Peloton Interactive Aktie

Well, good afternoon. Thank you all for joining us. So my name is Brian Nagel. I'm the senior equity research analyst here at Oppenheimer, covering consumer growth and e-commerce. This is our 26th Annual Oppenheimer Consumer Growth and E-Commerce Conference. It's held virtually. So again, thank you all for joining us. So I'm very pleased to have with us our next presenting company, Peloton, and the company's still new CEO, Peter Stern. So Peter, thank you for joining us.

It's my pleasure to be here, Brian.

So we're going to structure this as an informal fireside chat with me asking questions and Peter respond to those questions. To the extent there are questions from the audience, just please send them through the chat function. I'll be happy to work them into our conversation. And Peter, thank you.

So the first question I want to ask, Peter, you still -- like as I mentioned in my quick opening there, you're still relatively new to Peloton. So maybe before we start talking about some of the specifics of the company, we can discuss kind of your impressions. You joined the company not that long ago. There's been a lot going on since you've joined. But I guess the question is any surprises, positive or negative and how you view the company and importantly, its brand evolving right now?

Yes. I mean the company is -- it's so unique. It has this magic formula of equipment, software, content and community that makes it not -- it's not a pure hardware business. It's not a pure software business. It's not a pure services company. It's an integrated experiences business. And that's what's, in many ways, so appealing to me about it because when you bring those things together, in the very particular way that Peloton does, it solves the biggest problem in the fitness industry, which is how do you sustain commitment on the part of a member.

I like to study these sorts of things. I'm a little bit of inert about it. But when we look at what drives habit formation, right, it's that something needs to be obvious, easy, attractive and rewarding. And in many ways, when you look at Peloton, you see that we've got this obvious equipment steering in the face every day. Our software makes it really easy to get into the right workout for you. The content is attractive and the experience of being in a community is part of what makes it so rewarding. And so you pull all that together and you actually -- you get an experience that's worth $50 a month or $600 a year to a member. And we, as a company, get some really meaningful lifetime value and return from that.

So you asked about -- so that's my impression of this company. You asked, Brian, about surprises, positive, negative surprises here, I think, are really actually opposite sides of the same coin. So when I joined Peloton, we didn't have a hardware road map. There were almost no changes to our frames or new pieces of equipment that were in our pipeline. So that's a negative. But we were able to overhaul our entire product line within the first year with the launch of the cross-training series. That's more of an incremental change, but we more recently announced the launch of our commercial series that's coming later this year, and there's a lot more behind that.

And so the positive side of my surprise is that we have this absolutely world-class product organization that was just waiting for a bit of permission. They pulled it off already, and I have great confidence in our future.

That's very helpful. I wanted -- one of my key questions here is to discuss further commercial amendment products. But before we do that, I do want to kind of pick your brain, so to say, given your seat here as the CEO of Peloton on the consumer backdrop. And so we've done a lot of work on what we view as a softer consumer backdrop and some of the risks that lie out there, gas price is probably the most notable.

But the question I want to ask you, as you're thinking about Peloton and particularly at this stage where it's almost like we're restarting growth here, how do you view the consumer backdrop? And is that -- is there any type of headwind there for Peloton and the initiatives of the company?

Yes. We can look at this on multiple dimensions. In terms of the impact, let's say, of a softer economy, we've studied the historical data, obviously, the COVID financial crisis is not instructive because it lit the home exercise market on fire. But we've gone back and looked at things like the 2008 financial crisis. And what we found in general is that fitness spend on go to gyms was one of the least impacted categories during a pretty tough time for a lot of people.

So our takeaway is that fitness is not one of the top places that people are going to scale back when times are tough. That all being said, there is very high price elasticity around fitness equipment. We certainly experienced that. So the business is very responsive to discounts as an example. And we have a lot of tools in our tool chest to be able to help out with that, not the least of which is that more than 50% of our subscriber gross additions come from the secondary market.

And in that case, many of the transactions are happening in the hundreds of dollars, not the thousands of dollars for our equipment as individuals buy and sell equipment from each other. When you couple that with things like 0% financing or what we've been able to do with refurbished units, we're able to somewhat address short-term dislocation from consumers. And of course, we can always, with reasonable confidence, depend on our large subscription business, which generates more than 60% of our revenue and over 90% of our profit.

Taking a longer view looking at the consumer, of course, we don't know how AI is going to play out. But -- and what that will do for the job market or job security. But what we do see in our case is that, that magic formula I described that combines equipment plus human coaching as such fundamental elements of what we do means that this is not a product that's really likely to be replaced by AI. So we feel pretty good about that longer-term impact on the consumer. So I think in general, this is a pretty comfort in the storm.

That's very helpful. So let's talk about the commercial business. You mentioned a few moments ago, I know we've studied it quite a bit. Definitely, I would say, -- I would view it as kind of a reinvigorated effort on the part of Peloton. So I guess you mentioned the new products. But I guess the way I want to frame the question is, what's Peloton doing now to really position the company, the brand better for that commercial opportunity? And as investors, how should we think about the timing of when this is going to start to take shape?

Yes. Let me provide a little bit of context on this one. If you go back a few years ago before Peloton bought Precor because the foundation of our commercial business unit is Precor, which we own. That business historically had somewhere we estimate around 5% to 6% share of the commercial fitness equipment market. Fast forward to today, we think we have only about a 3% share of what's about a $10 billion or so market growing pretty healthily, mid-single digits at least.

So we actually know what the formula was to be at the old 5% to 6% share for Precor, right? And that was the right level of investment in the sales team and account management and ensuring that we were refreshing the product and delivering equipment that gym operators considered cutting edge. We never lost the focus on producing really high-quality trustworthy equipment, and that's foundational because it means that we never lost the trust of the gym operators. But we've got to get back to the right, having the right-sized sales team, giving them the right sales support and ensuring that we're continuing to innovate on the product.

So that's a lot of the focus on the Precor side. But then we have the ability to also turbocharge our commercial business with the Peloton brand. And that's where this announcement we made 2, 3 months ago about the Peloton commercial series comes in. We've never had commercial-grade Peloton equipment before, designed for heavy-duty gym usage. We're talking about 10-plus hours per day of usage with people constantly adjusting the seat, for example, on the bike and using the tread almost without stopping.

But that's Precor's sweet spot. What gym operators have said since I joined the company was, well, we love what Precor does for us, but there's only one brand of equipment that our members or prospective gym goers ask for by name, and that's Peloton. If you could give us the Precor industrial-grade equipment with a Peloton experience, we'd love that. And so we announced the commercial series. We will launch that later this calendar year. And at that point, I think you can look to the combination of the revitalized Precor plus the Peloton to start to really accelerate the growth of that business.

Now we had a terrific Q3, 14% growth. I have indicated, including in our earnings at the end of Q3 that we had some really tough comparables in particular, in our Q4, the quarter that will end at the end of this month. That was a consequence a year ago of many gym operators trying to get orders in before the increased tariff rates kicked in. So this was, if you recall, a couple of months after Liberation Day. And so there was a rush to purchase equipment at that time a year ago. But as we fast forward to later this calendar year, I think we can feel really good about the growth prospects for the commercial business unit.

And help us understand the -- if you think about the customer, so you built out this sort of say commercial network, gyms you mentioned. Is that -- is it the same customer there that may have a Peloton device at their home? Or is this a new customer? And then how would you think about the usage there?

Yes. It's a little bit of both. So what we know most recently from our research is that just under about 1 in 5 Peloton residential members also belonged to a paid gym. And so there's definitely overlap between those categories. And that's terrific, right? Those are people who are really taking care of themselves. They're probably doing cardio at home, sometimes outside, and they're probably doing strength training in a gym using equipment that's there. They may be swimming. We encourage all forms of activity.

But there are also a lot of people, right? We've only got just under 6 million members at Peloton. There are a lot more people who belong to gyms than that. And so it's a huge population of people that we would love to expose to a Peloton experience, not because we have any belief that they would leave their gym or any desire for them to do so, but rather because we think that having Peloton become part of their diet would lead to a healthier diet overall.

And are gyms the big commercial opportunity? And I've also -- I noticed personally, Peloton now this was not the commercial grade Peloton, Peloton in a number of hotels. So as you think about where the commercial opportunity, you mentioned gyms, but is it hotels and other type of, I guess, commercial settings as well?

Yes. Our commercial business unit serves everything from residential multiple dwelling units, so think apartments, condos, where you have a shared facility to hotels, to universities, to workplace gyms, all the way up to big box commercial gyms that have near constant usage of the equipment. And historically, we've really only had on the Peloton side, the same residential equipment to put in that full array of locations.

But as we look forward, we have what we call the Peloton Pro Series, which is terrific for a multiple dwelling unit, even the right kind of hotel environment. But then as we get to those heavier usage locations, those really call for an industrial-grade solution. And that's where the expertise of Precor comes in so valuably because we can combine essentially the Peloton body with the frame and the experience of Peloton and you get a best of both worlds.

So shifting a little bit, talking about the commercial opportunity, where are we just on the overall development of products? There have been a number of enhancements and new products launched recently. So from your perspective, kind of where are you on the development of products? And what should we be expecting to come out here in the not-too-distant future?

Well, I probably won't do a major product announce here, but I'll try to give you at least a sense of how we look at this. So first of all, what we really offer is an integrated experience that cuts across, as I said earlier, hardware and software and content from our instructors and our community. So what are some of the things that we have done, right? I talked about launching the cross-training series. That was basically a very deliberate pivot on our part to embrace the trend toward people doing more and more strength training in addition to cardio, which we think is really the optimal combination, right?

People should be doing both. So making sure that we had the benefit of a pivoting or parading screen on every piece of equipment that we ship, making sure that on our plus series of equipment, we're introducing computer vision that can track your -- count your reps, monitor your form and actually give you form feedback as you're lifting weight and even suggest when it's time to go up in weight or if your form is breaking down, maybe even to drop down a weight.

So that was a pretty big advance and a combination of hardware and software to enable that. We also launched something called Peloton IQ a few months ago, and that's us using AI to augment what our instructors do. One way to sort of look at what we have at Peloton, right, is you've got 6-ish million members, and you've got just under 60 instructors. So we've got a ratio of about 100,000:1.

Every one of our members deserves to have a personalized plan from us. And so Peloton IQ allows us to add this element of deep personalization on top of what our human instructors do so that every member is getting a plan and getting feedback about how they're doing. And that system is just continuing to evolve. So I think what you can expect on the software side there is to see ever more flexibility in how we interact with the member.

Right now, the input method is a fixed list of goals, for example, from a member, but that should be an unstructured open dialogue with a member and one that can more dynamically change over time.

In terms of content, we've been investing in more, what I would call, more strength instructors, focusing on sort of soft strength. Over the last few months, we added 3 instructors in areas like Pilates and Barre also. We've been experimenting a lot with things like kettlebells, making sure that we double down on strength at this time when that's so important for many of our members.

In terms of what to expect, I won't give you too much except I will point you to a little announcement we made last week, and I just -- I'll try to contextualize this. We acquired a start-up relative -- we've actually been around for a few years, but we're still had small numbers of equipment out there in the Pilates space. I'm not here to make a big announcement of it, but what we've -- in this category.

But what we've realized is that there is a potential, we think, to deliver experiences in the Pilates space that are similarly revolutionary to those that we've delivered in the cardio spaces of cycling and running and rowing. We're still in the R&D stage there, but we've got some great now technology to augment what our internal teams are working on. And so I'm really excited about our future.

What about pricing? You took a price adjustment not that long ago. I guess I'll phrase the question, how do you think about pricing now? That was -- if I remember correctly, it was the first price adjustment you had taken -- I'm talking about the membership, first price adjustment you've taken in a while. But how do you think about pricing now and going forward?

Yes. I mean, the price that we charge needs to reflect the value that we deliver. And we -- as you noted, Brian, we hadn't taken a price increase in more than 3 years. That was despite the fact that there had been really substantial improvements in our product during that time, great investments in content, including the addition of dozens of new programs, as I mentioned earlier, hiring new instructors to focus on areas that were demanded by our members, the introduction of Peloton IQ, which I talked about earlier and which we made available to 100% of our members regardless of when they bought their equipment.

And so we felt like at that point, given everything that has transpired over the prior few years, including quite a lot of inflation on top of those improvements in the value we delivered that it was appropriate. And we're only going to do price increases when we feel like we've delivered a real step change in value for our members. So that was the case. And it's not something that we're going to signal in advance, but you need to expect big improvements before we were to do something like that again.

And on the topic of conversations, you mentioned just a few moments ago, the overlap you have [indiscernible] with your members and then those who have memberships at physical gyms as well. So one of the questions I get a lot from clients is they're looking at Peloton and the revitalization of the brand of the company. It's where does Peloton fit in this either health club or more broadly the wellness landscape? And who does Peloton really compete with? So I'd love your perspectives on that.

Yes. As I think I indicated with our magic formula, we're pretty unique. There are lots of hardware companies out there, lots of companies making gym equipment. But that's just one of the things that we do. There are lots of companies that make software for fitness, let's say, apps, but that's a really small part of what we do. There are plenty of trainers out there in the world. Again, we've got the best of them, but it's just part of what we do. There are companies that make apps that bring people together in terms of fitness communities. We do that, too, but no one brings it all together.

So we're the integrated experiences company that doesn't actually have anyone else in our class. It also -- because of the uniqueness of what we do and the relationship we've built with our members, we think it opens up the opportunity for us to become what we're referring to as a total wellness provider. And what I mean by that is not forsaking being the world's best connected fitness company. Of course, that's the foundation for anything that we'll do, but it means evolving into a connected wellness company as well and helping our members in all of the domains that can make a difference in the quality of their years on this earth in addition to the quantity of those years.

So it's addressing all of the areas that we can behaviorally influence cardio, strength, nutrition and supplementation, sleep, recovery. These are all areas where mental well-being. These are all areas where we can make a difference for our members, and they can also act as ways -- new ways for us to meet new members and bring them into the Peloton community because not everyone is going to find us through running or cycling or rowing. Some people, for example, in the future will find us through strength. And that's terrific. Any positive behavioral change, any positive activity is something that we want to play a role in encouraging and making a difference in people's lives at scale.

So discuss about your marketing. So I've noticed -- I first noticed what I think is some fresh TV commercials. So maybe you can talk about that. But then also just how you -- the messaging and the kind of the means of which you're talking to potential or even existing members at this point.

Let's divide that into potential versus existing members as you framed it, Brian. So for potential members, I think we're really getting now sharp on what we stand for, right? And we stand for the joy of movement. And you could see that in the recent campaign that we just did featuring Hudson Williams that garnered more than 60 million organic social views. I mean, it put us back in the center of the [indiscernible], which is where we belong.

Now I do want to note that at the same time that we're really reconnecting with that sense of fun and joy that is what not only gets people to start an exercise regimen, but to more importantly, stick with it. We remain really disciplined about our approach to marketing. So the formula we use is pretty simple here, which is that we'll spend up to or at least close to the point where the last marginal customer that we acquire has a higher lifetime value than the amount we paid to acquire the customer, right?

Spending up to that amount, we think is the way to drive our business most efficiently, but spending anything beyond that number is just irrational. So we're not going to do it. And when you look at how that played out mathematically, actually in Q3, the last reported quarter, we were able to deliver an average. So this is not the last marginal customer we acquire because we have to do that at the campaign level. But on average, it resulted in an LTV to CAC ratio that was 2x. So in a pretty healthy range, certainly what we're targeting.

Now the other part of the equation is what do we do with existing members. And for the existing members, we don't have to spend a lot of money marketing to them because we know who they are, and we know how to reach them. So the really important thing there is for us to make sure that we're delivering relevant messages and constantly re-earning their trust.

And so we've put in place a strategy to move from what most companies do, which usually is called CRM, right? That's customer relationship management, to something that we're calling PWM. I'm coining acronyms here. It's what we're calling personal wellness management. And the idea is that once you become a member of ours, every communication we do to you should be helpful to you and personalized. It shouldn't be about us. It should be about you and how we help you achieve your goals and become a better version of yourself.

And we're still relatively early in this journey, but AI makes this possible because it enables us to deliver dynamic personalization at scale so long as it sits on top of this mountain of human judgment and ultimately, the respect for every individual in our community and ultimately, right, is built on the idea that we're humans on both sides of that communication.

That's very helpful. So I know our time is going to wind down here, but I do want -- I want to -- there's 2 financial topics I'd love to discuss, maybe one easier than the other. But firstly, on the cost controls, Peloton has done a fantastic job over the last couple, maybe 3 years now, really controlling costs well to allow the company to get back to this point of growth.

So the question I want to ask there is you look at the cost model now, is it where it needs to be? Are there still opportunities to control costs, particularly in the event -- the possibility that maybe sales remain sluggish a bit longer?

Yes. I mean, first of all, I'm so proud of what this team has done. FY '25 savings of $200 million plus on an annualized basis. By the end of this year, we are on track to deliver another $100 million of annualized run rate cost savings. And all of that has basically meant that our operating expenses have -- excluding restructuring, have decreased by $50 million or 16% year-over-year just in Q3. And if you look at G&A, which is a particular area of focus for us, that's come down from the low to mid-20s percent of revenue to the mid-teens. So we are in a much better place now than we were. And the consequence of that, right, is what we've shared, right, that we're targeting to deliver somewhere in the vicinity of $350 million of free cash flow for FY '26.

As we look forward to your question, Brian, I think the future efficiencies are likely to be more surgical, not these types of programs that we've run the last couple of years. But there is still a lot of opportunities, for example, in using AI to optimize Software-as-a-Service spend.

The other couple of things I'd note are, given the work that we've done over the past few years, focusing on efficiency is now ingrained in how we run our business. And so that's what enables us to feel confident in our future and know that we'll continue to find efficiencies.

Also, you may not see our efficiencies manifest in the same way in the future. So a lot of what we're doing on our team right now is designing equipment that can be more cost effective. And that won't result in -- I mean, if we end up selling equipment for lower prices, it may not manifest in lower spend as a percentage of revenue, but it will allow us to charge less money, which means that we're going to get more sales units, and we're going to get more customer acquisition for the same investment in people as we were making for equipment. So I think you'll see the efficiencies manifest in a different way.

That's very helpful. And then the final question is balance sheet. Another big positive for Peloton has been the balance sheet and particularly the outsized cash balance. But I know you and your team have talked recently about making the balance sheet more efficient. So I guess the question I want to ask is kind of maybe any update on those -- that prior commentary with respect to the debt, cash, et cetera.

I mean I think the big update here is that our new CFO, Sid Thacker, is starting 2 weeks from today. And we do intend to go through a credit ratings process. I think it we'll have a much better credit ratings process. It will be the first one, by the way, in the history of the company. We'll have a much better process because we'll have a great CFO in the seat. And so I think that's something that I look forward to supporting Sid on. But I'm confident from all my conversations with Sid that we're going to be able to stick to the same framework that we've already laid out, which is that we're going to be focused on reducing our cost of capital, increasing our flexibility, reducing dilution and ensuring that we still have the capital that we need to support our operations and investment in the future.

Obviously, with where we are right now, which is rapidly approaching 0 net debt and having this pretty predictable subscription part of our equation, we don't need the cash -- as much cash as we have on our books. So you can count on us to make some moves here. We just want to do it the right way. And so we're being disciplined about the framework and making sure that we have a process with the right people at the table.

Well, Peter, it was nice chatting with you. I appreciate your time. Congratulations on the ongoing success here at Peloton.

Thank you so much, Brian.

Welcome. We'll get started here. I'm Jon Komp, Baird's analyst, covering the active lifestyle sector and very pleased to have Peloton with us next. And Peloton, as you may know, is the global leader in the connected fitness category with annual revenue of about $2.4 billion.

Company is well known for its premium fitness hardware, including the Bike, Tread and Row and along with the sector's most engaging instructor-led content with roughly 2.6 million subscribers on the Connected Fitness side today, we're pleased to have Peloton and President and CEO, Peter Stern. And the company, as you'll hear today, is really approaching its next chapter here having dramatically improved the efficiency and the operating capabilities of the business and looking for new avenues to growth really behind connected wellness and moving more out of the home. So Peter, welcome. Thank you for joining.

Jon, thanks for being here, and thanks for your loyalty as a Peloton member.

That's right. We were just comparing notes as loyal Peloton subscribers for many years. Peter actually joined in 2016.

So Peter, you're obviously no stranger to the fitness category in consumer subscription businesses and now approaching 18 months as CEO of the company. Maybe just start by walking through some of the key changes you've made to the company and really the shift in focus here as you pivot from improving operating efficiencies back towards growth.

Sure. So the first thing that we did was we put in place a formula for driving improved performance for the business that's really centered around our members. There's 4 elements to that. The first one is improving member outcomes. Because if our members actually feel better, get fitter, have more fun, that's going to drive their loyalty and word of mouth. And we've made tremendous changes in the last 18 months along those lines.

We replaced our entire product lineup in Q2 of this year around the holidays. And we also introduced Peloton IQ, which uses AI to deliver a completely personalized experience for our members. And we have a road map to follow on both of those that I think is really exciting. Second thing we did was introduce a strategy that we call meet members everywhere, right? To start to grow our business, we're going to need to be able to connect with members in many more places.

A couple of things that we've done along those lines are introducing our micro store concept. These are 300 square foot stores that are vastly more efficient than the old in-line stores that Peloton had and are now helping us meet people in the places where they shop. We launched 10 of those in Q2 of this year, and we have another 10 or so coming along. Another example of what we're doing to meet members everywhere is some of the work that we're doing in our commercial business.

The third part of the strategy is making members for life because we know that fitness is something that you need to commit to over a really long time, like Jon has with Peloton and I have as well. And that's also what drives value in our business, right? The lifetime value is driven by both the amount that the members pay us in any given year times the number of years. And so we've made real changes, for example, the introduction of something called Club Peloton, which is the first loyalty program for our members as well as a lot of blocking and tackling, making sure that members have options when it's -- when they're considering their -- what to do next and giving them, for example, the opportunity to pause a subscription rather than just to cancel it.

And then last but not least, along those lines is what we call business excellence. We have made such substantial changes in terms of the discipline with which we run the business that we've delivered enormous improvements in profitability and EBITDA and our balance sheet. I'm sure we can get into all of that later.

All of this is with the backdrop of a broader strategic objective of transitioning Peloton from not just being the world's leading connected fitness company but to being the world's leading connected wellness company. And the reason for that is that fitness markets are big, but wellness markets are huge. Global Wellness spend is around $7 trillion. And so as we open our aperture, we increased the range of opportunities available to the company and the vectors for growth that we can pursue.

And I think that's a good place to maybe talk about the markets that you see how they're developing. I mean, Peloton plays in a bunch of different markets, cardio, strength, wellness, recovery, maybe more to come. What do you see as the biggest opportunities as you brought in the focus more towards the total wellness market?

Yes, Jon, the way I look at our end market is -- basically, it's the entirety of areas that address human health span. And by health span, I mean the quality -- the number of quality years we enjoy on this earth as distinct from lifespan, which is just the sheer number of years that we spend on this earth.

When we start to look at what drives health span, right, it's things like your cardiovascular capacity and endurance. We see that, for example, every 4 points improvement in VO2 Max -- hopefully, people have heard of the VO2 Max measure of your cardio capacity. Every 4 points improvement in your VO2 Max results in somewhere between a 15% to 20% reduction in all-cause mortality. So we're absolutely committed to doing everything we've been doing with cycling, treadmills, rowers, but also making those products more accessible.

Strength, equally as important as cardio. And I think we're all becoming more educated about the importance of strength for your metabolic function, it's muscles are the best glucose sync that we have available to us, for bone density, for reducing the risk of a catastrophic fall for avoiding what's called sarcopenia, right, muscle wasting that happens for some people when they get on GLP-1 drugs. We already have 2 million or so of our members who engage in strength activities on a regular basis. And we have a substantial R&D agenda in the strain space to do a lot more there.

Mental well-being is another category that's really important. It is in fact the largest driver of the distinction between health span and lifespan which has now exceeded 10 years in the United States. And issues with mental health have risen to epidemic proportions, especially among young people, whether it's stress, anxiety, depression, ultimately even things like substance abuse. Many of those can be addressed, not fully, not all of them, but in a significant way with things like mindfulness practices.

And we at Peloton have over 1 million of our members who are engaging on a regular basis on things like sleep programs and meditation. So we've taken an asset that we built called Breathwrk, and we've been pouring our content into that in anticipation of a broader relaunch of something that we think will be the world's leading mental well-being app.

And then just to take another sort of look at our approach to this space. Peloton was really founded around in-home workouts, but gyms are a critical place where people can make a difference in their health span. And I'm so happy that we own Precor as a business. It's a good business, and it provides a foundation for us to not only scale that leading gym operator, but also bring Peloton into new places as well. All of these basically add up to, I think, a tremendous array of opportunities for growth for the company.

It's interesting to hear all the opportunities, those don't seem like themes that would be subject to macro sensitivity, but how do you view business in total relative to more uncertain macro conditions?

Yes. First of all, fitness as a category. We looked at very large macro disruptions like the 2008 financial crisis. And it turns out that fitness weathered that incredibly well. People will cut investments in themselves pretty close to last on the list. So we think the category overall is a relatively stable one during difficult times. Certainly, for Peloton our revenues come from subscriptions, which are quite sticky. And as long as people again, continue investing in themselves, we should be all right on the subscription side.

On the equipment side, which is roughly 30% of our revenues. There are so many ways to get into Peloton at this point. We're generating over half of our subscriber gross adds from the secondary market. So that's people selling old Peloton equipment, which still works like new and giving it to someone else who will love it again.

And when you look at whether it's that secondary market or the things that we can do with refurbished equipment or some of the programs that we've put in place like 0% financing or special pricing for things like first responders and health care workers and teachers our ability to promote our equipment when we need to, our launch is something called repowered, which is a Peloton mediated secondary market that unlike, let's say, Facebook marketplace means that a seller can put their equipment on the market and not require a buyer to have to show up at their house. You can have professional delivery, pickup and delivery. All of these are ways of ensuring that we keep Peloton's entry price affordable in case we run into macro headwinds.

There's a lot I want to come back to, but it's probably a good point to talk through the improvements you made as a business, the operating structure, the balance sheet, the leadership team. So maybe expand there a bit.

Yes. So let me try to walk through each of those in turn, Jon. I'll start with the operations, we have made enormous progress there. We are on track over the course of this year to reduce our operating expenses on a run rate basis by $100 million a year. We have now reached the milestone where we're generating over $1 million of revenue per employee in the company. The turnaround in our financial fortunes on the operating side has been, I think, nothing short of miraculous. And the consequence of that is that the balance sheet has dramatically improved as well.

Over the course of the last year, we've reduced our net debt by 70%. We have at the end of Q3, $1.13 billion in cash. We are rapidly therefore, approaching basically a net-zero debt situation. And that creates all sorts of options for us, which I could scarcely have envisioned given where the company was even a couple of years ago. And we've made, I think, similarly stunning improvements on the leadership team that we have at Peloton. Just I'll focus on the 3 most recent of our leadership hires.

Megan Imbres, we brought over from Apple to be our Chief Marketing Officer. For those who've been tuning in. You might have seen our Hudson Williams ad that has gone absolutely viral. That -- that's the kind of thing that, for a CMO, you hope happens once in a career. And in Megan's case, it happened in her first year at the company.

We brought on Sarah Robb O'Hagan, as our Chief Content and member Development Officer about 3 months ago, Sarah has an absolutely stellar background, having been the President of Equinox, President of Gatorade, CEO of Exos performance coaching company, really the absolute perfect person and really the only person in the world I would trust to manage our incredible cadre of instructors, and she is already off to a very fast start there.

And then I'm so pleased that we recently announced that Sid Thacker will be joining as our CFO in less than 3 weeks. Sid joins us from Rent The Runway. And he's both brilliant and a wonderful person, and I hope many of you as investors get a chance to know him as I have. He's going to do great things for Peloton.

That's great. Lots of heavy lift in improving across the board here. investors ask often about subscriber growth. So maybe talk about the health of your subscriber base, some of the metrics you look at? And any outlook commentary more generally, you're willing to share?

Sure. I mean there's a pretty simple formula for subscriber growth, right? It's the number of gross adds. So the number of subscribers you get minus your churn, so minus the subscribers you lose. And if you just look at the trajectory for Peloton, it's heading in the right direction, right? The rate of declines in gross adds has been improving year-over-year-over-year for the last 2, 3 years. At the same time that we have experienced either roughly stable or declining churn each year on a declining base.

The last time I spoke about this was on our Q3 earnings and at that time, I stated that we anticipated that we would be roughly flat with last year for churn. And that's despite the fact that we did a pretty significant price increase in Q2 of this year aligned with the introduction of a whole bunch of new value for our members. So if you just look at those 2 lines, they will, at some point in the future cross if the trends that I just described continue.

The question for my management team and for me is can we bend the trajectory of those lines. And our principal focus is on the gross add side. And the way to move that is one for us to be able to innovate in the existing categories in which we operate and make our products, for example, more accessible, more affordable to be able to introduce more ways to get to know Peloton, things like the micro stores that I mentioned earlier or our investments in third-party retail.

But ultimately, the thing that will really cause the lines to bend is our pursuit of new businesses in that wellness space that I described, unlocking new vectors for growth. Those are the things that will really kink the curve on gross adds. And then if we continue to deliver the enviable churn rates on the enviable churn rates that we have as a company, that's what gets it back to subscriber growth.

In the meantime, I'm pleased with the progress we've made on revenue growth. After all, this is a business and revenue and profit are pretty much what defines success. In Q3, we were able to deliver our first quarter of positive revenue growth in quite some time. We simply have more levers to play with in the short run on revenue, things like the growth of our commercial business unit, our content licensing, pricing, equipment sales. Those are things that deliver revenue and value for the business, but they don't translate directly certainly not immediately into substantial numbers of subscribers in most cases. So that's where we are in the business.

Looking at the hardware refresh from the second quarter, what did you learn? And then what are you willing to share about the product road map here and the R&D that you have in store?

So the product refresh in Q2 was the launch of what we call the Peloton cross-training series. What we saw really as soon as I joined the company, was this newfound excitement among consumers around the world, in part driven by the launch of GLP-1 drugs, which really became available in large numbers in 2022, 2023 toward adding strength training into a cardio regime, a regimen. And so that's what led us to launch the cross-training series, which included not just the ability to have a swivel screen across every piece of our equipment, which made our floor exercises more accessible to people.

But on all of our plus line of equipment, we used Peloton IQ and our AI capabilities to do things using computer vision like giving people form feedback on their exercises, advising them when it's time to go up or if necessary, down in their weights and even count their reps. So we're really starting to play the role of a personal trainer for them.

And the cross-training series is doing great. If you look at the Net Promoter Scores, Remember, this Net Promoter Scores are on a scale from minus 100 to plus 100. All our products right now are delivering over 70 on Net Promoter Scores, which is an extraordinarily high NPS level. So people are feeling great about it.

Now in Q2, we had in that quarter built into our models and assumption around a very high upgrade rate among our members into that new equipment, and that did not materialize. I view that less as a statement about the cross training series and more about a statement about the level of satisfaction and inertia that our members have with the equipment that they already possess. And given that we make 90% plus of our profit on the subscription business, it has no long-term consequences. And so Q2 was basically a blip from a forecasting standpoint, but you saw that it didn't impact Q3.

In terms of the innovation road map, an investor conference is not the moment for big product reveals. But what I can say is that we have a really robust R&D agenda. The near-term focus is on ensuring that in the largest of our current categories, we're able to ensure that our products are competitively priced and continue to be the absolutely best in class.

With a slightly longer time horizon, our focus is on new modalities. Going back to what I talked about in terms of kinking the curve on gross additions of subscribers, that requires us to break into new areas. And without being terribly specific about what we're doing, our focus is more on strength in that area.

I've got a laundry list of things I hope to add to my home gym, so we'll see. Maybe expanding a bit more on the revenue opportunities outside of just simply adding subscribers. Talk about the commercial business unit. It had a nice growth quarter in Q3. But if you could share more about Peloton and Precor, the positioning and really the opportunity.

Absolutely. So the commercial business, that market segment, we estimate globally is around $10 billion. And Peloton through Precor and the small Peloton for business line do somewhere around 3% market share. If you just go back in time a few years, Precor itself had roughly 5% to 6% market share in the commercial space.

But it has been -- the company really sort of disinvested in Precor. So we see a relatively clear path back to at least the 5% to 6% that Precor had before. That's things like reinvesting in our sales force and account management, it's revitalizing the product road map for Precor. It's providing the kinds of sales support that the team needs to succeed out in the marketplace, for example, with things like financing. So we've got a great team in place at the commercial business unit that's working on all of that kind of blocking and tackling and has the institutional memory to know what it feels like to win in that space.

But we've also given the commercial business unit, the capabilities of Peloton. When we talk to gym operators, they -- every one of them says that there's only one equipment brand that gym goers ask for by name, and that's Peloton. And there has never in history, been a piece of Peloton equipment that was built for a heavy-duty gym environment.

We just announced a couple of months ago the Peloton Commercial series. It will launch by the end of this calendar year. And we have a great deal of inbound interest in that equipment. They'll start with a treadmill and a bike, that are designed to stand up to the demands of a gym where you can have 10-plus hours a day of use on that equipment. And it will bring together the industrial prowess of Precor with the leading experience of a Peloton piece of equipment and design for gym environments. So we have very high hopes for that business.

I do want to reiterate something that I pointed out to folks though in last quarter, which is that our upcoming Q4 in that space has some tough comps. About a year ago, there was a lot of noise, if you recall, about tariffs. Independence Day had recently happened and there were -- there was an influx of orders that took place in last year's Q4. So although our Q3 this year was plus 14%. I wouldn't expect, at least for this quarter to come that you'll see that again. But again, that should just be a temporary moment and then we should be in a great place on the CBU commercial business unit.

That's great. Maybe expand also the licensing and nontraditional opportunity, both fitness and other wellness categories.

So one way to look at Peloton is we are a massive TV network for fitness content. In any given year, we produce about 10,000 episodes of extremely high-quality fitness programming with amazing star instructors. And historically, we've always monetized that through our All Access Membership, which comes with our equipment or it's part of the equipment experience, and with our apps, both App+ and App One. But given that we've already produced that content, and so the costs have already been expanded, there is opportunity for us to bring that to others and monetize it further. And we've done that in the past, for example, by our multiyear deal with lululemon to provide the programming for their mirror customers.

But I'm so pleased with our recent deal that we announced and launched with Spotify. This puts us in front of hundreds of millions of people in countries around the world. exposing the Peloton brand to people we would never have met before. Peloton today is only in 6 countries, Precor is in 60, but Peloton is only in 6 and so Spotify gives us an order of magnitude increase in the number of countries in which we operate. And we're getting paid for it. And we've already seen a significant fraction of the usage of Peloton content by Spotify members taking place in countries outside the ones where we currently operate. So it's a great source of growth and brand building for us.

We've also been doing something even within our own house along these lines, which is putting our Peloton content, the sleep and the meditation content into our Breathwrk app. which can then act as a new on-ramp for people to get to know Peloton and for us to build subscribers.

Certainly easy to access in those channels, too. With the minute we have left or so, I'll just ask on the balance sheet and outlook for strategic capital allocation. Should we expect to hear more soon on those topics?

Yes. I mentioned that Sid Thacker is going to be joining as our CFO in 3 weeks, and I want to give him a little bit of time to settle in before we make any big pronouncements or decisions even in that area. But we have a pretty straightforward framework for how we're thinking about capital allocation and we're privileged to actually be able to implement a framework like that because of the amazing progress that we've made on our balance sheet.

So for us, we're focused on reducing our cost of capital. We're simply paying interest rates that are too high. We're looking at being able to reduce dilution. We know that matters a lot. We've been trying to manage for example, stock-based compensation and try to find ways to engage in shareholder-friendly actions with regard to our capital allocation.

We want increased flexibility to be able to do things like buybacks if we decide to do that. Right now, we're limited by our covenants. And last but not least, we want to make sure that we've got the dollars set aside to invest in our future, whether that's organic investments or the right kind of shareholder-friendly and focused M&A. So all of that is what drives our decision-making on the capital structure.

I know we covered a lot of ground. I want to thank you and James Marsh for joining today. Peter and James will be available over in the Rockefeller foyer for a few minutes for a breakout session. So please join me in thanking Peter.

Thank you, Jon.

Thank you.

Good day, and welcome to Peloton's Third Quarter Fiscal Year 2026 Conference Call. [Operator Instructions] 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.

Thank you, operator. Good morning, and welcome to Peloton's Third Quarter Fiscal Year 2026 Conference Call. Joining today's call are Peloton Chief Executive Officer and President, Peter Stern, Interim Chief Financial Officer, Saqib Baig; and Vice President of Financial Planning and Analysis, Scott Burch.

Our comments and responses to your questions reflect management's views as of today only and will include forward-looking statements related to our business 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.

Please refer to our SEC filings, today's press release and our earnings presentation, all of which can be found on our Investor Relations website for a discussion of our material risks and other important factors that could impact our results.

During this call, we will discuss both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP financial measures and definitions for our user metrics are also provided in today's press release.

I'll turn it over to Peter.

Thanks, James, and good morning, everyone. Our Q3 results are proof that the strategy of evolving Peloton from a connected fitness company to a connected wellness company is delivering results. This strategy is in direct response to consumers not only wanting to add years to their life, but also life to their years.

Peloton's content, equipment and beloved brand position us to capture more market share within the growing $7 trillion global wellness economy and to achieve ever greater human impact.

As I've shared in prior calls, there are 4 pillars to delivering on our strategy: one, improve member outcomes; two, meet members everywhere; three, make members for life; and four, business excellence.

Let's start with our progress on improving member outcomes, which is how we empower them to live fit, strong, long and happy. During the quarter, over 400,000 people took our HiLit classes with Rebecca Kennedy. This contributed to 48% growth in our Pilates modality, which is becoming a central plank of our strength program and an area where we are investing both in R&D and instructors as exemplified by the 3 we onboarded last quarter.

Speaking of R&D, our work on producing new equipment in one of our existing modalities is progressing well, and I look forward to introducing some exciting new hardware and features to you this fall.

In the space of mental well-being, last week, we launched 140th Peloton instructor-led meditation and sleep classes in the Breathwrk as well as daily meditations and [ breath work ] programming that will begin to develop that app into a preeminent platform to help people relieve stress, sleep and achieve better focus.

To further our progress in improving member outcomes, I'm delighted to celebrate the arrival of Sarah Robb O'Hagan, our Chief Content and Member Development Officer. Sarah brings a wealth of experience, serving an executive and Board of Director roles for various well-known brands in the fitness space including Exos, Strava, Equinox, Gatorade and Nike.

Sarah is focused on accelerating innovation across our content ecosystem, driving engagement and in so doing, deepening loyalty across our community by evolving the member experience.

Second, let's talk about our strategy for meeting members everywhere. This part of our strategy is how we grow our Peloton community. Last week, we announced big news in this area, our content licensing partnership with Spotify. This partnership brings more than 1,400 Peloton classes across strength, pilates, bar, yoga, meditation, outdoor and cardio to hundreds of millions of Spotify Premium subscribers globally, exponentially growing our reach.

Our work with Spotify provides a powerful entry point into the magic of Peloton, allowing us to efficiently grow our brand through a platform that people everywhere already know and love while also providing a high margin, diversified revenue stream. We expect to bring hundreds more classes to Spotify Premium subscribers each month.

Our commercial business unit is another way we can meet members everywhere by reaching people in tens of thousands of gyms across more than 60 countries. In Q3, we delivered another quarter of standout growth in this unit, as revenue increased 14% year-over-year.

To build on this momentum, we recently announced the Peloton Commercial Series, which includes a new bike and treadmill specifically designed for heavy traffic gym environments. This equipment, which brings together Precor's industrial-grade durability with Peloton's unsurpassed connected experience, will become available to gym operators in Q2 of fiscal '27 and will help us continue to grow Peloton's international footprint and gym presence.

We see tremendous upside in this category as we estimate that we have only a 3% share of the more than $10 billion and growing global commercial fitness equipment market segment.

And I'd be remiss if I didn't mention our recent ad campaign featuring Hudson Williams. This campaign went viral because it's a glorious demonstration of the joy of movement that drives everything we do at Peloton. I want to congratulate Peloton's marketing team, led by Megan Imbres, which has delivered more than 60 million organic social views and significant global earned media buzz, helping us put Peloton back in the center of the Zeitgeist, where we belong.

Third, let's talk about our strategy of members for life. This is where we work to keep the members we have. Initiatives such as Club Peloton, personalized plans from Peloton IQ and some reactivation offers we implemented in Q3 helped us deliver net churn that was 7 basis points lower year-over-year in Q3, despite the price change we implemented in Q2. These results demonstrate the substantial value we provide to our members.

Last, but certainly not least, is our strategy of business excellence. I believe the numbers here speak for themselves, as we achieved an important milestone of positive year-over-year revenue growth in Q3, along with growth in gross margin, adjusted EBITDA and free cash flow. Free cash flow increased $56 million or 59% year-over-year.

While our Q4 expectations reflect that our path to sustained year-over-year revenue growth will not be linear, the underlying vectors of growth have never been clearer. As our business model evolves, we expect investors will see our growth materialize in total revenue first, driven in part by revenue streams like the commercial business unit and content licensing.

I'm also pleased to share that we expect Peloton to achieve positive net income on a full year basis in fiscal '26, in addition to our previously stated goal of positive operating income. This would be the first time in the company's history that we have achieved either of these metrics for a full year, let alone both.

We have rightsized our cost structure, in particular G&A and are now delivering in excess of $1 million of annualized revenue per employee, and we are well positioned to continue delivering innovations in cardio, strength, commercial, mental well-being, content licensing and beyond within a disciplined envelope for R&D spend.

Strong financials and consistent cash flow have resulted in a vastly improved balance sheet. We ended Q3 with a 70% reduction year-over-year in our net debt. Add all this up, and from a financial standpoint, we are no longer operating defensively. Instead, we are operating from a position of profound strategic optionality. This enables us to move to a new stage of financial maturity, characterized by strategic capital allocation.

In anticipation of the expiration of the prepayment penalty on our term loan at the end of this month, we are evaluating every avenue to maximize shareholder value, including debt optimization, capital returns and accretive strategic investments.

With meaningful excess cash on the balance sheet, we have the luxury of patience. We are actively finalizing our holistic capital allocation strategy, evaluating alternatives, including share repurchases, debt optimization and potentially highly targeted investments. Finalizing and executing on this plan will be a key agenda item for our permanent CFO once they are seated.

And speaking of a permanent CFO, our search is progressing well. We have met numerous qualified candidates, and we are gratified by the strong interest they have shown in Peloton.

As I wrap up these remarks, I want to reiterate my confidence in Peloton's future. We continue to make great progress on deepening our relationships with our members, growing our opportunities to reach new members globally, diversifying our revenue streams and planting new seeds for future growth, all while continuing to strengthen our financial foundation.

With that, I will now pass it over to Saqib, who I'm very grateful to for serving so ably as Interim Chief Financial Officer and who will share more details on our financial results.

Thanks, Peter. In Q3, we achieved total revenue of $631 million. This exceeded our guidance by $6 million and represents positive year-over-year growth. Our performance relative to guidance was driven by higher Connected Fitness equipment sales across Peloton and Precor brands.

We ended Q3 with 2.662 million ending paid Connected Fitness subscriptions in line with the midpoint of our guidance range. Q3 average net monthly paid Connected Fitness subscription churn was 1.2% and improved 7 basis points year-over-year.

Moving to gross profit and gross margin. As a reminder, in Q1 of fiscal 2026, we began assigning executive compensation and other corporate overhead expenses associated with corporate facilities across the P&L, as we focused on driving more accountability from cost at a functional level.

Prior to fiscal 2026, these costs were all recorded to G&A, but are now assigned to COGS, sales and marketing, G&A and R&D. All of the year-over-year changes discussed today reference last year on an as-reported basis.

Total gross profit was $327 million in Q3, an increase of $9 million or 3% year-over-year. Total gross margin was 51.9% in Q3, an increase of 90 basis points year-over-year and 210 basis points below our guidance of roughly 54%.

Lower total gross margin relative to guidance was driven by opportunistic promotions across our Connected Fitness equipment sales. We operate within strict LTV-to-CAC hurdle rates. And as we saw a 2x LTV-to-CAC ratio, we see an opportunity to get more aggressive. Please refer to our investor presentation for the segment-level breakdowns for revenue and gross margin.

Total operating expenses, excluding restructuring, and payment and supply settlement expenses; were $267 million in Q3, a decrease of $50 million or 16% year-over-year, reflecting the continued progress we have made in rightsizing our cost structure. We remain on track to achieve at least $100 million of run rate cost savings by the end of fiscal 2026.

We also continued to deliver strong profitability with $126 million of adjusted EBITDA, an increase of $37 million or 41% year-over-year and close to the midpoint of our guidance range. Q3 free cash flow of $151 million represented an increase of $56 million or 59% year-over-year.

Turning to our balance sheet. We ended the quarter with a strong cash position of $1.13 billion, a decrease of $53 million quarter-over-quarter. This decrease was driven by paying down roughly $200 million of convertible debt when it reached maturity in February, partially offset by strong cash flow generation in the quarter.

The significant progress we have made in profitability is reflected in our net debt of $173 million, which decreased $412 million or 70% year-over-year. Similarly, our gross and net leverage ratios have improved meaningfully to 2.9 and 0.4, respectively.

As Peter mentioned, we are focused on strategic capital deployment. A key element of this is managing dilution through a disciplined approach to equity compensation. Our stock-based compensation expense decreased $15 million or 22% year-over-year in Q3.

Next, I would like to take time to provide context for the financial outlook for the remainder of the fiscal year. Our full year fiscal 2026 total revenue outlook of $2.42 billion to $2.44 billion reflects an increase of $10 million at the midpoint compared to prior guidance and 2% revenue decrease year-over-year at the midpoint. The increase relative to prior guidance is primarily driven by higher equipment sales observed in Q3.

It is worth noting the anticipated content licensing revenue associated with Spotify partnership we announced last week was already reflected in our prior revenue guidance and will be recorded to the subscription segment.

Our full year fiscal 2026 guidance for total gross margin is roughly 52.5%, which reflects a decrease of roughly 50 basis points relative to prior guidance and an improvement of 160 basis points year-over-year. Our full year fiscal 2026 guidance range for adjusted EBITDA of $470 million to $480 million is in line with prior guidance and an 18% year-over-year increase at the midpoint.

Our Q4 guidance range for ending paid Connected Fitness subscription is 2.55 million to 2.57 million. Our guidance reflects an expectation that our average net monthly paid Connected Fitness subscription churn rate will be roughly flat year-over-year in full year fiscal 2026 despite the price change we implemented in Q2, while gross additions are expected to decrease year-over-year as a result of lower equipment sales.

Generating meaningful free cash flow remains a top priority for us. We expect full year fiscal 2026 free cash flow to be in the vicinity of $350 million.

I will now hand the call back to the operator for Q&A.

Before I turn the call over to the operator, let me ask a couple of questions from our retail investors. Our first question comes from the leaderboard named [ Vic83 ]. His question is, can you clear up some of the confusion around Section 232 tariffs? Are your products exempt? And what is the new view on tariff impact for the year? Do we expect a refund on previously paid IEEPA tariffs? Peter?

Thanks, Vic, for the question. Tariffs are, as you know, a moving target. So we follow it closely. First, the equipment we manufacture here in the U.S. is obviously not subject to tariffs at all. For everything else, based on the tariff policies that are currently in place, imported Peloton and Precor hardware are no longer subject to the Section 232 tariffs on aluminum and steel content, but they do remain subject to all other applicable tariffs, which include the MFN tariffs as well as Sections 122 and 301.

Regarding IEEPA, we're closely monitoring the updates from U.S. Customs and Border Protection on when we'll be able to submit our refund request. Our request is somewhat more complicated than the initial round of requests, but we will submit that as soon as the CBP is ready to receive it.

The changes that I just described, along with various inventory ins and outs, drive a net benefit to our tariff exposure. So we expect tariffs to represent roughly $30 million of free cash flow exposure for our full year '26, which is a reduction of $15 million relative to the $45 million that we shared last quarter.

Thanks, Peter. Our second question comes from leaderboard named [ John H. Schreiber ]. Please provide an update on the company's capital allocation plan, now that the balance sheet has been significantly improved, thanks to several quarters of positive free cash flow? Can shareholders expect the share repurchase plan to be announced soon? Peter?

Thanks for this, John. It's amazing what a difference 2 years have made in the strength of our balance sheet. And so it's my great pleasure to address your question from where we sit today.

As you may know, our $1 billion term loan has a $10 million prepayment penalty that expires at the end of this month. So we haven't wanted to touch that until then. At the same time, we are accumulating cash on our balance sheet, thanks to our disciplined operating approach. And at the end of the quarter, you heard Saqib say that we had about $1.13 billion in cash, and that's after paying down the $200 million of convertible notes that came due during the quarter.

We're now approaching zero net debt. And we need a lot less cash than we have on our books to operate our business, given the steady cash flows that our subscriptions business, in particular, generates. So all of this gives us, what I referred to in the remarks as, profound strategic optionality.

And so we're working with our banking partners on our plan. We're not ready to discuss the details of that plan right now, and this is ultimately something I want to craft in conjunction with our new CFO once they're onboarded, but I'll tell you the 4-part framework that we're using.

First, we're trying to reduce our cost of capital. Our current term loan was entered into at a different time and under very different circumstances. And so we believe there's an opportunity to improve our borrowing rates.

Second, we're trying to increase our flexibility. Our current term loan limits our ability to engage in shareholder-friendly actions like stock buybacks, and we'd like to reduce those types of restrictions.

Third, and you heard Saqib talk about this, we're working hard to find ways to reduce dilution. There are lots of ways of achieving this. We're already taking steps by reining in stock-based compensation and by moving to net settlement of restricted stock units rather than selling to cover for some of our executive officers. But we're evaluating what else we can do here, including your suggestion of a repurchase.

Fourth and last, we're making sure that we have the capital we need to operate our business sustainably and to invest in our future. And this includes rigorously vetted organic and potentially inorganic investments. We'll have more to share on all of this after we've concluded our CFO search. But we have the luxury of time, given the strength of our balance sheet.

Great. Thanks, Peter. Sheri, you can open the line for Q&A.

[Operator Instructions] And our first question will come from the line of Simeon Siegel with Guggenheim Securities.

Peter, I just want to make sure I understand the response to leaderboard member, John, I don't remember the full name, but it was great. How are you thinking about the timing for the strategic actions? Are you suggesting it's a next month thing? Is it a wait for the CFO thing? Just any help on timing, given the balance sheet really is in just such a different place than you were before. So that's been great to see.

And then just a quick follow-up comment on the dilution because you mentioned it twice. I think you changed some approaches to how management is paid and incentivized late last year. Can you just speak to your philosophy around executive comp now? And maybe what types of hurdles you think we should be judging you on going forward?

Absolutely, Simeon. And congrats on the new gig, and we are so happy that you're back in the family. I'll take the first part, and then I'll have Saqib talk about dilution and some of the changes on comp.

So as I said, first of all, we do have the ability to be patient. It doesn't mean that we feel patient, but we have the ability to be patient here. And as you know, debt maturities can span many years. And so we think it's unwise for us to rush the process, in particular, and I didn't talk about this in my answer to [ John Schreiber ], but we intend to go through a credit ratings process prior to doing any refinancing. And we want to make sure we do that right the first time.

It will be the first time that Peloton gets rated. And of course, as you know, the rating has a very substantial implication on the rates that we would pay over the years of that new debt instrument. So we think we get a better outcome, both on cost of capital and flexibility if we're a bit patient and do it right.

And certainly, that includes having a permanent CFO in the seat. So once they're there, we would begin that credit rating process. We'll evaluate the results of that credit rating process, and that will basically guide the pacing of any further actions we take, including the refinancing.

Why don't we -- I'll go to Saqib now, and he can talk a little bit about the dilution questions.

Yes, sure, Peter. The impact of stock-based compensation on share dilution is top of mind. And reducing the dilution over time is a top priority for us. So we are taking steps to reduce dilution. We are doing it through a net settlement program for equity vesting for select executives as well as ongoing disciplined approach to equity compensation. Let me give a little bit more color on that settlement program.

So in that program at equity vesting, the company withhold some of their vested shares rather than issuing and selling shares in the market to cover for employee taxes and deliver only the remaining shares to employees.

Regarding our disciplined approach to equity compensation, you all can see that in the sequential improvement we have been making in our stock-based compensation expense, stepping down from $300 million in fiscal '24 to $230 million in fiscal '25, and we are tracking around $200 million in fiscal '26. Looking ahead, we see this expense continuing to step down in fiscal '27 and beyond.

We have also taken significant steps to pay more on performance-based awards in our organization, and we have structured our SBC awards to better align with this approach going forward.

One thing you guys can also note is we are awarding fewer RSUs over time. For example, if you compare our 10-K disclosure in fiscal '25 versus fiscal '24, you'll notice a substantial reduction in the number of shares granted.

And one thing I would also like to highlight is because the compensation structure has a multiyear grant, we recognize the benefit over time due to the impact of grants vesting from prior year.

One moment for our next question, and that will come from the line of Arpine Kocharyan with UBS.

So churn has surprised to the upside for more than 3, 4 consecutive quarters for Peloton here. Peter, do you see churn turn stabilizing enough for you to then think about the delta between subscribers that are churning annually versus gross adds and how you look to close that gap over time?

Thanks, Arpine. We feel good about our Q3 churn results. Ultimately, your question goes to, I think, when do we reach the point where the two lines of our gross adds and our subscriber churn cross such that we get to net adds in subscribers. So let me talk a little bit about what we're seeing there.

On gross adds, while the number is still declining, the year-over-year rate of decline in gross adds in Q3 of this year is lower than last year. So we're seeing a decelerating rate of decline. And then on churn, after adjusting for the impact of our pricing changes, we're also seeing that our net churn rates are improving on a year-over-year basis.

Putting those two things together, if that keeps changing in the ways that I've described, then we would start to see subscriptions growth. And a big goal for us as a management team is on how we accelerate the pace at which that convergence happens, while making sure that we do it in a sustainable and profitable way because as you can tell from our results, we remain really disciplined in our marketing spend, so that our burden, LTV-to-CAC ratio remains efficient.

In other words, we will not engage in unnatural acts to bend this curve. Ultimately, the way forward here, the way to move the needle on gross adds is through our investments in R&D, which will result in us introducing new products that are more accessible in our existing categories while launching new categories as well.

I do want to point out that in the meantime, while we wait for subscribers to turn, we have a lot of vectors for revenue growth that don't result in paid Connected Fitness subscriptions. So you'll likely see inflections in growth -- in revenue before you see them in subscribers.

And this past quarter was an example of that. So some of the vectors that are at play this quarter and will be in the future are selling additional equipment to our existing members. That doesn't generate more subscriptions, but it does generate revenue. The revenue from our commercial business unit, which we talked about earlier, and that grew 14% year-over-year in the last quarter; that's predominantly equipment based. It doesn't come with very many subscribers.

The Spotify deal that we just announced is a revenue driver. But those aren't our subscribers, those are Spotify's subscribers. The pricing changes, again, that was a real positive impact in Q3. No subscribers attached to that, but real high-margin revenue.

And then even the promotional levers that you saw us pull in Q3, which helped us beat on revenue, don't come with particularly more subscribers or it's an indirect connection, but it does generate the revenue. So that's a little bit of which should help tide us all over while we wait for the ultimate growth in subscribers.

One moment for our next question and that will come from the line of Youssef Squali with Truist.

Nice to see you guys making real progress on some of these important KPIs. So maybe a couple of questions. One, maybe talk a little bit about the promotional intensity you saw in Q3. I think you called that out as one of the drivers of gross margin. And try to reconcile basically your Q4 guide for Connected Fitness subscribers with your comments around churn being relatively flat.

So maybe just give us some color as to what's going on outside of maybe the seasonally weak period that is this quarter we're going into. Is there anything else going on maybe you're pulling back on the promotional intensity that you've done in Q3?

And then just one last one. Peter, you talked a little bit about new hardware coming in this fall. Maybe can you just provide some preview of what those may be? I think, new modalities -- would strength be part of it? Would a cheaper tread be a part of it? Just any kind of color you can provide, knowing that, obviously, you'll provide a lot more this fall, more details.

Thanks, Youssef. There's a lot in there. So let me do my best to try to cover all of it.

As I said in my remarks, we use an LTV-to-CAC framework to drive our marketing and our promotional spend, right? And that -- we like that framework because it's inclusive of everything from how much money we spend on marketing to how aggressive we are on promotions. And what we saw about a month or so into the quarter was that we had real marketing efficiency. And so we took that opportunity to do a couple of things.

One, we had a promotion that was planned to expire sometime toward the end of February, and we extended that promotion an extra week or so. We also saw an opportunity to take a little bit of a deeper price promotion on a variety of our pieces of equipment throughout the sort of back half of the quarter, in order to take advantage of that. And we were still able to land our LTV to CAC at 2x, which is in our long-term goal range for LTV to CAC. So that's basically what happened in Q3 on that front.

We don't have any plans to repeat that activity in Q4, so our guidance reflects the expectation that our gross additions will continue declining year-over-year, and that's just us remaining disciplined and also being increasingly, I think, sophisticated about the best times to be promotional, right?

So we've done a lot of work, looked at our successes and our failures in the past. And we see that the periods where we acted in Q3 are some of the most productive ones. And Q4, as you mentioned, seasonality on the churn side, is also of a seasonal period for equipment sales as well.

So now turning to your question on gross adds and our guide, the seasonality we just talked about, you raised that as well, that is something well known in our business. I also talked about pulling back on promotional intensity and remaining disciplined in our marketing investment. And so all of that basically adds up to the Q4 that we're projecting.

With regard to the question that you had about our new equipment, for competitive reasons and because it's an earnings call, not a big product reveal moment, I'm not going to comment specifically on our unannounced hardware today, but I'll just elaborate a bit and say that, one, bringing more price accessibility in our existing modalities is a top priority for us.

We have the ability to do this in the bike category because we've been able to take advantage of the large reservoir of refurb inventory that we have available to us, but we have not had a similar opportunity in our other categories. And so that's really driving our R&D in that area.

With regard to new modalities, I want to note that they do take a little longer because we're building from the ground up. But as you mentioned, I will remind you that we're already a leader in the strength category. We have roughly 2 million of our members engaging with strength every quarter.

And we see an opportunity to broaden our equipment portfolio in that category, and I wouldn't even view that as a singular opportunity. I think there are multiple opportunities for us to pursue that category, which we define as all forms of resistance training. So I hope that tides you over.

One moment for our next question. That will come from the line of Doug Anmuth with JPMorgan.

It's Bryan Smilek on for Doug. I guess just two questions. Obviously, good to see the acceleration on the commercial series and revenue overall. Could you just elaborate more on the demand pipeline and how the product and go-to-market strategy is changing, especially as you launch the new products in 2Q '27?

And then I guess, more so on the marketing side, Peter, you talked about managing towards that 2 to 3x average LTV to CAC. Can you talk about some channels where you're seeing some of this efficiency and spend that allowed you to get those deeper promos throughout the quarter?

Yes. Thank you. I can start with the commercial business. So we -- just to double click on the Q3 performance, as Peter covered in his remarks were that CBU grew year-over-year 14% in Q3. As we look ahead in Q4, we expect CBU revenue growth to be a little softer in Q4 due to elevated CBU revenue in Q4 of last year, as we experienced increased demand ahead of tariff surcharges, which were announced in Q4 of FY '25. So I just want you guys to have a context with that.

When you think about the long-term growth potential for the commercial business, we see tremendous opportunity. We estimate that we roughly have around 3% of a growing $10 billion commercial fitness equipment segment market share. The commercial fitness market is expanding as we observed rising global health awareness, we're seeing growth in gym and corporate wellness centers and also an increased demand for digitally enabled fitness facilities. And all of these things drive demand for our high-quality equipment.

And we believe we have multiple growth vectors. A lot of them are going to play in the long run, but some of them in the short term as well. First, growing the legacy Precor business, and we can do that through sales enablement, channel partnership, investing in our strategy account. This is the core of our CBU business today.

Second, we see an opportunity in investing in commercial product road map. As you just highlighted that this quarter, we announced the Commercial Series, which will feature a bike and tread built specifically for high-traffic gym floors.

This is a milestone that combines Peloton Digital fitness leadership with Precor trusted industrial scale. And we have received great feedback, two of the leading industry events in this space and look forward to bringing these market -- into the market in fiscal '27.

The third thing that I would like to highlight is the opportunity for international expansion, which is a big opportunity for CBU by leveraging Precor's existing global presence to grow the Peloton brand. Currently, we believe CBU is underrepresented outside of the U.S., and we believe we have significant room to grow our market share internationally.

Doug (sic) [ Bryan ] let me cover the second question that you asked, which was about the various channels that we have and their impact on our LTV to CAC.

So let me focus on our first party versus our secondhand sales versus our third-party sales. In 1P sales, we saw good efficiency on web. And of course, a lot of that is driven by our e-mail marketing. We have a team that is just absolutely a crack team at working the funnel and getting ever more efficient at customer acquisition with the leads that we generate.

Within our first-party retail, we continue to see really encouraging results from our micro stores. And that is relative to our in-line stores, where I think our micro stores are actually now despite being, give or take, 1/10 the size of our in-line stores, they're significantly more productive than the in-line stores, and it shows some of the things that we've learned about the positioning of those stores. And that has given us the confidence to begin investing in the next round of micro stores that we'll have in line for our fiscal '27.

We also saw a good customer acquisition from secondhand sales, which in the quarter generated more than half of our gross adds. And that is influenced by our marketing, right? What we have found in our path to purchase research is that when we market to members, then that begins a process for them of discovering all the ways that they can get access to Peloton equipment. And some of them choose to do so, for example, through Facebook Marketplace or through our Repowered marketplace. And that has turned out to be very productive for us.

Relatively less productive in the quarter were our third-party retail and our Fitness-as-a-Service rental business, so those, I would say, just to round out the answer to your question, were among the less productive channels.

One moment for our next question, and that will come from the line of Brian Nagel with Oppenheimer.

So Peter, the first one I'm going to ask, I mean, I guess a little bit bigger picture. Recognizing you haven't provided official guidance beyond this current fiscal year, but on the commentary around the evolution of Peloton to more of a wellness company and some of these green shoots you're starting to see on that front, how long -- again, what's the duration? Do we see some type of -- within the total company results, a real inflection as a result of these efforts? I mean is it -- I guess is it an event that we could expect in the next fiscal year, or are we waiting longer than that?

And then my follow-up question, just to kind of tie this all together, again, I appreciate all the comments with regard to the balance sheet; the forthcoming balance sheet rework, how critical is that in order to drive this next leg of growth within Peloton?

Yes, Brian, thank you. So I think the question you're asking is how long do we have to wait until we get back to sustained growth? And there's a couple of ways of looking at that, right? One is subscriptions, the other is revenue.

And as I've shared earlier in the call, what we can expect is revenue to come ahead of subscriptions. We're not ready at this point to call when we get back to subscriptions growth, but I was very pleased that we were able to deliver a Q3 with positive revenue growth. While we won't see that likely sustain in Q4, based on our implied guidance for the quarter, I think we're now in a stage where hopefully we'll see some step forward and some steps back, as we right the ship.

And the ways that we do that are not only by continuing to build on our leadership in cardio but as we talked about on this call, starting to expand our impact into some areas like strength, where we know that there is substantial untapped opportunity and we have a really ambitious R&D agenda.

It's also in things like what we're doing in mental well-being, where we're generating now Peloton content for the Breathwrk app, and that will generate revenue, but app subscribers, not CF subscribers, which are the ones that we typically see investors tracking.

We're also making progress in some other areas like nutrition and hydration, and we'll have more to share about that hopefully in the not-too-distant future. And we also find, of course, that when members engage in multiple modalities, they stay with us longer and that can positively move the trajectory on subscriptions as well as revenue.

And so for example, the category of sleep is one where we're already a leader in sleep meditations. I made sure to take one last night before this morning's call, and I'd encourage everyone to do that. So those are some of the categories in the areas that will first get us back to revenue growth and then ultimately set the stage for the subscriptions turn.

With regard to the balance sheet, we don't need to refinance in order to be able to drive the strategy that we described, but we'd be foolish not to because we are, from where we sit right now, paying more interest than we need to.

And so that could generate additional funds for free cash flow or for investments, and that refinancing would also give us the flexibility to engage in shareholder-friendly actions like buybacks that could help reduce the float and address the dilution that we know is on many of our investors' minds.

So all of those things are absolutely on the table along with the fact that under the right circumstances, and it would require the right price and real discipline and rigor because we've worked super hard to accumulate this money, so we're not going to fritter it away.

If the right investment or acquisition opportunities come to us, we'll take those really seriously as one of the -- not the only public company in our segment of the fitness market, we are pretty common port of call for companies looking for an exit.

And if we find the right one at the right price, we would at least seriously consider that. So those are some of the things that we can do with our excess cash. But first and foremost, it's with the goal of serving our shareholders.

We have time for one last question. operator.

And that final question will come from the line of Shweta Khajuria with Wolfe Research.

I guess, could you please talk to how you think about the evolution of the business? So certainly, you spoke to the trends that you're seeing in gross adds and retention, implying that net adds could be flat at some point and then turn positive.

But as your business evolves, how do you view the overall market opportunity across commercial business unit and partnerships like the one you just announced with Spotify versus hardware sales, whereby is net adds going to be a key metric for you, if your revenue is coming from other diversified sources, so how do you think about that?

Yes, thanks, Shweta, I'll cover that. I mean, we try to be pretty practical and hard nosed when it comes to the business. So quality revenue ultimately is what matters. And by quality revenue, I mean, revenue with good margins and ultimately, really efficient cash flow generation from that.

We know that a substantial fraction of that quality revenue for us comes today from Connected Fitness subscriptions. And so that is also an important metric to us. But it's in service of the revenue metric, it's not an end metric in and of itself.

That being said, we are acutely focused on that one because we recognize its importance in our profit generation in particular. But we're incredibly excited about our ability to diversify this business, leveraging the power of the Peloton and the Precor brands. So the commercial business growth that we're experiencing is, one, because gym operators are so excited that Precor is back, right?

We were such an important supplier to them for many years. I think we took our eye off the ball for a couple of years there. But gym operators, they're all telling us they can see it that we're back, and that represents what we believe to be a sustainable source of high-quality revenue growth for many years into the future.

Content licensing is another area that's attractive for us because it allows us to leverage the investment that we've already made in content for our Connected Fitness subscribers and to generate additional high-margin revenue from that existing space.

Going back to the commercial business, the Peloton brand is woefully underexploited in that space. Again, gym operators tell us every time we speak with them that the only brand that their members ask for by name is Peloton. And so we've had people lining up to see our products when we've demonstrated at recent fitness conferences.

Those hardware sales will come with some subscribers just to tie those things back, but not at the same ratio as a household, right, where you sell one piece of equipment that's basically shared by a couple or 1 or 2 people in that household. In the case of gym, many people share the same piece of equipment. So that's a little bit about how all those things relate to each other.

But the evolution of the business is from Connected Fitness to Connected Wellness across all of the categories of cardio, both residential and commercial, strength, nutrition, mental wellbeing, sleep, recovery, realized through high-quality revenue with subscribers as a secondary metric that fuels that high-quality revenue.

Okay. Before we wrap, knowing that many of the people who participate in this call are also our members, I want to point out a few items that you shouldn't miss.

So first, check out the 2-for-1 Strength class that features Hudson Williams CoStars, Adrian and Tunde. So you too can build muscles like Hudson. I also want to encourage you to join our Live Spring Cross Training plan. Those classes have been dropping Monday through Friday, and they're also available on demand. And finally, if you're training for a marathon, be sure to try our new Pace Your Race: Marathon program that proudly features our cast of global Tread instructors.

With that, thank you for joining today, and please join me in wishing James Marsh a happy birthday.

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

Good day, and welcome to Peloton's Second Quarter Fiscal Year 2026 Conference Call. [Operator Instructions]. 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, Senior Vice President of Investor Relations. Please go ahead.

Thank you, operator. Good morning, and welcome to Peloton's Second Quarter Fiscal Year 2026 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 forward-looking statements related to our business 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. Please refer to our SEC filings and today's press release, both of which can be found on the Investor Relations website for a discussion of the material risks and other important factors that could impact our results.

During this call, we will discuss both GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP financial measures is also provided in today's press release. I'll now turn it over to Peter.

Thanks, James. This quarter, we made significant progress on our multiyear strategy of evolving Peloton from a Connected Fitness company to a Connected Wellness company, an ambition anchored in the societal shift from a focus on lifespan to health span. Peloton's platform equipment and beloved brand position us to capture more market share within the growing $7 trillion global wellness economy and to deliver ever greater human impact. As I shared in my annual shareholder letter last month, our path forward is focused on expanding our leadership in Cardio+ Strength, growing our global commercial footprint and using AI-driven personalization to help our members across a wider array of fitness and wellness domains.

As we begin the new calendar year, we are more prepared for this evolution than ever, as we have built a strong financial foundation. Our cost discipline has enabled us to reduce our net debt by 52% year-over-year. The hard work we've done to improve our balance sheet enables us to both invest in our long-term growth and as the year progresses, put in place an anticipated lower cost and more flexible capital structure. In the second quarter, we unveiled a number of exciting updates to our magic formula of industry-leading equipment, intuitive software powered by AI and unmatched human instruction. This included the Peloton Cross Training Series, our first-ever hardware portfolio refresh; Peloton IQ, our AI-powered personalized software and new instructors focused on innovative strength, yoga and Pilates offerings. We launched all of this going into our peak holiday sales period, which delivered 39% adjusted EBITDA growth year-over-year in Q2. We continue to drive higher margins and reduced operating expenses, thanks to our cost restructuring efforts.

This quarter also highlighted the resilience of our subscription business as we enjoyed strong member retention. Churn was lower than expected during the quarter with a price increase, underscoring the high value members place on our integrated experience. Revenue for Q2 came in below guidance, primarily due to fewer-than-expected equipment sales of the Cross Training Series to existing members. However, we were encouraged by the mix of existing members who purchased a new category of equipment, as more than 70% of Cross Training Series equipment sales to existing bike owners with Tread and Row products. Our installed base of equipment is quite durable, and member satisfaction is extremely high as evidenced by our consistently high Net Promoter Scores and low churn. We believe these factors likely contribute to a longer upgrade cycle than we had anticipated.

In contrast, with sales to new members coming roughly in line with our expectations for the quarter. We remain confident that our product lineup featuring the new Cross Training Series will continue to attract new members. We are also encouraged to see sales of the Cross Training Series lean more towards the + line for our bikes indicating that its premium features and camera vision-based personal coaching are important purchase drivers for consumers.

Our current marketing focus is on product education, helping both existing and prospective members discover the full power of what we've built. Swivel screens on all hardware products, more comfortable saddles on our bikes as well as + line feature upgrades, including the movement tracking camera that provides form feedback, rep tracking and weight suggestions. Reviewers from trusted publications have praised the reinvention of our product lineup, including The Wall Street Journal, Women's Health, Men's Health, PC Mag and more.

We also scaled our retail footprint to 10 micro stores by the end of October, offering capital-efficient Peloton-managed environments that showcase our hardware and educate consumers on the Cross Training Series. In Q2, micro stores drove more sales on average than our legacy showrooms and more than 8x the legacy showroom on a sales per square foot basis. In contrast, our third-party retail sales lagged expectations, so we are working with our distribution partners to share best practices in Q3 and beyond. We are committed to growing our commercial offerings and our brand touch points outside-the-home.

Our commercial business unit is well positioned to capture more market share by leveraging the strength of both the Precor and Peloton brands. Commercial showed strong performance achieving 10% revenue growth year-over-year and exceeding expectations across U.S. and international markets. In Q2, we continued to make meaningful progress in improving member outcomes. We saw a 7% year-over-year increase in workout time per Connected Fitness Subscription, a clear indication that our content and programming continue to resonate with our members and contributed to our member retention.

We also see rapid adoption of Peloton IQ which makes personal training more accessible and impactful by providing dynamic coaching that's responsive to each member's goals. 46% of active members engaged with their performance insights and recommendations during the first quarter since its rollout, and All-Access member engagement with personalized plans was up more than 10% from Q1. Based on our post-purchase research, Peloton IQ was ranked the most compelling feature by those who purchased the Cross Training Series Bike+, Tread and Tread+. We expect member engagement to increase further as we refine and evolve Peloton IQ to encompass more fitness and wellness domains.

As strength continues to grow in popularity, in part due to the broader adoption of GLP-1s, we will continue to evolve our programming to support both Cardio and Strength. We welcomed 3 new Strength instructors, all of whom premiered in December teaching yoga sculpt and Pilates. In addition to our content, we have a robust R&D agenda in the Strength category as well.

This Thanksgiving, we celebrated one of Peloton's most beloved traditions, the 12th Annual Turkey Burn. We produced a full slate of live classes throughout Thanksgiving morning, and saw a 6% increase in completed live workouts year-over-year. The Feast, our strength class featuring 6 instructors had a 24% increase in live workouts year-over-year and was our biggest live Strength class of all time. Our commitment to health outcomes is further evident in the strategic partnerships we initiated.

In October, we announced a partnership with Twin Health to deliver personalized guidance with recommended Peloton content to improve metabolic health and reverse type 2 diabetes. Several thousand Twin Health members are engaging with our Cardio, Strength, Yoga and Meditation programming.

Focusing on women's health, we collaborated with Respin Health on a 60-day study with more than 200 Peloton members experiencing menopause symptoms. Results from the program, which included Cardio and Strength workouts by Peloton and online community and coaching sessions showed that 84% of women experienced overall symptom improvement, including relief from brain fog, lack of energy, weight gain and poor memory. This further validates the impact Peloton can have on health outcomes.

A pillar of our strategy remains meeting members everywhere. Peloton was the official fitness partner of F1's Grand Prix in Las Vegas and filmed a first-of-its-kind class series on site, bringing the high-energy race vibe to members through on-demand content and immersive experiences. These classes performed well above individual class benchmarks. And according to a search lift study, the activation led to a 10% increase in brand sentiment and an 11% rise in purchase intent as online conversation pivoted toward our world-class content instructors and excitement for the partnership.

Turning to our strategy of creating members for life. We're strengthening member ties through our new loyalty program, Club Peloton, which is designed to reward our members for their engagement and consistency. Since launching on October 1, 24% of active members engaged with Club Peloton, exceeding our 20% internal target. Benefits thus far have included Peloton apparel discounts and access to exclusive live rides, depending on the members tier. Members using their exclusive Club Peloton apparel discounts drove nearly 50% of apparel purchases in Q2. We also launched 4 new official teams: Menopause Health, HYROX, Move for Life and Cross Training with 25,000 members joining one or more of them in the quarter. Business excellence remains a top priority and it shows in our balance sheet and P&L. We remain on track to achieve our $100 million run rate savings goal by the end of fiscal year 2026.

As we shared in August, we are achieving this by evolving our global operating model, thereby enabling us to invest in areas that give us a competitive advantage and most directly support our long-term growth. We recently entered into a relationship with a leading global business services provider to support and deliver some of our operational work while also expanding Peloton's presence in lower-cost locations. The progress we've made in optimizing our cost structure shows in our meaningful free cash flow generation and continued de-leveraging. Optimizing capital allocation is one of our top priorities as we believe it is critical to achieving our growth goals. While our updated full year revenue guidance does not turn positive for the year, our trajectory reflects a meaningful improvement compared to the declines Peloton sustained last year. More important, we are making this progress while improving unit economics and profitability, demonstrating our discipline in pursuing sustainable and profitable growth.

By prioritizing business excellence, we are doing what is right in the long term for our shareholders and our community of loyal members. I will now pass it over to Liz, who will share more details about our Q2 financial results and guidance for the remainder of fiscal 2026.

Thanks, Peter. We are proud of our profitability performance this quarter as total gross margin and adjusted EBITDA outperformed our guidance. And as Peter mentioned, we continue to benefit from the loyalty of our members with Q2 ending paid Connected Fitness subscriptions coming in above the midpoint of our guidance range. Q2 total revenue was $8 million below our guidance. In addition to the lower-than-expected equipment sales, primarily to existing members, revenue was also impacted by longer-than-expected delivery times, delaying roughly $4 million of revenue recognition into Q3.

We ended the second quarter with 2.661 million Paid Connected Fitness Subscriptions, reflecting a decrease of 7% year-over-year and 6,000 above the midpoint of our guidance range. Q2 is typically a seasonally stronger quarter for hardware sales and seasonally lower quarter for churn. However, we expected elevated churn in Q2 due to our subscription pricing changes announced on October 1. Following the announcement of those pricing changes, we observed a short-term lift in cancellations that quickly stabilized, resulting in stronger-than-expected retention. Average net monthly Paid Connected Fitness Subscription churn was 1.9% in the quarter, an increase of 50 basis points year-over-year.

Our churn performance demonstrates the underlying health and resilience of our high-margin subscription business and reinforces the value and human impact we deliver for our millions of members. Our better-than-expected performance on churn was partially offset by lower growth additions, which were primarily impacted by longer equipment delivery and activation times that delayed growth additions to Q3 as well as lower-than-expected equipment sales in third-party retail channels.

Total revenue was $657 million in Q2, comprising $244 million of Connected Fitness products revenue and $413 million of Subscription revenue. Connected Fitness products revenue decreased $9 million or 4% year-over-year, driven by lower equipment sales and deliveries, partially offset by a 10% increase in commercial business unit revenue and higher average selling prices for our products in our Cross Training Series.

Subscription revenue decreased $8 million or 2% year-over-year, primarily driven by lower ending Paid Connected Fitness and App subscriptions, and lower content licensing revenue, partially offset by the benefit of subscription price increases, which contributed a partial quarter benefit due to the timing of billing cycles which are spread throughout each month.

As we discussed last quarter, in Q1 of fiscal 2026, we began assigning executive compensation and other corporate overhead expenses associated with our corporate facilities across the P&L. As we focus on driving more accountability for costs at a functional level. Prior to fiscal 2026, these costs were all recorded in G&A but are now assigned to cost of goods sold, sales and marketing, G&A and R&D. All of the year-over-year changes discussed today are referencing last year on an as-reported basis.

Total gross profit was $331 million in Q2, an increase of $13 million or 4% year-over-year. Total gross margin was 50.5%, an increase of 320 basis points year-over-year and 150 basis points above our guidance of 49%. Margin outperformance relative to guidance was driven by a larger mix of Subscription revenue and higher Subscription gross margin. Connected Fitness products gross margin was 13.9%, an increase of 100 basis points year-over-year, primarily driven by lower warranty costs and a mix shift towards higher-margin products, partially offset by increases in tariff import charges and inventory reserves. Subscription gross margin was 72.1%, an increase of 420 basis points year-over-year. Subscription gross margin benefited from a $9.7 million reduction to accrued music royalties. Excluding this nonrecurring benefit, Subscription gross margin would have been 69.7%, an increase of 180 basis points year-over-year, of which 100 basis points of favorability was driven by Subscription pricing changes net of churn.

Total operating expenses, excluding restructuring, impairment and supplier settlement expenses were $320 million in Q2, a decrease of $24 million or 7% year-over-year, reflecting the continued progress we've made in rightsizing our cost structure.

Sales and marketing expenses were $152 million in Q2, a decrease of $1 million or 0.4% year-over-year inclusive of the cost assignment changes from G&A, I mentioned before that began this fiscal year, driven by decreases in fixed costs for retail stores and IT and software expenses. As of the end of Q2, we had 7 legacy retail showrooms and 10 micro stores, down from 28 showrooms at the end of Q2 of last year.

Research and development expenses were $65 million in Q2, an increase of $5 million or 8% year-over-year, driven by increases in personnel-related expenses inclusive of stock-based compensation and rent expense. These increases are primarily driven by cost assignments from G&A that began this fiscal year. General and administrative expenses were $103 million in Q2, a decrease of $28 million or 22% year-over-year, driven by decreases in personnel-related costs, inclusive of stock-based compensation and rent expenses, in part driven by cost assignments to other functional areas that began this fiscal year as well as a decrease in professional fees.

This quarter, we recognized $26 million of impairment and restructuring expenses, of which $24 million was noncash. The noncash charges were primarily related to plans to rightsize portions of our corporate office footprint, while the remaining $2 million of cash restructuring charges were primarily related to exit and disposal costs and professional fees. Adjusted EBITDA was $81 million in Q2, which was an improvement of $23 million or 39% year-over-year and $6 million above the high end of our guidance range. We generated $71 million of free cash flow in Q2, exceeding our internal expectations and reflecting a decrease of $35 million year-over-year, primarily driven by a greater inventory tailwind to net working capital in Q2 of last year.

Free cash flow performance in Q2 of this year included roughly $25 million of timing benefits in the quarter. We ended Q2 with $1,180 million in unrestricted cash and cash equivalents, an increase of $76 million quarter-over-quarter. Net debt was $319 million, a decrease of $351 million or 52% year-over-year. Overall, our second quarter profitability performance has enabled us to continue deleveraging our balance sheet. Our gross leverage ratio, defined as our gross principal debt outstanding divided by trailing 12-month adjusted EBITDA, was 3.6x in Q2, a substantial improvement from 6.2x in Q2 of last year.

Similarly, our net leverage ratio, defined as gross principal debt outstanding less cash and cash equivalents divided by trailing 12-month adjusted EBITDA, was 0.8x in Q2, down from 2.9x in Q2 of last year.

We believe we have more cash on the balance sheet today than we need to run the business and are evaluating opportunities to optimize our capital structure. We will pay down roughly $200 million of 0% convertible notes this month as they come due. Our $1 billion term loan has a 1% prepayment penalty through May of 2026. We are mindful of this timing of when this prepayment penalty expires. As we evaluate our capital allocation strategy, we expect a refinancing to deliver a lower cost of capital and more flexibility over time.

Next, I'd like to share context for our financial outlook for Q3 and the remainder of the fiscal year. Our full year fiscal 2026 total revenue outlook of $2.40 billion to $2.44 billion reflects a decrease of $30 million compared to our prior guidance, and a 3% revenue decrease year-over-year at the midpoint. The decrease relative to prior guidance is primarily driven by lower equipment sales to existing members observed in Q2. Our Q3 total revenue outlook of $605 million to $625 million reflects a decrease of 1% year-over-year at the midpoint and a decrease of 6% quarter-over-quarter as a result of seasonally lower equipment sales expected in Q3, partially offset by the benefit of higher Subscription pricing recognized across the full quarter.

We are raising our full year fiscal 2026 guidance for total gross margin to roughly 53%, which is an increase of 100 basis points from our prior guidance and an improvement of 210 basis points year-over-year, primarily driven by a larger mix of Subscription revenue as well as higher Subscription gross margin. Q3 total gross margin is expected to be roughly 54%, an increase of 300 basis points year-over-year due to a large mix of Subscription revenue as well as favorable gross margins in both segments. We are raising our full year fiscal 2026 guidance for adjusted EBITDA to $450 million to $500 million, an increase of $25 million from our prior guidance and an improvement of 18% year-over-year at the midpoint. The improvement relative to prior guidance is driven by expected favorability to gross profit and operating expenses including recalibrating media spend in response to equipment sales trends.

We also anticipate additional upside by realizing cost savings sooner than previously anticipated. Our Q3 outlook for adjusted EBITDA of $120 million to $135 million reflects an increase of 43% year-over-year at the midpoint and an increase of 57% quarter-over-quarter, primarily due to seasonally lower sales and marketing spend in Q3 relative to Q2. Our Q3 guidance for ending Paid Connected Fitness Subscriptions of $2.650 million to $2.675 million reflects a decrease of 8% year-over-year at the midpoint. Average net monthly Paid Connected Fitness Subscription churn is expected to improve both year-over-year and quarter-over-quarter, with the sequential improvement due to elevated Subscription cancellations following pricing changes announced in Q2 that have since stabilized in addition to Q3 at the historically seasonally lower churn quarter.

Our guidance reflects an expectation that our net churn rate will be roughly flat year-over-year and full year fiscal 2026, while gross additions are expected to decrease year-over-year as a result of lower equipment sales. Generating meaningful free cash flow remains a top priority for us. We are raising our full year fiscal 2026 minimum free cash flow target by $25 million to at least $275 million reflecting our continued progress in lowering operating expenses. Our free cash flow target reflects an expectation for a roughly $45 million impact from tariff exposure, in line with our expectations last quarter. Tariffs remain a dynamic situation that may change in the future.

Overall, our guidance reflects continued improvement in profitability and progress inflecting toward revenue growth. While our full year guidance reflects the 2% year-over-year revenue decline at the midpoint, this rate of decline is moderating significantly compared to last year's revenue decline of 8% year-over-year. We are balancing our pace of inflection toward growth with remaining disciplined about unit economics, ensuring the customers we acquire are profitable and continuing to optimize our costs, all of which are enabling us to invest responsibly and deliver on a path towards sustainable, profitable growth over the long term. We still expect to achieve the important milestone of positive operating income on a full year basis in fiscal 2026.

Okay. Before we move to Q&A, I want to address the news that we announced this morning regarding Liz, who will be leaving at the end of March to pursue an opportunity at a private clean tech energy company. Because of Liz' leadership, we are a significantly stronger company today than when she arrived in 2022. Liz is leaving us with a solid financial foundation and a world-class team. We've launched a comprehensive search for Liz's successor who will have very big shoes to fill. Liz, I'd love for you to share a few words.

Thank you, Peter. It has truly been a privilege to serve as CFO of Peloton. I am incredibly proud of the work we've done together to dramatically improve our financial profile, put in place a winning strategy and position the business for the future. When I leave in a couple of months, I will do so with mixed emotions, knowing that Peloton's best days lie ahead. And I really want to take this moment to thank Peter, our entire Board and our team members for the opportunity to serve as your CFO.

Thanks for everything, Liz. Now let's open up for questions.

Our first question comes from leaderboard name [ Trav Russel ]. His question is, do you expect hotel partners to upgrade to Peloton Pro products as assets reach end of life? And how should we think about the pipeline for new hospitality and enterprise relationships?

Thanks, [ Trav Russell ]. In short, yes. We launched the Peloton Pro Series so that we would have products designed for light commercial environments like hotels. And this is the first time we've actually designed Peloton equipment for commercial use at all, and it's our first ever Tread that enables use outside the home. And we also have an exciting road map of commercial equipment as we look ahead, including commercial-grade equipment, designed for heavy use environments like commercial gyms.

One thing to keep in mind is that we've transitioned the management of our commercial technical support and our field service from Peloton's residentially-focused organization to Precor, given Precor's expertise in providing maintenance and other services for higher use locations. So that should help extend the life of the products that are already out there. But our commercial business unit has a really healthy pipeline of relationships, across categories.

You can see that in last quarter's 10% year-over-year revenue growth and our expectations for continued growth looking ahead. With regard to hospitality in particular, we -- our research shows that many consumers make the choice of where to stay based on whether they have Peloton equipment. We have very strong relationships with Hyatt and Hilton, and we're in thousands of their hotels worldwide and the [Technical Difficulty] plus strength solution in a really compact footprint. So we feel great about what we can do for travelers.

Great. Thank you, Peter. Our next question comes from leaderboard named Steve-C 109. Steve asks, how does Peloton think about creating new revenue streams and deeper monetization of the brand beyond the core subscription and hardware sales. For example, are there $100 million-plus revenue opportunities in sponsorship, ads, in-person events and/or brick or mortar expansion. Peter?

Thanks, Steve for that question. I think the crux of your question is whether we can create meaningful new revenue streams and deeper monetization, leveraging our brands and our relationships. And we believe the answer to that is, yes.

While we're not exploring advertising on our platform, which is one of the ideas you just raised, we do see additional ways to monetize our content and our brand, for example, through content licensing. The largest examples of that to date have been what we've done with Lululemon Studio and with Google and the Fitbit App, but we're actively pursuing additional opportunities. We also -- you mentioned in-person events and brick-and-mortar expansion. Those are less about new revenue streams. They're more about making more of the revenue streams that we have. And we're doing that as part of our strategy to meet members everywhere.

So for in-person events, in Q2 of -- just this past quarter, our instructors appeared at more than 3x the number of events that they were in, in Q2 of the year before. And we were able to expand our brick-and-mortar retail presence to 46 states in Q2, including our Micro Stores and our third-party relationships. I spoke another vector for growth here is one that I just spoke about, which is our Commercial business unit. And that's an area where the combination of both Precor but also the Peloton brand is really compelling because what we hear from gym operators is that the one brand that people ask for by name is Peloton. And so that's another way that we can create revenue streams and deeper monetization of the Peloton brand.

We see significant additional opportunities to expand our Connected Fitness business with hardware and software innovations. So those will be additional drivers of growth. And our internal market research shows that consumers have a lot of demand and trust in us in other categories, Strength we've talked about extensively, mental wellbeing, nutrition, hydration, sleep and recovery. Those are all areas we'll share more about when we're ready.

Great. Thanks, Peter. Operator, can you open the line for Q&A now?

[Operator Instructions] Our first question will come from the line of Youssef Squali with Truist.

Hi Peter. And Liz, best of luck in your next endeavor. Maybe to the -- Peter, so the story looks great from a profitability, from a gross margin perspective. Also from a balance sheet perspective, you guys have done a lot. But top line growth remains elusive as you kind of showed in your top line report this morning. Can you maybe talk about the elements you have in place that gives you the confidence that growth is around the corner? I think if my math is right, the high end of your '26 guide implies some growth anemic, but still some positive growth in Q4. And then I guess, the miss on the top line seems to be related to existing customers, not upgrading in period rather than new customers not buying, which is good. Can you maybe flesh that out a little bit? And what's baked in the new guide as far as that's concerned?

Thanks, Youssef. There are a bunch of pieces to that. So let me try to address them all. One, we are super proud of the work that we've done on profitability and improving the balance sheet, and those are foundational for us addressing.

The second part of your question, which is relating to growth. It's clear from your question that you'd like us to do better on growth, and I'm with you on that. I will not be satisfied until this company is back to healthy sustained top line growth. And while we didn't reach that this quarter, I will note that the full year guidance that we just announced of the 3% decline at the midpoint compares favorably with last year's 8% and includes Q1's minus 6%. So as we start to look at the trajectory here, like you got last year at minus 8%, you have Q1 minus 6%. You had this at minus 3%. Obviously, that implies continued improvement as the year progresses. Again, not enough, but progress.

Let me talk about the path back to growth. And there are a number of points to that. The first one is we are developing a more complete set of product offerings across the right array of fitness and wellness categories and with the right price points. I'm not here to share our product road map today. And this is a hardware business. So that takes time, but we're making real rapid progress on this. And if you want a proof point of our ability to do that, I joined in January of last year and within months, we were shipping a completely revamped product lineup. So this is an organization that is capable of doing hard things,and producing quality products on the hardware side.

Second thing is that we got to make sure that we've got appropriate pricing for our Subscriptions. We took the key step on that in Q2 and I think it went according to plan, if not better. Third piece, we've got to keep the members that we've got in order to get to growth. So we have to keep improving our net churn, and as you can see from our results and our remarks, we're projecting net churn flat this year despite the pricing action. So the underlying trends here are absolutely heading in the right direction.

Fourth, we have to exploit new avenues for growth. I talked about the Commercial business unit. That's, again, a proof point of our ability to generate new forms of growth. In this case, we grew 10% in the last quarter on the top line there. And then, of course, coming back to the first part of your question, we've got to demonstrate that we can do all of this efficiently. So we have to have an appropriate overhead structure. We have to have a positive return on our sales and our marketing investments so that when we deliver the growth, it's real sustainable growth. And you can see that we're on track to deliver against that, including with the full year adjusted EBITDA guidance, reflecting the year-over-year increase of over 40%.

Now let me go to the third part of your question, which is to explain what's happening with the sales to existing members and the -- versus existing members. So yes, revenue missed our expectations for the quarter, but I don't think it's a reflection on the new generation of our equipment. I think that's a reflection on our old equipment. So what happened here is we simply overestimated the rate with which existing members would want to upgrade their existing equipment to new equipment. The only historical data point we had as a company on this was when we launched Bike+ a few years ago. And that was a really fundamental reinvention of the entire frame of the Bike. And so we did not, as it turns out, see the same rate of upgrade from existing members. I think that just speaks to the quality and durability of the existing equipment that our members have and the satisfaction, which I've spoken about at length with that equipment. The other side of this coin, though, is that our sales to our new members met our expectations. And so it shows that our products do resonate with prospective customers. And we step back on this, the existing members, that sales -- that impacts our revenue, but it doesn't impact our subscribers because they're already existing members. So the consequence of that is that our subscriber performance was strong, and we performed 6,000 or so subscriptions above the midpoint as a result.

I was just going to add one thing. You had asked about how the existing member sales miss influences our guidance for that half of the year.

And I just want to clarify that our guidance doesn't assume any of the softness that we observed in Q2 from lower sales to existing members, is timing and that we will see any of it in the second half. So with the holidays, the Cross Training Series launch and our Subscription pricing changes behind us, we feel we have greater visibility to revenue for the rest of the fiscal year. And really, the changes in our guidance reflect the sales mix from Q2 to existing members. And then that is partly offset by favorable Subscription revenue relative to our prior guidance.

One moment for our next question and that will come from the line of Shweta Khajuria with Wolfe Research.

Let me try 2, please. The first one for Liz. There's some noise in media coverage around the recent head count reduction. So could you please clarify how much of that is incremental, if any, at all? And what is already accounted for in the guidance already?

And then the second question is for Peter on the Commercial business unit -- of commercial business opportunity, how do you view that in terms of where you see the biggest impact? Is this a retention sort of a driver where you improve net churn because those who use Peloton are going to choose hotels and places that have Peloton equipment? Or is it a lead-gen where you are better positioned to get new subscribers? Thanks a lot.

Yes. So let me address the first part of the question first around our OpEx and the announcement that we had last week. So when we announced in August, our goal to achieve our $100 million of annualized run rate cost savings by the end of fiscal '26. We -- this action that we took in just last week was always been part of that plan. And so as of last week, we've actioned the remainder of our run rate savings plan with changes in our workforce as well as shifting work to lower-cost locations, including moving some work to a global business partner. And doing all of this from a P&L perspective, we're reducing both G&A and sales and marketing as a percentage of revenue. And that's enabling us to reinvest more into R&D while still reducing total OpEx as a percentage of revenue. And with these actions, we are on track to deliver against our $100 million cost savings target.

And then Shweta, thanks for the question about the CBU. There's been an interesting evolution in our goals regarding the Precor business since Peloton first acquired it. When it was first purchased, it was done for essentially supply augmentation for the company. Then subsequently, there was a belief that it was essentially a way of driving new subscribers for the Peloton, let's call it, residential business. But today, we've realized that the opportunity in Commercial Fitness is extremely large. It's a multi, multibillion dollar market. And we have a relatively low share there. And we're now demonstrating the ability to not only grow that business but to grow that business profitably. And so we're approaching the CBU primarily as a new vector for profitable growth for the company and to generate value for our shareholders on a stand-alone basis. And let me just talk a bit about some of those opportunities.

Some of that's just blocking and tackling, like we know just adding back salespeople, getting more focused on key accounts will help grow the business. We also have the potential to bring Peloton equipment to commercial customers through new products like the Peloton Pro Series, and also using the Precor team's existing relationships in 60 countries and with tens of thousands of gym operators. And then we also have an opportunity to reinvest in Precor's product road map.

For example, we just relaunched Precor's first Slatted Belt Treadmill. And the preorders on that exceeded expectations, and we're also seeing strong performance in Precor strength equipment, both on the plate-loaded and the free weight side. So we think this is a sustainable driver of growth on a stand-alone basis. That all being said, we know that our Peloton members are looking for Peloton equipment when they travel and that getting Peloton equipment into gyms is a terrific way for us to generate new relationships and awareness of our product. So I would view those as an ancillary but important benefit of us achieving the success with our CBU that we're aiming for.

One moment for our next question and that will come from the line of Arpine Kocharyan with UBS Investments.

So churn was overall better than what you had talked about earlier for the quarter. But you had also talked about flattish churn for the year and it seems like today, you're reiterating that guidance together with decrease in gross adds, which was also expected. Could you maybe update us now that you have a quarter behind you post price increase and kind of better churn than expected, where you're thinking gross adds trajectory could end up for the year?

Sure. So we don't actually -- we aren't providing guidance on Subscribers or on gross additions for the year. So we talked about our Q3 guidance. First of all, I do want to reiterate the fact that our churn was lower than we expected in Q2. And as a result of that, we have been able to update our expectations around Subscriptions for the end of the year. And for Q3, our outlook, we shared that as well. Q3, just to give you a little bit about our guidance for that, that is 2.65 -- our subscriber guidance is 2.650 million to 2.675 million Paid Connected Fitness subs. That reflects an increase of 2,000 subs quarter-over-quarter and a decrease of 218,000 year-over-year.

Q3 is typically a seasonally low quarter for churn. It's also a seasonally stronger quarter for new sub additions. And that's just something that we tend to say -- tend to see every year, especially with the winter months in the Northern Hemisphere. Now we're not guiding for Q3 net churn, but we do expect churn to improve year-over-year in Q3. And as Peter said earlier, we do expect it to be flat -- relatively flat on a year-over-year basis.

This is Peter. I'll just jump in a moment on gross adds because you specifically asked about that and reiterating Liz's point, we don't guide to it, but -- if we look at the last quarter, our equipment sales were roughly in line with what we expected and we had slightly lower third-party sales but slightly higher first-party sales. And so that's kind of what comprised the sales piece. But then our activations were delayed and Liz talked about the revenue impact of that in the quarter, but that was basically delayed by just delivery dates and then some sense that it was the holidays and people were taking some time to activate. So that had some impact on gross adds in Q2 that then we should flow into Q3.

Yes. I just want to reiterate that when Peter said sales were in line, he met sales to new members were in line overall with our expectations. With the outperformance really coming from first-party sales orders, again, with that delay, and then the underperformance coming from our third-party retail partners.

That's very helpful. And one quick follow-up. And I know it's probably hard to speak of exact time lines given you just introduced a bunch of new products this fall. But I was wondering if, Peter, you could talk about your broad sort of takeaways or thoughts around new hardware product road map that you're looking at over the next, I don't know, 12 to 18 months? And how you are thinking about the timing of a separate strength skew as well as your thoughts around more affordable Tread product?

Yes, Arpine, I think in the earnings call is not where we would make a major new hardware product announcement. But what I can say is that I remain incredibly impressed by the capabilities of our hardware engineering teams here at Peloton. And as I mentioned earlier they have demonstrated the ability to produce really high-quality equipment in a very short period of time. That being said, hardware is -- it takes time not only to design and engineer it, but to make sure we test it because this is the kind of equipment that people run on it and they engage in other physical activity with regard to this equipment. And so we have to be incredibly careful about it. So with all of that said, I feel very confident that we will be able to make some meaningful announcements in the next 12 to 18 months and that those will start to create new opportunities for us as a company.

One moment for our next question and that will come from the line of Eric Sheridan with Goldman Sachs.

Wishing you the best going forward, Liz. Building on some of the comments you've made so far, Peter, would love to understand where -- what you prioritize from a strategy perspective? When you think about building increased value across the member base, how should we be thinking about investments and product gains around content and the services layer and maybe even going a little bit deeper in what some of the early signals you've gotten with respect to IQ and the adoption rate there?

Absolutely, Eric. And thank you for the question. So here are some of the things that I'm prioritizing. One is delivering even more differentiated Cardio experiences. You could see that in our innovations with the Cross Training Series and the Pro Series, both of which we announced and launched on October 1. The second area is providing a much more full array of Fitness & Wellness experiences. So that's, of course, leaning into strength. Some of the things that we're doing with Sleep & Recovery, you could see that with our partnership with the hospital for special surgery, mental well-being, building on that acquisition we did with Breathwrk, and then, of course, beginning to personalize our offerings for every member, and Peloton IQ takes our personalized plans to the next level there. So that's another way for us to be able to add value for our members and encourage them to try, for example, more categories of content like getting people who are principally focused on Cardio to do more with Strength, which we know is good for the member and good for us.

In terms of your question about Peloton IQ. One, let me just start with this. I am incredibly proud of the fact that The Wall Street Journal, when they put Peloton IQ up against the AI Fitness Coaching from Apple and Google, we came out on top. And as a dedicated fitness company, I'd expect to beat them at our game, but it's still gratifying given that these are some pretty well-resourced companies to be compared against.

As we mentioned earlier on the call, nearly half of our active members engaged with their performance insights and their personalized recommendations during the quarter, and that was the first quarter that Peloton IQ was even out there. and the engagement with personalized plans among our members with Connected Fitness equipment increased 10% quarter-over-quarter. Another thing that we're seeing Peloton IQ do, is it's changing the purchasing patterns of our customers. So when we ask customers why they bought what they bought, Peloton IQ was ranked the most compelling feature by those who purchased the Cross Training Series, Bike+, Tread and Tread+. And all of this is just going to keep getting better because we plan to expand Peloton IQ to cover more domains besides Strength.

Thank you, operator. I think we're going to wrap up the call at this stage so we can get this wrapped up before market open. Thank you for joining us today. Closing remarks, Peter?

I'll just say a couple of words before we wrap up. Fitness & Wellness isn't a quarterly goal for our members, and it shouldn't be for our business either. With Peloton's disciplined operational focus, we're providing the foundation necessary to fuel continued innovation. We remain committed to returning the business to sustainable growth and we're encouraged by our steady progress. I want to highlight a few classes and programs that you may be interested in between now and the next call.

First, Rebecca Kennedy launched HiLIT, which is a 4-week high-intensity low-impact Cross Training program. For those of you who are looking to take up running this year, Kristen Ferguson can help you with her Call Yourself a Runner program, which we also released a few weeks ago. And if you haven't tried our new Strength instructors, I encourage you to take a Sculpt Flow, Pilates or [indiscernible] class with Greta, Johanna or Zacharias. Okay. With that, we look forward to seeing you on the leaderboard. Thank you.

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

Good afternoon, everyone. Thank you so much for joining us. My name is Nathan Feather, I'm Morgan Stanley's small and mid-cap Internet analyst. I'm excited to be joined today by Peter Stern, CEO of Peloton. Thanks much for joining us.

Thanks for having me, Nathan.

Yes. Before we begin, quick housekeeping item. For important disclosures, please see the Morgan Stanley research disclosure website at www.https://www.morganstanley.com/disclosures/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative.

And with that, it's been about a year since you joined Peloton, I think just under. Give us a recap of what you've changed in year 1 and your key learnings up until this point?

Yes. Well, let me walk you through both what changed and what didn't change. A lot, a lot has changed. We put in place our new growth strategy. I've communicated that over the course of the last few letters to our shareholders attached to our earnings. But we really have, I think, now a robust multiyear plan to get this business back to growth. We launched an entirely new lineup of products, the Peloton cross-training series.

Not only did we launch all new residential products, but we also launched the first ever commercial line of products from the company, the Peloton Pro series. And so in one day, we launched 9 new products in the company that previously had 5 products. We launched a new software platform headlined by Peloton IQ, which is an AI-powered personal coach and vaulted us overnight into the leading position in the world in terms of providing AI-powered personal fitness coaching. We launched a slew of new partnerships that push us in the direction of becoming a total wellness provider.

We greatly expanded our distribution footprint, including our micro stores, launching at 100 Johnson Fitness & Wellness stores around the U.S., including -- and also expanded our distribution internationally. We shored up our leadership team, making some key changes in areas like supply chain and marketing. Last but not least, we reduced our net debt by half over the course of the last year.

So that's a lot of stuff that changed. There are some things that didn't change, right? Our focus on our members and our commitment to their outcomes is, if anything, certainly strengthened over the last year. And our commitment to our shareholders and the financial discipline that my predecessors began to implement is something that my team and I remain steadfastly committed to. So those things have not changed.

In terms of what I've learned, I've learned that Peloton for its members is so much more than just a cardio company. We're a brand that they love and that they trust and that they count on for inspiration and also that they look to for so many other modalities besides just whether it's the bike or the tread or the rower that they have.

Okay. Great. Well, a lot that's changed over the past year. If we zoom forward a few years from today, interested to hear what's your vision for what Peloton can become?

So the vision starts with what we are now, right? And what we are now is this magic formula of best-in-class equipment plus intuitive software powered by AI, human coaching without parallel anywhere in the world and a supportive community of millions of members.

And so if you fast forward to what that can become, one, I'll note that although that is sort of a beautiful portrait, I think I've just described, we're painting with very few colors. I want us to become a total wellness provider. What does that mean? It means expanding not only from cardio into strength, which we have made amazing progress on in a short period of time, but also into areas like mental well-being. You can see that progress, for example, in our little tuck-in acquisition of the Breathwork app recently into areas like sleep; over time, even into areas like recovery.

You saw our partnership perhaps announced at the beginning of October with the Hospital for Special Surgery and into areas like supplements and nutrition. All of that adds up to us impacting the major levers for consumer behavior that can impact their fitness, their strength, their longevity and ultimately their happiness. All of that needs to get wrapped in an ecosystem, right? And what's that ecosystem?

It's the personal coaching that you get from Peloton IQ. It's the outcomes that you see when you adhere to that. It's the incremental commitment that you make as a member. And it's the data that you supply us as a consequence, both first party and third party that fuels Peloton IQ, creating a virtuous cycle where we can actually become an ever more impactful partner to you in your well-being journey. So that's my vision for where we go over the next few years.

Okay. Great. Well, if we bring it back to the present. I think the first step along that vision was the launch of your new cross-training series and Peloton IQ. I guess what do you feel has been most impactful from the wide variety of updates that you announced? And how has the early consumer receptivity been?

So let's start with, right, the fact that it's called the cross-training series for a very good reason. And that is that the science is clear that adults should engage in a mix of cardio, strength and other types of activities, for example, like stretching, which you can get through yoga or Pilates or lots of other modalities. And so the cross-training series was very deliberately designed to expand the range for our members of their activities so that we could drive the outcomes of making them more fit, more strong and live longer and happier. And we're seeing that happen, right? So since we launched these new products, we're seeing move, for example, toward more strength workouts.

Peloton IQ, we launched at the same time, and it was even more important than the launch of the cross-training series. And the reason that I say Peloton IQ is more important than the hardware launch is that on the day we announced Peloton IQ, we also launched it to every one of the millions of members that we have regardless of what generation of equipment they own so that they were now getting a level of AI-powered personal coaching that has never been available to people in the world.

And the consequence of that, right -- so that was available to millions of people, whereas right now, we've got to sell in the new equipment, and that takes time to impact the whole base. I mentioned earlier, we're seeing more strength workouts. We're also seeing a shift toward more workouts being launched from our home screen from the recommendations that we provide. Most important of all is that we're seeing more workouts per member. We saw a 4% increase in the month of October, and that may not sound like a lot. But remember, we're trying to impact something that is very hard to impact, which is getting people to work out more.

And so for us to see that move year-over-year so soon after we made this change gives us the confidence to know that we're heading in the right direction, and we're making a big difference for people. So we feel great about the hardware. The reviews have been uniformly positive. We feel great about the software, the quantitative impact is evident, and we get to build on both of those now.

Okay. Great. Well, despite all that positivity, new product has only been in the market for about 2 months. So it's still very early. So I guess, how long is the traditional consideration cycle for your products? And we just got past the critical Black Friday and Cyber Monday selling season. I guess, any early reads in performance there?

So consideration cycle, first of all, in this category can be very, very long. These are big investments, and people are making a commitment that they plan to keep for years. And so we see consideration cycles measured in months; for many of our customers, multiple months. And in some cases, for example, for our Tread+ product, a meaningful fraction of our customers have a consideration cycle that approaches a year. So we announced a lot of new stuff on October 1. It's going to take time for that all to percolate.

That being said, I would say right now, we're probably in the fourth inning of 9 of our holiday season because our holiday season runs into mid-January. From where we sit right now, we continue to remain confident in the guidance that we issued at the end of last quarter. And that's pretty much all I can say right now on how we're doing on the absolute level of sales.

What I can say is that we're seeing some interesting mix shifts that seem to be sticking. So what are those? One, we're seeing more of our -- more customers buy our Plus products as a percentage than the base level products. And I chalk that up to a couple of things. One is people are really excited about camera and other AI features that are available on the Plus series that allow us to do things like movement tracking and form feedback, rep counting, provide weight suggestions. I think that's captured people's imaginations.

We also widened the gap in the features and functionality of the Plus series versus standard models with everything from on the bike comfort features like the fan and the phone holder to the sound by Sonos, which allows you to have a more immersive workout experience on those products. So that's one change that has been relatively pronounced.

We've also seen a shift toward our Tread products. This is something that we were seeing previously, but we've seen even more of it since October 1. I think there may have been some people who are kind of on the fence waiting, should I buy a treadmill from Peloton and we came out with new ones and they're pretty awesome. And so that caused people to say, "Okay, it's time." We're also seeing relative to our expectations, relatively more sales to new members than to existing members. So this is a little bit more of a -- which from a subscription standpoint, I'm happy about, right? It generates more new customers. But I think a lot of people are still -- if they're existing members, they still have products that work great, and they got all the benefits of Peloton IQ.

So those are a few -- the other thing actually that we're just seeing over the last week is that we -- for Black Friday, Cyber Monday for that period, we wanted to experiment with a really aggressive refer bike price to see if we could grow our subscription market even more. And because it's -- there's good margins on that product for us because we already built it in the past, and we're selling it the second time. And it's great for the environment. So there's a lot of positive things associated with that refer bike program. And we are seeing a shift from the new bike to the refer bike over the last week or so. So just -- that's a little bit of color. Again, it's too early to call the overall, but that's what I'm seeing right now.

Okay. Well, that's great color. And along with all of the product changes you've made, you also increased subscription pricing, but encouragingly guided to churn flat for the full year. I guess what have been the key drivers that have kept churn in check? And then how has churn compared to the prior price increase?

So again, let's talk about why churn is flat for the year despite doing a price change first. That's a great question. There are a lot of factors at play here. One is this is something that you see in virtually all Subscription businesses, which is that there's a ten-year effect. The longer people have been with you, the more likely they are to keep being with you. And so we are the beneficiaries of that. In other words, your loyal customers are definitionally your most loyal customers. And so we have -- we are seeing that benefit.

The second thing is that we -- as I mentioned earlier, we're seeing an increase in workouts per member. We started seeing that in October when we launched our new software. And the most important driver of longevity in a business like ours is frequency and consistency. And so that gives us encouragement. We also -- yes, we had a blip in cancellations and pauses at the moment of the price increase, which was to be expected, right? We interrupted inertia for people. But some of that is a pull-forward effect.

There were people who are going to cancel at some point anyway. They were likely our least engaged members. And the consequence of that is that while we had this blip, then we had a really rapid moderation in the churn rate. So all of those things, when you combine it with the fact that over the course of our Q1, our churn rate was down year-over-year. We think we get back there by Q3, Q4. And in fact, we'll have a little bit of a rebound when people who paused their subscriptions rather than canceled them in Q2 unpaused those subscriptions during that time.

So that's a little bit about -- in terms of -- recall, the last price increase was in 2022. So it was more than 3 years before it's been in a pretty inflationary period during that time. But this price increase was in a very different environment. Actually, 2022, when that happened, there were still a lot of lockdowns. They were happening, then people would get out in the world, then there'd be a new version of COVID blowing through. Hopefully, that's in our distant memory now, but that was a reality. So the churn rate was a little lower for that price increase than this one. But in terms of our expectations, we're doing -- we're pleased with how this one is going, and it's going according to plan.

Okay. Great. Well, shifting over to distribution. You've been expanding in physical with a growing micro store footprint and various retail partnerships. How are you thinking about the optimal mix between digital channels and physical presence over the next, let's call it, 2, 3 years? And what's the path to get there?

I am really encouraged by what's happening, first of all, with our micro stores. For those who haven't been following along with that story, at our peak, Peloton had over 100 full-sized stores. These were stores that were 3,000 to 6,000 square feet to carry 5 products. And we realized that there's a more efficient way to do this. And so we have been gradually reducing that number of those stores, and we're in the single digits at this point of those stores remaining.

We had, at the time that I joined the company, one micro store in Nashville, Tennessee, which was very exciting. These are 300 square feet. So they're 1/10 the size of the others. And our initial read was that, that Nashville store was doing the same volume as the stores that were 10x the size. But it was a data point of 1.

So when the team came to me and said, "We'd like to try another one." I came back to them and said, "You know what, data point of 2 is probably not a statistically significant sample. Let's go for 10. And let's go see if we can replicate those results that we saw from that 1 store 10 times." Because if we can do this 10 times, I think we can feel pretty confident that we're on the right track. And it's -- again, because of this particular time of the year for us in a very seasonal business, it's too soon to draw a full conclusion.

But so far, I would say 8 out of 10 of those stores are performing at or above the level that we would have hoped for. And we're learning a lot actually from the other 2, which is great. And so I don't know what the right number of micro stores is, but I feel pretty confident it's more than 10 based on what we're seeing right now.

At the same time, so why don't we expand to Johnson's and make that big step because we had never been an independent fitness store before. We've been in DSG, which has been a great partner -- that's DICK'S Sporting Goods. But we've never been in a mix up with our competitors' products before. But what we realized in particular is that if I say at-home cycling, everybody thinks Peloton, we've got the data to prove it. But if I say at-home treadmill, not everybody thinks that yet. They should, but they don't.

And so we need to be in the place where people go shopping for treadmills in particular. And Johnson's is great because their average salesperson has 7 years of tenure. This is a retail store employee who is such an expert, so committed to their craft that they are there on average, 7 years. That's the kind of person that we trust to sell our product. And so we're very excited to be in every store that they operate in the United States. And I hope they launch more, and I hope we can help them accomplish that.

At the same time, digital retailing is incredibly efficient for us. If we could sell everything on first-party web, I'd be delighted to because it comes with no incremental infrastructure cost. So this is just a matter of making sure we got enough places where people can try it out. And given that long consideration cycle, that's important for people because it's a very considered purchase that sometimes requires hands on while also trying to keep things as efficient as possible.

Okay. Great. Well, one more on Peloton IQ, certainly a big part of the release 2 months ago. You already talked about some of the really encouraging early adoption metrics and engagement patterns. I guess how does this impact your thinking on forward software development priorities?

Yes. So the beauty of what we've been able to do with Peloton IQ is we have amazing engineers who are essentially standing on the shoulders of giants. So all the foundation models that are out there that are consuming enormous amounts of resources in terms of training models and advancing the state-of-the-art on AI, we don't have to do that work, right? What we need to do is basically leverage the amazing investments that are being made by those companies and build on top of that a set of domain-specific capabilities around everything from developing the right workout plan for you to identifying the specific workout you should do today to analyzing your form and giving you feedback on your form to even saying -- identifying things like you know it is time for you to increase your weight.

And so a lot of our focus now as a team is saying, "Well, we barely scratched the surface on this, right?" Right now, we're counting and providing formal feedback on dozens of moves. But there are hundreds of those that we could do, and we could expand that into more categories than just lifting weights and doing some basic body weight exercises. And so you can imagine additional modalities where that type of -- those types of features would be equally, if not even more so, appreciated. So that's a big part of what we're doing from a software development standpoint, and it will keep us busy, I think, for a really long time on that front.

At the same time, we've got amazing teams working on things like AI dubbing so that we can deliver our workouts from our amazing instructors in many more languages, and that will unlock more opportunities for international expansion for us in the future, which have historically been prohibitive because we're not like a typical media company. I look at -- I grew up in the media business and a really great TV show. They make 10 episodes a season. Last year, we produced 10,000 workouts. That's a lot of dubbing if you have to have human beings do the dubbing. So we need to use technology for it, and we've got great people working on it.

Okay. Well, a lot of encouraging stuff on the revenue side. Let's switch over to profitability. The company has really made remarkable progress rightsizing the cost base over the past 2 years. Do you see additional opportunities to remove costs from the business? And if so, where?

Yes. So I'm so grateful for the work that my predecessors did and that we were able to continue. When I joined in FY '25, we set a target of run rate savings of $200 million a year, and we exceeded that. This year, we set a target of saving another $100 million in FY '26 on a run rate basis. And what I would say is we're halfway there right now and feel very confident in our ability to achieve the goal that we set forth.

So yes, there's more to be done because we're halfway there. As I look ahead beyond this year, I would say it becomes more surgical in nature. And again, as we continue to inflect toward growth, it will be blended in with a mix of some incremental cost, but there'll be incremental costs spent wisely given how much we know. You count on us for that.

Okay. Well, on gross margin, you mentioned in the last call that you expect 2Q Connected Fitness gross margins to improve, at least as compared to 1Q. What's driving that? Is it related to the new product line? And long term, where do you think Connected Fitness gross margin can land?

Yes. So Q2 versus Q1 is really a pretty tough compare for Q1 because we get -- we have so much more volume in Q2 than Q1 that you get essentially a deleveraging effect on the fixed costs that we incur quarter-over-quarter. So that's one benefit.

As I mentioned earlier, we're seeing a little bit of a trend toward the Plus line. That obviously has a nice positive impact. Last quarter, we had to accrue for the Bike+ seat post recall. So that was a hit in Q1 that is in our rearview mirror, thankfully. On the other hand, Q2 is our most promotional quarter. And so that has an offsetting effect. on margins. But again, you kind of add it all up, and we should be ahead Q2 versus Q1.

In terms of where we head over time, all I'll say is I'm really pleased with the fact that we have made material progress, taking these products up from low to mid-single digits gross margins into the mid-teens, onetime issues notwithstanding. And I think there's still a little bit of continued -- a little bit more progress that we can make on that front.

Well, over the past 2 years, marketing has been another key area we've been able to find efficiencies with LTV to CAC rebounding off lows. That being said, you're still seeing net subscriber attrition. What needs to happen for you to stabilize the sub base while maintaining LTV to CAC in the targeted 2 to 3x range?

So in terms of marketing efficiency, first of all -- essentially, the way that we're running the company is we will keep acquiring a customer until the last marginal customers' lifetime value equals the customer acquisition cost. It's rational to acquire customers to that point, and it's irrational to acquire any more customers past that point.

And a lot of what we've been doing is basically building the science, which -- I think we've got a phenomenal team working on this. Building the science so that we actually know where that point is, and we can differentiate it by campaign, by channel, by country, et cetera. And that's as far as we will take the marketing, right? Now we're working to save money overall in the areas of marketing. So for example, partnerships that aren't working for us. Over time, those things will -- those will time out, getting more value for our dollars spent on media. All of those things effectively increase our marketing efficiency and allow us to spend more and get more out of the marketing that we do spend. And we will continue to pull those levers as long as we can.

Ultimately, I think turning the subscriptions back to positive will require more work on the product portfolio. We've got an amazing engineering hardware team. I look where we are right now, we have the best bikes on the market, we have the best treadmills on the market. Our Tread+, for example, that slided treadmill is -- that is a screen deal compared with any other slided treadmill that's out there, and it comes with the benefit of the Peloton ecosystem. But the fact is the majority of treadmills in the market are sold for less than our baseline treadmill sells for, and we're not in the game.

So just looking at the cardio category alone, there's untapped opportunity in the marketplace that will help over time, turn this company back to subscriptions growth. And that's just focused on the cardio category.

Okay. Now one of the company's other priorities in the past few years has been deleveraging in the balance sheet. With the prepayment premium on your $1 billion term loan expiring in May, it sounds like you're going to be evaluating your potential options. I guess what's the potential time line if you do decide to restructure the current debt load?

Yes. I'll sort of share at least the notional time line in my mind here. And of course, our amazing finance team and our CFO, Liz Coddington, are really -- they're the experts on this. But you have to look at our debt in sort of 3 tranches. There's a $200 million -- we have -- overall, by the way, we've got about $1.5 billion in debt. And we've got $1 billion of cash, which is too much. Let's start with that.

But we've got a $200 million 0 coupon slug of our debt that is coming due in February. And because of 0 coupon, we'll hold on to it until the last day we possibly can. And then we'll give back the money in February. So that's kind of already set aside. We've got $300-ish million in converts that are not within our control. They're exercisable by the debt holders for now. And so we can't do anything about that, and it's fine. It's a decent cost of capital.

And then we've got a $1 billion term loan that has this prepayment penalty, Nathan, that you talked about. At this point, it's just 1% -- but when you're looking at where we sit right now, which is 6 months out, that basically is 2% on an annual basis. I don't want to have to pay if we don't have to. So I think what we'll be doing over the next few months is developing the plan to build the right level of confidence in the debt holder community around the company and preparing for around that May time frame to refinance some of that debt, we may or may not refinance all of it.

But when we do that, we get a couple of benefits. One of those is a reduction in our cost of capital, right? So our cost of capital right now is reflective of a company that was in a very different financial position 2 years ago or 1.5 years ago than it is now. We're a consistent cash flow generator, and I think we've demonstrated now a track record of delivering on what we promise. And so it's my hope that we'll be able to refinance that debt at significantly more attractive terms, not to mention the fact that we've seen some improvement in the interest rate environment. And so that should take down our cost of capital, which will further, by the way, improve our potential for cash flow generation.

The second thing that happens when we do that is we get more flexibility. And what do I mean by that? Currently, we are restricted under the terms of that $1 billion loan from basically doing buybacks. I think there's a limited amount we can do, $15 million a year or something like that. We are limited in terms of what we could do from an M&A standpoint. And I'm not saying this means that we're going to go on a buying spree. But if we saw something that could help us achieve our vision and it was at the right price around becoming more of a wellness provider, for example, or enhancing our product portfolio, we'd be in a position to make a move along those lines, too, again, keeping in mind that the team and I are extremely focused on generating shareholder value and coming up with the right capital allocation strategy that maximizes value for you.

So we get lower cost of capital and more flexibility, hopefully, in about 6 months. That's the way I'm looking at it.

Okay. Great. And if you do refinance and have less restrictions on the use of cash in the balance sheet, how might you outline a potential capital allocation framework? Could we see potentially some return to shareholders?

Yes. I mean, again, we've got work to do here and a world-class finance team that has a number of months ahead of them before we need to make any of these choices because they're really not within our control until we were to refinance that debt in May.

But I think it's reasonable to assume that what we would do is set some target leverage ratios. And given the resilience and predictability of our Subscription business, which we feel great about, and you've now seen us do a price increase, which was long overdue, and we still feel great about the resilience of that subscription business that we've got. We should be in a position where certainly the possibility of buybacks are on the table. All of that is always weighed against something else that I hope you'll want us to do, which is to invest in our future.

And so if we see opportunities that significantly exceed our cost of capital for us to invest the money in the growth of this business, and we do so with the level of rigor and responsibility that we have demonstrated, then I hope you'll reward us for that in addition to the possibility of buying back stock, but we will certainly look at our capital allocation strategy very, very closely and in consultation with our shareholders.

Okay. Great. Well, 2 more for me. First, you recently changed your executive compensation structure to be more performance weighted. Can you talk about the changes there? And then more broadly on the company's tighter control of stock-based compensation? How does this align with potential capital allocation framework you mentioned earlier?

Yes. So we are exquisitely sensitive to dilution. We know that's important to our shareholders. And a significant contributor to dilution has been stock-based compensation. So if you look, for example, at our fiscal year '25 stock-based compensation versus FY '24, we were able to make substantial progress in reducing the total stock-based compensation outlays.

It takes time for that to actually manifest in the financial results that you see because stock-based compensation is typically given in the form of multiyear grants and vests over time. And so there is a delayed effect to that, but you can see it in what we granted. At the same time, Nathan, as you mentioned, we are moving toward a performance orientation, which is appropriate given the greater predictability associated with our business and our greater confidence in our future.

And so we have shifted a meaningful fraction of the equity grants that we make to our leadership into performance-based stock units as opposed to restricted stock units and aligned around key metrics that you would care about, both top and bottom line growth.

We also, for example, given our confidence in the company, agreed as a leadership team to implement stock ownership requirements for a number of our top executives. Now I, for one, don't need to have a stock ownership requirement to make me want to hold Peloton stock because I happen to think it's a great investment. But it's nonetheless, an indication of our confidence in our company and shareholder orientation that we made that change.

Okay. Well, this has been a great conversation, Peter. Let's wrap it up with one final thing. What are the 1 or 2 pieces you think investors most underappreciate about the Peloton story?

Yes. One thing I think is really important is to recognize that Peloton is so much more than a cardio company. And again, that's not to belittle the importance of cardiovascular fitness because it is the foundation of everything that we do in fitness. And it is so closely tied to longevity, improvements in VO2 Max to get really technical on you all, have a material impact on your lifespan. So please keep working on your cardiovascular fitness.

But I was so surprised when I joined Peloton to discover that we're actually the largest strength subscription company in the world based on the number of our members that are doing our strength workouts. And we've become, I think, ever more attuned as a society over the last few years and then driven in part by the adoption of GLP-1s and the risk to people's musculature, ever more attuned to the importance of strength workouts. And so I feel like Peloton is just at the cusp of something really, really big in a space that no one has actually -- no one has figured out.

There are some players out in the strength space, but no one's conquered that, and we're in the pole position as a strength provider. I would say the other thing is just -- just to reiterate the point that I made earlier, which is that the brand love as manifested in the enviable churn rates that we have and the member satisfaction rates that Peloton has really put us in a class of one. There is no one else in our category that does anything like what we do. And there are very few companies in the world that, for example, have product level Net Promoter Scores in the mid- to high 70s, even touching 80 every now and then. Remember, that's on a scale of negative 100 to 100.

We have a very special and precious relationship with our members. It makes us distinctive who we are, and it's what should make -- it makes me as a manager of this company and should make those of you who are investors in this company feel really confident about the resilience of this business and our ability to provide ever more value to those members and hopefully to get paid for it.

Okay. Great. Well, thank you so much for being here.

Thank you, Nathan. It's a pleasure.

Thank you for standing by. My name is Karen, and I will be your conference operator today. At this time, I would like to welcome everyone to Peloton Interactive First Quarter Fiscal Year 2026 Earnings call. [Operator Instructions] I will now turn the call over to James Marsh, SVP of Investor Relations. Please go ahead.

Thank you, operator. Good afternoon, and welcome to Peloton's First Quarter Fiscal 2026 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 forward-looking statements related to our business 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. Please refer to our SEC filings and today's press release, both of which can be found on our Investor Relations website for a discussion of our material risks and other important factors that could impact our results.

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 press release. I'll now turn the call over to Peter.

Thank you, James. Good afternoon, everyone, and thank you for joining today's call. Before I summarize our performance in Q1, I'd like to address our voluntary recall announced earlier today.

As previously disclosed, we have received a small number of reports of an original series Bike+ seat post breaking during use. As of today, we are aware of 3 such incidents. The well-being of our members is our highest priority, and therefore, in cooperation with the U.S. Consumer Product Safety Commission and Health Canada, we are voluntarily recalling approximately 833,000 units in the U.S. and approximately 44,800 units in Canada of the original series like Bike+ model. These units were manufactured from December 2019 to July 2022 and sold beginning in 2020 to April 2025. We are offering an updated self-installable seat post replacement, which is the CPSC approved remedy. Impacted members will receive an e-mail with order instructions, and the notification will also appear on their Bike+ touch screen. This recall does not impact any other equipment models, including our new cross training series Bike and Bike+.

The anticipated financial impact is reflected in our results and our guidance, including the increases to our adjusted EBITDA guidance and minimum free cash flow target. Liz will share more details about the financial impact later in this call.

Turning our attention to the first quarter of the fiscal year. I am proud of Peloton. In the quarter leading up to our October 1 innovation review. Our team once again successfully executed on our business priorities, progressed our financial results and delivered positive human impact at scale. As a result, our performance came in above the guidance range on most key financial metrics in this seasonally slower quarter for fitness equipment sales, and we continue to see year-over-year growth in average workout time per connected fitness subscription.

Looking from the outside in during the first quarter, it may have felt like business as usual. As we continue to demonstrate financial discipline and established a strong foundation for achieving our full year financial guidance. But behind the scenes, the quarter was anything but. Throughout the quarter, the Peloton team was hard at work setting the stage for our new chapter by innovating on every aspect of our magic formula of premium equipment, software powered by AI, world-class instructors and a deeply engaged community.

In last quarter's remarks, I laid out Peloton's strategy. The first and most foundational part of that strategy is our commitment to improving member outcomes. To that end, on October 1, we simultaneously unveiled and began shipping the most significant product update in our history with an all-new equipment lineup, the Peloton cross-training series and the Peloton Pro series. Our understanding of human health has progressed since Peloton took the world by storm with the introduction of the original bike. And today, we know that adults need to pursue a combination of cardio, strength and more to achieve their wellness goals. To that end, all Peloton products now feature advanced swivel screens, allowing members to easily transition between cardio and strength to complete floor workouts, including strength, yoga, Pilates and stretching.

Our new plus line includes an advanced computer vision movement tracking camera that counts your reps, corrects your form and offers weight suggestions in real time, along with voice control, enabling members to adjust weights, skip moves or pause their workout without touching the thing. We've made several additional upgrades, including improvements in audio across the board and featuring sound by Sonos in our plus line for a studio like experience.

On October 1, we also launched Peloton IQ, which gives every Peloton member of personalized coach regardless of whether they own our new cross-training series, our original series or work out with a Peloton at subscription. Peloton IQ uses AI to turn years of insights and data points, including your goals, class activity and health tech from wearable devices into personal training guidance. In so doing, Peloton IQ makes some of the benefits of personal training accessible to millions of people, providing individual insights and recommendations based on members' intentions, preferences, level of fitness and performance.

Since launching the cross-training series in Peloton IQ, we've observed a favorable mix shift toward our more premium products, including a mix shift toward tread sales and toward our plus line of products. The latter of which we believe is driven by excitement around the advanced computer vision features. Beyond our work on cardio and strength, the trust we've built with our community gives us an opportunity to address an even broader array of wellness domains.

In September, we acquired Breath work, an award-winning app specializing in breathing exercises which have been shown to positively impact sleep, focus, blood pressure, heart rate variability, stress and anxiety. The breath work subscription app makes mental fitness accessible to all and now our members can enjoy breadthwork as part of their -- all Access or -- at Plus subscriptions. We'll have more to share over time as we evolve in this important category.

We also announced a first-of-its-kind collaboration with the Hospital for Special Surgery, the world leader in orthopedics to offer Peloton members access to expert care for joint in muscle pain, injuries and orthopedic conditions. We've codeveloped class collections with HSS medical experts recently launching the first 5 on preventing some of the most common types of injuries.

We're also committed to meeting members where they are in their life stages. In response to member demand, we started with menopause, a life stage that impacts the majority of our members at some point in their lives. We're extremely proud of our partnership with ReSpin Health founded by Halle Berry to revolutionize menopause care with an integrated holistic approach and have just launched a study with over 1,000 women to measure the benefits of targeted movement strategies and other evidence-based lifestyle interventions. These findings will power our evolving evidence-based exercise programming and menopause support.

The second part of our strategy is to meet members everywhere. We have made great progress on this front over the past few weeks. We now have 10 micro stores in the U.S., up from 1 prior to Q1. And we also announced a new retail partnership with Johnson Fitness and Wellness, the nation's largest independent fitness retailer with 100 locations across the U.S. We now have a physical retail presence in 46 states. While in Australia, we launched a retail presence in 11 franchise locations throughout the country.

Our expanded retail footprint positions us well for the holiday season, providing opportunities for consumers to test and experience our new innovations. Our commercial business unit continues to show strong performance and is an area in which we are also innovating. The new Peloton Pro series offers a complete lineup of Peloton equipment for commercial environments such as hotel gyms and multi-residential buildings and includes the Tread+ Pro, Peloton's first ever commercial treadmill. And Precor launched its new commercial Tread, the Breakaway. This new Slatbelt treadmill includes a sled style push mode, cadence Coach and a new console design.

Peloton also recently became the primary fitness partner powering Utah City, a 700-acre mixed-use development outside of Salt Lake City. And now every residential building in Utah City will feature a Peloton space that includes several pieces of Peloton equipment and accessories for residents.

The third part of our strategy is to make members for life. Celebrating achievement is crucial for sticking with any program. So last month, we launched Club Peloton, our first loyalty and recognition program. As members engage with our platform, they progress through levels from bronze to legend. Unlocking exclusive content recognition and rewards. Already more than 500,000 members have engaged with Club Peloton.

On October 1, we also introduced official Peloton teams led by Peloton instructors including move for life, menopause, Hiro and cross training. These teams provide a forum for members to connect, discuss goals and learn from each other and from experts, further elevating Peloton's community. Since October 1, engagement with Teams is up nearly 50%.

Ultimately, all these strategic initiatives, product innovation, wellness expansion and new distribution are underpinned by the fourth part of our strategy. Our commitment to operational discipline and business excellence. Our full year guidance announced in August included targeted initiatives to improve monetization, such as the introduction of expert assembly fees. These were implemented within the quarter and exceeded our expectations. At the same time, our cost reduction plans remain on track. Perhaps most important, we remain confident in our ability to inflect toward revenue growth as the fiscal year progresses, building on the actions we took in Q1 and on October 1.

We continue to monitor and respond to evolving tariff policies and broader changes in the macro environment and consumer spending. While those external factors are real, our focus remains on execution and being the best fitness and wellness partner to our members. We believe we offer an unmatched ecosystem of products and experiences to help our members invest in their health and well-being.

As we enter this important holiday season, Peloton is exceptionally well positioned with great new equipment, Peloton IQ, new wellness partnerships, expanded distribution, a resurgent commercial business unit, new loyalty features, successful monetization changes and improvements in our financial performance.

I'll now pass it over to Liz, who will share more details about our Q1 financial results and guidance for the remainder of the year.

Thanks, Peter. I want to begin with our first quarter financial results in which we exceeded the high end of our guidance on most key metrics. We ended the first quarter with 2.732 million paid connected fitness subscriptions, reflecting a decrease of 6% year-over-year. Q1 is typically a seasonally lower quarter for hardware sales and seasonally higher quarter for churn. We exceeded the high end of our guidance range by 2,000 driven by higher-than-expected gross additions.

Connected Fitness gross additions outperformed our expectations due to higher unit sales of our Connected Fitness products in both first-party and third-party retail channels. Average net monthly paid Connected Fitness subscription churn was 1.6%, an improvement of 20 basis points both year-over-year and 10 basis points quarter-over-quarter, in line with our expectations. We ended the quarter with 542,000 ending paid app subscriptions, inclusive of subscriptions from our acquisition of Breath work.

Total revenue was $551 million in Q1, comprising $152 million of Connected Fitness products revenue and $398 million of subscription revenue, outperforming the high end of our guidance range by $6 million. Outperformance relative to guidance was primarily driven by Connected Fitness products revenue from higher-than-expected hardware sales of both Peloton and Precor products. Connected Business Products revenue decreased $7 million or 5% year-over-year, driven by lower equipment sales and deliveries, partially offset by a mix towards higher-priced products.

Subscription revenue decreased to $28 million or 7% year-over-year, primarily driven by lower ending paid connected fitness subscription, lower content licensing revenue and lower ending paid app subscriptions, partly offset by used equipment activation fee revenue, which was introduced in late August of fiscal 2025.

Total gross profit was $284 million in Q1 and a decrease of $20 million or 7% year-over-year. Total gross margin was 51.5%, a decrease of 30 basis points year-over-year and 50 basis points below our guidance of 52%. Total gross margin was negatively impacted by a $13.5 million accrual for Bike+ seat post inventory costs this quarter, in addition to $3 million we accrued in the prior quarter, representing a total estimated impact of $16.5 million. Excluding this $13.5 million charge in Q1, total gross margin would have been 54%. or 200 basis points above our Q1 guidance.

Beginning in the first quarter of fiscal 2026, we began assigning executive compensation and other corporate overhead expenses associated with our corporate facilities as we focus on driving more accountability for cost at a functional level. Prior to fiscal 2026, these costs were all recorded in G&A, but starting in Q1 are assigned across cost of goods sold, sales and marketing, G&A and R&D.

Connected Fitness products gross margin was 6.9%, a decrease of 230 basis points year-over-year, primarily driven by the Bike+ seat post inventory accrual I just noted. Excluding the inventory accrual, Connected Fitness product gross margin would have been 15.8%, an improvement of 660 basis points year-over-year, driven by a mix shift toward higher-margin products, lower warranty costs, a decrease in inventory reserves and lower warehousing and distribution costs.

Subscription gross margin was 68.6%, an increase of 80 basis points year-over-year. Total operating expenses, excluding restructuring, impairment and supplier settlement expenses, were $230 million in Q1, a decrease of $30 million or 12% year-over-year, reflecting the continued progress we've made in rightsizing our cost structure, as well as a reduction to advertising expenses in Q1 ahead of our hardware portfolio refresh announced on October 1.

We are on track to achieve our target to deliver at least $100 million of run rate cost savings by the end of fiscal 2026. Sales and marketing expenses were $67 million in Q1, a decrease of $15 million or 18% year-over-year, primarily driven by decreases in acquisitions, brand and creative marketing spend as well as a decrease in retail showroom expenses. As of the end of Q1, we had 7 legacy retail showrooms remaining.

Research and development expenses were $62 million in Q1 an increase of $4 million or 6% year-over-year, primarily driven by cost assignments from G&A, which were partially offset by lower product development costs from reduction in contractor spend.

General and administrative expenses were $101 million in Q1, a decrease of $19 million or 16% year-over-year, primarily driven by cost assignments to other functional areas and lower professional fees.

This quarter, we recognized $13 million of impairment and restructuring expenses, of which $8 million was noncash. The noncash charges were primarily related to asset write-downs associated with accelerated retail store closures, while the remaining $5 million of cash charges were primarily related to exit and disposal costs and professional fees.

Adjusted EBITDA was $118 million in Q1, which was a $2 million or 2% improvement year-over-year and $18 million above the high end of our guidance range. To note, the $13.5 million accrual for Bike+ seatpost inventory cost was not added back to adjusted EBITDA. We generated $67 million of free cash flow in Q1, an increase of $57 million year-over-year, significantly outperforming our prior expectation for slightly negative cash flow in the quarter.

Free cash flow benefited from tariff-related favorability associated with both lower-than-expected tariff rates and delayed timing for certain tariffs going into effect, lower operating costs associated with realizing indirect cost savings faster than anticipated, revenue favorability and other smaller impacts. Q1 free cash flow included roughly $30 million of timing favorability. We ended Q1 with $1.104 billion in unrestricted cash and cash equivalents, an increase of $64 million quarter-over-quarter. Net debt was $395 million, a decrease of $382 million or 49% year-over-year.

Overall, our first quarter profitability performance has enabled us to continue deleveraging our balance sheet. Our gross leverage ratio, defined as our gross principal debt outstanding divided by trailing 12-month adjusted EBITDA, was 3.8% in Q1, a substantial improvement from the 14% in Q1 of last year. Similarly, our net leverage ratio, defined as gross principal debt outstanding net of cash and cash equivalents, divided by trailing 12-month adjusted EBITDA, was 1.1% in Q1, down from 7.5% in Q1 of last year. We believe we have more cash on the balance sheet today than we need to run the business and are evaluating opportunities to optimize our capital structure over time.

In February 2026, roughly $200 million of 0% convertible notes will come due and we intend to pay them down at that time. It's also worth noting our $1 billion term loan has a 1% call premium through May of 2026. We are mindful of the timing of when this call premium expires as we evaluate our options. We expect a refinancing to deliver a lower cost of capital and more flexibility to our capital allocation strategy.

Next, I'd like to share context for our financial outlook for Q2 and the remainder of the fiscal year. Our full year fiscal 2026 revenue outlook of $2.4 billion to $2.5 billion is unchanged from what we provided last quarter and reflects a 2% revenue decrease year-over-year at the midpoint. Our recently announced changes to subscription pricing were incorporated into our previous full year outlook. And so far, the impact of those changes has been in line with our expectations.

We are pleased that our members continue to see the value in their Peloton membership and the recently added benefits like Peloton IQ, Club Peloton, Breath work and more. As we noted last quarter, our full year guidance anticipates an inflection toward growth during certain quarters within the fiscal year. Our Q2 revenue outlook of $665 million to $685 million reflects this expectation, with a slight increase of 0.2% year-over-year at the midpoint and an increase of 23% quarter-over-quarter as a result of seasonally higher equipment sales and recent pricing changes.

We are raising our full year fiscal 2026 guidance for total gross margin to 52%, which is an increase of 100 basis points from our prior guidance and an improvement of 110 basis points year-over-year. primarily driven by favorable tariff rate relative to our prior full year guidance as policy continues to evolve, a favorable mix of sales towards higher-margin products and our continued focus on driving cost efficiency to our supply chain. These tailwinds are partially offset by the accrual for the Bike+ depot inventory impacting Q1.

Q2 total gross margin is expected to be roughly 49%, down 250 basis points quarter-over-quarter, due to an expected seasonally higher mix of Connected Fitness products revenue. We are raising our full year fiscal 2026 guidance for adjusted EBITDA to $425 million to $475 million reflecting an increase of $25 million from our prior guidance and an improvement of 12% year-over-year at the midpoint. Driven by favorable gross profit and operating expenses, reflecting our expectation for realizing cost savings faster than previously anticipated. To note, we are increasing our full year guidance by $25 million, notwithstanding the $13.5 million accrual for Bike+ epost inventory costs. in Q1.

Our Q2 outlook for adjusted EBITDA of $55 million to $75 million reflects an increase of 11% year-over-year at the midpoint, but a decrease of 45% quarter-over-quarter due to seasonally higher marketing spend in Q2. Our Q2 guidance for ending paid Connected Fitness subscription of $2.64 billion to $2.67 million reflects a decrease of 8% year-over-year at the midpoint. Average net monthly paid Connected Fitness subscription churn is expected to increase year-over-year and quarter-over-quarter due to an increase in subscription cancellations and following our pricing changes announced on October 1. However, our guidance reflects an expectation that our net churn rate will be flat year-over-year in full year fiscal 2026. We also expect growth additions to decrease year-over-year as a result of an expected year-over-year decrease in hardware sales.

Generating meaningful free cash flow remains a top priority. We are raising our full year fiscal 2026 minimum free cash flow target by $50 million to at least $250 million, reflecting the benefit of lower tariffs, both from lower rates, and later-than-expected implementation timing and our progress on realizing indirect cost savings sooner. This target reflects our expectations for a roughly $45 million impact to free cash flow as a result of tariff exposure, which remains a dynamic situation that may change in the future.

Overall, our guidance for Q2 and the remainder of the fiscal year reflects continued improvement in profitability and progress toward revenue growth. We still expect to achieve the important milestone of positive operating income on a full year basis in fiscal 2026.

Now we'd like to open the line for Q&A. SP27461696 Thanks, Liz.

We'll begin the Q&A process this evening by taking a couple of questions from investors that send in their topics in advance. The first question will come from Bill. Leaderboard name is Life Bill asked, what is the market opportunity for the new commercial business unit? How we be approaching the new geographical markets and will successfully integrate Precor and Peloton for unified B2B offering. Peter?

Bill, I love your leaderboard name. Strategically, our commercial business unit is set up to win. First, the market opportunity is large, and we still have very low share. And when I talk to gym operators, they all tell me that there's only 1 brand that consumers ask for by name, and that's Peloton. Second, the combination of Precor and Peloton just makes sense. You think about Precor's brawn coming together with Peloton's brains and you've got something no one else can match. And let me explain what I mean by that because we've got plenty of smart people over on the Precor team.

Precor builds equipment that is truly commercial grade. It's the kind of stuff that's built to be run like 12 hours a day. And they also have the installation and service capabilities for commercial establishments. Peloton has software, content, community that's absolutely unmatched. You bring those things together, and we've got every reason to be able to win.

Bill, you talked also about a third point I'd raise, which is international. Peloton is only in 6 countries right now, but Precor is in over 60 countries. So that opens up opportunities for Peloton to enter these new markets in ways that build on existing distribution and relationships that we've already got, starting with B2B. So strategically, we're in a great place. It's just an execution challenge from here, and you can already see us executing on this. For example, Precor now provides all the installation and service for Peloton commercial locations, including hotels.

Last month, we announced Precor's first slated Tread, the breakaway with a new smarter, more powerful screen and Peloton's first ever commercial tread initially for hospitality and for multi-dwelling units was launched as part of the new Peloton Pro line. So you add all of this up, I feel great about where we are with our commercial business unit, and I'm confident we're going to be able to bring this together and deliver an industry-leading set of products and solutions on behalf of commercial clients.

Great. Thanks, Peter. Our second question comes from Christopher in San Francisco. Leaderboard named Create. Are there any plans in the next 5 years to provide for dividends? Liz, maybe you can handle this one.

Sure. So while this question is specifically asking about offering dividends, it might actually be more helpful if I take a step back and update you all on our current capital structure and talk through our perspective on overall capital allocation strategy. As many of you may recall, in May of 2024, we were approaching a maturity wall, and we successfully completed a $1.35 billion refinancing of our balance sheet.

Now following our refinancing, we have generated meaningful free cash flow with $380 million of free cash flow in the last 12 months. And we're really proud of the work that we've done to really strengthen and quickly deleverage our balance sheet with net debt decreasing by $382 million or 49% year-on-year. Our net leverage ratio really reflects the great work that the company has done to get healthy. And the deleveraging story really is a positive for our company, and it should open doors for us to be able to potentially lower interest expense in the future and also invest in strategic uses of our cash.

We do think it's still a bit early to discuss a specific framework for capital allocation, but we do expect that it will become a focus when we pursue a refinancing at the right time. Now there are a few things that I would like to highlight. We talked about this earlier, but we believe there is more cash on our balance sheet than we need to run the business today and that we are a much better credit today than when we last refinanced. Our current priority is continuing to deleverage as we believe this will maximize the optionality for us in the future and reduce our cost of capital.

Now when we think about appropriate range for our gross leverage ratio targets, we're thinking about them in terms of established frameworks, such as the public ratings framework. Ideally, we would want to align with companies that maintain high single B to BB ratings, and we think a gross debt-to-EBITDA ratio in the range of 2x to 4x is reflective of a good sustainable structure.

So with that continued deleveraging, we expect to have more capital allocation alternatives available to us, and those could include things like buying back stock, reinvesting in the business to drive organic growth, pursuing potential inorganic growth opportunities or going back to your original question, offering cash dividends.

Great. Karen, can you open it up to Q&A at this stage?

[Operator Instructions] The first question comes from Andrew Boone from Citizens Bank.

I would love to just ask about the recall. Can you guys compare this to the initial recall and just help us understand why those 2 recalls weren't combined?

Sure, Andrew. I'll cover that. This is Peter. As I'm sure you can imagine, decisions around recalls are really complicated and depend on a lot of factors. But what I can say is that the original series Bike and the original series Bike+ are different models and they're physically different pieces of equipment. And at the time of the Bike seat post recall, there were no incidents or 0 incidents relating to the Bike+.

Okay. And then just as a follow-up, I'd love to understand if there are any derivative impacts from the recall around the business, the brand. Can you guys, again, compare this to the previous recall, just help us to understand if there are any ripples that we should be thinking about the broader business?

Sure. So I can take this one. So let me just first talk about the cost impact. We talked in our prepared remarks about the $13.5 million accrual that we booked in Q1 and in addition to the $3 million that we accrued in Q4, which is a $16.5 million impact. And we do believe that, that is -- that we made the appropriate assessments and judgments around sizing that accrual but estimates are forward-looking and what actual results may differ.

For subscriptions, which I think is 1 of the things that you were asking about comparing to the prior recall, based on behaviors from our prior post recall that was in May of 2023 and which applied only to our original Bike models, our Q2 guidance incorporates a small anticipated headwind to paid Connected Fitness net churn, and that's driven by elevated subscription pauses. We expect the majority of these incremental positives to be unpaused in Q3. And so that nets out to a small drag on subscriptions for the year.

Now in terms of revenue impact, unlike our prior seat post recall, this recall effect bikes manufactured during a specific period that we no longer sell and we already have replacement seat post inventory available to begin to fulfill anticipated replacement orders. And the overall revenue impact is expected to be immaterial and is reflected in our full year guidance.

The next question comes from Arpine Kocharyan from UBS. .

So I'm going to combine 2 questions into one, if I may. And you alluded to this in your prepared remarks, but you're raising EBITDA and your revenue guidance is unchanged, which tells me that there's no major change in your thinking as it relates to underlying churn assumptions from before you raised pricing. First, is that a correct read? And secondly, if you could talk through your thinking of how you see churn normalizing. I think you said or normalizing within 8, 12 months post price increase back in 2022. Could you maybe talk about how your base of subscribers is different today versus '22 kind of emerging from COVID lockdown. On the other hand, you've been targeting maybe segments of the market that have underlying turned a bit higher through your rental program in the secondary market. Just if you could talk through what you see different today would be super helpful.

Yes, Arpine, this is Peter. I'll get started on this, and then Liz, feel free to jump in as always. As Liz said, the impact of the price increase in terms of churn has been in line with our expectations, and we're pleased with how it's going. Just to give you a sense of kind of the timing of the thing, we saw elevated cancellations in the first week or so after the announcement. And that was, as you can imagine, mostly concentrated in the first couple of days and it was concentrated also in members who were more inactive versus our most active members, as you'd also imagine. And some of those people were likely to cancel at some point anyway.

Since then, our churn has mostly moderated back to normal. As we indicated in our remarks here, our churn was actually down in Q1. That was the second quarter in a row that has taken place. And so we feel pretty good about the overall churn dynamics associated with the business. We have an increasingly tenured base of loyal members at this stage. And so if we step back and look at what to expect over the course of the year, the higher cancellations and pauses as a result of the price increase will -- that will manifest as higher churn in Q2. Then we should see an improvement in Q3, especially because we'll be reactivating some of the people who paused rather than canceled in Q2.

And if we look at the year overall, we're projecting to see overall flat churn on a percentage basis over the entire year despite the tick up in Q2, and that's based on our confidence in the relationship that we have with our members. Yes, we have a very -- a different composition of our members. We have more people who are on programs like rentals, for example, are coming from the secondary market, which tend to have higher churn, but that's offset by the fact that we have more -- much more tenured members and that tenured effect leads to lower churn. So all of those things add up to us feeling the level of confidence we've expressed about churn.

Yes, I could just -- I was just going to add a little bit about EBITDA -- so our EBITDA for the year, we did -- it reflects the outperformance that we had in Q1 because we are taking it up relative to our prior guidance by about $25 million on a full year basis. And so we outperformed in Q1, and then we do expect to see continued tariff favorability associated with the timing delays and lower rates than we had anticipated when we set our prior guidance. And then we also expect that we will realize some of the cost savings related to our $100 million run rate cost savings plan sooner than we anticipated. So all of those factors are driving some of that improvement in adjusted EBITDA.

Next question comes from Marni Lysaght from Macquarie Capital. .

I know you've called out, Peter, some of the factors driving the free cash flow result. You're talking to the full year as well. But can you just when we kind of go through the balance sheet and you're talking about timing benefits, like receivables has come in quite lower relative to sales. And I appreciate inventories are a touch high. You've obviously been potentially preparing new products. So just thinking about some of the working capital nuances feeding into free cash flow trends going into this quarter and how you might think about this current quarter and for the -- and how that ties into the full year?

Yes. So in terms of Q1, we certainly exceeded our expectations, which we had thought would be slightly negative. And we had some that performance, and we talked about tariffs and some of those things as well. and our cost savings plan. But we did have about $30 million, which I talked about earlier, a benefit from vendor payment time. And so some of that is related to payment terms, improvements in our payment terms and things like that. So that is probably a bit of what you're seeing. And on a full year basis, I do -- we expect to see that continued favorability and then the -- but the timing will reverse in there. So we're taking our free cash flow target up by $50 million, but that is a minimum free cash flow target also. I want to make sure that to remind you all of that, we expect to be able to outperform that. over the course of the year.

Understood. And just kind of, I guess, with new products coming to market, the right way of thinking about industry?

Yes. So we are balanced in terms of how we thought about inventory for our new products. Even though it's news to everyone here that we launched them in October, obviously, we have been planning for this for quite a while. And so we had a balance of working down our inventory on our old products, and we're being pretty measured about how much we built up in advance of the holiday season. So we feel pretty good about where we are at this point. .

Okay. That's understood. And just a quick 1 on with repowered the kind of like the marketplace platform. How do we think about, I guess, the early progress at had a national rollout over the summer? And would the recall -- would that impact some of the vendors on that?

Yes. Yes. So on Repowered, we -- again, that -- it's still a relatively new marketplace for us. And -- but we did create it as a way to help facilitate secondary market transactions because we're -- we are pretty -- the secondary market is an important entry point for us for price-sensitive customers. Now in terms of the recall, we do have -- we will have -- either we do already or we very well have a process in place to make sure that anyone buying on our Repowered marketplace will have access to a Bike+ seat post. It will be part of kind of the flow that they go through when they purchase a bus through that marketplace.

The next question comes from Shweta Khajuria from Wolfe Research.

Let me try 2, please. First is, Liz, if you could speak to just the overall demand environment. And as you think about the rest of the quarter and into calendar quarter Q1 post the holidays, how are you -- what are you seeing right now that gives you conviction on demand trends, generally, especially in the U.S.? And then, my follow-up question is on your commercial opportunity. You kind of talked to this earlier as part of your answer to the first question, could you please help us frame how big that opportunity could be for you in the, call it, near to midterm? And how are you measuring progress as you tap into that opportunity.

Sure. So let me talk a little bit about demand trends that we're seeing. So for the Connected Fitness market overall, our internal estimates when we use third-party sales data do indicate that, that category in the U.S. is still declining year-over-year post the surge that we saw from the 2020 to mid fiscal 2022, but the rate of decline has decelerated to low single digits. So we're pretty encouraged by the trajectory it is moving towards. But we do expect to see some continued softness in Connected Fitness equipment demand in the short to medium term, and that is incorporated into our full year guidance.

It's also worth reminding everyone that we are a large player in the Connected Fitness market segment. So our actions to focus on profitability do have an impact within the segment overall, especially for hardware sales. But in the long term, we do remain bullish on our growth potential as well as growth for that -- for the Connected Fitness category and the fitness and wellness economy overall.

I do want to touch on the overall economy, wellness fitness and wellness economy because we do see that consumers are placing just a higher value on fitness and wellness. And if you think about that, it's much broader than just Connected Fitness in the framing of cardio fitness for the most part. And while is not a nearly defined TAM today, there is third-party research overall that sizes, if you think about the entire wellness economy in totality, just within the U.S. at over $2 trillion. And now that's a huge number. We don't plan to participate in all of those categories that fall within the wellness economy. But we are focusing on moving toward areas beyond connected cardio and toward categories that demonstrate scale and growth and proven results for our members.

And you've heard Peter talk about some of these as we redefine our strategy, our market opportunity becomes much larger than connected cardio fitness. So you can think about cardio connected fitness as a big piece of us today, but our intent is to go well beyond that. And some of those categories, we've mentioned them before, but I'll just mention them 1 more time are in addition to cardio, we've got strength, we've got mental well-being, nutrition and hydration and sleep and recovery. And we'll continue to talk about these more as we execute on our strategy.

And just to cover the commercial side of that equation. The overall gym market in the United States is considerably bigger than the in-home connected fitness market. And although our internal analysis suggests that it experienced a bit of a slowdown over the last month or 2. If we look over the last couple of years, it's been continuing to grow, and we've experienced growth from the Precor side of our business. In some ways, I think we should be able to outpace the growth rate of the others due to the strategic benefits that I talked about earlier as well as the fact that we are refocusing on the commercial business unit and on Precor itself and recommitting to our commercial partners in that space.

In terms of the metrics for success there, as you, I think, at this point, know about us overall as a management team, we are focused on growth, but the growth needs to be profitable. And so we are working with the commercial business unit to ensure that the plans that we develop results both in top line growth as well as increased margins associated with that business as well. And again, we feel really good about that category and in particular, our positioning in the category.

The next question comes from Douglas Anmuth from JPMorgan.

It's Bryan Smilek on for Doug. Just 2 quick questions. Just thinking about the durability of double-digit sustainable Connected Fitness gross margins. Can you just help parse out the drivers between product mix shift, the cost savings, obviously, that you're enacting and I guess, conversely, but also similarly tied. You mentioned increased marketing spend in 2Q. Can you just shed more color on just overall brand positioning, where you're leaning into in terms of target demographics or service or channels as well for marketing?

Yes. So in terms of gross margin, let me just -- I think your question was really kind of more about like long term and thinking about where we're going with gross margins. So if you look back at Q1, our to get to -- this is Connected Fitness gross margin specifically, was 6.9%. That was negatively impacted by the inventory accrual for Bike+ seat posts. And if you exclude that, our gross margin would have been 15.8%, and that's up 660 basis points year-over-year. Now if you look ahead to Q2, we're anticipating Connected Fitness products margin to improve compared to Q1, and that's driven by fixed cost leveraging with seasonally higher hardware sales and favorable mix of higher-margin products. And it's also worth noting that it's our highest quarter for seasonal promotions over the holidays. So even with that, we are expecting margins and margin improvement.

We do anticipate our full year fiscal '26 Connected Fitness products gross margins to increase year-over-year. And then in terms of a long-term target, you mentioned double digits. Our goal is eventually to be in around the 20s range, and we intend to make progress towards that in the fiscal year. I do want to point out though, as we've talked about on many prior calls that we will continue to make trade-offs between gross margin and marketing spend based on the LTV to CAC efficiency that we see. Now Peter, do you want to talk a bit I can talk about marketing?

I mean on marketing spend, so for us, Q1 was a particularly low quarter. As Liz sort of intimated, we were we were sort of finishing up in many cases, the inventory that we had of our products. In fact, we went out of stock on the original bike in September in anticipation of the big launch. So there was no point, for example, in blowing it out on marketing when we knew we were doing great and running out of equipment. But as we look at Q2, we have a lot of messages to convey. And I'm so excited about those messages, right?

Our launch of an entirely new product lineup with the cross-training series is a great reason for us to talk to our members and nonmembers alike. The introduction of Peloton IQ is it's a new concept, right, what we're trying to do in this space. And there's a lot of education that needs to take place. Then of course, we've got all of this additional distribution. So we want to make sure that we actually are driving people into those stores because you've got to provide the air cover in order for people to see that. That being said, we are, as always, very careful about our spend and pay close attention to our LTV to CAC and ensuring that we are acquiring members profitably.

So what you will see is an increase in our marketing spend in Q2. There will be a higher percentage of our spend on brand and education than you've seen historically as compared with performance marketing in the early parts of the quarter. And then as we get into the latter parts of the quarter, the holiday season itself provides quite a lot of momentum for us. And we shift over to much more efficient performance marketing, and then you should see that over the -- much of the balance of the year, where we'll basically reap the benefits of some of the investment we made in Q2. But all of that, as you can tell, is included in the guidance that we provided for Q2, which still has considerable profitability. So again, our discipline is something that we take pride and that is certainly the case in the marketing area.

Great Thanks, Peter. Karen, maybe we have time for 1 more question. .

And the last question comes from Susan Anderson from Canacor.

I guess maybe just to follow up on all of the additional wellness offerings you guys added to the subscription. Just curious if you've seen an uptick in uses of those services, yes, it still may be a little early. And then maybe also if you can give an update on how the new certified refurbished equipment program is going? .

So let me start with the usage point. It's actually been really -- that's been really positive. So we mentioned earlier that we've had 500,000 of our members use Club Peloton already. We're also seeing more people taking workouts from our home screen, and let me explain why that matters. For a lot of our members, they kind of stay with the same old, same old. They go to the classes page and go to their comfort zone. But when people are taking work out from the home screen, it means that the recommendations that we're delivering with Peloton IQ are starting to hit home.

We've also seen a meaningful increase in strength workouts. And that's based on both our understanding of the science and what's important to our members in terms of their overall health as well as the personalized programs that we've developed for people who started to set goals around building strength and increasing longevity.

The most important point is that if we look at the month of October, every kind of usage on a per member basis is up. And what I mean by that is like whether you're talking about workouts in that month, total workouts or the total workout days or total workout time, all those things are up, whereas historically, we typically see workouts go down from September to October.

So we think our investments, in particular, AI, but also the investments we're making in the community on the software side are making a difference. In terms of the -- I think Susan, your question was about the repowered program. When you talked about a certified refurb program. And what I'll note right now is that the repowered program actually doesn't do certified. It is, by the way, an awesome idea. And 1 of the things that is certainly in our consideration set to actually provide certification because I think trust in this space is 1 of the areas that we can help to address. But so far, what we've been doing is solving a sort of more basic set of problems.

One is creating a trusted marketplace to match sellers and buyers locally, but also to be able to give them the option to have a professional come and do the pickup and the delivery so that you don't have to go into somebody else's house. if you don't want to or have somebody come into your house if you don't want someone there. So that's been the focus so far for repowered. It's still early days, but we're seeing from what we're being told, good performance from the partner that we're working with on that program, and it's scaling as we expected, but stay posted for more cool stuff, and thanks for the idea.

Why don't I put this out at this point with thanks, first of all, for everyone who joined today's call. and also some encouragement for you to tune into some fun class moments that we have coming up. For Thanksgiving, we will have a veritable buffet of new live and on-demand classes available including a live turkey burn ride with Robin Arzon, alive Turkey burn run with Kristen Ferguson and the feast, a live full body strength class with 6 of our strength instructors. And coming soon, Emma Lovewell will release her third installment of her popular Crusher core program, and we recently launched a podcast move for life hosted by instructor Matt Wipers and Dr. Kavita Patel that's focused on longevity, and it's available on YouTube.

And for the investment professionals and analysts out there, our codeveloped collection with the hospital for special surgery on desk workers strength and mobility was made for you. With that, we look forward to seeing you on the leaderboard and wish you a happy and healthy holiday season.

Thank you. .

Ladies and gentlemen, this concludes today's call. Thank you all for joining, and you may now disconnect.

[Audio Gap] at Citi, and I'm always happy to have with us Peloton's CFO, Liz Coddington. Liz, you've been with Peloton since January of '22, no...

June of '22.

June of '22. I knew I have my January role. And yes, so it's been quite a whirlwind. It's been great, though, watching everything go through. And so what I wanted to do is go through the business and get started, but before I do, maybe an icebreaker, so favorite instructor?

So it's really hard for me to pick just one favorite, but I got to say, I really love Emma Lovewell's kind of music-related workouts. She's one of my favorites. And I am a big fan of Jess Sims and her Sims 60. She has like these tread bootcamps and these bike bootcamps, and they are a killer workout, but I always feel great after I do them. So those are probably my 2 favorites right now.

I don't disagree. Maybe another question, given newer forms of exercise and workouts, any -- besides bike, any other tips for us? Obviously, strength is a big one...

Yes. I got to say strength training for me has been -- become a key part of my workout routine. And I know it is for a lot of our members as well. And I got to say I'm like the strongest that I've ever been after doing a lot of strength workouts, but also our treadmill works are pretty, too. It's really nice to even just -- even with -- you can become a better runner on the Peloton platform, but it's also great for just walking and hiking, and we have really great workouts for that as well.

Yes. I know we enjoyed it. We've been Peloton users since 2016. We still have original bike, a new tablet. We have a new bike as well. So it's the...

Maybe it's time for a new one.

There you go. Well, let's get into that. So maybe bigger picture, let's start with some strategic questions. it's been about 7 months since Peter joined as -- officially joined as a CEO. And clearly, this last quarter, we heard a lot about the future direction of where Peloton might be headed, right? And we heard about an additional focus on cardio, wellness and strength and there's always talks about pricing changes or what have you, but free cash flow targets are good. So a lot going on. Liz, talk to us about just these past 7 months and just the broader evolution of Peloton's since you've joined in '22.

Yes. So Ron, you are absolutely right. There is a lot going on. But the important thing to understand is that it all fits together as part of a strategic road map intended to deliver sustainable and profitable growth over the long term. Now if I step back, I really think about kind of Peloton's turnaround in really 3 phases. So in Phase 1, we were really focused on aligning our cost to the size of our business, and that was really a multiyear journey that started in mid-fiscal '22 even before I joined and really continued through fiscal 2024. So we had to rightsize our organization through multiple rounds of restructuring. We had to really shift our high fixed cost operating model to one that was much more variable in nature and really exercise a lot of cost discipline and improve our unit economics so that we could achieve positive free cash flow. And this all enabled us to be able to successfully refinance $1.35 billion worth of debt in May of 2024. And then in fiscal '25, we moved on to what I would call Phase 2, where we've been proving our ability to operate sustainably while investing in future growth.

And now with our new management team in place, we are continuing to focus on profitability while also reallocating resources to invest in really building out that foundation for future growth. And what we're working on next is getting to Phase 3, which I would characterize as returning to growth with a derisked balance sheet that really -- with a capital allocation strategy that really maximizes shareholder value.

And you also talked about our strategy. So in terms of business strategy, and we talked a little bit about this at earnings, we really are seeing a profound shift in how people really define a life well lived. And it's no longer just about increasing your lifespan, but also about making those incremental years healthier and happier and really increasing health span. And consumers are really looking for a trusted partner to help them on that long-term journey of fitness and wellness. And that really goes beyond cardio fitness and is increasingly including categories like strength, mental well-being, sleep and recovery and nutrition and hydration. And as I think about our path for delivering shareholder value, it's really about maximizing the human impact that we can deliver for our members. And human impact is really the thing that drives Peloton's business, and really informs our key aspirations as a company, which we've laid out previously as improving member outcomes, meeting members everywhere, really creating those members for life and all with the foundation of operating with business excellence.

Yes. There's a lot that we're going to jump into with all of that. Maybe to set the foundation for Phase 2, Phase 3, but then these newer forms of fitness and wellness. Maybe let's talk about what Peter has done in his first 7 months here. And so we now have a new CMO. I think we have a new CTO or a promotion into a Chief Technology Officer, a new COO joined the company, a new Chief Commercial Officer, or at least an expansion of Chief Commercial Officer's role. So is Peter's executive team now fully rolled out? Are we now -- all the pieces are in place, so to speak, for this next Phase 3, if you will, whenever that is ready?

Yes. So we definitely have made some leadership changes recently, but we are excited about the value that these new leaders are already bringing to our business. We talk about a few of them. So our new Chief Marketing Officer, Megan Imbres. She joined just roughly 2 months ago. And she's also making -- already making some exciting changes to our branding that you'll start to see in our advertising pretty soon.

And then we have our Chief Communications Officer, Dianna Kraus, who is really building out a holistic communication strategy to really elevate our member-focused brand. And she's already making some really important impacts by defining our corporate narrative, which is really that kind of unifying foundation that really informs all the ways that we talk about our business externally.

Then we have our Chief Operating Officer, Charles Kirol, who joined us in May, and he's really enforcing a much higher level of rigor around our supply chain and procurement processes. And honestly, Charlie has been an incredible partner to me on helping to drive our cost optimization efforts internally.

Now most recently, we just welcomed Corey Farrell, who is our new Chief Information Officer, reporting to Charlie. And I am thrilled that Corey has joined us because we do have a lot of tech debt. We have a lot of duplication in our software and across our tech teams. And we also need to continue to evolve our enterprise architecture so that we can efficiently take advantage of AI and machine learning technology that is becoming so important to so many other businesses. Now I could just keep going on and talk about more tenured members of our leadership team, but I do believe that we have the right team in place now to execute on our strategy.

Yes, that's great. I mean I look forward to seeing the new ads and the new commercials coming out. Let's talk about the product. Now that we have the foundation, we understand sort of the journey that we've been on and now where we're going, AI personalization, I thought was a key focus from what we heard on the call last, 2 weeks ago now, I think, maybe 3 weeks ago, maybe 4, goodness, time flies by when you're having fun. So I wanted to hear more about just the personalization side of it all, particularly as newer content and product announcements might come, and I think we're waiting for new product announcements as well. So any insights on -- or help us understand the personalization side of it.

Yes. So we believe that a greater degree of personalization on our platform can really help improve member outcomes by really creating an experience that is tailored to an individual's goals and workout preferences. And we've already made some progress on that front. In January, we launched our Personalized Plans feature, which creates customized workout plans that are informed and based on an individual's goals that they've shared with us and their workout preferences. As of the end of June, we had roughly 700,000 members set up a personalized plan, and we are seeing higher engagement as well as a broader engagement in the variety of our content from the members who have a plan set up.

But looking ahead, we do see an opportunity to provide personalized guidance on a deeper level. And I'm not ready to go into the specifics on that. We'll share more about them when we're ready. But at a high level, you can think about holistic goal-oriented onboarding experiences, seamless integration with third-party fitness tracking devices and even like actionable insights that you can use to really help inform your workout routine.

And so one of these -- what I think is fascinating all these new verticals that are coming out and the Personalized Plans are really a key part of that. But then we heard 2 million engaged members are on Strength. I think we heard sleep recovery is 1 point. These are big numbers, big penetration numbers of the overall member base. And so I would love your thoughts on just the lessons learned from these newer verticals, and how we can maybe use those lessons into other verticals coming on? And I think, Liz, I'm going to just wrap that question up with I think we said the goal is to be the #1 sort of across -- #1 category -- #1 provider across each category that's offered. And so lessons learned from strength, from sleep recovery, from wellness into these newer experiences?

Yes. So when we think about new categories that we want to participate in, there are kind of 3 types -- there are lots of factors that we consider, but there are really like 3 main factors that we think about. The first is the size of the category as it exists today, which is kind of an obvious one. The second is really our expectations for how fast that category can grow. And the third and probably the most important one is whether we see ways that we can participate in that category that provide benefits that are really backed by science.

Now if you think about the fitness and wellness, space, there are many fads that grow very quickly and even achieve some level of scale, but then they quickly sort of fizzle out because the consumer benefits are unproven and they turn out to be less valuable than was originally anticipated.

And so for us, when we look at these categories that we want to participate in, they need to have reasonable size, they need to be growing relatively quickly, and they need to have proven benefits. And so we selected and prioritized these 4 categories around strength, mental well-being, sleep and recovery and nutrition and hydration as the 4 kind of priorities for us. So I'm going to -- let me take a minute and talk -- I'll talk a little bit about each of those.

So let's start with strength. The data is clear. Strength is already a scaled category on our platform, with, as you mentioned, 2 million members engaging in strength workouts on our platform in Q4. Now the benefits of strength are also backed by science. The CDC's, what do they call it, the physical activity guidelines for Americans, it recommends that you engage in at least 2 strength training sessions per week and also about 150 minutes of moderate aerobic activity. Research also shows that a combination of cardio and strength has a lot of benefits, including stronger muscles and bone health, improved weight management, reduced risk of chronic illness and also just general overall improved daily function. So with these tangible benefits, we are also seeing an increased interest in strength in the marketplace today. So when you look at all of those things collectively, it makes sense that Strength is a category that we see as a big opportunity for us, and we believe actually that we are already the #1 strength subscription service today.

Now let's talk a little bit about sleep and recovery. So sleep and recovery is also a relatively scaled category on our platform, with we also mentioned the 1.2 million members who engaged in our sleep and recovery content in Q4. We are investing in third-party integrations so that members who choose to share their sleep and recovery data with us that will enable us to recommend better workouts for them. Then if we talk about mental well-being, we are seeing that people are placing a greater emphasis on mental well-being more than before. And we're seeing that also with the engagement of our members with 400,000 of our members engaging in mental well-being content on our platform in Q4. And so we're really trying to explore ways that we can improve our members' moods and mindfulness through our software and also our human coaching. For example, one area that we see as a potential opportunity is offering breathing exercise experiences to members to help manage stress.

And lastly, I'll talk about nutrition and hydration. That category for us is we're really kind of in the early days of formulating our strategy on that one. We do know that our members have an interest in understanding how our instructors really fuel their bodies. And in Q4, we launched the Peloton Kitchen series on social media, where our instructors shared some of their favorite recipes and that was in partnership with an expert dietitian and nutritionist. And we'll continue to test and iterate on nutritional content over time. But really, our primary goals there are to find ways to participate that are science-backed and also supportive and nonpolarizing.

So we just talked a lot about these newer verticals. And a lot of it, I think you mentioned software and improvement, strength, sleep. Talk about the hardware. So any -- I know we're not going to break any news here today, but I think we talked about on the call that maybe new hardware might be coming out or some improvements. There's an article. So any thoughts on what to expect or just stay tuned and we'll see?

Yes. I think I'm going to have to go with stay tuned on that one. We do have some exciting product updates coming, but we'll be ready to share those ahead of our next earnings call, but we'll just have to stay tuned and...

Okay. Noted. All right. Let's talk to member base. I think one of the biggest assets that Peloton has is that 2.8 million or so connected fitness subscriptions. And I think guidance calls for maybe continued sort of challenges or declines here overall, but we're always impressed with the retention rate or call it the churn rate. And so talk to us about the member base, about the drivers of this relatively low churn that Peloton has been able to have for years and years and years, case in point, this analyst here. So talk to us about just the member base and churn.

Yes. So our subscription business really does benefit from a low churn profile due to the strong engagement and retention that we do see of our loyal base of roughly 6 million members. When someone -- when members choose to invest in our Peloton equipment, they're really making a commitment to themselves to work out with our community. And that commitment really helps them establish a routine, and we also have a vast library of content across more than 16 modalities for them to choose from.

Now that being said, our churn rate in Q4 was -- our average net monthly churn rate was 1.8%, which is a seasonally high churn quarter for us as many members choose to temporarily pause their subscriptions in the summer. But if you look on a year-over-year basis, we actually improved our churn rate by 10 basis points. And this is the first time we improved our churn rate since -- year-over-year since March of 2021. So what we're really benefiting from is the maturing -- kind of the maturing of our subscriber base toward a population that is more engaged and that's less likely to churn. And we see that in our engagement data with the average monthly workout time for subscription increasing 4% year-over-year in Q4.

And so when we think about that improvement in churn rate, talk to us about the balance between investing and the trade-offs between going -- growing the member base versus managing to improve profitability. So to your point, churn improved in a population that knows how to use the product, but tell us how you think about you balance the growth with profitability there?

Yes. So when I talk about growth, I think it's important to really have to have a distinction between sustainable and profitable growth and growth at all costs. When I talk about and think about sustainable and profitable subscription growth, that first requires us to optimize our marketing spend to ensure that the customers that we are acquiring, the subscribers that we are acquiring are profitable. And we leverage an LTV to CAC frame mark to measure our marketing efficiency in terms of customer acquisition. And we've made a lot of great progress on improving that metric over the years, and we'll continue to optimize it.

Now operationally, what our goal is to spend on media such that the CAC or the last or marginal subscription that we acquire exceeds their LTV so that on an average basis, we are meaningfully profitable and achieve an LTV to CAC ratio of roughly 2 to 3x on a fully burdened CAC basis. Now with our improvements to our gross margins, combined with our kind of cost discipline with our media spending, we improved our LTV to CAC ratio by roughly 30% year-over-year in fiscal 2025.

It's also worth noting that we reduced our marketing spend by over 35% year-over-year. And in Q4, our LTV to CAC ratio was just shy of that 2 to 3x target. So the challenge that we face right now is that with all this discipline around our marketing spend, our subscriber base just isn't growing right now, as you pointed out. And so we need to continue to evolve our marketing strategy and tactics all across our marketing funnel so that we can increase gross additions while also being more efficient.

And so when I think about that, if you think about sort of the top of our marketing funnel, we need to continue to evolve our strategy and our messaging there to really create awareness beyond the bike and really get prospective members to consider us and even reconsider us. And I mentioned earlier that Megan is working on some really exciting updates to our branding that should really help support this goal.

And then if you think about it, we also need to optimize our kind of the middle layer and the lower part of our funnel to just our messaging there to be more efficient. And many consumers, in the case of our products, the consideration period can be quite long before somebody decides to invest in our premium-priced products. And so we need to keep those prospective members engaged with the right messaging and offers to drive action. But I do want to point out that growing our subscriber base isn't just about increasing customer acquisition. Even with our low 1.6% average monthly churn rate on an annualized basis, we churned out over 500,000 subscriptions in fiscal '25. So we need to continue to deliver on our innovation road map in order to keep those members engaged so they don't churn. And we do see an opportunity to both retain and reactivate subscriptions so that we can really keep those members for life, which improves their LTV, but is also a key element of our strategy.

So collectively, all of these efforts should actually enable us over time to be able to efficiently increase our marketing spend so that we can increase the number of gross additions.

So that's a very good point on even though churn is low, it's still a substantial number. And again, talking overall in the number of subscribers that the firm -- the company has. So I'm going to go back to a comment you said earlier. In June, I think we had 700,000 or so set up personalized plans for greater engagement as it related to, I believe, AI personalization. And so just talk to us how can I, as a member, or how are you targeting someone like myself or anyone for that matter to set up those personalized plans so that we stay on the platform longer?

Yes, that's a good question. We are -- we do try to kind of direct you to see those personalized plans. There's 2 ways to do it. You can do it from within the app. We also try to be able to message to you on the screen on your fitness equipment that we offer these personalized plans. But I think that is an area that we can do better to really help convince you to sign up and set one up. What is nice about it is that when you do have one set up, when you log in on your console, you do see your personalized plan for the week laid out. You don't have to select that class by the way. You're free to do whatever you want. It's your world, you get to pick, but you do get to see like what you did earlier in the week, what it recommends that you do today and recommends recovery days, which I think is really important. And if you want to do some sort of work out on your recovery day, it may suggest something that is just lighter like a yoga class or other types of content that we offer to really kind of round out your workout experience.

Sure. Yes, I look forward to more of that. And you can do more on...

Have you set one up?

No, I have not.

Right. Well, that's your homework. You need to go set one up at the end of the day today. All of you, everyone in the room and listening in, please set one up. Try it.

So we talked a little bit about the marketing strategy. And I wanted to hear more about the distribution strategy. I think the comment was meet members everywhere is the strategy. And so this past quarter, we heard more about third-party distribution partners, reinvestment in showrooms via these micro stores. Peloton Repowered is now live nationwide. So if we break some of these distribution channels down, let's talk about the micro store approach. I think we'll have around 10 of those by the calendar year 4Q, which is perfect for holiday season. I think there's about 13 showrooms left maybe around there. I don't -- anyway, would love to hear your thoughts on the micro store versus showroom and sort of the distribution side on the physical footprint owned and operated type?

Yes. So with one of our key business aspirations being really meeting members everywhere, we need to have both a physical and online retail presence. And that includes third-party retail partners like Amazon, DICK's Sporting Goods, Fitshop, those are all really important sales channels for us so that we can meet members where they already shop. I also want to mention that we are considering -- we're always looking at new third-party partnerships that really give us those physical touch points that reach incremental audiences while also optimizing our owned retail experience to be more flexible and efficient. And this is kind of really where the micro stores come in.

So we do expect by the end of the year to have 10 micro stores live. In fiscal '25, we launched 1 pilot micro store, and we saw higher revenue and engagement compared to one of our average legacy showrooms at 1/10 of the square footage, with a much more flexible operating model and much more flexible capital -- much better capital efficiency. So we've decided to cautiously expand and add 9 more.

Our one micro store gives us optimism that we should be able to successfully execute that more flexible and capital efficient micro store operating model and then shift away from those legacy showrooms to these micro stores.

You are correct that as of the end of Q4, we did have 13 retail showrooms remaining. We plan to close those over the course of fiscal '26. And we actually expect to close 5 of them by the end of Q1.

You also mentioned Repowered. So let me take a minute and talk about Repowered. For those who may not be aware, Peloton Repowered is an online marketplace that connects buyers and sellers of used Peloton equipment, that we launched in response to the sustained volume of gross additions that we see coming from this channel that we think of that we refer to often as the secondary market. In Q4, we launched Repowered as a beta in a few select markets. And then more recently, we decided to roll it out nationwide based on the high level of interest that we saw and the positive feedback on the member experience. But it is still really early days for Repowered, and it will take time before we are able to tell if we're actually seeing a lift in secondary market growth additions as a result of Repowered.

And look, while a lift would be a great outcome for us, the primary goal for us launching Peloton Repowered was really about improving the member experience for members who joined Peloton from the secondary market.

Yes. Well, I look forward to hearing more about it because it's a big market out there. Maybe shifting topics a little bit. We talked about product, distribution. There's been a lot of discussions on just pricing changes overall across the membership base or the subscription base and also hardware. And I know there's nothing to really announce here, but it's been out there, and we've been talking about it. So maybe a different way of asking this is just the last time we saw an increase in subscription, which I think was a few years ago, June of '22, would love to hear lessons learned when we did it then? Is there an optimal time to do it? How do you think about pricing? Was there an impact to churn? Any thoughts on the pricing side?

Yes. Well, there certainly has been a lot of interest in our plans around subscription pricing lately. But what I'll start by saying is one of the things that Peter shared during earnings, which is, the best time to announce a pricing change is when you are actually telling your members and not before that. But conceptually, we believe that the best time to announce a price change is when you have delivered a significant amount of value to -- or when we have delivered a significant amount of value to our -- to increase the value of our membership since the last time we did a pricing change. And then also when we're able to share more benefits that are on the way that are really going to increase the value of that membership further.

And so we've kind of checked the box on the first aspect of that. It has been over 3 years since June of '22, which is the first and only time we increased prices for our All-Access Membership in North America. When we did that, we did see a spike in churn from the affected population and that quickly normalized after the pricing changes went into effect. We've also delivered a lot of value since the last time we increased prices. I don't have a comprehensive list, but I'll call out a few things. So we have more than doubled the number of instructor-led programs on our platform. We added new categories like rowing and kettlebells. We launched our entertainment offering, which includes things like YouTube TV and Disney+ and NBA league pass and Netflix, which offer our members a variety of content experiences that they can use while they are working on their Peloton equipment.

We launched the Strength+ app, which is included in the All-Access Membership and that offers structured strength workout programs as well as a custom workout generator that is suitable for using in a gym setting. And then I talked about it earlier, but we launched the Personalized Plans feature, which really allows you to create a customized workout plan tailored to your goals and preferences. Now with all that value added, I do want to emphasize that we will not change our prices until we have additional benefits coming to share, and we'll have more to say about that at the right time.

Great. We're looking forward to it. There's no doubt there's been more value to the product. Let's transition to the cost side in a few minutes that we have left. We achieved the $200 million in ARR annualized or cost savings in fiscal year '25. I think we're targeting another $100 million for this fiscal year. Just tell us how this reduction is different from prior reductions? And any insights on where you might -- where you're taking these reductions? I think a certain amount was taken during the last quarter as well.

Yes. So at our last earnings call, we announced a new goal beyond the $200 million in cost savings that we achieved in -- our run rate cost savings that we achieved in fiscal '25 to achieve an additional $100 million in run rate cost savings by the end of fiscal '26. Similar to our last cost -- our May '24 cost savings plan for the $200 million, we actioned roughly half of that run rate cost savings through a workforce reduction that we announced on August 7. And we intend to achieve the balance of it over the course of the fiscal year through indirect spend optimizations and workforce relocations. We do expect to achieve cost savings across our operating expenses, the bulk of which would -- we expect to come from SG&A, although we do expect some cost savings to come from R&D and COGS as well. And we expect about 15% of the run rate cost savings to come from reduced stock-based compensation.

Now you asked about the differences, though, between our new cost savings plan and the one that we had that we announced in May of '24. And there are some fundamental differences that I do want to highlight. Internally, we are referring to this cost savings plan as our Fit for Growth initiative. And Fit for Growth is not intended to be a onetime event, but rather a way that we intend to operate our business going forward. And it really -- the Fit for Growth framework is really about optimizing spend by segmenting our spend into really different categories. There's those lights-on capabilities that are needed to run any business, any of the table stakes capabilities that are specific capabilities that we need to just even compete effectively in our industry. And then there's that third group of really differentiating capabilities that really enable us to create and sustain long-term durable competitive advantage that really allows us to achieve our aspirations as a company.

And so by being more efficient and creating cost savings within areas like SG&A, we're able to reallocate a portion of that savings to invest in strategic initiatives to drive long-term growth.

Very helpful. And so we have a few minutes left here. Taking that question or that answer, and I think the guidance for free cash this year was around $200 million plus. And so I wanted to maybe combine the free cash confidence. So what gives you confidence in free cash? But then also with this improving free cash generation, I would love to hear your thoughts on capital allocation, right? How we prioritize around debt reduction, growth investments, capital return potentially, which is a whole different conversation that we haven't had recently?

Yes. So first, I really do want to take a victory lap and talk about our fiscal '25. We delivered $324 million in free cash flow in fiscal '25, which is a $400 million year-over-year improvement compared to fiscal 2024. And that enabled us to reduce our leverage ratio -- our net leverage by $343 million, 43% year-over-year and achieve a net leverage ratio of 1.1x. So we are deleveraging our balance sheet really quickly, and it's really great progress for the business.

Now for fiscal '26, we said that we expect to deliver at least $200 million in free cash flow. Now that is intended to be a minimum, and our goal is to exceed that. Now in fiscal '25, we had a benefit from being able to really improve the flexibility in our supply chain. And that allowed us to reduce our production so that we were able to reduce our inventory balance to the tune of $125 million. So if you think about that $200 million minimum, it's about $124 million reduction from the $324 million that we achieved. And so because that benefit that we achieved in inventory was a onetime benefit that now becomes a free cash flow headwind.

Now offsetting that headwind, we do expect to achieve additional cash savings from the run rate cost savings -- from the cost savings plan that we talked about, net of restructuring charges. Now in terms of capital allocation, I think we're running out of time, so I'm not going to have an opportunity to go through our debt stack. But the way I think about it is, we now have more excess cash on our balance sheet more than we need to run our business today. We do have $200 million in convertible notes that we need to pay down as they mature in February of 2026. There is no rush to pay them off ahead of maturity because they are a 0% coupon. And like I mentioned, we have the cash to do it.

But it is worth noting that with our deleveraging on our balance sheet, we believe that we are a much better credit than we were when we refinanced 15 months ago. And so when it comes time to refinance, we believe that there will be a lot more options available to us. And our goals, when we do decide to refinance, are really going to be about reducing our interest rate, but also improving the flexibility of our loan terms so that we can use some of that excess cash on our balance sheet to do things like potentially pay down debt, buy back stock, invest and allocate more capital to organic growth opportunities and then even potentially pursue inorganic growth if the right opportunities present themselves.

That's great. Well, Liz, thank you very much. We are in over time, but that was a very helpful answer, and appreciate your time here today. Thank you.

Good day, and welcome to the Peloton Interactive Fourth Quarter Fiscal Year 2025 Earnings Call. [Operator Instructions] 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, sir.

Thank you, operator. Good morning, and welcome to Peloton's Fourth Quarter Fiscal Year 2025 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 forward-looking statements related to our business under federal securities law.

Actual results may differ materially from those contained in or imply these forward-looking statements due to risks and uncertainties associated with our business. Please refer to our SEC filings and today's shareholder letter, both of which can be found on our Investor Relations website for a discussion of the material risks and other important factors that could impact our results.

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 over the call to Peloton's Chief Executive Officer and President, Peter Stern.

Thank you, James. Good morning, everyone, and thank you for joining today's call. As we wrap up our fiscal year, everyone at team Peloton should take pride in our results and all that we accomplished. While Liz will review the results in more detail, our team exceeded all our key financial performance goals for Q4 and fiscal 2025.

We delivered what we promised operationally and then some. And we reignited our innovation engine on every aspect of our magic formula of equipment, software and human coaching. As we look to the future, our team is rounding out nicely. We recently got 2 new hires to the leadership team, Chief Marketing Officer, Megan Imbrez, who joined us from Apple and Chief Communications Officer, Diana Kraus, who joined us from Fleishman Hillard.

We have also completed the search for our CIO. Corey Farrell joined last week from Pearson and reports to our COO, Charles Kirol. As I promised when I started at Peloton in January, in today's shareholder letter, I outlined Peloton's strategy. I won't reiterate that strategy in these remarks, but I will provide some highlights and color. Our strategy is grounded in our purpose, which is nothing short of delivering human impact at massive scale by empowering our members to live fit, strong, long and happy. We already deliver on this purpose in part as the trusted fitness partner for approximately 6 million members in 6 countries, but we are just getting started.

Let me explain by providing historical context. Over the past century or so, advances in medical science contributed to the prolonging of life here in the U.S. by a remarkable 30 years from 1900 to 2020. However, as life span has increased health span, the quality as opposed to the quantity of those years has failed to keep up.

People are living longer, but they are also living sicker. In the U.S. alone, we now have the largest gap between lifespan and health span in history at over 12 years. Addressing health span requires a different approach from lifespan because health spend depends less on medical interventions and more on our choices and behaviors regarding exercise, sleep, stress and diet.

This is where Peloton comes in. Cardio fitness is the foundation of wellness and is critical to maximizing health span. If it were a drug, it would be a miracle drug available to everyone without negative side effects. But while cardio fitness is essential for health span, it is not enough by itself.

With each passing year, we are coming to understand better the importance of strength, stress management, sleep, and nutrition to living our best lives. This creates the opportunity. No more than that, the mandate for Peloton to evolve from being a cardio fitness partner to become the world's most trusted wellness partner across the full array of behaviors that maximize health span. There is no company better positioned than Peleton to achieve this kind of human impact.

Behavior change is hard, but we've spent over a decade helping millions of people start and maintain healthy habits by making it fun and by creating a real sense of community and human connection. So with that backdrop, here's where we're taking the business with the goals of returning to sustained growth in revenues and members and of sustaining our progress in achieving profitability.

We plan to support our members' wellness journeys by expanding our offerings in strength, where we are already a category leader, mental well-being, sleep and recovery and, over time, nutrition and hydration. While we're exploring new wellness areas, we will continue to build on our strength in cardio, cycling, running, walking and rowing recognizing the centrality of cardio for human well-being.

We recognize that our members come to us at various stages of their fitness journey. And so a one-size-fits-all approach fits no one. Determining what to do to meet your goals can be overwhelming. So we will employ advanced technologies like AI to enhance our ability to serve as personalized coaches, delivering individual insights, recommendations and custom tailored plans that make it easier and more efficient to achieve your goals.

To grow our member community, we will increase our global presence through hotel partnerships, retail expansion and the launch of new markets. An example of this is our successful Micro Store pilot in Nashville. Last month, we opened our second micro store, this one in Utah. And we plan to launch an additional 8 stores in time for the busy holiday season. Here's another example. We launched Peloton repowered, a platform for buying and selling used equipment to sellers nationwide last week, following a successful data in 3 U.S. metro areas. Peloto

And yet another. In May, we launched a special pricing program that offers a discount on equipment to military personnel, health care workers, first responders and educators. These purchases have already made a meaningful impact on first-party retail sales in Q4 and while making Peloton more accessible to thousands of people we all count on for the quality of our lives.

We also launched special pricing for students, offering them discounted access to our Peloton App subscriptions. Precor is a strong asset to Peloton as it has a presence in more than 60 countries and 80,000 locations. We see a tremendous opportunity to expand our commercial presence and serve a broader range of gym operators by bringing the best of Precor and Peloton together.

We have integrated Precor with Peloton for business and formed a new commercial business unit under Chief Commercial Officer, Dion Camp Sanders hiring Ian Reeves as its General Manager. Dustin Gros, President of Precor, will be retiring and we sincerely thank for his leadership in returning the Precor business to growth.

Our commercial business unit plans to expand on the success we've achieved with our Hilton and Hyatt partnerships. Peloton for business currently operates in over 9,000 hotels and Peloton is now a must-have amenity in quality hotels.

Growing our member base also means expanding our online and in-person presence through social channels and events. In Q4, our instructors participated in over 40 events, more than 3x the amount in Q4 of last year.

When you purchase a piece of Peloton equipment, you aren't just getting a fitness tool. You're also joining a supportive community. We've experimented with ways to strengthen this community and foster more engagement through our social network teams. We have more features on the horizon to deepen connections and engagement among our members.

We are also continuing to elevate the member life cycle with new onboarding programs and to recognize our most loyal and committed members. A core pillar of our strategy is ensuring our prices reflect the human impact we deliver to our members. We continue to improve our unit economics and will adjust prices to reflect the value we provide to our members and the cost of operating our business, including shipping, returns, tariffs and other fees we pay. Peloton is at a critical juncture in our transformation a moment to invest intentionally in our future.

To earn the right to grow, we must align our spending with areas of competitive advantage, specifically our equipment, software and content while reducing costs in areas that do not differentiate us. To that end, we plan to capture an additional $100 million of run rate cost savings by the end of FY '26 by optimizing indirect spend reshaping our teams and, in some cases, the locations where we work and parting ways with a number of our talented colleagues.

Decisions that impact our people are the most agonizing ones we make. We are deeply grateful for the contributions of our departing team members, and we are committed to supporting them through this transition making fundamental changes to the way our business operates takes sacrifice and hard work, but I'm even more confident in our team now than when I started. I will now turn it over to Liz to discuss our Q4 and full year 2021 results.

Thanks, Peter. I want to begin by highlighting our sustained progress toward improving the financial health of our business over the course of fiscal year 2025. Our successful efforts to expand gross margins, reduce operating expenses and optimize inventory levels enabled us to generate $324 million of free cash flow, an increase of $409 million year-over-year.

We also materially deleveraged our balance sheet, reducing net debt by $343 million or 43% year-over-year. We are pleased with the progress we've made improving profitability in fiscal 2025 and continue to prioritize delivering meaningful free cash flow. Now I'd like to touch on our fourth quarter results, which reflect another solid quarter for financial performance as we exceeded the high end of our guidance on all key metrics.

We ended the fourth quarter with 2.8 million paid Connected Fitness subscriptions, reflecting a net decrease of $80,000 quarter-over-quarter due to seasonally lower hardware sales and seasonally higher churn. Ending paid connected fitness subscriptions decreased 6% year-over-year. We exceeded the high end of our guidance range by 10,000 driven by both higher gross additions and favorable net churn.

Gross additions outperformed our expectations due to higher unit sales of our Connected Fitness products in both first-party and third-party retail channels. Secondary market additions were in line with expectations. Average net monthly paid Connected Fitness subscription churn was 1.8%, an improvement of 10 basis points year-over-year and an increase of 60 basis points quarter-over-quarter in line with our expectations for a sequential increase in Q4 due to seasonality.

We ended the quarter with 552,000 ending paid app subscription. Total revenue was $607 million in Q4, comprising $199 million of Connected Fitness products revenue and $408 million of subscription revenue, outperforming the high end of our guidance range by $21 million.

Our performance relative to guidance was primarily driven by Connected Fitness products revenue from higher-than-expected hardware sales of both Peloton and Precor products. Connected Fitness products revenue decreased $13 million or 6% year-over-year, driven by lower sales and deliveries, partially offset by a mix shift toward higher-priced products.

Subscription revenue decreased $23 million or 5% year-over-year, driven by lower paid Connected Fitness subscriptions and lower paid app subscriptions, partly offset by used equipment activation fee revenue, which was introduced in Q1 of fiscal 2025. Total gross profit was $328 million in Q4, an increase of $16 million or 5% year-over-year. Total gross margin was 54.1%, an increase of 560 basis points year-over-year and 380 basis points above our implied guidance of 50.3%, driven by outperformance in both segments.

Connected Fitness product gross margin was 17.3%, an increase of 900 basis points year-over-year, driven by inventory write-downs recorded in Q4 of last year, a mix shift towards higher-margin products and decreases in service and repair, warehousing and transportation costs. Subscription gross margin was 71.9% an increase of 370 basis points year-over-year, driven by decreases in music licensing royalties, personnel-related expenses, inclusive of stock-based compensation and depreciation and amortization.

Subscription gross margin benefited from a onetime balance sheet adjustment to accrued music royalties associated with drilling and music licensing agreement. Excluding this onetime benefit, subscription gross margin would have been 69.2%. Total operating expenses, including restructuring and impairment expenses, were $299 million in Q4, a $77 million or 20% decrease year-over-year, reflecting the continued progress we've made in rightsizing our cost structure, partially offset by expenses associated with today's announced restructuring plan.

We exceeded our target to achieve at least $200 million of run rate cost savings by the end of fiscal 2025. Sales and marketing expenses were $81 million in Q4, a decrease of $32 million or 28% year-over-year, driven by decreases in advertising and marketing spend, personnel-related expenses, inclusive of stock-based compensation and retail showroom expenses.

We exited 24 retail showroom locations in fiscal 2025, reducing our retail footprint from 37 to 13 showrooms at the end of Q4, excluding the addition of 1 micro store location. Research and development expenses were $56 million in Q4, a decrease of $14 million or 20% year-over-year, driven by decreases in personnel-related expenses, inclusive stock-based compensation and product development costs.

General and administrative expenses were $125 million in Q4, a decrease of $61 million or 33% year-over-year driven by decreases in stock-based compensation associated with executive departures in Q4 of last year and other personnel-related expenses were offset by slightly higher professional fees.

This quarter, we recognized $37 million of impairment and restructuring expense, primarily consisting of severance and personnel-related charges as a result of today's announced restructuring plan as well as other noncash impairment charges. Adjusted EBITDA was $140 million in Q4, which was a $70 million or 99% improvement year-over-year and $54 million above the high end of our implied guidance range.

We generated $112 million of free cash flow in Q4, an increase of $86 million year-over-year. Q4 free cash flow benefited from outperformance in revenue and gross margin as well as lower operating expenses. We ended Q4 with $1.40 billion in unrestricted cash and cash equivalents, an increase of $125 million quarter-over-quarter.

Overall, our fourth quarter performance reflects a continuation of meaningful profitability improvement for our already high retention, high gross margin Connected Fitness subscription business. Our continued focus on rightsizing our cost structure and derisking our balance sheet has enabled us to achieve a strong financial footing from which we can execute our strategy that is focused on achieving sustainable, profitable growth.

Next, I'd like to share context for our financial outlook. For full year fiscal 2026 and on a quarterly basis, we are providing guidance for total revenue total gross margin and adjusted EBITDA. We will also continue to provide an annual target for minimum free cash flow and a quarterly guidance range for ending paid connected fitness subscriptions.

Our full year fiscal 2026 total revenue outlook of $2.4 billion to $2.5 billion reflects a 2% revenue decrease year-over-year at the midpoint. As we execute on our strategy over to the year, we may evaluate changes in pricing, promotional strategy and other actions to achieve our financial targets. Q1 total revenue is expected to be $525 million to $545 million and reflects a decrease of 9% year-over-year at the midpoint. As a result of anticipated year-over-year declines in hardware sales and paid enacted fitness subscriptions. Similar to fiscal 2025, we expect Q1 to be a seasonally low quarter for hardware sales.

Taken together with our guidance for revenue for the full fiscal year, which reflects a lesser decline at the midpoint compared to what we expect in Q1, you can see that we expect to inflect toward year-over-year revenue growth over the remaining 3 quarters of the fiscal year.

Starting in fiscal 2026, we will assign executive and other corporate overhead associated with our New York headquarters and other corporate facilities as we focus on driving more accountability for cost at a functional level. Historically, these costs were all reported in G&A, but going forward, will be assigned across COGS, sales and marketing, G&A and R&D.

Our guidance for total gross margin reflects these assignments, which drives a roughly 70 basis point headwind to total gross margin. Full year fiscal 2026 total gross margin is expected to be roughly 51%. Adjusting for the impact of assigning executive and corporate overhead expenses, our outlook reflects a total gross margin improvement of roughly 140 basis points year-over-year as a result of our continued focus on optimizing costs.

Our Q1 fiscal '26 total gross margin outlook is roughly 52%. Our fiscal '26 6 adjusted EBITDA guidance range of $400 million to $450 million reflects an increase of $21 million or 5% year-over-year at the midpoint, primarily driven by operating expense savings connected to the new restructuring plan we introduced today. We've actioned roughly half of the run rate cost savings as of today and expect the remainder to be realized over the course of the year.

Roughly 15% of the $100 million run rate savings goal is expected to come from lower stock-based compensation. Q1 adjusted EBITDA is expected to be within the range of $90 million to $100 million, reflecting a decrease of $21 million or 18% year-over-year at the midpoint, primarily driven by our expected revenue decline.

We have decided not to provide annual guidance for ending paid connected fitness subscriptions because over time, we plan to make trade-offs between pricing for both subscriptions and hardware and subscription growth. We also believe that we have many vectors for growth that do not result in an increase in subscription. We will continue to provide quarterly guidance for ending paid connected fitness subscriptions.

Going forward, total revenue will be our primary top line metric because it is a better measure of Peloton's long-term health. Q1 ending paid Connected Fitness subscription guidance of $2.72 billion to $2.73 million reflects a year-over-year decrease of 6% at the midpoint. We expect gross additions to decrease year-over-year as a result of an expected year-over-year decrease in Peloton hardware unit sales.

Average net monthly paid connected fitness subscription churn is expected to follow our historical seasonal pattern with higher churn in Q1, but still slightly lower than Q1 of last year. Before we cover free cash flow, I wanted to share a quick note on tariff policy, which as you know, is a dynamic situation. While we manufacture some Precor products in the U.S., we are subject to country-specific reciprocal tariffs for Peloton and Precor equipment, including but not limited to, Peloton and Precor equipment imported from Taiwan and other Precor products imported from China. While Peloton tablets are currently subject to a tariff exemption for computers, we anticipate that our imported tablets from Thailand may become subject to a country-specific reciprocal tariff rate within the coming months.

Peloton and Precor imported equipment are also currently subject to a 50% tariff on their aluminum content. We remain committed to generating meaningful free cash flow with a target to achieve at least $200 million in fiscal 2026, inclusive of anticipated tariff exposure of roughly $65 million.

As the rates continue to evolve, this exposure could change. In fiscal 2025, we reduced our inventory position, creating a significant net working capital benefit to free cash flow. While we do expect a small cash benefit from inventory in fiscal 2026, overall, we expect changes in net working capital to be a free cash flow headwind this fiscal year. We also expect greater onetime cash restructuring charges within the fiscal year as a result of our $100 million run rate cost savings plan.

These headwinds are partially offset by improvements in gross margin and operating expenses as a result of our focus on improving monetization and optimizing costs. For [ Q ] specifically, our typical seasonal sales pattern for Connected Fitness equipment requires us to build up inventory ahead of the holiday season and puts pressure on free cash flow within the quarter. When compounded by cash outlay for restructuring costs, we expect Q1 free cash flow to be slightly negative.

By continuing to generate meaningful free cash flow in fiscal 2026, we expect to continue to make progress on reducing net debt and deleveraging our balance sheet over time, while also investing meaningfully in innovation so that we can make progress on our long-term objective to return Peloton to sustainable, profitable growth. Now we'd like to open the line for Q&A.

Thanks, Liz. We'll begin the Q&A process this morning by taking a couple of questions from investors that set their topics in in advance. We received more than 2 dozen questions this quarter. So what while we can't add all of them, we did pick a couple of representative ones that will tackle before the operator opens the line for additional questions.

Our first question was asked by a number of U.S. investors, so I'll paraphrase. How does Peloton see the opportunity for growth as Americans focus more on health and fitness? And in particular, can you speak to how this impacts the younger demographic. Peter, maybe you can jump on the one.

Thanks, James. The attitudes of younger people are a big reason for the strategy that we announced today. When we look at young people, they're expanding their definition of what it means to live well. From a narrow focus on cardio as a tool for weight loss toward a more holistic approach that brings together cardio and strength in sleep, stress management and nutrition to improve the quality of their lives and as I talked about, their health span.

We also see the younger people are more likely to do training for their mental health they pursue a more diverse range of training approaches with more of an equal approach to strengthen cardio. They are also adopting functional nutrition thinking about food as a tool to enhance their wellness.

At the same time that we're seeing all of those positive trends, we're also seeing just upsetting high levels of stress and depression and anxiety among young people. So while we're reorienting Peloton with the announcement of today's strategy to maximize human impact for everyone, we know young people need us more than ever. And that means we're going to be focusing even more on personalized training programs that cut across the many disciplines that we offer.

That means even more investment in strength, including things like our strength plus app because people are more likely to pursue hybrid workout regimens, both at home and at the gym. It means more investment in areas like meditation and sleep for mental well-being, we have something really cool on the way. I can't wait to talk more about it soon, using a mix of software and human coaching.

And then last but not least, our special pricing program that I talked about earlier, offers discounted subscriptions on the Peloton app for students because not everyone has access to our equipment at college.

Great. Our next question comes from Barak in San Jose, California, leaderboard named B Metin. He asks stock-based compensation expenses have been growing disproportionately to the growth in your business. What are management's thoughts on current levels of SBC. Peter?

Thanks, Barak. Great question. I'll start by just noting that some stock-based compensation is a good thing. It aligns the interests of the company's employees, especially in your leadership with the interests of shareholders, where all -- we all benefit when we see stock improvements in the value of our stock.

It's also retentive. So typically, cash payments happen within the year, but parts of stock-based compensation require employees to stay for multiple years in order to receive the benefits. It also encourages a long-term mindset as a consequence. That being said, your question was what's our thought on the current level of stock-based compensation.

And I I'd say, historically, it's been too high. But I'll note that in FY '25, we were able to reduce our stock-based compensation expense by $77 million, which is a 25% reduction year-over-year. And we do expect that to decline further in FY '26. So I think we are definitely focusing on on dilution, it's important. But the other thing that we're doing is trying to even more closely align the interests of our leadership with interest of our shareholders.

And to that end, in FY '25, we introduced performance stock units, PSUs as a component of our executive compensation, and we are planning on increasing the mix of PSUs as a fraction of total stock-based compensation as we entered FY '26. Thanks again for the question.

Thanks, Peter. Sheri, can you open up the question -- the line for questions, please?

[Operator Instructions]

And that will come from the line of Arpine Kocharyan with UBS.

I was wondering if you could go over what's baked into your revenue assumptions for the year. You provided some good context in terms of sort of current strategy of why all you're doing could increase sort of higher engagement and that can lead to better churn and outcomes and ultimately, hopefully, stabilization in subs.

But -- and I know it may be challenging to get into pricing given there is no -- there was no profit increase announcement from Peloton in the release. But maybe you could go over the key inputs of how you get to your revenue numbers for the year? And then I have a quick follow-up for Liz.

Sure. So thank you, Arpine, for the question. So we talked about a little while ago that our Q1 revenue guidance reflects a 9% decline at the midpoint. And our full year guidance reflects a 2% decline at the midpoint, and that does imply that we expect to inflect toward year-over-year revenue growth in the following 3 quarters of the year.

And we intend to achieve this through a combination of growth levers that are available to us, and that includes sales and subscriptions as a result of some exciting product updates that we hope to be able to share with you soon. adjusting prices to reflect the value that we provide to our members and cost of operating our business.

And this includes things like charging delivery and return fees and adjusting pricing and promotions. And in today's shareholder letter, we did note that we'll have more details to share about our product innovation before our next earnings call, and we're very excited about these, and they make us optimistic for the holidays. And then we'll be able -- in our next earnings call to be able to provide some more color on how these are impacting our full year expectations.

That's very helpful. And then maybe this one is for you as well. Would it be possible to go over the cadence of that $100 million of Costa? And you alluded to where they're coming from? Outside of headcount where else you see opportunities? There's always that concern that incremental cost cutting is always more difficult when the low-hanging fruit has been harvested, but if you could help us sort of break down the cadence of those cost saves throughout the year, it would be helpful.

Sure. So today's announced restructuring plan is designed to achieve at least $100 million in annualized run rate savings by the end of FY '26. And as of today, we will have actioned about roughly half of the run rate savings through the reductions in our workforce, and we expect to achieve the remainder throughout the balance of the year, one of the areas that we are focused on is indirect spend optimization and then also potential workforce locations.

So -- and the $100 million run rate savings target consists of reductions across our operating expenses. The biggest area is G&A. And then we also expect some savings across R&D, sales and marketing and COGS. And then I mentioned it earlier, but I'll mention it again, that our stock-based comp represents about 15% of the run rate savings period.

One moment for our next question, and that will come from the line of Youssef Squali with Truist Securities.

Congrats on that solid quarter. Maybe just a follow-up to the prior question about growth. And just to be clear, so it's great to see you guys going from having shrunk for the last several years to look in at a pivot in revenue growth starting hopefully in Q2 through the rest of the year.

But as we look at the business maybe longer term and maybe beyond the price adjustments that may get you there near term. Can you maybe just talk about your expectations for kind of the secular growth in this business. Is this business still at a holistic level still flat to maybe declining from an overall market standpoint? Or do you see that having maybe improved? And then I have a quick gross margin question for [indiscernible] that.

Yes, Youssef Josef, thanks for that question. We have great optimism for the future of this business. One of the things that we've done here is some research focusing on the U.S. and looking at what we believe the market opportunity is even if we just focus on fitness for a moment.

And so we looked at -- in this case, just people with household income of over 75,000 spend money on fitness. And that's 17 million people in the U.S. just alone. And then if we further qualify that group, to add that they're willing to spend money on both fitness equipment and fit subscriptions, we believe that's about 17 million households in our service addressable market.

And in the U.S., we have only a fraction of those households and subscribers. And so we've got plenty of upside just in the market as it's been sort of as it exists right now. I talked earlier about the trends that we're seeing in the marketplace as well with people becoming ever focused on one, their quality of life and recognizing that, that creates a real need for them to engage in behavioral change. That has, one, the potential to further increase those numbers that I just described but second for us to open up additional vectors for growth for our company.

We basically only really been serving people through cardio and then the rest of the disciplines, while we have amazing offerings and really impressive uptake of those are essentially adjust to that. But as you start to think about each of those as a vector for customer acquisition and potentially drivers of incremental value from our members, you can start to see a significant potential for growth.

And as I said earlier, I believe that there is no company better positioned as a matter of credibility and the resources that we have and the amazing people that we have in our company to capture those opportunities. So I view this as a an expanding market and one that we have barely scratched the surface of.

That's awesome. That's really helpful. And then maybe, Liz, could you please double click on your expectations for gross margin for 2026, particularly across both subscription and hardware, I think you guys have done a really good job improving margins on the hardware business. How does that progress throughout the year as maybe you could gain maybe some headwinds to that top line.

Sure. So let me talk a little bit about Q1 and then I'll talk about the full year. So in Q1, we do expect our total gross margin to decrease sequentially, and that's due to lower margin across both of our segments. Our Connected Fitness gross margin will be impacted by the fact that we will have less -- we expect to have less hardware sales.

So that causes some fixed cost deleverage. And similar to prior years, we do expect to have just a lower seasonal mix of revenue from Connected Fitness in Q1. And then Q1 sub-margin is expected to return into the 68% to 69% range that we are typically in. We outperformed a bit in Q4, but we expect to be back in kind of our 68% to 69% range.

Now on a full year basis, if you look at our fiscal '26 guidance, it reflects a year-over-year improvement of 140 basis points after you adjust for the impact of assigning the executive and corporate overhead costs into COGS. I talked a little bit about how we are making that change in assignment that starting this year. And so we do expect margin improvement in both of our segments.

Connected Fitness segment, we expect to benefit from things like lower service and repair costs, lower warranty costs, and also some of the benefits associated with our FY '26 cost savings plan. And then the subscription segment, we do expect to benefit from optimization to our content production and music royalty expenses.

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

Yes, great. Maybe just switching gears a little bit. We touched on this a bit on the call, but just thinking about capital allocation and potential refi that you guys have demonstrated very strong EBITDA and cash flow. How are you thinking about that, I guess, in relation to the term loan?

Sure. So let me just sort of recap a little bit on our capital allocation strategy and kind of where we've been and where we're going. So many of you may recall that in May of '24, we were approaching a maturity wall, and we successfully completed a $1.35 billion refinancing of our balance sheet.

And then since that time, we have grown our adjusted EBITDA from $4 million in fiscal '24 to over $400 million in fiscal 2025, and we also generated over $320 million of free cash flow. So with that progress, which we've been really pleased with, we have been able to quickly deleverage our balance sheet, and our net debt has decreased 43% year-over-year.

So we ended the quarter with just under $1.4 billion of unrestricted cash and cash equivalents. And we also are mindful that we do have those $200 million in convertible notes that are due in Feb of next year. And obviously, we have enough cash on our balance sheet to be able to pay them down and then some.

And we don't intend to pay the way at this point because they are a 0% coupon. Now as you think about -- we think about our capital allocation strategy going forward, we do believe that we have more cash on the balance sheet that we need to run the business. And our top priority is just to continue to deleverage as we believe this will create more optionality for us in the future.

Now regarding our $1 billion term loan, specifically, it is a 5-year term loan. It's priced now at SOFR plus 5.5%. It used to be 6%. We achieved a 50 basis point rate step down for achieving our first lien net leverage ratio of less than 5x a couple of quarters ago. If we were to take the term loan out today, it comes with a penalty of 1% or roughly $10 million, and then that reduces to par in May of '26.

So we are always looking at optimizing our our capital structure, but we do want to be mindful of that $10 million penalty, which as we get closer and closer to May of '26, it's less of a benefit to take out and restructure ahead of that date. But we're always looking at what opportunities we have, and we do believe that our much stronger balance sheet should enable us to achieve better interest rates at the right time when we do restructure.

Okay. Got it. Then maybe just, Peter, a quick one for you, just in terms of sizing commercial opportunity. You have a new working group dedicated to that. So in terms of how material that could be to revenue and results this year, just any thoughts there?

Yes. Citis, thanks. The commercial business unit that we launched has already turned back to growth. And that is the consequence of the amazing work of the Precor team in rebuilding relationships with gyms around the world. I love this combination.

You've got basically Precor, which builds world-class heavy-duty equipment for the commercial environment. And just as important as the service model that they've got, that's ideal for the high-use environments and the expectations of commercial gym operators. And then you've got Peloton with our magic formula, a beautiful high-quality equipment and software and human coaching. When you put those things together, you've got a foundation in terms of equipment, software, content and the services that just no one can match for Jim. You add to that the fact that Precor is already in 80,000 facilities across 60 countries.

Peloton's in 20,000. We haven't deduced the whole thing, but we're talking about relationships with close to 100,000 facilities around the world. So when you do what we're now -- we're working on, which is you get to one combined sales force with 2 powerful complementary brands. We think commercial fitness and wellness is ours to win and it is an important vector for growth for us.

One moment for our next question. And that will come from the line of Brian Nagel with Oppenheimer.

So I want to -- I apologize, I think this will be a little repetitive, but I do want to bounce back to the revenue guidance for the year. The question I want to ask is, as you've laid it out here in fiscal Q1, revenue is expected for your guidance to be down high single digits that improved through the year. So what are -- to help us understand better that guidance or the achievability of that guidance. Can you point to anything you're seeing in the business now that gives you that confidence?

And then I guess with that, how should we think about the split, if you will, between any changes you plan to make on on subscription pricing versus new member acquisition within that guidance.

Brian, why don't I take a little bit of a crack at this because Liz sort of did the first pass at this question. So again, as you noted, the first point is that from a revenue standpoint, if you look at Q1 versus the rest of the year, we go from down at the midpoint, minus 9% to the rest of the year, minus 2. So we are inflecting toward growth in the back part of the year. The -- what are the vehicles for accomplishing that right? It's growing the -- our new member acquisition. And you'll see that happening as a consequence of some of the innovations that we are not talking about today, but that we will reveal before our next earnings call.

And we believe that will attract more new members to the company alongside the fact that Q2 is usually a seasonally strong business that we hope to achieve an acceleration of that progress. It comes from higher revenue per member. We believe we'll be able to accomplish that by selling more equipment. And again, we're very excited about our innovations, but more to come on that.

Some of that can be to existing members. Some of that can be to new members. You're pushing on questions around the price change. And I guess what I would say is the best time to announce a price change, if you're going to do that is when you've actually got the value lined up, looking both backwards and forwards.

And looking back, we are delivering tremendous value to our members, and we feel great about where we are. We've more than doubled our instructor-led programs since we lasted a price change over 3 years ago. We've significantly increased our library workouts. We've done so much on strength, whether it's the launch of the Strength Plus app or whether it's launching new categories like Kettle bells and weighted vests.

We've expanded many of the features of our product like we launched entertainment options like YouTube and Disney+ and NBA League path to our product. I've talked a lot about personalized plans and we're now up to 700,000 of our members having an advantage of personalized plans that are based on their goals and their preferences. So I think looking backwards, we feel really great about the value we provided. But a lot of members will feel like, well, I already got that.

So what are you going to do for me going forward? And today is not the day for me to talk about those sorts of things. But when we do, I think our members are going to be even more excited about what Peloton has to offer. So again, I'm not going to comment anymore on that particular topic, except to just signal the value we have -- we already deliver and intend to deliver, it's been really positive.

But there are those things. The other point that I'd like to make, right, is that there are a lot more ways of driving growth now for us as a business, right, selling a second or even a third connected fitness product to our existing subscribers.

I talked a moment ago about the revenue that we generate from our commercial business unit, and we're seeing so much momentum now from that unit. We're starting to see some real interest in the marketplace on content licensing opportunities because there is simply nothing like Peloton out there in the world. And so all of those basically aggregate up to give us the confidence that we can turn the tide on the revenue side.

One moment for our next question. And that will come from the line of Shweta Khajuria with Wolfe Research.

Let me try 2, please. Peter, thanks for the context on how balloon cable, it sounds like there will be more details coming here in the next few months. But to the degree that you can comment on any -- so is Peloton going to -- the value proposition going to be one of a wellness app rather than fitness app.

And if we are thinking about it that way, the value proposition that will be added on, are you thinking about offering different types of gearing because if I just want to have a part of it, versus the full package. And then the second is the TAM has been big. I think it is pretty well understood in terms of how big your TAM is. One of the concerns has been adding new subscribers at the price point because it's a premium product.

So could you please address that? And in the past, it has been fitness as a service and/or certified refurbished. Are those going to still be strategies that you're going to be doubling down on? Or where do those stand?

Well, that's great. Lots to cover there. so I want to start with the fact that cardio is and will continue to be the foundation for Peloton as it is the foundation for our members achieving their health and wellness outcomes. And our leadership in that space and the trust that we've built with our members in the category are what entitle us to be able to offer these additional offerings.

So right now, strength is already a key part of our approach. If you were to if you were to listen to the CDC, they will tell you that a mix of cardio and strength is optimal for adult fitness. And we are seeing 2 million of our members engaging in our train classes again this quarter. And so we've been doing even more in that area. I talked about cedable classes.

[indiscernible] strength plus app, which now allows you to take Peloton into the gym. We're evolving our software capabilities in the strength space, and we'll have some very exciting updates in that area coming soon. mental well-being -- we continue to see strong levels of engagement in our medication cost.

And as I indicated a little while ago, we have something cool coming along those lines that I can't wait to tell you more about that I think will make a big difference for people, and it will help with sleep as well. And then we're basically using our content team as an R&D lab on nutrition. So in Q4, we launched our Peloton Kitchen series on social media.

We're working in partnership with Dr. Jamie Sher, who's an expert nutritionist and dietician, and we're going to be attending and iterating on nutritional content over time. In terms of your questions then on -- there are a number of them that followed from that, Shweta, with regard to tiering, we already do have a tiering structure between F1, F+.

We've got the Strength+ app that's available a la carte. And those, we think, are really nice gateways for people to discover Peloton and ultimately ladder up to the all Access membership. With regard to our TAM, as I discussed earlier, there is a big -- there is 117 million people who are -- who spend money in the category and have the capability to invest in our type of equipment, but there's a big gap between that and the people who are ready for subscription.

And so it's important for us to be able to tell our story and to reignite the innovation engine that excites people in the way that Peloton once did and certainly will in the very future. With regard to -- and by the way, in so doing, we will essentially close the gap between the $17 million and $117 million, and that's where so much opportunity for us.

With regard to FAS and we are committed to both of those programs as well as to the secondary market, which is contributing a very large fraction of our new members. Essentially, what you see here, and this is the tiering of our equipment prices, is that without having to produce in the case particularly of our bikes without having to produce a lower-end bike, we're able to use our premium products and use the combination of the refurbishment and that secondary market to offer a lower price access point for people.

And because we build that equipment to last, it's basically as good as new for secondary owners. So yes, we're committed to all of those, and I appreciate the question.

Great. And now let's [indiscernible] the hour here. Sherry, I'll ask the last question. It comes from Debbie in New York, leaderboard name Get Busy Living. And Debbie asked what are some of your strategies and ideas for keeping Peloton interesting and exciting, particularly for loyal and long-time users. Peter? .

Debbie, thank you. I love that question because I'm one of them, too. I'm approaching my ninth year anniversary as a Pelton member in September. So -- and there are occasions when I find myself just getting in the [indiscernible] of like my go-to instructors and just doing the latest classes from them.

But fortunately, I'm privy to all the amazing things that we're doing here. So here's some advice, and this is what I've been doing. We'll try to branch out. And we support about 15 different disciplines. And that's not just good for keeping your interest in Peloton. It's good for your body. It's good for your mind. So strength in addition to cardio.

If you belong to a gym, please download and try the strength plus app. It's amazing, add in meditations, whether you're doing them at a time -- during the daytime for focus or whether you're doing it at night time to help you sleep, it will reduce your stress that might even improve your interpersonal relationships, try one of our new approaches like weighted best classes or Cataby workout.

Again, branch out on the instructors. I've had the privilege of meeting all of them. We have more than 50 remarkable instructors and every one of them is an inspirational expert. Pleased to set up a personalized program. We've improved them a lot, even in the last quarter to make them flexible around your schedule. And then what the personalized program will do is it will recommend a mix of both newer and older classes that will help you achieve your goals faster, definitely joined a team.

I'm a member of one of them. And that is basically now it is supportive [indiscernible], it's like a safe social network that gives you tips on what works for other people and encouragement we also recently just added the ability in the team's feed to link to work out. So our members are now recommending workout to each other, which is awesome.

If you can afford it, add another piece of our equipment into the mix, I know that sounds self-serving, but it's -- if you add, let's say, you're recycling die hard and you add to rod tread or row into your routine is going to activate different muscles for you, both physically and mentally.

And then last but not least, and since you're a longtime member like me, I think you're going to really appreciate the work that we're doing to recognize and reward healthy habits and loyalty to our community.

So that's one of the cool things we're going to be announcing really soon, and it's going to grow over time. So all that -- with all that stay with it, Debbie, stay tuned, and I welcome your feedback as we share more.

Great. I want to thank everyone for joining us today. Have a good day. Thank you.

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

Thanks for joining. I'm Curt Nagle. I'm the SMID Cap Internet analyst here at BofA. I'm very pleased to welcome Peter Stern, CEO of Peloton. Thanks for joining today, and really looking forward to the conversation.

Thanks for having me, Curt. And I wanted to take a moment to acknowledge that today is a Global Running Day. So if you haven't gotten out already, I would encourage you to do it. And we're also launching today for the first time, outdoor runs from Peloton Studios in New York. It won't work for those of you here in San Francisco, but this is something that we pioneered out in London. People loved it, and it's just a great way to celebrate this day.

Perfect. So I guess the first question I'd like to start with Peter, 6 months on the job, right? In terms of -- maybe just quickly talking through some of the organizational changes you've already made and kind of what's left to do in getting the full senior management team kind of up and running.

Yes. First, I just want to note that, Curt, I stepped into a great team. And I'm really grateful to the leaders that came before me for having recruited people on that team like we have Liz here in the audience, our CFO. But there were some areas where I felt like we had opportunity to grow.

So the first change that I made was hiring our Chief Operating Officer, Charlie Kirol. We've actually made great progress on a number of elements on supply chain over the years, gotten a lot better. We can talk about it some more later at things like logistics. But we make equipment as a company. We actually are -- we're a manufacturer, and we needed a person who had deep experience in producing consumer electronics that we could scale and we could get those things to be more cost effective and also be more agile. And Charlie, with his background at places like iRobot and Stanley Black & Decker and GE was just the right person for that, not to mention a Rear Admiral in the Navy Reserves. So incredible leadership characteristics.

We also designated Dion Camp Sanders to be our Chief Commercial Officer. That was in recognition of the fact that so many of our growth vectors are under his purview. So Dion is responsible for everything from international to retail, to our inside sales teams to our commercial business, including Precor. And so a lot of the vectors for growth are under his purview, and so we needed to recognize that. We have some -- we still have some more work to do, but I'm really happy to have Dianna Kraus having joined a couple of weeks ago to help tell the story of the new Peloton. She's just an absolutely fabulous addition to our team.

The next holes that we've got to fill are, one, we need a CIO. We didn't have a Chief Information Officer at the company. So we had multiple tech organizations spread throughout. That resulted in some inefficiencies, some tech debt that I think we can clean up as we get the right leadership. And that person is going to focus on automation and bringing AI to everything that we do. And then the Chief Marketing Officer is the last one. And so that will be my partner and drive growth in the company and hope to have some good news there soon.

Maybe I'll just follow up on that. So like you said, new CEO, CMO, hopefully soon. I guess, how do you think about that shaping the go-forward marketing strategy? You've cut the budget by I think, 40% kind of year-over-year. How do you expect to do more with less? How does that differ from the prior strategy? And just yes, shaping marketing kind of going forward and driving growth?

Yes. So I think the exercise over the last year or so has basically been trying to find the efficient frontier for us on marketing spend and getting to the point where we feel like we can acquire new members in a way that is really cost effective. And you can see that manifesting in, for example, in the third quarter, our LTV to CAC ratio exceeded 2. And so at this point, on an average basis, we're doing really well. The challenge now is for us to take the sophistication to the next level. And the way I think about that is deaveraging.

So the work now we're starting to do is to basically say, by channel, how do we get to the point where the incremental subscriber acquisition cost of the last marginal customer is less -- materially less ideally, but less than the lifetime value of that customer. That's the level that we should be spending at and no further because we take into consideration, of course, the cost of capital. So we're doing, I think, what's right by our shareholders in that situation, but we're spending to the right level of growth by channel. So that deaveraging is a big part of what we'll be doing in 2026.

Then that equation gets easier as we start to become more effective at both acquisition. So now the cost of acquiring an incremental subscriber will decline as well as we get better at retaining our members and generating as much revenue and value from them as we can over their lifetime, that actually eases that equation. You have to, of course, sprinkle a little bit of marketing magic on top of all of them. And we have an opportunity, I think, to tell really a new story working between communications and marketing about the brand, and that will be the real focus for the next year.

Understood. So in my view, kind of really interesting sort of maybe a transition point for Peloton, right? Like past 1.5 years or so, huge focus on margins, cleaned up the balance sheet pretty dramatically. Now as we're kind of talking about, right, getting back to a growth plan. So I guess in terms of your philosophy on balancing the margins and the earnings and growth, what is it? Can you do both, I guess?

Yes. We can. I'm quite confident that we can do both. It's just going to take a little bit of time to get sort of all the way to where we want to get to. So let me tell you a little bit about the journey. right? So the journey that we're going to be on is one where we visualize the P&L for a company. We're going to be migrating up the P&L, moving toward growth in each of the elements that we care about on that P&L. So the team has already made just phenomenal progress, for example, on the free cash flow part of the P&L.

So having generated $211 million year-to-date at the end of Q3, basically talking about landing in the vicinity of $0.25 billion of free cash flow, that's tremendous progress. If you look at things like adjusted EBITDA, having moved that to, give or take, $335 million of adjusted EBITDA, that's up compared with the prior 12 months by $435 million. So you can start to see the bottom of the P&L starting to take shape and telling, I think, a really compelling growth strategy is a story.

The next steps will be moving to operating income as we continue to get more efficient and spending on the things that absolutely matter that drive our differentiation, but not so much on the things that are basically what you might call table stakes or keeping the lights on. As we go from there, sort of the next big moment will be revenue. And we'll start to see the revenue declines moderate, I think, over time as we begin to deliver more innovation, more reasons for both existing and new members to buy into the hardware that we offer as well as for us to do things like start to move the needle on customer lifetime with some of the initiatives that we're delivering to improve the member experience.

The last frontier will be turning the member or subscription growth to positive. I think that happens as we deliver on the full array of initiatives that we're working on to reach new members through new channels as well as to materially improve the churn rate of the members that we have.

So -- and then kind of following up on that, right? So you alluded to some of the stuff in terms of the growth strategy, we'll get kind of a plan or at least the first kind of partial plan in the next coming months. I guess could we talk about just in terms of just like what that growth algorithm is going to look like at least kind of a holistic or high level? And then I have a couple of follow-ups on that.

Yes. I mean the growth algorithm for the company is -- that part is pretty straightforward. It's average revenue per member times number of members times lifetime of a member. And if you multiply that out, that's basically the top line value that we can create. Now the hard part is how do you actually move the needle on those things. And so I'll unpack it a little bit.

On the average revenue per member, that's basically a matter of the value that we're delivering to the member. And the way that they'll measure that is in terms of both the results they anticipate getting from us as well as the results they actually achieve by being a Peloton member, which is why improving member outcomes is the first part of our strategy. It's the area that we're focusing really heavily on from an innovation standpoint.

Again, not here today to announce the future product road map of the company. I think we'll do that a few weeks after the fourth quarter earnings because I think I'd like to separate in time, we'll do earnings. We'll tell the growth story with even more specificity and give you a sense of what to expect in '26. But then a few weeks after that, leading into the holidays, that's the moment, I think, to tell that innovation story in a more consumer media-oriented way. So that investment in innovation is going to be the first part that drives average revenue per member.

The second piece is driving up the number of members. And the way we do that is this strategy that I call meet members everywhere. And there are so many ways that we can expand on the number of members we have, whether it's our retail presence. We have been in a period of contracting our retail presence. If you went back a few years, a couple of years, we had over 100 retail stores, first-party stores as a company. We're now down to 10 of those. But I'm really feeling encouraged about the work that we've done in our micro store, and we're going to start to scale that sort of thing back up. So you can sort of see that we're at the midyear of our first-party retail presence. But you add to that the work that we can do on third-party retail, both physical and online.

We've had, I think, really great success with Amazon, for example, as a channel, we measure incremental sales and they do generate real incremental sales for us. Retail is one of these vectors for meeting members everywhere. There are a lot more, though, things like getting into gyms more gyms, right, because we've been -- we're an at-home company, but we're really lucky that we own Precor. We actually have one of the largest commercial gym equipment companies out there with tremendous credibility with gym operators, and they have what it takes to service the Peloton equipment that we put out there also and to put Peloton content on those devices, I think, is just some natural synergy that's just waiting for us to achieve, great way to meet people and have them experience Peloton in that kind of setting.

Look at hospitality. I think there is -- hopefully, many of you are staying in hotels where you have access to Peloton equipment. But this is a must-have amenity for hotels of a certain type. And we need to get to the stage where every hotel operator agrees with that.

International is another one of these vectors for meeting members everywhere. Our penetration in international markets where we operate, U.K., Germany, Austria, Australia, even Canada is a fraction of the penetration that we have in the U.S. So there's real opportunity there.

Last but absolutely not least on this list is get back in the Zeitgeist online. There was a period where the Peloton was basically uttered in any breath when people talked about fitness. And I feel like we are -- we have made tremendous progress even over the last few months in terms of awareness, in the belief in members and nonmembers alike that we're a leader, not just in cycling, but in running, in walking, in strength, getting back into the Zeitgeist and taking advantage of our incredible instructors as ambassadors for the company, along with activating our millions of members will help us meet members everywhere.

The last piece but not least, and I realize, Curt, I'm giving you sort of the full version of this, but is member lifetime. Because if we can keep the members we have for longer, that's the best thing. First of all, it means that we're treating them right. It also means that we don't actually have to spend the money to acquire a member to replace that member. And so we are investing quite a lot right now, more time as opposed to money and just bringing the right expertise in making sure that we nail every aspect of the member service experience because we should not be footfaulting with our valued members and losing them unnecessarily.

But we're also beginning to, I think, really hit our stride in some things like teams. We know that being connected to others is one of those things that motivates people to stay with a fitness regimen. And so investing in these community features, I think, over time, will start to show up in increased usage and decreased churn.

I guess just a follow-up, one thing we didn't mention or talk about and a very common question I get is how to think about pricing, right, particularly for the connected subs. Your predecessor was, Barry, I think, of potentially raising prices. Just I think the idea was maybe this hurts gross adds. How does your thinking differ? Or does it differ?

I don't know exactly what Barry's thinking was about this. But what I do know is that we're at a really different time right now. So when Barry joined, we weren't that far off having done a price increase on our subscription business. I think the last time that was done was in April of '22. But where we sit right now, right, in June of '25, it's been more than 3 years since we've made any kind of adjustment on that. So again, I'm not here to say what we would or we wouldn't do. But what I will tell you is a little bit about how we think about it because I've said on multiple occasions that it's something that we think a lot about.

So for us, the question is, are we delivering not just sufficient value to our members, are we delivering value in excess of what we're charging? And is the value increasing over time? And I think on all of those, the answer is absolutely yes. You can look at, for example, where we are from a programming standpoint. We're now, I think, over somewhere over 50,000 classes that are available on our platform. We've been introducing new types of classes, whether it's rowing classes or kettlebell classes more recently in response to demand from our members.

We've been adding all sorts of other features like our entertainment portal now. We just, a couple of weeks ago, launched YouTube in there, and it's already driving something like 14% of the entertainment consumption on our platform and driven up the entertainment usage there. I talked a little bit earlier about Teams, the work that we're doing on community features, is something that we're getting great feedback from our members on. And we launched a Strength+ app that's just bundled into your All-Access Membership.

We know if we listen to the CDC and their recommendations about what an adult needs in order to be healthy, we need to do 75 minutes of vigorous cardio activity week or 150 minutes of moderate cardio activity week, and they should be doing 2 strength training sessions a week. Those things are equally important. And so the work that we did, for example, with Strength+ is to make sure that we can provide a full fitness diet, so to speak, for our members. I can keep going on this, but I think the key point is we've got, I think, a great value proposition for our members. It just keeps on getting better.

Maybe just kind of dovetailing on that point about potential tailwinds about a greater focus on health, right? In the U.S., it seems like it could be a pretty interesting opportunity, maybe more specifically, the PHIT Act, right, which would allow people more seamlessly to use health account spend for things like Peloton and gyms and whatever. If reconciliation bill, I guess, it's signing a law, how do you see that as a potential growth driver for, I guess, member.

Yes. I mean I love the PHIT Act. By the way, it's called P-H-I-T. It's currently passed the house, right, as you noted. It's now up to the Senate. And I really hope that they do the right thing here because let me explain what the PHIT Act is. It allows consumers to be able to apply their HSA, Health Spending Account or FSA, the Flexible Spending Account dollars toward, among other things, fitness subscriptions. I think about $500 a year for individuals, $1,000 for a family or for filing jointly toward a fitness subscription.

And why do I think this is great, right? Because what we know is that fitness is probably some of the best medicine that you can give someone, right? It has been demonstrated, whether we're talking about cardiovascular disease, whether we're talking about metabolic dysfunction. In many cases, when we talk about things like issues with mental health, exercise is more effective in most cases than any drugs that are out there and a lot more cost effective. So we can give people an opportunity to put the money against that kind of investment in themselves as opposed to waiting until somebody gets sick where the costs are much, much higher for the government, then we are talking about something that's great for the American population. It's great for the government.

What this would do is then allow consumers to basically use before tax income, right, to pay for the subscription as opposed to after-tax income. So from a policy standpoint, I just -- I love the PHIT Act, and I hope that Congress follows through with it.

Yesterday, announcement that we launched a new marketplace, repowered, right, where you used inventory and used hardware. Maybe tell us a little bit more about this effort and how, I guess, important the resale market for hardware is to Peloton.

Yes. I mean there's already a really robust secondhand market for Peloton equipment. I think in the last quarter, something like 45% of our new members came from secondhand equipment. But it's not -- I think a lot of people, it's sort of a little uncomfortable, right? You have to go on a place, let's say, like Facebook Marketplace and interact with a stranger and then somebody has to come to your house and you have to go to someone's house, you don't know to get the equipment. And we just want to create a more streamlined customer-friendly way for sellers to be able to get rid of equipment.

If for whatever reason, they fell off the horse and they are just not able to continue taking advantage of that equipment, that is doing nobody any good. It's not generating subscription revenue for us, first of all, but it's also if they're not using and helping that person stay fit. And so I would rather get it in the hands of someone who will love and use that equipment. It's great for our business, by the way, also. I mean I know this is an investor conference, so I'll just focus on that.

All things being equal, I would be delighted to have a new member come from a piece of equipment that we didn't have to spend $1 of capital on, then one that we do have to spend the money on. And from an environmental standpoint, getting that equipment back into somebody's homes that will enjoy it is terrific. And we build the equipment to last.

So the other thing I'll note about this secondary market is it's just -- it's phenomenal from a price tiering standpoint. There was a period before I joined, where the company was looking at, is it -- should we make a sort of like a bargain basement version of our bike. And of course, we would never compromise at Peloton on the fundamental quality, but you have to make some trade-offs in that situation. What I think the team quite wisely realized is that consumers can solve this problem for us. We can get a product out there. I don't know what the average selling price of those is. I think it's somewhere in the $600, $700 range. That is a great product. It's the product that we sold for 2x that price at some point in the past. And so they're actually solving that tiering problem for us, and we didn't have to make those compromises on the product.

Great value and then you don't have to make margin either -- LTV.

And the buyers can -- one of the options for the buyers will be to actually have it shipped to them. So they don't have to go into somebody else's house.

Make it seamless and unlock already an important market. I'm spending maybe just kind of the last 5, 6 minutes on the margins and the cash flow. And again, it's been a great area of success for you. So maybe just starting with OpEx, right? I mean you've taken out hundreds of millions of dollars over the past few years. You've hinted at more sort of pockets for optimization. But I guess, kind of going into the next fiscal year, should we assume another plan to be announced? And kind of where do you see the biggest opportunities for takeout? You mentioned the tech debt as one. Where else could we see them? And could you elaborate on sort of those points?

Yes. Let me elaborate by starting with the last point. And we talked about tech debt, but tech debt sounds -- it's just a convenient business term. And I want to give you a sense of what do I actually mean when I talk about tech debt. So I'll give you a couple of examples of this. right? We actually have, I think, a best-in-class partnership with a company called Kinaxis for our inventory management system, but we actually haven't implemented the whole thing and tied it into all of our inventory management systems.

So right now, every quarter, at the end of the quarter, we have to shut down our warehouses for 3 days and manually count every single thing we own. That's an example of tech debt. And I'm really hopeful that as we look at the latter part of our fiscal year '26, we'll be in a place where we have to do that sort of thing less frequently. There's another example of tech debt. Right now, I mean, I think our global member support people are heroes and the progress that we have made year-over-year in that area is nothing short of remarkable, having moved from the mid-3s in terms of member satisfaction scores into the mid-4s in a pretty short period of time.

But right now, we don't have the tools for our global member support people to actually be able to see what our members are seeing. So if a member calls in with a question or a concern about a piece of their equipment, we basically have to sit on the phone with them and say, tell me what you're seeing. And that is going -- it results in less than perfectly accurate diagnosis of the problem. And unfortunately, too often having to send someone out to the customer's home to actually do the diagnosis and then maybe order parts and have a second visit.

So tech debt manifests itself in both of those cases in like real costs and in some cases, real impact for the member. So that's the kind of thing that we're going to be able to fix those sorts of things. Some tech debt problems take a long time, but we'll be able to fix those things, I think, over the course of FY '26. And that enables us to start to take out more costs. That, along with -- our G&A is just too high. We've got a project Liz and Charlie, who I talked about earlier, are leading this to look at our spend on vendors. Our tail spend, I think, is just too high. All that opens up opportunities for us to be able to just continue to rightsize the cost structure to reflect the revenue of the company.

Related subject in terms of just thinking about a little higher in the P&L, connected hardware margins, a ton of progress there. And as you sort of alluded to under your new COO, some opportunities for continued gains. Could we see margins get above kind of the mid sort of teens we are now? Would you perhaps use additional efficiencies or gains to reinvest as a customer acquisition tool up? How should we think about the connected hardware margins?

Yes. There's so many things here that are all kind of connected. The way I -- first of all, I just want to take a moment to celebrate the progress that the company has made. Having moved 1,000 basis points in the course of a year on our gross margins on our equipment is really -- is quite an achievement. A lot of that has basically been driven through improvements in things like inventory and logistics. We haven't fundamentally addressed the actual cost structure of the equipment itself. That is not something that you can do overnight because it requires reengineering, it requires evolving the relationships that we have with our key suppliers. Of course, it's impacted by things like tariffs as well.

But the fact is that there is continued -- there's more upside there. What I would say though is I don't really want to guide to that number because I view the gross margins that we have on our equipment is sort of a lever alongside our marketing spend, that we'll use to basically essentially modulate in order to grow the company. And so there may be quarters, for example, where we do more on price on our equipment, and we'll spend relatively less on marketing, and then there may be quarters where we do the opposite. So there's value creation opportunity. How it actually manifests, I think, is a little bit more of an open question.

Understood. And then going to the balance sheet, great position at the moment, leverage under 2x and falling, plenty of excess cash, right? Free cash flow, as you mentioned, $0.25 billion this year. How do you think about the optimal amount of cash on the books? I mean that's a question I get, seeming like you might have too much. So in terms of like thinking about the debt paydown going forward, thinking about potential for share buybacks, particularly if you read the debt, how should we think about just optimal cash return and to look at the balance sheet?

I just want to take a moment to appreciate that question because a year ago, right, this company was sort of just in the process, I think, of refinancing the debt, and there were really fundamental questions about the company and our capital structure was really at the heart of those questions. So the fact that you're even asking right now that we might have too much cash is just music to my ears. Just at the highest level, I think it's just helpful to understand sort of what the debt stack looks like here.

We've got a couple of hundred million dollar loan that comes due. It's current right now in February of '26. We're in no rush to pay it off because it's 0 coupon. But come February of '26, we'll use cash to pay that off. So that's the first step. We've got another $350 million or so that the debt holders have certain rights on, and we'll determine the right way to handle that when or if they decide to exercise those rights. The last $1 billion has some penalties associated with prepayment. They're not onerous at this point, but I think there is an opportunity for us to take a look at that $1 billion in the fullness of time, potentially get rated and then likely after the prepayment penalties are gone, see if there are ways for us to reduce our total cost of capital.

So we're taking, I think, a very deliberate approach here, but you'll certainly see that $200 million debt cash pay that off within the next year.

Understood. Well, I think we're out of time. Peter, really appreciate your thoughts and time here. And yes, this was a fun discussion.

Great. It's my pleasure. Thanks so much.