Peloton Interactive, Inc. — Fiscal 2023 Second-Quarter 10-Q Summary
Reporting period: Three and six months ended December 31, 2022; filed February 1, 2023. Peloton operates an interactive fitness platform offering Connected Fitness Products, including Bike, Bike+, Tread, Tread+, Guide and Row, together with recurring subscription services. The company reported 6.7 million Members and 3.03 million Connected Fitness Subscriptions at quarter-end.
Financial Results and Liquidity
| Metric | Three months ended Dec. 31, 2022 | Year-over-year change | Six months ended Dec. 31, 2022 |
|---|---|---|---|
| Total revenue | $792.7 million | Down 30.1% | $1,409.2 million |
| Connected Fitness Products revenue | $381.4 million | Down 52.1% | $585.6 million |
| Subscription revenue | $411.3 million | Up 21.8% | $823.6 million |
| Gross profit | $235.0 million | Down 16.3% | $452.2 million |
| Net loss | $335.4 million | Improved from $439.4 million | $743.9 million |
| Adjusted EBITDA | $(122.4) million | Improved from $(266.5) million | $(155.1) million |
| Net cash used in operating activities | $(88.5) million | Improved from $(446.6) million | $(291.3) million |
| Free cash flow | $(94.4) million | Improved from $(546.7) million | $(340.7) million |
Margins: Consolidated gross margin was approximately 29.6% in the quarter and 32.1% for the six-month period, compared with approximately 24.8% and 28.1%, respectively, in the prior-year periods. Connected Fitness Products gross margin declined to negative 11.2% in the quarter and negative 16.8% for six months, versus 6.5% and 8.6%. Subscription gross margin was 67.6% in the quarter and 66.9% for six months. Subscription Contribution Margin was 72.1% and 71.7%, respectively.
Balance sheet and liquidity: Cash and cash equivalents were $871.0 million at December 31, 2022, down from $1.254 billion at June 30, 2022. Cash, cash equivalents and restricted cash totaled $951.9 million. Inventories, net, declined to $790.6 million from $1.1045 billion, but included $258.9 million of reserves. Total assets were $3.301 billion and stockholders’ equity was $30.5 million, compared with $592.9 million at June 30, 2022.
Debt: The company had $1.0 billion principal amount of 0% convertible senior notes due February 2026, carried at $985.7 million net, and a $750.0 million term loan carried at $697.9 million net. Total borrowings under the credit agreement were $746.3 million after a $3.8 million principal repayment. No revolving facility borrowings were outstanding. The term loan’s effective interest rate increased to 13.7% on November 25, 2022. Peloton was in compliance with its debt covenants at quarter-end.
Material Changes Versus the Prior Comparable Period
- Product revenue fell sharply because deliveries normalized after pandemic-driven demand, with fewer Bike, Tread and accessory deliveries. Promotional pricing, inventory reserves and higher logistics costs pushed Connected Fitness Products gross margin into negative territory.
- Subscription revenue grew from higher subscription volumes and the All-Access price increase from $39 to $44 per month effective June 1, 2022. Average net monthly Connected Fitness churn increased to approximately 1.1% from 0.8%.
- Sales and marketing expense declined 37.8% in the quarter, primarily due to lower advertising and marketing spending. General and administrative expense fell 22.5%, and research and development expense fell 19.8%.
- Operating results included $49.0 million of restructuring expense, $9.7 million of impairment expense and $17.9 million of supplier settlements in the quarter. Six-month charges were $155.9 million, $72.6 million and $19.1 million, respectively.
- Stock-based compensation increased to $81.6 million in the quarter and $263.7 million for six months, compared with $71.9 million and $124.8 million in the prior-year periods.
- The company adopted ASU 2020-06 effective July 1, 2022, reducing additional paid-in capital by $160.1 million, increasing the carrying value of the convertible notes by approximately $119.6 million and reducing accumulated deficit by $40.6 million.
- Cash burn improved substantially year over year, aided by a $316.4 million reduction in inventory and lower capital expenditures, although operating cash flow remained negative.
Outlook, Commentary, Risks and Unusual Items
Management stated that near-term demand and operating performance remain difficult to forecast following significant changes in consumer demand and supply conditions after the pandemic. The company believes in the long-term Connected Fitness opportunity but is recalibrating its operations and cost structure.
The restructuring plan includes exiting owned manufacturing, expanding the relationship with Taiwanese manufacturer Rexon Industrial, transitioning North American field operations to third parties, reducing member-support roles and retail showrooms, and eliminating approximately 500 global positions. The plan is expected to be substantially completed by the end of fiscal 2024. Management estimates approximately $35 million of additional cash charges and approximately $25 million of additional non-cash charges, primarily impairment and stock-based compensation, in fiscal 2023 and beyond.
Peloton launched and began delivering the Row in the United States during the quarter and planned to make Tread available in Australia in February 2023. Management stated that existing cash balances and operating cash flow are expected to fund working capital and capital expenditure needs for at least the next 12 months, but additional financing could be required if liquidity becomes insufficient.
The Tread+ recall remains a significant contingency. The full-refund period was extended to November 6, 2023, and the company held a $44.5 million recall-related return reserve at December 31, 2022. Recall-to-date reductions to Connected Fitness Products revenue totaled $166.9 million. In January 2023, Peloton agreed to pay a $19.1 million CPSC civil penalty. DOJ, DHS and SEC investigations, securities and derivative litigation, personal injury claims and patent litigation remain relevant risks. The filing states that many potential losses cannot currently be estimated, and reserves have not been established except where indicated.
As of December 31, 2022, the company disclosed material weaknesses in internal control over financial reporting related to inventory controls and controls over fair-value measurements, impairment analysis and restructuring assessments. Management concluded that the financial statements were fairly presented but that disclosure controls were not effective because of these weaknesses.
Investor Verification Items
- Verify the pace and cost of the restructuring plan, including the remaining approximately $35 million of estimated cash charges and $25 million of estimated non-cash charges.
- Monitor cash burn, inventory reserves, product gross margin and the company’s ability to achieve positive operating cash flow without additional financing.
- Assess the refinancing and repayment risks associated with the $1.0 billion convertible notes, the high-cost term loan and applicable liquidity and revenue covenants.
- Track Tread+ refund activity, recall-related costs, the $44.5 million reserve and the potential effect of the CPSC, DOJ, DHS and SEC matters.
- Evaluate whether subscription growth and retention can offset continuing weakness in Connected Fitness Products sales and negative product gross margins.
- Review remediation of the disclosed material weaknesses, particularly inventory valuation and impairment-testing controls.