Peloton Interactive, Inc. (NASDAQ:PTON) Q3 2024 Earnings Call Transcript

Peloton Interactive, Inc. (NASDAQ:PTON) Q3 2024 Earnings Call Transcript May 2, 2024

Peloton Interactive, Inc. misses on earnings expectations. Reported EPS is $-0.45 EPS, expectations were $-0.39. PTON isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

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. [Operator Instructions] 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 : 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’s 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 : 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 : 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 format, 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 : 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’re 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. Anyone can access a Peloton History Summary for a Bike or Bike+ by searching the serial number on our website. 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 the 2025 fiscal year. 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 positives, 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] (ph) 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 : We can open up to questions.

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Q&A Session

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

Douglas Anmuth: Great. Thanks for taking questions. Can you talk about what drives your confidence in Peloton being meaningfully free cash flow positive and fiscal ‘25, how you get there, and does that require the business to return to growth? Thanks.

Liz Coddington: 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: Thanks. And maybe just a follow-up for Karen and Chris. Does anything — anything stand out in particular in terms of what your most excited about in go-to-market initiatives when you think about rental and certified preowned or third-party retail or anything else? Thanks.

Chris Bruzzo: Yes. Thanks for the question. This is Chris Bruzzo. Yes, I mean, we’re — when we say we are excited about the growth potential for Peloton, we mean things like treadmill and Peloton for business and the innovation we’re bringing to software and continued focus on international. It’s all of those areas. So treadmill is — the installed home treadmill base is double that of bike, and yet our bike demand is still greater than our Tread demand. And to me, that just spells opportunity. Peloton for business, we made a great announcement yesterday, we’ll continue to look for those opportunities, and I think there is lots available to Peloton going forward. And some of what’s happening in the product organization around software innovation is pretty exciting.

There is much room to get to greater and greater personalization in the experience for our members. Things like virtual coaching, helping getting them to the right workouts for them, lots of opportunity there. And we already have an incredibly sticky and engaged experience. So this is — that’s only going to make it better. And although we are talking about optimizing the way we spend to reach international markets, we are not any less interested in that potential. There is a lot of growth potential for us in our existing markets, and even looking to efficiently expand to new markets. And then I guess, I should finish based on my background with my appreciation for what the marketing team is doing. So Lauren, who’s our newly appointed Chief Marketing Officer, has done — already done some meaningful things to drive cost optimization to focus to bring Peloton to some new audiences.

All of that is starting to bear fruit, and I’m really excited about it.

Karen Boone: 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: And we’re both — Karen and I both been remarking in the last couple of days about how strong the executive team is here. And that in itself is something to be excited about. We are here to support that team as it continues to drive these levers for growth.

James Marsh: Great. Thanks Doug. Our next question please operator.

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

Ronald Josey: 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: Sure. This is Karen. I’ll start with the first one. And I think, we tried to address some of this in today’s release and our opening remarks. But just to — we do want to reiterate that Barry has done a tremendous job stabilizing the business. He came in at a very challenging time, and he’s been really relentless in rightsizing an aggressive build out that was not uncommon for many companies during the pandemic. He had to navigate a lot of curved-balls thrown his way, and he’s done some incredible work in rearchitecting the cost structure. And again really big highlight. I want to highlight that under Barry’s leadership, we achieved one of his primary goals, which was generating positive free cash flow this quarter.

And we do expect to do the same thing in the fourth quarter and for the full year in ’25. But with the business more stable, the Board decided to pivot to a leader who’s going to architect and lead the next phase of growth for the company. So the new leader will kind of be not — pretty focused on architecting, articulating and executing a vision for growth.

Liz Coddington: 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.