Ladies and gentlemen, thank you for standing by, and welcome to the Peloton Interactive Q2 2020 earnings call. At this time, all participants are in a listen only mode. After the speaker presentation, there will be a question- and- answer session. To ask a question during the session, you will need to press star one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker, Ms. Alison Brightly, Vice President, Finance. Please go ahead, ma'am.
Good afternoon, and welcome to Peloton's second quarter earnings conference call for our fiscal year ending June 30th, 2020. Joining us on today's call to answer your questions are John Foley, our Co-Founder and CEO, William Lynch, our President, and Jill Woodworth, our CFO. A copy of today's shareholder letter is available on the investor relations section of our website at www.onepeloton.com, has been furnished to the SEC on Form 8-K. Before we begin, I would like to remind you that 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 law. 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 actual results, please refer to our SEC filing and today's shareholder letter, both of which can be found on our 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. With that, I'll turn the call over to John, who will begin with a few opening remarks.
Thank you, Alison. Hi, everyone. Thank you for joining us today. We are excited to share our results for the second quarter. Our results were positively impacted by strong holiday performance across all regions, a lift in conversion from the introduction of Home Trial, which allows prospective members the ability to try our Bike risk-free for 30 days, and some additional drivers Jill will discuss in a moment. Most importantly, our results are due to the great execution of each and every team member at Peloton. I want to give special appreciation and recognition to our dedicated frontline employees during the busy holiday season, including our global showroom and inside sales specialists, member support teams, and field operations delivery teams.
We know that a great member experience starts with a great sales and delivery experience, an important part of our overall Net Promoter Score. Let's jump right into a few highlights from Q2. Q2 ended with over 712,000 Connected Fitness Subscribers, representing 96% year-on-year growth. We now have over 2 million members on our platform. Our Connected Fitness Subscribers worked out with us over 24.3 million times in Q2, averaging 12.6 monthly workouts per Connected Fitness Subscriber, up from 9.7 monthly workouts in the same period a year ago. That means that our Connected Fitness Subscribers are working out 30% more than they did a year ago, getting even more value from their Peloton subscription. In addition, our Connected Fitness Subscribers are taking more and more non-cycling classes, making us incredibly excited about the investments we are making in new fitness verticals and our Digital app.
In Q2, over 30% of the classes taken by our Connected Fitness Subscribers were non-cycling classes. Importantly, our strong member engagement led to a low average net monthly Connected Fitness Subscriber churn of 0.74% in Q2. Lastly, I want to share a few thoughts on the home fitness category and our digital membership. We have strong conviction that consumers will continue to migrate to Connected Fitness experiences that offer better locations, better instructors, time-shifted consumption, and a much broader and better selection of content. We do see other companies entering the Connected Fitness space from several different angles with digital streaming and/or hardware offerings with limited interactivity. But as the pioneer and clear category leader with an undeniable first-mover advantage, we plan to continue to invest smartly in new products, interactive software, and innovative content across every major fitness vertical in order to maintain our lead.
Over time, our number one goal is to make the Peloton experience more accessible to more people across all demographics. As we have discussed before, our long-term goal is to have a better best product portfolio. With high volume scale production, marketing efficiencies, and strong subscriber unit economics, we see an opportunity to pass savings onto the consumer, allowing us to broaden our reach and increase our addressable market. One important aspect of our strategy to maintain leadership in Connected Fitness is to also win in digital-only fitness. In Q2, we made some important changes to Peloton Digital around accessibility, price, and trial. Peloton Digital started as a companion app for our Connected Fitness Subscribers. Access to the app is included in the Connected Fitness Subscription and has been and will continue to be an important driver of engagement and increased value for our Connected Fitness Subscribers.
However, over time, Peloton Digital has become an incredibly powerful lead generation tool for us as well. We see strong organic conversion from digital subscribers to connected fitness product owners as digital members fall in love with the classes, the instructors, and the community. We believe more digital members will lead to the sale of more connected fitness products. We saw a big opportunity to broaden the funnel by lowering our digital subscription to $12.99 per month and extending the free trial period to 30 days. As a reminder, our digital subscription limits access to a single user, while the Connected Fitness Subscription is available to the entire household. Also, given that we already create the content on our app for our Connected Fitness Subscribers, our current philosophy around investment in digital is to run it at breakeven.
At the lower price, we believe we will see lower churn, especially as we continue to improve our content and our software, which will drive better LTV to CAC ratio, allowing us to spend more marketing dollars against Peloton Digital over time, continuing to expand our member base. Our goal is to make Peloton Digital available on every screen in your hand and in your home. We were excited to add both an Amazon Fire TV app and an Apple Watch app to a growing list of immersive capabilities that differentiate the Peloton offering and give our members the best value in fitness. We hope to add several more platforms in the coming quarters. Now I will hand it over to Jill to provide additional information on our Q2 financial results and guidance for the balance of the year. Jill?
Thanks, John. Turning to our financials, revenue for Q2 was $466 million, representing year-over-year growth of 77%. As John noted, our results reflect the conversion uplift from Home Trial, a strong holiday driven by our largest omni-channel marketing program to date, and continued growth in global showrooms. In addition to healthy results for our U.S. Bike business, Tread sales continue to exceed our expectations. From a geographical perspective, we also saw better than expected performance in each of our international markets. We are especially pleased with our entry into Germany, where sales are pacing with our successful U.K. launch in fall of 2018. The introduction of Home Trials drove improved Bike conversion in the quarter, pulling many customers off the fence without having a meaningful impact on our low single-digit return rates.
Looking ahead, we expect the conversion gains of Home Trial to moderate as it becomes less newsworthy and an expected part of our sales experience. During the holiday period, we also ran our largest promotion of the year for both the bike and tread for two weeks ending Cyber Monday. Given that Thanksgiving fell later in the year, the longer promotional period allowed us to better distribute our sales and deliveries to ensure bikes and treads arrived in time for the holidays. Our delivery self-scheduler, investments to scale supply chain and logistics, and seasonal hiring allowed us to achieve much shorter order to delivery times than in previous holiday periods and versus our expectations. This will be an important point in the discussion of our Q3 guidance. Gross margin in Q2 was 42.3%, surpassing our expectations.
Connected fitness gross margin was 40.5%, driven by continued product cost improvements, helped by the Tonic acquisition and better than expected leverage in our logistics platform. These improvements helped offset the expected year-over-year margin decline due to the continued mix shift to Tread, which currently has a lower gross margin than our Bike. Subscription gross margin and subscription contribution margin both showed a significant improvement versus the same period last year at 58% and 64.4% respectively. The strong year-over-year improvement was due to lower content costs for past use and faster leveraging of our fixed costs as we scale our subscriber base. We also saw improvement in streaming costs versus expectations. Given our sales and gross margin performance, we were able to drive strong sales flow through and fixed cost leverage, resulting in an adjusted EBITDA of -$28.4 million and an adjusted EBITDA margin of -6.1%.
Before addressing the balance of the year, I want to discuss our guidance philosophy in light of Q2 results. In providing guidance ranges, our aim is to convey reasonable expectations for our future performance. This quarter, a number of factors led to the outperformance. Stronger than anticipated holiday traffic, increased conversion from Home Trial, lower than anticipated churn, and strong revenue growth, aided by a significant year-over-year narrowing of our order to delivery window. Looking ahead, we believe we have a better understanding of the key sources of forecast variability in our financial model. Specifically, we have a better view into the impact of Home Trial on sales performance and return rates. We also have more clarity on the benefits from our investments in supply chain and logistics.
Lastly, with the heaviest volume months now behind us, we believe our results moving forward will map more closely to our guidance. For Q3, we expect to end the quarter with 843,000-848,000 Connected Fitness Subscribers, representing 85% year-over-year growth at the midpoint of the range. For FY 2020, we are raising our guidance range to 920,000-930,000 ending Connected Fitness Subscribers, representing 81% year-over-year growth at the midpoint of the range. We expect average net monthly Connected Fitness churn to be below 0.95% in Q3 and below 0.95% for the full FY 2020, which reflects recent trends in churn, the lower observed return rates for Home Trial, and higher retention of those rolling off of prepaid Connected Fitness Subscriptions. We expect revenue of $470 million-$480 million for Q3. This represents 50% year-over-year growth at the midpoint.
There are a couple of factors impacting year-over-year revenue and net subscriber growth for Q3 fiscal 2020 that are worth pointing out. First, please recall that we recognize Connected Fitness product revenue at the time of delivery, not at the time of order. Therefore, delivery windows can impact the phasing of our quarterly performance. In Q2 of fiscal 2019, we had a particularly strong holiday, and that outperformance unfortunately caused very long order-to-delivery periods, pushing thousands of deliveries into Q3 fiscal year 2019. Our experience last holiday was the reason why we have been so focused this year on investing in our logistics infrastructure and rolling out our delivery self-scheduler. This past holiday, we shortened order-to-delivery windows by several days versus our expectation. As a result, over 6,000 expected deliveries and subscription activations shifted from Q3 into Q2, representing roughly 5% of Connected Fitness product revenue growth in Q2.
Also in FY 2019, we delivered the vast majority of pre-orders for Tread during the third quarter, creating a challenging revenue comp for Q3 FY 2020. We estimate that these pre-orders for Tread impact revenue growth in Q3 by about 10 percentage points. This had a nominal impact on year-over-year subscriber growth because the majority of these pre-orders went to existing bike owners. When a bike and a Tread go into the same household, we only charge for one Connected Fitness Subscription, which means most of these Tread deliveries didn't result in a new subscriber. For FY 2020, we are raising our guidance on revenue to $1.53 billion-$1.55 billion, representing 68% year-over-year growth at the midpoint. Our gross margin outlook reflects efficiencies in both Connected Fitness and subscription margin.
Our improved Connected Fitness margin guidance includes product cost improvements, which are offsetting the negative margin impact of the mix shift of sales to Tread and international. Subscription Contribution Margin guidance reflects savings and streaming costs and faster leveraging of fixed content production costs. Additionally, we are not assuming any incremental content costs for past use at this time. For gross margin in Q3, we expect overall gross margin of 43%-44%, Connected Fitness gross margin of 41.5%-42.5%, and Subscription Contribution Margin of 60%-61%. For fiscal year 2020, we expect overall gross margin of 43.5%-44.5%, Connected Fitness margin of 41.5%-42.5%, and Subscription Contribution Margin of 61.5%-62.5%. For Q3 2020, we expect adjusted EBITDA in the range of - $35 million to - $25 million, and an adjusted EBITDA margin of - 6.3% at the midpoint of revenue and EBITDA ranges.
For fiscal year 2020, we expect adjusted EBITDA in the range of -$115 million to -$95 million, and an adjusted EBITDA margin of - 6.8% at the midpoint. I will now turn it over to the operator to take your questions.
Thank you. As a reminder, to ask a question, you will need to press star one on your telephone. We ask that you please limit yourself to one question and one follow-up question. You may return to the queue. To withdraw your question, press the hash key. Please stand by while we compile the Q&A roster. Our first question comes from Doug Anmuth with JPMorgan.
Great. Thanks for taking the questions. Just two I wanted to ask. John, first, you talked more about the digital strategy and the price cut late in the quarter, and I understand you want to grow the ecosystem and make the products more accessible. You're also making it easier for your competition to leverage your platform and content. Can you just talk about the trade-offs there, and then also what you're seeing early on with digital since the price cut? Then just secondly, you've teased some significant software updates over the next few months. Can you just talk about the importance of social features w ithin the platform, and also how should we expect those features to extend to digital? Thanks.
Yeah. Digital, we're excited about expanding the top of the funnel, as we said, to $1,299. We haven't seen any of these. Obviously, we've seen some marketing from some of these other pure hardware players trying to take advantage of our content. To the extent that they get any traction, which we haven't seen, and they're becoming Digital Subscribers, we would celebrate that because it is an introduction into our ecosystem, and it's on a dramatically inferior Bike and an inferior experience because you don't get all the interconnectivity and the leaderboard and the community and the big screen and all of the special stuff that creates these really special Peloton experiences. To the extent it allows you to taste the content easily without having to buy the Connected Fitness product in advance.
Let's say you have a spin bike in your basement or you're interested in buying a lower price spin bike that's not interconnected, we're excited about that as an entrée into our universe and exposure to our instructors and our content and all that stuff. We believe that we will continue to see strong conversion from digital members into connected fitness members as we've seen. We're excited about that. That doesn't scare us. One of the things, Doug, to be totally honest, is we want to make sure that if somebody's going to do that, it's with Peloton content. We are servicing that customer who wants to do that with Peloton content, scaling our investment in the studios and the instructors.
We believe that the connected fitness investment and the investment in other devices, as a technology company, we say we are platform agnostic with our content. I think it's a really smart strategy. We're excited. All of the early metrics from our lower priced, our switch to the $1,299 price point and the 30-day free Home Trial, all of the leading indicators across that business are going in the right direction, and we're very confident and bullish on what we're seeing for that. The second thing on social features, we do have a couple really sexy social features in the queue for the connected fitness offering and for digital, for that matter. We have a lot of innovation in software. We have hundreds of the best Python and iOS and Android engineers in New York City, writing code and working with some great product minds.
We're not going to announce them on the call, but they are social. They are going to help protect and moat from a network effect perspective. You think about social software and gamification, all of that, it's a high priority for us because we know our members want it, and it's going to protect us and strengthen the moats for our business.
Great. We'll take the next question.
Yeah.
Thank you. Our next question will come from Heath Terry with Goldman Sachs.
Great. Thanks. I guess, one for Jill. Jill, can you give us a sense of how much you actually saw a financial impact from owning your contract manufacturer, this quarter, how that actually flowed through, the income statement or the cost structure? Then John, as you look at the initial results in some of your international markets with the rollout in Germany as well as a few more months in the U.K., how are you starting to feel about additional markets internationally and sort of the pace of your rollout beyond the U.S., U.K., Germany, and Canada?
Great. Hi, Heath. Very quickly on connected fitness gross margin, that's effectively where you see the majority of the impact from Tonic. Certainly, in the quarter, we were pleased with our Connected Fitness Subscription margin of 40.5%, and our outlook, as well as our performance for the quarter, do reflect some product cost improvements from Tonic. That's really where it hits the most. That being said, we also saw, contributing to our margin for the quarter, we also leveraged our fixed costs of our logistics platform, given our sales outperformance. There's a small amount, a really immaterial amount of G&A associated with other staff that we now need in Taiwan, such as finance and accounting and some other G&A expenses. They're very, very small. We have incorporated those product cost improvements due to our acquisition of Tonic in our go-forward guidance on connected fitness margin.
Hey, Heath, it's William Lynch. On international, we are so far very pleased with the Germany launch. It's notably ahead of our very successful U.K. launch, which is really good news. In terms of those three markets now, U.S., U.K., and Germany, we are in the three largest fitness markets in the world, building a strategic moat. Those three markets are over half of subscription fitness spend, that has us excited as well. If you look at what we're going to do going forward, we're going to focus on the four markets. We're in the three I mentioned, plus Canada, as we're studying other markets to go into. We think we're very early on in the U.K. We think we're early on in the U.S., there's a lot of growth in those four markets.
In answer to your international expansion question, that's the strategy as we look over the next couple quarters.
Great. Thank you.
Next question, please.
Thank you. Our next question comes from Justin Post with Merrill Lynch.
Great. Thank you for taking my question. Maybe one for John and one for Jill. John, a lot of new competition entered over the last six months. Have you seen any impact in your busy months, November, December, and January, on either units or pricing? Any impact there? Does that maybe create a bigger sense of urgency to get a lower price Tread out? Jill, just in the quarter, any commentary you can provide on ASPs, average ASPs year-over-year in the quarter, or what's contemplated in your outlook on Connected Fitness products? Thank you.
Yeah. Good question on competition. We are obviously not surprised that others are coming to realize the Connected Fitness opportunity. We expect more investments on the part of competitors, to be honest. That said, we are confident in our leadership position. We will continue to invest aggressively behind our Connected Fitness products, content, and community. We can talk later on the call about our new Peloton Studios opening. We talked a little about software. We are going to be innovating on hardware. You know about our better, best product strategy across the categories that we're in. We feel good. To answer your direct question, we have not seen any pressures that have impacted our need to change prices or the like. I will say a macro note on competition.
It is my strong feeling that as an innovation company, innovation has been core to what we've been doing for the past seven years, and we plan to continue innovating across hardware, software, and content. Again, like Jill mentioned earlier, with an eye towards affordability and the democratization of fitness, which means affordability for all people. I believe, and it's kind of our ethos, that we believe that if anyone's going to disrupt Peloton, it's going to be Peloton. I know that words are cheap at this point, so we're just going to have to show you through our actions in the coming quarters what we mean on that front.
Great. On the average selling price, just to put it into context, Q2 was lower versus Q1, primarily due to the fact that we run a holiday promotion in Q2, leading up to Cyber Monday. Obviously, as we mentioned earlier this year, it was a two-week promotion. That is really what is driving some sequential decline as well year-over-year. For the balance of the year, we do expect the average selling price per product to be lower. It's driven by a couple of things. Lower penetration of tread. Again, remember, we actually delivered a large number of our pre-ordered treads back in Q3 of last year. Also, we have higher financing penetration than we did a year ago. Also, we do have a slightly higher return reserve associated with Home Trial, albeit it's lower than what we had expected it to be.
As you know, there are so many inputs that go in addition to the ones that I've mentioned, obviously geographical mix, accessory, and warranty attach rates can vary the average selling price. Again, I think what you'll see in our revenue guidance is a slight lowering through the balance of the year.
Thank you.
Next question.
Thank you. Again, ladies and gentlemen, if you have a question at this time, please press the star then one key on your touch tone telephone. Our next question comes from Ron Josey with JMP Securities.
Great. Thank you. Thanks for taking the question. Wanted to ask about, Jill, you talked about supply chain and order delivery windows being lowered by several days in the quarter. delivery self-scheduler helped here. Just can you talk about the other things that helped drive those deliveries better in the quarter? Secondly, on Home Trial, you talked about increased conversion rates and benefits and just a better overall view on the sales and return rates. Just any sort of lessons learned here on Home Trial would be helpful, as I think you mentioned benefits would moderate going forward, and I'm just wondering if that's a change in marketing approach or just the newness of the product. Thank you.
No, great. The first one on supply chain, I'm going to have William chime in, and then I'll take the second one.
Thanks, Jill. Hey, Ron. We were really pleased, as Jill noted, we cut our order to delivery rate to members in half this year from last year, which is a huge win for our members, certainly, but also the team. The way we were able to do this, we now have 31 warehouses spread across the U.S. What that does is it brings bikes and treads closer to customers. Our ops team has done a great job, not only on the warehouse footprint, but also with our trucks and vans and logistics and coordinating forecasts such that we could drive that kind of performance.
That has been investments we've been making over the last 2+ years, and we think set us up really well in the future, and led to a lot of what Jill talked about, which is sort of the shift in what we would traditionally have in Q3 deliveries pulling into Q2.
Let me jump in there, Ron, because it's a great question, and I think it did impact the Q3 guidance this year, which is it's a two-fer. Last year, we were really bad at it took us a long time from the order to delivery. That pushed a lot of sales that were in Q2 into deliveries in Q3, which we recognize revenue when the delivery takes place. Last Q3 was artificially inflated. Jill explained this, I want to make sure that everyone got it. This year, we did the opposite.
Things that we thought might have been pushed into Q3, we pulled into Q2. We sold them in Q2, we delivered them in Q2, which was a win for our members. From a year-on-year comp, as we guided Q3, it just optically looked like a de-sell, which it was not, in essence. I'm glad, Ron, you're digging into that better than our ordered delivery shortening. It's a great question.
Great. Just to go back on Home Trial, obviously another big driver of our Q2 performance in addition to some of the efficiencies that we now have in our logistics and delivery. We were very pleased with the conversion uplift from Home Trial in the quarter and its impact on the performance. We were also extremely excited by the fact that our return rates were lower than forecasted and not really moving the needle on our already very low single-digit return rate. It's exciting because we've been able to break down the purchase barrier of will I use this? Overwhelmingly, our new customers are using their product and keeping it. We're very excited about that. I think in terms of looking forward with Home Trial, I think, yes, it had a great lift in Q2, but it is a program change.
We do think that as it becomes less newsworthy and more expected in terms of the whole consumer sales experience, we do expect that to moderate over time. Certainly in the initial weeks and months, it has pulled a lot of buyers off the fence. Again, very pleased with the performance.
Thank you.
Operator, our next question, please.
Thank you. Our next question comes from Laura Martin with Needham.
Hey, guys. Great numbers. John, one for you. I love this idea of lowering the Digital-only price because I do think it's a clever on-ramp into the ecosystem. My question is, we had a little controversy over some of the TV ads in the fourth quarter. Does this lower the risk as you on-ramp people through the lower-priced Digital tier now, A? B, do you find it has higher conversion rates given the trial of the Digital versus television ads?
Hi, Laura.
Hi.
I'm not totally sure I understand the question. I'm glad you like the digital strategy. I do as well. It's really opening the aperture and getting more people into the ecosystem. I don't know how what you're saying impacted our advertising or it increases the risk.
Lowers the risk.
Lowers.
I mean, yeah. What's the conversion rate, television ads versus digital subscriptions?
Oh, I see. I got you. Well, we are a multi-channel marketer. We do television and digital and out-of-home and direct mail, and digital is an acquisition vehicle. Over time, each one of these things ebbs and flows as the most efficient marketing dollar. In concert with our stores, they all work in a multi-channel marketing efficient cocktail that will ebb and flow. I will tell you, January is the time to market Digital. You've kind of fish while the fish are biting around New Year's resolutions. January will definitely be one of our heaviest months for marketing the Digital app. In the summertime, it won't be as aggressive. It ebbs and flows.
If we can run the digital business at unit economic break even, again, considering that the content effectively coming to that business model is free, then you could see in a world that future Connected Fitness purchasers could have effectively a zero CAC, which is a weird thing to get your brain around. As we learn more about this business in the coming quarters and coming years, that opportunity exists, and it's very exciting to me. We have high hopes. Again, this woman, Karina Kogan, and her team who run digital are incredible leaders and executors. We have high hopes for that. Again, as you know, we get excited about digital as an acorn that could grow into a big oak. Still, the vast majority of our business and the financials are around the Connected Fitness business.
Yeah. These churn numbers are unbelievably low. I've never seen subscription businesses with such low churn numbers. Kudos to you guys for making a great product.
Thank you, Laura.
Thank you.
Thank you.
Next question, please.
Our next question comes from Youssef Squali with SunTrust.
All right. Hi, guys. Two questions for me, please. On the margin, the improved margin leverage, it seems like you guys are kind of barreling towards profitability potentially earlier than we had you or the street has you kind of coming in. Maybe, John, can you just speak to how you look at profitability relative to growth? I know that historically you've talked about growth, but within the context of margins that you had shared with us in the past, seems like the margin profile is changing a bit. Second, this is still for John or maybe William. Maybe can you speak to the difference between both showrooms and the concept store? What's the genesis of the concept store idea? What are you trying to do there that you can't do in the showrooms? Maybe speak to it in terms of costs maybe versus ROI. Thank you.
Great. Hi, it's Jill. I'm actually going to take the first question. Certainly, John chime in. We have said previously that we expect to become adjusted EBITDA profitable by 2023. At this juncture, we are not going to update our view on timing of profitability. I think we've also said in the past as well, that profitability for us is a managed outcome. We continue to see a massive opportunity in front of us. We're prioritizing our subscriber growth over profitability. I think what you're seeing in the business though, is that we have an ability to achieve both growth and profitability. There are many reasons for that. One is that our U.S. bike business is profitable and still growing at a high rate. We believe we have a compelling unit economic model with rapid payback of our sales and marketing.
We also have a high lifetime value, and I think that's underscored by the great low churn that we produced in Q2. Of course, the high margin of that subscription business. Lastly, we do expect a lot of operating leverage in our business over time on all OpEx lines, trying to hold R&D steady, but certainly in G&A and sales and marketing. I think, the way you can think about it is that 2020 will be our trough year from a profitability standpoint, but that's on an adjusted EBITDA margin basis. Obviously with the revised guidance, I know it's been improving over the last couple of quarters. Again, for us at Peloton, we believe we can achieve both growth and profitability over time.
I know I didn't give you a specific stake in the ground, but we're just not prepared at this time to do that.
Hey, Youssef, this is William Lynch. On your showroom question, we are at 96 doors now globally, and we've been building out our retail presence, which we view as a real advantage for us. We think Connected Fitness products are demonstrable. People want to see them, evidenced by our new Tread as a higher penetration of retail sales than Bike, which we think is further evidence of that. We have two, what you called concept stores. One we launched in Cleveland, the other in San Diego. Really the underpinning strategically for that is to show off products beyond the Bike. We use that extra footprint to show off Tread, show off some new class types and offerings. In fact, the fastest-growing part of our catalog, Connected Fitness catalog, we show off Strength, which is up 3x year-on-year. We show off things like Meditation.
We discuss yoga and merchandise around yoga content and products. That's what that additional footprint allows us to do. I would say we're in test mode on those two. We have three formats now in retail. We also have a smaller store. It's about a third of our fleet, called a micro store, which is our highest productivity store. I think it's just further evidence of our sort of strategic advantage in this very valuable category, where we're almost at 100 showrooms now. We're learning a lot, and we can touch the consumer in really interesting ways and different formats.
Awesome. Thank you both.
Operator, next question, please.
Thank you. Our next question comes from Dana Telsey with Telsey Advisory Group.
Good afternoon, everyone. Congratulations on the terrific results. As you think about your reach, and you've obviously added Amazon Fire TV and Apple Watch app, along with the new fitness options like the Total Body Strength program, what are you seeing in terms of expanding engagement, who that customer is, and the ability to expand the community? It certainly seems like you're capturing a customer who's also spending more time in your community. Lastly, on the content cost, what type of leverage do you see on content costs going forward? It seems like those have come down a little bit. Is there more opportunity there? Thank you.
Hey, Dana, it's William. I'll take the first part of your question, then turn it over to Jill. On non-cycling content, overall engagement's up, as John mentioned in his opening remarks. It's up close to 30% year-on-year, which we feel great about. That is our true north. We know that engagement is the leading indicator for retention, I forgot who congratulated us on our low churn, but that is without question, a function of this massive engagement increase. What's driving that is certainly cycling, but non-cycling content's actually the fastest-growing workout types we have. I mentioned that Strength is up 3x year-on-year. Meditation's up 22% year-on-year, if you look December to December in terms of engagement. We're investing heavily beyond cycling content.
We think between that and then opening up these new interfaces, John also mentioned Apple TV, Amazon Fire TV, that's going to continue to drive this engagement more and more. When we say we're just scratching the surface, both in terms of content offered and interfaces and experiences, we mean it.
Real quick clarification, Meditation's up 22x.
X, yeah.
Yeah. I will add that in the next couple of months, we're commissioning Peloton Studios New York, which is going to allow us to proliferate this content even more, with more Strength and more Yoga and more Bootcamp and better cycling. We are investing in content in a way that we're pretty excited about. As Jill's pointed out, a lot of those costs, the CapEx and the OpEx, have been burdening the P&L for over a year. As those things start to come online, I think Jill is going to start to talk about the leverage you're going to see.
Yeah. just to address, hi, Dana.
Hi.
The second part of the question. I want to just go into some of the drivers on our Subscription Contribution Margin. What you're pointing out is that if you look across all of our cost of goods for subscription, about half of them are fixed in nature. John just mentioned the Peloton Studios, New York, and obviously our studio that's going to come online in London. That includes all of our instructors, all the people that work inside the studios, and production. All of those fixed costs will be leveraged over time because we only need those two production facilities over the next several years to continue to grow our member base. We're going to see a lot of fixed cost leverage for about 50% or so of our cost base today.
The other half is really variable costs that include mostly music, streaming costs, and merchant fees, which we are not baking in at this juncture, any improvement in those over time. Although I will say in Q2 of this year, we did see some streaming cost efficiencies through a contract renegotiation, which we've carried through for the balance of the year in our guidance for Subscription Contribution Margin. The last thing I would say is that I do think, what you saw in Q2, we did see a nice jump in our Subscription Contribution Margin at 64.4%. For the full year fiscal 2020, our expectation around Subscription Contribution Margin is 61.5%-62.5%. We did see a benefit in Q2 as well, in that we were able to push some of our hiring needs for our new studio in New York into Q3.
We do expect that Q2 number of 64.4%, we won't see that type of jump in subscription margin. We still feel very good about our long-term target of 70%+ over time.
Thank you.
We'll take the next question, please.
Thank you. Our next question comes from Eric Sheridan with UBS.
Thanks for taking the question. Going back to the commentary in the letter on the Germany launch. Obviously, there's some language differential between Germany versus the U.K. Is there any way to call out some of the investments that might be pressuring margins from launching a market like Germany until it gets to a breakeven point or a point where the initial incremental investments to just put a baseline of sort of physical and digital infrastructure in place to launch the market might act as a headwind to cost and how that might compare to what the launch costs were like in a market like the U.K. over a year ago? Thanks so much.
Eric, I'll take that. It's William Lynch. Well, the two biggest sort of buckets of investment are really around sales and marketing. I'm sure you've looked at our operating expenses. We make significant investments there. When we launch a market like Germany or the U.K., we don't apply the same kind of CAC. We look at CAC, but we think about it differently, which is trying to get awareness and build demand for our service in that market. While in the U.S., which we've said repeatedly, our U.S. core bike business is profitable, we continue to see efficiency in CAC, and it's been a big driver of this great business model and allowed us to funnel investments into these growth planks like geographic expansion, like Tread.
We think about that equation differently in Germany, from a sales and marketing standpoint and still the U.K., where we want to build demand, we want to get leadership. We're tracking awareness. Over time, we will look at that CAC equation, and we do, but we expect to see those efficiencies. The other piece of it is on the content side. Again, it goes back to kind of leveraging the investments we've made. We've got the two studios. John mentioned the new studio launch in New York. Within a year, we'll have a Peloton Studios London, but we're able to broadcast content. Our German language classes are out of that London studio, we're able to provide global content, including U.S. instructors, U.K. instructors, and German instructors out of two facilities. It leverages a lot of that fixed cost over time.
Sure, early on, what you're seeing definitely through the P&L and in CapEx is investments in marketing, logistics, and content.
Great. Thank you.
Next question.
Thank you. Our next question comes from John Blackledge with Cowen.
Great. Thanks. On margins, the current Bike and Tread have different gross margin profiles. How should we think about the gross margin profile for lower priced upcoming Connected Fitness products? Second question on engagement. The rising workout frequency seemed to drive lower churn than we were expecting. Just any further color on engagement by cohort tenure, i.e. are the newer subs engaging at different rates than older cohorts? Thank you.
Great. I'll take the first question. Certainly as we introduce new products, we naturally will be faced with a higher cost structure until we can achieve the quantities that allow us to take our cost down. That said, I think we've talked about this a lot before. We're very focused on gross margin dollars, not margin. We've talked about it in the past with bike and tread. We care about the dollars that we can use from that connected fitness margin to offset our sales and marketing expenses, so that from a unit economic perspective, we're sort of paid back day one. Yes, as we launch new products over time, we will expect some temporary imbalance, where the margin may not be able to cover all of those marketing expenses.
In the long run, and as a portfolio of products over time, we do believe we can keep these unit economics intact to be profitable day one. If you look at the outlook that we've provided, in terms of just going back through that Net Customer Acquisition Cost, again, which is total sales and marketing spend, less gross margin dollars, that figure for Q2 was $4, based on the midpoint of our guidance range for Q3 in fiscal year 2020. Essentially for both periods, at the guidance midpoint, it's $1. Again, we're continuing to smartly reinvest our sales and marketing dollars off of the back of that Connected Fitness gross profit margin.
On your engagement question, we were, as Jill noted, pleasantly surprised. Obviously, our retention's incredibly high, but we were even surprised by the improvements. It is true that it's improved across every cohort. If you look at retention and engagement, it's actually steady, all those gains you're seeing across our older members and then the newest members. In fact, notably, what has us excited is the newest members, as we dial in more content, as we're getting better at marketing and cross-marketing that content in the onboarding process, are working out, in month one and month two, three, four, five, six, more than members we onboarded three and four years ago. It's just all goodness across the board, and it's really something we look at and focus on.
Thank you.
Next question please.
Thank you. Our next question comes from Edward Yruma with KeyBanc Capital Markets.
Hey, guys. Thanks for taking the questions. I guess first, I know you had some favorable resolution on litigation against Flywheel. Just trying to understand broadly the implications of it and maybe how it points to the defensibility of your tech platform. Secondly, obviously when you changed credit, I think you were able to really capture a wider demographic. How have the demographics been with Home Trial, and are they allowing you to catch an even broader group of consumers? Thank you.
Ed, how are you doing? This is John. I will take the Flywheel one. There is not a ton we can say because it is still loosely in the legal world. As you heard our GC talk about this week, in his quote, "We're very excited to have registered a massive win in our fight to protect Peloton's intellectual property. This result reinforces the strength of our patent portfolio." I think that kind of speaks for itself and why we're excited about the settlement. I would personally add that we're happy to have it resolved, as you can imagine. That's all I can say at this time, Ed, sorry.
On the demographics of our new buyers, we haven't updated that since our last call. Just a reminder for everyone, it's true our trends have been our new members are younger and less affluent. Certainly to your point, financing, Home Trial, the things we're doing, the more retail stores in more areas, that's all helping for us to penetrate SAM, which again, has us excited about the future.
Great. Thanks so much.
Next question.
Thank you. Our next question comes from James Hardiman with Wedbush Securities.
Hey, good afternoon. Thanks for fitting me in. I wanted to circle back to the Digital subscription. Obviously, not that much time has passed since the price was lowered. I was hoping you could give us a little bit of color, sort of before versus after that price reduction. I guess, A, have you seen an acceleration in new Digital subs since it was lowered? B, have you seen churn rates come down as a result of that? Lastly here, obviously the gap between the Connected Fitness Subscription and the Digital subscription is now wider. Is there any evidence that there's been some cannibalization there and that some Connected Fitness Subscribers have seen the lower price and decided to switch?
James, I'll take a little bit of this, and these guys can jump in. Thank you for your coverage. We watched a nice interview of you on CNBC, I think. Appreciate your interest in our business.
Thank you.
I'll take the last question first, which is, has anyone downgraded from a Connected Fitness Subscription to a Digital Subscription? We checked with our member experience team. In the last couple of months, we've seen, you can count on one hand the number of people that we've tracked that have made that trade. I was actually surprised by that. No meaningful headwind on that front. One thing with the Digital business I have to point out is that with this 30-day free trial, everyone who got on board with the free trial in December, didn't have the chance to become a subscriber until after the quarter closed. The number that you see is artificial. From the quarter close, last week, for instance, was by far our biggest net sub adds in the Digital business, the biggest week in history, coming out of the excitement of that trial.
It'll be interesting to see this quarter how we do. We're optimistic. Again, all of the metrics are moving in the right direction. It's early to say the impact on LTV, because that's going to play out in the coming quarters, as we see what it looks like. These people just became subscribers, so we don't have any data yet on how long they're going to last. I apologize.
That's helpful. Thank you.
The only other thing I might just add on that point is just to make sure that the terms of service are one member for each digital subscription versus our Connected Fitness, which is a household membership that can have multiple members using the product. We currently average about two members per Connected Fitness sub. For that $39, they're getting a lot of value.
All right, everybody. Sounds like we're wrapping up. I'll give a quick closing. I do want to thank the entire Peloton team, as I did. We believe we've got one of the strongest teams in consumer tech. We're very proud of the culture that we are building and all the people who have contributed to these Q2 results. Thank you all for your hard work. Thank you for any of the members that are listening. We love you. You know that. You are our true north. We do everything for you. I know some of you analysts, buy side, sell side, are also Peloton Bike Ed, I'm talking to you, Bike owners or Tread owners in Digital, Heath, you as well. I guess all of you are excited. Thank you for your business as members. Thank you for being a part of our community.
I also want to thank all of you investors that are on the call who believe in us. We will continue to work hard in your honor. I think we will continue to put points on the board like we did in Q2, and I'm confident that we will not disappoint you. Anyway, have a great rest of your week. Thanks everybody for dialing in.
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.