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(Exact name of registrant as specified in its charter)
iDelaware
i47-3533761
(State
or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
i441 Ninth Avenue, Sixth Floor
i10001
iNew
York, iNew York
(Zip Code)
(Address of principal executive offices)
(i917) i671-9198
(Registrant’s
telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
iClass
A common stock, $0.000025 par value per share
iPTON
iThe Nasdaq Stock Market LLC
Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. iYes☒ No ☐
Indicate by check mark whether the
registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). iYes☒ No ☐
Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
iLarge
accelerated filer
☒
Accelerated filer
☐
Non-accelerated filer
☐
Smaller reporting company
i☐
Emerging
growth company
i☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No i☒
As of October 31, 2022, the number of shares of the registrant’s Class A common stock outstanding was
i313,517,712 and the number of shares of the registrant’s Class B common stock outstanding was i26,536,209.
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements contained in this Quarterly Report on Form 10-Q other than statements of historical fact, including, without limitation, statements regarding our execution of and timing of and the expected benefits from our restructuring initiatives and cost-saving measures, the cost savings and other efficiencies of expanding relationships with our third party partners, details regarding and the timing of
the launch of new products and services, our new initiatives with retailer partners and our efforts to optimize our retail store footprint, the prices of our products and services in the future, our future operating results and financial position, our business strategy and plans, market growth, and our objectives for future operations, are forward-looking statements. The words “believe,”“may,”“will,”“estimate,”“potential,”“continue,”“anticipate,”“intend,”“expect,”“could,”“would,”“project,”“plan,”“target,” and similar expressions are intended to identify forward-looking statements, though not all forward-looking statements use these words or expressions.
We have based these forward-looking statements on our current expectations and projections about future events and trends that
we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties, and assumptions and other important factors that could cause actual results to differ materially from those stated, including, but not limited to:
•our ability to achieve and maintain future profitability;
•our ability to attract and maintain Subscribers;
•our ability to accurately forecast consumer demand of our products and services and adequately maintain our inventory;
•our
ability to execute and achieve the expected benefits of our restructuring initiatives and other cost-saving measures;
•our ability to effectively manage our growth;
•our ability to anticipate consumer preferences and successfully develop and offer new products and services in a timely manner, or effectively manage the introduction of new or enhanced products and services;
•demand for our products and services and growth of the connected fitness products industry;
•our reliance on a limited number of suppliers, contract
manufacturers, and logistics partners for our Connected Fitness Products (as defined below);
•our reliance on and lack of control over suppliers, contract manufacturers and logistics partners for our Connected Fitness Products;
•our ability to predict our long-term performance and declines in our revenue growth as our business matures;
•the effects of increased competition in our markets and our ability to compete effectively;
•declines in sales of
our Bike and Bike+;
•the direct and indirect impacts to our business and financial performance from the COVID-19 pandemic;
•our dependence on third-party licenses for use of music in our content;
•actual or perceived defects in, or safety of, our products, including any impact of product recalls or legal or regulatory claims, proceedings or investigations involving our products;
•our ability to maintain, protect, and enhance our intellectual property;
•our
ability to stay in compliance with laws and regulations that currently apply or become applicable to our business both in the United States and internationally; and
•those risks and uncertainties described in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I, Item 2, and the sections titled “Risk Factors” in Part I, Item 1A and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 in our Annual Report on Form 10-K for the fiscal year ended June 30, 2022, as such factors may be updated in our filings with the Securities and Exchange Commission (the “SEC”).
Moreover, we operate in a
very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties, and assumptions, the future events and trends discussed in this Quarterly Report on Form 10-Q may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.
You should not rely upon forward-looking statements as predictions of future events. The events and circumstances reflected in the forward-looking statements may not be achieved or occur. Although we believe that the expectations reflected
in the forward-looking statements are reasonable, we cannot guarantee future results, performance, or achievements. Our forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q, and we undertake no obligation to update any of these forward-looking statements for any reason after the date of this Quarterly Report on Form 10-Q or to conform these statements to actual results or revised expectations, except as required by law.
You should read this Quarterly Report on Form 10-Q, and the documents that we reference in this Quarterly Report on Form 10-Q and have filed with the SEC, with the understanding that our actual future results, performance, and events and circumstances may be materially different from what we expect.
In this Quarterly Report on Form 10-Q, the words
“we,”“us,”“our,” and "Peloton" refer to Peloton Interactive, Inc. and its wholly owned subsidiaries, unless the context requires otherwise.
Current
portion of long-term debt and other bank borrowings
i7.5
i7.5
Operating
lease liabilities, current
i89.8
i86.4
Other
current liabilities
i10.3
i13.2
Total
current liabilities
i927.2
i1,105.5
i0%
Convertible senior notes, net
i984.6
i864.0
Term
loan, net
i690.1
i690.0
Operating lease liabilities,
non-current
i691.6
i725.4
Other
non-current liabilities
i40.5
i50.7
Total
liabilities
i3,334.0
i3,435.6
Commitments
and contingencies (Note 8)
i
i
Stockholders’ equity
Common
stock, $iiii0.000025///
par value; i2,500,000,000 and i2,500,000,000 Class A shares authorized, ii311,105,668/
and ii308,241,938/ shares issued and outstanding as of
September 30, 2022 and June 30, 2022, respectively; i2,500,000,000 and i2,500,000,000
Class B shares authorized, ii28,733,963/ and ii30,032,078/
shares issued and outstanding as of September 30, 2022 and June 30, 2022, respectively.
i—
i—
Additional
paid-in capital
i4,320.0
i4,291.3
Accumulated
other comprehensive income
i17.1
i12.2
Accumulated
deficit
(i4,078.6)
(i3,710.6)
Total
Stockholders’ equity
i258.5
i592.9
Total liabilities and stockholders'
equity
$
i3,592.5
$
i4,028.5
See
accompanying notes to these unaudited condensed consolidated financial statements.
4
PELOTON INTERACTIVE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
See
accompanying notes to these unaudited condensed consolidated financial statements.
7
PELOTON INTERACTIVE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(in millions, except share and per share amounts)
1.
iDescription of Business and Basis of Presentation
Description and Organization
Peloton Interactive, Inc. (“Peloton” or the “Company”) is the largest interactive fitness platform in the world with a loyal community of Members, which we define as any individual who has a Peloton account through a paid Connected Fitness Subscription (“All-Access Membership”) or a paid Peloton Digital
Subscription. The Company pioneered connected, technology-enabled fitness with the creation of its interactive fitness equipment (“Connected Fitness Products”) and the streaming of immersive, instructor-led boutique classes to its Members anytime, anywhere. The Company makes fitness entertaining, approachable, effective, and convenient while fostering social connections that encourage Members to be the best versions of themselves.
Basis of Presentation and Consolidation
The accompanying interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP") and applicable rules and regulations of the U.S. Securities
and Exchange Commission ("SEC") regarding interim financial reporting. The condensed consolidated balance sheet as of June 30, 2022, included herein, was derived from the audited financial statements as of that date, but does not include all disclosures including certain notes required by GAAP on an annual reporting basis. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations of the SEC. Therefore, these interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2022 (the "Form 10-K").
However, the Company believes that the disclosures provided herein are adequate to prevent the information presented from being misleading.
The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
In the opinion of management, the accompanying interim condensed consolidated financial statements reflect all normal recurring adjustments necessary to present fairly the financial position, results of operations, cash flows, and the changes in equity for the interim
periods. The results for the three months ended September 30, 2022 are not necessarily indicative of the results to be expected for any subsequent quarter, the fiscal year ending June 30, 2023, or any other period.
Certain monetary amounts, percentages, and other figures included elsewhere in these financial statements have been subject to rounding adjustments. Accordingly, figures shown as totals in certain tables may not be the arithmetic aggregation of the figures that precede them, and figures expressed as percentages in the text may not total 100% or, as applicable, when aggregated may not be the arithmetic aggregation of the percentages that precede them.
Certain immaterial amounts presented in the condensed consolidated statement
of operations and comprehensive loss for the three months ended September 30, 2021 have been reclassified to conform to the current year presentation.
Except as described elsewhere in Note 2 - Summary of Significant Accounting Policies under the section titled “Recently Issued Accounting Pronouncements,” there have been no material changes to the Company’s significant accounting policies as described in the Form 10-K.
8
2.
iSummary of Significant Accounting Policies
Use of Estimates
iThe preparation of these financial statements requires the
Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. On an ongoing basis, the Company evaluates its estimates, including, among others, those related to revenue related reserves, the realizability of inventory, content costs for past use reserve, fair value measurements, the incremental borrowing rate associated with lease liabilities, impairment of long-lived and intangible assets, useful lives of long lived assets, including property and equipment and finite lived intangible assets, product warranty, goodwill, accounting for income taxes, stock-based compensation expense, transaction price estimates, the fair values of assets acquired and liabilities assumed in business combinations and asset acquisitions, contingent consideration, and commitments and contingencies. Actual results may differ
from these estimates.
i
Recently Issued Accounting Pronouncements
Accounting Pronouncements Recently Adopted
ASU 2020-06
In August 2020, the FASB issued ASU 2020-06, Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging- Contracts in
Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. The guidance will simplify the accounting for convertible instruments by reducing the number of accounting models for convertible debt instruments and convertible preferred stock, thereby limiting the accounting results in fewer embedded conversion features being separately recognized from the host contract as compared with current GAAP. Convertible instruments that continue to be subject to separation models are (1) those with embedded conversion features that are not clearly and closely related to the host contract, that meet the definition of a derivative,
and that do not qualify for a scope exception from derivative accounting and (2) convertible debt instruments issued with substantial premiums for which the premiums are recorded as paid-in capital. ASU 2020-06 also amends the guidance for the derivatives scope exception for contracts in an entity’s own equity to reduce form-over-substance-based accounting conclusions. In addition, the guidance eliminates the treasury stock method to calculate diluted earnings per share for convertible instruments and requires the use of the if-converted method. ASU 2020-06 will be effective for public companies for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. Early adoption is permitted, but no earlier than fiscal years beginning after December
15, 2020, including interim periods within those fiscal years. The Company adopted the standard, effective July 1, 2022, using the modified retrospective transition method. Adoption of the new standard resulted in a reduction to Additional paid-in capital of $i160.1 million to remove the equity component separately recorded for the conversion features associated with the Notes (as defined in Note 5 - Fair Value Measurements), an increase
of $i119.6 million in the carrying value of its Notes to reflect the full principal amount of the Notes outstanding net of issuance costs, and a decrease to Accumulated deficit of $i40.5 million.
Accounting
Pronouncements Not Yet Adopted
ASU 2021-08
In October 2021, the Financial Accounting Standards Board issued ASU 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers. The guidance requires that an acquirer recognize and measure contract assets and liabilities acquired in a business combination in accordance with ASC 606, Revenue from
Contracts with Customers. This standard is effective for annual periods beginning after December 15, 2022, including interim periods therein, with early adoption permitted, and should be applied prospectively to acquisitions occurring on or after the effective date. The Company will continue to evaluate the impact of this guidance, which will depend on the contract assets and liabilities acquired in future business combinations.
/
3.
iRevenue
i
The
Company’s primary source of revenue is from sales of its Connected Fitness Products and associated recurring Subscription revenues.
The Company determines revenue recognition through the following steps:
•Identification of the performance obligations in the contract;
•Determination
of the transaction price;
•Allocation of the transaction price to the performance obligations in the contract; and
•Recognition of revenue when, or as, the Company satisfies a performance obligation.
Revenue is recognized when control of the promised goods or services is transferred to the Company’s customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange
for those goods or services. The Company’s revenue is reported net of sales returns, discounts, incentives, and rebates to commercial distributors as a reduction of the transaction price. Certain contracts include consideration payable that is accounted for as a payment for distinct goods or services. The Company estimates its liability for product returns and concessions based on historical trends by product category, impact of seasonality, and an evaluation of current economic and market conditions and records the expected customer refund liability as a reduction to revenue, and the expected inventory right of recovery as a reduction of cost of revenue. If actual return costs differ from previous estimates,
the amount of the liability and corresponding revenue are adjusted in the period in which such costs occur.
9
Some of the Company’s contracts with customers contain multiple performance obligations. For customer contracts that include multiple performance obligations, the Company accounts for individual performance obligations if they are distinct. The transaction
price is then allocated to each performance obligation based on its standalone selling price. The Company generally determines the standalone selling price based on the prices charged to customers.
The Company applies the practical expedient as per ASC 606-10-50-14 and does not disclose information related to remaining performance obligations due to their original expected terms being one year or less.
The Company expenses sales commissions on its Connected Fitness Products when incurred because the amortization period would have been less than
one year. These costs are recorded in Sales and marketing in the Company’s Condensed Consolidated Statements of Operations and Comprehensive Loss.
Connected Fitness Products
Connected Fitness Products include the Company’s portfolio of Connected Fitness Products and related accessories, Precor branded fitness products, delivery and installation services, Peloton branded apparel, extended warranty agreements, and commercial service contracts. The Company recognizes Connected Fitness Product revenue net of sales returns and discounts
when the product has been delivered to the customer, except for extended warranty revenue that is recognized over the warranty period and service revenue that is recognized over the term of the service contract. The Company allows customers to return Peloton branded Connected Fitness Products within ithirty days of purchase, as stated in its return policy.
The
Company records fees paid to third-party financing partners in connection with its consumer financing program as a reduction of revenue, as it considers such costs to be a customer sales incentive. The Company records payment processing fees for its credit card sales for Connected Fitness Products within Sales and marketing in the Company’s Condensed Consolidated Statements of Operations and Comprehensive Loss.
Subscription
The Company’s subscriptions provide unlimited access to content in its library of live and on-demand fitness classes. The
Company’s subscriptions are offered on a month-to-month basis.
Amounts paid for subscription fees, net of refunds are included within Deferred revenue and customer deposits on the Company’s Condensed Consolidated Balance Sheets and recognized ratably over the subscription term. The Company records payment processing fees for its monthly subscription charges within cost of Subscription revenue in the Company’s Condensed Consolidated Statements of Operations and Comprehensive Loss.
Sales tax collected from customers and remitted to governmental
authorities is not included in revenue and is reflected as a liability on the Company’s Condensed Consolidated Balance Sheets.
Standard Product Warranty
The Company offers a standard product warranty that its Connected Fitness Products will operate under normal, non-commercial use for a period of ione year covering the touchscreen and most
original Bike, Bike+, Tread, Tread+, and Guide components from the date of original delivery. The Company has the obligation, at its option, to either repair or replace the defective product. At the time revenue is recognized, an estimate of future warranty costs are recorded as a component of cost of revenue. Factors that affect the warranty obligation include historical as well as current product failure rates, service delivery costs incurred in correcting product failures, and warranty policies and business practices. The Company’s products are manufactured both in-house and by contract manufacturers, and in certain cases, the
Company may have recourse to such contract manufacturers.
i
Activity related to the Company’s accrual for our estimated future product warranty obligation was as follows:
The
Company also offers the option for customers in some markets to purchase an extended warranty and service contract that extends or enhances the technical support, parts, and labor coverage offered as part of the base warranty included with the Connected Fitness Products for additional periods ranging from i12 to i36
months.
Extended warranty revenue is recognized on a gross basis as the Company has a continuing obligation to perform over the service period. Extended warranty revenue is recognized ratably over the extended warranty coverage period and is included in Connected Fitness Product revenue in the Condensed Consolidated Statements of Operations and Comprehensive Loss.
10
Disaggregation of Revenue
The Company’s revenue from contracts
with customers disaggregated by major product lines, excluding sales-based taxes, are included in Note 12 - Segment Information.
i
The Company’s revenue disaggregated by geographic region, were as follows:
The
Company’s revenue attributable to the United States was $i545.1 million and $i696.1 million, or i88%
and i86% of Total revenue, for the three months ended September 30, 2022 and 2021, respectively.
Customer Deposits and Deferred Revenue
As of September 30, 2022 and June 30, 2022, customer deposits of $i105.9
million and $i109.2 million, respectively, and deferred revenue of $i91.4 million and $i91.9
million, respectively, were included in Deferred revenue and customer deposits on the Company’s Condensed Consolidated Balance Sheets.
In the three months ended September 30, 2022 and 2021, the Company recognized revenue of $i88.1
million and $i72.6 million, respectively, that was included in the deferred revenue balance as of June 30, 2022 and 2021, respectively.
iDeferred
revenue is recorded for nonrefundable cash payments received for the Company’s performance obligation to transfer, or stand ready to transfer, goods or services in the future. Customer deposits represent payments received in advance before the Company transfers a good or service to the customer and are refundable.
4. iRestructuring
In
February 2022, we announced and began implementing a restructuring plan to realign the Company’s operational focus to support its multi-year growth, scale the business, and improve costs (the “Restructuring Plan”). The Restructuring Plan originally included: (i) reducing the Company’s headcount; (ii) closing several assembly and manufacturing plants, including the completion and subsequent sale of the shell facility for the Company’s previously planned Peloton Output Park; (iii) closing and consolidating several distribution facilities; and (iv) shifting to third-party logistics providers in most locations. The Company
expects the Restructuring Plan to be substantially completed by the end of fiscal 2024.
In July 2022, August 2022 and October 2022, the Company took actions to update the Restructuring Plan. On July 12, 2022, the Company announced it is exiting all owned-manufacturing operations and expanding its current relationship with Taiwanese manufacturer Rexon Industrial Corp. Additionally, on August 12, 2022, the Company announced the decision to perform the following restructuring activities: (i) fully transition its North American Field
Operations to third-party providers, including the significant reduction of its delivery workforce teams; (ii) eliminate a significant number of roles on the North America Member Support team and exit its real-estate footprints in its Plano and Tempe locations; and (iii) reduce its North America retail showroom presence. On October 6, 2022, the Company announced approximately i500 global team member positions
have been eliminated.
iAs a result of the Restructuring Plan, the Company incurred the following charges, of which Asset write-downs and write-offs are included within Impairment expense in the Condensed Consolidated Statements of Operations and Comprehensive Loss. The remaining charges incurred due to the restructuring plan are included within Restructuring expense in the Condensed Consolidated
Statements of Operations and Comprehensive Loss:
In
connection with the Restructuring Plan, the Company committed to the closures of certain warehouse and retail locations, the discontinuation of manufacturing in North America, and the wind down of certain software implementation and development projects. Due to the actions taken, the Company tested certain long-lived assets (asset groups) for recoverability by comparing the carrying values of the asset groups to estimates of their future undiscounted cash flows, which were generally the liquidation value, or for operating lease right-of-use assets, income from a sublease arrangement. Based on the results of the recoverability tests, the Company determined that during the three months ended September 30,
2022, the undiscounted cash flows of certain assets (asset groups) were below their carrying values, indicating impairment. The assets were written down to their estimated fair values, which were determined based on their estimated liquidation or sales value, or for operating lease right-of-use assets, discounted cash flows of a sublease arrangement.
i
The following table presents a roll-forward of cash restructuring-related liabilities, which is included within Accounts
payable and accrued expenses in the Condensed Consolidated Balance Sheets, as follows:
In
addition to the above charges, the Company incurred approximately $i1.9 million of capital expenditures related to Peloton Output Park during the three months ended September 30, 2022.
In connection with the Restructuring Plan, the Company estimates that it will incur additional cash
charges of approximately $i70 million, primarily composed of severance and other exit costs, in fiscal year 2023 and beyond. Additionally, the Company expects to recognize additional non-cash charges of approximately $i70
million, primarily composed of asset impairment and stock-based compensation charges, in fiscal year 2023 in connection with the Restructuring Plan.
5. iFair Value Measurements
Fair Value Measurements of Other Financial Instruments
i
The
following tables present the estimated fair values of the Company’s financial instruments that are not recorded at fair value on the Condensed Consolidated Balance Sheets:
iThe
fair value of the i0% Convertible Senior Notes due February 15, 2026 (the “Notes”) is determined based on the closing price on the last trading day of the reporting period./
The carrying value of the Term Loan approximates the fair value as the Term Loan as of September 30, 2022.
(1)
Includes $i46.9 million and $i36.4 million of finished goods inventory in transit, products owned by the Company that have not yet been received at a Company distribution center, as of
September 30, 2022 and June 30, 2022, respectively.
The Company periodically assesses and adjusts the value of inventory for estimated excess and obsolete inventory based upon estimates of future demand and market conditions, as well as damaged or otherwise impaired goods. The Company recorded inventory reserves as of September 30, 2022 primarily in the amounts of $i124.9
million related to excess accessories and apparel inventory that the Company does not expect to sell above its current carrying value, $i88.3 million related primarily to returned Connected Fitness Products that the Company does not expect to sell, and $i41.9
million in reserves for component parts that the Company estimated would have no future use.
In February 2021, the
Company issued $i1.0 billion aggregate principal amount of the Notes in a private offering, including the exercise in full of the over-allotment option granted to the initial purchasers of $i125.0 million. The Notes were issued pursuant
to an Indenture (the “Indenture”) between the Company and U.S. Bank National Association, as trustee. The Notes are senior unsecured obligations of the Company and do not bear regular interest, and the principal amount of the Notes does not accrete. The net proceeds from this offering were approximately $i977.2
million, after deducting the initial purchasers' discounts and commissions and the Company’s offering expenses.
Each $1,000 principal amount of the Notes is initially convertible into 4.1800 shares of the Company’s Class A common stock, $i0.000025 par value per share (“Class A Common Stock”), which is equivalent to an
initial conversion price of approximately $i239.23 per share. The conversion rate is subject to customary adjustments under certain circumstances in accordance with the terms of the Indenture. In addition, if certain corporate events that constitute a make-whole fundamental change occur, then the conversion rate will, in certain circumstances, be increased for a specified period of time.
The Notes will
mature on February 15, 2026, unless earlier converted, redeemed, or repurchased. The Notes will be convertible at the option of the holders at certain times and upon the occurrence of certain events in the future.
On or after August 15, 2025, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert all or any portion of their Notes, in multiples of $1,000 principal amount, at the option of the holder regardless of the foregoing circumstances. Upon conversion, the Company may satisfy its conversion obligation by paying and/or delivering, as the case may be, cash, shares of the Class A Common Stock or a combination of cash and shares of
the Class A Common Stock, at the Company’s election, in the manner and subject to the terms and conditions provided in the Indenture. It is the Company’s current intent to settle the principal amount of the Notes with cash.
The Company may redeem for cash all or any portion of the Notes, at its option, on or after February 20, 2024 and on or before the 20th scheduled trading day immediately before the maturity date, if the last reported sale price per share of the Class A Common Stock exceeds
i130% of the conversion price then in effect on (1) each of at least i20 trading days (whether or not consecutive)
during the i30 consecutive trading days ending on, and including, the trading day immediately preceding the date on which the Company provides notice of redemption and (2) the trading day immediately before the date the Company sends such notice at a redemption price equal to i100%
of the principal amount of the
13
Notes to be redeemed, plus any accrued and unpaid special interest, if any, to, but excluding, the redemption date. No sinking fund is provided for the Notes, which means that the Company is not required to redeem or retire the Notes periodically.
Upon the occurrence of a fundamental change (as defined in the Indenture), subject to certain conditions, holders may require the Company
to repurchase all or a portion of the Notes for cash at a price equal to i100% of the principal amount of the Notes to be repurchased, plus any accrued and unpaid special interest, if any, to, but excluding, the fundamental change repurchase date.
The Notes are the Company’s senior unsecured obligations and rank senior in right of payment to any of the
Company’s existing and future indebtedness that is expressly subordinated in right of payment to the Notes; equal in right of payment to any of the Company’s existing and future unsecured indebtedness that is not so subordinated; effectively subordinated in right of payment to any of the Company’s existing and future secured indebtedness to the extent of the value of the collateral securing such indebtedness; and structurally subordinated to all existing and future indebtedness and other liabilities of current or future subsidiaries of the Company (including trade payables and to the extent the
Company is not a holder thereof, preferred equity, if any, of the Company’s subsidiaries).
i
The net carrying amount of the liability component of the Notes was as follows:
(1)
The decrease in total interest expense during the three months ended September 30, 2022 was due to the derecognition of the unamortized debt discount, partially offset by the increase in the amortization of issuance costs previously recognized in equity. These changes were the result of the Company’s adoption of ASU No. 2020-06, as of July 1, 2022, as described in Note 2 - Summary of Significant Accounting Policies,
/
Capped Call Transactions
In connection with the offering of the
Notes, the Company entered into privately negotiated capped call transactions with certain counterparties (the “Capped Call Transactions”). The Capped Call Transactions have an initial strike price of approximately $i239.23 per share, subject to adjustments, which corresponds to the approximate initial conversion price of the Notes. The cap price of the Capped Call Transactions will initially be approximately $i362.48
per share. The Capped Call Transactions cover, subject to anti-dilution adjustments substantially similar to those applicable to the Notes, i6.9 million shares of Class A Common Stock. The Capped Call Transactions are expected generally to reduce potential dilution to the Class A Common Stock upon any conversion of Notes and/or offset any potential cash payments the Company would be required to make in excess of the principal amount of converted Notes, as the case may be, with such reduction
and/or offset subject to a cap based on the cap price. If, however, the market price per share of Class A Common Stock, as measured under the terms of the Capped Call Transactions, exceeds the cap price of the Capped Call Transactions, there would be dilution and/or there would not be an offset of such potential cash payments, in each case, to the extent that the then-market price per share of the Class A Common Stock exceeds the cap price of the Capped Call Transactions.
For accounting purposes, the Capped Call Transactions are separate transactions, and are not part of the terms of the Notes. The net cost of $i81.3
million incurred to purchase the Capped Call Transactions was recorded as a reduction to Additional paid-in capital on the Company’s Condensed Consolidated Balance Sheets.
Second Amended and Restated Credit Agreement
In 2019, the Company entered into an amended and restated revolving credit agreement as amended, modified or supplemented prior to entrance into the Second Amended and Restated Credit Agreement (as defined below). The Amended and Restated Credit Agreement provided for a $i500.0 million
secured revolving credit facility, including up to the lesser of $i250.0 million and the aggregate unused amount of the facility for the issuance of letters of credit.
The Amended and Restated Credit Agreement also permitted the incurrence of indebtedness to permit the Capped Call Transactions and issuance of the Notes.
14
On
May 25, 2022, the Company entered into an Amendment and Restatement Agreement to the Second Amended and Restated Credit Agreement (and as amended, restated or otherwise modified from time to time, the “Second Amended and Restated Credit Agreement”) with JPMorgan Chase Bank, N.A., as administrative agent, and certain banks and financial institutions party thereto as lenders and issuing banks. Pursuant to the Second Amended and Restated Credit Agreement, the Company amended and restated the Amended and Restated Credit Agreement.
The Second Amended and Restated Credit Agreement provides for a $i750.0
million term loan facility (the “Term Loan”), which will be due and payable on May 25, 2027 or, if greater than $i200.0 million of the Notes are outstanding on November 16, 2025 (the “Springing Maturity Condition”), November 16, 2025 (the “Springing Maturity Date”). The Term Loan amortizes in quarterly installments of i0.25%,
payable at the end of each fiscal quarter and on the maturity date.
The Second Amended and Restated Credit Agreement also provides for a $i500.0 million revolving credit facility (the “Revolving Facility”), $i35.0
million of which will mature on June 20, 2024 (the “Non-Consenting Commitments”), with the rest ($i465.0 million) maturing on December 10, 2026 (the “Consenting Commitments”) or if the Springing Maturity Condition is met and the Term Loan is outstanding on such date, the Springing Maturity Date. The key terms of the Revolving Facility remain substantially unchanged from those set forth in the Amended and Restated Credit Agreement, including requiring compliance
with a total level of liquidity of not less than $i250.0 million and maintaining a minimum total four-quarter revenue level of $i3.0 billion (which are replaced with a covenant to
maintain a minimum debt to adjusted EBITDA ratio upon our meeting a specified adjusted EBITDA threshold).
The Revolving Facility bears interest at a rate equal to, at our option, either at the Adjusted Term SOFR Rate (as defined in the Second Amended and Restated Credit Agreement) plus i2.25% per annum or the Alternate Base Rate (as defined in the Second Amended and Restated Credit Agreement) plus i1.25%
per annum for the Consenting Commitments, and bears interest at a rate equal to, at our option, either at the Adjusted Term SOFR Rate plus i2.75% per annum or the Alternate Base Rate plus i1.75%
per annum for the Non-Consenting Commitments. The Company is required to pay an annual commitment fee of i0.325% per annum and i0.375%
per annum on a quarterly basis based on the unused portion of the Revolving Facility for the Consenting Commitments and the Non-Consenting Commitments, respectively.
The Term Loan bears interest at a rate equal to, at our option, either at the Alternate Base Rate plus i5.50% per annum or the Adjusted Term SOFR Rate plus i6.5%
per annum. Each such margin will increase one time by i0.50% per annum if the Company chooses not to obtain a public rating for the Term Loan from S&P Global Ratings or Moody’s Investors Services, Inc. on or prior to November 25, 2022. Any borrowing at the Alternate Base Rate is subject to a i1.00%
floor and a term loan borrowed at the Adjusted Term SOFR Rate is subject to a i0.50% floor and any revolving loan borrowed at the Adjusted Term SOFR Rate is subject to a i0.00%
floor.
The Second Amended and Restated Credit Agreement contains customary affirmative covenants as well as customary covenants that restrict our ability to, among other things, incur additional indebtedness, sell certain assets, guarantee obligations of third parties, declare dividends or make certain distributions, and undergo a merger or consolidation or certain other transactions. The Second Amended and Restated Credit Agreement also contains certain customary events of default. Certain baskets and covenant levels have been decreased and will apply equally to both the Term Loan and Revolving Facility for so long as the Term Loan is outstanding. After the repayment in full of the Term Loan, such baskets and levels will revert to those previously disclosed in connection with the Amended and Restated Credit Agreement.
The
obligations under the Second Amended and Restated Credit Agreement with respect to the Term Loan and the Revolving Facility are secured by substantially all of our assets, with certain exceptions set forth in the Second Amended and Restated Credit Agreement, and are required to be guaranteed by certain material subsidiaries of the Company if, at the end of future financial quarters, certain conditions are not met.
During the three months ended September 30, 2022 and 2021, the Company incurred total commitment fees of $i0.4
million and $i0.3 million, respectively, which are included in Interest expense in the Condensed Consolidated Statements of Operations and Comprehensive Loss.
As of September 30, 2022, the Company had drawn the full amount of the Term Loan and we had inot
drawn on the Revolving Facility, and we had $i748.1 million of total outstanding borrowings under the Second Amended and Restated Credit Agreement.
In connection with the execution of the Second Amended and Restated Credit Agreement, the Company incurred debt issuance costs of $i1.1
million which are capitalized and presented as Other assets on the Company’s Condensed Consolidated Balance Sheets. These costs are being amortized to interest expense using the effective interest method over the term of the Second Amended and Restated Credit Agreement.
As of September 30, 2022, the Company was in compliance with the covenants under the Second Amended and Restated Credit Agreement. The Company is required to pledge or otherwise restrict a portion of cash and cash equivalents as collateral for standby letters of credit. As of September 30,
2022, we had outstanding letters of credit totaling $i82.6 million, of which $i77.8 million is classified as Restricted cash on the Condensed Consolidated Balance Sheet.
Our proceeds in connection with the
Term Loan were $i696.4 million, net of discount of $i33.8 million and issuance costs of $i19.8
million. Both the discount and issuance costs are being amortized to interest expense over the term of the Term Loan using the effective interest rate method. The effective interest rate was i10.2%.
15
The net carrying amount of the Term Loan was as follows:
The Company is subject to minimum guarantee royalty payments associated under certain music license agreements.
i
The
following represents the Company's minimum annual guarantee payments under music license agreements for the next three years as of September 30, 2022:
Future Minimum Payments
Fiscal Year
(in millions)
2023 (remaining)
$
i100.7
2024
i125.5
2025
i43.8
Total
$
i270.0
/
Content
Costs for Past Use Reserve
To secure the rights to stream music on the Peloton platform, the Company must obtain licenses from, and pay royalties to, copyright owners of both sound recordings and musical compositions. The licensors have the right to audit our royalty calculations and routinely exercise those rights. The Company has entered into negotiations with various music rights holders, to pay for any and all uses of musical compositions and sound recordings to date and, at the same time, enter into go-forward license agreements for the use of music in the future.
Prior to the execution of go-forward music license agreements, the
Company estimates and records expenses inclusive of estimated content costs for past use as well as normal and recurring music royalty expenses. The Company includes both of these components in its reserve. As of September 30, 2022 and 2021, the Company recorded reserves of $i10.3 million and $i10.8
million, respectively, included in Accounts payable and accrued expenses in the accompanying Condensed Consolidated Balance Sheets.
Product Recall Return Reserves
On May 5, 2021, the Company announced separate, voluntary recalls of its Tread+ and Tread products in collaboration with the U.S. Consumer Product Safety Commission ("CPSC") and halted sales of these products to work on product enhancements. On October 18, 2022, the CPSC and the Company jointly announced that consumers
now have more time to get a full refund if they wish to return their recalled Tread+. With the extension of the full refund period by one additional year, to November 6, 2023, the Company expects that more Members will opt for a full refund, and has accordingly increased the Company’s return reserve. The Company accrued for a reduction to Connected Fitness Products revenue for actual and estimated future returns of $i26.5
million and $i11.4 million for the three months ended September 30, 2022 and 2021, respectively, and a return reserve of $i57.9
million and $i31.1 million, respectively, was included within Accounts payable and accrued expenses in the accompanying Condensed Consolidated Balance Sheets related to the impacts of the Tread+ recall. The estimated returns reserve is primarily based on historical and expected product returns. The Company recorded costs associated with inventory write-downs and logistics costs of $i2.5
million and $i0.5 million for the three months ended September 30, 2022 and 2021, respectively, in Connected Fitness Products cost of revenue.
16
Commitments to Suppliers
The
Company utilizes contract manufacturers to build its products and accessories. These contract manufacturers acquire components and build products based on demand forecast information the Company supplies, which typically covers a rolling 12-month period. Consistent with industry practice, the Company acquires inventories from such manufacturers through blanket purchase orders against which orders are applied based on projected demand information and availability of goods. Such purchase commitments typically cover the Company’s
forecasted product and manufacturing requirements for periods that range a number of months. In certain instances, these agreements allow the Company the option to cancel, reschedule, and/or adjust our requirements based on its business needs for a period of time before the order is due to be fulfilled. While the Company’s purchase orders are legally cancellable in many situations, there are some that are not cancellable in the event of a demand plan change or other circumstances, such as where the supplier has procured unique, Peloton-specific designs, and/or specific non-cancellable, non-returnable components based on our provided forecasts.
Through the date of this filing, the
Company’s commitments to contract with third-party manufacturers for their inventory on-hand and component purchase commitments related to the manufacture of Peloton products were estimated to be approximately $i332.0 million.
Legal and Regulatory Proceedings
The Company is, or may become, a party to legal and regulatory proceedings
with respect to a variety of matters in the ordinary course of business.
For example, we received reports of a number of injuries associated with our Tread+ product, one of which led to the death of a child. As a result of those reported Tread+ incidents, in April 2021, the CPSC unilaterally issued a warning to consumers about the safety hazards associated with the Tread+. While we do not agree with all of the assertions in the CPSC’s warning, in May 2021 we initiated a voluntary recall of our Tread+ product in collaboration with the CPSC. The CPSC is currently investigating the matter, and in August 2022 the CPSC notified us that the agency staff believes we failed to meet our statutory obligations under the Consumer Product Safety Act and intends to recommend that the CPSC impose civil monetary penalties. While we disagree with the agency staff, we are engaged
in ongoing confidential discussions with the CPSC. In addition, shortly after the May 2021 recalls, the U.S. Department of Justice (the “DOJ”) and the Department of Homeland Security (the “DHS”) subpoenaed us for documents and other information related to our statutory obligations under the Consumer Product Safety Act and is continuing to investigate the matter. The SEC is also investigating our public disclosures concerning the recall, as well as other matters. In addition to the regulatory investigations, we are presently subject to class action litigation and private personal injury claims related to these perceived defects in the Tread+ and incidents reported to result from its use.
Additionally on April 29, 2021, Ashley Wilson filed a putative securities class
action lawsuit against the Company and certain of its officers, captioned Wilson v. Peloton Interactive, Inc., et al., Case No. 1:21-cv-02369-CBA-PK, in the United States District Court for the Eastern District of New York (the "Wilson Action"), and on May 24, 2021, Leigh Drori filed a related putative securities class action lawsuit, captioned Drori v. Peloton Interactive, Inc., et al., Case No. 1:21-cv-02925-CBA-PK, also in the United States District Court for the Eastern District of New York (the “Drori Action”). On November 16, 2021, the district judge consolidated the Wilson and Drori Actions under the caption In re Peloton Interactive, Inc. Securities Litigation, Master File No. 21-cv-02369-CBA-PK, and appointed Richard
Neswick as lead plaintiff. On January 21, 2022, lead plaintiff filed an amended consolidated complaint in the action purportedly on behalf of a class consisting of those individuals who purchased or otherwise acquired our common stock between September 11, 2020 and May 5, 2021. Lead plaintiff alleges that the Company and certain of its officers made false or misleading statements in violation of Sections 10(b) and 20(a) of the Exchange Act of 1934 (“Exchange Act”) regarding the Company’s Tread and Tread+ products and the safety of those products. Defendants served their motion to dismiss the amended consolidated complaint on March
7, 2022, and briefing was complete on April 26, 2022. A hearing on the motion to dismiss was held on June 8, 2022. The court has not yet ruled on the motion to dismiss.
On May 20, 2021, Alan Chu filed a verified shareholder derivative action lawsuit purportedly on behalf of the Company against certain of the Company’s executive officers and the members of the Board of Directors, captioned Chu v. Foley, et al., Case No. 1:21-cv-02862, in the United States District Court for the Eastern District of New York (the “Chu Action”). Plaintiff Chu alleges breaches
of fiduciary duties, unjust enrichment, abuse of control, gross mismanagement, waste, and violations of Section 14(a) of the Exchange Act, as well as a claim for contribution under Sections 10(b) and 21D of the Exchange Act against the Company’s Chief Executive Officer and Chief Financial Officer. On August 13, 2021 and August 19, 2021, two related verified shareholder derivative complaints were filed, captioned Genack v. Foley, et al., Case No. 1:21-cv-04583 and Liu v. Foley, et al., Case No. 1:21-cv-04687, also purportedly on behalf of the Company, in the United States District Court for the Eastern District of New York. On October 13, 2021, the
parties in the three putative derivative actions filed a stipulation seeking to consolidate the actions, and agreeing to a schedule for plaintiffs to file motions to be appointed lead plaintiff. On October 26, 2021, the court entered the stipulation consolidating the three actions under the caption In re Peloton Interactive, Inc. Derivative Litigation, Master File No. 21-cv-02862-CBA-PK. On November 23, 2021, Anthony Franchi filed a shareholder derivative action in the United States District Court for the Eastern District of New York against certain of the Company’s executive officers and members of the board of directors captioned Franchi v. Blachford, et al., Case No. CV 21-06544 (the
“Franchi Action”), which alleges breaches of fiduciary duty, unjust enrichment, and violations of Sections 14(a) and 20(a) of the Exchange Act. On January 24, 2022, the court entered a stipulation consolidating the Franchi Action into In re Peloton Interactive, Inc. Derivative Litigation and appointed each plaintiff a co-lead plaintiff. On February 3, 2022, the parties filed a stipulation to stay the consolidated derivative action, which the Court entered on February 11, 2022.
On November 18, 2021, the City of Hialeah Employees’ Retirement System filed a putative securities class action
lawsuit against the Company and certain of its officers in the United States District Court for the Southern District of New York, captioned City of Hialeah Employees’ Retirement System v. Peloton Interactive, Inc., Case No. 21-cv-09582-ALC (the “Hialeah Action”), and on December 2, 2021, Anastasia Deulina filed a related putative securities class action against the same defendants also in the United States District Court for the Southern District of New York captioned Deulina v. Peloton Interactive, Inc., Case No. 21-cv-10266-ALC (the “Deulina Action”). On May 5, 2022, the Court consolidated the Hialeah and Deulina Actions and appointed Robeco Capital Growth Funds SICAV – Robeco
Global Consumer Trends as lead plaintiff. Lead
17
plaintiff filed its amended complaint on June 25, 2022, purportedly on behalf of a class of individuals who purchased or otherwise acquired the Company’s common stock between February 5, 2021 and November 4, 2021, alleging that the Company and certain of its officers made false or misleading statements about demand for the
Company’s products and engaged in improper trading in violation of Sections 10(b), 20(a), and 20A of the Exchange Act. Defendants filed their motion to dismiss on August 22, 2022, and briefing will be completed by November 3, 2022.
In April 2021, DISH Technologies L.L.C., and Sling TV L.L.C. (“DISH”) filed a complaint in the United States District Court for the Eastern District of
Texas. DISH, and, along with DISH DBS Corporation, also filed a complaint in the United States International Trade Commission (“ITC”) under Section 337 of the Tariff Act of 1930 against the Company, along with ICON Health & Fitness, Inc. (now iFIT Inc. f/k/a Icon Health & Fitness,
Inc.), FreeMotion Fitness, Inc., NordicTrack, Inc., lululemon athletica, inc., and Curiouser Products Inc. d/b/a MIRROR. The complaints allege infringement of various patents related to fitness devices containing internet-streaming enabled video displays. In the ITC matter, on September 9, 2022 an Initial Determination was issued recommending that the ITC enter an exclusion order and cease and desist against Peloton’s Bike, Bike+, Tread and Tread+ products (and others that operate similarly) on the basis that those products infringed all four asserted patents of DISH. Peloton has filed a Petition for Review of that determination to the ITC. The ITC currently has 60 days from the date of Initial Determination to determine whether to review the Initial Determination and until January 9, 2023 to make a final determination on a remedy. In the Eastern District of Texas complaint,
DISH is seeking an order permanently enjoining the Company from infringing the asserted patents, an award of damages for the infringement of the asserted patents, and an award of damages for lost sales. The ITC investigation is ongoing and the Texas litigation remains stayed pending resolution to the ITC investigation.
We dispute the allegations in the above-referenced matters, intend to defend the matters vigorously, and believe that the claims are without merit. Some of our legal and regulatory proceedings, such as the above-referenced matters and litigation that centers around intellectual property claims, may be based on complex claims involving substantial uncertainties and unascertainable damages. Accordingly, except where otherwise indicated, it is not possible to determine the probability of loss or estimate
damages for any of the above matters, and therefore, the Company has not established reserves for any of these proceedings. When the Company determines that a loss is both probable and reasonably estimable, the Company records a liability, and, if the liability is material, discloses the amount of the liability reserved. Given that such proceedings are subject to uncertainty, there can be no assurance that such legal proceedings, either individually or in the aggregate, will not have a material adverse effect on our business, results of operations, financial condition or cash flows.
9.
iEquity-Based Compensation
2019 Equity Incentive Plan
In August 2019, the Board of Directors adopted the 2019 Equity Incentive Plan (the “2019 Plan”), which was subsequently approved by the Company’s stockholders in September 2019. The 2019 Plan serves as the successor to the 2015 Stock Plan (the
"2015 Plan"). The 2015 Plan continues to govern the terms and conditions of the outstanding awards previously granted thereunder. Any reserved shares not issued or subject to outstanding grants under the 2015 Plan on the effective date of the 2019 Plan became available for grant under the 2019 Plan and will be issued as Class A common stock. The number of shares reserved for issuance under the 2019 Plan will increase automatically on July 1 of each of 2020 through 2029 by the number of shares of the Company’s Class A Common Stock equal to i5%
of the total outstanding shares of all of the Company’s classes of common stock as of each June 30 immediately preceding the date of increase, or a lesser amount as determined by the Board of Directors. On July 1, 2022, the number of shares of Class A Common Stock available for issuance under the 2019 Plan was automatically increased according to its terms by i16,913,700
shares. As of September 30, 2022, i49,846,256 shares of Class A Common Stock are available for future award under the 2019 Plan.
Stock Options
i
The
following summary sets forth the stock option activity under the 2015 Plan and 2019 Plan:
Options Outstanding
Number of Stock Options
Weighted-Average Exercise
Price
Weighted-Average Remaining Contractual Term (years)
The
aggregate intrinsic value of options outstanding and vested and exercisable was calculated as the difference between the exercise price of the options and the fair value of the Company’s common stock as of September 30, 2022. The fair value of the common stock is the closing stock price of the Company's Class A Common Stock as reported on The Nasdaq Global Select Market. The aggregate intrinsic value of exercised options was $i3.1
million and $i176.4 million for the three months ended September 30, 2022 and 2021, respectively.
On July 1, 2022, the Compensation Committee approved a one-time repricing
of stock option awards that had been granted to date under the 2019 Plan. The repricing impacted stock options held by all employees who remained employed through July 25, 2022. The repricing did not apply to our U.S.-based hourly employees (or employees with equivalent roles in non-U.S. locations) or our C-level executives. The original exercise prices of the repriced stock options ranged from $i12.94
to $i146.79 per share for the i2,138
total grantees. Each stock option was repriced to have a per share exercise price of $i9.13, which was the closing price of the Company’s Class A Common Stock on July 1, 2022. There were no changes to the number of shares, the vesting schedule or the expiration date of the
repriced stock options. Incremental stock-based compensation expense resulting from the repricing was $i21.9 million in the aggregate. Approximately$i4.7 million
was recognized immediately during the three months ended September 30, 2022, for vested options, with the remainder to be recognized over the remaining weighted-average vesting term of approximately i2.9 years.
For the three months ended September
30, 2022 and 2021, the weighted-average grant date fair value per option was $i6.74 and $i45.45,
respectively. iThe fair value of each option was estimated at the grant date using the Black-Scholes method with the following assumptions:
(1)
Based on U.S. Treasury yield curve in effect at the time of grant.
(2) Expected volatility is based on a blended average of average historical stock volatilities of several peer companies over the expected term of the stock options, historical volatility of the Company's stock price, and implied stock price volatility derived from the price of exchange traded options on the Company's stock.
Restricted Stock and Restricted Stock Units
i
The
following table summarizes the activity related to the Company's restricted stock and restricted stock units:
In August 2019, the Board of Directors adopted, and in September 2019, the Company's stockholders approved, the ESPP, through which eligible employees may purchase shares of the Company's Class A Common Stock at a discount through accumulated payroll deductions. The ESPP became effective on the date the registration statement, in connection with the Company’s IPO, was declared effective by the SEC (the "Effective Date"). The number of shares of the Company's Class A Common Stock that will be available for issuance and sale to eligible employees under the
ESPP will increase automatically on the first day of each fiscal year of the Company beginning on July 1, 2020 through 2029, equal to i1% of the total number of outstanding shares of all classes of the Company's common stock on the
immediately preceding June 30, or such lesser
19
number as may be determined by the Board of Directors or applicable committee in its sole discretion. On July 1, 2022, the number of shares of Class A Common Stock available for issuance under the ESPP was automatically increased according to its terms by i3,382,740
shares. As of September 30, 2022, a total of i13,145,078 shares of Class A Common Stock was available for sale to employees under the ESPP.
Unless otherwise determined by the Board of Directors, each offering period will consist of ifourisix-month purchase periods, provided that the initial offering period commenced on the Effective Date and ended on August 31, 2021, and the initial purchase period ended February 28, 2020. Thereafter, each offering period and each purchase period will commence on September 1 and March 1 and end on August 31 and February 28 of each itwo-year
period or each isix-month period, respectively, subject to a reset provision. If the closing stock price on the first day of an offering period is higher than the closing stock price on the last day of any applicable purchase period, participants will be withdrawn from the ongoing offering period immediately following the purchase of ESPP shares on the purchase date and will automatically be enrolled in the subsequent offering period (“ESPP reset”), resulting in a modification under ASC 718.
Unless
otherwise determined by the Board of Directors, the purchase price for each share of Class A Common Stock purchased under the ESPP will be i85% of the lower of the fair market value per share on the first trading day of the applicable offering period or the fair market value per share on the last trading day of the applicable purchase period. During the three months ended September 30, 2022, there were ESPP
resets that resulted in total modification charges of $i2.7 million, which are recognized over the new itwo-year
offering period ending August 30, 2024.
i
The Black-Scholes option pricing model assumptions used to calculate the fair value of shares estimated to be purchased at the commencement of the ESPP offering periods were as follows:
The
expected term assumptions were based on each offering period's respective purchase date. The expected volatility was derived from the blended average of historical stock volatilities of several unrelated public companies that the Company considers to be comparable to its business over a period equivalent to the expected terms of the stock options and the historical volatility of the Company's stock price. Beginning in the fiscal quarter ended March 31, 2022, the expected volatility is based on the historical volatility of the Company’s stock price. The risk-free rate assumptions were based on the U.S. treasury yield curve in effect at the time of the grants. The
dividend yield assumption was izero as the Company has not historically paid any dividends and does not expect to declare or pay dividends in the foreseeable future.
During the three months ended September
30, 2022 and 2021, the Company recorded Stock-based compensation expense associated with the ESPP of $i7.6 million and $i3.6
million, respectively.
In connection with the offering period that ended on August 31, 2022, employees purchased i386,121 shares of Class A common stock at a weighted-average price of $i8.66
under the ESPP. As of September 30, 2022, total unrecognized compensation cost related to the ESPP was $i20.3 million, which will be amortized over a weighted-average remaining period of i1.9
years.
Stock-Based Compensation Expense
i
The Company's total stock-based compensation expense was as follows:
As
of September 30, 2022, the Company had $i744.1 million of unrecognized stock-based compensation expense related to unvested stock-based awards that is expected to be recognized over a weighted-average period of i2.8
years.
20
In the three months ended September 30, 2022, isix employees of the Company who were eligible to participate
in the Company’s Severance and Change in Control Plan (the “Severance Plan”) terminated employment. Certain modifications were made to equity awards, including, in certain instances, the post-termination period during which an employee may exercise outstanding stock options was extended from 90 days to one year (or the option expiration date, if earlier), and extended vesting was tied to certain consulting services that were deemed to be non-substantive. In one instance, the post-termination period during which an employee may exercise outstanding stock options was extended from 90 days to approximately 2.8 years. As a result of these modifications, the Company recognized incremental Stock-based compensation expense of $i43.4
million within Restructuring expense in the Condensed Consolidated Statements of Operations and Comprehensive Loss.
10. iIncome Taxes
The Company recorded a provision from income taxes of $i0.8
million and $i2.4 million for the three months ended September 30, 2022 and 2021, respectively. Furthermore, the Company's effective tax rates were (i0.20)%
and (i0.63)% for the three months ended September 30, 2022 and 2021, respectively. The income tax provision and the effective tax rate are primarily driven by state and international taxes.
The Company maintains a valuation allowance on the majority of its deferred tax assets as it has concluded
that it is more likely than not that the deferred assets will not be utilized.
Basic
and diluted loss per share are the same for each class of common stock because they are entitled to the same liquidation and dividend rights.
i
The following potentially dilutive shares were not included in the calculation of diluted shares outstanding as the effect would have been anti-dilutive:
The Company expects to settle the principal amount of the Notes in cash upon conversion, and therefore, the Company uses the if-converted method for calculating any potential dilutive effect of the conversion option on diluted net income per share, if applicable. The conversion option will have a dilutive impact on net income per share of Common Stock when the average market price per share of the Company's Class A Common Stock for a given period exceeds the conversion price of the Notes of $i239.23
per share. During the three months ended September 30, 2022, the weighted average price per share of the Company's Class A Common Stock was below the conversion price of the Notes.
The denominator for basic and diluted loss per share does not include any effect from the Capped Call Transactions the Company entered into concurrently with the issuance of the Notes as this effect would be anti-dilutive. In the event of conversion of the Notes, if shares are delivered to the Company under the Capped Call Transactions, they will offset the dilutive effect of the shares that the
Company would issue under the Notes.
12. iSegment Information
The Company applies ASC 280, Segment Reporting, in determining reportable segments. The
Company has itwo reportable segments: Connected Fitness Products and Subscription. Segment information is presented in the same manner that the chief operating decision maker ("CODM") reviews the operating results in assessing performance and allocating resources. The CODM reviews revenue and gross profit for both of the reportable segments. Gross profit is defined as revenue less cost of revenue incurred by the segment.
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No
operating segments have been aggregated to form the reportable segments. The Company does not allocate assets at the reportable segment level as these are managed on an entity wide group basis and, accordingly, the Company does not report asset information by segment.
The Connected Fitness Products segment derives revenue from sale of the Company's portfolio of Connected Fitness Products and related accessories, delivery and installation services, branded apparel, and extended warranty agreements. The Subscription segment derives revenue from monthly Subscription fees. There are no internal revenue transactions between the
Company’s segments.
i
Key financial performance measures of the segments including Revenue, Cost of revenue, and Gross profit are as follows:
Operating expenditures, interest income and other expense, and taxes are not allocated to individual segments as these are managed on an entity wide group basis. iThe reconciliation between reportable Segment Gross Profit to consolidated Loss before provision for income tax is as follows:
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our interim condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2022, filed with the SEC on September 7, 2022 (“Form 10-K”). As discussed in the section titled "Special Note Regarding Forward Looking Statements," the following discussion and analysis contains forward looking statements that involve risks, uncertainties, assumptions,
and other important factors that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those identified below and those discussed in the section titled "Risk Factors" in Part II, Item 1A of this Quarterly Report on Form 10-Q and in Part I, Item 1A of our Form 10-K.
Overview
Peloton is the largest interactive fitness platform in the world with a loyal community of 6.7 million Members as of September 30, 2022. We pioneered connected, technology-enabled
fitness, and the streaming of immersive, instructor-led boutique classes to our Members anytime, anywhere. We make fitness entertaining, approachable, effective, and convenient, while fostering social connections that encourage our Members to be the best versions of themselves. We define a Member as any individual who has a Peloton account through a paid All-Access Membership, or a paid Peloton App subscription.
Our Connected Fitness Product portfolio includes the Peloton Bike, Bike+, Tread, Tread+, and our first connected strength product, Peloton Guide. Our revenue is generated primarily from recurring Subscription revenue and the sale of our Connected Fitness Products. We have historically experienced significant growth in sales of our Connected Fitness Products, which, when combined with our low Average Net Monthly Connected Fitness Churn has led to significant
growth in Connected Fitness Subscriptions.
Our financial profile has been characterized by strong retention, recurring revenue, and efficient customer acquisition. Our low Average Net Monthly Connected Fitness Churn, together with our high Subscription Contribution Margin, yields an attractive lifetime value (LTV) for our Connected Fitness Subscriptions well in excess of our customer acquisition cost (CAC). Maintaining an attractive LTV/CAC ratio is a primary goal of our customer acquisition strategy.
First Quarter Fiscal 2023 Update and Recent Developments
As we have previously disclosed, forecasting for our business during and following the COVID-19 pandemic, particularly in its more recent stages, has proven to be very challenging.
While we have been able to grow more than we anticipated just two years ago, fluctuations in demand and supply that we have been navigating during this time period led us to grow our operations beyond what we believe is currently best suited to our business. Although our belief in the positive long-term outlook for Connected Fitness remains unchanged, the long-term cost demands of our business require us to recalibrate our near-term expectations. Additionally, while demand for our Connected Fitness Products has continued to strongly outpace pre-pandemic levels, we have had significant difficulty in forecasting near-term consumer demand and, as a result, our expected near-term operating performance. See “Risk Factors—Risks Related to Our Business—Our operating results have been, and could in the future be, adversely affected if we are unable to accurately forecast consumer demand for our products and services and adequately
manage our inventory” in our Form 10-K.
Restructuring Plan
In February 2022, we announced and began implementing a restructuring plan to realign our operational focus to support our multi-year growth, scale the business, and improve costs (the “Restructuring Plan”). The Restructuring Plan originally included: (i) reducing our headcount; (ii) closing several assembly and manufacturing plants, including the completion and subsequent sale of the shell facility for our previously planned Peloton Output Park; (iii) closing and consolidating several distribution facilities; and (iv) shifting to third-party logistics providers in certain locations. We expect the Restructuring Plan to be substantially implemented by the end of fiscal 2024.
In
July 2022, August 2022 and October 2022, we took actions to update the Restructuring Plan. On July 12, 2022, we announced we are exiting all owned-manufacturing operations and our expansion of our current relationship with Taiwanese manufacturer Rexon Industrial Corp. Additionally, on August 12, 2022, we announced our decision to perform the following additional restructuring activities: (i) fully transition our North American Field Operations to third-party providers, including the significant reduction of our delivery workforce teams; (ii) eliminate a significant number of roles on the North America Member Support team and exit our real-estate footprints in our Plano and Tempe locations; and (iii) reduce our North America retail showroom presence. On October 6, 2022, we announced approximately 500 global team member
positions have been eliminated..
Total charges related to the Restructuring Plan were $169.8 million for the three months ended September 30, 2022, consisting of cash charges of $27.0 million for severance and other personnel and $3.1 million for professional fees and other related charges, and non-cash charges of $62.9 million related to non-inventory asset write-downs and write-offs, and $76.8 million for stock-based compensation expense.
In connection with the Restructuring Plan, the Company estimates that it will incur additional cash charges of approximately $70 million, primarily composed of severance and other exit costs in fiscal year 2023 and beyond. Additionally,
the Company expects to recognize additional non-cash charges of approximately $70 million, primarily composed of asset impairment and stock-based compensation charges in fiscal year 2023 in connection with the Restructuring Plan.
We may not be able to fully realize the cost savings and benefits initially anticipated from the Restructuring Plan, and the expected costs may be greater than expected. See “Risk Factors—Risks Related to Our Business—We may not successfully execute or achieve the expected benefits of our
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restructuring initiatives and other cost-saving measures
we may take in the future, and our efforts may result in further actions and/or additional asset impairment charges and adversely affect our business” in our Form 10-K.
Product and Content Highlights
On September 20, 2022, we announced the launch of Peloton Row. Row combines the innovative software, premium hardware design, and exclusive content that make up the signature Peloton experience, providing Members with a unique low-impact, full-body cardio and strength workout. Currently available through our online store and in 71 U.S. Peloton showrooms, we look forward to expanding Row's availability to additional U.S. Peloton showrooms in the near future and internationally over time. Veteran Peloton instructors
Matt Wilpers and Adrian Williams are joined by former U.S. Olympic Team rower Alex Karwoski, former Ohio State University rower and coach Ash Pryor, and Katie Wang, who will lead Row Bootcamp offerings.
In the first quarter of fiscal year 2023, we were able to deliver on our promise of an always-improving experience for Peloton Members. Peloton Tread Members now have the option for an even smoother workout with Auto-Incline, and can dial in the perfect workout with mile splits and the ability to set Goals in a Just Run workout. We also launched Tread Talkback to empower blind and low vision Members to use the Tread independently.
We also introduced the much-requested Rep Counting to Guide Members, enabling them to see target reps for a given move in class, record the weight they are using, and automatically
track their total weight lifted over time for the ultimate in effortless strength training. We also invested in the cross-platform member experience, including personalizing the home-screen and post-class recommendations and improving Lanebreak with additional filtering options and entry-points.
On October 3, 2022, we announced our industry-first partnership with Hilton, which will become the first hospitality brand to feature Peloton bikes across its entire hotel portfolio. The partnership also includes offering Hilton Honors members free access to special Peloton offers, including a 90-dial trial subscription to the Peloton App, as well as preferred pricing on select Peloton connected fitness products.
On October
13, 2022, Amazon announced that Peloton was one of the best sellers among the Top 100 Deals for Amazon's Prime Early Access sale. Expanding our third-party retail strategy, Peloton products will soon be available through over 100 DICK's Sporting Goods retail locations and through DICKS.com.
Product Recall Update
On May 5, 2021, we announced separate, voluntary recalls of each of our Tread+ and Tread products in collaboration with the CPSC and halted sales of these products to work on product enhancements. Members were notified that they could return their Tread or Tread+ for a full refund, or wait until a solution is available. Tread+ owners were also given the option to have Peloton move their Tread+ to a different location
within their home. We announced a repair for the Tread in August 2021, shortly before resuming sales. We continue to work on potential hardware enhancements for Tread+, which remains recalled. More recently, in August 2022, we were notified by the CPSC that the agency staff believes we failed to meet our statutory obligations under the Consumer Product Safety Act and intends to seek civil monetary penalties. While we disagree with the agency staff, we are engaged in ongoing confidential discussions with the CPSC. On October 18, 2022, we announced a one- year extension of the full refund period for our Tread+ if consumers wish to return their Tread+ pursuant to the recall. With the extension of the full refund period by one additional year, to November 6, 2023, the
Company expects that more Members will opt for a full refund, and has accordingly increased the Company’s return reserve. For the recall-to-date period, the Company recognized a reduction to Connected Fitness Products revenue for actual and estimated future returns of $166.9 million, and a return reserve of $57.9 million and $31.1 million is included within Accounts payable and accrued expenses in the accompanying Condensed Consolidated Balance Sheets related to the impacts of the recall as of September 30, 2022 and September 30, 2021, respectively. We may continue to incur additional costs that could include costs for which
we have not accrued or established adequate reserves, including increases to the return reserves, inventory write-downs, logistics costs associated with Member requests to return or move their hardware, subscription waiver variable costs of service, anticipated recall-related hardware development and repair costs, and related legal and advisory fees. Recall charges are based upon estimates associated with our expected and historical consumer response rates. Our plan for the Tread+ recall is still being finalized and actual costs related to this matter may vary from the estimate, and may result in further impacts to our future results of operations and business. See “Risk Factors—Risks Related to Our Connected Fitness Products and Members—We may be subject to warranty claims that could result in significant direct or indirect costs, or we could experience greater product returns than expected, either of which could have
an adverse effect on our business, financial condition, and operating results” in our Form 10-K.
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Key Operational and Business Metrics
In addition to the measures presented in our interim condensed consolidated financial statements, we use the following key operational and business metrics to evaluate our business, measure our performance, develop financial forecasts, and make strategic decisions.
Net Cash Used in Operating Activities (in millions)(3)
$
(202.8)
$
(561.0)
Free Cash Flow (in millions)(3)
$
(246.3)
$
(651.9)
______________________________
(1) Please see the section titled “Non-GAAP Financial Measures—Subscription Contribution and Subscription Contribution Margin” for a reconciliation of Subscription Gross Profit to Subscription Contribution and an explanation of why we consider Subscription Contribution and Subscription Contribution Margin to be helpful measures for investors.
(2) Please see the section titled “Non-GAAP Financial Measures—Adjusted EBITDA and Adjusted EBITDA Margin” for a reconciliation of Net loss to Adjusted EBITDA and an explanation of why we consider Adjusted EBITDA to be a helpful measure for investors.
(3) Please see the section titled “Non-GAAP Financial Measures—Free Cash Flow” for a reconciliation of net cash provided by (used in) operating activities to Free Cash Flow and an explanation of why
we consider Free Cash Flow to be a helpful measure for investors.
Connected Fitness Subscriptions
Our ability to expand the number of Connected Fitness Subscriptions is an indicator of our market penetration and growth. We define a “Connected Fitness Subscription” as a person, household, or commercial property, such as a hotel or residential building, who has either paid for a subscription to a Connected Fitness Product (a Connected Fitness Subscription with a successful credit card billing or with prepaid subscription credits or waivers) or requested a “pause” to their subscription for up to three months. We do not include canceled or unpaid Connected Fitness Subscriptions in the Connected Fitness Subscription count. A subscription is canceled and ceases to be reflected in the above metrics as of the effective cancellation date,
which is the Member’s next scheduled billing date.
Average Net Monthly Connected Fitness Churn
We use Average Net Monthly Connected Fitness Churn to measure the retention of our Connected Fitness Subscriptions. We define “Average Net Monthly Connected Fitness Churn” as Connected Fitness Subscription cancellations, net of reactivations, in the quarter, divided by the average number of beginning Connected Fitness Subscriptions in each month, divided by three months. When a Connected Fitness Subscription payment method fails, we communicate with our Members to update their payment method and make multiple attempts over several days to charge the payment method on file and reactivate the subscription. We cancel a Member’s Connected Fitness Subscription when it remains unpaid for two days after their billing cycle date. This metric does
not include data related to our Peloton Digital subscriptions for Members who pay a monthly fee for access to our content library on their own devices.
Components of our Results of Operations
Revenue
Connected Fitness Products
Connected Fitness Product revenue consists of sales of our portfolio of Connected Fitness Products and related accessories, delivery and installation services, branded apparel, extended warranty agreements, and the sale, service, installation, and delivery contracts of our commercial
business. Connected Fitness Product revenue is recognized at the time of delivery, except for extended warranty revenue that is recognized over the warranty period and service revenue that is recognized over the term, and is recorded net of returns and discounts and third-party financing program fees, when applicable.
Subscription
Subscription revenue consists of revenue generated from our monthly Connected Fitness Subscription and Peloton Digital subscription.
As of September 30, 2022, 99% and 87% of our Connected Fitness Subscription and Peloton Digital subscription bases were paying month-to-month, respectively.
25
If
a Connected Fitness Subscription owns a combination of a Bike, Tread or Guide product in the same household, the price of the Subscription remains $44.00 monthly (price increased from $39 to $44 USD effective as of June 1, 2022). As of September 30, 2022, approximately 6% of our Connected Fitness Subscriptions owned both a Bike and Tread product.
Cost of revenue
Connected Fitness Products
Connected Fitness Product cost of revenue consists of our portfolio of Connected Fitness Products and branded apparel product costs, including manufacturing costs, duties and other applicable importing costs, shipping and handling costs, packaging, warranty replacement and service costs, fulfillment costs, warehousing
costs, depreciation of property and equipment, and certain costs related to management, facilities, and personnel-related expenses associated with supply chain logistics.
Subscription
Subscription cost of revenue includes costs associated with content creation and costs to stream content to our Members. These costs consist of both fixed costs, including studio rent and occupancy, other studio overhead, instructor and production personnel-related expenses, depreciation of property and equipment as well as variable costs, including music royalty fees, content costs for past use, third-party platform streaming costs, and payment processing fees for our monthly subscription billings.
Operating expenses
Sales and marketing
Sales
and marketing expense consists of performance marketing media spend, asset creation, and other brand creative, all showroom expenses and related lease payments, payment processing fees incurred in connection with the sale of our Connected Fitness Products, sales and marketing personnel-related expenses, expenses related to the Peloton App, and depreciation of property and equipment.
General and administrative
General and administrative expense includes personnel-related expenses and facilities-related costs primarily for our executive, finance, accounting, legal, human resources, IT functions and member support. General and administrative expense also includes fees for professional services principally comprised of legal, audit, tax and accounting services, depreciation of property and equipment, and insurance, as well as litigation settlement
costs.
Research and development
Research and development expense primarily consists of personnel and facilities-related expenses, consulting and contractor expenses, tooling and prototype materials, software platform expenses, and depreciation of property and equipment. We capitalize certain qualified costs incurred in connection with the development of internal-use software that may also cause research and development expenses to vary from period to period.
Impairment expense
Impairment expense consists of non-cash impairment charges relating to long-lived assets. Impairments are determined using management’s judgment about our anticipated ability to continue to use fixed assets in-service and under development,
current economic and market conditions and their effects based on information available as of the date of these condensed consolidated financial statements. Management disposes of fixed assets during the regular course of business due to damage, obsolescence, strategic shifts, and loss.
Additionally, long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset group to future undiscounted net cash flows expected to be generated by the assets. If the carrying amount of an asset group exceeds its estimated undiscounted net future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset group exceeds its fair value.
Restructuring
expense
Restructuring expense consists of severance and other personnel costs, including stock-based compensation expense, professional services, facility closures and other costs associated with exit and disposal activities.
Supplier settlements
Supplier settlements are payments made to third-party suppliers to terminate certain future inventory purchase commitments.
Non-operating income and expenses
Other income (expense), net
Other income (expense), net consists of interest income (expense), unrealized and realized gains (losses) on investments, and impacts from foreign exchange transactions.
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Income
tax provision
The provision for income taxes consists primarily of income taxes related to state and international taxes for jurisdictions in which we conduct business. We maintain a valuation allowance on the majority of our deferred tax assets as we have concluded that it is more likely than not that the deferred assets will not be utilized.
Results of Operations
The following tables set forth our consolidated results of operations in dollars and as a percentage of total revenue for the periods presented. The period-to-period comparisons of our historical results are not necessarily indicative of the results that may be expected in the future.
On July 1, 2022, the Compensation Committee of the Board of Directors of the Company (the “Compensation Committee”) approved accelerating the vesting requirement for unvested restricted stock units held by certain employees by one year. This applied to eligible unvested restricted stock units that had more than eight quarterly vesting dates remaining in their vesting schedule. The acceleration resulted in approximately $26.6 million of stock-based compensation pulled forward and
recognized in the three months ended September 30, 2022. The remaining unvested restricted stock units have approximately $376.0 million of unamortized expense to be recognized over the remaining weighted-average vesting term of approximately 2.6 years. Additionally, on July 1, 2022, the Compensation Committee approved a one-time repricing of certain stock option awards that had been granted to date under the 2019 Plan. The repricing impacted stock options held by all employees who remained employed through July 25, 2022. The repricing did not apply to our U.S.-based hourly employees (or employees with equivalent roles in non-U.S. locations) or our C-level executives. The modification resulted in incremental stock-based compensation expense of $21.9 million in the aggregate. Approximately$4.7
million was recognized immediately during the three months ended September 30, 2022, for vested options, with the remainder to be recognized over the remaining weighted-average vesting term of approximately 2.9 years.
____________________
(2) Includes depreciation and amortization expense as follows:
Connected
Fitness Products revenue decreased $296.8 million for the three months ended September 30, 2022 compared to the three months ended September 30, 2021. This decrease was primarily attributable to fewer Bike and Accessory deliveries, and charges associated with the voluntary product recalls.
Subscription revenue increased $108.1 million for the three months ended September 30, 2022 compared to the three months ended September 30, 2021. This increase was primarily attributable to the year-over-year growth in our Connected Fitness Subscriptions and the price increase of the All-Access membership fee from $39 to $44, effective as of June 1, 2022.
The growth of our Connected Fitness Subscriptions was primarily driven by the number of Connected Fitness Products delivered during the fiscal year ended June 30, 2022 under new Subscriptions and our low Average Net Monthly Connected Fitness Churn of 1.14% for the three months ended September 30, 2022.
Connected Fitness Products cost of revenue for the three months ended September 30, 2022 decreased $180.9 million, or 41.0%, compared to the three months ended September 30, 2021. This decrease was primarily driven by fewer deliveries for the three months ended September 30, 2022 compared to the three months ended September 30, 2021.
Our Connected Fitness Products Gross Margin decreased to (27.2)% from 12.0% for the three months ended September
30, 2022 compared to the three months ended September 30, 2021, primarily driven by higher logistics expenses per delivery, increased port and storage costs, fixed logistics cost deleveraging, and charges associated with the voluntary recall of our Tread+ product.
Subscription cost of revenue for the three months ended September 30, 2022 increased $38.1 million, or 37.6%, compared to the three months ended September 30, 2021. This increase was primarily driven by an increase of $21.5 million in music royalties and platform streaming costs, an increase of $9.2 million in stock-based compensation expense primarily driven by the acceleration of certain restricted stock unit vesting schedules, the repricing of certain stock option awards,
and an increased number of awards vesting.
Subscription Gross Margin remained consistent for the three months ended September 30, 2022 compared to the three months ended September 30, 2021.
Sales and marketing expense decreased $145.4 million in the three months ended September 30, 2022 compared to the three months ended September 30, 2021. The decrease was primarily due to a decrease in spending on advertising and marketing programs of $137.5 million and a decrease in personnel-related expenses of $7.1 million, primarily due to decreased average headcount. The overall decrease was partially offset
29
by
an increase in stock-based compensation expense of $4.1 million, primarily driven by the acceleration of certain restricted stock unit vesting schedules, the repricing of certain stock option awards, and an increased number of awards vesting.
General
and administrative expense decreased $46.9 million when comparing the three months ended September 30, 2022 with the three months ended September 30, 2021. This decrease was primarily due to a decrease in professional services fees and IT costs of $45.9 million and a decrease in personnel-related expenses of $17.7 million, primarily due to decreased average headcount. The overall decrease was partially offset by an increase in stock-based compensation expense of $22.8 million, primarily driven by the acceleration of certain restricted stock unit vesting schedules, the repricing of certain stock option awards, and an increased number of awards vesting.
Research and development expense for the three months ended September 30, 2022 decreased $9.6 million, or 9.8%, compared to the three months ended September 30, 2021. The decrease was primarily due to a decrease in product development and research costs associated with development of new software features and products of $9.7 million and a decrease in personnel-related expenses of $7.0 million, primarily due to decreased average headcount. The overall decrease
was partially offset by an increase in stock-based compensation expense of $13.3 million, primarily driven by an acceleration of certain restricted stock unit vesting schedules, the repricing of certain stock option awards, and an increased number of awards vesting.
Impairment expense was comprised primarily of asset write-downs and write-offs related to our previously announced restructuring initiatives,
including write-downs and write-offs related to Connected Fitness assets comprised primarily of connected fitness and supply chain asset impairments related to our exits of our remaining field operations locations, as well as assets at certain corporate office locations, which we exited during the quarter.
Restructuring expense was $106.9 million in the three months ended September 30, 2022. The restructuring expenses consisted of $76.8 million of stock-based compensation expense, driven by incremental stock-based compensation expense from exercise window modifications and the acceleration of certain restricted stock unit vesting schedules pursuant to severance arrangements, and $27.0 million of cash severance and
30
other personnel costs. In addition, there was an increase of $3.0 million in professional fees and other costs associated with exit and disposal activities. There were no restructuring expenses for the three
months ended September 30, 2021.
Other expense, net, was comprised of the following for the three months ended September 30, 2022:
•Interest expense primarily related to the amortization of the convertible notes discount and deferred financing costs of $(20.9) million;
•Interest income from cash, cash equivalents, and short-term investments of $4.0 million; and
•Foreign exchange losses of $(17.0) million.
Other expense, net, was comprised of the following for the three months ended September
30, 2021:
•Interest expense primarily related to the amortization of the convertible notes discount and deferred financing costs of $(8.6) million;
•Interest income from cash, cash equivalents, and short-term investments of $0.6 million;
•Foreign exchange losses of $(5.2) million; and
•Unrealized losses on short-term investments of $(0.7) million.
Income tax expense for the three months ended September 30, 2022 of $0.8 million was primarily due to state and international taxes.
Non-GAAP
Financial Measures
In addition to our results determined in accordance with accounting principles generally accepted in the United States, or GAAP, we believe the following non-GAAP financial measures are useful in evaluating our operating performance.
Adjusted EBITDA and Adjusted EBITDA Margin
We calculate Adjusted EBITDA as net (loss) income adjusted to exclude: other expense (income), net; income tax expense (benefit); depreciation and amortization expense; stock-based compensation expense; impairment expense; product recall costs; litigation and settlement expenses; transaction and integration costs; reorganization, severance, exit, disposal and other costs associated with restructuring plans; supplier settlements; and other adjustment items that arise outside the ordinary course of our business. Adjusted EBITDA Margin is calculated
by dividing Adjusted EBITDA by total revenue.
We use Adjusted EBITDA and Adjusted EBITDA Margin as measures of operating performance and the operating leverage in our business. We believe that these non-GAAP financial measures are useful to investors for period-to-period comparisons of our business and in understanding and evaluating our operating results for the following reasons:
•Adjusted EBITDA and Adjusted EBITDA Margin are widely used by investors and securities analysts to measure a company’s operating performance without regard to items such as stock-based compensation expense, depreciation and amortization expense, other expense (income), net, and provision for income taxes that can vary substantially from company to company depending upon their financing, capital structures, and the method by which assets
were acquired;
•Our management uses Adjusted EBITDA and Adjusted EBITDA Margin in conjunction with financial measures prepared in accordance with GAAP for planning purposes, including the preparation of our annual operating budget, as a measure of our core operating results and the effectiveness of our business strategy, and in evaluating our financial performance; and
•Adjusted EBITDA and Adjusted EBITDA Margin provide consistency and comparability with our past financial performance, facilitate period-to-period comparisons of our core operating results, and may also facilitate comparisons with other peer companies, many of which use similar non-GAAP financial measures to supplement their GAAP results.
Our use of Adjusted EBITDA and Adjusted EBITDA
Margin have limitations as analytical tools, and you should not consider these measures in isolation or as substitutes for analysis of our financial results as reported under GAAP. Some of these limitations are, or may in the future be, as follows:
31
•Although depreciation and amortization expense are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA and Adjusted EBITDA Margin do not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements;
•Adjusted EBITDA and Adjusted EBITDA Margin exclude stock-based compensation
expense, which has recently been, and will continue to be for the foreseeable future, a significant recurring expense for our business and an important part of our compensation strategy;
•Adjusted EBITDA and Adjusted EBITDA Margin do not reflect: (1) changes in, or cash requirements for, our working capital needs; (2) interest expense, or the cash requirements necessary to service interest or principal payments on our debt, which reduces cash available to us; or (3) tax payments that may represent a reduction in cash available to us;
•Adjusted EBITDA and Adjusted EBITDA Margin do not reflect certain litigation expenses, consisting of legal settlements and related fees for specific proceedings that we have determined arise outside of the ordinary course of business based on the following considerations which we assess regularly: (1)
the frequency of similar cases that have been brought to date, or are expected to be brought within two years; (2) the complexity of the case; (3) the nature of the remedy(ies) sought, including the size of any monetary damages sought; (4) offensive versus defensive posture of us; (5) the counterparty involved; and (6) our overall litigation strategy;
•Adjusted EBITDA and Adjusted EBITDA Margin do not reflect transaction and integration costs related to acquisitions;
•Adjusted EBITDA and Adjusted EBITDA Margin do not reflect impairment charges for goodwill and fixed assets, and gains (losses) on disposals for fixed assets;
•Adjusted EBITDA and Adjusted EBITDA Margin do not reflect the impact of purchase accounting adjustments to inventory related to the Precor acquisition;
•Adjusted
EBITDA and Adjusted EBITDA Margin do not reflect costs associated with Tread and Tread+ product recalls including increases to the return reserves, Tread+ inventory write-downs, logistics costs associated with Member requests on Tread and Tread+, the cost to move the Tread+ for those that elect the option, subscription waiver costs of service, and recall-related hardware development and repair costs;
•Adjusted EBITDA and Adjusted EBITDA Margin do not reflect reorganization, severance, exit, disposal and other costs associated with restructuring plans;
•Adjusted EBITDA and Adjusted EBITDA Margin do not reflect non-recurring supplier settlements; and
•The expenses and other items that we exclude in our calculation of Adjusted EBITDA and Adjusted
EBITDA Margin may differ from the expenses and other items, if any, that other companies may exclude from Adjusted EBITDA when they report their operating results and we may, in the future, exclude other significant, unusual expenses or other items from these financial measures. Because companies in our industry may calculate such measures differently than we do, their usefulness as comparative measures can be limited.
Because of these limitations, Adjusted EBITDA and Adjusted EBITDA Margin should be considered along with other operating and financial performance measures presented in accordance with GAAP.
The following table presents a reconciliation of Adjusted EBITDA to Net loss, the most directly comparable financial measure prepared in accordance with GAAP, for each of the periods indicated:
(1)
Represents adjustments and charges associated with the Tread and Tread+ product recall, as well as accrual adjustments. These include a reduction to Connected Fitness Products revenue for actual and estimated future returns of $26.5 million and $11.4 million, recorded costs in Connected Fitness Products cost of revenue associated with inventory write-downs and logistic costs of $2.5 million and $0.5 million, and operating expenses of zero and $1.0 million associated with recall-related hardware development costs, in each case for the three months ended September 30, 2022 and 2021, respectively.
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(2) Includes litigation-related expenses for certain non-recurring patent infringement
litigation, consumer arbitration, and product recalls for the three months ended September 30, 2022 and 2021.
(3) Includes transaction and integration costs of $0.8 million and $3.1 million for the three months ended September 30, 2022 and 2021, respectively, supplier settlements of $1.1 million for the three months ended September 30, 2022, and short-term purchase accounting adjustments of $1.9 million for the three months ended September 30, 2021.
Subscription Contribution and Subscription Contribution Margin
We
define “Subscription Contribution” as Subscription revenue less cost of Subscription revenue, adjusted to exclude from cost of Subscription revenue, depreciation and amortization expense, and stock-based compensation expense. Subscription Contribution Margin is calculated by dividing Subscription Contribution by Subscription revenue.
We use Subscription Contribution and Subscription Contribution Margin to measure our ability to scale and leverage the costs of our Connected Fitness Subscriptions. We believe that these non-GAAP financial measures are useful to investors for period-to-period comparisons of our business and in understanding and evaluating our operating results because our management uses Subscription Contribution and Subscription Contribution Margin in conjunction with financial measures prepared in accordance with GAAP for planning purposes, including the preparation of our annual operating budget, as
a measure of our core operating results and the effectiveness of our business strategy, and in evaluating our financial performance.
The use of Subscription Contribution and Subscription Contribution Margin as analytical tools has limitations, and you should not consider these in isolation or as substitutes for analysis of our financial results as reported under GAAP. Some of these limitations are as follows:
•Although depreciation and amortization expense are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Subscription Contribution and Subscription Contribution Margin do not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements; and
•Subscription
Contribution and Subscription Contribution Margin exclude stock-based compensation expense, which has recently been, and will continue to be for the foreseeable future, a significant recurring expense for our business and an important part of our compensation strategy.
Because of these limitations, Subscription Contribution and Subscription Contribution Margin should be considered along with other operating and financial performance measures presented in accordance with GAAP.
The following table presents a reconciliation of Subscription Contribution to Subscription Gross Profit, the most directly comparable financial measure prepared in accordance with GAAP, for each of the periods indicated:
The
continued growth of our Connected Fitness Subscription base will allow us to improve our Subscription Contribution Margin. While there are variable costs, including music royalties, associated with our Connected Fitness Subscriptions, a significant portion of our content creation costs are fixed given that we operate with a limited number of production studios and instructors. We expect the fixed nature of those expenses to scale over time as we grow our Connected Fitness Subscription base.
Free Cash Flow
We define Free Cash Flow as Net cash (used in) provided by operating activities less capital expenditures and capitalized internal-use software development costs. Free cash flow reflects an additional way of viewing our liquidity that, we believe, when viewed with our GAAP results, provides management, investors and other users of our financial
information with a more complete understanding of factors and trends affecting our cash flows.
The use of Free Cash Flow as an analytical tool has limitations due to the fact that it does not represent the residual cash flow available for discretionary expenditures. For example, Free Cash Flow does not incorporate payments made for purchases of marketable securities, business combinations and asset acquisitions. Because of these limitations, Free Cash Flow should be considered along with other operating and financial performance measures presented in accordance with GAAP.
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The following table presents a reconciliation of Free Cash Flow to Net cash used in operating activities,
the most directly comparable financial measure prepared in accordance with GAAP, for each of the periods indicated:
Our operations have been funded primarily through net proceeds from the sales of
our equity and convertible debt securities, and term loan, as well as cash flows from operating activities. As of September 30, 2022, we had Cash and cash equivalents of approximately $938.5 million.
We anticipate approximately $75 million to $100 million of capital expenditures over the next 12 months, which includes amounts related to capitalized labor, investments in content and our studios, product development, systems implementation, and the impact of expenditures before any proceeds from the expected eventual sale of Peloton Output Park.
We believe our existing cash and cash equivalent balances and cash flow from operations will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months. Our future
capital requirements may vary materially from those currently planned and will depend on many factors, including our rate of revenue growth, timing to adjust our supply chain and cost structures in response to material fluctuations in product demand, timing and amount of spending related to acquisitions, the timing and amount of spending on research and development and manufacturing initiatives, the timing and financial impact of product recalls, sales and marketing activities, the timing of new product introductions, market acceptance of our Connected Fitness Products, timing and investments needed for international expansion, and overall economic conditions. To the extent that current and anticipated future sources of liquidity are insufficient to fund our future business activities and requirements, we may be required to seek additional equity or debt financing. The sale of additional equity would result in additional dilution to our stockholders. The incurrence of
debt financing would result in debt service obligations and the instruments governing such debt could provide for operating and financing covenants that would restrict our operations. There can be no assurances that we will be able to raise additional capital. The inability to raise capital would adversely affect our ability to achieve our business objectives.
Restructuring Plan
In February 2022, we announced and began implementing the Restructuring Plan to realign our operational focus to support our multi-year growth, scale the business, and improve costs. The Restructuring Plan originally included: (i) reducing our headcount; (ii) closing several assembly and manufacturing plants, including the completion and subsequent sale of the shell facility for our previously planned Peloton Output Park; (iii) closing and consolidating several distribution
facilities; and (iv) shifting to third-party logistics providers in certain locations. We expect the Restructuring Plan to be substantially implemented by the end of fiscal 2024.
In July 2022, August 2022 and October 2022, the Company took actions to update the Restructuring Plan. On July 12, 2022 we announced we are exiting all owned-manufacturing operations and our expansion of our current relationship with Taiwanese manufacturer Rexon Industrial Corporation. Additionally, on August 12, 2022, we announced the decision to perform the following additional restructuring activities: (i) fully transition our North American Field Operations to third-party providers, including the significant reduction of our delivery
workforce teams; (ii) eliminate a significant number of roles on the North America Member Support team and exit our real-estate footprints in our Plano and Tempe locations; and (iii) reduce our North America retail showroom presence. On October 6, 2022, we announced approximately 500 global team member positions have been eliminated.
Total charges related to the Restructuring Plan were $169.8 million for three months ended September 30, 2022, consisting of cash charges of $27.0 million for severance and other personnel costs and $3.1 million for professional fees and other related charges, and non-cash charges of $62.9 million related to non-inventory asset write-downs and write-offs, and $76.8 million for stock-based compensation expense.
In
connection with the Restructuring Plan, the Company estimates that it will incur additional cash charges of approximately $70 million, primarily composed of severance and other exit costs in fiscal year 2023 and beyond. Additionally, the Company expects to recognize additional non-cash charges of approximately $70 million, primarily composed of asset impairment and stock-based compensation charges in fiscal year 2023 in connection with the Restructuring Plan.
We may not be able to realize the cost savings and benefits initially anticipated as a result of the Restructuring Plan, and the costs may be greater than expected. See “Risk Factors—Risks Related to Our Business—We may not successfully
execute or achieve the expected benefits of our restructuring initiatives and other cost-saving measures we may take in the future, and our efforts may result in further actions and/or additional asset impairment charges and adversely affect our business” in our Form 10-K.
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Convertible Notes
In February 2021, we issued $1.0 billion aggregate principal amount of 0% Convertible Senior Notes due 2026 (the “Notes”) in a private offering, including the exercise in full of the over-allotment option granted to the initial purchasers of $125.0 million. The Notes were issued pursuant to an Indenture
between us and U.S. Bank National Association, as trustee. The Notes are our senior unsecured obligations and do not bear regular interest, and the principal amount of the Notes does not accrete. The net proceeds from the offering were approximately $977.2 million, after deducting the initial purchasers’ discounts and commissions and our offering expenses.
Capped Call Transactions
In connection with the offering of the Notes, we entered into privately negotiated capped call transactions with certain counterparties (the “Capped Call Transactions”). The Capped Call Transactions have an initial strike price of approximately $239.23 per share, subject to adjustments, which corresponds to the approximate initial conversion price of the Notes. The cap price of the Capped Call Transactions will initially be approximately $362.48 per share.
The Capped Call Transactions cover, subject to anti-dilution adjustments substantially similar to those applicable to the Notes, 6.9 million shares of Class A Common Stock. The Capped Call Transactions are expected generally to reduce potential dilution to the Class A Common Stock upon any conversion of Notes and/or offset any potential cash payments we would be required to make in excess of the principal amount of converted Notes, as the case may be, with such reduction and/or offset subject to a cap based on the cap price. If, however, the market price per share of Class A Common Stock, as measured under the terms of the Capped Call Transactions, exceeds the cap price of the Capped Call Transactions, there would be dilution and/or there would not be an offset of such potential cash payments, in each case, to the extent that the then-market price per share of the Class A Common Stock exceeds the cap price of the Capped Call Transactions.
Class
A Common Stock Offering
On November 16, 2021, we entered into an underwriting agreement (the “Underwriting Agreement”) with Goldman Sachs & Co. LLC and J.P. Morgan Securities LLC as representatives of the several underwriters named therein (collectively, the “Representatives”) relating to the offer and sale by the Company (the “Offering”) of 27,173,912 shares (the “Shares”) of the Company’s Class A Common Stock, which includes 3,260,869 shares of Class A Common Stock issued and sold pursuant to
the exercise in full by the underwriters of their option to purchase additional shares of Class A Common Stock pursuant to the Underwriting Agreement. We sold the Shares to the underwriters at the public offering price of $46.00 per share less underwriting discounts. The net proceeds from the Offering were approximately $1.2 billion, after deducting the underwriters’ discounts and commissions and our offering expenses.
Second Amended and Restated Credit Agreement
In 2019, the Company entered into an amended and restated revolving credit agreement (as amended, modified or supplemented prior to entrance into the Second Amended
and Restated Credit Agreement (as defined below), the “Amended and Restated Credit Agreement”). The Amended and Restated Credit Agreement provided for a $500.0 million secured revolving credit facility, including up to the lesser of $250.0 million and the aggregate unused amount of the facility for the issuance of letters of credit.
The Amended and Restated Credit Agreement also permitted the incurrence of indebtedness to permit the Capped Call Transactions and issuance of the Notes.
On May 25, 2022, the Company entered into an Amendment and Restatement Agreement to the Second Amended and Restated Credit Agreement (as amended, restated or otherwise modified from time to
time, the “Second Amended and Restated Credit Agreement”) with JPMorgan Chase Bank, N.A., as administrative agent, and certain banks and financial institutions party thereto as lenders and issuing banks. Pursuant to the Second Amended and Restated Credit Agreement, the Company amended and restated the Amended and Restated Credit Agreement.
The Second Amended and Restated Credit Agreement provides for a $750.0 million term loan facility (the “Term Loan”), which will be due and payable on May 25, 2027 or, if greater than $200.0 million of the Notes are outstanding on November 16, 2025 (the “Springing Maturity Condition”), November 16, 2025
(the “Springing Maturity Date”). The Term Loan amortizes in quarterly installments of 0.25%, payable at the end of each fiscal quarter and on the maturity date.
The Second Amended and Restated Credit Agreement also provides for a $500.0 million revolving credit facility (the “Revolving Facility”), $35.0 million of which will mature on June 20, 2024 (the “Non-Consenting Commitments”), with the rest ($465.0 million) maturing on December 10, 2026 (the “Consenting Commitments”) or if the Springing Maturity Condition is met and the Term Loan is outstanding on such date, the Springing Maturity Date. The key terms of the Revolving Facility remain substantially unchanged from those set forth in the Amended and Restated Credit Agreement, including requiring compliance with a total
level of liquidity of not less than $250.0 million and maintaining a minimum total four-quarter revenue level of $3.0 billion (which are replaced with a covenant to maintain a minimum debt to adjusted EBITDA ratio upon our meeting a specified adjusted EBITDA threshold).
The Revolving Facility bears interest at a rate equal to, at our option, either at the Adjusted Term SOFR Rate (as defined in the Second Amended and Restated Credit Agreement) plus 2.25% per annum or the Alternate Base Rate (as defined in the Second Amended and Restated Credit Agreement) plus 1.25% per annum for the Consenting Commitments, and bears interest at a rate equal to, at our option, either at the Adjusted Term SOFR Rate plus 2.75% per annum or the Alternate Base Rate plus 1.75% per annum for the Non-Consenting Commitments. The
Company is required to pay an annual commitment fee of 0.325% per annum and 0.375% per annum on a quarterly basis based on the unused portion of the Revolving Facility for the Consenting Commitments and the Non-Consenting Commitments, respectively.
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The Term Loan bears interest at a rate equal to, at our option, either at the Alternate Base Rate (as defined in the Second Amended and Restated Credit Agreement) plus 5.50% per annum or the Adjusted Term SOFR Rate (as defined in the Second Amended and Restated Credit Agreement) plus 6.50% per annum. Each such margin will increase one time by 0.50% per annum if the Company chooses not to obtain a public rating
for the Term Loan from S&P Global Ratings or Moody’s Investors Services, Inc. on or prior to November 25, 2022. Any borrowing at the Alternate Base Rate is subject to a 1.00% floor and a term loan borrowed at the Adjusted Term SOFR Rate is subject to a 0.50% floor and any revolving loan borrowed at the Adjusted Term SOFR Rate is subject to a 0.00% floor.
The Second Amended and Restated Credit Agreement contains customary affirmative covenants as well as customary covenants that restrict our ability to, among other things, incur additional indebtedness, sell certain assets, guarantee obligations of third parties, declare dividends or make certain distributions, and undergo a merger or consolidation or certain other transactions. The Second Amended and Restated Credit Agreement also contains certain customary events of default. Certain baskets
and covenant levels have been decreased and will apply equally to both the Term Loan and Revolving Facility for so long as the Term Loan is outstanding. After the repayment in full of the Term Loan, such baskets and levels will revert to those previously disclosed in connection with the Amended and Restated Credit Agreement.
The obligations under the Second Amended and Restated Credit Agreement with respect to the Term Loan and the Revolving Facility are secured by substantially all of our assets, with certain exceptions set forth in the Second Amended and Restated Credit Agreement, and are required to be guaranteed by certain material subsidiaries of the Company if, at the end of future financial quarters, certain conditions
are not met.
As of September 30, 2022, we were in compliance with the covenants under the Second Amended and Restated Credit Agreement. As of September 30, 2022, we had drawn the full amount of the Term Loan and we had not drawn on the Revolving Facility, and we therefore had $748.1 million total outstanding borrowings under the Second Amended and Restated Credit Agreement. As of September 30, 2022, we had outstanding letters of credit totaling $82.6 million, of which $77.8 million is classified as Restricted cash on the Condensed Consolidated Balance Sheet.
Net cash (used in) provided by investing activities
(43.6)
29.3
Net
cash provided by financing activities
2.1
29.6
Operating Activities
Net cash used in operating activities of $202.8 million for the three months ended September 30, 2022 was primarily due to a net loss of $408.5 million and a net increase in operating assets and liabilities of $106.8 million, offset by an increase in non-cash adjustments of $312.5 million. The increase in operating assets and liabilities was primarily due to a $178.7 million decrease in accounts payable and accrued expenses as a result of a decrease in payables due to decreased inventory spending, partially offset by a $109.9 million decrease in inventory. Non-cash adjustments
primarily consisted of stock-based compensation expense, long lived asset impairment expense, depreciation and amortization, non-cash operating lease expense, and net foreign currency adjustments.
Investing activities
Net cash used in investing activities for the three months ended September 30, 2022 of $43.6 million was a result of capital expenditures primarily related the continued build out of our showrooms and offices, and software placed into service throughout the year.
Financing activities
Net cash provided by financing activities of $2.1 million for the three months ended September 30, 2022 was primarily
related to exercises of stock options of $4.1 million, partially offset by a $1.9 million principal repayment to the Term Loan.
(1)
Lease obligations relate to our office space, warehouses, production studios, equipment, and retail showrooms and microstores. As of September 30, 2022, the Company had additional operating leases for real estate that have not yet commenced of $11.5 million which has been included above. The original lease terms are between one and twenty-one years, and the majority of the lease agreements are renewable at the end of the lease period. The Company has finance lease obligations of $2.6 million, also included above.
(2) We are subject to minimum royalty payments associated with our license agreements for the use of licensed content. See “Risk
Factors — Risks Related to Our Business— We are a party to many music license agreements that are complex and impose numerous obligations upon us that may make it difficult to operate our business, and a breach of such agreements could adversely affect our business, operating results, and financial condition” in our Form 10-K.
(3) Pursuant to the Second Amended and Restated Credit Agreement, we are required to pay a commitment fee of 0.325% and 0.375% on a quarterly basis based on the unused portion of the Revolving Facility for the revolving loans maturing on December 10, 2026 and June 20, 2024, respectively. As of September 30, 2022, we had outstanding letters of credit totaling $82.6 million, of which $77.8 million was classified as Restricted cash.
(4)
Other purchase obligations include all other non-cancelable contractual obligations. These contracts are primarily related to cloud computing costs.
(5) Refer to Note 7 - Debt in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for further details regarding our convertible senior notes obligations.
(6) Supplier settlements relate to payments to third-party suppliers to exit purchase commitments.
The commitment amounts in the table above are associated with contracts that are enforceable and legally binding
and that specify all significant terms, including fixed or minimum services to be used, fixed, minimum or variable price provisions, and the approximate timing of the actions under the contracts.
We utilize contract manufacturers to build our products and accessories. These contract manufacturers acquire components and build products based on demand forecast information we supply, which typically covers a rolling 12-month period. Consistent with industry practice, we acquire inventories from such manufacturers through blanket purchase orders against which orders are applied based on projected demand information and
availability of goods. Such purchase commitments typically cover our forecasted product and manufacturing requirements for periods that range a number of months. In certain instances, these agreements allow us the option to cancel, reschedule, and/or adjust our requirements based on our business needs for a period of time before the order is due to be fulfilled. While our purchase orders are legally cancellable in many situations, some purchase orders are not cancellable in the event of a demand plan change or other circumstances, such as where the supplier has procured unique, Peloton-specific designs, and/or specific non-cancellable, non-returnable components based on our provided forecasts.
As of September 30, 2022, our commitments to contract
with third-party manufacturers for their inventory on-hand and component purchase commitments related to the manufacture of our products were estimated to be approximately $332.0 million. See “Risk Factors—Risks Related to Our Business—Our operating results could be adversely affected if we are unable to accurately forecast consumer demand for our products and services and adequately manage our inventory” in our Form 10-K.
Off-Balance Sheet Arrangements
We did not have any undisclosed off-balance sheet arrangements as of September 30, 2022.
Critical Accounting Estimates
Our
discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with GAAP. In preparing the condensed consolidated financial statements, we make estimates and judgments that affect the reported amounts of assets, liabilities, stockholders’ equity, revenue, expenses, and related disclosures. We re-evaluate our estimates on an on-going basis. Our estimates are based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Because of the uncertainty inherent in these matters, actual results may differ from these estimates and could differ based upon other assumptions or conditions. The critical accounting policies that reflect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements include those described in “Management's
Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates” in Part I, Item 7 of our Form 10-K.
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Revenue Recognition
As described in Note 8 - Commitments and Contingencies in the Notes to Condensed Consolidated Financial Statements, the Company announced voluntary recalls of the Company’s Tread+ and Tread products, permitting customers to return the products for a refund. The amount of a refund customers
are eligible to receive may differ based on the status of an approved remediation of the issue driving the recall, and the age of the Connected Fitness Unit being returned. We estimate a returns reserve primarily based on historical and expected product returns, product warranty, and service call trends. We also consider current trends in consumer behavior in order to identify correlations to current trends in returns. However, with current uncertainty in the global economy, negative press and general sentiment surrounding Peloton’s post-pandemic business and financial performance, and the absence of a complete remediation plan with the CPSC for our Tread+ product, predicting expected product returns based on historical returns becomes less relevant, requiring reliance on highly subjective estimates based on our interpretation of how current conditions and factors will drive consumer behavior.
On
October 18, 2022, the CPSC and the Company jointly announced that consumers now have more time to get a full refund if they wish to return their Tread+. With the extension of the full refund period for one additional year, to November 6, 2023, the Company expects that more Members will opt for a full refund, and accordingly has increased the Company’s return reserve. As of September 30, 2022 and June 30, 2022, our returns reserve related to the impacts of the recalls was $57.9 million and $40.8
million, respectively.
Recent Accounting Pronouncements
See Note 2 - Summary of Significant Accounting Policies in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q under the section titled “Recently Issued Accounting Pronouncements” for a discussion about new accounting pronouncements adopted and not yet adopted as of the date of this Quarterly Report on Form 10-Q.
Item
3. Quantitative and Qualitative Disclosure About Market Risk
Interest Rate Risk
We had Cash and cash equivalents of $938.5 million as of September 30, 2022. The primary objective of our investment activities is the preservation of capital, and we do not enter into investments for trading or speculative purposes. We have not been exposed, nor do we anticipate being exposed, to material risks due to changes in interest rates. A hypothetical 10% increase in interest rates during any of the periods presented in this Quarterly Report on Form 10-Q would not have had a material impact on our condensed consolidated financial statements.
We are primarily exposed to changes in short-term interest rates with respect
to our cost of borrowing under our Second Amended and Restated Credit Agreement. We monitor our cost of borrowing under our facilities, taking into account our funding requirements, and our expectations for short-term rates in the future. A hypothetical 10% change in the interest rate on our Second Amended and Restated Credit Agreement for all periods presented would not have a material impact on our condensed consolidated financial statements.
Foreign Currency Risk
Our international sales are primarily denominated in foreign currencies and any unfavorable movement in the exchange rate between U.S. dollars and the currencies in which we conduct sales in foreign countries could have an adverse impact on our revenue. We source and manufacture inventory primarily in U.S. dollars and Taiwanese dollars. A portion of our operating expenses are incurred
outside the United States and are denominated in foreign currencies, which are also subject to fluctuations due to changes in foreign currency exchange rates. For example, some of our contract manufacturing takes place in Taiwan and the related agreements are denominated in foreign currencies and not in U.S. dollars. Further, certain of our manufacturing agreements provide for fixed costs of our Connected Fitness Products and hardware in Taiwanese dollars but provide for payment in U.S. dollars based on the then-current Taiwanese dollar to U.S. dollar spot rate. In addition, our suppliers incur many costs, including labor and supply costs, in other currencies. While we are not currently contractually obligated to pay increased costs due to changes in exchange rates, to the extent that exchange rates move unfavorably for our suppliers, they may seek to pass these additional costs
on to us, which could have a material impact on our gross margins. Our operating results and cash flows are, therefore, subject to fluctuations due to changes in foreign currency exchange rates. We have the ability to use derivative instruments, such as foreign currency forwards, and have the ability to use option contracts, to hedge certain exposures to fluctuations in foreign currency exchange rates. Our exposure to foreign currency exchange rates has historically been partially hedged as our foreign currency denominated inflows create a natural hedge against our foreign currency denominated expenses.
Inflation Risk
Given the recent rise in inflation, there have been and may continue to be additional pressures on the ongoing increases in supply
chain and logistics costs, materials costs, and labor costs. While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, we have recently experienced the effects of inflation on our results of operations and financial condition. Our business could be more affected by inflation in the future which could have an adverse effect on our ability to maintain current levels of gross margin and operating expenses as a percentage of net revenue if we are unable to fully offset such higher costs through price increases. Additionally, because we purchase component parts from our suppliers, we may be adversely impacted by their inability to adequately mitigate inflationary, industry, or economic pressures.
Item 4. Controls and Procedures
Evaluation
of Disclosure Controls and Procedures
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Under the supervision of our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of September 30, 2022.
Disclosure controls and procedures are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be
disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure. As described below, we previously identified material weaknesses in our internal control over financial reporting. Solely as a result of these material weaknesses, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of September 30, 2022 due to the material weaknesses in our internal control over financial reporting described below.
Previously Reported Material Weaknesses
As reported in Part II, Item 9A. “Controls and Procedures” of our Form 10-K, we previously identified a material weakness in our internal
control over financial reporting related to controls around the existence, completeness, and valuation of inventory.
While management has made enhancements to its physical inventory compilation process throughout fiscal year 2022, we identified ongoing deficiencies in the operation of controls to validate the completeness and accuracy of key reports used in compiling and reviewing the results of our physical inventory counts.
These same reports are also used in other controls over the valuation of ending inventory balances which results in those controls also being deficient. We continue to implement remediation efforts, which include:
•Increasing our communication with third-party logistics providers and our oversight over third-party logistics
providers’ inventory management policies and procedures.
•Implementing additional monitoring controls to ensure consistency of inventory data across Peloton internal systems, our warehouses, and third-party logistics providers.
•Evaluating the effectiveness of our current cycle count program and controls, including IT general controls over systems facilitating cycle counts, to automate inventory count and reporting.
•Providing training of standard operating procedures and internal controls to key stakeholders within the supply chain, logistics, and inventory processes.
In addition, in connection with our assessment of the effectiveness of internal control over financial reporting as of June
30, 2022, control deficiencies were identified that, in the aggregate, represent a material weakness in our internal control over financial reporting. These control deficiencies relate to (i) the design of our controls associated with the application of fair value measurements pertaining to goodwill and long-lived asset impairment analyses, as well as (ii) evidence of the review supporting the validation of the inputs and assumptions used in our goodwill and long-lived asset impairment testing and restructuring assessment. In order to remediate this material weakness, we are implementing the following measures:
•Enhancing the design of our controls and implementing guidelines setting forth specific requirements for documenting our procedures for validating the data used in our impairment analysis and restructuring assessment.
•Implementing
additional review and analysis procedures to validate compliance with our guidelines and our policies outlining the application fair value in accounting processes when required, including steps to improve the operation and monitoring of control activities and procedures associated with our impairment assessments.
•Determining any additional resources that may be necessary to effectively implement additional review and analysis procedures over the assumptions, inputs, and methodologies described herein.
The actions that we are taking are subject to ongoing senior management review, as well as oversight of the audit committee of our Board of Directors. We also may conclude that additional measures may be required to remediate the material weaknesses or determine to modify the remediation plans described above. We will not be able to conclude
that we have remediated the material weaknesses until the applicable controls are fully implemented and operate for a sufficient period of time and management has concluded, through formal testing, that these controls are operating effectively. We will continue to monitor the design and effectiveness of these and other processes, procedures, and controls and make any further changes management deems appropriate.
These material weaknesses did not result in any material misstatements in our financial statements or disclosures. Based on additional procedures and post-closing review, management concluded that the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q present fairly, in all material respects, our financial position, results of operations, and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States.
Changes
in Internal Control over Financial Reporting
Other than the remediation efforts described above, there were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended September 30, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Limitations on the Effectiveness of Disclosure Controls and Procedures
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and implemented,
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can
provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues within a company are detected. The inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple errors or mistakes. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures
may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, we may be involved in claims and proceedings arising in the ordinary course of our business. The outcome of any such
claims or proceedings, regardless of the merits, is inherently uncertain.
For a discussion
of legal and other proceedings in which we are involved, see Note 8 - Commitments and Contingencies in the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.
Item 1A. Risk Factors
Investing in our Class A Common Stock involves a high degree of risk. You should carefully consider the risks and uncertainties previously disclosed under the section titled "Risk Factors" in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2022, together with all of the other information
contained in this Quarterly Report on Form 10-Q, including the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our condensed consolidated financial statements and the accompanying notes and the information included elsewhere in this Quarterly Report on Form 10-Q and in our Form 10-K and our other public filings before deciding whether to invest in shares of our Class A Common Stock. These risks and uncertainties are not the only ones we face. Additional risks and uncertainties that we are unaware of or that we currently deem immaterial may also become important factors that adversely affect our business. If any of the previously disclosed risks occur, our business, financial condition, operating results, and future prospects could be materially and adversely affected. In that event, the market price of our Class A Common Stock could decline, and you could lose part or all of your investment. There have
been no material changes to our risk factors since the Form 10-K.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item
4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
We are reporting the following information in lieu of reporting on a Current Report on Form 8-K under Item 5.02 Departure of Directors or Certain Officers; Election of Directors; Appointment of Certain Officers; Compensatory Arrangements of Certain Officers.
On November 2, 2022, the Company and Allen J. Klingsick agreed that Mr. Klingsick would step down from his position
as Chief Accounting Officer and Principal Accounting Officer of the Company, effective November 15, 2022 (the “CAO Transition Date”). Mr. Klingsick will provide certain consulting services to the Company through February 18, 2023, supporting the Company in the reporting of its second quarter of fiscal year 2023 financial results, among other functions. Mr. Klingsick’s departure is not the result of any disagreement with the Company on any subject, including its operations, policies or practices.
On
November 2, 2022, the Company appointed Saqib Baig as the Company’s Chief Accounting Officer and its Principal Accounting Officer, effective as of the CAO Transition Date.
Mr. Baig, age 45, has 25 years of global experience at several public companies and accounting firms providing leadership to various aspects of the finance function. Mr. Baig most recently served as Controller - Accounting Risk, Valuation and Financial Reporting at Meta Platforms, Inc. (“Meta”), from July 2019 to November 2022, overseeing multiple controllership pillars, including SEC Reporting, Internal Reporting, Technical Accounting and Policy, Mergers & Acquisitions, Business and
Asset Valuations, Financial Accounting & Reporting Risk Management, Loss Contingencies Controllership, and Equity Accounting. Prior to joining Meta, Mr. Baig served from August 2015 to July 2019 across various Treasury and Controllership roles at Colgate-Palmolive Co. Mr. Baig was a member of the Global Technical Controllership Team at the General Electric Company from December 2012 to August 2015, and he previously spent 15 years in roles within various public accounting firms, including PricewaterhouseCoopers, Ernst & Young, and Deloitte across Asia, Europe, and North America. Mr. Baig received a Bachelor of Commerce degree from the University of Karachi in Pakistan and a Bachelor of Science in Accounting from Western Governors University in the United States. He is a licensed Certified Public Accountant, an Associate Member of The Institute of Chartered Accountants of Pakistan, and a Chartered Financial Analyst.
There
are no arrangements or understandings between Mr. Baig and any other persons pursuant to which he was appointed as an officer of the Company, no family relationships among any of the Company’s directors or executive officers and Mr. Baig, and he has no direct or indirect material interest in any transaction required to be disclosed pursuant to Item 404(a) of Regulation S-K.
In connection with his designation as Chief Accounting Officer and Principal Accounting Officer, Mr. Baig is entering into an employment offer letter, pursuant to which he is eligible for the following compensation: (i) an annual base salary of $750,000, (ii) a restricted stock unit award to acquire shares of the
Company’s Class A Common Stock with an aggregate value of $3,250,000 (the “Equity Award”), (iii) up to $100,000 reimbursement of incurred relocation expenses, (iv) a one-time commuter travel benefit payment in the net amount of $45,000 for travel to New York City prior to and during his relocation, and (v) a sign-on restricted stock unit award to acquire shares of the Company’s Class A Common Stock with an aggregate value of $500,000 (the “Sign-On Award”). The Equity Award will vest over a four-year period, with 25% vesting on November 15, 2023 and 6.25% vesting quarterly thereafter, subject to Mr. Baig’s continued service. The Sign-On Award will vest over a two-year period, with 50% vesting on each of November 15, 2023 and November
15, 2024, subject to Mr. Baig’s continued service. Mr. Baig is also eligible to participate in the Company’s Severance and Change in Control Plan as a Tier 2 Participant.
The Severance and Change in Control Plan was filed as Exhibit 10.9 to the Company’s Annual Report on Form 10-K (No. 001-39058), as filed with the SEC on September 11, 2020.
In addition to the compensation arrangement described above, the
Company intends to enter into its standard form of indemnification agreement with Mr. Baig. The form of indemnification agreement was filed as Exhibit 10.1 to the Company’s Registration Statement on Form S-1 (No. 333-233482), as filed with the Securities and Exchange Commission (the “SEC”) on September 10, 2019.
Inline
XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
The certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Quarterly Report on Form 10-Q and are not deemed “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of
that section, nor shall they be deemed incorporated by reference into any filing under the Securities Act of the Exchange Act.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
