Peloton Interactive, Inc. ($PTON)

Welcome. We'll get started here. I'm Jon Komp, Baird's analyst, covering the active lifestyle sector and very pleased to have Peloton with us next. And Peloton, as you may know, is the global leader in the connected fitness category with annual revenue of about $2.4 billion. Company is well known for its premium fitness hardware, including the Bike, Tread and Row and along with the sector's most engaging instructor-led content with roughly 2.6 million subscribers on the Connected Fitness side today, we're pleased to have Peloton and President and CEO, Peter Stern. And the company, as you'll hear today, is really approaching its next chapter here having dramatically improved the efficiency and the operating capabilities of the business and looking for new avenues to growth really behind connected wellness and moving more out of the home. So Peter, welcome. Thank you for joining.

Jon, thanks for being here, and thanks for your loyalty as a Peloton member.

That's right. We were just comparing notes as loyal Peloton subscribers for many years. Peter actually joined in 2016.

So Peter, you're obviously no stranger to the fitness category in consumer subscription businesses and now approaching 18 months as CEO of the company. Maybe just start by walking through some of the key changes you've made to the company and really the shift in focus here as you pivot from improving operating efficiencies back towards growth.

Sure. So the first thing that we did was we put in place a formula for driving improved performance for the business that's really centered around our members. There's 4 elements to that. The first one is improving member outcomes. Because if our members actually feel better, get fitter, have more fun, that's going to drive their loyalty and word of mouth. And we've made tremendous changes in the last 18 months along those lines. We replaced our entire product lineup in Q2 of this year around the holidays. And we also introduced Peloton IQ, which uses AI to deliver a completely personalized experience for our members. And we have a road map to follow on both of those that I think is really exciting. Second thing we did was introduce a strategy that we call meet members everywhere, right? To start to grow our business, we're going to need to be able to connect with members in many more places. A couple of things that we've done along those lines are introducing our micro store concept. These are 300 square foot stores that are vastly more efficient than the old in-line stores that Peloton had and are now helping us meet people in the places where they shop. We launched 10 of those in Q2 of this year, and we have another 10 or so coming along. Another example of what we're doing to meet members everywhere is some of the work that we're doing in our commercial business. The third part of the strategy is making members for life because we know that fitness is something that you need to commit to over a really long time, like Jon has with Peloton and I have as well. And that's also what drives value in our business, right? The lifetime value is driven by both the amount that the members pay us in any given year times the number of years. And so we've made real changes, for example, the introduction of something called Club Peloton, which is the first loyalty program for our members as well as a lot of blocking and tackling, making sure that members have options when it's -- when they're considering their -- what to do next and giving them, for example, the opportunity to pause a subscription rather than just to cancel it. And then last but not least, along those lines is what we call business excellence. We have made such substantial changes in terms of the discipline with which we run the business that we've delivered enormous improvements in profitability and EBITDA and our balance sheet. I'm sure we can get into all of that later. All of this is with the backdrop of a broader strategic objective of transitioning Peloton from not just being the world's leading connected fitness company but to being the world's leading connected wellness company. And the reason for that is that fitness markets are big, but wellness markets are huge. Global Wellness spend is around $7 trillion. And so as we open our aperture, we increased the range of opportunities available to the company and the vectors for growth that we can pursue.

And I think that's a good place to maybe talk about the markets that you see how they're developing. I mean, Peloton plays in a bunch of different markets, cardio, strength, wellness, recovery, maybe more to come. What do you see as the biggest opportunities as you brought in the focus more towards the total wellness market?

Yes, Jon, the way I look at our end market is -- basically, it's the entirety of areas that address human health span. And by health span, I mean the quality -- the number of quality years we enjoy on this earth as distinct from lifespan, which is just the sheer number of years that we spend on this earth. When we start to look at what drives health span, right, it's things like your cardiovascular capacity and endurance. We see that, for example, every 4 points improvement in VO2 Max -- hopefully, people have heard of the VO2 Max measure of your cardio capacity. Every 4 points improvement in your VO2 Max results in somewhere between a 15% to 20% reduction in all-cause mortality. So we're absolutely committed to doing everything we've been doing with cycling, treadmills, rowers, but also making those products more accessible. Strength, equally as important as cardio. And I think we're all becoming more educated about the importance of strength for your metabolic function, it's muscles are the best glucose sync that we have available to us, for bone density, for reducing the risk of a catastrophic fall for avoiding what's called sarcopenia, right, muscle wasting that happens for some people when they get on GLP-1 drugs. We already have 2 million or so of our members who engage in strength activities on a regular basis. And we have a substantial R&D agenda in the strain space to do a lot more there. Mental well-being is another category that's really important. It is in fact the largest driver of the distinction between health span and lifespan which has now exceeded 10 years in the United States. And issues with mental health have risen to epidemic proportions, especially among young people, whether it's stress, anxiety, depression, ultimately even things like substance abuse. Many of those can be addressed, not fully, not all of them, but in a significant way with things like mindfulness practices. And we at Peloton have over 1 million of our members who are engaging on a regular basis on things like sleep programs and meditation. So we've taken an asset that we built called Breathwrk, and we've been pouring our content into that in anticipation of a broader relaunch of something that we think will be the world's leading mental well-being app. And then just to take another sort of look at our approach to this space. Peloton was really founded around in-home workouts, but gyms are a critical place where people can make a difference in their health span. And I'm so happy that we own Precor as a business. It's a good business, and it provides a foundation for us to not only scale that leading gym operator, but also bring Peloton into new places as well. All of these basically add up to, I think, a tremendous array of opportunities for growth for the company.

It's interesting to hear all the opportunities, those don't seem like themes that would be subject to macro sensitivity, but how do you view business in total relative to more uncertain macro conditions?

Yes. First of all, fitness as a category. We looked at very large macro disruptions like the 2008 financial crisis. And it turns out that fitness weathered that incredibly well. People will cut investments in themselves pretty close to last on the list. So we think the category overall is a relatively stable one during difficult times. Certainly, for Peloton our revenues come from subscriptions, which are quite sticky. And as long as people again, continue investing in themselves, we should be all right on the subscription side. On the equipment side, which is roughly 30% of our revenues. There are so many ways to get into Peloton at this point. We're generating over half of our subscriber gross adds from the secondary market. So that's people selling old Peloton equipment, which still works like new and giving it to someone else who will love it again. And when you look at whether it's that secondary market or the things that we can do with refurbished equipment or some of the programs that we've put in place like 0% financing or special pricing for things like first responders and health care workers and teachers our ability to promote our equipment when we need to, our launch is something called repowered, which is a Peloton mediated secondary market that unlike, let's say, Facebook marketplace means that a seller can put their equipment on the market and not require a buyer to have to show up at their house. You can have professional delivery, pickup and delivery. All of these are ways of ensuring that we keep Peloton's entry price affordable in case we run into macro headwinds.

There's a lot I want to come back to, but it's probably a good point to talk through the improvements you made as a business, the operating structure, the balance sheet, the leadership team. So maybe expand there a bit.

Yes. So let me try to walk through each of those in turn, Jon. I'll start with the operations, we have made enormous progress there. We are on track over the course of this year to reduce our operating expenses on a run rate basis by $100 million a year. We have now reached the milestone where we're generating over $1 million of revenue per employee in the company. The turnaround in our financial fortunes on the operating side has been, I think, nothing short of miraculous. And the consequence of that is that the balance sheet has dramatically improved as well. Over the course of the last year, we've reduced our net debt by 70%. We have at the end of Q3, $1.13 billion in cash. We are rapidly therefore, approaching basically a net-zero debt situation. And that creates all sorts of options for us, which I could scarcely have envisioned given where the company was even a couple of years ago. And we've made, I think, similarly stunning improvements on the leadership team that we have at Peloton. Just I'll focus on the 3 most recent of our leadership hires. Megan Imbres, we brought over from Apple to be our Chief Marketing Officer. For those who've been tuning in. You might have seen our Hudson Williams ad that has gone absolutely viral. That -- that's the kind of thing that, for a CMO, you hope happens once in a career. And in Megan's case, it happened in her first year at the company. We brought on Sarah Robb O'Hagan, as our Chief Content and member Development Officer about 3 months ago, Sarah has an absolutely stellar background, having been the President of Equinox, President of Gatorade, CEO of Exos performance coaching company, really the absolute perfect person and really the only person in the world I would trust to manage our incredible cadre of instructors, and she is already off to a very fast start there. And then I'm so pleased that we recently announced that Sid Thacker will be joining as our CFO in less than 3 weeks. Sid joins us from Rent The Runway. And he's both brilliant and a wonderful person, and I hope many of you as investors get a chance to know him as I have. He's going to do great things for Peloton.

That's great. Lots of heavy lift in improving across the board here. investors ask often about subscriber growth. So maybe talk about the health of your subscriber base, some of the metrics you look at? And any outlook commentary more generally, you're willing to share?

Sure. I mean there's a pretty simple formula for subscriber growth, right? It's the number of gross adds. So the number of subscribers you get minus your churn, so minus the subscribers you lose. And if you just look at the trajectory for Peloton, it's heading in the right direction, right? The rate of declines in gross adds has been improving year-over-year-over-year for the last 2, 3 years. At the same time that we have experienced either roughly stable or declining churn each year on a declining base. The last time I spoke about this was on our Q3 earnings and at that time, I stated that we anticipated that we would be roughly flat with last year for churn. And that's despite the fact that we did a pretty significant price increase in Q2 of this year aligned with the introduction of a whole bunch of new value for our members. So if you just look at those 2 lines, they will, at some point in the future cross if the trends that I just described continue. The question for my management team and for me is can we bend the trajectory of those lines. And our principal focus is on the gross add side. And the way to move that is one for us to be able to innovate in the existing categories in which we operate and make our products, for example, more accessible, more affordable to be able to introduce more ways to get to know Peloton, things like the micro stores that I mentioned earlier or our investments in third-party retail. But ultimately, the thing that will really cause the lines to bend is our pursuit of new businesses in that wellness space that I described, unlocking new vectors for growth. Those are the things that will really kink the curve on gross adds. And then if we continue to deliver the enviable churn rates on the enviable churn rates that we have as a company, that's what gets it back to subscriber growth. In the meantime, I'm pleased with the progress we've made on revenue growth. After all, this is a business and revenue and profit are pretty much what defines success. In Q3, we were able to deliver our first quarter of positive revenue growth in quite some time. We simply have more levers to play with in the short run on revenue, things like the growth of our commercial business unit, our content licensing, pricing, equipment sales. Those are things that deliver revenue and value for the business, but they don't translate directly certainly not immediately into substantial numbers of subscribers in most cases. So that's where we are in the business.

Looking at the hardware refresh from the second quarter, what did you learn? And then what are you willing to share about the product road map here and the R&D that you have in store?

So the product refresh in Q2 was the launch of what we call the Peloton cross-training series. What we saw really as soon as I joined the company, was this newfound excitement among consumers around the world, in part driven by the launch of GLP-1 drugs, which really became available in large numbers in 2022, 2023 toward adding strength training into a cardio regime, a regimen. And so that's what led us to launch the cross-training series, which included not just the ability to have a swivel screen across every piece of our equipment, which made our floor exercises more accessible to people. But on all of our plus line of equipment, we used Peloton IQ and our AI capabilities to do things using computer vision like giving people form feedback on their exercises, advising them when it's time to go up or if necessary, down in their weights and even count their reps. So we're really starting to play the role of a personal trainer for them. And the cross-training series is doing great. If you look at the Net Promoter Scores, Remember, this Net Promoter Scores are on a scale from minus 100 to plus 100. All our products right now are delivering over 70 on Net Promoter Scores, which is an extraordinarily high NPS level. So people are feeling great about it. Now in Q2, we had in that quarter built into our models and assumption around a very high upgrade rate among our members into that new equipment, and that did not materialize. I view that less as a statement about the cross training series and more about a statement about the level of satisfaction and inertia that our members have with the equipment that they already possess. And given that we make 90% plus of our profit on the subscription business, it has no long-term consequences. And so Q2 was basically a blip from a forecasting standpoint, but you saw that it didn't impact Q3. In terms of the innovation road map, an investor conference is not the moment for big product reveals. But what I can say is that we have a really robust R&D agenda. The near-term focus is on ensuring that in the largest of our current categories, we're able to ensure that our products are competitively priced and continue to be the absolutely best in class. With a slightly longer time horizon, our focus is on new modalities. Going back to what I talked about in terms of kinking the curve on gross additions of subscribers, that requires us to break into new areas. And without being terribly specific about what we're doing, our focus is more on strength in that area.

I've got a laundry list of things I hope to add to my home gym, so we'll see. Maybe expanding a bit more on the revenue opportunities outside of just simply adding subscribers. Talk about the commercial business unit. It had a nice growth quarter in Q3. But if you could share more about Peloton and Precor, the positioning and really the opportunity.

Absolutely. So the commercial business, that market segment, we estimate globally is around $10 billion. And Peloton through Precor and the small Peloton for business line do somewhere around 3% market share. If you just go back in time a few years, Precor itself had roughly 5% to 6% market share in the commercial space. But it has been -- the company really sort of disinvested in Precor. So we see a relatively clear path back to at least the 5% to 6% that Precor had before. That's things like reinvesting in our sales force and account management, it's revitalizing the product road map for Precor. It's providing the kinds of sales support that the team needs to succeed out in the marketplace, for example, with things like financing. So we've got a great team in place at the commercial business unit that's working on all of that kind of blocking and tackling and has the institutional memory to know what it feels like to win in that space. But we've also given the commercial business unit, the capabilities of Peloton. When we talk to gym operators, they -- every one of them says that there's only one equipment brand that gym goers ask for by name, and that's Peloton. And there has never in history, been a piece of Peloton equipment that was built for a heavy-duty gym environment. We just announced a couple of months ago the Peloton Commercial series. It will launch by the end of this calendar year. And we have a great deal of inbound interest in that equipment. They'll start with a treadmill and a bike, that are designed to stand up to the demands of a gym where you can have 10-plus hours a day of use on that equipment. And it will bring together the industrial prowess of Precor with the leading experience of a Peloton piece of equipment and design for gym environments. So we have very high hopes for that business. I do want to reiterate something that I pointed out to folks though in last quarter, which is that our upcoming Q4 in that space has some tough comps. About a year ago, there was a lot of noise, if you recall, about tariffs. Independence Day had recently happened and there were -- there was an influx of orders that took place in last year's Q4. So although our Q3 this year was plus 14%. I wouldn't expect, at least for this quarter to come that you'll see that again. But again, that should just be a temporary moment and then we should be in a great place on the CBU commercial business unit.

That's great. Maybe expand also the licensing and nontraditional opportunity, both fitness and other wellness categories.

So one way to look at Peloton is we are a massive TV network for fitness content. In any given year, we produce about 10,000 episodes of extremely high-quality fitness programming with amazing star instructors. And historically, we've always monetized that through our All Access Membership, which comes with our equipment or it's part of the equipment experience, and with our apps, both App+ and App One. But given that we've already produced that content, and so the costs have already been expanded, there is opportunity for us to bring that to others and monetize it further. And we've done that in the past, for example, by our multiyear deal with lululemon to provide the programming for their mirror customers. But I'm so pleased with our recent deal that we announced and launched with Spotify. This puts us in front of hundreds of millions of people in countries around the world. exposing the Peloton brand to people we would never have met before. Peloton today is only in 6 countries, Precor is in 60, but Peloton is only in 6 and so Spotify gives us an order of magnitude increase in the number of countries in which we operate. And we're getting paid for it. And we've already seen a significant fraction of the usage of Peloton content by Spotify members taking place in countries outside the ones where we currently operate. So it's a great source of growth and brand building for us. We've also been doing something even within our own house along these lines, which is putting our Peloton content, the sleep and the meditation content into our Breathwrk app. which can then act as a new on-ramp for people to get to know Peloton and for us to build subscribers.

Certainly easy to access in those channels, too. With the minute we have left or so, I'll just ask on the balance sheet and outlook for strategic capital allocation. Should we expect to hear more soon on those topics?

Yes. I mentioned that Sid Thacker is going to be joining as our CFO in 3 weeks, and I want to give him a little bit of time to settle in before we make any big pronouncements or decisions even in that area. But we have a pretty straightforward framework for how we're thinking about capital allocation and we're privileged to actually be able to implement a framework like that because of the amazing progress that we've made on our balance sheet. So for us, we're focused on reducing our cost of capital. We're simply paying interest rates that are too high. We're looking at being able to reduce dilution. We know that matters a lot. We've been trying to manage for example, stock-based compensation and try to find ways to engage in shareholder-friendly actions with regard to our capital allocation. We want increased flexibility to be able to do things like buybacks if we decide to do that. Right now, we're limited by our covenants. And last but not least, we want to make sure that we've got the dollars set aside to invest in our future, whether that's organic investments or the right kind of shareholder-friendly and focused M&A. So all of that is what drives our decision-making on the capital structure.

I know we covered a lot of ground. I want to thank you and James Marsh for joining today. Peter and James will be available over in the Rockefeller foyer for a few minutes for a breakout session. So please join me in thanking Peter.

Thank you, Jon.

Thank you.