Shares of Peloton Interactive lost about 18 percent of their value on Thursday after the connect fitness leader posted a staggering loss and a bleak forecast that doused hopes of a quick turnaround.

The company’s exercise bikes, priced at above $1,400, treadmills, and connected classes were all the rage with fitness enthusiasts during COVID-19 lockdowns, but as gyms reopened following vaccinations, demand nosedived.

Since taking over as chief executive from Peloton founder John Foley in February, Barry McCarthy has pursued sweeping changes that have yet to pay off fully. Peloton raised membership fees, increased prices on some equipment, laid off thousands of workers, tested a rental option, exited last-mile delivery, and outsourced production. In his latest effort, Peloton, on Wednesday, said it would start selling its fitness equipment on Amazon in the U.S., fueling a 20 percent jump in shares on the day.

In his letter to shareholders on Thursday, McCarthy, a former Spotify and Netflix executive said he expected the market for connected fitness would “remain challenging for the foreseeable future” as consumer demand for at-home workout machines waned from pandemic highs. He noted that the U.S. market for connected fitness is down an estimated 51 percent year-to-date, while Peloton’s market share is up an estimated 17 percent year-to-date.

McCarthy nonetheless highlighted the company’s progress in bringing in new executive leadership, renegotiating supply contracts and significantly reducing cash outflow.

“The naysayers will look at our [fourth quarter] financial performance and see a melting pot of declining revenue, negative gross margin and deeper operating losses,” said McCarthy. “But, I see significant progress driving our comeback and Peloton’s long-term resilience.”

He noted that in the six months leading up to Q422, Peloton averaged a negative free cash flow of approximately $650 million per quarter, but the outflow was reduced to $412 million in the latest quarter. McCarthy said, “Our goal is to reach breakeven cash flow on a quarterly basis in the second half of FY23. We continue to make steady progress, but we still have work to do.”

McCarthy also noted that while Peloton logged an operating loss of $1.20 billion after $415 million in restructuring charges in the fourth quarter, the loss “reflects the substantial progress we made this last quarter re-architecting the business to reduce the current and future inventory overhang, converting fixed to variable costs, and addressing numerous supply chain issues. This progress, plus the reduced cash flow burn, is the positive story behind the headline loss.”

The net loss came to $1.24 billion, or $3.68 a share. The loss compares to a year-ago loss of $313.2 million, or $1.05 per share, and marked Peloton’s sixth-straight quarterly loss. Wall Street’s consensus estimate had called for a loss on a GAAP basis of 76 cents a share.

Revenues fell 28 percent to $678.7 million from $936.9 million a year earlier and below Wall Street’s consensus estimate of $718.2 million.

Connected Fitness revenue, which includes the contribution from the Precor fitness equipment line, was $295.6 million, down 55 percent year-over-year. The primary driver of the year-over-year revenue decline was a reduction in consumer demand exiting the pandemic’s peak.

Subscription revenue of $383.1 million grew 36 percent year-over-year, representing 56.4 percent of total company revenues, Peloton’s first reported quarter where high-margin subscription revenues contributed the majority of our total revenue. McCarthy has prioritized expanding subscription revenue over hardware sales. Earlier this year, for example, Peloton raised the price of its all-access subscription plan in the United States to $44 per month from $39.

Gross margins in the quarter eroded to negative 4.4 percent from 27.2 percent a year ago.

Connected Fitness’ gross margin was negative 98.1 percent, primarily driven by a significant increase in inventory reserves of $182.3 million. Additionally, Peloton experienced higher logistics expenses per delivery, increased port and storage costs, fixed logistics cost deleveraging, and charges associated with the voluntary recall of its Tread+ product. The inventory reserves are primarily related to excess accessories and apparel inventory that are not expected to sell above its current carrying value returned Connected Fitness Products that are not expected to sell, and reserves for raw materials that are estimated to have no future use as a result of restructuring activities.

Subscription gross profit was $260.3 million in Q4, representing 46 percent year-over-year growth. Subscription gross margin was 67.9 percent, up from 63.3 percent in the year-ago period, primarily driven by fixed cost leverage with more connected fitness subscriptions and modest efficiencies associated with certain variable costs.

Total operating expenses surged 111 percent to $1,172.1 from $556.3 million a year ago. One-time expenses included $337.6 million in supplier settlements, $337.2 million of non-cash impairment expenses for write-downs and write-offs of fixed and intangible assets, primarily related to restructuring initiatives, and $22.2 million of restructuring expenses. Excluding these non-recurring items, operating expenses declined 14 percent year-over-year to $475.2 million, representing 70.0 percent of revenue.

Of the non-cash impairment expense of $337.2 million, roughly half was attributable to the impairment of acquisition-related intangible assets. Additional impairments in connection with restructuring activities include the wind-down of certain software implementation and development programs and its Peloton Output Park facility that is being readied for sale later this calendar year. The $22.2 million restructuring expense related to additional severance and personnel costs and other cash exit charges.

Adjusted EBITA amounted to negative $288.7 million against negative $45.1 million a year ago. The primary drivers of the year-over-year decline were lower revenue and Connected Fitness gross margins and higher operating expenses. Peloton said the primary reasons actual results were short of guidance in the range of negative $120 million to $115 million was primarily due to inventory reserves.

Inventories at the quarter’s end were $1.1 billion, including the increase in its inventory reserves of $182.3 million. Year-ago inventory levels were $937.1 million.

Peloton ended its latest quarter with 2.97 million Connected Fitness subscriptions, about flat with prior-quarter levels and up 27 percent from a year ago. Connected Fitness subscribers are consumers who own a Peloton product, such as its original Bike, and pay a monthly membership fee for access to live and on-demand workout classes. Its total member count, however, declined by about 143,000 from the prior quarter to 6.9 million.

Member engagement remained strong at 14.8 Average Monthly Workouts per Connected Fitness Subscription. While down sequentially from Q322 due to typical seasonal trends, engagement is tracking well above pre-COVID levels, up over 20 percent versus Q419. Peloton’s average net monthly churn levels for connected fitness users ticked up to 1.41 percent from 0.73 percent a year ago, slightly ahead of internal expectations.

Exiting the quarter, churn has been tracking lower than Q4 levels, although Peloton sees a sequential increase in churn in the current quarter due to seasonal trends and the announcement of its All-Access Membership subscription price increase.

On Peloton’s quarterly call with analysts, McCarthy touted several actions Peloton is testing to revive sales. Those include selling pre-owned bikes, renting bikes for a monthly fee and adding new tiers to Peloton’s digital app, including a premium tier where consumers would pay more for expanded content and better features.

“It is not enough to just cut expenses; we have to grow revenue,” he said.

Using the movie rental wars as an example, McCarthy said that Netflix was able to come out on top of Blockbuster, a movie rental business that filed for bankruptcy in 2010 because it offered its customers personalized content and lots of choices. He also said extensive content had been the core of Spotify’s success.

Said McCarthy, “The more content you have, the more important it becomes that you’d be good, even great, at building that personalized user interface. So it is currently a focus for us, and we will be relentless about it. And I would say we’re still really in the very early stages.”

Peloton, which warned of a cash crunch in May, did not offer an outlook for its upcoming fiscal year 2023. For the first quarter, it said it sees subscribers staying flat and revenue ranging between $625 million and $650 million, below analysts’ consensus estimate of $783 million. Adjusted EBITDA is expected to be in the range of negative $115 million to negative $90 million.

Peloton, in its shareholder letter, said the outlook reflects “near-term demand weakness associated with our recent hardware price increases as well as typical seasonal demand softness. We expect an improving gross margin, primarily due to the price increases for Bike+ and Tread that were implemented in mid-August.”

Photo courtesy Peloton/Business Insider