Good day, and welcome to Peloton's first quarter 2027 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 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, press star 11 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker, Mr. James Marsh, Treasurer and Head of Investor Relations. Please go ahead.
Thank you, operator. Good morning, and welcome to Peloton's first quarter fiscal year 2027 conference call. Joining today's call are Peloton CEO Peter Stern and CFO Sid Thacker. Our comments and responses to your questions reflect management's views as of today only and will include forward-looking statements related to our business 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. Please refer to our SEC filings, today's press release, and our earnings presentation, all of which can be found on our investor relations website, for a discussion of the material risks and other important factors that could impact our results. During this call, we will discuss both GAAP and non-GAAP financial measures.
A reconciliation of GAAP to non-GAAP financial measures and definitions for our user metrics are also provided in today's press release. I'll turn it over to Peter.
Thank you, James, and congratulations on becoming our Treasurer in addition to Head of IR. Good morning, everyone. We kicked off fiscal year 2027 by delivering Q1 results ahead of expectations, fully deleveraging our balance sheet as measured by net debt, and debuting a new Tread lineup engineered for every runner, walker, and hiker. These achievements demonstrate our progress on our ongoing financial and strategic transformation and position us to continue expanding Peloton's footprint across a broader swath of the multi-trillion dollar global wellness economy. In previous calls, I've intimated about our innovation pipeline, and in Q1, we put hard proof behind those words. In late September, we introduced Tread Flex, our first-ever folding Tread, which was designed from the ground up to solve the two biggest barriers to purchase, price and space.
We also launched the Peloton Tread Vision and Tread+ Vision as part of our revamped Tread portfolio. All three new Treads have met with acclaim from consumers and press. At the same time, we also brought the Peloton Commercial Series Bike and Tread to market and rolled out the next evolution of our AI-powered operating system, Peloton IQ. In Q1, we exceeded the midpoint of guidance on revenue, marking our third consecutive quarter of year-over-year revenue growth, aided by the price changes we implemented last year. While we don't forecast revenue growth to remain linear for the balance of FY 2027 once we lap those changes, we're encouraged by this progress. We also reached the top end of our guidance for subscriptions and substantially outperformed in gross margin and Adjusted EBITDA. Our transformation continues to be guided by four strategic imperatives. First, improve member outcomes. Second, meet members everywhere.
Third, make members for life. And fourth, business excellence. We continue to make significant progress across all four. First, to improve member outcomes, we focus on human impact, elevating our members' cardio fitness, strength, longevity, and happiness. When we help members achieve their goals, we prove our value and build stronger relationships. Product innovation is central to delivering these outcomes, and we are entering the FY 2027 holiday season with the best lineup of products in the history of Peloton, featuring major advances in hardware, software, and affordability. Our revamped Tread portfolio with Tread Flex, Peloton Tread Vision, and Peloton Tread+ Vision has emboldened us to set the goal of becoming as famous for running as we are for cycling. Alongside our hardware innovations, we introduced new Peloton IQ capabilities that deliver more advanced personalized guidance to help our members achieve their goals.
These updates, which became available to members on October 1st, include Run Analysis, which analyzes running form to help members run safer and faster, IQ Pace Targets, which constantly adjust personalized target speed ranges based on a member's running performance, and ReRuns, which allow members to recreate their favorite outdoor routes on any Peloton Tread. By deepening our commitment to running, walking, and hiking, modalities that are seeing strong momentum both in culture and on our platform, we aim to engage broader audiences, expand our share of home treadmill sales, and better empower members to attain their fitness and wellness goals. We also expanded our wearable and connected app integrations to include Whoop and Google Gemini, in addition to existing integrations with Apple, Garmin, and Fitbit, enabling even more members to seamlessly sync their metrics with Peloton IQ.
By integrating the devices our members already wear every day, we can deliver more personalized guidance that puts Peloton at the center of their daily wellness routines. As you've heard me say before, our ambition extends far beyond cardio. With our revamped Tread portfolio rolled out in North America and our other markets set to follow in the spring, we are now turning our attention to launching products in new categories beyond bike and Tread. By combining premium hardware in an expanding array of categories with personalized software and the world's best human instruction, we're building a connected wellness ecosystem designed to support our members across every aspect of their health span.
We plan to launch hardware in a new category in the fall of 2027, which we believe will meaningfully expand our TAM, and together with other initiatives we are discussing today, puts the company on track for sustained revenue growth in the future. Moving to meet members everywhere, our second strategic pillar, we took big steps to expand our cultural presence and extend Peloton's reach beyond the home. To generate excitement around our newly launched Tread lineup, we introduced the next chapter of our Let Yourself Go brand platform. Let Yourself Run is a multi-channel marketing campaign featuring global superstar and Peloton super fan, Miley, alongside the debut of her latest studio album. Marketing messaging generated a more than 100% surge in demos at our first-party retail stores and a measurable uptick in our share of voice.
Turning to our Commercial Business Unit, B2B continues to be a growth engine for the company. In Q1, the CBU delivered double-digit growth with a 13% year-over-year revenue increase. We recently made our new Peloton Commercial Series equipment available for sale, marking a critical step in Peloton's expansion beyond the home. Early interest has exceeded our initial expectations, and we are already in trials and advanced conversations with leading global gym operators and premium hospitality partners. We look forward to sharing more on our progress here soon. Additionally, we have expanded our physical retail presence ahead of the holiday season by opening 10 new Peloton micro-store locations since the beginning of FY 2027, bringing our total to 19 stores across the U.S., nearly double our fleet from this time last year.
Our micro-stores continue to provide an efficient first-party retail channel, both on a unit sales per square foot basis and by driving a higher mix of premium SKUs. In addition to our micro-stores, we also launched a number of Fitness Factory locations, our first Canada-specific retail partner. Our Members for Life pillar focuses on strengthening subscription retention. Loyalty to Peloton is correlated with engagement, which is driven by our world-class instructors who continually refresh our content and keep members motivated and inspired. We continue to see healthy engagement from our subscription base and achieved year-over-year growth in average monthly workouts per subscription. We are also seeing more variety in engagement from our members, with strength offerings increasing share and Pilates workouts, in particular, growing by 53% year-over-year in Q1.
We know that engagement with multiple modalities is correlated with better retention, not to mention longer lifespan and health span, and our instructors' ability to guide members into new modalities continues to be essential to this momentum. Our business continues to benefit from low churn. In Q1, our churn rate of 1.7% showed significantly improved trends versus Q4 2026, and we finished at the high end of our guidance range for paid connected fitness subscriptions. Sid will speak to this in more depth shortly. Last, on our strategy of business excellence, we continue to improve the financial health of our business and instill financial discipline across our operations. This includes our implementation of AI. By embedding AI across our operations, we are innovating faster and at lower cost.
In FY 2024, we spent over $300 million on R&D, which declined to roughly $240 million in FY 2026 and an even lower run rate in FY 2027, yet our pace and scope of innovation have increased dramatically. Another example in the category of business excellence is diversification of our supply chain. With this quarter's new product lineup, we have diversified hardware equipment suppliers, which will help us ensure continuity of supply and manage our costs, as evidenced by our ability to launch a Treadmill at $1,000 less than our prior base model. Finally, I want to provide you with a quick update on our capital structure and our goals of lowering our cost of capital and gaining more flexibility. We have significantly improved our credit profile since our last refinancing in May of 2024.
That credit profile was further enhanced by our voluntary debt paydown of $280 million subsequent to quarter end, on top of a roughly $200 million note repayment at maturity in February, cumulatively lowering our gross debt by a third, or approximately half a billion dollars in calendar 2026. Given recent volatility in the debt markets, we are being opportunistic and disciplined to optimize our cost of debt and flexibility. As we look ahead, I continue to be filled with confidence and optimism about Peloton's future. Our multi-year innovation roadmap is robust, our commercial business is opening vital new touchpoints with new audiences, and our brand remains unmatched in its ability to inspire members every day. We have the right strategy and the right team, positive forward momentum with encouraging results, and I'm excited about what's ahead.
Speaking of the right team, I'll now pass it over to Sid to share more details about the quarter.
Thanks, Peter, and good morning, everyone. Last quarter, I highlighted our recurring subscription business, the opportunity in our commercial business unit, and our product pipeline as foundations for building a stronger Peloton. Our Q1 performance provides solid evidence of our progress on all three. We delivered our third consecutive quarter of year-over-year revenue growth, expanded gross profit, and generated strong free cash flow. That provides us the ability to both invest in our future and strengthen our balance sheet. Our focus is to do this in a disciplined way so we maximize shareholder value. Diving into our Q1 financial results, we ended the quarter with 2.475 million ending paid connected fitness subscriptions, at the high end of our guidance range. Q1 net churn was 1.7%, an increase of 11 basis points year-over-year, compared with a 37 basis points year-over-year increase in Q4.
Last quarter, we discussed the one-time factors that we believe accounted for roughly 50% of the year-over-year degradation in churn. I am pleased to report that we saw both a normalization of those one-time factors along with improving underlying churn. As a reminder, Q1 of fiscal year 2027 will be the last quarter that we compare against the period prior to our October 2025 subscription price increase. Our churn trajectory this quarter gives us confidence in our expectation of flat full-year churn for fiscal year 2027 versus fiscal year 2026, and highlights the best-in-class engagement and retention profile of our loyal member base. Total revenue was $559 million in Q1, an increase of $8 million or 2% year-over-year, and $4 million above the midpoint of our guidance range. Total gross profit was $343 million in Q1, an increase of $59 million, or 21% year-over-year.
Total gross margin was 61.3%, an increase of 975 basis points year-over-year, and 430 basis points above our guidance of approximately 57%. Total gross margin benefited from tariff favorability on Peloton and Precor products, as well as lower recall costs compared with last year and versus our expectations. Please refer to the investor presentation for the segment-level breakdown for total revenue and total gross margin. Total adjusted operating expenses, which exclude restructuring and impairment expenses, were $226 million in Q1, a decrease of $4 million or 2% year-over-year. This included lower G&A and R&D expenses, primarily driven by lower payroll and stock-based compensation, partially offset by higher sales and marketing expenses. We increased acquisition and brand marketing spend for our Tread launch campaign, which began in earnest during the last 10 days of the quarter prior to October 1 on sale day.
We remain focused on managing dilution through a disciplined approach to equity compensation, which includes changes in our program design and tying more SBC to financial performance. Our stock-based compensation expense was $40 million and decreased $7 million or 16% year-over-year in Q1. This represents the lowest stock-based compensation we have had in many years. Adjusted EBITDA was $168 million in Q1, or approximately 30% of revenue, an increase of $50 million or 42% year-over-year, and $23 million above the high end of our guidance range. Outperformance relative to guidance was primarily driven by tariff favorability and lower-than-expected recall-related costs. Excluding these non-recurring factors, adjusted EBITDA would have been $143 million, or $3 million above the midpoint of guidance. As a reminder, Q1 of last year had a $13.5 million non-recurring charge for seat post inventory.
Q1 free cash flow was $143 million, or 26% of revenue, which reflects an increase of $76 million, or 113% year-over-year. The year-over-year improvement reflects the year-over-year growth in adjusted EBITDA, paired with timing benefits associated with net working capital. Turning to our balance sheet, we ended the quarter with $1.34 billion of cash and equivalents, an increase of $136 million from the prior quarter last year. We ended the quarter with cash and equivalents exceeding our total debt. on October 9th, we made a $280 million voluntary prepayment on our term loan using cash on hand, reducing our existing term loan to around $700 million. Our strong balance sheet, significant cash generation, and confidence in our innovation pipeline allows us to reduce gross leverage while continuing to invest in the business and drive shareholder value. Let me provide an update on our refinancing efforts.
At this point, we have completed meetings with the rating agencies and investors and received positive feedback. Given the volatility in credit markets since late August, we are being methodical about our approach to any future refinancing. Our results this quarter, combined with strong free cash flow, further strengthen our operating and financial profile with the credit markets. We have no near-term debt maturities, a net cash balance sheet, and we will take steps to ensure that this process results in the best possible outcome for the business. Next, I would like to share context for our financial outlook. Our full year fiscal 2027 total revenue outlook of $2.3 billion-$2.4 billion remains unchanged from last quarter, reflecting a decrease of approximately 4% year-over-year at the midpoint. As we discussed last quarter, our revenue comparisons reflect the impact of last year's subscription price increase.
Those pricing changes provided a year-over-year tailwind in Q1, and we begin lapping them midway through Q2. Our Q2 total revenue outlook of $625 million-$650 million reflects a decrease of approximately 3% year-over-year at the midpoint and an increase of approximately 14% quarter-over-quarter. As in prior years, Q2 is a seasonally strong quarter for equipment sales, reflecting holiday demand and the lead-in to the new year. Our revenue guidance reflects a blend of optimism regarding the positive feedback from our refreshed Tread lineup, balanced by uncertainty over what will transpire during a quarter that is heavily back-weighted towards Black Friday, Cyber Monday, and winter holiday sales. We are maintaining our full year fiscal 2027 total gross margin outlook of approximately 54%, an increase of 140 basis points year-over-year, primarily driven by higher connected fitness gross margins and including the tariff and recall-related favorability this quarter.
Q2 total gross margin is expected to be approximately 50%. The sequential change versus Q1 reflects a seasonally higher mix of connected fitness product revenue and comparison with a quarter that benefited from non-recurring items. Our full fiscal year 2027 Adjusted EBITDA guidance range of $475 million-$525 million is also unchanged, reflecting an increase of approximately 7% year-over-year at the midpoint. This outlook reflects continued cost discipline as well as the benefit of lapping non-recurring costs incurred last year. For Q2, we expect Adjusted EBITDA of $85 million-$100 million, an increase of 14% year-over-year at the midpoint. The sequential change from Q1 reflects seasonally higher marketing investments and the comparison with Q1's tariffs and other favorabilities. Our Q2 guidance for ending paid connected fitness subscriptions of 2.425 million-2.445 million reflects a decrease of approximately 8.5% year-over-year at the midpoint.
As we lap last year's subscription price increase, we expect year-over-year net churn to improve meaningfully in Q2 and subsequently increase year-over-year in Q3 due to an unpause benefit we observed in Q3 last year following elevated pauses in Q2 from pricing changes. Overall, we continue to expect net churn to be roughly flat year-over-year for full year fiscal 2027. Generating meaningful free cash flow remains a priority. We are maintaining our full year fiscal 2027 minimum free cash flow target of at least $350 million, consistent with the approach we have taken in prior years. We are focused on converting earnings into cash and maintaining the flexibility to invest in long-term growth. We are strengthening Peloton's financial foundation and setting the stage for a return to sustained growth. In the meantime, we remain focused on generating cash, investing with discipline, and delivering value for our shareholders.
I'll now turn it over to James, who will kick off the Q&A with questions from our retail investors.
Thanks, Sid. We'll answer a question from retail now. Travis in Denver, leaderboard name Trav Russell, asks the following question: "Peloton continues to mature in existing markets. Significant international growth opportunities remain untapped. What are the primary barriers to entering these markets, and how do you envision international expansion contributing to long-term growth?" Peter, do you want to handle that one?
Sure. Thanks, Travis, for the question. I don't actually believe we are mature in our existing markets. We recently ran a survey in the countries where we currently operate. We're in six of them right now with Peloton-branded products. We heard from people who are interested, willing, and able to pay for the products that we offer today and the products that we have in our roadmap over the next couple of years. The results of that survey suggested that there are about 45 million people in the countries we operate in that are interested in Peloton products. So, that represents substantial growth opportunities still available to us.
We feel, at least in the five countries outside the U.S. where we operate, that we've achieved strong product market fit because our subscriptions in those markets display retention and engagement behaviors that are similar to those that we have in the U.S. In a lot of countries outside the six where we operate with Peloton-branded products, people live in smaller homes that are closer to urban centers, and the population that's able and willing to invest in home fitness equipment is proportionally smaller. However, there are plenty of people in those countries that want to get fit and they're willing to invest in themselves. It's just more likely to happen in the context of a gym or a studio setting. So, our focus right now is on using our commercial business unit to drive the growth of Peloton-branded product expansion outside our six countries.
Precor already serves more than 80,000 facilities. They are across 60 countries versus six. They already have a powerful distribution network. When we look at the capabilities of that Precor distribution system with the new Peloton Commercial Series that just went on sale, we think we have got some real opportunity to penetrate gyms, studios, hospitality, and other vertical markets like multiple dwelling units, as we seed the ground for further Peloton expansion in the future.
Great. Thanks, Peter. Can we open it up to questions, please?
Thank you. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, press star 11 again. Due to time restraints, we ask that you please limit yourself to one question and one follow-up question. Please stand by while we compile the Q&A roster. Our first question will come from the line of Youssef Squali with Truist. Your line is open.
Great. Thank you so much, and congrats on the ongoing turnaround, guys. Peter, can you maybe just address how the lower price and new Tread Flex that you have just introduced and other upcoming products that are coming down the pike, and I think you kind of referred to a new vertical in your prepared remarks, are potentially expanding the TAM for Peloton, maybe make it easier to compete, particularly in these times where maybe the consumer may be a little more cost-conscious? Then, talk to us also about the opportunity around the commercial business units and especially the sustainability of those double-digit growth rate that you just put up for the first quarter. Thank you so much.
Absolutely. Thanks, Youssef. So, affordability certainly seems to be in the air this week as an important theme. We are very excited about the fact that with the launch of Tread Flex and the revamping of our entire Tread portfolio with Peloton Tread Vision and Peloton Tread+ Vision, we now have a good, better, best model, and a much more effective differentiation across the products in terms of things like price, foldability with Tread Flex that allows us to serve people who live in smaller homes, with the use of computer vision now on the Peloton Tread Vision, with not just the benefit of a flat belt Tread on the Peloton Tread+ Vision, but also Sled Mode. All of these things are allowing walkers, runners, and hikers the optionality to pick the best product at the right price point for them.
It should go without saying that us having a product now that is skirting the $2,000 price point in the Treadmill category puts us really right in the sweet spot of the market for high-quality Treads. So, that certainly opens up our TAM in the Tread market, which is a large market with still continued growth. We expect our sales of Treadmills to be materially higher in a world where we have full good, better, best lineup than one where we did not. Now, looking ahead at TAM, I am not going to reveal the products specifically today. That will wait for an appropriate consumer moment.
But I did share that the first of them will launch in the fall of 2027, and we are targeting areas where there is tremendous consumer interest and momentum, and where we believe there is a real hole in the market for what Peloton has to offer, which is integrated experience of premium equipment, state-of-the-art software powered by AI, human instruction, and our unique ability to bring together a community that keeps people feeling committed and accountable. So, that will also significantly increase our TAM. Now, focusing on the commercial business, that is one where there is still tremendous TAM available to us. We believe that even with the strong growth that we have demonstrated, we still have only roughly 4% market share in the commercial space.
We are benefiting, we think, from the dual brand portfolio that we have created that ranges from mass market offerings to premium segment offerings, through the combination of Precor and now the new Peloton Commercial Series. On the Precor side, we are just in the early stages of reinvesting in the product, in our sales capabilities, in introducing things like financing that we think will continue to power the growth of that part of our commercial services. We are still actually getting relatively limited contribution from the Peloton-branded side of the equation, given that the Commercial Series just went on sale and we are still in early conversations and trials with gym operators. That being said, the interest, the initial feedback we are getting is really encouraging. So, we view that as a potential turbocharger to the Commercial Business Unit.
Awesome. Thanks, Peter.
Thank you. One moment for our next question. That will come from the line of Sandra Pinzow with Wolfe Research. Your line is open.
Hi, this is Shweta at Wolfe. Thanks for taking my questions. Let me try two, please. For the new Tread line, how should we be thinking about the contribution of new products that is accounted for in your full-year guide, especially as we head into seasonally strong quarters? The second question I had was on your refinancing. It sounds like your conversations have been positive with the environment. You are vigilant of the environment. Is it fair to think that perhaps you will take it as it comes as the environment eases up, and there is no expectation of coming to a refinancing deal by year-end or anything like that, sort of market-dependent? Is that how we should think about it? Thank you.
Thanks, Shweta. This is Peter. Why don't I take the first part of the question about Tread Flex, and then Sid will cover the refinancing. I will note that it is still very early in a critical quarter for us. I would call this the first inning, given that we still have Black Friday, Cyber Monday, the December holiday period all ahead of us. But we do expect both Tread Flex, and in the context of our completely revamped Tread lineup, to have a positive impact on both our revenue and our subscriptions. All of this is factored into our guidance. As I said earlier in response to Youssef, for Q2 specifically, what I can say right now is we are really pleased with the press reception, the customer reviews of the revamped treadmills. All of those things lead us to feel optimistic.
But given that it's early, I think we should hold out on providing more detail on our performance until this quarter is complete and we roll around to our Q2 earnings. Sid?
Great. Hi, Shweta. This is Sid. Let me talk about the refinancing. When we set out to do the refinancing, there were four primary goals. The first was we needed to complete the inaugural ratings process. The second, we wanted to deleverage our balance sheet. The third is we wanted to lower our cost of capital. And fourth, we wanted to provide increasing flexibility for capital deployments to improve shareholder value, but we also wanted to do that while maintaining a strong balance sheet. So, let's talk about what we've done. We've completed the ratings process and the investor meetings, and we're quite pleased with the feedback. Given, as you've seen in Q1, and our strong balance sheet, we've paid down about $280 million of our term loan in October. So we've brought that down from just about $1 billion to about $700 million.
Having said that, the last two months have been very volatile in the credit markets. There have been very few opportunistic issuances. And as you know, we have a very strong balance sheet. We have no upcoming maturities. We have cash that exceeds debt. And so, I think our strong Q1 results further improve our position, our operational and financial profile with the credit markets. I think the message is we'll be patient, we'll be methodical in our approach, and we're confident we'll get the best outcome for the business and for shareholders.
Okay. Thank you both.
Thank you. One moment for our next question. That will come from the line of Arpine Kocharyan with UBS. Your line is open.
Hi, good morning. Thank you for taking my question, and apologies, I am hopping between calls today. It is very possible you addressed some of this in your prepared remarks, but I was hoping you could dive maybe a little bit deeper into what you are seeing in underlying subscriber trends after the Tread introduction. How is new product lineup kind of helping you target new subscribers versus anchoring the subscriber you already have, because they are less likely to churn if they now have both a Bike and a Tread, obviously? Ultimately, I am really just curious to hear how much closer does this bring you toward more stabilized net sub adds? I am going to have a quick follow-up.
Sure, Arpine. Why don't I take this first part of your question before the follow-up? As I said earlier, it is still early in the quarter with regards to our equipment sales, and the big moments still lie ahead. That being said, we are encouraged, as I said earlier, about the reviews that we received on the product. I will also note that our Tread products tend to sell more to a mix of both existing and new members. Either way, we win. When we sell a Treadmill to an existing member, we know that the likelihood of churn from that member drops precipitously as they have reinvested or really retaken their vows with Peloton.
With regard to the non-members who have been purchasing our Treadmills, we have been very pleased to date to see that the rate of subscription sign-up on those Treadmill sales has been on par with the rate of subscription sign-up from non-members who take our Bikes. So, the actual mix of new versus existing subscribers really needs time to play itself out, especially because we began the quarter by extending our most generous promotional pricing to our existing members as a way of showing our appreciation to them for their loyalty. So that will play out over the course of the quarter, but we feel good either way.
Now, to your broader point about to what extent treadmills will address the shortfall between our gross adds and our churn, what I would say is that treadmills represent essentially a down payment on the work that we are doing in both existing categories this year and in new categories starting next year to close that gap. We are very pleased by the trajectory where we see the rate of decline in gross adds continuing to improve, and as you can see in our quarterly results, the rate of our churn trajectory improving significantly quarter-over-quarter, implying that we will be down in churn on both a rate basis and certainly an absolute basis over the remainder of the year. Eventually, if those trends continue, the lines do cross, and our challenge as a company and as a management team is to accelerate the timeline at which those lines cross.
That is excellent. Thank you. Very, very helpful. In terms of capital allocation, I wanted to You are in a net cash position today, which is a really great position to be in in the current environment. How are you thinking about reinvesting back into the business to drive subs versus kind of inorganic growth opportunities, and how you balance that against returning cash to shareholders?
Yeah, sure. This is Sid. I think, look, what do we want to do? We want to maintain a really strong balance sheet, we want to deploy excess capital to increase shareholder value, and we want to invest to grow the business. Given, as you pointed out, our very strong balance sheet and the substantial cash generation that we generate, we can do all three. Let me just talk about cash first. We do not need a significant amount of cash to operate the business under normal circumstances. Our subscription business provides a very steady stream of cash every month. We are also very efficient in how we fund our inventory.
In thinking about a cash balance, we think about debt maturities, so we have obviously our convertible notes, and we want to make sure that we have enough liquidity to operate prudently and to manage the business under a variety of scenarios. That still leaves us with excess cash that can be deployed to create shareholder value. Speaking of shareholder value, we believe very strongly in the value of our existing member base, as well as in the potential for the best-in-class innovation pipeline that Peter mentioned to drive sustainable growth in shareholder value. We are also sensitive to dilution, so we are going to think about those things as we think about capital deployment and return of capital to shareholders. I think we will work with the board to assess capital deployment. Any decision we make is going to be made in the best interest of shareholders.
We're going to assess the expected returns, risks, and we're going to do all of this while maintaining a very strong balance sheet.
Thank you very much.
For your next question, please.
That will One moment, please. That will come from the line of Doug Anmuth with JPMorgan. Your line is open.
Hey, this is Danny Flynn on for Doug. On the first question on Peloton IQ, can you maybe talk about how members are interacting with your AI-driven tools and what impact you are seeing in terms of engagement and retention? On the second one, on connected fitness gross margins, can you unpack the drivers of the material year-over-year and quarter-over-quarter step-up in 1Q, and any color you could provide on cadence going forward? Thanks.
Thanks, Danny. This is Peter. Why don't I cover your questions on Peloton IQ, and then I will pass to Sid to talk about gross margins. I am actually really pleased to say that we now have, in the month of September, over 1 million of our monthly active users engaged with Peloton IQ, and that can be everything from interacting with the insights that we provide them to taking classes from the personalized plans that we develop with Peloton IQ or engaging with things like our computer vision-based movement tracker. What I love about Peloton IQ is it is an example of an application of AI that is just an unalloyed good. We use Peloton IQ to know our members, to develop personalized plans for the members, and then to customize the workout. There are a lot of companies that can actually develop a personalized plan.
You could go in right now to Claude or to ChatGPT and give it a bunch of information about yourself and ask it to personalize a workout, but no one can customize the workout in the ways that we can. Take something like the IQ Pace Targets that we just announced, which modify your workout based on the things that we know about you, and they change that workout on the equipment. That is a unique capability using AI that only Peloton can bring to our members. The consequence of that is that it has become a key feature of interest from prospective customers, as well as a real driver of differentiation across our product lineup, giving people a reason to step up into our Plus line and now into the Peloton Tread Vision product that includes computer vision. Sid, why don't you talk about gross margin?
Sure, Peter. If you look at Q1 connected fitness gross margins of about 33%, just about 33%, that was obviously a very significant improvement from the 6.9% gross margins we reported in last year's Q1. What we outlined in the prepared remarks in the release is we had a substantial amount of tariff and recall-related favorability. When you back out that roughly $25 million of favorability between recalls and tariff favorability, we end up with a margin just about 17% on the connected fitness side. That is still up substantially from the 6.9% last year. Bear in mind, last year we also had about $13.5 million of recall costs.
Even if you were to normalize both years and have an apples-to-apples comparison, you will still see that our connected fitness gross margins were healthy and up year-over-year as we mixed into higher-margin products. I think going forward, we've obviously provided our Q2 gross margin guidance of 50%, and I think the only thing to keep in mind there is in last year's Q2, we had a particularly favorable gross margin in actually the subscription business. We had about a $10 million favorability on music royalties that was non-recurring. I think that's the only thing to keep in mind. But in general, we're pretty pleased with where gross margins are overall and certainly on the connected fitness side.
Great. Thanks. Operator, could we take another question, please?
Yep. One moment for our next question, and that will come from the line of Simeon Siegel with Guggenheim Securities. Your line is open.
Great. Thanks. Hey, everyone. Morning. Peter, I'm sorry, it's a big earnings day, so if you already answered this question, just let me know and I'll go back to the transcript so you don't have to repeat it. But could you elaborate on the work you guys have done around Tread opportunity? I'm just curious, contrasting with the past. Do you think the primary issue was price and that'll be the fix? Because I'm curious how you isolated the difference now versus earlier when the company entered market, probably at the height of Peloton popularity. Then thinking through your expectations for Tread sales, any color on how you're thinking about how many are new members versus more of a retention vehicle for existing? Then Sid, also, sorry if I missed this, does the full year gross margin guidance include the Q1 non-recurring benefits? Thank you.
Hey, Simeon. We covered a little bit of this earlier, but no worries. Let me try to cover the parts of your question that we have not yet addressed, and then I'll pass to Sid to sort of bring us home on the question about guidance. When we laid out our Tread roadmap, we tried to go back to the real foundational question, which is, what's most important to consumers around treadmill? It turns out there are different segments of consumers who had different needs. In particular, we identified a very large group of consumers who would love to buy a Peloton Treadmill, but they were constrained due to some combination of affordability, space, and in some cases, even things like noise, the sound of the product. For example, people who live in apartments where they're close to a neighbor.
We very specifically designed Tread Flex from the ground up to address all of those issues, and we're excited to have introduced a product that is really a no-compromises product that addresses all three of those issues with a price point that's approaching $2,000, with foldability that reduces it to really quite a small space, and it looks great folded up, and it's super quiet. I think we've assessed it as something like 70 decibels, even when you're really cranking on that thing. That definitely opens up a big part of the market that was simply unaddressable for Peloton, especially because we have not had any kind of refurbished business around Treads like we've had in the Bike category, where we were able to redeploy inventory that had been returned to us for a variety of reasons at much lower prices.
At the same time, though, we also identified a demand from other segments of the market for things feedback, that people were actually saying, "I need a coach. I'd love to learn how to become a better runner, and I trust Peloton to do that, but I need you to do that and make it really intuitive." Our ability to bring the computer vision feature to Tread Vision, we think, enabled us to offer a product that is simply unavailable from anyone else in the market. Then, of course, our Tread+ Vision has always been a screaming deal, honestly, in this flat belt Tread market, and delivers unprecedented energy return. But what we saw in the market there was tremendous interest in HYROX. When you look at the HYROX modalities, one of them, which is the Sled Push, is really hard to train for at home.
That requires very specialized equipment with a lot of space in a home gym that most people simply aren't going to have. We realized we could actually integrate Sled Mode into Tread+ and play into another segment of the market, and we were actually able to make that backward compatible to every Peloton Tread+ we've ever offered. All of that basically adds up to why we feel optimistic about our Tread sales. We think we're going to attract lots of new members, but we also think it's a reason for existing Peloton members to take the leap, if they've, for example, only had a Bike, and get into the Treadmill space with us. Sid, you want to cover the other part of the question?
Yeah, thanks, Simeon and Sid. The short answer to your question is, yes, it does include the favorability we saw in Q1. I mean, just taking a step back, when we actually set full-year guidance, we sort of were aware of the potential tariff favorability and recall-related favorability. I think that we incorporated that into our full-year guidance. We just didn't know when we were going to get it, so it wasn't incorporated exclusively into our Q1 guidance. It is all part of the guidance for the full year.
Perfect. Thanks, guys. Sounds great. Hope you and your families have a happy holiday season.
Thank you.
Thanks, Simeon. Operator, we have time for one last question.
Thank you. Just one moment, please. That will come from the line of Nathan Feather with Morgan Stanley. Your line is open.
Hey, everyone. Thanks for taking the question. Two, if I may. First, just interested to hear on the new Peloton Commercial Series, what has been the early receptivity to that? From a client mix, where are you getting the most incremental traction, and how should we think about the ramp and consideration cycle for that product? On the flip side, Sid, just interested to hear, as you have had a little more time with the business, do you see any additional opportunities for cost reduction or greater efficiency that you circle above and beyond where you first started? Thank you.
Nathan, could you repeat the second question? We got the first one about the Commercial Series, activity there, consideration period, et cetera, but we missed the second part.
Yeah, on the second, just if you have any incremental areas for cost reduction or greater efficiencies that you have seen since you have come into the business, Sid.
Great. Thanks.
Hey, Nathan. Again, I will take the first part of your question on the Commercial Series, and then we will pass to Sid to talk about costs. We are still in the relatively early stages, but have met with even better than anticipated interest from commercial clients. We are actually seeing, interestingly, a very broad spread in the types of clients that are interested in purchasing the Peloton Commercial Series.
Everything from the HVLP gym segments, or the high-value, low-price gym operators, are seeing the Peloton Commercial Series as a way for them to attract new members who might not have Peloton equipment at home, but would love to be able to have that experience in a shared gym environment, to very high-end club operators that know that they appeal to, for example, travelers and other consumers who have Peloton equipment at home, and have been longstanding Peloton equipment customers, but want to be able to enjoy those experiences in the club setting. The beauty of Peloton is, it is such a recognizable brand. It democratizes fitness and makes it accessible to so many people that we are seeing the initial traction coming from really across the board.
As you noted, the consideration period on commercial equipment sales is typically longer, and one of the things that we see with fundamentally new equipment that actually comes with a subscription attached to it, which is new to a commercial environment, is a desire to, in many cases, start with a trial and then progress to a full rollout. The stage we are at right now is building those trials with many gym operators. But again, feedback has been nothing but positive on that product, or on both products, the Peloton Commercial Series Bike and Tread.
Okay. Great, Nathan. This is Sid. Let me just address your question on costs. I think if you look at our guidance for the full year for gross margin and Adjusted EBITDA, you can infer from that that we are going to have lower costs year-over-year. Part of that is the carry-through impact of the reductions we had last year. But I think the broader point is, we are in investment mode, but we're doing that in a really balanced way. I mean, just take Q1, for example, right? We had $14 million lower R&D, G&A expense. We had $10 million in higher sales and marketing expenses we decided to fund and get behind the Tread launch. So costs were still down about $4 million year-over-year.
We cut costs throughout last year, so I think the roughly $14 million in R&D, G&A quarterly run rate will decline. Then obviously in Q4, just as a modeling note, last year we had our legal accrual, so you should take that into account. But the main message is, we are, within the context of these cost reductions, have been funding this innovation pipeline that Peter has talked about. We're working through it. We already are incurring costs related to that and have been for a while, but we have been disciplined about how we manage the business to incorporate all of those costs in the results we're producing. So I think there will be some. We're going to be targeted about costs going forward, and it is our intention to focus on things and keep investing in things that truly differentiate us.
So we want to invest in content, we want to invest in development and R&D, and all of the great things we do to delight customers.
Very helpful. Thank you.
Thank you. I would now like to turn the call back over to Mr. Stern for any closing remarks.
I just want to share that we are getting an early start on giving thanks this year. Leading up to our regularly scheduled Turkey Burn, which takes place over Thanksgiving, we have launched our first member gratitude season to celebrate our community through loyalty rewards, in-person studio moments, partners, and more. Personally, I am enjoying collecting double Club Peloton points as I close in on my 500th run. Additionally, we recently released a ride that was truly out of this world. It is a first-of-its-kind 20-minute ride led by Robin Arzón, featuring special guest Dr. Jessica Meir, who rode with Robin via satellite from the International Space Station. It is incredibly inspiring, and I think everyone should take this class. I look forward to seeing you all on the leaderboard and wish everyone a happy holiday season. Take care.
This concludes today's program. Thank you all for participating. You may now disconnect.