Last month, I said Peloton Interactive (PTON -7.32%) would be among the stocks I'd be watching the closest in May because it was scheduled to report its earnings results. The numbers were released last week, and investors sent the stock 14% lower.
While the pessimism is somewhat justified given the company's short-term future appears uncertain, it did make some positive moves to improve its longer-term outlook. Make no mistake, there is still cause for concern, but here's why investors shouldn't rush to sell the stock.
Image source: Peloton.
Peloton beat expectations on the top and bottom lines
Peloton's fiscal 2023 third quarter (ended March 31) results were certainly mixed for a few reasons, but at face value, it beat its own guidance for revenue and adjusted earnings before interest, tax, depreciation, and amortization (EBITDA).
On the revenue side, the company delivered $748.9 million compared to the $715 million forecast, and it generated negative adjusted EBITDA of $18.7 million, but it thought it was going to be as steep as negative $50 million.
Peloton saw strong sales from its third-party sellers like Amazon, which is great news because reaching customers outside of its own sales channels was a key strategic shift to capture more demand. Plus, the company posted a whopping 70% year-over-year increase in customers subscribed to its new fitness-as-a-service (FaaS) sales model.
FaaS was introduced to lessen the up-front cost of purchasing Peloton's exercise equipment. Rather than forking out the entire amount, customers can pay it off monthly under a subscription arrangement that lasts about 18 months. This is a win-win because according to a survey, 62% of FaaS subscribers wouldn't have joined if not for the flexibility of monthly payments compared to the one-off purchase price.
Peloton's better-than-expected revenue was paired with a 41% year-over-year reduction in operating costs. While the company still lost $275.9 million on the bottom line, it had $257.2 million worth of one-off and non-cash expenses like legal settlements and stock-based compensation, which is why the adjusted EBITDA figure is more reflective of its actual business performance in this case.
Peloton's guidance for the upcoming quarter is weak
This is where the company disappointed investors. In 2021, television network provider Dish Network sued Peloton and a handful of other companies for infringing on its adaptive bitrate streaming patents -- in other words, DISH felt the technology Peloton was using to stream its virtual content to its customers was too similar to the technology it designed.
In 2022, a judge sided with Dish, and rather than appealing the final decision, Peloton has decided to settle at a cost of $75 million, which will be recognized in its fiscal fourth-quarter (ending June 30) financials. Management believes it's in the best interests of shareholders to move on and focus on continuing to grow the business, and it's probably the right move.
Additionally, Peloton is making significant changes to its branding and advertising. When the company launched in 2013, its marketing campaigns were centered around the Peloton Bike product, but the company has since evolved. Today, it says 62% of its connected fitness subscribers were participating in non-cycling activities like strength training and yoga, and 38% of workouts involved no Peloton hardware at all. However, the company's advertising strategy wasn't representative of those facts.
It plans to relaunch its brand with new marketing initiatives in Q4, and it will take time to optimize them. As a result, Peloton expects revenue to come in at $650 million for the quarter, down compared to the year-ago period and also the most recent quarter.
The combination of less revenue and higher costs relating to the legal settlement equals guidance for negative adjusted EBITDA of between $10 million and $25 million. At the low end of the range, it would be a step backwards from the most recent quarter.
Peloton deserves more time before investors abandon ship
In fiscal 2022, Peloton generated a net loss of over $2.8 billion with negative adjusted EBITDA of almost $1 billion. Despite collapsing revenue combined with a barrage of restructuring costs and legal settlements, CEO Barry McCarthy -- who joined in February 2022 -- stands to improve both of those metrics considerably in fiscal 2023.
Peloton's adjusted EBITDA for the full fiscal 2023 year is tracking to come in slightly better than negative $200 million, which would be $800 million better than the fiscal 2022 result. That's a remarkable achievement in such a short period of time.
Plus, the company ended Q3 with $873 million in cash on hand, a slight improvement over the previous quarter. It also has a $400 million credit facility available which remains untapped. Arresting the decline in its cash balance was crucial because the company was at risk of running out of runway last year given the size of its losses.
Overall, while next quarter might be a bump in the road on Peloton's path to recovery, I think the company has succeeded in stabilizing its financial position. The next steps involve delivering consistent revenue growth and achieving true GAAP profitability by carefully managing costs. Peloton's new CEO has earned at least another year to move closer to those milestones.
