Peloton Interactive, Inc. Q2 FY2024 Earnings Call

Good day and welcome to the Peloton Interactive Q2 2024 Earnings Call. At this time, all participants are in a listen-only mode. After a few brief opening remarks, we will begin immediately going into our Q&A session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker, Mr. Peter Stabler, Head of Investor Relations. Mr. Stabler, the floor is yours.

Thanks, Sherry. Good morning, and welcome to Peloton's Second Quarter Fiscal Year 2024 Conference Call. Joining today's call are CEO, Barry McCarthy, and CFO, Liz Coddington. Our comments and responses to your questions reflect management's views as of today only and will include statements related to our business that are forward-looking statements under federal securities law. Actual results may differ materially from those contained in or implied by these forward-looking statements due to risks and uncertainties associated with our business. For a discussion of the material risks and other important factors that could impact our actual results, please refer to our SEC filings and today's shareholder letter, both of which can be found on our Investor Relations website. During this call, we will discuss both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP financial measures is provided in today's shareholder letter. I'll now turn the call over to the operator for our first question.

Thank you. One moment for our first question. And that will come from the line of Doug Anmuth with JPMorgan. Your line is open.

Great. Thanks so much. Hi, Barry and Liz. A couple of questions. You called out that the Treadmill market is 2x that of Bikes. Can you just help us understand how you're going to lean into those products more going forward? And if Tread+ demand is strong, why isn't that helping free cash flow more in the back half of this year, just given the considerable existing inventory that you have? And then secondly, can you just help us understand the current mix of sales or perhaps sub additions across Peloton direct and third-party and Bike rental and any thoughts on how this could trend going forward? Thanks.

Let me take the first part of the question, maybe Liz can take the second part, Doug. Thanks for joining today. The demand for Tread has been stronger than we anticipated, both for Tread and for Tread+. I think that interest in Tread+ has made the Tread look even more attractive in comparison because of the price point differences. So that would be category one. The other exciting thing about the Tread and the fact that we're seeing real growth year-over-year in units is that for as long as I've been associated with the business, we've been largely dependent on the Bike business. And now it appears that we have at least an important second leg of the stool to help support growth. Now with respect to Tread+, we do have a substantial number of units in inventory. The good news is we've paid for them. So each sale is quite helpful to cash flow, and initial demand was quite strong. But we have limited sales experience, and we have even more limited sales experience at full price. So I'm a little uncertain about what the demand will be coming into Q4. We're also a little bit uncertain about our ability to fulfill the demand. So our first obligation is to retrofit the existing units in the field with the Rear Guard. And to the extent that we are manufacturing more Rear Guards than we have capacity for installs and retrofits, then they're available for us to retrofit existing inventory and ship to new purchasers. So that's the perspective on Tread+. There was a mixed part of the question, Liz, I was going to kick over to you.

Yes, sure. In terms of the mix, I think the question was about what are we thinking in terms of our mix going forward into the back half of the year. As far as the hardware sales piece of the business, from a Bike rental perspective, we are leaning into that. So we do expect to continue to see our mix shift toward the Bike rental or the FaaS rental. In terms of third party, for the back half of the year, our third-party business is impacted by a lot of key moments in those third-party channels. And so we'll lean into those, and depending on how well those actually do that, that may result in some mix shift into third-party at certain moments, but we don't expect it to be a significantly higher portion of our sales in the back half of the year versus the first half of the year.

One additional comment about Tread. I am pretty excited about some of the content that we're going to bring to the platform. It will be oriented towards more of the performance athletes, particularly marathon training. We entered into a partnership with New York Road Runners, and I'm super excited about that, and we filmed in 3D the Marathon course, the New York Marathon course this year, and that will be available on our platform for runners who are training for the marathon. We also captured the metadata, and so the elevation on the Treadmill will automatically change as you progress down the course. We hope to expand that to other leading marathons in the world and continue to lean into that segment of the marketplace, which I think helps to reposition the brand in important ways.

Thank you. One moment for our next question. And that will come from the line of Ron Josey with Citi. Your line is open.

Great. Thanks for taking the questions. Hi, Barry. Hi, Liz. I wanted to ask on engagement, Barry. It was up 6% year-over-year. Just curious, can you tell us how engagements evolved on the platform over the last several years with Peloton offering more content across more devices? Of course, the app, or are we seeing members adopting more of a hybrid style, or is it one or the other? And then Barry, you mentioned in the letter that you've disappointed if the team can't improve performance in the current quarter as you did in the second quarter. Just talk to us about some of the improvements you saw in Q2 that helped numbers come in better than expected. Thank you.

I was having trouble hearing during the second quarter improvement in what?

What helped us beat Q2, I think.

What helped us beat Q2? Is that the question?

Yes. And I think you said you'd be disappointed if the team can't improve performance in the quarter similar to 2Q. So curious what happened in the last quarter to maybe do better here going forward?

Yes. I'll do part of it, and Liz will take part. Well, as you mentioned, engagement was up 6%. The Connected Fitness engagement was up 4% year-over-year, and the app was up 7% year-over-year. We have not really made significant progress yet in personalization. I should say it differently: we've made good progress, but we can run a lot faster and we can do significantly better. I am tremendously excited about the work that we are doing now and the insights that Nick Caldwell brings to the table. A year from now, I think we're going to be in a significantly better place, and it will have a really positive impact on engagement. We know that engagement is a big driver of churn. So churn was down in the quarter and engagement was up. I think there are opportunities to continue to broaden engagement, plus we're doing some really interesting things in the content team on different platforms that are contributing to the overall improvement in the user experience. I'm thinking by way of example, in entertainment with YouTube Video and the NBA League Pass. Just by a way of example, we've seen a very substantial increase in engagement in that content amongst Tread users, by a way of example. We've come a long way, but we're going to come a lot further faster in the foreseeable future. Certainly, AI will play an important role here.

Yes. A few things to add about our outperformance in Q2. Some of the areas that really worked well for us were our Bike rental and FaaS, the third-party, and our refurbished inventory sales or Bike sales. Those all outperformed our internal expectations in the quarter, which is great. Our Bike rental also benefited from the fact that we've had lower churn, so that helped with subscribers. We also launched self-service buyouts on our platform, which was a really great win because we saw 11% of our rental members buy out in the quarter, which contributed to some of the outperformance. There are other factors that are impacting our subscriber growth for the quarter. As we mentioned, our hardware demand was lower overall than we forecasted, but we had some offsetting tailwinds that benefited us. Our supply chain team did a great job and outperformed in terms of delivery efficiency. That means we had a bit of a pull forward in our deliveries into Q2 that we expected to have in Q3. We also had faster subscription activations in the quarter than we expected. Sometimes over the holidays, people lag a bit with activating their subscriptions. We saw that was faster than we expected too, so that helped with subscribers. Additionally, we had lower new subscription passes in the quarter and higher-than-expected reactivations from a pass state than we expected. That helped overall retention and is one of the drivers of our better-than-expected Q2 churn results. One more thing that is also really important to understand about our performance in the quarter is the secondary market. That continues to outperform our expectations and was a key contributor to subscriber growth in the quarter.

Thank you. One moment for our next question. And that will come from the line of Andrew Boone with JMP Securities. Your line is open.

Thanks so much for taking my questions. I wanted to ask about the increase in media spend that you guys called out in the letter. As we get further away from the re-launch of the digital app, how should we think about marketing, especially as you just mentioned, the pullback in overall demand for hardware? And then, Liz, is there anything you can call out in terms of Connected business gross margins going forward, that stepped up in the quarter? How do we think about that for the back half of the year and then going forward? Thanks so much.

So to the first question, it sounds like it was about the increase in media spend that we saw in Q2. We generally see an increase in our media spending in Q2 because it is our holiday quarter, and we use that as a way to drive leads and demand for our hardware products and our app on all of our products. In the back half of the year, we do expect to spend less on media just seasonally. We expect lower quarterly media spending going forward. Another thing to understand about our business is what I really come back to on these calls is to talk about LTV to CAC. So we're trying to optimize for that for the business. When we look at our media spending, we want to ensure that it is efficient and drives an efficient LTV to CAC, definitely over one. Ideally, we want to be in the 2x to 3x range. We were not there for Q2, but we were above one, and our goal is to move towards more increasing media efficiency. Now on the Connected Fitness gross margins, we expect some improvement in the back half of the year, in part because our Tread+ deliveries will benefit gross margin in the back half. We do see a little bit of pressure from areas like Bike rental as that continues to take share, which will put some pressure on our Connected Fitness gross margin, but we expect sequential quarterly improvement. It's important to note that gross margin, promotional activity, obviously, affects gross margin. We'll optimize for LTV to CAC. If we see the opportunity to reduce our LTV by reducing our gross margin and optimizing our media spend, we'll make that trade-off and evaluate it as we go.

I would say at a high level, I'm pretty optimistic about our ability to try to bring more efficiency out of the marketing spend, and we're making some structural changes in the way that we run the business that will help contribute to increased operating leverage. I'm being intentionally vague, but it's among the reasons why I have some optimism about the go-forward performance.

Thank you. One moment for our next question. And that will come from the line of Shweta Khajuria with Evercore ISI. Your line is open.

Thanks a lot for taking my questions. I have two, please. One, Liz, could you please talk about the free cash flow? So your guidance now calls for lower expectations than what you talked about last quarter, you expect to be positive free cash flow in the fourth quarter and not for the full year. So help us think about why the change and what drove that? And then the second question is on how to think about the impact from TikTok and lululemon. Is $10 million a quarter that you quantified last time, did it come in better than expected? How should we think about it going forward? And then the impact of TikTok on P&L, please. Thank you.

Sure. Let's start with the free cash flow question about why our free cash flow outlook is lower than we had previously expected. So, for Q2, while our paid subscriptions for Connected Fitness outperformed our expectations, our hardware sales, as I mentioned earlier, were a bit softer than we expected. We're projecting that softness from a trend perspective to continue into Q3 and Q4, which creates a bit of a cash headwind for us. We're also continuing to see a mix shift into Bike rental or FaaS, which puts pressure on our cash because, again, we don't collect all of that hardware revenue upfront. Putting that together means we have a bit of a cash headwind from inventory compared to our prior forecast, mainly coming from our Bikes. We also had a few payment timing benefits that pushed from Q2 into Q3 that helped Q2 cash flow but will impact us a bit in Q3. The other question was about TikTok and lululemon. I can probably take the lulu piece, Barry, I don't know if you want to talk about that.

She was anchored on $10 million and I think wanted confirmation on that.

Yes, our lululemon partnership, at least we're talking about the Studio - the Studio All-Access Members who have what was formerly known as the Mirror hardware product. That performed as expected, actually slightly better than we expected. So that is on track. Regarding TikTok, that marketing relationship is really early days. We don't have a lot of explicit assumptions around how that is going to provide upside to our financials going forward in Q3 and Q4.

Yes. We're in the third week of the TikTok deal, and we've seen a substantial increase in the number of pieces of content in those three weeks. Comparing to week one, I think it was about a 50% increase, and we've seen a 3x increase in total views, but it's much too early to know where that's going to land. We're excited; our first live class had over 130,000 views, which is a pretty good start, but I'm sure we can do much better than that. The important thing to note is we're reaching a demo that's much younger, and TikTok is proving to be an enormously effective platform to help us do that. We want to lean into that. If we do it well, it has implications for growth in the app. It's too early to have any meaningful insights yet. For those of you who saw the headline yesterday that TikTok squared off with Universal over music rights, I want you to know that doesn't implicate our marketing agreement; our content on TikTok is fully licensed with the labels.

There is one thing I wanted to comment on with regard to the $10 million from lululemon for the Studio All-Access Members. That was just reflective of November and December. That was just two months in Q2, and it will obviously be a full quarter in Q3 and beyond.

Coming back to the cash flow thing here is what I would say. Let's remind ourselves what the two objectives for the business are: one is to stop the bleeding; the other is to grow the business. I'd hope that we would generate more cash flow in the second half of the year than we currently think we're going to. The important thing is we still think we will cross the finish line and get cash flow positive in Q4. If you look at our balance sheet, the business is not going away, which for a long time was a systemic threat. Because of that, we're able to focus on renewed growth. What have we accomplished in the last two years to assist with that? Well, there's been very little product innovation. We reintroduced an existing product, Tread+, and we launched the Row, which mostly we sell to existing subscribers and a little bit to new members. So not much on the product side, a lot of innovation with respect to the business model, different go-to-market strategies, 3P and FaaS being to note were the examples. I think you're going to see in the next two years a significant product innovation, which I'm very excited about because we have a real shot at changing the growth trajectory of the business in a meaningful way.

And one moment for our next question. And that will come from the line of Aneesha Sherman with Bernstein. Your line is open.

Great. Thank you. Barry, you've talked about the seasonality of the business with more growth clustered in the winter months. Can you square that with your view of flat growth in Q3, which is a winter quarter, especially in light of all the successful initiatives you've highlighted in your letter? And then on the other side of this, you're lapping a weak Q4 this year, and you expect positive growth. Are you comfortable with having fully lapped the seasonality effect at that point? So from Q4 onward, you're basically like-for-like on seasonality?

Well, our view hasn't changed on seasonality, actually. It is Q2, the holiday season, which drives 40-plus percent of the annual volume. There's not much seasonality in the rest of the year; it slows in the summer months a little bit. That would be the only other qualifier to mention.

And I also think it depends on what you're looking at. If you're looking at subscribers, we do expect to grow subscribers in Q3, both on the Connected Fitness side as well as the app side.

Now we did deal with the seat post recall beginning in May of last year, which caused a lot of softness for the B1 Bike. But we've been living with that softness for B1 Bike ever since. It's not like consumers suddenly rediscovered a love for that product in the aftermath. We see a significantly different trajectory for unit growth for Bike+ by the way.

And also our Treadmill products; we're seeing growth there.

Sorry, I didn't mean to imply that wasn't the case. I just meant to say that if you're expecting a resurgence in demand post the seat post recall for B1 Bike, that really hasn't happened.

And if I can ask a quick follow-up. Do you believe at this point, you're kind of a huge inflection in growth in your 2020, 2021 cohorts. Have those COVID users now normalized in terms of churn, and is your churn level now back to normal across cohorts, including the COVID cohort?

Yes. I would assume that's the case. Yes.

I think there was a short thesis that maybe they came in with COVID and they're all going to fly out the door afterwards, and that's just flat wrong.

If you look at our churn profile, our churn rates on a cohorted basis, like a 12-month churn rate by cohort, it's not coming down substantially in any way. The only factors that influence our churn are the mix into the Bike rental, which we have talked about in prior quarters, where our Bike rental subscriptions do have a higher churn rate than our regular All-Access Members, although we are working to bring that down and it did improve quarter-over-quarter in Q2, which is great. Also, I think we've talked about in prior calls, the secondary market, which is the people who buy a Bike not through us but through someone else, like from a marketplace of some sort, does have a slightly higher churn than people who buy directly from us. As that increases, it will put some pressure on our churn as well. But our underlying churn for our All-Access Members that come through is pretty stable.

Thank you. One moment for our next question. Our next question will come from the line of Edward Yruma with Piper Sandler. Your line is open.

Hey, guys. Two quick ones from me. I guess, first, Barry, a bigger picture question. You've been at this for some time and certainly had some success in turning the business around. But as you step back and think about Connected Fitness and growing it, it seems like you had most success lowering the cost of ownership. So I'm trying to understand if further growth is predicated on continuing to drive down cost of ownership through things like rental, or is it still a marketing issue? And then as a follow-up, just so I'm clear on the POP sale, was that aligned with the impairments you've taken? And are there further impairments that are necessary when you close that? Thank you.

Let me acknowledge that you're quite right that the go-to-market innovations that have resulted in lower cost of entry, like FaaS, like refurb, have been enormously successful. FaaS is now a $100 million run rate business from zero, and we grew not quite 300% year-over-year in the quarter. We see very fast growth in the secondary market, north of 40%. Value matters. There are lots of ways to deliver value. One way is investing in the product and the user experience. I think there's a tremendous opportunity for us to lean into the performance aspect of the market with premium-priced products to drive new growth for us, meaningful growth. An existence proof that there's an appetite amongst consumers for that kind of positioning is the Tread+. If you give people something they want, they'll be delighted to pay for it, but it has to be a uniquely compelling user experience, which is why we're leaning heavily into investing in product innovation. We need the right talent in the building to pursue that. We had some interesting talent walk into the building last quarter, and I'm pretty optimistic based on what's being discussed in the building today.

And then just really quickly on that question about POP and impairments. In Q2, we did book an impairment charge of roughly about $2 million to bring the value of POP in line with what we sold it for, and that gets closed in early Q3.

Thank you. One moment for our next question. And that will come from the line of Youssef Squali with Truist Securities. Your line is open.

Great. Thank you. So a couple of questions. Maybe starting with Bike rental, that's one of the positive developments that you had in the business. Can you remind us about the size of it today, but more importantly kind of the unit economics? I think in the letter, you mentioned attractive unit economics. How have they kind of performed over time? Where are we now relative to the rest of the business? And then on Q4 guide, Q4 is typically one of the weaker quarters, and you're guiding for an inflection point to growth there. Can you maybe just help us with the puts and takes as to what needs to happen for you guys to hit that milestone? Thank you.

I'm going to let Liz take most of that, but I just want to make one observation about FaaS linking back to a previous question. We learned last year about FaaS that it's not very seasonal. The demand seems to be pretty consistent across the calendar year. We saw accelerated growth in FaaS this quarter due to some work we've done on landing pages and the way we're merchandising it to members. Liz, do you want to talk about the Q4?

Yes. Let me first provide a little bit of information about FaaS around the unit economics. Our unit economics for FaaS are improving. Our churn was better than it was in Q1; it was slightly under 5%. We talked about it being around 5%. We expect to continue to improve the gap between rental churn and purchase churn. It improved quarter-over-quarter by 100 basis points versus Q1. Our average payback is now averaging around 16 months for FaaS, which is also an improvement over Q1. We still use a rich mix of refurbished units, and as we lower our churn going forward and make improvements there, we expect to shift to more new Bikes as we continue to sell down that refurbished inventory while achieving attractive payback results. Regarding the Q4 inflection, we expect revenue growth; our guidance shows that we'll end the year for Connected Fitness subs just slightly above where we started. It’s a tough quarter for growth. Revenue growth in Q4 is driven largely by Tread+ deliveries, which so far skews towards existing subscribers rather than new ones, which makes sense because we just re-launched it.

Thank you. One moment for our next question. And that will come from the line of Simeon Siegel with BMO Capital Markets. Your line is open.

Thanks. Hi. Good morning, everyone. Congrats on the strength of third-party retailers. Can you remind us what the unit level revenue and margins look like for a Bike sold or any equipment sold via third-party retailer versus when you sell it directly? And then you called out, and I think you've spoken a few times encouragingly about the continued growth in the secondary market sales. Can you just let us know roughly what percent of the current CF subscriptions are on their second or life or so? Thank you.

So the first question was related to unit economics for a third-party. From a gross margin perspective, the unit economics for selling through a third-party channel like a Dick's Sporting Goods or an Amazon are lower because, obviously, there is that margin given to the wholesaler. We make up the difference in our sales and marketing spend. We expect our customer acquisition costs through those channels to be substantially lower, and that's how we model and run those channels. So you see gross margin pressure from third-party, which should be offset, and that's how we optimize with more efficient sales and marketing spending. Regarding what percentage of our Connected Fitness subs are from the secondary market, it's increasing quarter-over-quarter. In Q2, it was slightly down as a percentage of our total gross additions versus Q1, just under 30% coming from that channel.

Let me come back to 3P for a minute and talk about FaaS in that context. It only makes sense to give up margin if a large percentage of customers are incremental. It's relatively easy to calculate the crossover point to determine if you're economically advantaged by making the lower margin trade-off. We saw explosive growth with our 3P partners in Q4, but it cost us some incrementality. We need to be thoughtful about our sell-through to those partners during uniquely special periods. We talked about incrementality on FaaS; it's consistently north of 60%, around 63%. Even though economics compared with the cash flow aspects of it are less attractive, we're attracting a significant audience we wouldn't otherwise be attracting.

Thank you. One moment for our next question. And that will come from the line of John Blackledge with TD Cowen. Your line is open.

Great. Thanks. Just on Tread+, Liz kind of just addressed it. My question is, is demand more so from existing members? Or is it a mix of existing and new members? I think she said more so from existing members now. But I guess as we get through the second half and into next year, would you expect to see more demand from new members, given the market is two times bigger than the Bike market? And then my second question on paid apps. The high end, it looks like the high end of paid app subs is down a little bit. Just how should we think about the trajectory of paid app subs kind of into the back half and kind of into fiscal '25 and beyond? Thank you.

I think you're absolutely right that it's reasonable to expect that we would see a shift in the mix from existing members to new members because really the only members who know what the Tread+ represents are the existing members.

Also, our Tread+ was just reviewed as the best overall Tread in 2024 by CNN, which should help grow the awareness of the product.

With respect to the app, I think in the past, we've referred to it as the best product we have that nobody knows about. The unaided brand awareness is down at 1%, but 6% is our unaided brand awareness.

There was a question about the range. So I can take that part. So...

Sorry, hang on a second. I just wanted to talk about the momentum and where we are in the learning curve, and I think it is important for us about our go-forward view. At a very high level, I think your question is, okay, so we restructured our app pricing model. Is the business better off for it? The answer is, today, not yet. But we think the crossover point happens in June, and we're pretty optimistic about the trend line we're on now. We foot-faulted early when we focused primarily on free. We struggled for several months, and then we pivoted to focusing on the paid piece. Ever since we focused on that, we have seen significant progress. We're making important steps to improve the overall user experience. The work we're doing in personalization will have its biggest impact, and some partnerships we've struck, like TikTok, will help drive significant growth, I think. Sorry, Liz, over to you.

I was just going to point out that if you look at our guidance, what it implies is that Q2 was the low of our paid app subscriber base. We were pleasantly surprised by the retention level of those subscribers given the expiration of their legacy period. We feel like we've bottomed in Q2, and now the question is how quickly we can grow the sub base from there in the next couple of quarters. As Barry pointed out, there are great things we're working on, and those features will continue to roll out in the coming quarters. There's uncertainty regarding how quickly we'll be able to grow it, particularly with Peloton for business offerings and in the corporate wellness space. Those deals take time, so there's uncertainty on those closures. They could accelerate app subscription growth. There’s a lot of upside potential; it just reflects the uncertainty of how quickly we can accelerate it over the next few quarters. We're super optimistic about it.

Thank you. And our last question for the day will come from the line of Lee Horowitz with Deutsche Bank. Your line is open.

Great. Thanks for taking the question. Barry, you talked in the letter about outgrowing the overall Connected Fitness market. Subs growing marginally year-on-year, which would suggest that the overall market remained depressed at this point. I guess how do you think about what's holding the market back and growing more meaningfully at this point? How do you think about the conditions that maybe allow some of those headwinds to abate, and what do you think about the long-term growth rate of this overall market at a steady state? Thanks.

I don't really know what the long-term growth rate of the market is. It's got to be at least population growth with a couple of accelerants. The more you age, the more important it is to invest in health, and the more likely you are to have disposable income to make that investment. No question that product innovation drives growth, and there's interesting technology coming into the marketplace to help drive that. We really have only scratched the surface regarding gamification, which will be a vector for growth for us. Lastly, corporate wellness is having a moment in corporate America, and companies are investing more in fitness, nutrition, and mental wellness. We're well positioned to participate in that, and product innovation will also drive growth. We've been busy saving ourselves for the past two years and are now positioned to invest in innovation again. A lot of talent is present to assist with that, and Nick will be impactful in this area.

And Mr. Stabler, that was our final question. I'll turn the call back over to you for any closing remarks.

Thank you, everyone, for joining us today. We look forward to speaking with you next quarter. Have a good day.

Thank you all for participating. This concludes today's program. You may now disconnect.