Earnings Call Transcript - PTON Q1 2022

Operator, Operator

Thank you for standing by, and welcome to Peloton's Fiscal First Quarter 2022 Earnings 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 may be recorded. I would now like to hand the conference over to your host, Head of Investor Relations, Peter Stabler. Please go ahead.

Peter Stabler, Head of Investor Relations

Good afternoon, and welcome to Peloton's fiscal first quarter conference call. Joining today's call are John Foley, our Co-Founder and CEO; President, William Lynch; and CFO, Jill Woodworth. Our comments and responses to your questions reflect management's views as of today only and will include statements related to the 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. And with that, I'll turn the call over to John.

John Foley, CEO

Thank you, Peter. Good afternoon, everyone. Thanks for joining us today. Before we recap the quarter and discuss our forecast, I want to spend a moment providing some context for our updated outlook. As you all know, stay-at-home and work-from-home orders, coupled with commercial gym closures, drove massive awareness gains for Connected Fitness, accelerating an adoption curve that was already well underway. Given the unprecedented circumstances presented by the global pandemic, we said last quarter that modeling the exit from COVID and the massive growth we saw in fiscal 2021 would be a challenging task, and that has certainly proven to be true. With reduced backlogs, our visibility into our future performance has become more limited. From forecasting consumer demand to accurately predicting logistics costs, our teams have never seen a more complex operating environment in which to guide our expected results this year. As noted in our shareholder letter, we are reducing our guidance for fiscal year 2022. We have returned to presenting ranges given the uncertainty. The swift timing of these changes since giving our initial guidance in August is not lost on us. As we prepared our previous guidance, we had to make assumptions about consumer behavior coming out of COVID, the impact of our original Bike price reduction and the cost structure within our Connected Fitness segment, all against the backdrop of a global supply chain crisis. While we have had to manage carefully around many issues, such as component shortages, elevated freight costs and increased transportation costs, I'm proud of our team who has moved mountains to ensure that we have ample inventory across our portfolio ahead of the holiday season. While we continue to see a nearly 100% two-year growth CAGR in both traffic and unit sales in Q1 and into Q2, we've seen a greater-than-anticipated taper of our website traffic levels over the past two months and a slower-than-expected pickup in retail showroom traffic, both of which are important inputs into our forward-looking demand model. This reduction in traffic has added increased near-term uncertainty into our forecast. As expected, our original Bike price reduction created a step shift in demand, helping to broaden our demographic mix and expand our market opportunity. The price move did significantly improve our e-commerce conversion rate, in fact, greater than we expected, but not enough to offset the year-over-year declines we have seen in overall traffic. We saw a positive and sustained reception to the price moves in our international markets. This was anticipated as our international consumers have proven to be more price sensitive. To maintain a premium end-to-end member experience, we made significant investments over the past year to scale manufacturing, logistics and operations. Overall, we believe we met the challenge, but there's no doubt that in some cases, we overcorrected. That combined with the reduction to our demand picture and higher-than-expected costs across product, transportation and delivery are causing a near-term compression of our hardware margins. However, we are taking significant corrective actions to improve our profitability outlook, which will impact the back half of fiscal year 2022 and into fiscal year 2023. While it's important for us to optimize fixed costs across the company, we won't compromise our Net Promoter Score position in the process. We remain committed to our goal of winning Connected Fitness and our long-term thesis of fitness moving into the home is unchanged. We track our estimated market share closely. And while sales are currently not meeting our previous forecast, third-party data suggests that we continue to build on our leading share of the Connected Fitness market. We firmly believe at-home fitness customers will want one subscription for a comprehensive home fitness platform and we are determined to be that one subscription. Moving on to thoughts on the quarter. On August 30, we officially launched our new lower price Tread in the U.S. and resumed sales in the U.K. and Canada. On September 28, we launched sales in Germany, and we look forward to bringing Tread to Australia in the not-too-distant future. We have high expectations for our Tread. Our Tread platform provides members with both running and full body workouts taught by a great roster of instructors. We have reimagined the Tread experience in the same way we fundamentally improved the stationary Bike experience with the launch of our original Peloton Bike. Since its introduction, we have brought millions of people into home fitness through a dynamic ever-changing fitness platform, and our all-new Tread provides that same immersive experience. But it will take some time to educate consumers. That's okay. We're committed to the platform and gained confidence from the high marks the product is receiving from both consumers and the press. Since the launch of our media support in late September, we've seen steady progress in building Tread sales. Our Tread Net Promoter Scores are very encouraging with an initial NPS in the U.S. of 89 points. And with our planned investments in content and software, our already great Tread experience will continue to improve. Ask any Bike member who joined the platform three years ago to compare the experience today versus when they purchase their Bike, there's no comparison. And from an investment perspective, as we've said previously, we expect the Tread market to be foundational to our long-term growth. Turning to our Bike portfolio. The original Bike price reduction accelerated sales, allowing us to convert more price-sensitive households. While we believe the wider price gap between Bike and Bike+ has resulted in some trade down impact, we're comfortable with that outcome. As we've said, growing household penetration remains our primary objective. On the engagement front, we recently passed a significant milestone, over 1 billion classes taken by our members. We're honored to be playing such a positive role in our members' lives and look forward to many billions more. We finished the quarter with 2.49 million Connected Fitness subscriptions, up 87% versus the year-ago period. End of quarter digital subscriptions were 887,000, up 74% versus a year ago, and our global Peloton member community now stands at over 6.2 million. Engagement per Connected Fitness subscription totaled 16.6 workouts per month declining modestly from Q4 and more significantly when compared to last year's COVID-impacted quarter. On a two-year basis, engagement was up 42% over the first quarter of 2020. As we have said, summer months have traditionally seen lower engagement levels, and we expect our first quarter to represent the trough quarter for engagement for the fiscal year as it has in every non-COVID year in our history. In the quarter, we continued to aggressively invest behind content and new software features for our members. We produced over 2,500 new classes and launched features requested by our members. Examples include subtitles for live classes, redesigned class filters, a reimagined progress tracking feature and structured workout plans to help keep our members on track. We also welcomed eight terrific new instructors bolstering both our New York and London-based teams. Our new instructors will be teaching in English, German and Spanish with a focus on running Tread boot camp, strength, walking, outdoor and stretching. Finally, this quarter featured the addition of 60 new running and cycling phoenix classes, which were taken over 1 million times in the period. Looking ahead, we're about to enter our busiest time of the year. Our inventories are healthy and our logistics teams are well equipped for the seasonally strong sales period. We have low expected delivery times across our portfolio as we know delivery is greatly appreciated during the holiday and New Year's resolution periods.

Jill Woodworth, CFO

Thanks, John. I will start with a review of our first quarter results. In Q1, we generated total revenue of $805 million, representing 6% year-over-year growth and an 88% two-year CAGR. In terms of revenue drivers, we had lower-than-expected financing penetration, better-than-expected Connected Fitness churn partially offset by the $11 million adjustment to our return reserve for our tread recalls. We added 161,000 net Connected Fitness subscriptions in the quarter, bringing our end of quarter Connected Fitness membership base to 2.492 million, up 87% year-on-year. Average net monthly Connected Fitness churn was 0.82%. As a reminder, we disclosed last quarter that we will no longer be offering forward churn guidance, but will continue to report this metric. We continue to expect low industry-leading churn and high engagement, especially as we head into colder weather. At the end of Q1, we had over 887,000 app subscribers, representing 74% year-over-year growth, slightly ahead of our internal expectations. For the quarter, we saw modestly better retention than expected, but we're also seeing some challenges related to acquisition efficiencies. As you likely know, there have been some significant changes made by Apple that are leading to some targeting headwinds. Like many other direct-to-consumer marketers, we're seeing some disruptive impact as our teams adjust to the new data landscape. Looking ahead, we remain bullish on our app business and its role as an important lead generation tool for Connected Fitness. Our teams will continue to adjust to the new marketplace reality, and we expect our corporate wellness initiatives to begin to contribute more meaningfully to our app business as the year progresses. Moving to gross margin. Gross margin for the quarter was 32.6%, which came in slightly below our expectations. This was entirely due to our Connected Fitness products segment, which had a gross margin of 12% below our guidance of 15%. There were two primary drivers of our Connected Fitness gross margin shortfall, an increase in our return reserve for our recalled Tread products and some inefficiencies seen in freight out and logistics. As we mentioned last quarter, forecasting Tread returns has proven to be very challenging. While we saw an easing of return activity through late summer, we believe the expiration of our subscription waivers motivated a higher-than-anticipated number of Tread+ owners to initiate returns. Consequently, in the quarter, we increased our reserve to account for this activity. As a reminder, the impact of recall-related returns is added back to our adjusted EBITDA but is fully reflected on the revenue and gross profit line. With this increase in our reserve, we are attempting to capture the entirety of expected returns from now until the end of the recall-related return window, which lasts for another 12 months. But there is the possibility that future adjustments will be needed. Excluding the impact of the unexpected increase to our return reserve, our Connected Fitness margin in Q1 would have been 14% and overall gross margin would have been 33.6%. On the logistics front, we saw some additional inefficiencies associated with middle and last mile delivery costs and Precor related freight-in expenses. These negative impacts were partially offset by lower-than-anticipated Bike financing rates and Bike-related reserve adjustments. Subscription gross margin was 66.7%, and subscription contribution margin was 69.6%, ahead of expectations, as we continue to leverage fixed costs associated with content production. As a reminder, quarter-to-quarter, we continue to see some variability, but we now expect to reach our subscription contribution margin target of 70% by Q4 of this year. Turning to operating expenses. Sales and marketing expense was 35.3% of total revenue versus the prior year period of 15.1%. As we explained last quarter, this deleverage was planned as we ramped marketing. Looking ahead, we expect to realize substantial sequential leverage against sales and marketing expense as the year progresses. G&A expense was 29.8% of total revenue versus 14.3% in the year prior. We invested over the last 12 months to scale operations, including significant investments in team, systems and member support. While this led to a series of significant sequential step-up in G&A spending over the last year, nearly all of this investment is completed. Looking ahead, we expect a sequential increase in G&A spend in Q2, but anticipate our Q1 spending level to represent a reasonable approximation of quarterly spend for the second half of the year. R&D expense was 12.1% of total revenue versus 4.8% in the year-ago period. The year-over-year deleverage reflects the onboarding of several key hires and the R&D team from Precor, and as with G&A, we expect to roughly flatten quarterly spend for the remainder of the fiscal year. Our Q1 adjusted EBITDA loss was better than expected at $233.7 million. Net loss for Q1 was $376 million, or a loss of $1.25 per basic and diluted share. We ended the quarter with $924 million of cash and marketable securities and have additional liquidity in the form of an untapped $285 million credit facility. Now onto our outlook. We are reintroducing ranges for our guidance. As John alluded to earlier, the overall consumer and logistics environment has been challenging to predict coming out of COVID and we are providing guidance just a few weeks ahead of our busiest sales season. For fiscal 2022, we are now forecasting ending Connected Fitness subscriptions of 3.35 million to 3.45 million, implying approximately 1.1 million net ads and representing 46% year-over-year growth and a 77% two-year CAGR for ending subs at the midpoint. This equates to roughly a 6% reduction in our forecasted end-of-year Connected Fitness subscriptions at the midpoint. Our revised full year revenue forecast is $4.4 billion to $4.8 billion, representing 14% year-over-year growth and a 59% two-year CAGR at the midpoint of the range. For Q2, we expect ending Connected Fitness subscriptions of 2.8 million to 2.85 million, implying 333,000 net ads and representing 69% year-over-year growth and nearly 100% two-year CAGR for ending at the midpoint. For Q2, we expect revenue of $1.1 billion to $1.2 billion, representing 8% year-over-year growth and a 57% two-year CAGR at the midpoint. Our revised guidance reflects a reduction in our expected Bike portfolio sales and Tread sales versus our original forecast, given traffic trends over the past several weeks. It also contemplates a greater-than-expected mix of original Bike versus Bikes+ since the price drop, and lastly, headwinds in our commercial or Precor business.

John Foley, CEO

Traffic and conversion are the key inputs in our demand forecast. Many of the modeling assumptions that predict e-commerce traffic that we made in August were too optimistic. Our baseline traffic forecast reflected our unchanged view of the growing consumer interest in Connected Fitness, our growing market share in the category, our leading brand awareness and expected increased word-of-mouth. However, it is clear that we underestimated the reopening impact on our company and the overall industry. Importantly, we also expected the price drop to further drive a traffic uplift and increased conversion. While the price drop led to conversion rates that exceeded our forecast, overall traffic has not met our initial expectations. We have also seen a richer-than-anticipated mix of Bike versus Bike+ further impacting both revenue and our gross margin expectations. As we've said previously, we are agnostic to which entry point members choose given that the lifetime value of our Connected Fitness subscriptions remains highly attractive.

Jill Woodworth, CFO

We started selling our own new Tread on August 30 and began our media support on September 27. We noted on our last earnings call that the rollout of Tread would be slow to start in order to ensure that our members are receiving a positive delivery experience. We take the time to reposition inventory to match demand by region. Since launching media for Tread, we have seen a progressive increase in Tread sales and remain bullish on the category and our ability to grow from our currently low product awareness. Our primary test today is educating the consumer about our own new Tread and how it differs from other treadmills on the market. However, much like our Bike portfolio, our revised traffic estimates will also impact our Tread forecast for the balance of the year. Lastly, we have reduced expectations for our commercial channel or legacy Precor business given both supply and demand dynamics. While the commercial gym industry has made significant gains as a country reopen, overall visits remained below pre-COVID levels, leading operators across some commercial segments to delay capital investments in new equipment. However, more importantly, sourcing certain component parts has become materially more challenging since we provided our guidance in August. This has led to supply concerns for some Precor products, leaving us unable to fulfill some of our commercial demand.

John Foley, CEO

The reduction to our demand outlook is creating margin compression in our Connected Fitness segment, as we have a significant amount of fixed costs associated with our supply chain, particularly within middle and last mile logistics. Migrating from quarterly sequential growth during COVID back to our pre-COVID seasonality has proven challenging. However, we plan to optimize the mix of our own delivery and third-party networks to help drive savings in the coming quarters. On the variable cost side, hardware cost efficiencies and ocean savings that we expected in Q2 won't start to materialize until the second half of the year, given the lower-than-expected demand profile for Q2. On Tread specifically, we are locking in better long-dated right. We also intend to shift towards in-source unit production at Tonic and evaluate other strategies that will benefit our cost structure in future quarters. Also, within our commercial business, we are seeing incremental pressure and additional sourcing constraints that will weigh on our margins for the remainder of the year.

Jill Woodworth, CFO

In light of the current cost increases in units, freight and delivery, and while we expect some of this pressure to abate in the back half of the year, we are evaluating ways to improve our fixed cost efficiency and move to a more variable cost structure in addition to other strategies to better balance growth, profitability and member experience. All-in we now expect the Connected Fitness product gross margin of 7% in Q2 and 16% for fiscal year 2022. As we said before, we are more focused on Connected Fitness gross profit dollars than margin percentage with the goal of using those gross profit dollars to offset our sales and marketing expense. This is an extraordinary year where this goal is difficult to achieve. But we are committed to making material improvements to our cost structure that will help us get back towards being net cash neutral in fiscal 2023. For our Subscription business, we expect a contribution margin of 69% in Q2 and 70% for the full year with the improvement to last year reflecting continued fixed cost leverage and some benefit from identified cost savings. Rolling up our segments, we now expect total company gross margin of 24% in Q2 and 32% for fiscal 2022.

John Foley, CEO

We know the positive impact we are having on our members' lives. And while our growth is not what we had expected just a few short months ago, we are extending our lead in home fitness cardio and becoming a leader in strength. We make the best, most immersive and interactive home fitness products available, and we have more on the way in the coming weeks and months. We will come out of the other side of this uncertain operating environment, a much stronger and more nimble company. We will be vigilant in managing our cost structure for both growth and profitability. In conclusion, I want to let you know that managing this business is incredibly personal to me and the entire team here at Peloton. As one of the founders and the biggest individual shareholder, I can't tell you how much we care about Peloton, and we want every piece of it to be beautiful, including the financial model and performance. I am incredibly proud of the vision that we have laid out, and I'm energized by the clear path to get there. Nothing is in our way. We see exactly what needs to be done, and we are going to do it. Continued growth, innovative new products, smart performance marketing, improved hardware margins, rightsized operational expenses and a relentless focus on the value that our members receive from their Peloton membership; all of this is within our control. We are operators and leaders. We love what we do, and we have never been more excited about our future than we are today. With that, I'll turn it over to the operator for questions.

Operator, Operator

Our first question comes from the line of Doug Anmuth of JPMorgan. Your line is open.

Doug Anmuth, Analyst

Thank for taking the questions. I have two. First, just hoping you could help us understand how much of your reduced forecast is due to Bike versus Tread; there's some more color that you can add there? And then second, I think just in terms of balance sheet and cash flow, you burned about $650 million in cash in Q1 and obviously looking at further EBITDA losses ahead. So with $924 million in cash on the balance sheet, just curious how much cash you're comfortable operating the business with going forward? Thanks.

Jill Woodworth, CFO

Doug, it's Jill. Thanks for your questions. I think I'll just answer your second question first, and I think that's a little bit of a shorter answer than the first. I think just cutting to the chase, we don't see the need for any additional capital raise based on our current outlook. As we mentioned, we're taking significant steps to adjust our expenses across cost of goods sold and operating expenses with this revised revenue guidance. And we have a lot of levers to pull. In addition, what we're also going to do is reevaluate the cadence of some of the capital investments that we're making, inclusive of TOP. And while we know that TOP is a decade-long right term strategic move for us, there are definitely ways for us to find ways to make that a more economical spend over the next couple of years. In terms of your first question, certainly, I would say, as we think about the three or four contributors to the reduction of guidance, I would say, the Bike portfolio is the largest. And that is obviously a decrease in the demand profile. But secondarily, as you know, with the mix shift, it is also more heavily weighted towards the original Bike, right, or the lower-priced bikes than Bike+. And so that does have revenue implications and EBITDA implications and effectively Connected Fitness gross margin implications relative to what we thought. Just giving you a little bit more detail there. As you know, we're agnostic on entry point. But certainly, before we did the drop in original Bike, we were seeing about a 50-50 mix that expanded a lot after we dropped the price. It has come down a little bit, but call it more like three-quarters original Bike. So that's also contributing. But again, just remember, we're agnostic to entry point, and that has no impact on sub growth. And then, Tread we're still in very early days. But obviously, the traffic trends that we're seeing on Bike are the same for Tread. And so we have also taken down Tread. And then, the last piece would be Precor or our commercial business where we've moderated some of our expectations for the year, given some of the headwinds we saw in Q1. So those are the - that's the order.

William Lynch, President

Thanks for taking my question. Just a bigger picture question on Tread, obviously, you indicated that results have improved once you kind of deployed more marketing. But just kind of what is the initial consumer feedback on the device? Do you think that people understand that it's a total body fitness solution? Or are they comparing it to conventional treadmills? And then as you look forward, are there other things you can do to help the consumer understand the attributes of the product? Thanks.

John Foley, CEO

I'm glad you asked. We are very excited about the Tread. You heard in our prepared remarks that we have a fantastic 89 Net Promoter Score out of the gate, which is just off the chart, incredible reception from our members. The press reviews have been coming in. I encourage you to read them as Gadget just had a great review this week. So, the reception to the product has been fantastic. You are pushing on, I think that's a real dynamic that treadmills have been in the market for decades and decades. There's some - we talked about last quarter, there's an asset and a liability with the awareness of what a Tread is where you see it and you think it's something to run on. And certainly, it is; ours is the best Tread to run on. But to your point, it's also a portal to a full-body workout as we call it. Circuit workouts are so popular, if you think about Orange Theory and boot camp classes and then even CrossFit, huge category, huge opportunity. So Tread on the hardware side is huge. And then the content from a circuit training perspective is a fantastic, huge opportunity, huge market and huge consumer demand. And so we do have some education to work through in the coming quarters and coming years. It's the same education we went through with the Bike, where people would say, years ago, why do I need a $2,000 stationary bike? And it's like, well, it's not a stationary bike, it's a portal to a fantastic indoor cycling class with the community and the quantified self and the instructors and the programming and the music and everything that the Peloton Bike brought. Similarly, the Tread is so innovative that there is some education and we're going through that. I will point out, we've only been, call it, 30 days on television, trying to start telling that story. And the trend of sales of Tread has been fantastic. So, we're bullish on this year and we're bullish on the coming years. And it's going to be a huge new product line for us. So, we're super excited.

William Lynch, President

No, I'll just add to Ed's question. As evidence of the awareness, John mentioned, we measure awareness of our various products in the brand and track various measures. And our unaided awareness among the target is only at 11%. You have to go back to close to 2000, late 2015 to find that kind of awareness on bikes. So we actually view that as a massive opportunity. Our formula for growth that we've been able to hone on bike and then as we roll out internationally starts with product experience. We deliver the best product experience in Connected Fitness and Tread within 89 as high as what we've seen on bike. And so when we start from there as the core, we start to build awareness. We build the installed base to John's point on momentum. We get people talking about it. And we have an expression that our members sell more bikes than we do. We're seeing that word of mouth with Tread just start. And we feel like as we climb with these investments in marketing through the holiday, we feel really good that Tread is going to be everything we hope for short, mid, and long term in terms of growth. We've actually said we think it could be a bigger category than Bike. Everything we're seeing early suggests that could be true, but it's all about getting the awareness up.

John Foley, CEO

Yes, Youssef, thank you. With respect to engagement, we always expected the engagement to come down slightly coming out of COVID. I mean, it's just the idea that gyms are available; people can get out of their house now. They're not locked down. So we knew that we weren't going to see those crazy elevated COVID engagement numbers forever. But I will say that the two-year CAGR in the prepared remarks, you might have heard there was over 40% quarter-to-quarter. But to answer your question, there are a whole host of things we're doing, and we are always innovating on content and software features and building. Every time we launch a new content vertical or content category or a new instructor, we're not retiring other categories. We're just - it just continues to get more selection, more music genres, more instructor styles. And so what you saw in Q1 is a seasonal impact that we've always had going back six, seven years in our business. So some of this you can't fight. I mean, in the cold winter months coming out of New Year's resolutions, people are working out on our platform more than they are in August. And that's just - there's only so much we can do to shift that. But I will say we continue to be dramatically - to see dramatically better engagement than any gym or any other Connected Fitness product platform. So we feel good, and we're bullish about the coming quarters and how that's going to play out with engagement.

Lynch, President

Just to remind everyone why we made that acquisition. First and foremost, it was about building substantially the best Connected Fitness equipment manufacturer in the world. We feel like one of our objectives internally, and we've said this, is to build a structural advantage, not only in scale and our ability to build Connected Fitness equipment. I'll remind everyone, this has been a very fragmented market where any one line making tens of thousands of things was remarkable or making millions of things. And that's been challenging to build that capability over time, especially with our growth. But we've done that and then also build a structural cost advantage and quality advantage while we build that scale advantage. We feel like to win Connected Fitness, as John noted, you have to be best of breed in that and Precor's talent, Rob Barker, Greg May, that team, is remarkable. We thought it was the best team when combined with ours and everything we've seen in terms of the integration, some of the work we've done out of the North Carolina facility on domestic manufacturing staging for our POP, it has been going remarkably well and everything we believe and hoped in our diligence has been true there.

John Foley, CEO

We will be vigilant in managing our cost structure for both growth and profitability. In conclusion, I want to let you know that managing this business is incredibly personal to me and the entire team here at Peloton. As one of the founders and the biggest individual shareholder, I can't tell you how much we care about Peloton, and we want every piece of it to be beautiful, including the financial model and performance. I am incredibly proud of the vision that we have laid out, and I'm energized by the clear path to get there. Nothing is in our way. We see exactly what needs to be done, and we are going to do it. Continued growth, innovative new products, smart performance marketing, improved hardware margins, rightsized OpEx and a relentless focus on the value that our members receive from their Peloton membership; all of this is within our control. We are operators and leaders. We love what we do, and we have never been more excited about our future than we are today.

Operator, Operator

This concludes today's conference call. Thank you for participating. You may now disconnect.