Okay. All right. I think in the interest of time, we're gonna get going with our next fireside chat. It's my pleasure to welcome the team from Peloton Interactive here. I'm gonna have a fireside chat with Liz Coddington, CFO. Liz, thanks so much for being part of the conference again.
Yeah, thanks for inviting me back. Good to be here.
Okay, so I wanna start with what I thought was one of the key messages coming out of the last set of results. You've had a pretty big pivot towards profitability that started last quarter, positive free cash flow. You've obviously given fiscal 2025 guidance that highlighted continued improvement in those metrics. Can you just discuss your change in philosophy as it relates to EBITDA margin and free cash flow guidance?
Yeah. So first of all, you know, we're really proud of the progress that we have made in improving our profitability metrics over the last couple of quarters. But it's honestly been quite a journey to get to this point, and I think, as part of describing the philosophy, it's important to kind of reflect back on our path towards getting to this point. So as many of you probably know, Peloton experienced an outsized surge in growth in both our hardware and subscriptions during the COVID-19 pandemic. And now that we're arguably at least two years past the end of the pandemic, it's become clear that, you know, that there's a high likelihood that we pulled forward multiple years of demand for our hardware during the pandemic.
You know, it's also possible that we are not completely past the impact of that demand pull forward. When Peloton's demand was soft, sales volume declined toward the end of the pandemic, it became clear that the high cost structure that the company had built to support that surge in demand was unsustainable, so we focused on reducing our high fixed cost structure and shifting to much more variable structure, particularly for our areas of supply chain and manufacturing. We shifted our manufacturing entirely to third-party contract manufacturers, and we variabilized our supply chain, including doing things like outsourcing all of our logistics to third-party logistics providers.
We also reduced our fixed costs, we reduced headcount, we reduced fixed operating expenses, but our demand declined more than we anticipated at that time, and our cost structure was just not yet right-sized, and it's taken us a couple of years to rightsize our costs. So the pivot that we've made now is that we're focused on delivering profitability and ensuring that we have sustainable unit economics, both in our hardware and our subscription, without requiring growth in the near term to be able to achieve it. And we're demonstrating our ability to do that with our bottom line performance over the last couple of quarters, as well as in our FY2025 guidance outlook.
It's interesting to note that if you look at the midpoint of our Connected Fitness subscription guidance for FY2025, which does suggest that we will be declining in subscribers year over year by the end of the fiscal year, and compare that to where we were at the end of fiscal 2019, so pre-pandemic, that six-year CAGR is over 30%. What that suggests is that even with the demand pull forward from COVID, if you look over the long term, Peloton subscriber growth has been strong. While it's important for us to focus on growth in the long term, we're also focused on the things that we can control, which is ensuring that Peloton is on sustainable financial footing and able to meaningfully invest in growth for the future, and also de-leverage our balance sheet.
The way that we're doing that is by continuing to optimize our costs. We announced a cost reduction plan of $200 million back in May, that we are on track to be able to achieve by the end of fiscal 2025. Those cost reductions were necessary in order to rightsize our cost structure to the size of our business and enable us to guide to those strong profitability metrics for FY2025 of between $200 million and $250 million in Adjusted EBITDA, and also deliver at least $75 million in free cash flow in FY2025. We're confident that we can do that even with contraction in our top-line sales in FY2025. Just one more thing, keep going a little bit longer.
With that focus on profitability, we are still investing in growth for the future. We're investing in content, we're investing in product innovation, both in our hardware and our software, and we're investing in marketing in order to drive growth for the future. But the key change that we are making, and the key point I wanna make sure to get across, is that we're not relying on success from new initiatives in our outlook for our profitability targets for FY2025. And the reason for that is that there's just a lot of uncertainty around them, both in terms of the magnitude of what they can deliver and also in terms of the timing of when they'll be able to gain traction and start to deliver it.
And we are committed to not spending on marketing until we feel really good about the product market fit that we're seeing from these new initiatives and fitness experiences that we're investing in.
Okay. I wanna build on that point with the shift to profitability. You talked about, cost reduction in May. One of the other things that took place in May was when you went through a refinancing of your balance sheet. Can you review the elements of that refinancing and why you think they're important to the Peloton long-term equity story?
Absolutely. So, we completed a $1.35 billion holistic refinancing back at the end of May, and we were really pleased with it, because it was both competitively priced and also significantly oversubscribed, which suggests strong demand from investors and also a really strong vote of confidence in the future for Peloton. The components of the refinancing included: a $1 billion five-year term loan facility with a broad investor base, $350 million in five-year senior convertible notes, and then also a $100 million revolving credit facility that remains undrawn to date, and we used the proceeds from that refinancing to strategically repurchase roughly about $800 million in our outstanding 0% convertible notes that mature in February of 2026.
We were able to do that at a discount, which is great for us, and we do still have roughly about $200 million of those converts still outstanding. And look, we're really pleased with the outcome from that refinancing because it achieved our goals that we hoped to achieve, which includes slightly deleveraging, extending our maturities out to 2029, and also providing some slightly more flexible loan terms, all at a reasonable cost of capital.
Okay, understood. So you've got positive Free Cash Flow. That's a pivot. You're moving from raising capital to allocating capital. How should we think about capital allocation going forward, and what the potential roadmap might be?
We believe that we have more cash than we need on hand today in order to operate our business, and we do expect to generate, as I mentioned earlier, at least $75 million, a minimum of $75 million in free cash flow in FY2025. We could deal with the outstanding converts that mature in February of 2026 now, if we wanted to, but there's no urgency for us to do that because they are 0% coupon. We are continuing to evaluate our capital allocation strategy, and we remain very focused on deleveraging.
And for us, in addition to de-risking the business and improving our multiple, deleveraging actually has a real dollar financial benefit to us, because we do have a 50 basis point step down in our term loan, if we are able to reduce our leverage ratio to less than 5x.
Okay. So moving on from improving profitability, we still yet haven't seen a return to growth on the top line. How are you thinking about the potential for a return to growth from here? And then maybe I'll try to ask a couple of follow-ups, depending on how broad the answer is.
Yeah. So that's a great question. First of all, Peloton is a leading player in a large and attractive fitness and wellness industry, and there's a tremendous amount of growth potential for the business over the long term. We estimate that our total addressable market is roughly a hundred and thirty million households that in the markets that we currently operate in that invest in their own personal fitness and mindfulness. And of that, we estimate that our service addressable market is about twenty-four million households who are willing to purchase connected fitness hardware and subscribe to fitness content.
And then for our app, it's similar, but we focus on individuals there rather than on households, and we see our total addressable market as roughly three hundred million individuals who invest in their personal fitness and mindfulness, and about two hundred and fifty million of those are either currently or willing to use a fitness app. And so, you know, that we see that as growth potential for us. In terms of areas that we're focused on with regard to growth, our Tread area remains a big focus for us, because of the market opportunity. We see that the at-home treadmill market, we estimate, that it is more than twice the size of the stationary bike market, and yet for us, our Tread sales are a much smaller share of our overall hardware demand.
And so we see that there's a really big opportunity for us to reach incremental audiences, incremental subscribers, through growth of our Tread and Tread+ products. The ways that we are doing that are focused in a couple of key areas. One of them is around just enhancing our content and product offerings in relation to running and walking. Some of the things that we recently announced on that front are Pace Targets. We also have marathon training programs. We also recently expanded our entertainment offerings to include things like Kindle. You can read a book while you are either biking or running. Things like AMC, DirecTV, so really broadening our entertainment offerings available on our platform.
And then we also introduced a GPS guidance feature for Tread. We're also evolving our marketing to really better associate the Peloton brand with running, walking, and hiking, and that includes, you know, really focusing on marketing campaigns to drive awareness of Peloton and our Tread product offerings. Another area that we're focused on in relation to growth is really around product innovation, both across our hardware and our software. We tend not to comment much about innovation that we're doing on the hardware front for competitive reasons. But software is an area where I have some exciting things to talk about. Talked about them a little bit before, but they are very interesting to us.
So as recently as last week, we announced some new features and offerings in order to be able to start to test and iterate on. The first one that is exciting is we recently launched a new app called Strength+ , and it's a beta test for that new app, which is really focused on workout programs that cater to a gym setting, and that includes things like audio guidance and expert coaching through programs designed by our instructors that are sort of prepackaged.
We also have the Strength+ app also has something called a Custom Workout Generator, where you're able to provide it with information such as what types of equipment you have access to, how much time you have to work out, and what areas you want to focus on, and then it generates a custom workout for you, which is great. And so anyone can sign up for the beta to try Strength+. You don't even have to be a Peloton member to sign up. You actually just need to be based in the U.S. and have access to an iPhone. And actually, in the week since we launched the beta test for the Strength+ app, we've had over 50,000 sign-ups of people who are interested in trying Strength+.
We have currently limited the beta test group to around 3,500 participants based on the user information that they provided during sign-up, and the reason that we did that is in order to be able to really optimize our ability to learn and iterate quickly on the beta test. Another area that we recently launched, we actually, about a week ago, launched a new feature on our Peloton App called Private Teams, and the goal with Private Teams is really to provide a way to engage people on our platform beyond just using the leaderboard or the high fives that you can do when you're riding on your bike or going on your treadmill or whatnot, and with Private Teams, what members can do is they can share workouts with each other.
They can also participate in challenges with other members and with prospective members. They can include them in those challenges, and our goal there is to be able to drive organic acquisition over time, and also really increase the engagement on our platform beyond just working out. And in the first week since we launched the Private Teams feature, we've seen over 20,000 private teams created. And of the users who joined a team, we're seeing an increase in those users following other users through our platform. And while it's still very early days, what this does is it's an encouraging sign that we can enhance community building on the Peloton platform and also potentially drive organic acquisition over time through this feature.
But again, it is early days, and we're really looking forward to learning how users use the Private Teams feature over a sustained period of time, and then the third area on the software front that I'll mention is something called Personalized Plans. With Personalized Plans, our goal there is to provide a way to offer fitness routines to members based on their needs and goals, and really eliminate the friction for members who just don't know where to start.
So with Personalized Plans, you provide information about the types of workouts that you like to do, how many days you want to work out, how much time you want to work out each day, and it generates a weekly plan of recommended classes for you based on that, that you can do through the app or on a connected fitness hardware device. For now, that Personalized Plans, we did launch a small test in mid-August. We're continuing to learn and iterate on that one before we're ready to extend that to a broader audience.
Okay. So a lot there on growth levers and newer use cases. Maybe turning to the subscription business and subscriber growth. As the company focuses on profitability and generating Free Cash Flow, what needs to happen to reignite growth in the subscriber base?
Yeah. So as I mentioned, you know, we do have this large addressable market. And, we do see that over the long term, we're very optimistic about our long-term growth potential. That being said, if you look at our Connected Fitness paid subscriber guidance for FY2025, it, the-- we guided to a decline of between 230,000 and 300,000 subscribers by the end of the fiscal year. And while some of that is driven by the broader macro environment, a large portion of that is driven by conscious decisions that we are making to ensure that our subscriber acquisition is profitable.
As we've talked about in the past, the framework that we use to evaluate our subscriber acquisition is our LTV to CAC framework, and our goal is to be between 2-3x in terms of LTV to CAC. Over the past couple of years, we've hovered in the 1-1.5x range, mainly to maximize our growth potential. So now, as we focus on getting that LTV to CAC ratio to 2x and moving closer to 3x, you know, obviously, we need to make improvements on both the numerator and the denominator of the LTV to CAC equation. Let me talk about the numerator first and how we intend to improve our LTV.
So our strategy around improving our LTV is really centered around increasing our connected fitness growth margins, and doing that in a couple of different ways. Our intention is to be less promotional in FY2025, so that will increase the average price paid per hardware unit sold. And then we are also considering pricing changes for specific products in specific markets. Overall, our goal there is to increase growth margins, which improves our LTV and helps us fund our customer acquisition costs to drive acquisition of hardware. And our goal is to really have meaningful positive growth margins across all of our hardware products, in all of our sales channels, in all of our geographies.
Now, on the subscription side, we do benefit from the fact that we have a really high subscription growth margin, and a really low churn rate. But we also do see opportunities over time to innovate on things that will drive engagement, that should hopefully improve our retention over time. And anything that we can do to extend the life of a subscriber obviously helps our LTV over time, which is great. If I turn to the CAC side of the equation or customer acquisition side, anything that we are doing to reduce our sales and marketing costs will improve our CAC. So some of the things that we're doing are, you know, we are reducing our brand and creative spending. We're reducing our showroom footprint for our retail stores, which is part of our sales and marketing costs.
And we're optimizing international marketing resources and sort of shifting our strategy there to more one of a centralized strategy with localized execution in order to optimize our resources spent there. And we're also reducing our media costs year-over-year, our media spending, to improve our overall media efficiency. So when you take those things together, you see that our, you know, we are optimizing our costs and our LTV to CAC ratio, and we should be able to make significant improvement and progress in our LTV to CAC over time. And as we improve our LTV to CAC efficiency and reach our targets, we'll then be able to invest more in media in order to grow incremental subscribers in a more profitable way.
Okay. You also recently announced an activation fee for the secondary market. Maybe share your thinking there about the pricing strategy and the implementation of such a fee, and how that might factor into driving growth as well?
Yeah, that's a great, a great question. So first of all, our pricing strategy, kind of as I was just talking about, is really on ensuring that we have sustainable unit economics. And changes from prior years are really just mainly focused on reducing promotional activity. And then I mentioned that we may change some prices in order to make sure that all of our hardware has meaningfully positive growth margins across the board. On the subscription front, absent a new CEO in place, we are avoiding any one-way doors that could be considered something that would be difficult to walk back. And so we're not considering any pricing changes with regard to our All Access subscription at this point in time. Now, you mentioned the hardware activation fee, and that is an interesting one for us.
As our secondary subscribers, the growth additions coming from the secondary market have increased over time. We added a used equipment activation fee so that we can invest in improving the experience for those members. And some of the things that we've done include creating a Peloton history summary, offering discounts on bike shoes and mats, offering a free or an included virtual custom bike fitting for those members. And since we launched the activation fee, although it is early days, we launched it just around the time of our last earnings call, we've been encouraged by the response to it. We have seen no measurable impact to our growth additions coming from the secondary market since the launch so far.
Okay. One last one on growth, just distribution channels. Can you talk a little bit about the new distribution channels like FaaS and the secondary market, and the pros and cons of how you approach channels like that as additional distribution that can drive growth?
Yeah, so at a high level, our goal with all of these channels is to reach incremental audiences and subscribers, meaning that these are people who are joining Peloton that would not have joined us if these channels were not available. Now, on the flip side, there is a con to these channels, and the con is that the unit economics of these channels is generally not quite as attractive as if somebody were to purchase directly from us through a first-party sale. Now, the net impact of these two forces has been positive due to the high incrementality that we tend to see across all of these channels, but that's kind of a high-level view, but let me kind of pick it apart and I'll talk about some of these channels individually, so first, let's talk about the secondary market.
We were talking about the equipment activation fee earlier. secondary market is a really interesting channel because it operates independently from us, and it is where either an existing member or a churned member decides to sell predominantly a used bike to another prospective member, and we are not involved in that selling process at all. Since we did experience that large demand surge during COVID, even with our low churn rates, over time, the amount of inventory available in that secondary market has increased, and then the price for selling that hardware has come down and kind of in line with the laws of supply and demand.
That's great, because it allows price-conscious consumers, who, you know, may not be willing or may not be able to afford our hardware by purchasing directly from us, to be able to join Peloton. So we are very supportive of that channel and are leaning in with the used equipment activation fee to make a much better experience for those members. So that's the secondary market. I think the next one you mentioned was FaaS, which we also call bike rental. So our bike rental channel is actually, of all the channels, the one with the highest level of incrementality. And the reason for that is because it offers consumers who are not comfortable committing to an outright purchase, a way to rent a bike from Peloton, and be able to cancel their subscription at any time.
Now, the negative about the bike rental program is that it does have the highest churn rate, which is not surprising because of the fact that you can return, you can cancel your rental membership and return the bike to us. And in line with that, you may have seen that we recently announced that we are discontinuing offering.
There you go.
You guys won't hear me. Ha! that we are discontinuing offering Bike Rental for our original Bike. And the reason that we're doing that is, while the unit economics were very attractive, or were attractive enough for us using refurbished inventory to support that program, as our refurbished inventory has become depleted, the economics are just not attractive for us to continue to offer it with new inventory. So we ceased offering it in early August. That being said, for Bike+, the economics are attractive for us, both with new and used inventory, and so we are continuing to offer Bike Rental for Bike+, and we plan to do that for the foreseeable future. And then the next one, I think, was refurb, right?
Yeah.
Yeah. So let me talk a little bit about refurb. So our refurb program, the way that we get most of our inventory to support our refurbished sales program, is from our thirty-day home trial, which is a really important part of our subscriber acquisition strategy. And while our return rates are quite low, we do get inventory back, and it's great that we're able to refurbish it and offer it to consumers who are a bit more price-conscious, so that they have a lower entry point to join Peloton. And the other great thing about refurbished sales is that the subscribers who join by purchasing a refurbished bike or Bike+ exhibit the same low churn that we see from subscribers who purchase new inventory directly from us as well. So that's really great.
And then the thing about these three channels taken together that is also great is that because they leverage a large portion of used inventory, they enable some sustainability in our business model. Peloton creates really great hardware that can have quite a long, useful life, and we do support the notion that it should be reused. I think the last one was third-party retail.
Yeah.
Yeah. So third-party retail is another channel for us to reach incremental audiences and subscribers. For example, Amazon has a very broad audience, and then our partners, like Dick's Sporting Goods, give us an opportunity to showcase our products in their stores alongside other hardware offerings, which is great. Now, over the past couple of years, since we launched these third-party relationships with third parties, we've learned a lot about how to optimize the incrementality of these partners. And one thing that we found that really works well is when we lean into key promotional moments for those third parties that don't cannibalize our first-party sales. And a great example of that would be something like Amazon Prime Day. Third-party retail is also really important to us, as part of our international expansion strategy, as an efficient way for us to expand internationally.
As an example, our Austrian business is entirely served by third-party retail partners, and we also announced about a week ago that we are shifting our German business to be entirely serviced by third-party retailers and distributors, namely, Amazon and Fitshop.
Okay. We've got a few minutes left, so I'll try to get through maybe one or two more topics. Just turning to current trends in churn, how should we think about the key underlying factors driving an increase in churn that you're seeing now, and how do you think about churn leveling off at a certain point?
So our churn rate for Q4, our average paid monthly connected fitness net churn rate, was 1.9%, which is still quite low, but Q4 is a seasonally high churn quarter for us. For Q1, we do expect our churn to be roughly similar to Q4, and then we do expect it to dip down in Q2 and Q3, in line with our historical trends, before ticking back up in Q4 of FY2025. Now, on a full year basis, we do expect an increase in our churn rate in FY2025 due to a few factors, which I'll talk through now. The first one is that we are seeing slightly worsening churn rates in our subscribers who joined Peloton through purchasing directly from us.
The second factor is a one-time headwind that we see because we experienced a tailwind in FY2024. So at the end of our fiscal 2023, Q4 of 2023, we had a seat post recall, and as a result, we had a number of subscribers pause their memberships as they waited for the delivery of their seat posts. And those subscribers unpaused at a relatively high rate in fiscal 2024, and so we aren't expecting the benefit to repeat in FY2025. Then the third factor is really that as we are seeing an increase in subscribers coming from the secondary market, that does create a bit of a headwind to churn for us because the secondary market subscribers do have a slightly higher churn rate than those who are purchasing from us directly.
Now, we do see a high correlation between engagement and retention, and we're pleased with our engagement trends. We measure those in terms of average monthly workouts per subscriber. They were down slightly year over year in Q4, but up significantly if you look back to FY 2019 or pre-COVID times, and you know, I talked about some of the software innovation that we were working on earlier, and our goal there is, you know, some of the goals there were really around driving engagement, which we expect could have benefits to retention and reducing churn over time. But I want to be clear that we are not factoring in any upside in our churn in FY2025 from any of those new initiatives at this point.
Okay. In the last few minutes we have left, maybe we'll try to end on this. You're obviously in the midst of a CEO search still. You've had sort of a lot of initiatives we talked about today. Can you explain to investors how confident they can be that the new CEO won't change tack to reverse some of the progress, and what might some of the timing be on the CEO announcement?
So while I can't comment with 100% certainty on what a new CEO will or won't do, what I can say is that the board, inclusive of our co-CEOs, Karen Boone and Chris Bruzzo, our interim co-CEOs, is aligned with the strategic changes that we've made and the progress and the way we are making progress, and that's the same group that is making the CEO hiring decision. And I also can't comment on any specific timing, but what I can also say is that the board has hired a leading executive search firm, and that they are very pleased with the quality of the candidates that they are interviewing.
Okay. I think we're gonna leave it there. Liz, thanks so much for being part of the conference. Please join me in thanking Peloton for being part of the conference this year.