Good morning. I'm Arpine Kocharyan, Leisure, Gaming, and Lodging Analyst at UBS, and I'm very pleased to have CFO of Peloton Interactive, Liz Coddington, here with us today. Before we get started, just a quick reminder on my end. As research analysts, we have some disclosures in terms of our relationship and that of UBS on companies that we might talk about today, all of which could be found at UBS.com/disclosures. With that out of the way, Liz, thank you so much for making the time today for us.
Yeah, thank you for having me.
Wonderful. Liz, you came to Peloton at a tough time, and you've been there throughout the turnaround for over two years now. Maybe we could start off with your broad assessment of where Peloton is today, progress that's been made, and your focus now on more profitable.
Sure. So if we go back, many of you know that Peloton experienced an outsized surge in demand, both in the demand for our hardware products as well as in our subscriptions during the time of COVID-19. And now that we are more than two years post the end of the pandemic, we have the benefit of hindsight. That does suggest that we likely pulled forward multiple years of demand for our hardware products due to COVID, and that we may not be completely past the impact of that pull forward yet. As our hardware sales began to decline post-COVID, it became clear that the high fixed cost structure that the company had built was just unsustainable. And it's taken us some time to right-size our costs. Some of the initial things that we changed is we exited our first-party manufacturing and shifted entirely to third-party contract manufacturing.
We shifted our last-mile logistics from a high-cost first-party model to one leveraging third parties, basically shifting our supply chain entirely from a high fixed cost structure to a much more variable model. And then we also reduced headcount significantly across the business. However, our sales declined more than we had anticipated at that time, and our cost structure was just not yet right-sized. So the pivot that we have made is that we are now focused on delivering profitability and sustainable unit economics both across the hardware as well as subscriptions portions of our business 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 results that we've had over the last couple of quarters, as well as in our fiscal 2025 guidance.
Now, growth remains very important to us over the long term, but we also remain focused on the things that we can control, which is ensuring that we are on solid financial footing so that we can invest in growth for the future and also deleverage our balance sheet. Now, in order to do that, we have had to continue to optimize our costs. And many of you may know that in May, we announced a $200 million cost restructuring plan that we are on track to be able to achieve by the end of the fiscal year. And those cost reductions were necessary in order for us to be able to deliver meaningful positive free cash flow of at least $125 million and meaningful positive Adjusted EBITDA between $240 million-$290 million in FY2025.
We're confident that we can achieve those targets without, well, even in the face of declining top-line revenues. Now, with all this focus on profitability and in a scenario of contracting top-line revenue in fiscal 2025, we are still able to meaningfully invest in content and product development and in marketing in order to set ourselves up for growth in the long term. The key thing that I want to point out is that we aren't relying on growth from new initiatives to be able to achieve our profitability targets. The reason that we're not doing that is there's a lot of uncertainty around them, both in terms of the magnitude of the success that we may see from them as well as the timing of when we will see that success materialize.
We're committed to not spending on marketing until we feel really good about the product-market fit from these new features and experiences that we're working on.
That's wonderful. That's great. In terms of how you build to profitable growth, could you go over maybe the stepping stones of how you get there? It seems like stopping the cash burn was the first step, then getting balance sheet in order was next, then you have done that with the refinancing. Can you maybe walk us through the steps to achieve sustainable financial footing? Now that refinancing of the balance sheet is behind you, what's next for you?
Yeah. So you mentioned stopping free cash flow burning. The first critical step, you are correct, in fixing the Peloton business was stopping the free cash flow burn that was largely driven by the high fixed cost structure put in place by the business during the time that we saw a surge in demand during COVID. We burned just under $2.4 billion in free cash flow in fiscal 2022, which was the year that Peloton's hardware sales began to decline. And that led us to restructure our costs, which have taken time to be able to implement, but we are in a much better, more stable place now. Over the course of the couple following years, we made significant changes to improve the free cash flow profile of the Peloton business.
Some of the most notable ones included. I mentioned this a little bit earlier, but exiting the first-party manufacturing, shifting from first-party last-mile logistics to third parties, basically transforming our supply chain from a high fixed cost model to a variable one, selling down high inventory balances, reducing our retail showroom footprint, which was another high fixed cost area for us. We talked about the fact that we reduced headcount significantly across all areas of the business. We also implemented a price increase to our All-Access Membership from $39-$44 in North America in June of 2022. Now, right-sizing our cost structure, re-architecting our cost structure, and stabilizing Free Cash Flow was critical to be able to address our balance sheet. You mentioned that a little bit.
In May, just as a reminder for some of the folks, we completed a $1.35 billion holistic refinancing that achieved our overall objectives of extending our debt maturities, securing more favorable long terms, deleveraging on a gross debt basis, and doing that all at a reasonable cost of capital. And I'm proud to say that we are really pleased with the fact that we have delivered three consecutive quarters of positive Free Cash Flow and positive Adjusted EBITDA, and that we are able to provide the guidance that we can deliver at least $125 million in Free Cash Flow and between $240 and $290 million in Adjusted EBITDA as per our full-year guidance. And in order to do that, we had to continue to optimize our costs. We talked a little bit about that, the $200 million cost restructuring plan that we announced in May.
That's actually my next question in terms of sort of before we move to top-line and growth. You gave a lot of detail when you announced the $200 million of cost saves and where it's coming from. Investors are really focused on that OpEx part of the equation, but there's obviously the key question of how you balance that versus marketing that supports the business. Could you talk a little bit about that?
Sure. So we evaluate our marketing spend using a framework of LTV to CAC, and our target for LTV to CAC is in the 2x-3x range, with our North Star goal being closer to 3x. Now, in recent years, we've hovered more in the 1x-1.5x range, and we are focused on what we can control in order to make progress there. Now, achieving those targets won't happen overnight, but we are making progress in the near term on the areas that we can control. Now, on the LTV front, that includes making pricing changes and also reducing promotional activity in order to improve our hardware growth margins. And we have made some progress on that in Q1. Now, on the CAC front, it really relies on two things. Number one, being disciplined with our marketing spending so that we aren't overspending to acquire unprofitable customers.
And two, evolving our marketing messaging so that we are able to target new audiences more effectively and improve our media efficiency.
Wonderful. Liz, so cost cutting has been something that's been ongoing at Peloton, right, which means that FY2026 should see some annualization benefit or some of those initiatives. Also, do you believe there is upside to that $200 million cost savings that you have guided, announced outside of kind of this annualization benefit that you get the next year? What would be some of the areas that you would look further into for cost optimization?
Sure, so we did mention the $200 million cost savings plan. We expect to achieve an annualized run rate of $200 million in cost savings by the end of FY2025, and we are a little bit ahead of our initial expectations on our ability to do that. We also mentioned that we mentioned this on our earnings call, and I think I mentioned a little bit ago that we're being disciplined with our media spending, and so we do see upside to our cost savings plan from optimizing our media spend to improve media efficiency, and our media spend is expected to be down materially year over year in FY2025, so that is upside to the $200 million in cost savings that we see. Now, looking ahead to FY2026, we do see further opportunities to improve our cost structure.
We know that our OpEx as a function of revenue is still too high, and that's particularly true within our G&A area. Some of the areas that we are focused on there include some examples being able to reduce our legal expense as we close out various legal matters, reducing the considerable amount of tech debt that we have, where we are solving technology gaps inefficiently with manual work today. Then there's one area I'm actually pretty excited about, which is our member support. Our member support costs sit within our G&A category. The member support team has done an incredible job of improving our member satisfaction scores over the last several months. They are focused now on reducing our contact volume as well as reducing our average handle times, and those should over time be able to meaningfully impact our costs as well.
That's wonderful. Could you remind us your near-term margin targets when it comes to hardware versus subscription side of the business? Do you still believe that the hardware business can get to double-digit margin at some point? And then on the subscription side, how might that margin profile evolve over time, do you think?
Sure. So first of all, our connected fitness margins, gross margins have improved significantly. In Q1, our connected fitness gross margins were 9.2%, which is a 600 basis points year-over-year improvement. Now, if you look at our hardware margins, they do tend to vary widely based on the products within our portfolio. Our more premium-priced products tend to have very healthy gross margins for us, whereas our lower-priced products carry thinner margins, but they are providing an option for more price-sensitive customers, and they do drive more subscriber growth. Overall, we do expect our connected fitness gross margins to continue to improve over time, and we do expect that on a full-year basis, our connected fitness margins will be in the double digits for fiscal 2025. Now, we're focused on improving the attractiveness of our hardware margins across all of our products, channels, and markets.
And in Q1, we did make some pricing changes for certain products when we needed to expand our hardware margins. Specifically, we increased the retail prices for our Bike and Bike + in international markets, and that was especially important for Germany, where we shifted entirely to a third-party retail and fulfillment model. And we also increased the price of our Peloton Row in North America. Now, just turning very briefly to the subscription side of our business, our subscription business benefits from the fact that we have very stable and strong gross margins. They've consistently hovered in the 67%-68% range, and we expect that trend to continue throughout the remainder of the fiscal year.
Great. Liz, I want to go back briefly to LTV to CAC for a second. Whether there's room to further reduce OpEx and sort of right level of marketing spend has been a key topic for investors, and for you, that's obviously very much informed by your LTV to CAC targets and what you consider growth that creates economic value over time. You've talked about the two to three times target for LTV to CAC for a while. How quickly do you think Peloton can get there?
Yeah. So I did mention LTV to CAC and that our target is to be in the two to 2x-3x range. The past couple of years, we have trended more in the one to 1.5x range, so we have a lot of work to do to be able to get to our target. And that requires us to work on both the numerator of that equation as well as the denominator. So in terms of the numerator on the LTV front, our primary focus has been on improving our hardware gross margins. I talked a bit about that, making pricing changes as appropriate, reducing promotional activity both in terms of the number of promotions that we are offering as well as the depth of those promotions. Those would have a meaningful impact on our hardware gross margins.
We also, although we do have a very low churn and high subscriber retention, we do see opportunities to improve retention. Primarily, our investments there are around improving engagement, which we believe is strongly linked to retention, and that could extend the LTV of our subscribers as well. Now, if we look at the CAC front, some of the changes that we've made or the cost savings that have been included in our $200 million cost savings plan are intended to improve our CAC. So reducing our spend on brand and creative, reducing our retail showroom footprint, optimizing our international marketing resources, those were all included as part of our $200 million cost savings plan, and we're on track to realize those, and those should reduce our CAC over time, and then I mentioned again that we're being really disciplined with our media spending.
Spending is expected to be down materially year over year, which is intended to ensure that we improve our media efficiency over time, and if you take both of those things together, those two focuses should improve our LTV to CAC ratios over time, and then as we get closer and achieve our goal of that 2x- 3x or close to 3x range, then we can lean into media spending because we know that the incremental growth that we will be driving will be profitable for us.
Interesting, which is a key focus today. Liz, turning to revenue growth, I think it was about a quarter or two ago you talked about approaching inflection for the connected fitness industry in terms of overall connected fitness trends. Could you talk to what you're seeing on the demand side of things and your broad takeaways on growth as your focus kind of turns more to profitable growth, not just growth for the sake of growth?
Sure. So what I'd first like to touch on here is what you're referring to, which is our internal estimates for connected fitness hardware sales leveraging third-party data. So through the end of fiscal 2024, our estimates showed that connected fitness hardware sales in the U.S. were continuing to decline, but that the rate of that decline was decelerating, suggesting that we could be approaching an inflection point. Now, we estimate that we could represent as much as two-thirds of the U.S. connected fitness hardware sales. And so any changes that we are making to our business in order to drive profitable and sustainable growth likely have an impact on the growth trajectory of the connected fitness hardware sales within the overall fitness market.
If you look at our FY2025 guidance, we do expect both our connected fitness subscribers as well as our paid app subscribers to decline year over year in FY2025 while we are still improving our profitability and free cash flow, and so we're remaining focused on the things that we can control and making sure that we are not overspending on media to chase unprofitable growth in the short term. I do think it is worth pointing out, though, that if you take the midpoint of our ending paid connected fitness subscriber guidance for the year, it represents roughly a 30% CAGR compared to fiscal 2019, which is pre-COVID.
What that demonstrates is that even with the surge in demand that we experienced during COVID and the decline in hardware demand that we have seen post that peak, if you look over the long term, Peloton has delivered substantial subscriber growth.
Yeah, no, that makes total sense. Liz, what are some of the levers that you see near term for the business to drive growth? Pricing is one strategy on the connected fitness side of things that we can talk about. But in terms of net subscriber growth over time, how should we think about levers when it comes to maybe the tread opportunity and others? What do you think is the most impactful driver of growth for Peloton over the next two years?
Yeah. So there's a few areas I'd like to touch on there. So number one, you're right, we do see Tread as a major market opportunity for us. As we've said multiple times, we estimate that the home install base for treadmills is more than twice the size of that for the at-home stationary bike, and yet our Tread sales represent a much smaller share of our overall sales. We've been pleased with our Tread sales performance over recent months, and we're actually experiencing extended delivery times for our premium Tread+ product today as our demand has outpaced our available supply.
While we're very pleased with that, that our demand is exceeding our expectations for our most premium-priced product, it is worth noting that Tread+ represents less than 10% of our unit sales and that the majority of our Tread+ sales are to existing members who are choosing to expand their workout options with Peloton by adding a Tread+. Now, as we think about the Tread+, our members, it is a beloved product, both the overall tread category. Our NPS scores are consistently in the 70s, but we do see an opportunity to improve our brand association and connection with running and tread beyond our member base today, and so some of the ways that we are focused on growing awareness is really involving more about walking and running in our media campaigns.
And a great example of a recent marketing activation is our activation that we had at the TCS New York City Marathon, where we had instructors who participated in running the race and also cheering on race participants. And we also had a demo of our Tread+ product available. And we were really pleased with that because it was helping to build a connection between Peloton and running and treads, and we saw some great results from that. Now, we're also looking at improving our member experience with our tread portfolio products, both in terms of the product features as well as content. We recently added pace targets, track visualization. On the content front, we added Walking Bootc amps and New York Road Runners content, which is great. So another area of growth for us is really reaching and targeting new audiences.
Roughly two-thirds of our member base is women today. So obviously, we see an opportunity to improve our targeting and awareness among the male demographic. In Q1, we saw a 9% year-over-year mix shift in our hardware sales towards men, with the greatest shift happening with our Tread and Tread+. Actually, in Q2, if you look at our marketing campaigns, they are a little bit more emphasizing running. We are placing ads in things like NFL games. You may see that if you're watching NFL games over the holiday season. We have an ad that features NFL players and brothers, TJ Watt and JJ Watt. We're seeing that that ad, at least the data that we've seen so far, suggests that it is resonating well with the male demographic.
A third area that is really important for us in terms of growth is software innovation, delivering innovative and engaging fitness experiences. And that is an important critical area of focus for our product development team in terms of long-term growth. Now, one area that I'm excited to talk about there is our Strength + app. Recently, we had talked about our Strength + app being in beta, but just about a week ago, we launched it officially on the Apple App Store. And in the first 48 hours, we had over 130,000 installs of the Strength + product. Now, most of those were to our existing members, which is great. We're offering them additional ways to be able to incorporate Peloton into their fitness routines. But we're also pleased to welcome thousands of new Strength + subscribers to Peloton.
And at least during the first week, we were number one on the Apple App Store in health and fitness category, which is really great. We're also continuing to do a lot of testing and learning. One area that we are exploring is a new gamified fitness experience, which is an alternative workout that's basically more of a social, more of an immersive social and competitive experience. We're also still testing something called personalized plans, which is another way for us to add value to our members. And then the key thing there is that we're focused on phased launching of these products and testing and iterating and learning so that we can evaluate the product-market fit and see what's scaling well before we continue to invest in things like marketing and full-scale launches.
Another area there I'd really like to point out is we recently launched a feature called Private Teams. We do know that members engage socially with each other off of our platform, and through Private Teams, we're trying to make it easier for them to engage socially through our platform. We're going to continue to evolve what Private Teams is over time, but today it includes things like the ability to create a private team with your friends, both members and non-members, to share results with each other, and also to participate in competitive challenges. Now, overall, we are really bullish about growth in terms of the secular trends that we see, the interest in health and wellness, and the value that people are placing on it in their lives, and our goal with all of these is to be able to be well-positioned to capitalize on that trend.
Now, I also do want to point out that we're really looking forward to Peter joining us in January as our new CEO, bringing a breadth of experience in growing and scaling subscription businesses to our growth strategy.
That's wonderful. Liz, you mentioned how members engage with you in different verticals. Can you maybe speak more about those engagement trends, knowing that it's an important driver of churn? And Peloton has had impressive churn since the inception of the company, really.
Yeah. So we are pleased with our engagement levels. We mentioned in our Q1 earnings call that our engagement, as measured in terms of average number of workouts per subscriber per month, was pretty stable in Q1, although well above pre-COVID levels. It's interesting. We recently looked at our engagement a different way in terms of the number of workout minutes per subscriber and per month. And we saw that if you look at it that way, we actually saw a modest increase in engagement in Q1, which indicates that our members are taking longer workouts. Now, we do see seasonality in our engagement. We tend to see higher engagement in the winter season, which makes sense. Our members are working out more indoors during the colder months. And Thanksgiving is actually an important engagement moment for us. We traditionally have had Turkey Burn classes.
This past year, we had over 50,000 members participate in live Turkey Burn classes on our platform, which is great. It was a seamless experience, which is even better. We also, for the first time, added a new strength class to our Turkey Burn class offerings. That was also a record for Peloton. The 50,000 was a record, and so was the fact that we had the largest live strength class that we have ever had in Peloton's history as a result of Turkey Burn.
Wonderful. Liz, I want to talk a little bit about the app and the role of the app in the customer acquisition playbook that you are looking at today. You know the tiered pricing strategy was good at driving app subscribers, but then conversion to connected fitness maybe perhaps was a little bit lower than your expectations. How does the app fit in the overall funnel today, and how do you think about it today?
Yeah. So the app remains an important part of our strategy. It provides a low-friction way to enter Peloton's ecosystem. Subscribers that are trying our app have access to Peloton's offering of 16 modalities through a 30-day free trial, and then after that trial, they can either remain a standalone app subscriber or, over time, upsell it to connected fitness as we sell them hardware. Key thing that I want to point out about the app is that not only is it important to the standalone app users, but it's also important to our connected fitness members as well. Over 50% of our connected fitness members engage with our app on a monthly basis, and so it is really important that our app has great features and functionality because our connected fitness members are using it, and it is an important part of their experience.
Now, we have limited our media spending to drive traffic for app downloads because we are seeing that our LTV to CAC dynamics are just challenged there. But we are optimistic that we will be able to continue to drive gross additions for our app and improve our churn rates as we improve the features and functionality of our app. I do want to go back to Strength+, though, because Strength+ is a new app for us that we did just recently launch. It offers an alternative workout experience to classes, and it is catered more to a gym setting.
And so it offers audio guidance, expert coaching, and actually my favorite part of Strength+ is the custom workout generator that it includes, where you tell it what type of equipment you have access to, what part of your body you want to focus on, how much time you have, and other factors, and it creates a custom workout just for you. And then one last thing to point out about Strength+ is that it does offer us a different type of cost structure because users bring their own music to that experience.
Great. I do want to have some time to talk about the exciting new leadership you have coming on at Peloton. If you could share with us what makes Peter the right candidate, why is he the right person to lead Peloton at this juncture, that would be great.
Yeah. So the board undertook a comprehensive search for Peloton's next CEO, and they chose Peter because he had all of the qualities that the board was looking for. Peter is aligned with Peloton's core values, and he has a breadth of experience across hardware, subscription businesses, software, and services. And he also has a track record of driving growth through innovation. In terms of the values that Peter embodies, he embodies operating with a bias for action, empowering teams of smart creatives, and working collaboratively, which are all things that he has demonstrated through his extensive and impressive experience. And he brings over 20 years of operating experience across hardware services, subscription, and content businesses with leadership roles at Ford, Apple, Time Warner Cable. All of these are large public companies.
Peter also has experience scaling and growing more than a dozen subscription businesses, including some notable ones like Apple iCloud, Time Warner Cable Home Security, and Ford BlueCruise, which is a hands-free highway driving technology. But more importantly, Peter appreciates Peloton. He is an active member, and he is obsessed with fitness and wellness. He's been a Peloton member for eight years, and I'm just really excited to have the opportunity to work with him and learn from him.
Fantastic. One last question we have time for, Liz, and that is New Year's coming up. Outside of new leadership, which is obviously very exciting, are there any other new things coming for the new year that you're excited about, whether it's new product, new market, or what makes you excited about next year?
Yeah. So I got to say, as CFO, one of the things that I am most excited about is that we are now on solid financial footing and that I feel really good about our ability to achieve our bottom-line profitability targets and our free cash flow. But beyond the benefit of positive free cash flow, this is really important operationally for us because it allows us to focus less on tactics to drive short-term sales and more on the meaningful growth and innovation that is going to drive growth in the long and medium term. And that includes some of the things that we talked about today: software innovation, content innovation, and also something we didn't touch on, which is partnerships. One area that I'm excited about is that we are testing a partnership model with Peloton in a gym setting with the YMCA of Greater Chicago.
And what we're seeing there is increased engagement with Peloton at those locations where we now have Peloton Bike+ and Row. And then we're also seeing increased engagement with our App One offering that is offered to all of the adult members in those YMCA locations, 15 locations in Chicago. And while this is just a pilot, some of the insights that we're learning from this could be really helpful for us as we think through a broader strategy for Peloton in the gym over time. Another recent launch for us is we launched our apparel on Nordstrom Marketplace. And beyond the incremental sales that we're benefiting from that, one thing that is interesting about it is that it's still very early days. We just launched it, I think, just about a month ago.
We are seeing a higher mix of apparel sales to men coming from the Nordstrom Marketplace than we see on our first-party site. So I'm really interested to see over time how this new marketplace approach can be a part of our broader apparel strategy over time. I do want to mention two more things really quick. One is software innovation. I know we've talked a lot about it. I do think that is key to Peloton's success over time. And I'm especially excited about some of the things that we are doing to broaden our social engagement because if we get that right, it could really be a meaningful unlock for us in the future. But I just want to close by saying I am really optimistic because I see that the pace of innovation at Peloton is continuing to increase.
All of these new initiatives and things that we're working on, it will be really exciting to see how they come together to accelerate growth for Peloton in the future.
Liz, that's a great note to conclude our discussion. Thank you so much for your time today.
Thank you.
Thanks, everyone, for joining us, and have a great rest of your day.
Thank you.