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

Okay. I think we're ready to start with our next session. So it's my pleasure to welcome the team from Peloton to the conference this year, Liz Coddington, CFO. Liz, thanks so much for being part of the conference.

Yes, thanks for having me.

So you've been in the role as CFO of Peloton for roughly about a year now. Maybe setting the table and taking a step back, what have been some of your key learnings so far in the role over the last year? And how was your experience been so far at Peloton?

Yes. It's a great question. I did join Peloton just a little over a year ago back in June of last year. And when I joined the company, I knew that it was going to be a challenge, first of all. I knew we had to fundamentally restructure the cost structure of the business. And shift away from being a very high fixed cost structure to one that's much more variable and scalable so that we could actually grow the business efficiently. And so that wasn't necessarily a surprise, but it was a big challenge coming in. And in terms of surprises over the past year, there have certainly been many. There are surprises in every business, every year. Two of the more negative surprises that we had most recently were our Seatpost Recall for the original bike that we had in Q4, that was not -- we did not expect that. And then we also had the Dish legal matter that we settled in the second half of the last fiscal year as well. Those were not so great surprises. But we made a ton of positive progress of the business over the last 12 months. We are -- in FY '22, our cash burn was roughly $2.4 billion. In fiscal '23, we reduced that to less than $500 million. And then in Q4, if you exclude the payout of the onetime cost for the Dish settlement, we would have been cash flow breakeven or even marginally positive. Now that's getting to just fairly positive is not our goal. Obviously, we have much more lofty goals for the business, but it is indeed a lot of positive progress. We also reduced our operating expenses by over $500 million year-over-year in FY '23. And we did all of this while adding new initiatives and launching new initiatives for the business. We scaled our bike rental program. We launched refurbished products for price-sensitive customers. And we also launched our new app tiering strategy, and we relaunched the Peloton brand. And did -- so we've made a lot of positive progress over the course of the year. Now if I think about Peloton's long-term strategy, the way that I like to think about it is that it's really to create the best fitness experience for people to achieve their fitness goals anywhere. And how we manifest that strategy or make it possible, will evolve over time, but you can be sure that it will include our tech-enabled fitness platform and improving our software, our hardware and our amazing content. It's also going to include a heavier investment in personalization because part of that goal -- that vision is to achieve people's individual fitness goals. And in order to do that, we need to have a better understanding of what each and every person specific fitness goals are. What type of hardware they have access to. Where they want to work out, whether it's at home or it's a gym or outside or wherever they want to be, we want to be able to have personalized fitness programming and content for them. So what that means is that we're okay now with not every single Peloton subscriber using our hardware. That's certainly the best and the most premium experience that you can have. But we also want to have the best fitness app experience. So for those customers who don't have Peloton hardware, maybe they're using a competitor's hardware, maybe they're working out at the gym, maybe they're working out outside, we want to be able to help them achieve their fitness goals anywhere.

Understood. Okay. So I think we're going to try to mind a lot of those topics in a little bit greater detail as we go through in the next 30 minutes or so. Just hit the refresh for us on the market opportunity. So obviously, there was the pandemic impact on the business. There's been the post pandemic impact on the business. How are you, Barry and the team thinking about the market opportunity and how it continues to evolve for Peloton? And you even talked about somehow the product iteration inside the company might be tapping into new areas of market opportunity.

Yes. So we still see a very large opportunity in terms of market size. The fitness industry in the U.S. alone is over $50 billion. And we see tech-enabled fitness as a category that continue to grow. We actually can even accelerate growth over the coming years as we're able to bring in new paid members to fitness by offering our world-class instruction, the personalization that I talked about. And also our Peloton community, which is a really important part of Peloton, that's hard for people to understand until they actually join Peloton. The way that we -- one of the key challenges that we actually face is how do we lower the barriers to entry to get more people into Peloton. And we made some progress there. Again, I mentioned already the bike rental program as a way to tap into customers who are not willing to necessarily commit to buy our hardware outright. We've got the refurbished products for more price-sensitive customers. And then we just recently launched our free tier of our app, which is -- makes it very easy and frictionless for people to try out our platform and try out our amazing content. Now we do have competition. We have a lot of competitors in the market. We compete with brick-and-mortar gyms. We compete with boutique fitness studios. We compete with other competitive hardware platforms, and we also compete with digital pure-play content or fitness content apps. But the way that we continue to compete with them is we're investing aggressively and having the best content. And that includes our instructor-based content. That includes content now that we're offering through Peloton gym for people who want to work out of the gym. It also includes investing in new types of content like our gaming experiences that we have as well. And then I already mentioned personalization. I'm probably going to mention that a lot today because that is an area that we're really leaning in on and investing heavily in. But overall, we believe that we have the most comprehensive offering in the market today. And we intend to keep that leadership position by continuing to innovate across our platform, whether that's our hardware, our software or our amazing content.

Maybe one of the topics you talked about in there, Liz, is the digital app and how the strategy has changed and now there's multiple price tiers. Talk about what you're trying to think about in terms of the digital app as a strategy, stand-alone. How it feeds into the broader ecosystem and any early learnings from sort of the repositioning of the digital app across those price points?

Yes. That's a great question. As you all may know, we are leaning in on our app opportunity. And our app tiering strategy is really intended to expand our addressable market for Peloton. So in part of that app tiering strategy that we launched back in May includes our free tier, which we introduced as a way, like I said earlier, to give customers the opportunity to easily download our app, try out our platform and experience our content. Now the paid portion of our app tiering strategy is really intended to align the value that customers are getting from our platform for different types of consumers and how they use it. So for example, for our customers who tend to not workout using hardware, and do more of our strength training and a variety of our other workouts that don't require connected fitness hardware, we have our App One offering at $12.99. And then for the customers who are doing those premium connected fitness workouts on other people's hardware, we have our App+ offering. And then as I mentioned, we're also leaning into gyms -- folks who workout at the gym by having our Peloton gym workout as well. So we are leaning in on all of that. Now in terms of how we're doing since we launched the app tiers, we're pleased with the number of customers who have downloaded our free app. We've had over 900,000 customers or people download it since we launched it back in May. Of those, over 600,000 of them are new to Peloton, so not Peloton members. And now our focus is really on how do we get those 600,000 people who had a fitness mindset and downloaded our apps to engage with our content and ultimately create the most efficient path to get them to convert to paid members. Now this is a challenge. It's not -- it was not an unexpected challenge. The good news is that when we launched the free trial, we had a huge number of people interested in it. But we do have a lot of work to do on testing and learning, iterating to create that efficient path to paid conversion. And it is still really early days for the app as we work on all of that. But that is stuff that we will continue to work on over the coming quarters, and we have a good plan in place for that. Over the long term, our view about our app is that it is a way for us to lean in and grow our subscriber base substantially over time. And we believe that it will enable Peloton to have a significantly larger member base over time.

So keeping with this theme of making the experience around your content and your platform more affordable and more accessible. You've also launched Fitness-as-a-Service. You've talked about the certified refurbished program. How should we be thinking about the scaling of those initiatives in the next couple of years and what they also might do to open up pockets of market opportunity for Peloton?

It's a great question. I'm going to break it into 2 pieces. I'll talk about the Fitness-as-a-Service first, and then I'll talk about the refurbished. So our rental program, which we also call Fitness-as-a-Service or sometimes you might hear us refer to it as FaaS. Currently, it only covers our Bike and our Bike+ today. And the intent of that program, as I mentioned earlier, is really to lower the barriers to entry for customers into Peloton. We realize that there is a segment of customers who were just not comfortable with making a commitment to buy our hardware. And so we offer them this rental option with no commitment to use -- to rent our hardware and subscribe to our All-Access Membership. And we've been pleased with the program so far. We've been scaling it and growing it in the U.S. over the past year. And we -- it's been successful enough for us that we also launched it in Canada and very recently also launched it in Germany. We also hope at some point over the course of the year to launch it in other international markets as well. But what we are -- while we still need to evolve and continue to work on our go-to-market strategy and our marketing messaging for the program, we are really pleased with our research and our analysis that shows that our bike rental program is over 60% incremental. And what that means is that over 60% of the people who choose to use our FaaS program or bike rental, would not have purchased hardware or joined Peloton, if not for that offering. So that's really great. Now in terms of churn, we've talked about this before. Our churn rate for the rental program is higher than it is for customers who choose to purchase outright. Although we do expect that it will decline over time as the subscriber base matures, but we do see a lot of opportunity to improve our attention and engagement. We've seen that rental members do fewer workouts on a monthly basis than those who purchased outright. We also see that they have lower engagement with our app than those who purchased outright as well. And we see that as opportunity. We need to improve the onboarding experience for people who do the bike rental program so that they can activate and find that first -- that great first-class and second-class and third class. We added several months ago shoes to the rental program, because we realized that a lot of the people who are less committed weren't investing in the shoes, and we know that having good shoes on the bike is a much better experience than if you try to use your sneakers or whatever, you may use instead. And so we see those as opportunities there to improve and drive engagement and further retention. We also offer -- and many people probably don't know this, but buyout offers on the rentals and for customers who realize over time that they do want to come in and purchase. But that experience today is actually quite clunky. I'm surprised at how many people actually do take us up on it, given how funky even experience it is, and we're going to be working on fixing that and addressing it and making it an easier experience for folks over time. Now let me talk a little bit about refurbished. So our strategy around our Peloton certified refurbished product is actually relatively similar to that for the rental program in that we are trying to lower the barriers to entry by offering refurbished products at a lower price point to attract that more price-sensitive customer. And we have this inventory because we offer a 30-day trial program, and so we do get some small amount of returns back and we're able to efficiently refurbish the product and sell it in an attractive cash margin for us at a price point that is more sense -- that is lower, so we can attract that more price-sensitive buyer. Now with regard to that program and the metrics there, we actually don't see any measurable difference in either engagement or churn from customers who purchase new hardware.

Okay. The other recently announced initiative, which we've been thinking about through the lens of potential market opportunity has been Peloton for business. Can you talk a little bit about the decision to launch that? And how you think that might play into your broader strategy of continuing to look and examine for ways to open up market opportunities for the platform?

Platform for business. We've actually always had elements of a commercial strategy at Peloton. But what we're doing now with the launch of Peloton for business is we've consolidated disparate teams, brought in really strong new leadership and then created a revamped entry point for commercial companies and so that they can access our Peloton platform, whether they want to purchase hardware, whether they want to add -- do something with app subscriptions or whether they want to do some sort of commercial partnership. In terms of channels, some of the channels that we're focused on are hospitality. We're focused on colleges and universities. And we've seen our recent launch in the Michigan, partnership with the University of Michigan, and then also things like multiunit apartment buildings as well. In terms of -- we also are leaning in on our corporate wellness opportunities. So for corporate wellness, that's the way that employers can access Peloton benefits and provide them to their employees. Well, that is a relatively small part of our business today. It is an area where we have a pretty strong track record with over 93% of renewal rates for our corporate wellness clients. And we actually recently launched a partnership with Sequoia, which is the PEO to access the small to medium business market, which is a really great opportunity for us because that's been a market that up until now we haven't been able to really access efficiently. And then last but not least, it's really important that I mentioned we brought in this amazing strong new leadership to the team with the addition of Greg Hybl, who comes to us with over 12 years of strategic partnerships experience from American Express. So as I think about Peloton for business right now, it's still a relatively small part of Peloton overall. But we're really excited about accelerating the growth. We think that we have a winning strategy now and that we will be able to greatly accelerate our growth for Peloton for business over the fiscal year.

Okay. So all interesting opportunities to open up market potential for the platform. One of the questions we get a lot from investors, and I know there might not be anything new to add today, but just general product categories. How you think about expanding the fitness mandate across the platform. You've launched a rower. You've got a treadmill. You've got the bike product. We always get asked about strength training in areas of that. How does the company think about opening up new areas of potential content classes that would feed back into the hardware strategy longer term?

Yes. So it's important that we stay innovative as a business, and we look at new different ways that we can provide innovative content to our subscribers and to both existing and to new. I'll talk a little bit about strength. So strength, we certainly see as an important area of opportunity for us. It is one of the fastest-growing modalities on our platform and has been for the past 2 years. In fact, actually, over 60% of our All-Access members take at least one strength class on a monthly basis, and that is second only to cycling. And we -- there's a good reason why we think strength is a really important opportunity. We also know from research that more Americans do strength workouts at home than any other type of fitness experience. Now what makes strength challenging is the fact that there are lots of different ways to get stronger. So for some people, it might be doing work out with heavyweights. For other people, it might be yoga. For someone else, it might be barre classes. For someone else it might be pilates. There's really a lot of really great modalities that you can use to get stronger. And so for Peloton, our strategy with strength is to have a really broad and comprehensive and inclusive offering for people so that they can choose the way that they want to get stronger. In terms of a dedicated hardware product, today, we have the Peloton Guide, which is an AI-powered device that connects to your TV and allows you to be able to do count your reps, it can automatically count reps for you, allows you to see with the camera side by side with the instructor and also form tracking capabilities, which is great. And then -- but for hundreds of thousands of our Peloton members, they don't necessarily use hardware or they may access our strength content through their bike or tread. The Bike+ has that swivel screen that you can turn so you can do great strength workout off of your hardware. And then actually, all of our strength content is available at our App One tier at $12.99, and we even have some strength workouts for free. For strength, we're also leaning in on the personalization front. Some folks who may have a guide may have noticed that we launched something called personalized plans for Guide, where it asks you a few questions and spits out a weekly program for you to do strength training with workouts that target various different muscle groups. So that's really great. Now you also mentioned other innovation areas. We are winning on gaming. We're dabbling in the space of augmented reality, virtual reality type things, which we expect to be transformative, although those may take a little bit longer to bear out.

Understood. Okay. One of the things that's changed a lot in the last 12 months has been some of your approaches to retail distribution. You've been in a program of sort of closing some of your own retail distribution sites, but then also adopting platforms like Amazon and Dick's Sporting Goods. Talk a little bit about the learnings of the evolution of the go-to-market and retail distribution strategy over the last year.

Yes. Retail. So -- the goal of our third-party retail strategy is to really drive incremental hardware sales and incremental subscriptions for Peloton. And the way that we're doing that is by meeting customers at their preferred point of sale or channel that they want to purchase. We know that there are millions of customers who walk into Dick's Sporting Goods and looking for fitness equipment and fitness gear. We also know that millions -- or that lots of people search on Amazon ask for fitness products. In fact, we know on Amazon that we have hundreds of thousands of searches for Peloton on their site. In the case of Dick's, one of the opportunities there is that customers can go in, they can touch, they can see our hardware, our bike and our tread and they can compare it to other products. And we believe that we show up really well when compared to our competitors. And I don't know why Dick's is becoming even more important to us as we rightsize our retail showroom footprint and get out of some of that high fixed cost, so that we do have a showroom for people to try out our hardware as well. Third-party retail is a relatively small portion of our business today. It's less than 10%, but we do believe that there is a decent amount of incrementality from that business. Now internationally, we also have a partnership with Amazon in the U.K. and in Germany. And we recently expanded our partnership with third-party retailer, John Lewis in the U.K. And actually, I don't know if any of you saw the announcement. But just yesterday, we announced a partnership with a company called Sport-Tiedje, a retailer based in Germany. And starting in October, we will be selling our bikes and our tread on our Bike+ in their stores and their 35 stores across Germany, which is really exciting. Now our third-party retail strategy is going to continue to evolve over time, and we're going to evaluate new partners, potential partners as appropriate, but we have nothing else to talk about there.

Understood. And you talked a little bit in the answer on retail about some of your approaches to markets like the U.K. and Germany. And while I acknowledged the focus is on margin and free cash flow. Help us understand a little bit of the thought process the company might go through into expanding into new international markets. What kind of international market looks interesting to Peloton broadly as a company? And how should we be thinking about the decision to possibly deploy into new markets in the years ahead?

That's a great question. Well, first of all, we are in 4 markets outside of the U.S. today. We're in Canada, we're in the U.K., we're in Germany and we're in Australia. And we see opportunities to continue to grow and expand just within those existing markets. If you think about 18 months ago, 1.5 years ago when Barry joined Peloton. He set out kind of 3 main things that he was focused on. One was getting to free cash flow breakeven. Another was to bring new talent into the building. And then the third was to return to growth. Now as part of the first one, we had to -- we had pretty substantial international losses, if you remind, over a year ago. And so we had to restructure our international business, reduce our fixed cost base there and also reduce our sales and marketing investment in order to reduce our losses. So now that we've kind of gone through that exercise, and we've fixed our cost structure, we're able to refocus our efforts and reaccelerate our growth internationally, and that is what we're focused on doing in FY '24. Now we see a tremendous amount of opportunity, like I said, in our existing markets. The U.K. and Germany are very big fitness markets, and our awareness and penetration in those markets is still very low. But what we're doing in fiscal '24 is we're going to evolve our go-to-market strategy and focus on being much more localized. And you can see that manifest in some of the partnerships that we've started. We recently announced a partnership with Liverpool FC in the U.K. And then I just mentioned the third-party retail partnership with Sport-Tiedje in Germany that we just announced as well. And then, of course, we also have our app tiering strategy that we are exploring internationally. Now in terms of new markets, we do expect to enter some new markets in the second half of fiscal '24. Those are likely to -- those are adjacent markets in Europe, smaller markets. We don't expect them to be a very large contributor to our subscriber growth or our revenue in fiscal '24. But we see them as good opportunities, and we're excited about pursuing them. But our main focus is really about growing our existing international markets. Now you asked also about like how do we think about markets to enter and what are some of the characteristics of the market that's good for us to enter. Well, number one, as we look at the size of the fitness market in that -- in a particular country, we also look at the demographics. We look at the technology infrastructure. We look at the ability to partner with -- for logistics, third-party retail. And then, of course, also very importantly, we look at the dynamics of a particular market and our content offerings and whether we need to invest in market specific content, for example, specific languages as well.

Okay. Maybe turning to the cost side of the equation and margins. One of the areas we continue to get questions about is just sort of the hardware gross margins. Obviously, the journey you've been on over the last year where there's been a lot of things outside of your control, that have hit the hardware gross margins and the pathway going forward to more normalized hardware gross margins. How should investors think about that?

Yes. So -- over the course of the past year, we did a lot to improve our cost structure and the efficiency of our hardware business. We went from a very heavy fixed cost part of our business to one that is much more variable and much more scalable. We reduced our last-mile logistics cost. We reduced our warranty costs. And as we rightsized our inventory, we've reduced our storage costs. But it's true that for Q4, if you -- even if you normalize for onetime items, we were -- our hardware gross margins were negative in Q4. And the primary reason for that is because of seasonally light volume quarter, we had some deleveraging on our fixed costs, mainly our corporate overhead costs. Now as we look into fiscal '24, it's important to understand that from a unit economics perspective, which is our variable cost profile, all of our hardware products are positive double-digit gross margin products with the exception of Peloton Guide. Now that's great on a variable contribution basis, but we do also have fixed costs which include our corporate overhead, stock-based comp, depreciation and amortization. And then right now, we also have the cost of storing our Tread+ inventory, which we aren't selling at the moment, although we are excited about being able to hopefully bring that product back to market very soon. So the good news about that our gross margin profile from a unit economics perspective is that we do have the ability to achieve significantly positive hardware gross margins, particularly in quarters where we have seasonally higher hardware sales and are able to effectively leverage those fixed costs. But it is important that you all understand something that Barry and I have talked about on multiple earnings calls, which is that maximizing hardware gross margins isn't necessarily our goal. It's really about optimizing our hardware gross margin, using the framework and the lens of LTV to CAC. And what I mean by that is that we know that we have significant price elasticity for our products. And there are times where we will make a trade-off to invest in price, which lowers the LTV and lowers the gross margin and offset that with lower marketing spend or reducing our CAC because that is the more efficient way to drive subscriber acquisition. We also know that for certain products, particularly tread and row that we need to have positive -- significantly positive gross margins for those, because over 50% of that hardware currently is sold to existing members who already have an All-Access membership. So while our goal is to have significantly positive hardware margins, we are going to use that framework of LTV to CAC to make the appropriate trade-offs. And so in terms of the long-term gross margin target, which lots of folks have asked me about, it's really hard to provide one because it's going to be dynamic based on how we look at and where we're going to get the biggest bang for our buck, whether investing that dollar in a promotion versus investing that dollar in media spend is going to give us the better return. I will, however, offer the fact that we do have a long-term target for LTV to CAC. Our goal is to be in the 2x to 3x range. We have hit over 2x in the past and over the past year in certain quarters. We don't necessarily expect to be there every year, but that is a target that we are going after.

Okay. Just bringing the margin conversation back to what you led with, which is the path the company has been on from one point of free cash flow to where they are now and where they want to go. Maybe just help the audience understand a little bit better some of the levers inside your control and how much of the dynamics of growth and returning to certain levels of more normalized growth are some of the drivers that would lead to sustained free cash flow at the levels you're aiming for on a multiyear view, just so we can understand some of the variables that play in terms of the pathway towards more positive free cash flow.

Yes. So over the course of the past year, we have rationalized our inventory tremendously, which is great news. What that means is that we are now purchasing inventory, which is good in the sense that we -- in the sense that we are able to get better freight cost and it lowers our average cost for some of our products. We've reduced our storage costs as well. But it does mean that in Q1, our inventory will be a consumer of cash as we get out for the holidays, and we will use cash for inventory in Q1. And that for the remaining 3 quarters, actually, inventory should be a source of cash for us. Also, in Q2, we do have our seasonally higher marketing spend for the holidays as we spend in advance of the customer acquisition over the holiday season. What that means is that for the first half of the year, when you combine our inventory purchasing, our marketing spending and then also the onetime cash costs to deliver those seat posts from the recall, our free cash flow for the first half of the year is -- we expect it to be negative. But then we expect to be solidly positive in the second half of the fiscal year. In terms of the magnitude of the negative free cash flow, we expect to be roughly $150 million for the full -- first half of the year, maybe a little better than that, with no quarter being -- with both quarters being substantially less than $100 million free cash burn. On a full year basis, our target for Peloton is to get to free cash flow breakeven or even slightly positive. But at this point, it's just too difficult to offer with any certainty that we'll be able to fully achieve that. But I can tell you that if we don't get to breakeven or better on the full year, we should get very close.

Okay. So we only have about a minute or 2 left, just to bring the conversation full circle because we've talked a lot about the evolution of margins and cash flow and some of the product initiatives. If we're having this conversation in the year, when you think about some of the product initiatives, platform evolution and continued refinement of cost structure and margin for the business long term, what are the top key priorities and focus areas to allocate capital and execute inside the business that you, Barry and the team are most focused on?

Yes. So as I mentioned, like the last 12 months, they were about fixing our cost structure, right? The next 12 months and hopefully for the foreseeable future, it's really about returning to growth and then accelerating growth. And by that, I mean growing subscribers and growing revenue for Peloton. And we've made a tremendous amount of progress in improving the efficiency of our operations, but we've also become a much more nimble organization internally. And what I mean by that is we've been able to launch new initiatives, scale ones that are working well, point to rental is a great example of that. And we're also finding that there are some things that we're going to try and do that aren't going to work as well and will be either reduce investment in those. Stop doing those entirely if it makes sense. We'll figure out how to pivot them into something that makes a lot more sense for the business. But really, it's about finding those initiatives and investing in them and driving growth in the business that way. And I'm pretty confident that we'll be doing all of that over the course of the coming year, while also maintaining a very strong cost discipline and a discipline around our cash management so that we can drive growth and also keep the business operating efficiently.

Great. Okay. Well, really enjoyed the conversation. Please join me in thanking Liz and the whole Peloton team for being part of the conference this year.