Peloton Interactive, Inc. (PTON) Earnings Call Transcript & Summary

All right. We're going to go ahead and get started. I'm Douglas Anmuth, JPMorgan's Internet analyst. I'm very excited to have with us today Peloton's President and CEO, Barry McCarthy. So Peloton provides nearly 7 million members with expert instruction, world-class content and the fitness industry's leading music library to create impactful and entertaining workout experiences for anyone, anywhere at any stage in their fitness journey. Peloton content can be accessed via the Peloton Bike, Bike+, Tread, Guide, Row, or the Peloton app, and now has multiple membership tiers, which I'm sure Barry will talk to us about. Barry joined as CEO in February of '22. He was previously CFO of Spotify from 2015 to 2020, and prior to that, CFO of Netflix from 1999 to 2010. He's also been a consultant to TCV and on the Boards of a number of companies across the tech sector. So welcome, Barry.

Thanks, Doug.

All right. So kicking off in year 2 of your tenure as CEO, so how do you gauge Peloton's turnaround progress so far?

Well, let's see, when I came in, in my very first communication to investors, I'd say we had 3 priorities: one was fixed cash flow, which was badly broken; second was talent density because talent density is foundational to businesses, large and small; and the third was to reestablish growth. So the good news is that we've made tremendous progress on the cash flow front. Just to put it in perspective, in that first quarter of my tenure as CEO, the business lost $747 million in free cash flow. That is $2 million less than we had in revenue this past quarter. So -- and in that quarter, we reported negative cash flow of $55 million, and we reaffirmed that we were on track to get the business cash flow breakeven at the end of the current fiscal year, which will be our Q4, which is the quarter we're currently in. So check box on the first priority. Talent density. We have turned over most of the executive team and there is a lot of terrific talent in the building today, and we're executing much faster with greater precision as a result. And because we've been successful with -- in addressing the first two priorities for the business, we're able to start focusing on growth. And we called that turn in the ship, I think it was 2 quarters ago. And the good news is, we've stopped talking about the viability of the business, which was very much in question. And the question on everybody's mind today rightly so is, okay, what's the growth going to be? When are we going to see it? Where is it coming from? How are you going to do that? And in terms of where it's coming from, I think there were four priorities we had identified. Most of them are new product related, but -- one of which was Fitness-as-a-Service, which we spent a fair amount of time talking about. We ended the last quarter with, I think, 47,000 subs. We saw a Q-over-Q growth of 70% in that category. We have a related product, which is certified pre-owned, and that also is growing pretty quickly for us. International is an area of growth. We'll be talking more about that in quarters to come. We are launched in the U.K., Germany, Australia, Canada. This past fiscal year, we've mostly focused our efforts on reducing the operating loss in those markets rather than leaning into growth. We've made a tremendous amount of progress doing that. And in the upcoming fiscal year, we'll be leaning back into growth mostly in existing markets and a few new markets in Western Europe, enabled in part by the relaunch of the digital app. Other areas of growth include corporate wellness and hospitality. Last quarter, we expanded our partnership with Hilton with 5,400 locations in the U.S., and we've pushed into Puerto Rico and some other new markets with them. I think that holds a lot of promise for us over the next few years. And yes.

All right. Let's talk more about brand. I thought your comments in the 3Q letter were really interesting just about some of the misperceptions around Peloton. So how will you get potential users to really appreciate the breadth of Peloton's offerings?

Well, let me answer it this way. Yesterday, we relaunched the brand. I think it comes on the heels of us having been able to attract super talented new CMO, Leslie Berland, who joined us from Twitter. So I'd like to say thank you, Elon. The feeling inside the company is that we have not done a very good job of helping new users understand what existing members already know. I've communicated anything about the passionate engagement of the community. Mostly we protected this image of we're a product for white suburban housewives who are trying to stay fit for their husbands. Aside from the fact that you could hardly be more tone deaf, it represents almost nothing about the users on the platform today. And so the -- if anybody has seen the new ads or when you see the new ads, we actually think it's an authentic representation of who our users actually are and what they actually do on the platform. So mostly, we had talked about ourselves even as if we were just a bike company, but 38% of users last quarter didn't use Peloton hardware in their workouts. 62% of them did engage in -- were engaged on the platform, but not on a bike. If you go to our gym -- we have a pretty nice gym at Peloton, big surprise, and you looked at one of the screens on one of our treads or one of our rows, as well as one of our bikes, the visual imagery you see scrolling across the screen is someone on a bike. Like that's just ludicrous. If you're on a tread, why would you see somebody on a bike? If you're on a row, why would you see somebody on a bike? So it's -- so we need to change the vocabulary that we use then the way sort of experience ourselves and kind of get beyond the historical success of the franchise, which was based on the bike and become more representative of the behaviors we see on the platform today.

Okay. Great. So the new brand, the ad efforts, they also tied to the digital app and a tiered pricing strategy that you rolled out yesterday. So maybe you can talk about your goals for the digital product, whether you think about it as on-ramp to hardware or strong stand-alone product or somewhere in between those 2?

The strength of the franchise is the content. That is the user experience. Yes. Look, the bike is terrific. It was -- it's the first stationary bike I've ever been on that kind of felt like a road bike. And that was a big accomplishment, and I don't mean to diminish it. But it isn't the reason that people are passionate about the brand. They are passionate about the brand because of the content. There are many things that have been broken about the business that still remain to be fixed, but none of them relate to the content. Okay. So do I want to sell hardware? Or do I want people to be engaged in the content? I want to be engaged in the content. I wanted to subscribe. And if you want to consume the content on our platform, that will be a terrific experience. And more power to you. But if you bought somebody else's hardware, I'd be delighted to have you engaged in our content. Integration won't be quite as good. The user experience won't be quite as compelling, but if you want a piece of the Magic Kingdom, I'd be delighted to sell it to you. So if you can afford a Mercedes, great, [ well, take a ] Mercedes. But if all you can afford is a Ford, then we'd be delighted to sell you part of what we do as well, and that will be the content. You'll experience it on some kind of a mobile device. So it could be your iPad while you're sitting on a Nordic track, treadmill or bike. And you can sync it via Bluetooth to our content, go for it. So how do I think broadly about the digital opportunity? I think of it as TAM expanding. Yes, it's an asset-light model. And yes, the gross margins would be compelling, but it's mostly about allowing users to consume the content wherever they are, whenever it's convenient for them. So if you want to take our content into a gym and do a strength workout or a stretch or meditate or ride a bike or walk on a treadmill, we're delighted to have you do that. And from our perspective, that's a much better business model than us trying to negotiate with Equinox, even if they did know a sales cycle, or any other health club. So whether it's in your home, whether you're outdoor exercising and you want to do a running work out with Matt Wilpers on a mobile device or if you want to use it in the health club, all that, it can be enabled by digitally on a phone or mobile device. And the magic we are selling is the content.

How big of a part of the revenue acceleration and just the growth story in your view, is digital? I guess when we think about -- it's about 8% of sub revenue today, obviously, much less of total revenue. Where could digital go as a part of the business?

Well, I think in comparison to the All-Access Membership, it's like 21%, something like that, if I'm doing the math correctly. I think we finished last quarter with 3.1 million All-Access members. And off the top of my head, 850-something -- 840,000, 850,000 app members. We can get it to somewhere between 27% and 30% of the total. I think that would be fantastic over the foreseeable future. I can see my finance team and my IR team freaking out at the moment. But I don't know if we had 4 million All-Access members, 1.5 million, something like that, so that would be like a double. What's the foreseeable future? I don't know, 4, 5 years. I'm speaking about my aspiration for the business. Now look, we are just relaunching the digital app. And so we'll see whether there's good, better, best on-ramp using a free service that intentionally frustrates users, but gives them a taste of what it would be like to upgrade to various paid tiers of service, the most expensive of which unlocks for you our content on a hardware platform.

Okay. Great. So let's shift gears a little bit, talk about Fitness-as-a-Service and then also certified refurb. So those drove almost a 1/4 of hardware sales in 3Q, up from 19% in the December quarter. What are the early learnings here around those 2 products, and especially around FaaS, just given how big of a priority that is?

FaaS stands -- it's an acronym that stands for Fitness-as-a-Service, and it's a rental program. It's not a sale. And the -- so you rent from us a hardware platform could be new, could be certified pre-owned. And then we're betting that you'll stay long enough for us to earn an economic return on it. And today, we think the payback cycle is somewhere between 18 and 19 months. And if you stay longer than that, we make more money. Our research shows us that about 62% of the volume we're doing is incremental. Those are people who are coming to the platform because they're able to rent and don't have to make a financial commitment upfront. So -- and the early demographic profile for those users looks like professional women who value the optionality and plenty of household income. They just don't want to get locked -- they have commitment issues. So given the underlying economics of it, it's -- it makes a lot of sense for us economically to lean into it and continue to pursue it. Now if you want to buy, I'd be delighted to sell you a used, refurbished platform or something new. But I'm also delighted to rent if, over your expected life, you're going to be profitable. So we're going to pursue both. Now if the incrementality was less than 50%, it would be a suboptimal strategy for us to pursue, and we would kill it. But so far, it looks very promising. So we're going to continue to lean into it.

What's the -- what do you think the awareness is of the rental program of Fitness-as-a-Service? And then also certified pre-owned as well, how much airtime will those get in the new set of brand ads?

They're low single digits. We're moving away from advertising platforms to advertising the brand generally, but a tagline at the end of a 30-second ad might be -- relate to one of the other Fitness-as-a-Service or certified pre-owned or something else.

And what's the -- I guess what's the message for how -- it's hard to model this business, which you know because, look, a hardware sale obviously can be an outright sale. It can be a rental. Those would vary...

Yes. A lot of moving pieces.

A lot of moving pieces. They look very different. Maybe you can just walk through a little bit of the financial impact there across rental and PCR, the pre-owned product?

Let me just jump back for a moment. You mentioned I need brand awareness. I want to link this back to our discussion about the digital app. So the primary challenge in the digital app is the unaided brand awareness is 5%. So -- and the Net Promoter Score for it is 20% higher than our next highest rated piece of hardware. So users absolutely love it. And nobody in the room knows it exists, 4 out of 100 do. So that's the talent is we need to increase awareness for it in order to be successful. Okay. Sorry for the digression. I digress.

No, not at all.

You mentioned that there are many moving pieces in the model, intentionally, because one of the learnings at Netflix was that you win by having lots of dials to turn in order to fine-tune the performance of the business and you can never be exactly sure which one of those dials you're going to turn that's going to drive performance. And so you're only in trouble when you run out of dials. So as long as you're clear about what your strategic priorities are and you're making the right resource allocation decisions, then it's imperative that you have enough irons in the fire that even in the presence of uncertainty, you can deliver the performance you've committed to. So that's the priority.

Okay. Maybe shift gears, talk about Tread a little bit. Installed base of treadmills in the U.S. is at least 2x that of bikes. How do you get Tread to have a bigger impact across the product portfolio?

The most beloved product we've had seems to be a product I've never actually -- well, I've seen it, but we've never been able to sell it, and that's the Tread+. And people who talk to me about Tread+, just go nuts for Tread+, which was a more expensive, heavier kind of industrial grade. It wasn't -- isn't a belt, it's a slat machine that was subject to recall before I joined. And the -- our regulatory agency, the CPSC, had just approved a retrofit for the Tread+. It will enable us to bring that back to the marketplace. So one of the things that's going to help accelerate, at least awareness of tread, will be the excitement around the comeback for the Tread+, which I hope will happen in the fall. We need to -- it hasn't been manufactured for 2 years, so we need to set up the manufacturing line and whatnot. So thing one. Thing two is, we need to get better at installing it so that there's kind of less friction and white noise. When we variabilized the cost structure, we eliminated our own installation team. They were pretty good at installing Tread+. The contractors have been less good than installing it. And that's created a lot of friction for users, unfortunately. And I think we're now starting to get our arms around that, but it's been a little bit of a headwind. And that's a marketing challenge. And we have a new marketing team and will take a slightly different approach.

You mentioned -- I mean, obviously, a bigger product, the slat belt, of course, a more premium type of item. I know it's still early, but is there any chance that it could -- that you could put this out at a cheaper price point than what it's been in the past?

No.

Okay. Got it.

Well, I mean, let's just think about the economic environment we're in and what's happened to cost over the last 12 months, and it hasn't -- we're not reengineering any of the parts. So it's not like...

The same product.

Yes. I mean, as compared with COVID, the cost of getting it out of Taiwan and the United States has gone down, but everything else has gone up. And it's not like we have the benefit of writing an experience curve where we've dramatically increased the volumes we're shipping. And so our average unit costs are falling because of the experience curve. So just for inflationary reasons alone, it's -- and the fact that the BOM hasn't changed, it means not likely to cost less.

Okay. You hit on a little bit the CPSC, but I want to talk about some of the recent resolutions there. Maybe if you could give us an update on the very recent bike recall and what you're learning there so far?

Yes. Well, let's see. We've shipped 2,165,000 bikes, 35 seat posts failed. That's a pretty small fraction. The CPSC, who is an agency -- federal agency created in 1972 to protect consumers against death and injury associated with product failures, mandated a recall of the seat posts. So that was announced on the 11th, I think. Most at risk are the majority of the 35 breaks occurred for people who were 5'11" or taller and 250 pounds or heavier. Of the 35 breaks, there have been, I think, 12 injuries, and the most serious of which was a fractured wrist. So our initial focus has been on shipping replacement seat posts. This is just for the bike, by the way, not the Bike+. Shipping replacement seat posts to those larger, heavier members who are most at risk, and we will have shipped those -- all of those by, I think, Wednesday of next week, if I'm recalling correctly. And if it's not Wednesday, it's shortly after that. In total, we've had a request for just north of 0.5 million seat posts and which is significantly larger than we were expecting. I think we also -- and it is going to take us a while to work through the -- all of the requests. Now the CPSC would like all of you if you have a bike to just stop using it until you get a replacement seat post. By the way, you're more likely to become a professional athlete or to be hit by lightning or to injure yourself in your bath when you're showering after your workout than you are to have a broken seat post. But -- so -- but they would like you to stop.

So how do we think about the financial impact on the -- you said the 0.5 million request that you've got, and I know you took a reserve in the third quarter, I think almost $8.5 million, certainly with, I guess, some expectation that it could increase. I guess did you account for that and leave room in gross margins, let's say, for the June quarter?