PTON - NASDAQ

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 by 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 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 welcomed 2 new hires to the leadership team, Chief Marketing Officer, Megan Imbres, who joined us from Apple and Chief Communications Officer, Dianna 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 in 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 healthspan in history at over 12 years. Addressing health span requires a different approach from lifespan because healthspan 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. 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, 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 Grosz, President of Precor, will be retiring and we sincerely thank him for his leadership in returning the Precor business to growth. Our commercial business unit plan 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 2025 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 renewing 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 of 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 partially 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 the course of 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 Connected 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 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 subscriptions. 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 million 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 tariff 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 Q1 26.07 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 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 towards a more holistic approach that brings together cardio and strength, and sleep, stress management and nutrition to improve the quality of their lives as I talked about their healthspan. We also see that 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+ app because young 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 senior 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 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. Sherry, can you open up the question from 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 price 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 cost saves? 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 relocation. 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 Liz after that.

Yes, Youssef, 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, who spend money on fitness and that's 117 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 as 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 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 adjunct 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 is 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 keep seeing 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 to 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 now 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 them early 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 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. Curtis, 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 deduped 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 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. 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 sort of 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 backwards, 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+ app or whether it's launching new categories like kettlebells 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 Pass to our product. I've talked a lot about personalized plans and we're now up to 700,000 of our members taking 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 people -- 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 Peloton could evolve, 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 a 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 tiering 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 strength classes again this quarter and so we've been doing even more in that area. I talked about kettlebell classes. The dedicated Strength+ 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 meditation classes. 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've been working in partnership with Dr. Jaime Schehr, who's an expert nutritionist and dietitian, and we're going to be testing and iterating on nutritional content over time. In terms of your questions then on -- there are a number of them that followed from that [indiscernible]. So 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 most certainly will in the very near 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 there is so much opportunity for us. With regard to fast and refurbish, 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 we're bottom of 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 Peloton member in September, so -- and there are occasions when I find myself just getting in the rut 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. One, 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 do strength in addition to cardio. If you belong to a gym, please download and try the Strength+ app, it's amazing, add in meditations, whether you're doing them at daytime -- 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 vest classes or kettlebell workouts. 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. Please go ahead and set up a personalized program. We've improved them a lot, even in the last quarter to make them more 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 environment, it's like a safe social network that gives you tips on what works for other people and encouragement that 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 thread 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.