Connected-fitness company Peloton Interactive (PTON -0.98%) reported financial results for the first quarter of its fiscal 2023 on Nov. 3, and boy, was it a doozy. The company's Q1 revenue was down 23% year over year to $616.5 million. And its net loss widened from $376 million last year to $408.5 million this year.
With those headline numbers, observers might conclude that Peloton is going in the wrong direction. But not according to CEO Barry McCarthy. In his letter to shareholders, McCarthy expressed optimism with Peloton's Q1 results and said, "The ship is turning."
Here's what McCarthy means, and here's what shareholders should do with this information.
Were Peloton's Q1 results good or bad?
Let's not sugarcoat this: Peloton's $409 million net loss on just $617 million in revenue is unequivocally bad. And I don't think that even Peloton's own executives would quibble with my frank assessment. But investing isn't about what's already happened. Investing is about what happens next. And that's where McCarthy is expressing optimism.
To be sure, Peloton's financial results in previous quarters were worse as the chart below shows.
| Quarter | Q2 2022 | Q3 2022 | Q4 2022 | Q1 2023 |
|---|---|---|---|---|
| Revenue growth | 6% | (24)% | (28)% | (23)% |
| Gross margin | 24.7% | 19.1% | (4.4)% | 35.2% |
| Net loss | $439 million | $757 million | $1.2 billion | $409 million |
Data from letters to shareholders by Peloton Interactive. Chart by author.
Perhaps this does show a slight turning of the ship for Peloton. After all, the trend did improve. Q1 revenue was down but not as much as in previous quarters. The company's gross-profit margin sharply recovered. And its net loss was enormous but not as bad as before.
McCarthy believes this improvement can continue.
What's next for Peloton?
Let's turn now from Q1 and start thinking about future quarters. Peloton's membership base shrunk in Q1, and that has greater potential implications for the business down the road.
| Quarter | Q2 2022 | Q3 2022 | Q4 2022 | Q1 2023 |
|---|---|---|---|---|
| Connected-fitness subscriptions | 2.77 million | 2.96 million | 2.97 million | 2.97 million |
| App subscriptions | 862,000 | 976,000 | 980,000 | 875,000 |
Data from letters to shareholders by Peloton Interactive. Chart by author.
Peloton users who own Peloton hardware devices like the stationary bike or the treadmill are connected-fitness subscribers. Other users simply subscribe to the exercise app without hardware.
Some companies had started offering Peloton's app as a perk for employees. And Peloton was happy to sign these deals, believing it could turn these employees into lifetime Peloton members. But this doesn't appear to be happening. Peloton's management said that it lost some app subscribers in Q1 because of some renewal agreements with corporations. It seems users weren't willing to pay if it wasn't a perk.
More concerning is the drop in connected-fitness subscriptions for Peloton. Keep in mind that the company still generated over $200 million in Q1 in hardware revenue. This should have led to a higher connected-fitness subscriber base. However, its membership likely stagnated because the company increased the cost of its monthly subscription on June 1. It appears members are pushing back, cancelling their Peloton subscriptions at a higher rate than in times past.
That's a problem for Peloton shareholders. McCarthy is trying to get the company to a place where it's generating positive free cash flow. But this plan is predicated on generating a lot more higher-margin subscription revenue. If it doesn't grow its membership, then it's going to be hard to make the plan work.
There's another problem too. Peloton's subscription revenue has finally overtaken hardware revenue -- something shareholders like me have longed for. Subscription revenue has been 61% of total revenue over the past two quarters combined. Many investors, myself included, believed this would lead to positive cash flow at the company, given the high 66% gross margin for subscription revenue. But hardware's losses have been too great to overcome.
With Peloton's management still tweaking its pricing and potentially packaging hardware products in a monthly subscription plan dubbed Fitness-as-a-Service, hardware losses could remain too big for subscription revenue to lead to strong overall cash flows.
What to do with Peloton stock
I'm down 90% on my Peloton investment. If you're like me, it honestly doesn't much matter what you do with your shares. If you have a diversified portfolio, then Peloton is now down so much that it doesn't have much bearing on your overall returns. If you sell, it won't raise much cash. And if you keep holding, like me, it could double from here, and I would still be down 80% from my cost basis.
The bigger takeaway here is I wouldn't buy Peloton stock on Q1 results. I wouldn't double down either if you already own a position. Perhaps there are some positive signs, as we've seen. But questions too significant to overlook still remain.
