Peloton Interactive, Inc. (NASDAQ:PTON) Q2 2023 Earnings Call Transcript

Peloton Interactive, Inc. (NASDAQ:PTON) Q2 2023 Earnings Call Transcript February 1, 2023

Operator: Good day, and thank you for standing by. Welcome to the Peloton Interactive Second Quarter 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Peter Stabler, Head of Investor Relations. Please go ahead.

Peter Stabler: Good morning, and welcome to Peloton’s fiscal second quarter conference call. Joining today’s call are CEO, Barry McCarthy; and CFO, Liz Coddington. Our comments and responses to your questions reflect management’s views as of today only and will include statements related to our business that are forward-looking statements under federal securities 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 results, please refer to our SEC filings and today’s shareholder letter, both of which can be found on our Investor Relations website. During this call, we will discuss both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP financial measures is provided in today’s shareholder letter. I’ll now turn the call over to the Barry.

Barry McCarthy : Want to do something a little bit out of the ordinary just to kick off today’s call if you’ll indulge me. A good friend of mine and Gail Tifford once best summarize what’s special about Peloton? I think when she described the brand is golden and the members community is platinum. And what makes that possible is incredible work done by our content team and by the instructors who give it life. And because of that, and in particular, I want to welcome back to the platform today one of our Instructors in London by the name of Leanne Hainsby, who after disclosing her recent battle with cancer, and her announcement that she’s cancer free, is today, once again back on the platform, and started her class just coincidentally happens to coincide with the start of this earnings call. So welcome Leanne. And thank you for all you do for us. And with that, let me turn the call back to the operator and take her first question.

Courtesy of Peloton

Q – Doug Anmuth: Thanks for taking the questions. Barry, you wrote about how the new initiatives across rentals and retail partnerships and just changes in the overall go-to market drove 19% of CFU volume in the quarter. So, if you could talk more about how you think that will progress over the next 12 months? And which of these initiatives you expect to be most impactful to drive growth going forward? Thanks.

Barry McCarthy: Well, based on the last quarter performance and quarter to-date, I think perhaps and the preowned business will be the most significant on a quarter-over-quarter basis, last quarter to the quarter before, our pass has doubled by way of example, and is continuing to grow rapidly this quarter. And a large, very large percentage 63% I think with a 95% confidence is incremental to the business. They are tend to be slightly higher at household income, who — but to the fact that don’t have to make a tricycle commitment would not have come onto the platform. Now, one, two, what about the third-party retail? It has less incrementality. But we don’t have enough data to be confident that we know how much of the revenue is incremental, meaning, whether we would have sold it on our own platform, but for the fact that that we partnered with third parties.

It did outperform our expectations in the quarter. But of course, we had no history going into the quarter. So it’s difficult for us to know as with FaaS and CPO how exactly to forecast it. So, we continue to be optimistic. We’re quite pleased with the performance during the quarter. Uncertain about the incrementality, although we are invested in continuing to grow it and no more secret progressing.

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Q&A Session

Doug Anmuth: If I could just follow-up, you know Leslie joining the new CMO. Do you do you feel like there’s strong awareness of the new initiatives in the go-to-market strategy among potential consumers or is that going to be a big focus in your advertising and marketing efforts?

Barry McCarthy: Well, it’s — awareness is low, still, but it’s new. Are we going to make it a focus? No, not particularly. I think the focus is going to be anyone anytime anywhere. It would be less about bike, it will be about all of the occasions for use and inclusiveness.

Doug Anmuth: Great. Thank you, Barry.

Operator: Thank you. Our next question comes from the line of Justin Post with Bank of America, your line is now open.

Justin Post : Great, thank you. Can you talk about hardware gross margins in the quarter? What were some of the puts and takes there? What it’s going to take to get those to breakeven? And when you think about the model, like how much are you willing to lose or take upfront costs to get a subscriber? And do you think the model is working now, as you think about your hardware sales producing subscribers? Thank you.

Barry McCarthy: Liz, and I will tag team, let me do the high level stuff and backhoe on the specifics. So let me say we manage to LTV to CAC. And in making those calculations, we take a holistic view of the revenue stream and the expenses associated with both the hardware and the subscription associated with it. So from my part, I don’t particularly care about the hardware margin, or particularly about the subscription margin. I care about it on an aggregate basis, and I care about the relationship between the lifetime value of the customer relative to the cost of acquisition. And that’s the framework we use in deciding whether or not the model is working. And in the recent model, I think we were operating at 1.4 to one LTV to CAC, which means that each time we add a new subscriber to the business, we increase the enterprise value because that customer will be net profitable over their life.

Liz Coddington : Yes, to just to just add a little bit more detail to what Barry mentioned. Because we did enrich our holiday promotion, that of course has an impact on our hardware gross margin. And we did manage to our LTV to CAC ratio, so we may have spent more on promotion, but it balanced out and resulted in that 1.4 ratio of LTV to CAC. I also want to comment that our overall gross margin when we outperform on connected fitness, what that means is the lower margin of our hardware becomes a sort of has a higher penetration relative to subscription. And so that will depress the overall margin a bit. But we’re happy with that, because we get the subscribers and the subscription revenue over time that comes with them. The only thing I think that is worth pointing out here on our gross margin is that this quarter, we did take a number of reserves, we had higher costs, the cost of revenue were impacted by some excess and obsolescence reserves.

So after we got through the holiday period, for example, we looked at our guide inventory and realized that we had more than we needed and took a reserve against that. We also had some very specific returned inventory that we had on hand that we no longer plan to refurbish and sell, so we took a reserve for that. And then we continue to have some reserves associated with inventory from our tonic manufacturing facility. So all of those had roughly about a $32 million impact on our connected fitness gross margin in the quarter. I think there was a question about when is our hardware connected fitness margin going to turn gross margin positive? And we’re not giving any guidance on that timing. But as Barry said, we are continuing to focus on optimizing our LTV to CAC.

And if you think about the fact that some of the levers that go into that, as we mentioned, promotions are part of that, financing is part of that, third-party channel strategy is part of that equation, all of those things have create a drag on our gross margin. And those get offset by lower sales and marketing expenses in the form of lower media spending. So you have to look at very set as a whole thing and not just micro focus on gross margin.

Barry McCarthy: One additional comment, and that is to remind everyone that there are clear tradeoffs between the rate of growth of the business fueled by the pace of marketing sales and marketing spending on the one hand, and the impact that spending has on free cash flow. So, we spent more on marketing, we could have grown faster, but it would have come at the expense of free cash flow. And our overarching objective, which is to move the business to free cash flow on a sustained basis so we can control our own destiny. So our first priority is to manage the business free cash flow, and then within that framework to manage for growth.

Justin Post: Great, thank you.

Operator: Our next question comes from the line of Eric Sheridan with Goldman Sachs, your line is now open.

Eric Sheridan: Thanks so much. Maybe if I could ask a two-parter. Obviously, there was a lot of demand pull forward through the pandemic, and you went through this sort of normalization dynamic post the pandemic. Are we back on a firm ground where you think you understand with the sort of normalized end demand trends are in the category. And therefore, you’re now in a mode of sort of executing on leaning in or leaning out with respect to promotion and marketing and we could be back to some sort of normal seasonal cadence in the business? That’s number one. And number two, maybe following up on Doug’s question from earlier, just can you help us better understand how the mobile app strategy fits broadly into the Connected Fitness goals?

Are you still viewing it as a potential feeder product for conversion and the subscriber funnel? Or is there an increasing view that maybe this can operate as sort of a stand-alone strategy for folks who might never come around to the hardware? Thanks so much.

Barry McCarthy: I’ll jump in first, and I’ll hand it over to Liz. We outperformed in the quarter. The good news and the bad news is. The good news is we outperformed. The bad news is the accuracy of our forecasting — our ability to forecast the business and particularly given the many changes we made in the business model is not as highly evolved yet as it will be. Is that because of the changes we made in the model or because there’s consumer behavior is different than we have understood it to be historically. I think maybe it’s some of both. And the reason I think that is because we’ve continued to outperform even our updated for guests in the quarter. And so we don’t quite have our handle — our arms around consumer behavior.

So I think the answer to your question is, no, we’re not back to normal yet. There’s some new normal that’s happening, and I don’t feel like we’re quite grasped what it is, one. Minor point with respect to seasonality, I should have mentioned in answering Doug’s question about SaaS, that among the things we’re seeing that we didn’t expect is that FaaS does not — has not been exhibiting seasonal characteristics of the rest of the business. I wasn’t — didn’t spike at all, for instance, during the holidays, it’s just continued its march as if holidays didn’t happen. And then lastly, with respect to the app, I think of it as its own end game. And maybe we’ll see the all access subscription hardware business or maybe not — I don’t really care.

The end goal for that strategy is to expand the TAM by reaching a user base that historically we’ve not been able to access to do it with our core strength, which is all of the content and the user experience that our instructors give life to and to enable consumers to use that content on competitive hardware and to use it in the home and to use it in the gym and to use it outside, whether it’s strength or a yoga or it’s running outside or run a treadmill, whether it’s rowing what have you. And today, it’s a bike gets to treat, it’s a row. It’s in your home. But tomorrow, it’s all those other things. And the path to the promised land is the app, I think, at least that’s how I conceptualize it, and that’s the opportunity we’re trying to pursue.

Liz, do you want to add anything?