think we are in 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 improve in the medium- to long-term.
Jim Suva
Thanks so much for the additional details and clarifications. It’s greatly appreciate it.
Operator
Thank you. Our next question comes from the line of Erik Woodring with Morgan Stanley. Erik, your line is open.
Erik Woodring
Hey, guys. Thank you for taking the repeat question, just wanted to come back to one topic that was, I know last quarter you had mentioned 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 get at that there is just kind of how you think about seasonality for net new user adds as we move into the third quarter and the fourth quarter. Thank you.
Kimball Shill
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 still playing out. That said, I do think we’ll 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 be the case this year also. So we do expect to see some uplift in new user adds driven by machine sell-through in the second half of the year, but mostly weighted in Q4.
Ashish Arora
Yes, so let me just add to that. So first of all, we feel really good about all the things that we are doing to drive awareness and familiarity and we saw an evidence of that during Prime Day where with the promotions of machines, the consumer stepped in. So we feel that our job is to continue to build that awareness in demand and not overuse the price lever.
The second is I think there is a little bit of — you can probably look into the number where we gave that the second half of the year contributes a certain percentage of revenues. And I think as you can probably use that to model what the second half would look like. Again, while we believe that the customer sentiment will be more positive and they will be in holiday mode and they will be in the creativity mode, the trends haven’t changed, right? Now, it’s just a question of how the consumer is feeling about the economy and everything else that’s going on.
One thing that we have looked at — and even though I know you didn’t ask the question, I think there is an investment we made in subscriptions. We feel that while waiting for that customer to come back, there is an opportunity to continue to invest in both engagement and the subscriptions, right?
And for that matter, monetization. And I think because that — if that user gets more and more engage, they not only has an ability to monetize to subscriptions, but also there is an opportunity that they drive word of mouth, right? So I think there is — we have to grow top line awareness top of the funnel and we have to get our current customers more engage, which we have been able to do so with the subscription data point that we shared. So we have a pretty strong road map, and we just going to stick to our knitting and do what’s in our control.
Erik Woodring
Got it. Thank you for that color, guys. I appreciate it.
Operator
Thank you. This concludes today’s conference call. Thank you for participating. You may now disconnect.
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