Peloton Interactive Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 4, 2023

There are 12 speakers on the call.

Operator

Good day, and welcome to the Peloton Interactive Third Quarter 2023 Earnings Call. At this time, all participants are in a listen only mode. After a few brief opening remarks, we will be immediately going into our Q and A session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker, Peter Stapler, Head of Investor Relations.

Operator

Please go ahead, sir.

Speaker 1

Thank you, Sherry. Good morning, and welcome to Peloton's fiscal 3rd quarter conference call. Joining today's Call are CEO, Barry McCarthy and CFO, Liz Covington. 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.

Speaker 1

For a discussion of the material risks and other important factors that could impact our actual results, please refer to our SEC filings and today's shareholder letter, both of which can be found on our Investor Relations 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. I'll now turn the call over to the operator for our first question.

Operator

Thank you. One moment for our first question. And that will come from the line of Doug Anmuth with JP P. Morgan, your line is

Speaker 1

open. Thanks so

Speaker 2

much for taking the questions.

Speaker 3

I just wanted to ask,

Speaker 2

Barrett, you could talk more about the upcoming changes in brand positioning and just a little bit more about what you think is misunderstood Around the brand, the products and how people use them and how those changes in brand positioning can help drive growth going forward. And then Also perhaps Liz, if you could just talk about the potential, I know that the DISH settlement will weigh on free cash flow in 4Q. Can you just update us on your past deposit of free cash flow ex that settlement? Thank you.

Speaker 1

Good morning, Doug. Thanks everybody for making time to join us this morning. I'm not going to say too much about the brand Repositioning, I want everybody to experience it along with the consumers at the same time. In the letter, I spoke about the fact that we're primarily known as a bike company, But the behaviors of our members extend well beyond that, into many different categories of exercise and a large percentage of folks There's no hardware at all. We haven't done a very good job of communicating that to prospective members, And we're looking to improve upon that.

Speaker 1

I think the advertising can be more inclusive Than it has been historically. And then lastly, of course, we have been promising to reintroduce the app That moment is soon to be upon us and that will receive considerable focus And marketing relaunch as well.

Speaker 4

And Doug, to address your question about free cash flow, As Barry mentioned in the shareholder letter, the DISH settlement and related expenses associated with that settlement will put pressure on our free cash flow in Q4. So if you exclude those items, we actually are pretty close, but we're then striking distance of achieving free cash flow breakeven. And we are very the progress that we've made It's very positive, continues to be positive.

Operator

Thank you. One moment for our next question. And that will come from the line of Ron Josey with Citi. Your line is open.

Speaker 3

Great. Thanks for taking the question. Barry, I wanted to ask about SaaS and Peloton and PCR, given both I think accounted for about 3 quarter of new subs this quarter. So talk to us a little bit more just how these products are going, how you're going to market with these products and how they're being differentiated relative to the full membership. Understood There's nuances in between.

Speaker 3

And then Liz, I think this quarter guidance calls for a little bit of a decline in subs, just a seasonally slower quarter. We would love to hear more insights in terms of what you're seeing there as well. Thank you very much.

Speaker 1

That's the take on guidance piece and I'll talk about that and And the refurbished spikes, from a marketing perspective, We're doing nothing to basically in support of those products. So people are finding them on their own. In some instances, there's a banner across the top of the homepage, which skeers you towards 1 or the other. For the most part, you have to discover fast by clicking down a couple of layers On the web. So think of it mostly as organic pull through.

Speaker 1

But do you want to talk about the guidance piece?

Speaker 4

Sure. Yes. So, Ron, you alluded to the fact that we are guiding down on Connected Fitness subs for Q4. A few comments on that. So the Q4 is seasonally our toughest or rather our least efficient quarter for us to grow subscribers.

Speaker 4

Even with our best in class retention, we need a base level of growth additions to offset our churn, which while still quite low also tends to be seasonally highest in Q4. It's also important to understand that we are committed to growing our subscribers efficiently. And while we have As we expect to target a lower LTV to CAC ratio in Q4 than we did in Q3, our Q3 LTV to CAC was actually above a 2. Our forecast assumes that we will maintain a strong financial discipline and we will not overspend either via media spending or by cutting prices We're slashing them to acquire unprofitable subscribers. I also want to point out that we do have some uncertainties in our Q4 guidance.

Speaker 4

As Barry mentioned, we're in the letter and as we've talked about already on the call, we are relaunching the brand to better communicate our value proposition And we do expect that to widen our TAM over time. And we're also reintroducing the app. And we don't know the impact that these launches are going to have on We're cautiously optimistic about that, but we have not baked any of that optimism into our guidance forecast for the quarter.

Speaker 1

And when you speak about efficiency, you're talking about the long term value to CAC ratio.

Speaker 4

Yes, LTV to CAC ratio. Exactly.

Operator

Thank you. One moment for our next question. That will come from the line of Justin Post with Bank of America. Your line is open.

Speaker 1

Great. Maybe one for Liz and one for Barry. First on Liz, when you think about the app pricing and the tiering, how do you protect the connected fitness price, But also offer a very robust app that people can use on other devices. How do we think about that? And then Barry, maybe a big picture question, Added about 120,000 subs this year.

Speaker 1

I know there's a lot of macro and competitive headwinds and execution with the new team. How do you think about the right rate of growth for the company on subs as you look past this year? Was this an unusually challenging year and you're optimistic? Or It's just kind of the new baseline. How do we think about sub growth from here?

Speaker 1

Thank you. Do you want

Speaker 4

me to take the first part of the question first? Sure. So Justin, we're not sharing today any details about our new app tiers and the pricing associated with them. But the way to think about it is that they aren't all going to offer the same offering to consumers. So, For example, what we offer for Connected Fitness is all of our content on our hardware, along with access to the app, Kind of get everything, it's All Access.

Speaker 4

The different app tiers will have different amounts of content experiences available to you at different price So that's how we're protecting the All Access membership in that regard.

Speaker 1

Let me talk about the current environment and then try to share with you how I think about the new baseline, What some of the vectors for growth would be? It's been a super challenging year. I think since we walked in the door in restructurings and revaluations and Write down something like $1,700,000,000 And so there's been a tremendous amount of effort Invested in, let's say, restructuring the business, rebuilding the lead team, the rest of it. And as a leadership team, we are still finding our rhythm building relationships with trust, all the soft tissue relationships That make teams great. That only happened with over time.

Speaker 1

And so if we manage that process well, we will execute faster And the business will perform better with the passage of time. At least that's been my observation in my previous company. There are a couple of aspects vectors of growth. There are a couple of aspects of the business that we have been in the process of And we are only just beginning to see glimmers of the benefits Some of the efforts that we've invested. I'm thinking particularly about the commercial and corporate wellness business.

Speaker 1

We're starting to see some good momentum there. We're starting to see some good momentum in 3P And we're knows we have a lot of learning to do to become a good partner in a B2B relationship. But that's showing signs of life. International, I think, will provide opportunities for growth For us, also we introduced new hardware platforms this past year. Let's take the row by example.

Speaker 1

Still only has a 4% unaided Brand awareness guide is at 1%. The app is at 5%. I think we have opportunities to improve all of those significantly. But let's take the app by way of example, even before we Invested in making it better. The net promoter score is 20% higher Then our next highest rated product, which is Bike Plus, which has been quite successful for us, but only 5 Percent of people even know it exists, which makes it 10 times lower than bike.

Speaker 1

So there's lots of opportunity for us to lean into that. And we'll have a full year of ROE. At some point in our future, I anticipate we'll have a second treadmill product. That was 2 years ago roughly that we withdrew TripAdvisor from the marketplace. We don't control the timing on that, but we We have invested a lot in our relationship With the government, and that relationship has dramatically improved since Tammy and her team have Investing time in that with our engineering team.

Speaker 1

So I think that will be a vector for growth. So new platforms, New businesses, commercial, international, of course, we have new marketing leadership and We'll be leaning in aggressively to support them as they grow the business. And then lastly, I'm saying Connor and her team have really, I think, shown signs of Great progress for us in turning around our accessories and our apparel business. I think the apparel business in particular can be significantly more meaningful That it has been. And I'm excited about some of the initiatives that she's pursuing that we haven't discussed publicly that will unlock some growth opportunities there.

Speaker 1

So Sorry to be so long winded, but that's kind of how I'm thinking about the new baseline and the vectors growth.

Operator

Thank you. One moment for our next question. And that will come from the line of Edward Yruma with Piper Sandler. Your line is open.

Speaker 5

Hey, good morning. Thanks for taking the question. I guess first one Broader question. I know you guys called out Amazon as being a success story. I wanted to understand if you had any more context behind the remainder of 3P, particularly Physical retail like a dick.

Speaker 5

And then just a clarifying point on the relaunched app. Will Connected Fitness Devices have the option for a more a la carte subscription option? Or is that to remain the all Option or is that to remain the All Access membership? Thank you.

Speaker 1

It will remain All Access membership. I'm not This is DuPont.

Speaker 4

Yes, sure. I think the way to think about this is it's still very much a new partnership, A new relationship for us. Recall that we only launched that partnership back in November. So we've only got a couple of quarters under our belt with VIC. And as Barry commented, It's also about us learning how to be a good wholesale partner to a retail business that is more traditional brick and mortar.

Speaker 4

That's not where our business has come from. We've been mostly web centric in how we sell and how we deliver to our consumers. So we're still working through with Dick How to be a good partner to them and how to leverage their channel so that we can both be even more successful.

Operator

Thank you. One moment for our next question. That will come from the line of Eric Sheridan with Goldman Sachs. Your line is open.

Speaker 6

Thanks so much for taking the questions. First, you talked a lot about the commercial opportunity via the hospitality industry 3 in the letter and you've obviously got the Hilton partnership. Can we talk a little bit about what you think that means in terms of a driver for either The connected fitness subscriber funnel and or bringing additional people into the digital app that maybe would Utilize your hardware in a more nomadic sort of business travel type sense through partnerships like that. Just want to understand how you think about that as a stimulant to multiple different Parts of the business. And then in terms of the guidance you gave on quarter forward, wanted to understand a little bit of some of the puts and takes in the gross margin Guidance so we could better understand how some of the headwinds and tailwinds might evolve not just in Q4, but as we roll forward into the next fiscal year?

Speaker 6

Thanks so much.

Speaker 1

I don't have I'll talk about the funnel and hospitality and ask Liz to talk about The gross margin puts some calls in the guidance. Really, I don't have too much to say about hospitality, Jeff. It's been A fruitful source of consumer demand for us. Enormously productive historically. We'd anticipate that that will continue on a go forward basis.

Speaker 1

And So we like the hospitality business for two reasons. 1, it's profitable in its own right and 2, it's a good source of Future growth for us, because as you say, it helps to lead the funnel.

Speaker 4

I'll take the question about puts and takes for our Q4 margin. So first, just to remind you that our Overall gross margin is actually expected to go up quarter over quarter to 41% versus the 36% that we had in Q3. And the main driver of that is the shift Towards subscription revenue from hardware revenue because we do expect our hardware sales to be lower in Q4 versus Q3. Our guidance does assume some Effective pressure on Connected Fitness gross margins versus is a seasonally weaker quarter for Connected Fitness Hardware sales. We're also expecting some weaker sales and margin outlook Pre core as we continue to revamp that business.

Speaker 4

And then we do have about 200 basis points of impact to overall gross margin included in our guidance from anticipated one time items that mainly impact the Connected Fitness segment.

Operator

Thank you. One moment for our next question. And that will come from the line of Anisha Sherman with Bernstein, your line is open.

Speaker 7

Thank you and nice quarter. My question is about OpEx. So about a year ago, You were talking about or maybe your predecessors were talking about $2,000,000,000 in OpEx being the kind of watermark. You're tracking towards that at this point, and you've brought down the cost base Quite significantly on an underlying basis.

Speaker 4

Are you at the tail end of the OpEx improvement in cost cutting stage? Are you looking at this as kind of

Speaker 7

being the steady state level? Or are you looking for more improvement in the next year or so?

Speaker 4

Yes. Yes. So going back To the restructuring plan that we outlined about a year ago, we don't have a perfect apples to apples comparison to that because we had a number of additional actions that have been taken since we set those targets. But if you actually exclude restructuring, impairments, reserves and settlements, our OpEx is down over 550 $1,000,000 on a trailing 12 month basis as of Q3. If you can note, that does include the 4th quarter, which still had fairly elevated OpEx mainly in G and A and sales and marketing.

Speaker 4

On the COGS side, we've had significant volume based dependencies when it comes to determining the cost savings there. And while our volume has come down, we've continued to make significant progress in optimizing our cost of goods sold over the past year. Our cost structure now reflects the impact of the restructuring actions that we took to outsource our last mile delivery, exit our own manufacturing and really effectively shift our high fixed cost business model to a much more variable cost model. From a cost structure perspective, we are in much better shape. We do see some further opportunity to optimize cost of goods sold, particularly in the middle mile, and we're going to be working on that over the coming quarters.

Speaker 4

With regard to OpEx overall, we have made great progress. We're not finished and we're going to continue to optimize, but the big step function improvements are likely not to happen. It's going to be more about identifying improvements as we go, things like reducing our professional services spend, addressing our tech debt, which should drive some efficiencies. There may be some efficiencies in member support. We're going to continue to look at lowering our real estate costs over time.

Speaker 4

So those are some of the areas where you'll continue to see further optimizations over the coming quarters.

Speaker 1

I would add that.

Speaker 4

Thank you.

Speaker 1

On a go forward basis, I think there's opportunity for us to take the several categories Where there are tens of 1,000,000 of dollars of savings to be had as opposed to 100 of 1,000,000 of dollars of savings. So, the things related to IT infrastructure and Liz mentioned middle mile and This past year, we had a lot of suppliers payments by way of settling out Inventory commitments and things that are now in the after this quarter will be in the completely in the rearview mirror for us.

Speaker 4

Thank you so much. And if I

Speaker 7

can ask a quick follow-up for Liz, on your comment about Q4, can you reconcile your comments about seasonality and Lower subs versus your guidance of only a modest increase in churn. Is it just about expecting lower gross adds?

Speaker 4

So, seasonally, it's both, right? So, it's lower gross additions in the quarter expected because of the lower efficiency to go out and acquire them in the quarter, as well as a seasonal uptick in churn that we see pretty we've seen every year?

Speaker 1

If we were to relax The constraint we've imposed on marketing spending, if we were to relax the free cash flow goal that we've set for ourselves, We could absolutely grow faster. We're not prepared to make that trade off At the moment, and so it is kind of what it is.

Speaker 4

The focus is on I'm sorry, I was going to say the focus is on LTV to CAC And making sure that while we're willing to go lower than we were at in Q3, it has to be relatively efficient.

Speaker 1

1st priority is free cash flow, 2nd priority is growth.

Operator

Thank you. One moment for our next question. That will come from the line of Shweta Khajuria with Evercore ISI. Your line is open.

Speaker 8

Thanks a lot for taking my questions. Liz, could you please remind us what promotions you ran in the quarter and what your expectations That's for the upcoming quarter and for maybe upcoming quarters. And then and in addition to maybe perhaps talking about just the overall Demand environment. And then the other follow-up question I have is on free cash flow. So excluding The settlement costs, you are striking distance from breakeven.

Speaker 8

Could you please help us just remind us outside of Growth that you expect coming in for the next year, what are the key levers and how should we be thinking about working capital for the next fiscal year. Thanks a lot.

Speaker 4

Okay. I think there were a bunch of questions in there. We'll start with promotion, so what promotions did we have in Q3? So if you recall, we went into the Q3 with a promotion in January, related to kind of getting into fitness in the New Year. That ended I don't have the exact date of the promotion, but that For part of January and then we did have a promotion, we did have some referral rewards promotion.

Speaker 4

We also had Which is basically if someone refers someone to Peloton, they get a that person gets a discount and then the person who does the referral gets a credit for apparel purchase. And we also did a spring promotion in March, that had discounts on hardware purchases and bundles as well as a promotion on our refurb products and we also offered a financing promotion where we would offer Free financing or 0 percent financing for all of the term lengths for a period of time. In Q4, we do have Some promotional activity planned, but Mother's Day, which actually launches today, our Mother's Day promo. So that will be starting today. With regard to free cash flow and the question about working capital, so just For Q3, to give you a sense, we did have a cash tailwind from inventory.

Speaker 4

It was about to the tune of about $100,000,000 Net of any supplier settlements that we had in the quarter, we are nearing the tail end of those supplier settlements. We only have about $3,000,000 left That will occur in Q4. For Q4, we also expect inventory to be a bit of a tailwind and source of cash, But it will be materially lower than what we observed in Q3, again in part because of the fact that we won't be selling less hardware in Q3

Speaker 1

Sorry,

Speaker 4

in Q4 versus Q3. And then we're not really providing much perspective on FY 2024 yet, but as we move into FY 2024, We expect the tailwinds from inventory to continue to moderate over time because we will need to continue to we will need to produce connected fitness hardware Inventory for specifics, Steve.

Speaker 1

I would say about the demand environment, uncertain. We've seen consumers respond very favorably to promotional activity in the current environment, maybe even more so than historically. There's certainly no Zubrin's in the marketplace, But it's not frozen either. So it's kind of a mixed bag and We're definitely uncertain about what's next in terms of the economic environment.

Speaker 4

Yes. The one thing

Speaker 1

The recession is soft landing. What happens with jobs, how uncertain are people? It seems like household incomes who had money, still have money. They're able to spend, but and then there's everybody else. And for them, there's a lot of uncertainty.

Speaker 4

Yes. And while there's certainly uncertainties, When we do our demand forecasting, we incorporate the latest trends that we see into our bottoms up forecast. And so we believe our guidance contemplates some of that macroeconomic headwinds that maybe that we may be observing even though it's hard to Explicitly identify what they are.

Speaker 1

Yes. But we since we have no explicit assumption around What's going to happen in Washington around the death limit and then a blast radius associated with an inability of Congress You know, result that with the President just by way of example. So, we're just assuming the world continues on as we know it today We'll see.

Operator

Thank you. One moment for our next question. That will come from the line of Andrew Boone with JMP Securities. Your line is open.

Speaker 9

Hi, good morning and thanks so much for taking my question.

Speaker 1

Barry, I wanted to ask now

Speaker 9

that we're a year into the price increase, just philosophically how you are thinking about Subscription price increases going forward. Given your time in Netflix, it felt like there was a steady cadence there. Does that relate to Peloton?

Speaker 1

I don't think so. For the longest time, Netflix strategy was actually to reduce price and grow share. And it was only after they became dominant on a global basis. Did they Extract the premium from the marketplace associated with the share. So left to my own devices, I would be lowering prices, not raising prices.

Speaker 1

I think it's a very effective way to drive A virtuous cycle of increased engagement and increased word-of-mouth, lower marketing expense. You can increase Now you are making trade offs against gross margin. And I would like for us to be able to do that, but I don't foresee That being possible given the financial constraints of the business. We will see, as Liz commented, increasing gross margins that are a function of structural shifts in the business, for instance, And that relates to the rate of growth in the subscription business versus the hardware business. So by way of example, last quarter, Subscription revenue exceeded hardware revenue by $30,000,000 This quarter, it exceeded by 100,000,000 It's growing significantly faster.

Speaker 1

I think that is a long term trend in the business as I flagged, I think, in last quarter's Investor letter and but I don't foresee big structural changes in The gross margin of the subscription business itself or even of the hardware business itself.

Speaker 4

Excluding the restructuring charges that we Yes, Axle.

Speaker 1

And eventually that too would be in the rearview mirror.

Speaker 9

And then I just wanted to touch on the underlying new subs that are coming on the platform. Are you guys seeing any change there in terms of income or age or anything else that would be worth highlighting? Thank you so much.

Speaker 1

No, not so much. With respect to the new marketing campaign, We will be reaching slightly younger, but that's a TAM play And an inclusivity play, but no changes, particularly I had noted previously that Fast was bringing in a slightly different demographic. It was slightly more female. It was high household income, interestingly enough. Is it professional women who value the optionality?

Speaker 1

That continues to be true. But it's That continues to be true, but it's not skewing the macro numbers particularly.

Operator

Thank you. One moment for our next question. And that will come from the line of Mario Lu with Barclays. Your line is open.

Speaker 10

Great. Thanks, guys. This is Alex Hughes on for Mario. Just had a couple of questions around the rower product. Do you have any updates on sales versus your internal expectations And you guys launched the live rowing classes last quarter.

Speaker 10

Any update on Use your traction on that or how that's progressing? Thanks.

Speaker 1

Do you want to talk about sales versus expectations?

Speaker 4

We aren't sharing explicitly what our sales are for the grower, but it is still a new product. And similar to what Barry said, our sale it doesn't have a high unaided awareness yet. So one thing to point out is that our current sales are actually pretty heavily skewed to our existing Connected Fitness subscribers, which is similar to what we saw with our tread when we launched it. And so we are expecting sales to be more accretive to sub growth over time and to continue to build over time as we grow our unaided awareness of the product.

Speaker 1

Let me add that It received very favorable critical reviews. I think it's made it much more difficult for Some of the competitors in that space in particular. So it's grabbed a lot of share. Liz mentioned that the awareness is still low. I think we have opportunities to work on that.

Speaker 1

Frankly, we didn't really know what to expect when we launched this. And that but the combination of the Favorable critical reviews and then the reception from our users has been quite good. It's It's a lot of the rated net promoter score, slightly below the Tread product. So think of it as on par with bike and tread, which I think for a new product is Pretty good. I think we have opportunities to continue to improve the content, But it's a new category for us and I'm confident that we will.

Speaker 1

But That's not based on any research by the way. That's just my own assessment as a user.

Speaker 4

And then I just want to add, it's only available in the U. S. Today, and we are looking to launch it internationally and into other markets over time.

Operator

Thank you. One moment for our next question. That will come from the line of Deepak Mathivanan with Wolfe Research. Your line is open.

Speaker 11

Great. Thanks. This is Zack on for Deepak. Just first on marketing, just given with the brand relaunch and the app relaunch later this month, How that could affect kind of the typical seasonality of marketing spend this year over the next couple of quarters kind of relative to historical periods? And then second, just on SaaS, churn stepped up a little bit kind of quarter over quarter, now at 5%.

Speaker 11

Kind of how do we obviously, it's

Speaker 5

still early days, but how

Speaker 11

do we think kind of about the key drivers to kind of bring that down over the long term and That kind of gives you confidence in the kind of the unit economics of that model over the long term. Thanks.

Speaker 1

Liz and I will tag team this in terms of seasonality, marketing expense Q over Q will decline This quarter versus last quarter, that it will be up slightly Single digit percentage is kind of on a year over year basis. It was quite low a year ago Q4. And other than that, I don't expect particularly Any big changes in the seasonal pattern and the reason it's up year over year, of course, is because of the leading end of the launch of the app. In terms of churn, from my Netflix experience, I would say, it's all about the user experience. Sorry, Let me be more clear.

Speaker 1

We report an average churn. Average churn is a function of The average life of the user base, if you're pumping in a lot of new subs, they're going to churn at a higher rate than subs who've been with your service for a long period I'd like to say 12 months. I've seen that in every subscription business that I've been a part of and I've been a part of 3 of them now. Churn declines over time and my last two businesses was asymptomatic at 12 months. We see something similar here.

Speaker 1

So when growth accelerates, churn ticks up slightly. When growth slows down, the average reported churn ticks down. So to really understand what's happening with churn, You need to actually see the cohorts and see how over time the churn curve is, is the slope changing, is Shifting in parallel like what is happening. And that's how you drive increases in lifetime value. So having said that, how do you bend the shape of the churn curve?

Speaker 1

You do that with engagement largely and you do that And by controlling the quality of the subscribers that you acquire. And so let me start there. That's all about The responsibility for that rests with marketing. And if and you can generally judge How valuable a customer is going to be based on their retention very early in their life. And so you just have to self regulate And acquire subs from sources that are going to meet your expectations in terms of churn.

Speaker 1

In terms of engagement, let's say the last three quarters, we've seen Pretty good improvement about 5 percentage points in the base of customers, let's say, who are engaged with our All Access Product. The key, of course, is for Jen Kotter and her team to instructors continue to make great content, But that by itself is not sufficient. If we make great content, but you can't find it, When you hop on your bike or tread, your row might as well not exist. And so The product team, the engineering team used to be great at driving personalization and we have made that an investment priority. When I walked in the door, I think we're making a lot of good progress there.

Speaker 1

We're also introducing some new categories of Content like lanebreak, where we're seeing really off the charts kind of engagement And there's a slightly more mail and a much younger demo. So we need to continue to do the same thing with PowerZones, by the way. So we need We continue to lean into those use cases, lean into personalization. Sorry to be so long, Linda.

Speaker 4

I wanted to add just a couple of quick things. First of all, for FAST, I do want to comment that we are still within that 18 to 20 month payback period that we have been targeting even with the slight uptick in churn that we've seen. And then Barry's comments about sales and marketing. So our sales and marketing overall expense is actually down, expected to be down year over year in Q4, but our media Spend is expected to be up. So the overall sales and marketing function itself, which includes things like brand and creative and headcount and all those things is down year over year, But we're spending a bit more on media, to your point, around the brand relaunch in the app.

Speaker 1

Well, Fasta has been a great example of how it is you can make trade offs between Marketing spend, churn, growth in order to drive more overall profitability in the business. So that absolutely has a higher churn rate, But the incrementality is in the low 60s. And so even though the lifetime value we estimate to be And round numbers, half that of an all access member, we're growing so much faster because of FaaS, we're driving more profit. And so we're willing to take the churn hit because of the increase in enterprise value that results from us deploying that strategy.

Operator

Thank you. One moment for our next question. That will come from the line of Dana Telsey with Telsey Advisory Group. Your line is open.

Speaker 7

Good morning, everyone. As you think about the shift of the business model and the relaunch of the app or the launch of the app that's coming, How do you see the shape of what the financial profile of the company should look like? Does the cadence quarterly or revenue streams, How do you envision the mile on a quantitative basis? Thank you.

Speaker 4

Well, I'm not sure I fully understand the question. But as we've talked about, our business has shifted more towards subscription relative to connected fitness hardware. So as the app Growth as a larger share of our business that will continue to shift and more of our revenue will be coming from subscription. And as we know, the gross margin of our subscription business is higher. So that will also continue to help improve our gross margins overall and It will expand the business.

Speaker 4

We'll continue to grow. We'll be able to get scale, which will mean that our OpEx as a function of revenue will come down. So it's leading us all in the right direction towards getting to our North Star goal, which is to be a bigger business with more subscribers and higher operating income and getting us to operating income breakeven over time. But structurally, it's really more about that shift that we're continuing to see happen from the mix of Connected Fitness hardware to subscription. Now that doesn't mean that some of those app subscribers over time will also become Connected Fitness members, But we're going to have to see how that journey evolves and we'll have products available for them however they want

Speaker 1

to join Peloton. Building off of Liz's comments, if we're successful in growing the app business, We've become increasingly an asset light model and it most definitely will change the working capital attributes of the business in a favorable way, not at the risk of sounding like Captain Obvious. And the margins will benefit as a result both the gross margin and the operating margins.

Speaker 4

Right. And remember, our North Star around growth is LTV to CAC ratio, so we're going to continue to evaluate how we grow our subscriber base in that framework.

Speaker 1

I would tell you, if and if we're successful in deploying an asset light model, we've probably seen faster growth in international. It's much easier to launch internationally an app product than it is a hardware business for sure.

Speaker 7

And Barry, just following up on international, where international grew faster than the U. S. This quarter. What are you seeing internationally? And Leaning into the hospitality business, how do you see the pace of ads for new hospitality chains joining the platform?

Speaker 1

I'm going to hold off on answering that. I appreciate the question. I think hospitality for us primarily is as a U. S. Based business and at least for the coming fiscal year.

Speaker 1

And then I think there'll be opportunities for us to build beyond that. And in terms of international growth, I'm thinking primarily existing markets, with a few additional new markets, But it's mostly it's re architecting our go to market Strategy in existing markets with increasingly culturally relevant content that unlocks the growth opportunities of those markets Pursue some co branding opportunities for us, which is not a strategy that we've deployed. I think we're going to have an Exciting announcement, by way of example, over the next couple of quarters, in that regard to help accelerate our growth.

Operator

Thank you. One moment for our next question. That will come from the line of Youssef Swalley with Chua Securities.

Speaker 1

Hey, great. Thank you very much and good morning all. So, Barry, The Peloton brand was built on just great quality physical product historically. As the business moves App centric strategy, asset light strategy, can you maybe just speak to the competitive advantages that you are bringing, The moat you're trying to build and what gives you confidence that you'll be able to maintain the same type of Advantage that you've been able to build in the physical world. Thank you.

Speaker 1

I think both Leland and I No comment here. From my part, I would say, we faced many challenges in the past year, Almost in every aspect of the business except for content. Content is kind of the golden goose. Is the bike a great experience from a hardware perspective and better than things that have come before? It absolutely is.

Speaker 1

But the magic and the glue that binds the community with almost religious fervor Amongst the members is the content and the instructors. And so If we're successful in extending that into the app world and if we architect the app in ways That drives personalization, so that you can find and engage with all that content in a Quickly and in a frictionless way, then I think we'll do quite well. If we don't do those things, we won't.

Speaker 4

Yes. I mean, I completely agree with your comments there, Gary. The one thing that I will add is that it's important for us to continue Innovate on the content experience over time and that is something that we are focused on doing and we'll continue to do that. And over time, you'll see new forms of content coming from us and that'll be something that continues to keep that competitive moat there. And so content to your point is really our secret sauce at Peloton, our golden goose at Peloton.

Speaker 1

Thank you.

Operator

Thank you. That is all the time we have today for our question and Thank you again for participating. This concludes today's program. You may now disconnect.

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Earnings Conference Call
Peloton Interactive Q3 2023
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