Peloton Interactive Q2 2025 Earnings Call Transcript

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Provided by Quartr
February 6, 2025

Key Takeaways

  • Peloton achieved a 12.9% Connected Fitness products gross margin, the first double‐digit result in over three years, leading to a $60 million increase in full‐year adjusted EBITDA guidance and a free cash flow target raised to $200 million.
  • Paid Connected Fitness subscriptions ended at 2.88 million, a net decrease of 21,000 in the quarter, though average net monthly churn improved 50 bps to 1.4%, outperforming internal expectations.
  • Multi‐discipline engagement grew, with strength workouts equaling 75% of cycling workouts and churn 60% lower for members completing two or more disciplines per month.
  • Connected Fitness products revenue declined 21% year‐over‐year to $253 million due to lower hardware unit sales and third-party retail underperformance, while subscription revenue dipped 1% to $421 million.
  • Member satisfaction reached rarefied levels with NPS above 70 across bike and tread products, and community initiatives like Teams (70,000 created) and the Turkey Burn (50,000 participants) driving deeper connections.
AI Generated. May Contain Errors.
Earnings Conference Call
Peloton Interactive Q2 2025
00:00 / 00:00

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Operator

Good day, and welcome to the Peloton Interactive Q2 twenty twenty five Earnings Call. At this time, all participants are in a listen only mode. After the speaker presentation, there will be a question and answer To ask a question during the session, you will need to press 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press 11 again.

Operator

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, Head of Investor Relations. Please go ahead.

James Marsh
James Marsh
Senior VP & Head of Investor Relations at Peloton

Thank you, operator. Good morning and welcome to Peloton's second quarter fiscal twenty twenty five conference call. Joining today's call are Peloton Chief Executive Officer and President, Peter Stern and Chief Financial Officer, Liz Coddington. 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.

James Marsh
James Marsh
Senior VP & Head of Investor Relations at Peloton

For a discussion of those 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 it over to Peloton's Chief Executive Officer and President, Peter Stern.

Peter Stern
Peter Stern
President & CEO at Peloton

Thank you, James, and good morning, everyone. Thank you for joining today's call. It is an honor to be here with you. I'd like to start by thanking Karen Boone and Chris Brusso for their leadership during the past few months, inclusive of the quarter we're reporting on today. Both have now returned to their focus on board duties, having left Peloton stronger than they found it.

Peter Stern
Peter Stern
President & CEO at Peloton

And for that, we share our deepest gratitude. For me, the opportunity to lead Peloton is a dream come true. Fitness has been an important part of my life dating back to my childhood when my mother was a fitness instructor. I've personally been a Peloton member since 2016 and like millions of others, I love this category defining brand. Few companies deliver a product where the more people consume it, the better they feel.

Peter Stern
Peter Stern
President & CEO at Peloton

That's Peloton. And the wonderful thing is that the healthier our members become, the more likely they are to stick around and recommend us to others, which makes our business stronger too. That's Peloton's virtuous cycle. The Peloton team has made impressive progress over the last few quarters in putting the company on sound financial footing. Nonetheless, we have a tall hill to climb before we can demonstrate the impact of that virtuous cycle on member and revenue growth.

Peter Stern
Peter Stern
President & CEO at Peloton

So right now, our primary focus is on executing against and delivering our fiscal twenty twenty five financial and operating goals while we prepare to climb that tall hill in fiscal twenty twenty six and beyond. We'll share more about longer term strategy as the calendar year progresses. But today I can share my perspective after one month of official duties at Peloton. Achieving the new purpose we've defined for ourselves, empowering people to live fit, strong, long and happy means we need to focus on innovation on new products and experiences that lead to even better outcomes for members, presence in more places so we can meet members wherever they are, more ways to connect members with Peloton and our uniquely supportive community, and last, but certainly not least, improved unit economics and the cost structure that's right sized for our business. Like every Peloton workout, this will be part inspiration, part perspiration.

Peter Stern
Peter Stern
President & CEO at Peloton

There's a lot of research that shows that engaging in multiple fitness disciplines improves member outcomes. While Peloton is best known for our cycling workouts, we're a leader in strength too. In Q2, over 2,000,000 unique members completed a strength training, boot camp, Pilates or yoga workout. Strength drove seven thirty five million minutes of workout time in Q2 and in terms of workouts equaled 75% of our total number of cycling workouts. Variety is good not only for our members, but also for our business as it drives higher subscription retention.

Peter Stern
Peter Stern
President & CEO at Peloton

Churn is 60% lower for subscriptions where members engage with two or more disciplines per month versus just one. On the Cardio side, we continue to elevate Tread, thanks to our marketing efforts, which enabled us to exceed our Tread portfolio sales goals and achieve higher new subscription attach rates on Tread and Tread plus sales year over year in Q2. And with the release of our 10 ks training program in Q2, Peloton now offers training for all major race distances and already over 300,000 members have trained for a running race with Peloton. We're also seeing the positive impact of innovative new software features like PACE targets, which offer running instruction with personalized intensity levels rather than treadmill speed. Nearly 60% of our members who take instructor led running workouts on our Tread products are using pace targets and our members' running paces are improving as a result.

Peter Stern
Peter Stern
President & CEO at Peloton

Another way to improve our business is to meet members in more places, for example, at the gym. In December, we launched Strength plus a new app offering non class strength training programs with audio guidance from expert coaches and a custom workout generator. In Q2, it reached over 220,000 monthly active users, the vast majority of whom were existing All Access members. Third party retail enables us to meet new members in places where they already shop. Our new seasonal partnership with Costco in The U.

Peter Stern
Peter Stern
President & CEO at Peloton

S. Drove more bike plus unit sales than any other third party retail partner, enabling us to meet many new members at a retailer they trust. And we remain focused on meeting more new members across the globe. We are encouraged by the performance of international hardware sales in Q2 alongside our continued growth in paid connected fitness subscriptions from international markets. Turning to the connections between Peloton's members with the company and with each other.

Peter Stern
Peter Stern
President & CEO at Peloton

As you may know, Peloton is named after the pack of cyclists who ride closely together to reduce their collective resistance. So we are focused on deepening the connections our 6,000,000 members have with each other and with Peloton. In September, we launched Teams, which enables members to share workouts and compete in challenges. 70,000 teams have been created since launch. Then in November, we hosted the eleventh annual Thanksgiving Day Turkey Burn where over 50,000 members worked out together live.

Peter Stern
Peter Stern
President & CEO at Peloton

This year's Turkey Burn also brought The Feast, our first Thanksgiving live strength class, which became the largest live strength class in Peloton's history. One of the best ways to measure the strength of our members connection to Peloton is through member satisfaction and retention. In Q2, we made meaningful improvements in member happiness with net promoter scores improving across all our bike and tread products to over 70. As someone who has spent many years in consumer tech and services businesses, I can tell you that this level of member love puts us in truly rarefied air. Part of the reason for this was improvements in the responsiveness and quality of our member support.

Peter Stern
Peter Stern
President & CEO at Peloton

Our member support satisfaction score was 4.3 on a scale of one to five, up from 4.2 last quarter and meaningfully higher than the 3.1% in Q2 of fiscal twenty twenty four. From a retention standpoint, we continue to benefit from exceptionally low churn rates with average net monthly paid Connected Fitness subscription churn of 1.4% in Q2. Liz will discuss our second quarter financials in more detail, but I want to take a beat on unit economics and rightsizing our costs, because both of these are foundational for us to address before we can return to growth. During this important holiday quarter, we achieved a 12.9% Connected Fitness products gross margin, reaching double digits for the first time in over three years by selling a favorable mix of premium priced products and demonstrating real discipline by aligning our discounts with the margins of our products. On the cost side, the team has made great progress.

Peter Stern
Peter Stern
President & CEO at Peloton

We are on track to exceed $200,000,000 of run rate cost savings by the end of fiscal twenty twenty five, which was the target announced in our May 24 restructuring plan, as well as additional operating expense efficiencies including reduced media spend. The progress made so far shows in our profitability where we achieved meaningful improvements in Q2. Both adjusted EBITDA and free cash flow increased roughly 140,000,000 year over year. This enabled us to make meaningful progress deleveraging our balance sheet with net debt decreasing over $280,000,000 or 30% year over year. All this is to say that while we are working on our long term growth strategy for fiscal twenty twenty six and beyond, our financial goals for fiscal twenty twenty five and continued discipline toward improving gross margins, reducing operating costs and deleveraging our balance sheet are and will remain top priorities for me.

Peter Stern
Peter Stern
President & CEO at Peloton

Now I'll turn it over to Liz to discuss our Q2 results.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

Thanks, Peter. We are pleased with our second quarter results as we exceeded our guidance on key metrics and continued to make meaningful progress improving unit economics and profitability. We also made progress on our marketing objectives by improving LTV to CAC year over year and elevating tread with target audiences. We ended the quarter with 2,880,000 paid Connected Fitness subscriptions, reflecting a net decrease of 21,000 in the quarter. This exceeded the high end of our guidance range by 19,000 subscriptions.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

Outperformance was driven by favorable net churn, partially offset by lower gross additions. Average net monthly paid Connected Fitness subscription churn was 1.4%. This reflects a 50 basis points improvement quarter over quarter exceeding internal expectations for seasonally lower churn in Q2. Net churn was positively impacted by lower than expected subscription cancellations, lower subscription pauses and higher reactivation. Reactivation performance was positively impacted by marketing efforts targeting churned subscriptions.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

Q2 net churn of 1.4% also reflects an increase of 20 basis points year over year as the benefit from higher reactivation was offset by two main factors. First, in Q2 fiscal twenty twenty four, we had a one time benefit from fewer net pauses as a result of a shift towards shorter pause length options. Second, we continue to see a slight headwind to churn as a result of subscription mix shift towards the secondary market, which has a higher churn profile than subscriptions that purchase their hardware directly from us or our channel partners. Favorable churn was partially offset by lower gross additions due to slightly lower hardware unit sales, a higher mix of Tread portfolio sales, which have lower new subscription attachment rates than our bike products and longer delivery times for TreadPlus units that delayed subscription activations until Q3. Secondary market activations were in line with internal expectations and represented roughly 40% of total growth additions in the quarter.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

We ended the second quarter with 579,000 paid app subscriptions, inclusive of strength plus subscription, reflecting a net decrease of 4,000 in the quarter. This result exceeded the midpoint of our guidance range by $9,000 Total revenue was $674,000,000 in the second quarter, comprising $253,000,000 of Connected Fitness products revenue, a decrease of $66,000,000 or 21% year over year and $421,000,000 of subscription revenue, a decrease of $4,000,000 or 1% year over year. Total revenue was $14,000,000 dollars above the high end of our $640,000,000 to $660,000,000 guidance range due to higher than expected revenue from both segments. The holiday season is a critical period for Connected Fitness products revenue as Q2 has historically represented over 40% of annual hardware unit sales. Connected Fitness products revenue exceeded expectations from higher than expected premium priced hardware sales predominantly Tread and Tread plus partly offset by slight underperformance in overall unit sales.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

Due to higher than expected Tread plus sales, we faced inventory constraints that temporarily led to longer delivery times, delaying some Tread plus deliveries and associated Connected Fitness products revenue recognition to the third quarter. We also observed higher than expected sales for our low priced refurbished bike. Offsetting the higher sales of our Tread and refurbished bike products, we observed lower sales from the mid range price point, specifically the original bike. Subscription revenue was higher than expected as a result of higher paid Connected Fitness subscription. Seasonally higher hardware sales in the second quarter is reflected in the revenue mix of 38% Connected Fitness products revenue and 62% subscription revenue.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

From a sales channel perspective, third party retail sales were lower than we expected in Q2, which we believe was partly due to our decision to offer lower promotional discounts on the original bike compared to last year in accordance with our effort to increase hardware margins. Our holiday performance reflects the continued progress we've made in evolving our marketing strategy. In November, we launched our Find Your Power marketing campaign featuring J. J. And T.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

J. Watt. This campaign targeted men and highlighted Tread and strength products with media concentrated on live sports. This campaign resonated well with men. In Q2, '40 '2 percent of Connected Fitness subscription gross additions were men, a two eighty basis points increase quarter over quarter and two forty basis points increase year over year.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

In addition to advertising more towards men, our marketing efforts were also focused on demonstrating the full value of a Peloton membership through better education of our extensive offerings. Among the Latine and core female audiences exposed to our holiday campaign, we observed a lift in awareness of non cycling modalities like walking, running, yoga and high intensity interval training. We also saw an increase in the Latine audience that would consider using Peloton, which is a leading indicator of future intent to purchase. Alongside reaching new audiences and introducing additional disciplines to our members, we continue to make progress on improving our marketing efficiency, which we measure from a lens of our LTV to CAC ratio. While our LTV to CAC remains in the range of one to 2x, we have made progress year over year toward our target to reach at least 2x and ideally closer to 3x.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

Our Q2 LTV to CAC was roughly 15% higher than Q2 fiscal twenty twenty four. Total gross profit was $318,000,000 in Q2, an increase of $19,000,000 or 6% year over year. Total gross margin was 47.2%, seventy basis points above our guidance due to favorable Connected Fitness products gross margin and favorable subscription gross margin, partially offset by revenue mix shift for our Connected Fitness products segment. Connected Fitness Products gross margin was 12.9%, up eight sixty basis points year over year, primarily driven by a mix shift toward higher margin products, lower warehousing and transportation related costs and a reduction in inventory reserves. Subscription gross margin was 67.9%, up 60 basis points year over year.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

Total operating expenses, including restructuring and impairment expenses, were $364,000,000 in the second quarter, a $122,000,000 or 25% reduction year over year, reflecting the progress we've made thus far toward rightsizing our cost structure. We are tracking ahead of our cost savings targets for fiscal twenty twenty five. Sales and marketing expense was $153,000,000 a decrease of $78,000,000 or 34% year over year, primarily from a 38% decrease in advertising and marketing spend and lower personnel related expenses. General and administrative expense was $131,000,000 a decrease of $29,000,000 or 18% year over year, primarily driven by a decrease in settlement costs, professional services fees and personnel related expenses. Research and development expenses were $60,000,000 a decrease of $20,000,000 or 25% year over year, primarily driven by lower employee related and contractor expenses.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

In Q2, we recognized $20,000,000 of impairment and restructuring expenses, of which $17,000,000 was non cash. The non cash charges were primarily related to asset write downs in relation to retail showroom exits. The cash charges consisted of $3,000,000 of severance and other accident disposal costs as we continue executing on our restructuring efforts. Adjusted EBITDA was $58,000,000 in the second quarter, which was $28,000,000 above the high end of our guidance range and a $140,000,000 improvement year over year. We generated $106,000,000 of free cash flow in the second quarter, an improvement of $95,000,000 quarter over quarter and $143,000,000 year over year and our fourth consecutive quarter of positive free cash flow.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

We ended the quarter with $829,000,000 in unrestricted cash and cash equivalents, an increase of $107,000,000 quarter over quarter. We continue to make progress toward deleveraging our balance sheet as net debt reduced $281,000,000 or 30% year over year. Overall, our second quarter performance reflects our continued progress in re architecting our cost structure, while maintaining our leadership position within the connected fitness category. It also reflects the strength of our high retention, high gross margin subscription business. Next, I'd like to provide context on our financial outlook for the third quarter and full year fiscal twenty twenty five.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

Following our outperformance in Q2 relative to our previous guidance, we are raising our full year fiscal twenty twenty five guidance midpoint across our key metrics, including ending paid connected fitness subscriptions, total revenue, total gross margin and adjusted EBITDA. We are prioritizing these metrics along with delivering free cash flow. We are raising our full year fiscal twenty twenty five guidance for paid connected fitness subscriptions by 55,000 at the midpoint to a narrower range of $2,750,000 to $2,790,000 This increase reflects our expectations for lower net churn due to the continued favorability across subscription cancellations, pauses and reactivation, partly offset by our expectations for lower gross additions due to lower hardware sales and mix shift into Tread products, which have lower new subscription attachment rates than our bike products. Our guidance for third quarter fiscal twenty twenty five ending paid connected fitness subscriptions of $2,850,000 to $2,870,000 reflects our expectations for seasonally lower hardware sales trends following the holiday season and for our average net monthly paid Connected Fitness subscription churn rate to remain relatively in line with the second quarter. Our full year fiscal twenty twenty five guidance range for paid app subscriptions of 550,000 to $600,000 remains unchanged.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

Our outlook for third quarter fiscal twenty twenty five ending paid app subscriptions is $560,000 to $580,000 Our full year fiscal twenty twenty five outlook for total revenue of $2,430,000,000 to $2,480,000,000 reflects a narrower range and an increase of $5,000,000 at the midpoint. This reflects our expectations for favorable subscription revenue from higher paid Connected Fitness subscriptions and favorable Connected Fitness products revenue from higher trend portfolio sales, partly offset by lower bike portfolio sales. Q3 revenue guidance of $6.00 $5,000,000 to $625,000,000 reflects our expectations for seasonally lower hardware sales compared to the second quarter. We are increasing our full year fiscal twenty twenty five outlook for total gross margin to 50%, reflecting a 100 basis points increase from prior guidance from expected favorability in Connected Fitness product segment gross margin and higher subscription segment gross margin, as well as a slight revenue mix shift toward our subscription segment. Our third quarter total gross margin guidance of 50% reflects an expected sequential increase in gross margin of two eighty basis points as a result of a seasonal mix shift toward our subscription segment in the third quarter.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

We are raising our full year fiscal twenty twenty five guidance for adjusted EBITDA by $60,000,000 to the range of $300,000,000 to $350,000,000 which reflects our expectations for continued improvements in profitability, largely due to gross margin expansion and continued operating cost savings. Our third quarter adjusted EBITDA guidance of $70,000,000 to $85,000,000 reflects a sequential increase of $19,000,000 at the midpoint, mainly due to seasonally lower sales and marketing expenses following the holiday season. We are also raising our fiscal twenty twenty five free cash flow target to at least $200,000,000 an increase of $75,000,000 from our previous target. This reflects faster than expected improvements in operating expense reduction, a higher degree of confidence in full year hardware sales performance following the holiday season and inventory related networking capital efficiencies. We expect to continue making meaningful progress in deleveraging our balance sheet through fiscal twenty twenty five and beyond.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

Before we open for Q and A, I'd like to hand it back to Peter to talk about what makes Peloton so special and gives us such optimism for the future.

Peter Stern
Peter Stern
President & CEO at Peloton

Thanks, Liz. You and the team should be proud of the work you all accomplished in Q2. There are lots of companies that make fitness equipment, dozens of fitness apps, countless trainers, but there is only one Peloton. That's because we combine the best hardware, the best software and the best human coaches with the world's most supportive community. That's our magic formula and when we get it right, we are unstoppable.

Peter Stern
Peter Stern
President & CEO at Peloton

And as I just discussed, winning is about focusing on what matters most, improving outcomes for our members, meeting them in more places and deepening the connections between them and Peloton as well as with each other. And that will take operational excellence and financial discipline, attention to the details that raise our performance for members and as a business. This will be hard work. As Jess Sims often says, never easy, always worth it. With the energy, momentum and excitement I've seen from Peloton team members in the few short weeks since I started, I am more optimistic than ever about the future of Peloton.

Peter Stern
Peter Stern
President & CEO at Peloton

With that, Liz and I are delighted to answer your questions.

Operator

Thank And our first question will come from the line of Simeon Siegel with BMO. Your line is open.

Simeon Siegel
Simeon Siegel
Managing Director & Senior Analyst at BMO Capital Markets

Thanks. Hey, everyone. Good morning. Peter, honored. I can welcome you to the fund that is analyst Q and A.

Simeon Siegel
Simeon Siegel
Managing Director & Senior Analyst at BMO Capital Markets

Welcome. I was curious how you're thinking about the path to growth versus the ongoing improvement in profits. I know it's still early days for you, but just curious if you have any thoughts on any timeline you'd want to share in terms of your views as you dig in? And then just as a follow-up, not sure if this is for you or for Liz, but you guys have been doing such a nice job at improving profitability in recent quarters. Could you share any thoughts on continuing that profitability improvement if and when you do decide to start investing for growth? Thanks.

Peter Stern
Peter Stern
President & CEO at Peloton

Thanks, Simeon, for the warm welcome. As you know, I've been at Peloton for just over a month. So I'm not ready to talk about when or the details of how we plan to turn the business back to top line growth. But I can tell you what we're doing to earn the right to grow, share my belief that we will and suggest where to look when we do. So first, we're setting the stage to be able to grow while ensuring we can deliver meaningful adjusted EBITDA and free cash flow by rightsizing our expenses, which are down 25% year over year in Q2, improving our equipment gross margins, which are back up to double digits for the first time in years, and increasing our LTV to CAC ratio, which has improved about 15% year over year.

Peter Stern
Peter Stern
President & CEO at Peloton

And doing all this is reducing our net debt and our leverage ratios, which means that we'll have the financial capacity that we need to make investments that have strong returns. But I don't want to leave you hanging on the growth question, so I'll just sort of tell you where to look in the levers. So there are three areas. One, we're looking to improve member outcomes through innovation on new products and services. And if we get that right, then we have the potential to pull all three levers of growing members, growing revenue per member and increasing member lifetimes.

Peter Stern
Peter Stern
President & CEO at Peloton

The second is meeting members in more places, and that also allows us to pull the levers of meeting of growing members and revenue per member. And then third is deepening the connection that we have with our existing members, which in particular has the potential to lengthen the lifetimes that we have with our members, which are already impressively long. So again, no specifics today, but that's where to look.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

Sure. And I'll take the question about the continuing profitability improvement. As you just heard us say a few minutes ago, we did just raise our full year adjusted EBITDA target for FY 2025 by $60,000,000 And so that is reflecting continued improvements in profitability that we expect largely due to our gross margin expansion that we talked about as well as continued operating expense savings. We are on track to exceed our $200,000,000 annualized run rate cost savings plan by the end of fiscal twenty twenty five that we committed to in our restructuring plan back in May of twenty twenty four. And then on top of that, as we continue to talk about, we are seeing upside from savings in media, which we also expect to be down materially year over year for the remainder of FY 2025.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

And while we're pleased with this progress that we've made, we do see further opportunities for cost optimizations and we've built a culture of cost discipline into our company. We know that our OpEx as a percent of revenue is still too high overall for the long term and especially that's true within our G and A area. And we do see multiple opportunities to right size it. A couple of examples include things like we still have a lot of tech debt where we're continuing to solve technology gaps inefficiently with manual work. We're going to work to eliminate that.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

And then another example would be reducing our corporate real estate expenses over time as we see opportunities to do that.

Peter Stern
Peter Stern
President & CEO at Peloton

Thanks, Simeon. Operator, can we have the next question, please?

Operator

One moment, please. And that will come from the line of Shweta Kajuria with Wolfe Research. Your line is open.

Shweta Khajuria
Managing Director at Wolfe Research LLC

Thanks a ton for taking my questions. I have two, please. Well, so you're starting to make progress on deleveraging. Can you please highlight some of the milestones on your plan, deleveraging plan from here and maybe some of the tangible and intangible benefits of deleveraging? And then the follow-up question is on the tariffs. Do you expect to see any meaningful impact from tariffs if levied on your P and L? Thank you.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

Thanks, Shweta. I'll start with the question on deleveraging. So the increase to our minimum free cash flow target to at least $200,000,000 in fiscal twenty twenty five, That, first of all, reflects a tremendous improvement of over $200,000,000 year over year. And then if you go back to FY 2023, it's over $670,000,000 improvement. And that improving free cash flow has really enabled us to deleverage.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

And our reduction in net debt, we talked about it earlier of $285,000,000 or 30 percent year over year in Q2. Now if you pair that lower net debt with growing trailing adjusted EBITDA, that's helping our reported leverage ratio to decline from 7x in Q1 to 2.7x in Q2. Now in terms of the tangible benefits of that, the improvement to our leverage ratio has enabled us to achieve a first lien net leverage ratio below 5x. And that is resulting now in a 50 basis point step down on our term loan and that equates to roughly $5,000,000 of annualized interest expense savings going forward as long as we continue to hit that threshold each quarter. Now on the intangible side, the improvements that we're making to our balance sheet are lowering risk.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

They're positioning us well for future sustainable and profitable growth. And over time, we do expect that this will lower our cost of capital and that will give us more optionality around capital allocation.

Peter Stern
Peter Stern
President & CEO at Peloton

Why don't I jump in for a moment on the tariffs part of your question, Shweta, and then I'll pass it back to Liz for a bit more detail. As I'm sure you all know, the questions around tariffs really represent a rapidly moving target, and so we're closely monitoring it, I'm sure, alongside all of you. The good news here is that no Peloton branded hardware products are subject to the tariffs from China or if they were to reemerge from Mexico or Canada. And of course, most of our revenues come from subscriptions. Liz can provide a little more color here.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

Yes. So while the tariffs on imports from Mexico and Canada are currently paused, if all of the tariffs went into effect at the current proposed tariff rate, we would expect to see roughly 1% impact to our Connected Fitness products and that's mainly related to Peloton apparel and pre core. And that estimate also assumes no mitigation. For China only, our unmitigated impact is well under 1% of Connected Fitness COGS.

Peter Stern
Peter Stern
President & CEO at Peloton

Okay. Thanks, Clara.

Shweta Khajuria
Managing Director at Wolfe Research LLC

Very helpful. Thanks, Peter. Thanks, Liz.

Operator

Thank you. One moment for our next question. And that will come from the line of Curtis Nagle with Bank of America. Your line is open.

Curtis Nagle
Curtis Nagle
Analyst at Bank of America

Good morning. Thanks very much. I wanted to focus on the free cash flow. Just what drove the outperformance in 2Q? And then on the big rates for the full year, assuming that's mostly just the incremental flow through on the Hager EBITDA, maybe some working capital efficiencies.

Curtis Nagle
Curtis Nagle
Analyst at Bank of America

Could we I guess that will be our first question if you could go through that and then I have a follow-up.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

Sure. So let me talk a little bit through our free cash flow. So our Q2 free cash flow of $106,000,000 that did exceed our internal expectations. And some of the benefits that we saw were permanent and some of them are timing. On the timing front, we saw significant amount of favorability associated with the timing of invoices for music and media vendors that we do expect to pay in Q3.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

And our outperformance on the permanent side, our outperformance in Q2 adjusted EBITDA also benefited free cash flow. And so that outperformance was driven by favorable revenue and faster than expected operating expense reductions as we've talked about earlier. And then again, I also mentioned that we raised our guidance midpoint for adjusted EBITDA by $60,000,000 and we expect most of that to flow through to free cash flow. We also did see a benefit in net working capital from reducing inventory production levels. Previously, when we had set guidance last quarter, there was some uncertainty around how much we could optimize production.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

And so our full year guidance or target of at least $200,000,000 of free cash flow reflects those the impact of inventory production improvements to net working capital and then also that faster than expected operating expense savings. I do want to point out that the $200,000,000 minimum free cash flow target, which implies roughly $87,000,000 in free cash flow in the second half of FY twenty twenty five, that's our minimum expectation. Our goal is to achieve more than this.

Curtis Nagle
Curtis Nagle
Analyst at Bank of America

Awesome. Good to hear. Peter, maybe a question for you. Just churn numbers were certainly encouraging. I guess just in terms of maybe a little bit more what's driving it.

Curtis Nagle
Curtis Nagle
Analyst at Bank of America

I mean, it sounds like it's results of some of these engagement efforts. Maybe you're seeing a leveling off across the sub base more generally. Just digging into that and then just what's assumed in the guidance maybe a little more specifically, I think churn is lower, but yes, I'd love to hear your thoughts on that.

Peter Stern
Peter Stern
President & CEO at Peloton

Curtis, thanks for asking. I like to talk about our churn because we've our subscription business continues to show remarkable consistency and resilience with that exceptionally low average net monthly churn rate of 1.4% for Connected Fitness subscriptions. So what's going on here? One, like all the subscription businesses I've ever seen, there's a tenure effect here. We have a great deal of longstanding and highly loyal members.

Peter Stern
Peter Stern
President & CEO at Peloton

And so with the passage of time, that benefits our churn. The second thing is looking at engagements. Peloton is that rare brand that makes you healthier the more you use it. And so one of our goals is to get more people using our product more. And we're pleased to see here some growth in our engagement levels in terms of the average monthly workout time for ending Connected Fitness subscription, if we look at that on a year over year basis.

Peter Stern
Peter Stern
President & CEO at Peloton

So we've got a healthy customer base, we've got healthy usage. As I mentioned earlier, we have strong NPS scores and that all adds up to healthy churn. Liz, maybe do you want to provide a little more color?

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

I can provide a little bit more color on the outlook. I think you were asking a little bit more. We're not we don't guide specifically to churn, but we can I can tell you that in Q3, we do expect our average net monthly paid Connected Fitness churn rate to remain relatively in line with Q2? And then just on a full year basis, we do continue to expect our churn rate to increase modestly year over year. And as we've talked about before, we do continue to see a mix shift of our subscriptions into the secondary market, which has a lower retention rate compared to subscriptions where customers purchase their fitness hardware directly from us.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

And then we have talked about this one time subscription on pause benefit in fiscal twenty twenty four that won't repeat. And those are creating a slight headwind for us. And that's partially offset by all the great work our marketing team is doing to reactivate lapsed subscription.

Curtis Nagle
Curtis Nagle
Analyst at Bank of America

Helpful. Thank you.

Peter Stern
Peter Stern
President & CEO at Peloton

Thanks, Curtis.

Operator

One moment for our next question. And that will come from the line of Arpine Kocharayan with UBS. Your line is open.

Arpine Kocharian
Arpine Kocharian
Executive Director at UBS Group

Hi. Thanks for taking my question. Peter, welcome to Peloton. Great to hear you on the call. You talked a lot about improving churn.

Arpine Kocharian
Arpine Kocharian
Executive Director at UBS Group

I was wondering, is it fair to assume that this better than expected churn, which is probably not as much of a surprise to you as to us given the effort you've taken to get there. My question is, how should we think about potential price increases in light of improving churn? It seems like you feel better about churn today than you did three months ago. First, is that a fair assumption? Second, how should we think about sort of price increases in the subscription business in light of improving churn? Thank you. I have a quick follow-up.

Peter Stern
Peter Stern
President & CEO at Peloton

Hi, Arpine. Thanks for the question. And we obviously we feel good about the churn that we just reported and Liz just talked you through a little bit about how we're thinking about it for the rest of the year. With regard to pricing, to state the obvious, pricing is a powerful lever with every change up or down essentially dropping straight to the bottom line. So we're taking a hard look at pricing alongside everything else in our business.

Peter Stern
Peter Stern
President & CEO at Peloton

As a reminder, in Q1, we took steps to improve our unit economics by taking up the price of our rower in North America and we also raised prices for bike and bike plus in our international markets. This holiday season, we also improved our hardware unit economics by reducing the number of days that we were on promotion and by structuring our promotional strategy to better align with the margin profile of our products. So all of that added up to greater discipline, as well as some terrific learning opportunities for us around pricing. I think a question that might be in everybody's mind is around subscription pricing. We know how important subscription pricing is to our members, as well as to the performance of the business and we won't take any actions there lightly.

Peter Stern
Peter Stern
President & CEO at Peloton

So beyond what I've shared so far, that's about all we have to say today, but we'll share more about pricing when we're ready to.

Arpine Kocharian
Arpine Kocharian
Executive Director at UBS Group

Wonderful. Great. Thank you. Peter, I was wondering if you could share your initial impression of where you see low hanging fruit in terms of further cost optimization. Do you feel that that's first been hardware COGS versus more in sort of OpEx and the obvious sort of G and A that you have talked about before in terms of being higher than it's supposed to be?

Arpine Kocharian
Arpine Kocharian
Executive Director at UBS Group

Where do you see that low hanging fruit as you sort of look at the business with fresh eyes?

Peter Stern
Peter Stern
President & CEO at Peloton

Thanks, Arpine. Liz talked a little bit about this before. I think the important thing for us to note is that we're being very aggressive with regard to costs and we are on track to deliver the $200,000,000 in expense savings that we laid out just a few months ago. And you can see that reflected in the results that we reported today. We also think that there are some opportunities both in the IT space, both as an enabler of reducing manual effort from our employees, as well as an area that we're looking at are things like IT licenses.

Peter Stern
Peter Stern
President & CEO at Peloton

Liz shared with you the work that we're doing on reducing our corporate real estate expense as well, and that does feel like relatively low hanging fruit, although those savings do take time to materialize due to our contractual commitments. So we are absolutely planning on achieving those savings, but they'll materialize when it makes sense. In terms of free cash flow, you heard Liz's good news about the $5,000,000 step down in our interest expense. That's real money, and that's low hanging fruit that it might not have felt low hanging a year ago, but from where we are right now that's an immediate benefit that the team has achieved due to their impressive work on deleveraging.

Arpine Kocharian
Arpine Kocharian
Executive Director at UBS Group

Thank you very much.

Peter Stern
Peter Stern
President & CEO at Peloton

Thank you.

Operator

Thank you. One moment for our next question. And that will come from the line of Lane Chura with Goldman Sachs. Your line is open.

Eric Sheridan
Eric Sheridan
Analyst at Goldman Sachs

Hi. This is Eric Sheridan from Goldman Sachs. Hi, Peter. I had a quick question on brand versus direct marketing investments and generating end demand. How do you think about the mix of those marketing investments over the medium to long term and where there could potentially be a higher return on marketing spend as you think about deploying that those growth investments against your platform goals? Thank you.

Peter Stern
Peter Stern
President & CEO at Peloton

Thanks, Eric. The fitness category in particular is a category where you do have to remind people to get back into the market and do the right thing for themselves. So I don't think you can anticipate that this is a business where we're suddenly going to be able to do away with all brand marketing spend. And I think we've demonstrated the ability to do some brand marketing, for example, our Watt Brothers advertising and move the needles that we intended and promised to move, for example, with the increased uptake that we saw of our products by men. That being said, we recognize that brand marketing is more difficult to measure and justify than performance marketing.

Peter Stern
Peter Stern
President & CEO at Peloton

So what does that mean? With regard to brand marketing, Lauren and our team are being really disciplined about doing things like media mix modeling and holdout areas for us to try to determine the real impact of our brand marketing spend and know which half works versus which half doesn't work, so that we can be as efficient as possible with that. Secondly, we are doing as much of our marketing spend in the performance category where it's highly measurable as we possibly can. And the good news there is that when you look at the sum total of our marketing spend, we're getting more effective and more efficient. Our reduction in marketing spend in Q2 exceeded the reduction in our Connected Fitness sales by a meaningful amount.

Peter Stern
Peter Stern
President & CEO at Peloton

And that also resulted in improvement in our LTV to CAC ratio, Again, not where we want it to be long term, but material progress toward our goal of exceeding a ratio of two:one. So we're getting better. We're putting in place the tools and the discipline to achieve further improvements. And I think you'll see us balance performance and brand marketing in a thoughtful way going forward.

James Marsh
James Marsh
Senior VP & Head of Investor Relations at Peloton

Great. Thanks, Eric. Operator, we have time for one more question.

Operator

And our final question will come from the line of Lee Horowitz with Deutsche Bank. Your line is now open.

Lee Horowitz
Lee Horowitz
Analyst at Deutsche Bank

Thanks for sneaking me in. Maybe Peter, we appreciate the growth plans for '26 and beyond are still in the works, can you maybe talk at a high level as to what you see as the most obvious levers you can pull in order to stabilize sort of the gross addition declines that you've seen worsen to start off the calendar year? And one follow-up for Liz, if I could.

Peter Stern
Peter Stern
President & CEO at Peloton

Sure. Lee, the most important thing for us to do in the near term is to super serve the members that we have. And we've made real progress on that. If you look at the improvement, for example, in our MSAT scores, which year over year remember, this is a five point scale has gone up from 3.1 to 4.3. We have a and we have a higher target than that going forward.

Peter Stern
Peter Stern
President & CEO at Peloton

That's a situation where we're doing everything we can to ensure that every new customer, in particular, loves us as much as the ones that we've retained in the past. We're also working really hard in the near term to launch new capabilities that add value to our existing members. So as we mentioned in the remarks, when we see members who are engaging in two or more disciplines, we have a 60% reduction in our churn rate. So we're working really hard to get people to, for example, embrace the strength modality, which we know based on a lot of research, is a terrific addition to a cardio program. These things, I think, are the lowest hanging fruit in the next few months for us to continue to retain that customer base that we worked so hard to acquire. Liz, do you want to add anything?

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

No. The only thing that I would say is to your point, it's about retaining the subscribers that we have and then also for those that are joining us new making sure that they get off to a really great start and are able to engage because we do know that if they engage early that they're that that will predict that they will be a subscriber for a longer period of time. So that would also manifest in lower churn for the subscribers who are joining us as new gross additions.

Lee Horowitz
Lee Horowitz
Analyst at Deutsche Bank

Really helpful. And then maybe one just follow-up on Connected Fitness gross profit, gross margin. Sort of reaching that double digit sort of milestone for the first time is a great hurdle to clear, but we think that you still are always away from where you think this can go over time. Any context as to sort of where you see the upper band on Connected Fitness product gross margin and the levers you have there to sort of pull those higher going forward? Thanks so much.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

Sure. So our improvements in Connected Fitness gross margin are due to there's multiple dimensions to that. Some of that is mixed into some of our more premium products that do have a higher gross margin. And then some of that is also just being more optimized in how we offer discounts. And then we've also made some pricing changes.

Liz Coddington
Liz Coddington
Chief Financial Officer at Peloton

So we can continue to pull all of those levers over time. And we do expect our gross margins can't that they can continue to expand. I'm not going to give you a specific target for that, but we know that there is more opportunity to expand them over time. And we do expect for the remainder, just to clarify for Q3 and the full year for fiscal twenty twenty five at least, we do expect to maintain double digit Connected Fitness product gross margins, primarily because we are shifting towards those higher margin products and being really disciplined about our promotions.

Lee Horowitz
Lee Horowitz
Analyst at Deutsche Bank

Great. Thanks, Lee.

Operator

Thank you. I would now like to turn the call over to Mr. Peter Stern for any closing remarks.

Peter Stern
Peter Stern
President & CEO at Peloton

Before we end the call, I want to acknowledge that Peloton has a very special base of investors because many of you are also enthusiastic members. And in addition to being the CEO, I'm also an enthusiastic member. So let me leave you with a few thoughts that bridge the two ways we relate to Peloton. I talked earlier about improving member outcomes. One of the ways we're doing this is by providing personalized coaching.

Peter Stern
Peter Stern
President & CEO at Peloton

If you haven't already tried a Power Zone ride, PACE targets on Tread or the personalized plans feature we released last week, please do so. These are already delivering impact for our members and they're a taste of the future. And if you haven't already tried a Peloton strength, boot camp, pilates or yoga class, there's no time like the present. I also talked about meeting members in more places. There are lots of ways that Peloton shows up in the physical world, but one way that I'm excited about this month is in the virtual one, our appearance in Marvel Studios' Captain America: Brave New World in theaters next Friday.

Peter Stern
Peter Stern
President & CEO at Peloton

And while you wait for that, keep an eye out for some special workouts to help you get fit like a superhero. Finally, I talked about making members for life and the importance of connecting our members with each other. We launched public teams last week and I'd encourage every one of you to go on our app and join one. And if you're an analyst, please join James' team Together We Go Long, because we know that being part of a supportive community helps people establish and stay with healthy routines. Okay, you have your assignments.

Peter Stern
Peter Stern
President & CEO at Peloton

Thank you for joining today's call and I'll see you on the leaderboard.

Operator

Thank you all for participating. This concludes today's program. You may now disconnect.

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