Peloton Interactive, Inc. took an early beating after reporting fiscal 2023 first-quarter results after missing consensus Wall Street estimates but shares reversed course as the day progressed. PTON reported that total fiscal first-quarter revenue fell 23 percent to $616.5 million for the period that ended September 30. Revenues were comprised of $204.2 million of Connected Fitness segment revenue, reflecting a 59 percent year-over-year decrease, and $412.3 million of Subscription revenue, representing a 36 percent year-over-year increase.

The company reported a 6 percent year-over-year increase in members to 6.7 million from 6.3 million in fiscal Q1 2022 but also saw those memberships fall 3 percent from the 2022 fiscal fourth quarter. Connected Fitness Subscriptions totaled 2.973 million subscribers at the end of the fiscal first quarter compared to 2.492 million subscribers in the prior-year period.

The shortfall was said to be driven by a $26.5 million Tread+ reserve charge, which they accounted for as a reduction in revenue. The charge was booked as a post-close adjustment following the October 18, 2022 announcement of a one-year extension of the full refund period for Tread+ if consumers wish to return their Tread+ pursuant to the recall.

“With the extension of the full refund period to November 6, 2023, we expect that more Members may opt for a full refund, and have accordingly increased the recall return reserve. Other than the Tread+ return reserve, our revenue performance was above the mid-point of our guidance range,” Peloton said in a letter to investors.

Gross profit was $217.2 million for the quarter, yielding a gross margin of 35.2 percent. Connected Fitness gross margin of negative 27.2 percent was negatively impacted by the increase to the Tread+ recall reserve and related logistics expenses. Excluding these items, adjusted Connected Fitness gross margin was negative 11.6 percent for the quarter, and adjusted total gross margin was 38.3 percent. Subscription gross margin of 66.2 percent apparently “modestly underperformed” the company’s expectations due to projected under-recoupment against minimum music licensing guarantees and higher stock-based compensation related to the acceleration of certain restricted stock unit vesting and option price modifications.

Excluding restructuring, impairment and settlement expenses, operating expenses were $420.2 million, down 32 percent from $622.2 million in the year-ago period. This quarter Peloton recognized $107 million of restructuring expense, of which $77 million was non-cash. Key elements of these restructuring charges were: stock-based compensation expense due to exercise window modifications and the acceleration of certain restricted stock unit vesting schedules pursuant to severance arrangements, cash severance and other personnel costs, and professional fees and other costs associated with exit and disposal activities. The company also recognized $63 million of non-cash impairment expense in the quarter, comprised primarily of Connected Fitness and supply chain asset write-downs and write-offs stemming from previously-announced restructuring initiatives.

PTON’s net loss for the quarter was $408.5 million, compared to a net loss of $376.0 million in the year-ago period.

Net cash used in operations was negative $202.8 million. Free cash flow (cash flow from operations less capital expenditures and software development costs) was negative $246.3 million. Capital expenditures and internal-use software development costs were $43.6 million in the quarter, including continued expenditures associated with the completion of a construction phase of the Peloton Output Park facility prior to the anticipated sale of the asset. Peloton ended fiscal Q1 with $938.5 million in unrestricted cash and cash equivalents. The company also has a $500 million revolving credit facility, which remains undrawn to date.

Despite the tough news for investors, the company believes they have the right plan in place to turn around the business and pivot off the pandemic-based growth model that resulted in heavy fixed costs.

“A driver of our progress has been the restructuring of our business model from mostly fixed to mostly variable costs,” PTON said in the investor letter. “Other big shifts include the evolution of our go-to-market strategy including our third-party distribution deals with Amazon and Dick’s Sporting Goods as well as Hilton, our sale of certified pre-owned bikes, and the rollout of our Fitness as a Service (“FaaS”) bike rental service. On a conference call with analysts, company CEO Barry McCarthy said they are forecasting FaaS subscribers to be 30 percent or more of new subscribers and “more than that on a net basis because there’s effectively no churn across the installed base.” He said the “percentages of gross versus net would be quite a bit different.” McCarthy also said they are averaging about 175 FaaS sign-ups a day over the last two weeks.

McCarthy addressed questions about the new retail strategy adding AMZN and DKS, suggesting Amazon has “outperformed” their expectations. CFO Liz Coddington went into more detail about how the retail partnerships are working.

“So as far as the third-party retailers go, we do have a couple of different models that we use to work with them,” she elaborated. “In the case of Amazon, we have a wholesale model. So Amazon will buy the inventory from us and then they will resell it, and our revenue recognition will come at the time that we actually sell the inventory to them rather than when they sell it to the customer. And the subscriber will come even later. So they have to sell the bike to the subscriber. It has to get delivered and then the sub has to activate. So think about that being a longer timeframe from when the inventory gets sold to when we actually see the subscriber activation. There will be a disconnect in timing there.”

With Dick’s, she said they have some wholesale types of models. “So, we also have a drop-ship model,” she continued. “So that’s the case where somebody walks into the Sporting Goods, orders a bike or tread, and then they send a signal to us and we then fulfill the order and deliver it to the customer. So in that case, we recognize the revenue at the time of delivery like we do in our regular web sales. And so – and the activation will be similar timing we expect as from when they get received their bikes when we record revenue and we get the subscription. So there is a couple of different models going on there. But as these different models they’re out over time, they’re small right now, but they could have an impact on how we model out – how we see the subscription growth – revenue growth in comparison to the Connected Fitness.”

Looking at fixed costs, the company highlighted that they Peloton implemented a reduction in force of approximately 500 positions from its global team on October 6th. “As with prior actions, this decision was incredibly difficult but necessary to ensure the further health of our business by aligning costs with projected revenues in pursuit of our FCF objective for the fiscal year,” the letter stated.

“The combined effects of all of these changes, coupled with our low monthly subscriber churn of 1.1 percent, are the green shoots that demonstrate the turnaround in our business. Sustained success against our plan means continued, demonstrable progress against each of these measures.”

Looking ahead, Ms. Coddington said that they have seen some research that indicates the economy is a headwind for the company. “I was talking a little bit about the economy and creating a headwind for us and for many other businesses right now,” she said. “I do want to say that we do have confidence that our Q2 guidance forecast incorporates the latest on macroeconomic trends.”

Peloton is forecasting 3.0 million Connected Fitness Subscriptions for the fiscal second quarter with total revenue in the $700 million to $725 million range, well below Wall Street estimates. PTON shares sank in early trading on Thursday but closed up in mid-single-digits at the close of the market.

Photo courtesy Peloton