Earnings Call Transcript - PTON Q3 2024

Operator, Operator

Good day and welcome to Peloton's Third Quarter Fiscal Year 2024 Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker, James Marsh, Head of Investor Relations. Please go ahead.

James Marsh, Head of Investor Relations

Thank you, operator. Good morning and welcome to Peloton's Third Quarter Fiscal Year 2024 Conference Call. Joining today's call are Peloton Board Members, Karen Boone and Chris Bruzzo, who will be stepping in as Interim co-CEOs, as well as Chief Financial Officer, Liz Coddington. Our comments and responses to your questions reflect management views as of today only, and will include statements related to our business that are forward-looking statements under Federal Security Laws. 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 could 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 Karen.

Karen Boone, Interim Co-CEO

Thank you all for joining today. For those who don't know me, I've been a member of Peloton's Board since early 2019 and have served as Chairperson since September of 2022. We have a lot to cover this morning, so let's begin with the leadership update. As you may have seen in our release this morning, Barry McCarthy is stepping down as President and CEO and has also resigned as a Member of the Peloton Board. Barry will continue to serve as a Strategic Advisor to Peloton. I know I'm speaking for the entire Board when I say that we're very grateful for his contributions to Peloton. Barry joined Peloton during an incredibly challenging time for the business. During his tenure, he laid the foundation for scalable growth by steadily re-architecting the cost structure of the business to create stability and to reach the important milestone of achieving positive free cash flow. With a strong leadership team in place and the company now on solid financial footing, the Board has decided that now is the appropriate time to search for the next CEO of Peloton. While our search for a successor is underway, Chris and I will be stepping in as Interim co-CEOs and Jay Hoag, who has served on the Board since 2018, will step into the role of Chairperson of the Board. Peloton is at a critical inflection point, and as the board works to identify a permanent CEO, Chris and I will partner with our remarkable leadership team to ensure Peloton continues to deliver a best-in-class experience to our members and continue our work to achieve profitable growth. To give some background on Chris and my areas of expertise, I have significant experience with consumer brands, both at the executive and board level. Most recently, I was President, Chief Financial Officer, and Chief Administrative Officer of Restoration Hardware. Similarly, Chris brings more than two decades of experience working for global consumer brands, most recently as Executive Vice President and Chief Experience Officer of Electronic Arts. As Interim Co-CEOs, Chris and I will work in lockstep with and do everything we can to support Peloton's executive team. I'm excited about the progress that the product and content teams are driving, as well as the level of focus and efficiency that's being brought to Marketing Spend. Chris will expand on this in his remarks. The team has made significant progress in achieving positive free cash flow, which is important as we focus on strengthening our balance sheet and refinancing our debt. We look forward to bringing you updates on our progress in the coming quarters. Let me say that I'm honored to step into this role alongside Chris, whose skill set and background complement my own. I'll now hand it over to him.

Chris Bruzzo, Interim Co-CEO

Thanks, Karen. The board has entrusted us to serve an important role, and I couldn't have asked for a better partner than Karen to serve as Interim Co-CEO. Let me also reiterate our appreciation for Barry. It has been an immense and challenging effort to create this turnaround at Peloton, and we're grateful to him for his contributions over the last two years. We have already begun a search for Peloton's next CEO and are working with a leading executive search firm on this important effort. Our focus is on identifying a leader who brings the right combination of skills, experience, and vision to execute Peloton's exciting next chapter and drive shareholder value. While there's a lot of important work to do, there's also a lot to be excited about at Peloton, particularly when you look at the depth and strength of our team. While I would love to talk about each member of the team, I will just highlight a few examples for you today. Lauren Weinberg, our newly appointed Chief Marketing Officer, is driving transformation in the marketing organization. Since joining in January, she has identified meaningful opportunities for cost optimization in brand and creative spending, and has brought a fresh perspective to how we will deploy media. She has a critical eye for marketing efficiency that we're already starting to see materialized in our P&O. And Nick Caldwell, our Chief Product Officer, who joined us in November of 2023, has introduced a faster pace of innovation in our R&D organization and we are excited about the impact that our product initiatives will have to improve the fitness experiences for our current and new members. And Jen Cotter, our Chief Content Officer, who over the course of her five years at Peloton has assembled a team of world-class instructors who keep millions of members motivated and engaged on our platform. Not only has our team built a library of over 40,000 classes, it's presented in a way that is curated, data-driven, programmatic and purposeful. Jen's team continues to expand our content offering, which now includes 16 modalities, more content formats, and three languages. All of us share the conviction that Peloton is an amazing company with tremendous growth potential. And we look forward to finding the next great leader to drive this company forward. While our growth trends are challenged in the near-term, as the connected fitness market continues to normalize post-COVID, I'm incredibly excited about the trajectory of the connected fitness space, which appears to be nearing an inflection point of return to growth. We're deliberately investing in key areas of the business like software, hardware, and content innovation to drive growth and engage more people who want to improve their fitness and wellness. We offer an incredible experience that makes a huge impact on people's lives. We're confident in our ability to capitalize on the opportunities ahead. The steps we're taking today will make Peloton stronger. Ultimately, this is about propelling us into our next phase of growth and innovation. I have the utmost confidence in the team here to deliver. And with that, I'll hand the call over to Liz.

Liz Coddington, CFO

Thank you, Karen and Chris. I'd like to take a few minutes to discuss our newly announced restructuring plan and then spend some time talking through our Q3 results and finally discuss our current outlook for the remainder of fiscal year 2024. Today we are announcing a new restructuring program to reduce annual expenses by more than $200 million. The objective of the cost reduction is to reshape Peloton to align our cost structure with the current size of our business and position Peloton to generate sustained and meaningful positive free cash flow, which is a top priority for us. We expect to achieve the $200 million run rate savings by the end of fiscal 2025, with a significant share of the cost reductions taking place immediately. When fully implemented, we expect to reduce our team size by approximately 15% or roughly 400 global team members. Operationally, we will continue to reduce our retail showroom footprint. We are also reimagining our go-to-market approach for our international markets to be more targeted and efficient. While we have no plans to exit any of our existing international markets, we will leverage global strategies and capabilities where we can, allowing us to optimize and consolidate resources with localized execution. We made some very tough decisions, and while we firmly believe these actions are the right thing to do for the business. Cuts like these are painful, both because we are disrupting people's lives and because we're saying goodbye to genuinely good and talented people. We wish our outgoing colleagues the best. And while these decisions are always difficult, they have been made carefully to ensure we can continue to provide the best fitness experience for our members, maintain positive free cash flow over the long term, and continue to invest in core areas of our business that will drive subscriber growth. We will continue to invest in innovation across our software, hardware, and content portfolio and in improvements to our member support experience to meet the needs of current and future members. We'll also transform our marketing efforts to increase engagement with new targeted audiences and drive more efficient growth at scale. Now, let me touch briefly on our balance sheet. We are mindful of the timing of our debt maturities, which consist of convertible notes and a term loan, and we know this is also on the minds of our shareholders. We believe that achieving positive free cash flow makes Peloton a more attractive investment for debt holders. Overall, our refinancing goals are to de-leverage and extend maturities at a reasonable blended cost of capital. We want you to know that we've been working closely with our lead banks, J.P. Morgan and Goldman Sachs, and our financial advisor, BDT and MSD partners on our refinancing strategy. We are encouraged by the support and inbound interest from our existing lenders and investors, and we look forward to sharing more about this topic. Now let's spend a few minutes on our Q3 results. We ended Q3 with 3.06 million paid Connected Fitness subscriptions, reflecting a net increase of 52,000 in the quarter. Average net monthly paid connected fitness subscription churn was 1.2%, which outperformed internal expectations. Bike rental continued to outperform our internal expectations in Q3, with new rentals up 10% year-over-year. Our rental buyouts also exceeded expectations. While the churn rate for rental remains higher than that of outright purchase, churn from rental subscribers improved 60 basis points quarter-over-quarter. Peloton certified refurbished and third-party retail sales had strong growth year-over-year and outperformed our expectations. We also continue to see strong growth in subscriber additions who purchased their Peloton equipment in the secondary market. We ended the quarter with 674,000 paid app subscriptions, reflecting a net reduction of 44,000 in the quarter. Paid app subscriptions were lower than our forecast due to a couple of factors. First, additions were lower than expected. We saw underperformance in the Peloton for Business Channel and softer trial demand. Second, we saw higher than expected average monthly paid app subscription churn of 9.2%, primarily driven by subscription cohorts whose legacy pricing for App+ expired. Given the current growth headwinds we're seeing for apps, we decided to hold back media investment as we evaluate the tiered pricing strategy and subscriber acquisition funnel. We are continuing to invest in the product experience and in improving product market fit. It's worth noting that while paid app subscription declined quarter-over-quarter, app subscription revenue increased 2.4%, driven by continued growth in our premium App+ subscription. Q3 total revenue was $718 million, which was within our guidance range of $700 million to $725 million. Our revenue consisted of $438 million of subscription segment revenue, which represents 61% of total revenue, and $280 million of Connected Fitness segment revenue. Total Q3 gross profit was $310 million, resulting in a gross margin of 43.1%, roughly 60 basis points ahead of our 42.5% guidance. Our Connected Fitness Segment gross margin was 4.2% in-line with internal expectations. Excluding the impact of a one-time write-down of $9 million for Guide product inventory, our Adjusted Connected Fitness Segment gross margin was 7.4% in Q3. Subscription segment gross margin of 68.1% was in-line with our expectations and up 80 basis points quarter-over-quarter. Adjusted EBITDA was $6 million in Q3, exceeding the high-end of our Q3 guidance range by roughly $26 million due to lower operating expenses across multiple areas. Within sales and marketing, we've scaled back media spend that we determined to be less efficient than our investment threshold. We also benefited from cost reductions Lauren made during the quarter to improve the efficiency of our brand and creative investments, including reductions to spend with outside agencies. G&A expense was lower-than-expected due to lower legal, IT, and software expenses. R&D expense also came in favorable due to efficiencies in software development and contractor spend. We generated $9 million in free cash flow in Q3, the first quarter of positive free cash flow in 13 quarters. Free cash flow exceeded our expectations. While the majority of our app performance is permanent savings, we did incur an amount of timing savings that we expect to shift into Q4. We ended the quarter with $795 million in unrestricted cash and cash equivalents. And we also have access to a $400 million revolving credit facility, which remains undrawn to-date. Overall, our Q3 performance reflects our continued leadership in the Connected Fitness category and the strength of our subscription business, as well as the tremendous progress we have made in re-architecting our cost structure as evidenced by our achievement of positive free cash flow for the first time in over three years. I'd also like to highlight a few key areas of progress across the business in Q3. After a successful relaunch of Tread+ preorders in Q2, we started delivering Tread+ in Q3. Our logistics and delivery teams exceeded internal expectations for delivery time, delivering 67% of pre-orders in the quarter. We have also made substantial progress in the delivery and installation of Rear Guards requested by members who purchased the Tread+ before the product recall. We're continuing to see growth within the secondary market and are leaning into the opportunity. We recently launched the Peloton History Summary that provides greater visibility to our bike's age, usage, and service history to enhance the secondary market buying experience. Tread remains a key growth opportunity, and we were thrilled to recently launch the New York Road Runner Collection on Tread and Tread+. This is a series of scenic classes filmed on the TCS New York City Marathon Course. In a first-of-its-kind experience, these classes provide members with the ability to train the Marathon course with auto-incline functionality that matches the course's gradient fluctuations. We are also seeing positive results in service levels and member satisfaction in response to recent initiatives focused on turning around our member experience. These initiatives include investments in our global member support team, improvements to systems and tools, and onboarding new onshore outsourcing partners. We also observed improvements in Net Promoter Scores across multiple Connected Fitness products. Next, I'd like to provide context on our financial outlook for the remainder of the fiscal year. We're lowering our outlook for ending paid Connected Fitness subscriptions by 30,000 or 1% at the guidance midpoint to 2.97 million. Our full-year ending Paid Connected Fitness subscription guidance reflects an updated outlook for hardware sales, based on current demand trends and expectations for seasonally lower demand. Q4 is typically our most challenging quarter to grow due to lower seasonal growth additions as we enter the warmer months of Spring and Summer. We also anticipate a seasonal increase in Paid Connected Fitness subscription churn in Q4, in part due to seasonally higher subscription pause rates that we expect to come down in early fiscal year 2025. We're also lowering our outlook for Ending Paid App Subscriptions by 150,000, or 19%, at the guidance midpoint to 605,000. Our full-year Ending App Paid Subscription Guidance reflects lower gross additions due to expectations that Q3 trends continue through Q4. We are maintaining our disciplined approach to app media spend as we evaluate our app tiers and pricing and refine the paid app subscription acquisition funnel. As a result of trends driving our outlook for Ending Paid Connected Fitness Subscriptions and Ending Paid App Subscriptions, we're lowering our full-year revenue guidance by $25 million or 1% at the guidance midpoint to $2.687 billion. We're raising our full-year outlook for total gross margin by 50 basis points to 44.5%, primarily due to a revenue mix shift towards our subscription segment. We're also raising our outlook for full-year adjusted EBITDA by $37 million at the guidance midpoint to negative $13 million. This increase is largely driven by outperformance from Q3 combined with lower media spend and cost reductions from today's announced restructuring plan. While we are not providing any specific guidance on free cash flow, we do expect to deliver modest positive free cash flow in Q4, despite the timing shift from Q3 and cash outlays related to today's restructuring announcement. We also expect that the cost optimization measures announced today will enable us to drive meaningful free cash flow for fiscal year 2025. However, we do expect to have both positive and negative quarters within the year due to working capital impacts from timing of inventory purchases and seasonality of marketing spend. Before we open the line for questions, I want to reflect on the comment at the end of the shareholder letter about being optimistic about our path forward. First off, I'm pleased that we have finally achieved the critical milestone of becoming free cash flow positive, and I am confident that we will be able to sustain it on a full-year basis for fiscal year 2025. I'm also optimistic about the prospect of restructuring our debt and eliminating any potential concerns about the timing of our debt maturities. I'm delighted about our strong NPS for our Connected Fitness products because I believe it reflects the value that our members see in our connected fitness platform and should help drive organic growth for us. And I'm inspired by the dramatically faster pace of product innovation and marketing transformation that we are seeing internally, which I hope we'll be able to tell you all about next quarter. I'd be remiss if I didn't mention the important role that Barry McCarthy has played in these accomplishments. During his tenure, Barry successfully re-architected a cost structure that was unsustainable when he arrived. He built a strong and talented leadership team and established a scalable foundation for the business to grow. I'd like to sincerely thank Barry for leading us to this point in Peloton's transformation journey. We have so many reasons for optimism as we move into the next phase of Peloton's transformation focused on returning to profitable growth. And I'm confident that with a stable foundation now in place and with our stellar employees and loyal members, together we will go far.

James Marsh, Head of Investor Relations

We can open up to questions.

Operator, Operator

Thank you. Our first question will come from the line of Douglas Anmuth with JP Morgan. Your line is open.

Douglas Anmuth, Analyst

Great. Thanks for taking questions. Can you talk about what drives your confidence in Peloton being meaningfully free cash flow positive in fiscal 2025, how you get there, and does that require the business to return to growth? Thanks.

Liz Coddington, CFO

So first, I think it is important to highlight that we have a strong connected fitness subscription business which, as of Q3, generates over $1.7 billion of annualized run rate revenue at a 68% gross margin. Also, we have a very loyal Connected Fitness subscriber base with 1.2% average net monthly churn as of Q3. And while we firmly intend to return the business to growth, with today's announced cost reductions, we are lowering our cost base, and we see a path to positive free cash flow without requiring a significant improvement in growth to get there. We have architected a plan to achieve positive free cash flow without growth. And I also want to clarify that we have carefully reviewed the cost measures to make sure that we do still have the capability to invest in innovation so that the business can grow profitably.

Douglas Anmuth, Analyst

Thanks. I’d like to ask Karen and Chris if there's anything in particular that stands out as exciting in your go-to-market initiatives, especially regarding rental, certified pre-owned, third-party retail, or any other areas. Thank you.

Chris Bruzzo, Interim Co-CEO

Yes, thank you for the question. This is Chris Bruzzo. We are genuinely excited about Peloton's growth potential, which includes areas like the treadmill, Peloton for business, and the innovations we’re introducing in software as well as our continued focus on international markets. The installed base of home treadmills is twice that of bikes, yet our demand for bikes remains higher than for treadmills, which presents a clear opportunity. In terms of Peloton for business, we announced something significant yesterday and will keep exploring those opportunities. There’s a lot of potential ahead. The product team's advancements in software innovation are also very exciting, with much room to enhance personalization for our members. Options like virtual coaching can help connect them with the right workouts, and there’s significant potential there. We already have a highly engaging experience, and this will only improve. While we are optimizing our spending to access international markets, we are just as committed to their potential. There is considerable room for growth in our existing markets, as well as opportunities to efficiently expand into new ones. I want to acknowledge the impressive work of our marketing team, particularly Lauren, our new Chief Marketing Officer, who has implemented meaningful strategies for cost optimization and has been focused on reaching new audiences for Peloton. All of this is beginning to yield positive results, and I’m very optimistic about it.

Karen Boone, Interim Co-CEO

The only thing I would add is, I think Liz and her team are really looking at growth with an eye for sustainable profitable growth. So as we iterate some of the initiatives and make sure that we're optimizing it to make sure that it is contributing to the bottom line, and it's just not growth for growth's sake.

Chris Bruzzo, Interim Co-CEO

Karen and I have both noted how strong the executive team is here recently, which is something to be excited about. We are here to support that team as it continues to drive these levers for growth.

James Marsh, Head of Investor Relations

Great. Thanks Doug. Our next question please operator.

Operator, Operator

Thank you. Our next question will come from the line of Ron Josey with Citi. Your line is open.

Ronald Josey, Analyst

Hi, thanks for taking my question. I want to ask Karen and Chris, when you're looking for a new leader here, talk to us about what you are looking for as you balance overall profitability with product innovation and growth. So any insights on sort of the characteristics that you're looking for. And then, Liz, on the $200 million in restructuring, understood the reduction in force. But maybe talk just a little bit more you might be focused on that reduction and thoughts on the retail footprint and other areas that might improve overall profitability. Thank you.

Karen Boone, Interim Co-CEO

Sure. This is Karen. I’ll begin with the first question. We attempted to address some of this in today’s release and our opening remarks. I want to emphasize that Barry has done an outstanding job stabilizing the business. He joined us during a particularly tough time and has been relentless in right-sizing a significant build-out that many companies experienced during the pandemic. He faced numerous challenges, and he has done remarkable work in restructuring the cost framework. A significant achievement I want to highlight is that under Barry's leadership, we reached one of his main goals: generating positive free cash flow this quarter. We anticipate doing the same in the fourth quarter and for the full year in 2025. With the business now more stable, the Board has chosen to transition to a leader who will design and guide the next phase of growth for the company. The new leader will be focused on developing, articulating, and implementing a vision for growth.

Liz Coddington, CFO

Okay. I'll take the cost restructuring question. So as I said earlier, we announced a cost restructuring plan to achieve $200 million in run-rate savings by the end of fiscal '25. And a significant share of those cost reductions are going to take place immediately. Roughly about half of them, or about $100 million of those reductions, are going to come from payroll. The remainder are going to come from key non-payroll areas, including things like lower spending on brand and creative marketing, savings from our reductions in retail store footprint, lower contractor spending, lower IT spending, and software spending. Just to give a little bit more detail, in terms of the various lines in our operating expense areas, the biggest reductions are coming from our R&D organization. But those cost reductions, as I said earlier, are still going to allow for continued investment in all of the key initiatives that we are focused on, including software content and hardware innovation. The next largest area will be marketing where our cost reductions are really focused on things like the brand and creative and a few other areas. But I want to be clear that we aren't relying on significant media spend efficiencies to achieve our cost reductions. Although, we do see additional opportunities to scale back media spend at a higher efficiency. The third area, while not mapped perfectly to lines in our P&L, is international. As Chris talked about earlier and mentioned that it's still a growth area for us, but we are planning to cut our international operating losses in half, next year, over the next 12 months, by reimagining our go-to-market approach and being much more targeted and efficient. And so what we are going to do is we are going to stay in all of our existing markets. We have no plans to exit any of those. But we are focusing on more of global strategies and capabilities. And then that allows us to really consolidate resources so that we can focus on just local execution there.

Ronald Josey, Analyst

Got it. Thank you.

Operator, Operator

Thank you. One moment for our next question. Our next question will come from the line of Aneesha Sherman with Bernstein. Your line is open.

Aneesha Sherman, Analyst

Thank you so much. A follow-up on international, please. So a few quarters ago, you were talking about the growth potential in Germany and the UK, and some of these bigger markets for FY '24. Has your view changed in terms of the total upside of these markets or the kind of ROI of growing in these markets? I understand you are being more targeted and efficient, but has the total size of the pie-changed in your view? And then a quick follow-up on marketing. Chris and Liz, you both talked about investing in software and hardware and not as much on marketing. Ultimately, you do need to drive customer acquisition. How do you think about some of these short-term measures to conserve cash by cutting media spend and cutting sales and marketing and how they might impact acquisition in the next couple of quarters? Thank you.

Liz Coddington, CFO

Okay. There are several questions, so I’ll begin with the one about international growth potential. Our international Paid Connected Fitness Subscribers increased by 8% year-over-year in Q3. However, our current LTV-to-CAC ratios related to this growth are not meeting our target efficiency levels. Therefore, we need to optimize our marketing investments to improve efficiency. While this might slow our growth temporarily, it will enable us to achieve a better LTV-to-CAC ratio that supports profitable growth, aligning with Karen's earlier points. We are making specific changes on the international front to optimize and consolidate resources, focusing our marketing efforts on segments with the best product-market fit rather than trying to reach every individual in all markets. By refining our messaging and targeting the appropriate audiences, we expect to be more efficient and ultimately grow. We remain confident that international is a key growth driver. It's also worth noting that although our growth is slower than we initially anticipated, we are encouraged by the low churn rates for Paid Connected Fitness Subscriptions internationally, which are comparable to those in the U.S. Additionally, our unaided brand awareness in international markets remains low, except perhaps in Canada, indicating significant untapped potential in new countries and markets we may enter in the future.

Chris Bruzzo, Interim Co-CEO

And I would just add that it's a natural learning curve for companies as they engage in international markets to understand what works and what doesn't, and how to do it efficiently. You're seeing and hearing a disciplined approach from Peloton on how to enter those markets in a way that maximizes our reach efficiently. Some of what Liz mentioned about product market fit, the quality of the experience, and low churn are excellent starting points that showcase the strength of the company and its brand. From there, we are confident in our growth potential. Regarding marketing, it's important to note that our focus is shifting towards attracting new audiences, reaching the many people who have yet to experience Peloton. This reflects the same discipline we discussed in international markets, emphasizing the importance of aligning customer acquisition costs with the value those new customers bring. We acknowledge the ongoing healthy investment by Peloton in marketing, but we aim to maintain efficiency to ensure that these expenditures yield better returns and reach more people, which is our ultimate goal. There’s a lot of potential to be uncovered as Lauren takes on these opportunities at Peloton, and I believe we will see significant returns from her efforts.

Liz Coddington, CFO

I just wanted to add one thing. When we say that we pulled back on some of our marketing spending, we are not pulling it tremendously back in a way to release stifle growth. We are just looking at our LTV-to-CAC ratios and looking at the way that we can improve them and bring them back more in-line with our target investment levels. And then it's not just about media spending. I keep calling it on brand and creative spending as well. That's an opportunity that Lauren saw when she got here. We need to make sure that when we look at our marketing spend, that we are putting the right balance of working and non-working dollars in a more optimized way to work. And I just want to make sure that that comes through. That's really what we are focused on there as opposed to pulling back on spending.

Chris Bruzzo, Interim Co-CEO

And it is important to note, as Liz mentioned there, the amount of marketing adjustments that she just referenced a minute ago includes our fixed costs, includes headcount. And we have made some really tough decisions, and we are going through that restructure plan today. And so some of those reductions in costs related to marketing are about headcount or about fixed costs. So you shouldn't necessarily think of it all as a reduction in media spending. That's just not going to be the case.

James Marsh, Head of Investor Relations

Great. Thank you for the question. Next question please.

Operator, Operator

Thank you. One moment for our next question. And that will come from the line of Michael Graham with Canaccord Genuity. Your line is open.

Michael Graham, Analyst

Thank you. This has been a really helpful set of communications. I wanted to ask about the relaunch of Tread+. Could you discuss the market size for Tread and how you anticipate subscriber growth for the business?

Liz Coddington, CFO

Sure. As we mentioned earlier, we estimate the at-home treadmill market to be approximately twice the size of the bike market. It's also a smaller portion of our connected fitness hardware sales compared to bikes. Therefore, we see a significant market opportunity. Additionally, our current sales of Tread and Tread+ primarily come from existing members. Moving forward, we plan to intensify our marketing efforts to educate potential customers about our Tread and link running to the Peloton brand. The aim is to illustrate what Peloton can provide in terms of Tread and running. For instance, we introduced the New York Road Runner Scenic Collection on Tread and Tread+, enabling members to run the New York Marathon course with mapped data and automatic inclines based on the course's gradient, which is a unique offering. Furthermore, when we discuss Tread and its potential, we recognize a considerable opportunity to enhance Tread awareness, as our unaided awareness stands at about 24% in the U.S., compared to approximately double that for our bikes. There's plenty of room for growth.

Michael Graham, Analyst

Okay, thank you.

Operator, Operator

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.

Andrew Boone, Analyst

Thanks so much for taking the question. Can you talk about your learnings from the app strategy over the last year? In what way should we expect those to evolve going forward?

Liz Coddington, CFO

In terms of our app strategy, we've learned quite a bit. In Q3, our paid app subscriptions did not meet our expectations due to lower trial demand and underperformance in our Peloton for business channel, which was impacted by the timing of deals. Additionally, while we experienced lower churn in Q2, we saw a slight increase in churn in Q3 as some subscription cohorts transitioned away from legacy pricing. However, a positive takeaway is that more subscribers are opting for the App+ tier, which contributed to an increase in app revenue quarter-over-quarter, despite the decline in total subscribers. We have been focusing on media spending, but our customer acquisition costs are still not meeting our investment targets. Therefore, we are re-evaluating our app tiering strategy, including pricing and tier structure. To ensure a disciplined investment approach, we have scaled back our marketing spend for the app until we find a better product-market fit and can grow the app more efficiently. We are also exploring improvements in our subscriber acquisition funnel, specifically enhancing the conversion rate from app downloads to trials and from trials to subscriptions. Recently, we made a change by reducing the visibility of the free tier, which we believe is a step in the right direction. The app remains a vital component of the Peloton fitness experience, and we are committed to investing in app product innovation, with exciting developments in the pipeline that we are not yet ready to disclose. Moreover, it's essential to recognize that our paid app subscriber base plays an important role in our overall connected fitness subscription model, as most of our connected fitness subscribers also engage with our app monthly.

Chris Bruzzo, Interim Co-CEO

The company is demonstrating discipline and learning in several key areas. As we adjust our tiering strategies and pricing, we are observing members who previously used the legacy app upgrade. We're also refining the group experience based on what we learn, which necessitates optimizing our acquisition funnel. Given that this is a digital product, we receive numerous signals about what is effective and what isn’t from an acquisition perspective, leading to an ongoing process of optimization. You will continue to see us enhance the product, targeting methods, and our acquisition strategies.

James Marsh, Head of Investor Relations

Great. Shirley, we have time for one more question, please.

Operator, Operator

Thank you. And that question will come from the line of Jonathan Komp with Baird. Your line is open.

Jonathan Komp, Analyst

Yeah. Hi, good morning. Thanks everyone. A bit of a follow-up, I'll toss it out to the group. But could you maybe just spend a little time maybe diagnosing a little better. In your view, some of the challenges in returning to growth overall, and I guess the question really is the spending that you are doing and maintaining, are you spending on the right things? How do you know that? Are you really just beholding to some of the industry trends that are still an overhang? Just any more thoughts there would be helpful.

Chris Bruzzo, Interim Co-CEO

Yes, would you like to begin? We should start by discussing the connected fitness marketplace, which is very important. There was significant growth before the pandemic, and the exceptional experiences during that time were particularly beneficial for companies like ours, where the in-home experience was crucial. We are still experiencing the normalization that followed COVID, especially for products and experiences focused on home use. However, we are excited to see the Connected Fitness marketplace, where we hold a dominant market share, beginning to stabilize. Looking ahead, we can see it approaching an inflection point and achieving a steady pace of regular growth. The key question is whether the marketplace is contracting or expanding. We are seeing positive signs that the market is nearing that inflection point and is poised to return to growth. There is also the larger question of whether we are investing in the right areas. This is actually a significant part of what our restructuring focused on. We have made a considerable reduction in our operating costs, but it's not just about the size of the cut; it's also about the areas where we decided to make these changes. We are intentionally prioritizing those areas where we can concentrate our efforts more effectively. You will hear me emphasize repeatedly on this call that we have an opportunity to apply discipline—discipline in our approach to international markets, discipline in managing marketing expenses, and discipline in our investments in innovation and future growth. This is absolutely a primary focus. That's all. Liz, do you have anything to add?

Liz Coddington, CFO

Yes. I want to emphasize that in addition to our disciplined investments and strategic approach, we will continue to learn, test, and iterate. We will regularly measure our progress against the goals we've established, allowing us to make necessary adjustments as we move forward. A key aspect of our current cost reduction program is our confidence in generating positive free cash flow. This confidence enables us to pursue various innovations and find effective ways to deliver a top-tier connected fitness experience to a wider audience over time. It is evident that we recognize the long-term potential supported by a growing trend of individuals increasingly prioritizing fitness and wellness in their lives. This is a clear trend that we can leverage to Peloton's advantage, as we believe we lead in the connected fitness market.

Karen Boone, Interim Co-CEO

And that's really not going away. I want to emphasize what Liz mentioned about the trends in health, wellness, exercise, and fitness. These trends are beneficial for health and are strong indicators of longevity. People are increasingly focused on this. It is a lasting trend, and individuals are becoming more knowledgeable about it. Our business and brand have an important role to play in this conversation. We have an exceptional product with premium hardware, interactive software, incredible music, and engaging, motivating instructors. Our community connects with one another and competes on the leaderboard. This creates a strong product-market fit and offering for consumers. While some people are returning to the office, not everyone will go back every day, and many will continue to work from home. In the at-home fitness and connected fitness market, we are the leaders for a reason; we believe we offer the best experience. Over time, we aim to bring that experience to even more people.

James Marsh, Head of Investor Relations

Great. Thank you.

Operator, Operator

Thank you. I would now like to turn the call over to Karen Boone for any closing remarks.

Karen Boone, Interim Co-CEO

Great. Thank you. So I want to close with just reminding everyone that today is a really hard day. Change is always hard, and there is a lot of it to digest today. The restructuring we announced is especially difficult because it is impacting so much of our team. But it is a really critical and necessary step to meeting our objectives around cash flow generation and making sure the business is on solid ground and footing for the years ahead. Through all the changes over the last several years, our mission has remained constant, to connect the world through fitness, empowering people to be the best version of themselves anywhere, anytime. It has been and continues to be important and meaningful work, and we are so grateful to all the individuals who have contributed along the way. Thank you for your time.

Operator, Operator

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