Earnings Call Transcript - PTON Q4 2023

Operator, Operator

Good day, and thank you for standing by. Welcome to the Peloton Interactive 4Q '23 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised today's conference is being recorded. I would now like to hand the conference over to your speaker today, Peter Stabler. Please go ahead.

Peter Stabler, Speaker

Thank you, Ken. Good morning and welcome to Peloton's fourth quarter and fiscal year-end 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.

Operator, Operator

Thank you. Our first question comes from Ron Josey with Citi. Your line is open.

Ron Josey, Analyst

Great. Thanks for taking the question. Barry, I want to hear about two things. I think in the letter, you talked about an uptick in sales in the last eight weeks. I want to understand a little bit more about what you think is driving this. Is this the result of just new brand spend or maybe seasonality coming back? And in the letter, you also talked about free cash flow being positive, expected to be in the back half of '24. Just talk to us about the drivers that will lead to that positive free cash flow and the confidence in that metric? Thank you.

Barry McCarthy, CEO

I don't have an answer to the first question, Ron. If I did, we could explore it further. I suspect there are some macro factors involved, and seasonality may also play a role. However, we lack sufficient insight into the cause and effect to provide a comprehensive answer. The current trend appears stable, but I can't predict how long that will last or what the trajectory will be. Regarding cash flow in the second half of the year, our outlook is quite different from the first half. We aren't assuming aggressive growth, but achieving the growth we are projecting is necessary for the anticipated financial results. If we meet those targets, the metrics for the last quarter of the year will be impressive, including double-digit revenue growth, over 40% gross margins, positive adjusted EBITDA, and positive free cash flow, which would be very exciting if we can make it happen. We've had a reasonable track record of forecasting our financial performance relative to our recent ability to predict growth in subscriptions and Connected Fitness unit sales. I believe there may be a slight upward bias in our forecast, but it's difficult to say for sure. One reason for this is that I mentioned several new initiatives in the letter. We're working on a few things, and I am confident we will successfully implement them, though we haven't accounted for any potential upside in our plans yet. Until we finalize these initiatives, there remains some uncertainty, but if we do, it could enhance our confidence in the second half of the year.

Liz Coddington, CFO

I was just going to add one additional thing about the free cash flow, which I think Barry did mention in the letter, which is that we are getting into a much more normalized inventory position than we were last year. So we are buying more inventory, particularly for our Bike and Tread product, and we're going to have to spend in advance of holiday to build up some of that inventory for the season. We also have our seasonality in our marketing spend, and those two things put a bit more cash flow pressure on the front half of the year rather than the back half of the year, just due to the timing of those. So I wanted to call that out as well.

Ron Josey, Analyst

Thank you, Barry.

Barry McCarthy, CEO

One more comment, if I could. I'm sorry to be so long-winded, Ron. We certainly have had our fair share of unanticipated surprises and not all of them have been helpful to the business. The seat post being the latest example, and the DISH settlement being another example. I don’t know how many more of those unwelcome surprises there are in our future, but it seems to me we have to be getting closer to the end of that story than we are at the beginning.

Ron Josey, Analyst

Understood. Thanks, guys.

Operator, Operator

One moment before our next question. Our next question comes from Doug Anmuth of JPMorgan. Your line is open.

Doug Anmuth, Analyst

Thanks so much for taking the questions. Barry, you're about three months into the brand relaunch, though I know this has also come during a seasonally lighter period. I was hoping you could talk more just about the progress that you've seen here, and how marketing could evolve in the first half of your fiscal year as you head towards the holidays. Thanks.

Barry McCarthy, CEO

Hey, Doug. A couple of thoughts. One very high level. The team, investors have often heard me speak about the importance of talent density; that's never more true than it is in this instance, not to create more pressure for our CMO and the marketing team that has already existed for them. They have done just a spectacular job with the relaunch. The creative has been nothing short of amazing, and the creative that's going to follow is even more spectacular. The early indications are that we're achieving the objectives that they had set for the business, which is just to attract a younger audience. We've seen a tremendous increase in engagement with Gen Z, by way of example. We're capturing people earlier in their fitness journey than we ever had before. So the 'anytime, anywhere, any place' message is absolutely landing. And the last objective was to remind people that, particularly with the launch of the app, that we're more than just a stationary bike company. That message is also finding traction. So lots of reasons to be enthusiastic about where we're going. The last point I want to make is in reference to the two co-branding deals that we've already announced, one with Liverpool yesterday, and the University of Michigan. It's very clear from our conversations with those brands, which are both highly regarded, and other inbound traffic that we've had, which has been significant, the rest of the world regards the Peloton brand very highly and seeks us out as a partner. That affords us the opportunity to capitalize on that, and you'll be hearing us talk about that ad nauseam as the year unfolds.

Doug Anmuth, Analyst

Great. Thank you, Barry.

Operator, Operator

One moment before our next question. Our next question comes from Justin Post with Bank of America. Your line is open.

Justin Post, Analyst

Great. Thanks, a couple. Barry, in the letter and on the call already, you've mentioned some growth initiatives that you're excited about. I think we've already talked about fitness as a service and some of the retail initiatives, anything new or something you would call out that you're really enthusiastic about for the year? And then second, on churn. Can you help us quantify how much of the 80,000, I guess you'd say, inactivations at the end of the quarter, maybe related to the seat posts, and as people receive them, do they get back on? Are you seeing any positive progress this quarter as people receive the seats? Thank you.

Barry McCarthy, CEO

I'll take the first part, and then I'll ask Liz to take the churn part of the question. With respect to growth initiatives, Justin, we articulated a year and a half ago a good, better, best strategy to make the service increasingly accessible to new users. The reintroduction of the app was a component of that strategy. You mentioned fitness as a service. We started that a year ago with 50,000 subs, about $45 million in revenue. I think we'll grow it by more than 70% on a year-over-year basis if the current trends continue. Churn was up slightly in the quarter, but I think that was related to the seat post recall, and it’s likely to come back down. Certified pre-owned has worked extremely well for us, and we're seeing good momentum in that side of the business as well. So enormously excited about those initiatives. In the current year, International will be a growth opportunity for us. It was not this past year because the past year, the objective was to reduce the operating losses of that business, which we did to the tune of about $40 million. But you'll see us leaning aggressively into growth in existing markets like Germany, Canada, and the UK with new product launches and co-branded partnerships, like we did with Liverpool, by way of example. And then you'll see us in the U.S. using growth initiatives, replicating that co-branding experience. Components of those deals will be, I think, have a couple of common characteristics. They will be multi-year, they'll be global, they'll be exclusive. There will be collaboration on content creation, and there will be co-marketing and social media components. If we execute them well, we will benefit enormously from the association of our brand with theirs. Our members will benefit from the content creation that happens as a result of those deals. Altogether, I think, will contribute to an acceleration in our growth.

Liz Coddington, CFO

Okay. I'll go ahead and take the question on churn. So, as we mentioned last quarter, in Q4, we did expect to see a modest sequential increase in our churn, and that's consistent with the seasonal trends that we tend to see over the summer. If you look at our legacy churn metric, that 1.4% we had for Q4 was about 10 basis points roughly higher than we expected. We expected it to be about 1.3%. In relation to the seat post recall, we did see our churn rate increase a bit in May and June relative to April, and that’s atypical seasonality for us. We do believe that that was related to the seat post recall. When you're referring to the 80,000, you're referring to the POS subscribers, and those folks are now in our new metric, considered churn, and you can see that uptick from around the 50,000 to 55,000 range that we've had more typically to about 80,000, and that took us to a 1.8% churn rate when we consider those POS subscribers as churn. We did expect POS subscribers to go up a bit seasonally in Q4 because of seasonality, and people tend to pause their membership during that time. But we believe the outsized increase is related to the seat post recall. In Q1, it's important because we're guiding to this new metric that we kind of anchor on that 1.8% that we shared in the letter. We expect churn to come down substantially from that 1.8% because we don't expect to see an increase in POS subscribers like we did in Q4. We likely will see some level of decrease, but we're not really forecasting a huge decrease in pause, for part of the reason that subscribers can pause for up to three months; people started pausing in the June time frame. We know that some people are still awaiting their seat post, and they should all receive them by the end of September. However, we don't know that people will immediately un-pause the moment that they get their seat post. It's important to understand that just by not having the POS subscriber base increase, our churn should come down to around the 1.4% range and perhaps even a little bit better than that. We will also expect to see some benefit from seasonality as well. Hopefully, that clarifies.

Justin Post, Analyst

Thank you.

Operator, Operator

One moment before our next question. Our next question comes from Eric Sheridan with Goldman Sachs. Your line is open.

Eric Sheridan, Analyst

Thanks so much for taking the question. I wonder, if I could get some of your more updated thoughts on the Digital app strategy. What are some of your key learnings as you continue to position that strategy, and how should we be thinking about some of the investments you want to make to drive growth against your longer-term goals in terms of building the subscriber base around the Digital app? Thanks.

Barry McCarthy, CEO

Well, look, we've had about slightly in excess of 900,000 people download the app, and about 600,000 of those roughly are new to the platform. So we need to continue to lean into creating awareness and driving trial. With respect to the paid app, we're seeing a higher percentage of App+ users than we had anticipated, which is a good thing. So how do we continue to find success with the app? We need to continue to allocate marketing spending toward it. There’s this constant tension: do we spend it on Connected Fitness units or allocate a larger portion of the slices of the pie to spending in the app and see how the needs of the business develop as the year unfolds relative to our plan? Secondly, we need to ensure that the app interface continues to evolve in ways that make it compelling, easy to access, and engaging for members. It was originally designed to be an add-on to a CFU membership, not as a freestanding app. So we continue to evolve the design and interaction. Lastly, we need to continue our current investment in personalization, both for the app and on consoles for Connected Fitness units. So that great content that we create is discoverable by members who would enjoy it if they only knew it exists. The better we are at personalization, the stickier the user experience will be, which will lead to lower churn, greater satisfaction from members, more organic growth, lower costs, and higher lifetime value. That's the playbook for success.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from Andrew Boone with JMP Securities. Your line is open.

Andrew Boone, Analyst

Good morning, and thanks for taking my questions. The 1Q '23 gross profit margin guidance seems to imply that Connected Fitness margins are very near breakeven. As you guys think about pricing and bringing down the price of the Tread and the row, is the right way to think about managing hardware gross profit margins breakeven, or how do you guys think about this strategically?

Barry McCarthy, CEO

Liz, why don't you take that?

Liz Coddington, CFO

Yeah. Sure. So you're right that for Q1, it implies a roughly neutral Connected Fitness gross margin. When we look at our unit economics for the business, all of our unit economics show that we have the ability to keep our gross margin in positive territory. That does require us to have a certain level of volume, otherwise, we have fixed costs that we also have to cover. As our volume grows and scales, we have the ability to achieve a positive gross margin. But in Q1, we'll be challenged in terms of weak hardware sales that we're expecting, and that is impacting our Connected Fitness gross margin guidance in the quarter. The key thing to note here is our goal is to grow our subscriber base efficiently, and we will evaluate our hardware margin through the LTV to CAC framework. As we've said before, our focus is on driving efficient subscriber growth. Beyond Q1, we're going to look at the trade-off we have on reducing price or promotional activity, which reduces LTV in relation to efficient marketing spend. We'll continue to make those trade-offs each quarter to evaluate what the best strategy is.

Barry McCarthy, CEO

Let me jump in and add a different perspective, if I could, Andrew. When I walked in the door, it seems we had a limited number of tools in the toolbox to grow the business. Price promotion was about the only thing we had. We had a commercial business, but it needed to be re-architected from a cost perspective, like everything else related to Peloton. But I have never been more optimistic; we're excited about the future of the business. There is this disconnect between the stock price and the energy surrounding the partnerships and co-development programs that are in progress. If I'm right about that and we are less dependent on price promotions to drive growth, that should have positive implications for hardware margins, which is why I went through that long-winded explanation.

Andrew Boone, Analyst

For my second question, I wanted to ask about the corporate opportunity. Do you guys need to make any investments on the sales and marketing side to be able to support that, or what else needs to happen to drive growth for hospitality for everything else included? Thank you so much.

Barry McCarthy, CEO

Super good question. We just added to the team on the commercial side a senior executive from American Express, who led strategic partnerships there, to help build out our sales capability to drive growth in commercial and corporate wellness. So yes, there'll be some investment. But from a macro basis, it won't be a big impact on margin.

Liz Coddington, CFO

I just wanted to add one more point. Another thing that we're excited about for the business that's going to help drive growth is that we are working on commercially launching our Bike+ and our Row, and that should be coming really soon. That will give more opportunities for businesses to have our hardware in their settings.

Barry McCarthy, CEO

And Tread+ once it's reintroduced in the market as well.

Operator, Operator

One moment for our next question. Our next question comes from Shweta Khajuria with Evercore ISI. Your line is open.

Shweta Khajuria, Analyst

Okay. Thank you for taking my questions. I've got a couple. Barry, of all of the three things, getting to positive free cash flow in the back half of next year, your product initiatives, and your growth initiatives that include marketing spend, international expansion, corporate partnerships, where would you say your highest level of confidence is, and where do you think there's a greater level of uncertainty? And then I have a question on forecast. In terms of your first-quarter forecast, how different is your methodology this time than it was last time, in terms of your visibility and perhaps uncertainties? So how confident do you feel in your current guidance, and how different was your method this time? Thank you.

Barry McCarthy, CEO

Liz, do you want to take the second part of the question?

Liz Coddington, CFO

Sure. So it's a little bit of an odd question. One thing that is a little different about Q1 versus other quarters is that we are guiding much later in the quarter than we often do. Our confidence in our guidance range is higher because there's less of the quarter left to provide guidance on. There wasn't really a change in the methodology of our guidance; we just added an additional guidance metric regarding app subscribers. The other change would be that we're guiding to Connected Fitness subscribers, excluding FaaS subscribers and then our app subscribers. But otherwise, there's really no change to our methodology.

Barry McCarthy, CEO

I think the question for me was how much risk I perceive in the business related to the upside growth in the second half of the year. The short answer is, not much. It's a pretty low bar, and if we can't deliver against that, then what are we doing? At the moment, we're all consumed with the potential upside, which we haven't announced yet.

Shweta Khajuria, Analyst

Okay. Thanks, Barry. Thanks, Liz.

Operator, Operator

We'll move for our next question. Our next question comes from Mario Lu with Barclays. Your line is open.

Mario Lu, Analyst

Great. Thanks for taking the questions. The first one is on the free app. I know it's only been three months, but any early data points to share with regards to these free users eventually converting to either all access or paid members over time? And then on a separate note, is there an ad revenue opportunity for the free app similar to Spotify?

Barry McCarthy, CEO

Let me do the second part of the question and ask Liz to do the first part. So I'm a little bit familiar with the ad business since I ran it at Spotify. One of my takeaways from that experience is that advertisers buy reach, meaning it requires scale in your business to be a viable player, and we don't have that for a long time. Secondly, it's very resource-intensive; it requires a lot of engineers writing a lot of code with complexity to measure and automate the ad business at scale. The only way we could practically participate in that would be to outsource it, similar to what Netflix does, and that would not give the user experience we aspire for our members. Hence, I don't foresee a scenario in the foreseeable future where we're in the ad business.

Liz Coddington, CFO

Yes. The question was about early data points regarding the free app and users converting to paid. We've had over 900,000 downloads of the app. Over 600,000 of those have been new users to Peloton. We have about a quarter of a million monthly active users of the app. There’s clearly opportunity to drive further engagement. Many of these people are earlier in their fitness journeys, and as Barry mentioned, we have work to do on the app to make it easier for users to get started and drive that engagement. We believe that building a free tier base is important for long-term growth. We're focused on driving awareness, which has been good given the number of downloads, but these new users haven't decided yet to upgrade to the paid membership. That's a key focus for us: how to engage them better and get them to convert.

Mario Lu, Analyst

Great. That's helpful. And then second question is on fixed costs. You reduced your fixed OpEx items by 25% to 30% year-on-year this quarter. Just curious if there's any color you can provide in terms of how much further improvements we can expect to see in fiscal '24? In terms of the fixed cost reductions. Thanks.

Liz Coddington, CFO

Yeah. Regarding our OpEx, we will continue to optimize our fixed cost base over the course of the year. For G&A, we will continue to optimize and reduce costs in areas like staff augmentation, legal spending, and customer service. In Q4, we had a one-time benefit in our legal expenses that we don't expect to repeat. Annually, we have line of sight to over $100 million in expense reductions versus fiscal '23. For R&D, we expect R&D expenditures to be similar to FY '23, as we continue to invest in our platform, focusing primarily on software improvements like personalization and enhancing our app. Notably, we will not be capitalizing a substantial majority of our R&D for internal software use moving forward. You'll see that in P&L with more of our R&D costs expensed rather than capitalized. This is estimated to have about a $10 million impact on Q1 R&D expense. Additionally, we will be reducing our retail store footprint, so some fixed marketing costs will decrease, but we will reinvest some of those in channels that are more efficient.

Operator, Operator

Thank you. One moment for our next question. The next question comes from Edward Yruma with Piper Sandler. Your line is open.

Edward Yruma, Analyst

Hey. Good morning. Thanks for taking the question. So I guess just a bigger picture question and maybe in light of what happened with the seat post, I know you haven't reported like workouts per user in a long time, but I'm curious how you think about overall engagement within your Connected Fitness subscriber base? How has it been trending? Did the seat post have an impact on that? And then just real quickly on inventory. I know there were many extraordinary costs that were capitalized on some of the older layers of inventory. Moving forward, how should we think about the direction of cost of goods and how the Bike price compares to maybe some of the legacy inventory you had on the balance sheet? Thank you.

Barry McCarthy, CEO

Maybe Liz could take the inventory piece, and I'll take the engagement piece first. Macro engagement has remained strong. Liz mentioned that there were a number of folks who paused their account related to the seat post, but amongst the members who didn't, they just kept using their bike as if there was no notification. That likely explains why we didn't see an aggregate dip in engagement like you might have expected given the seat post proposal. Liz, do you want to comment on inventory or correct anything I just said?

Liz Coddington, CFO

Nothing to correct, but to discuss inventory: inventory will continue to be a source of cash for us in fiscal '24. We're in a much more normalized inventory position than we were last year and are already purchasing more hardware. In fact, we're buying more Bike and Tread inventory this quarter. Regarding cost of goods sold, for products like Tread, we have seen our cost of goods sold significantly decrease. That's part of the reason for the price reduction for Tread. We're not experiencing as notable an effect on our Bike from that perspective, but on Tread specifically. I did want to clarify a point about Barry's comment relating to the 80,000 subscribers; that was more around 15,000 to 20,000 incrementals.

Barry McCarthy, CEO

I think the 80,000 is the aggregate, yes.

Edward Yruma, Analyst

Thanks.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from John Blackledge with T.D Cowen. Your line is open.

John Blackledge, Analyst

Great. Thanks. Two questions. On the college initiative, can you talk about the pipeline for that opportunity? And then second, on the rental program launched in Germany on August 9. I know it's a couple of weeks in, but just curious how you view that opportunity in Germany? Thank you.

Barry McCarthy, CEO

In reverse order in Germany, they're more culturally accustomed to rental models. The team thought that a fitness as a service program would land well. It's too early to know, although there's enthusiasm about it initially. We’re incredibly optimistic. Regarding the college pipeline, I understand your question. I really don't want to answer it, but you can imagine that a program like the one we were fortunate to announce with Michigan could scale across other Division 1 programs. The opportunity to do co-branded bikes on college campuses and elsewhere is enormous. If we're lucky enough to see it take off, then the supply chain will be under pressure to fulfill demand.

John Blackledge, Analyst

Thank you.

Operator, Operator

One moment for our next question. Our next question comes from Aneesha Sherman with Bernstein. Your line is open.

Aneesha Sherman, Analyst

Thank you. So historically, Q1 has been your weakest quarter, and Q2 to Q3 have driven more than 60% of the year's sales. As you talk about seasonality impact in Q1, do you then expect to see a similar cadence through the year into Q2 and Q3? And then I have a follow-up. As you effectively lowered the dollar commitment for new members over your new pricing schemes, do you expect the seasonality in the business to get sharper, and do you believe your cost base is now aligned for a more seasonal business overall? Thank you.

Liz Coddington, CFO

Let me start with the revenue seasonality. We won't offer full-year guidance for our revenue, but we expect our fiscal '24 revenue seasonality to closely resemble fiscal '23. We expect it to be more heavily weighted to the back half of the year, not quite as heavy as fiscal '21, but heavier than fiscal '23. The second part of the question was whether our seasonality will change with pricing changes. It's a tougher question to answer, and we'll see as we go along. But there are macroeconomic factors that will affect this, as will our efforts to drive improvements in our app and enhance the user experience.

Barry McCarthy, CEO

I agree with everything Liz said. However, I think it's possible that the app business will be less seasonal than the Connected Fitness business because Connected Fitness units tend to stay indoors when people are outdoors, while the app can be accessed anytime, anywhere. Many workouts are designed to be done anywhere, such as outdoor running, yoga, or strength training at the gym.

Aneesha Sherman, Analyst

Thank you. That’s really helpful color.

Operator, Operator

One moment for our next question. Our last question comes from Jonathan Komp with Baird. Your line is open.

Jonathan Komp, Analyst

Yeah. Hi. Thank you. I just wanted to follow up, Barry. I think you mentioned some robust growth expectations by the fourth quarter. Could you maybe just share a little bit more about what's driving those assumptions? And then, Liz, just a modeling question. Are you willing to talk about the relative size of the Precor business on a quarterly or annual basis? Thank you.

Barry McCarthy, CEO

Liz is going to vote me off the island if I talk more about the forecast. I will say I'm referring to the year-over-year growth, and whether we achieve it depends greatly on how the previous quarters unfold. We're not projecting significant changes in seasonal cadence, so we stand on the shoulders of the previous quarters.

Liz Coddington, CFO

I do think it's worth adding just that bringing Tread+ back to market will impact the second half of the year. Also, regarding Precor, we don’t provide specifics and won’t break out that business, but it is expected to be less than 10% of our business in fiscal ‘24. We're making progress with that business and have installed a new management team there, which has made some restructuring changes. We're closing a Precor facility in North Carolina. We expect adjustments to improve adjusted EBITDA and free cash flow throughout the year.

Jonathan Komp, Analyst

Okay. That’s helpful. Thank you.

Operator, Operator

And I'd like to turn the call back over to Peter Stabler for any closing remarks.

Peter Stabler, Speaker

Thanks, everyone, for joining us today. We'll speak to you next quarter. Have a great day.

Operator, Operator

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.