Q2 2020 Earnings Call
Ladies and gentlemen, today's conference is scheduled to begin shortly please continue to standby. Thank you for your patience again, ladies and gentlemen, today's conference is scheduled to begin shortly please continue to standby. Thank you for your patience.
[music].
Ladies and gentlemen, thank you for standing by and welcome to the Palatine Interactive Q2 2020 earnings call. At this time, all participants are in listen only mode.
After the speaker presentation, there will be a question and answer session to ask a question. During the session. You want me to press Star one on your telephone. Please be advised to today's conference is being recorded if you require any further assistance. Please press star zero I would not only to hand the conference over to your Speaker Ms. Allison.
Lee Vice President of Finance. Please go ahead man.
Good afternoon, and welcome to Palatine second quarter earnings conference call for fiscal year, ending June Thirtyth 2020, joining us on today's call to answer your questions are John fully or co founder and CEO William Lynch, Our President and Joe would work our CFO a copy of today's shareholder letter is available on the Investor Relations section.
Our website at Www Dot, one Palatine dotcom and husband furnished to the FCC on form 8-K already began I would like to remind you that our comments and responded to your question reflect management's views as of today only and will include statements related business that are forward looking statements under Federal Securities Law Act.
Actual results may differ materially from does contain Dan or implied by these forward looking statements due to risks and uncertainties associated with our business.
Our discussion of the material risks and other important factors that could impact our actual results.
Please refer to our FCC filing and today shareholder letter.
Which can be found on our website.
During this call we will discuss both GAAP and non-GAAP financial measure a reconciliation of GAAP to non-GAAP financial measure is provided in today's shareholder letter with that I'll turn the call over to John will begin with a few opening remarks.
Thank you Allison.
One thank you for joining us today.
We're excited to share our results for the second quarter.
We'd like to start by saying that our financial results significantly exceeded our expectations. Our results were positively impacted by strong holiday performance across all regions, a lift and conversion from the introduction of home trial, which allows prospective members the ability to try or bike risk free for 30 days and some additional drive.
Yes, Joe will discuss in a moment.
Most importantly, our results are due to the great execution of each and every team member at pellet on I want to give a special appreciation and recognition to our dedicated frontline employees during the busy holiday season, including our global showroom and inside sales specialist.
Remember support teams and field operations delivery teams.
We know that a great member experience starts with a great sales and delivery experience an important part of our overall net promoter score.
Let's jump right into a few highlights from Q2.
Q2 ended with over 712000 connected fitness subscribers, representing 96% year on year growth.
We now have over 2 million members on our platform.
Our connected fitness subscribers worked out with us over 24.3 million times in Q2, averaging 12.6 monthly workouts per connected fitness subscriber.
From 9.7 monthly workouts in the same period a year ago.
That means that our connected fitness subscribers are working out 30% more than they did a year ago getting even more value from their palatine subscription.
In addition, our connected fitness subscribers are taking more and more non cycling classes, making us incredibly excited about investments, we're making a new fitness verticals and our digital out.
In Q2 over 30% of the class is taken by our connected fitness subscribers were non cycling classes.
Importantly, our strong member engagement led to a low average net monthly connected fitness subscriber churn of 0.74% in Q2.
Lastly, I want to share a few thoughts on the home fitness category and our digital membership.
We have strong conviction that consumers will continue to migrate to connected fitness experiences that offer better locations that are instructors time shifted consumption and a much broader and better selection of content.
We do see other companies entering the connected fitness space from several different angles with digital streaming and or hardware offerings with limited interactivity.
But as the pioneer and clear category leader with an undeniable first mover advantage. We plan to continue to invest smartly in new products interactive software and innovative content across every major fitness vertical in order to maintain our lead.
Overtime, our number one goal is to make the pellet on experience more accessible to more people across all demographics.
As we've discussed before our long term goal is to have a better best product portfolio.
With high volume scale production marketing efficiencies and strong subscriber unit economics, we see an opportunity to pass savings onto the consumer, allowing us to broaden our reach and increase our addressable market.
One important aspect of our strategy to maintain leadership in connected fitness is to also when in digital only fitness.
In Q2, we made some important changes to tell us on digital around accessibility price and trial.
Hello time digital started as a companion app for our connected fitness subscribers access to the App is included in the connected fitness subscription and has been and we'll continue to be an important driver of engagement and increased value for our connected fitness subscribers.
However, overtime peloton digital has become an incredibly powerful lead generation tool for us as well.
We see strong organic conversion from digital subscribers to connected fitness product owners as digital members fall in love with the classes the instructors and the community.
We believe more digital members will lead to the sale of more connected fitness products.
We saw a big opportunity to broaden the funnel by lowering our digital subscription to 12 99 per month and extending the free trial period to 30 days.
As a reminder, our digital subscription limits access to a single user while the connected fitness subscription is available to the entire household.
Also given that we already create the content on our app for our connected fitness subscribers. Our current philosophy around investment in digital is to run it at breakeven.
At the lower price, we believe we will see lower churn, especially as we continue to improve our content and our software, which will drive better LTV to CAC ratio, allowing us to spend more marketing dollars against digital overtime continuing to expand our member base.
Our goal is to make peloton digital available on every screen in your hand and in your home.
We were excited to add both an Amazon fire TV App and an Apple watch app to a growing list of immersive capabilities that differentiate the peloton offering and give our members the best value in fitness.
We hope to add several more platforms in the coming quarters.
And now I will hand, it over to Jill to provide additional information on our Q2 financial results and guidance for the balance of the year.
Joe.
Thanks, John turning to our financials revenue for Q2 was 466 million representing year over year growth of 77% as John noted our results reflect the conversion up from home trial, a strong holiday driven by our largest omni channel marketing program to date and.
Continued growth in global showroom.
In addition to healthy results for our U.S. bike business tread sales continue to exceed our expectations.
From a geographical perspective, we also saw better than expected performance in each of our international markets, We're especially pleased with our entry into Germany, where sales are pacing with our successful UK lunch in fall of 2018.
The introduction of home trial drove improved fight conversion in the quarter pulling many customers off the fence without having a meaningful impact on our low single digit return rates.
Looking ahead, we expect the conversion gains at home trial to moderate as it becomes less newsworthy and an expected part of our sales experience.
During the holiday period, we also ran our largest promotion of the year for both the bike and tread for two weeks ending cyber Monday, given that Thanksgiving. So later in the year the longer promotional period allowed us to better distribute our sales and delivery to ensure bikes in treads lived in time for the holidays.
Our delivery self scheduler investments could scale supply chain and logistic and seasonal hiring a lot as to achieve much shorter order to delivery time than in previous holiday period and versus our expectations. This will be an important point in the discussion of our Q3 guidance.
Gross margin in Q2 was 42.3%, surpassing our expectations connected fitness gross margin was 40.5% driven by continued product cost improvements helped by the tonic acquisition and better than expected leverage.
And our logistics platform.
These improvements helped offset the expected year over year margin declined due to the continued mix shifts tread, which currently has a lower gross margin than our bike.
Subscription gross margin and subscription contribution margin both showed a significant improvement versus the same period last year at 58% and 64.4% respectively. The strong year over year improvement was due to lower content costs, the past years and faster.
And leveraging of our fixed costs as we scale our subscriber base.
We also saw improvement in streaming cost versus expectations.
Given our sales and gross margin performance, we were able to drive strong sales flow through and fixed cost leverage resulting in an adjusted EBITDA of negative 28.4 million and an adjusted EBITDA margin of negative 6.1%.
Before addressing the balance of the year I want to discuss our guidance philosophy in light of Q2 results.
In providing guidance ranges, our aim is to convey reasonable expectations for our future performance.
This quarter, a number of factors led to the outperformance stronger than anticipated holiday traffic increased conversion from home trial lower than anticipated churn and strong revenue growth aided by a significant year over year narrowing of our order to delivery window.
Looking ahead, we believe we have a better understanding of the key sources of forecast variability in our financial model.
Specifically, we have a better view into the impact of home trial on sales performance and return rate.
We also have more clarity on the benefits from our investment in supply chain and logistics and lastly, with the heaviest volume month now behind US we believe our results moving forward will map more closely to our guidance.
For Q3, we expect to end the quarter with 843840, 8000 connected fitness subscribers, representing 85% year over year growth at the midpoint of the range.
For fiscal year Twentytwenty, we are raising our guidance range to 920000 to 930000, ending connected fitness subscribers, representing 81% year over year growth at the midpoint of the range.
We expect average net monthly connected fitness churn to be below 0.95% in Q3 and below 0.95% for the full fiscal year 2020, which reflects recent trends in churn the lower observed return rates for home trial and higher retention of.
Those rolling off of prepaid connected fitness subscriptions.
We expect revenue of 470 to 480 million for Q3 is represent 50% year over year growth at the midpoint.
There are couple of factors impacting year over year revenue and net subscriber growth for Q3 fiscal 2020 that are worth pointing out.
First please recall that we recognize connected fitness product revenue at the time of delivery not at the time of order therefore delivery windows can impact the phasing of our quarterly performance.
In Q2 fiscal 2019, we had a particularly strong holiday and that outperformance. Unfortunately caused very long order to delivery period, pushing thousands of deliveries into into Q3 fiscal year 2019.
Our experience last holiday was the reason why we have been still focused this year on investing in our logistics infrastructure and rolling out our delivery self scheduler.
This past holiday, we shortened order to delivery windows by several days versus our expectation.
As a result over 6000 expected deliveries and subscription activations shifted from Q3 into Q2, representing roughly 5% of connected fitness product revenue growth in Q2.
Also in fiscal 2019, we delivered the vast majority of preorders for tread during the third quarter, creating a challenging revenue comp for Q3 fiscal 2020.
We estimate that these preorders for tread impact revenue growth in Q3 by about 10 percentage points.
This had a nominal impact on year over year subscriber growth because the majority of these preorders went to existing bike owners when a bike in a tread go into the same household we only charge for one connected fitness subscription, which means most of these tread deliveries Didnt result in a new subscriber.
For fiscal 2020, we're raising our guidance on revenue to 1.53 to 1.55 billion, representing 68% year over year growth at the midpoint.
Our gross margin outlook reflects efficiencies in both connected fitness and subscription margin.
Improve connected fitness margin guidance includes product cost improvement, which are offsetting the negative margin impact of the mix shift of sales to tread an international.
Subscription contribution margin guidance reflects savings and streaming cost and faster leveraging of fixed content production costs.
Additionally, we are not assuming any incremental content cost for past use at this time.
For gross margin in Q3, we expect overall gross margin of 43% to 44% connected fitness gross margin, 41.5% to 42.5% and subscription contribution margin of 60% to 61%.
For fiscal year Twentytwenty, we expect overall gross margin of 43.5% to 44.5% connected fitness margin of 41.5% to 42.5% and subscription contribution margin of 61.5% to 62.5%.
For Q3 2020, we expect adjusted EBITDA in the range of negative 35 to negative 25 million and an adjusted EBITDA margin of negative 6.3% at the midpoint of revenue and EBITDA ranges.
For fiscal year Twentytwenty, we expect adjusted EBITDA in the range of.
Negative 115 to negative 95 million and an adjusted EBITDA margin of negative 6.8% at the midpoint I will now turn it over to the operator to take your questions.
Thank you as a reminder to ask a question you want me to press Star one and your telephone we ask that you. Please limit yourself to one question and one follow up question. You May then returned to the team.
Try your question press the pound.
Please standby, while we compile the culinary roster.
First question comes from Doug and Mush with JP Morgan.
Great. Thanks for taking my questions.
Just two I wanted to ask John first can you talk more about the digital strategy and the price cut.
Late in the quarter and I understand your you want to grow the ecosystem and make the products more accessible.
But you're also making it easier for your competition to leverage your platform and content can you just talk about the trade offs there.
And then also what you're seeing early on with digital since the price cut.
And then just secondly, youve t. some significant software updates over the next few months can just talk about the importance of social features within the platform.
Also how should we expect those features to to extend to digital thanks.
Yes, a digital we're excited about expanding the top of funnel as we said to 12 99, we haven't seen any of these obviously we've seen some marketing from some of these other pure hardware players are trying to take advantage of our content to the extent that they get any traction, which we haven't seen.
And there are becoming digital subscribers, we would celebrate that because it is.
Introduction into our ecosystem and it's in its on a dramatically inferior bike and an inferior experience because you don't get all the interconnectivity and the leaderboard in the community in the big screen and all of this special stuff that creates these really special pellets on experiences so to the extent it allows you to taste the comp.
Tent easily without having a you know to buy the connected fitness product in advance lets say you have a spend like in your basement or you're interested in buying a.
Lower price been bike, that's not interconnect connected we're excited about that as an entre into.
Into our universe and exposure to our instructors and our content and all that stuff and we believe that we will continue to see strong conversion from digital members into connected fitness members as we've seen so we're excited about that that doesn't scare us one of the things Doug to be totally honest is we want to make sure that if somebody's going to do that it's with peloton.
Content. So we are servicing that customer who wants to do that with pellets on content scaling our investment in the studios and instructors. So we believe that the connected fitness investment and the investments and other devices.
As a technology company, we say we are platform agnostic with our content. So I think it's a really smart strategy. We're excited all of the early metrics from our Oh.
Lower priced.
Switch to the 12 99 price point and the 30 day free home trial, all of the leading indicators across that business are in going into right direction and we're very confident bullish on what we're seeing for that on the second thing on social features we have some we do have a couple really sexy social features in the Q4.
For the connected fitness offering and for digital for that matter, we have a lot of innovation and soccer, we have hundreds of the best Python and iOS and Android Engineers in New York City, writing code and working with some great product minds.
We're not as good an outcome on the on the call, but they are social they are gonna help protect remote from a from a network effect perspective, you think about social software and game application all of that it's a high priority for us because we know our members want it and it's going to protect us and strengthen the modes for for our business.
Great well take that question.
Yes. Thank you. Our next question will come from Heath, Terry with Goldman Sachs.
Great. Thanks.
I guess, one for Joel Joel.
Give us a sense of how much you actually saw a financial impact from owning your contract manufacturer.
This quarter.
How that how that actually flowed through the.
The income statement or the cost structure and then John as you.
Look at the initial results and.
Some of these international markets with the rollout in Germany as well as.
A few more months in the UK how are you starting to feel about additional markets internationally in sort of the pace of.
Your roll out beyond the on the U.S. UK, Germany in Canada.
Great Hi, Heath. So so very quickly on connected fitness gross margin, that's effectively where you see the majority of the impact from tonic.
So certainly in the quarter, we were pleased with our connected fitness margin of 40.5% and our outlook as well as our performance for the quarter do reflect.
Some product cost improvements from tonic.
So thats really where where it hits the most that being said we also saw.
Contributing to our margin for the quarter, we also leveraged our fixed cost of our logistics platform given ourselves outperformance.
There's a small amount a really immaterial amount of DNA associated with other staff that we now need in Taiwan, such as finance and accounting and some other DNA expenses, but they're very very small so you will and we have incorporated.
Those product cost improvements due to our acquisition of tonic in our go forward guidance on connected fitness margin.
And then Heath its William Lynch on International we are so far very pleased with the Germany launch its notably ahead of our very successful UK launch, which.
Which is really good news in in terms of those three markets now U.S. UK and Germany. We are in the three largest fitness markets in the world.
Building, a strategic moat those three markets.
Our over half of the conduct of the of subscription fitness spend.
And so that has as excited as well if you look at.
What we're going to do going forward, we're going to focus on the four markets where in the three I mentioned plus Canada as we're studying as we're studying other markets to go into but if you.
We think we're very early on in the UK. We think we think we're early on in the U.S. and there's a lot of growth in those four markets and so.
In answer to your international expansion question. That's that's the strategy as we look over the next couple of quarters.
Next question please.
Thank you. Our next question comes from Justin Post with Merrill Lynch.
Great. Thank you for taking my question, maybe one for John and one for Joel.
Lot of new competition entered over the last six months have you seen any impacting your you're busy months in November December.
In January on either units or pricing any any impact there.
And does that mean create a bigger sense of urgency to get get a lower price spread out and Joel I'm just in the quarter any commentary you can provide on ASP or average ASP is year over year in the quarter or what's contemplated.
In your outlook on commitment connected fitness products. Thank you.
Yes, good question on competition.
We are obviously not surprised that others are coming to realize the connected fitness opportunity.
And we expect more investments on the part of competitors to be honest.
That said, we're confident in our leadership position and we will continue to invest aggressively behind our connected fitness products continent community.
We can talk later on the call about our new Super studio opening we talked a little bit software.
We're going to be innovating on hardware I know you.
Yeah.
You know about our better best product strategy across the categories that were in so we we feel good we will answer your direct question, we've not seen any pressures that have impacted the our our need to change prices or the like but I will I will say a macro note on competition.
It is my strong feeling that as an innovation company innovation has been quarter, what we've been doing over the past seven years, and we plan to continue innovating across hardware software and content again like Joe mentioned earlier with an eye towards affordability and the democratization of fitness, which means affordability for you.
Oh all people.
And so I believe in its kind of are those that we believe that if anyone's going to disrupt pellets on its going to be telecom.
And I know that Oh words are cheap at this point. So we're just going up to show you through our action to the coming quarters, what we mean on that front.
Great and and on the average selling price just to put it into context of Q2 was lower versus Q1, primarily due to the fact that we run a holiday promotion in Q2, leading up to fiber Monday, and obviously as we mentioned earlier this year it was.
It was a two week promotion.
So with that that is really what what is driving some sequential decline as well from year over year.
For the balance of the year, we do expect the average selling price per product to be.
Our its driven by a couple of things.
Lower penetration to try it again remember.
We actually delivered a large number of our preordered treads back in Q3 of last year.
Also we have higher financing penetration than we did a year ago.
And also we do have a slightly higher return reserve associated with home trial, albeit it's lower than what we had expected to be and then when you know there's so many inputs that go in in addition to the ones that I mentioned, obviously geographical mix.
Accessory and warranty attach rate.
Ken can vary the a average selling price.
So again I think what you'll see in our revenue guidance is a slight lowering.
Alan.
Thank you question.
Thank you again, ladies and gentlemen, if you have a question at this time. Please press. The Star then one key on your Touchtone telephone.
Next question comes from Ron Josey with JMP Securities.
Great. Thank you. Thanks for taking the question wanted to ask about Joe you talked about supply chain in order delivery windows being lowered by several days in the quarter self surgeon serves scheduling tool healthier just can you talk about the other thing that that helped drive the deliveries better in the quarter and then secondly on home trial, you talked about increased conversion rates and benefits and just to better overall.
Overall view on the sales return rates, just any sort of lessons learned to you on home trial would be helpful. As I think you mentioned benefits would moderate going forward and I'm. Just wondering if that's a change in marketing approach or just the newness of the product. Thank you.
No great. So so the first one on supply chain I'm going to have William chime in and then I'll I'll take the second one.
Thanks, Joe Hey, Ron So you know, we're really pleased as Joe noted, we cut our order to delivery rate to to members in half. This year from last year, which is a huge win for our members certainly but also the team.
And the way we were able to do this we now have 31 warehouses spread across the us and what that does is it brings bikes and treads closer to customers and are obscene a team has done a great job not only on the warehouse footprint, but also with our trucks and bands and logistics and coordinating.
Forecast such that we could we could drive that kind of performance and so that has been investments we've been making over the last two plus years, and we think set us up really well in the future and led to a lot of what Joe talked about which is sort of the shift in what would we would tradition.
Traditionally have in Q3 deliveries pulling into Q2.
Let me jump in there Ron because it's a great question, then I think it did impact the Q3 guidance. This year, which is at the two for last year, we were really bad at getting.
It took us a long time from the order to delivery and that pushed a lot of sales. They were in Q2 into deliveries in Q3, which we recognize revenue when the delivery takes place. So last Q3 was artificially inflated Joe explained this but I want to make sure that everyone got it and this year, we did the opposite.
Things that we thought might have been pushed into Q3, we pulled into Q2, we sold them in Q2, and then we delivered them in Q2, which was a win for our members, but from a year on year comp as we guided Q3, it just optically looks like a.
Diesel, which it was not in essence, and so I'm glad Ron you're digging into that.
Or better than deliver our order delivery shortening the great question.
Great and then just to go back on home trial, obviously, another big driver of our Q2 performance. In addition to some of the efficiencies that we now have seen our logistics and delivery.
If you we were very pleased.
With the conversion uplift from home trial in the quarter and its impact on the performance. We were also extremely excited by the fact that our return rates were up more than forecasted and not really moving the needle on are already very low single digit return rate. So it it's excite.
I mean, because we've been able to break down the purchase barrier barrier of Willeit use this and overwhelmingly our new customers are using their product and keeping it. So we're very excited about that.
I think in terms of of looking forward with home trial I think.
Yes, it had a great lift in Q2, but it is a program change and so we do think that as it becomes less worthy and more expected.
In terms of the whole consumer sales experience.
Do you expect that to moderate overtime, but certainly in the.
Initial weeks and months it is pulled a lot of buyers off the fence. So so again very pleased with the performance.
That's right. Our next question please.
Thank you. Our next question comes from Laura Martin with Needham.
Hey, guys great numbers, John one for you. So I love this idea of lowering the digital only price because I do think it's a clever onramp ecosystem. My question is we had a little controversy over some of the TV ads in the fourth quarter does this lower the risk as you onramp people through the digital.
The lower price digital tiered out and then see do you find it has higher conversion rates.
Given the trial of the digital versus television ads.
Hi, Laura Hi, I'm not.
I'm not totally sure I understand the question on I'm glad you like the digital strategy I do as well, it's really opening the aperture and getting more people in of the ecosystem.
But I don't know, how a what you're saying with the impacted our advertising or or it increases the risk.
Lowers the risk.
Lower is that I mean.
Yes, so I mean, it just what's the conversion rate television ads versus digital.
Descriptions, Oh, I see I see I got you well, we are a multichannel marketer and we do television and digital and out of home and direct mail and.
Digital is an acquisition vehicle overtime each one of these things ebbs and flows as the as the most efficient marketing dollar but in concert with our stores. They all work in a multichannel marketing efficient cocktail that will ebb and flow I will tell you January is the time.
To market digital you've kind of fish, while the Fisher biting around new years resolutions. So that we went to January will definitely be one of our heaviest mumford marketing digital app.
And then in the summertime it won't be as aggressive so it ebbs and flows but we are if we can run the digital business.
At unit economic breakeven you breakeven again, considering that the content effectively coming to that business model is free.
Then you could see in a world that future connected fitness.
Uh huh.
Purchasers.
Could have effectively as zero CAC, which is a weird thing to get your brain around but as we learn more about this business in the coming quarters in coming years that opportunity exists and it's very exciting to me. So we we have high hopes and again this woman greener Kogan and her team who run digital are incredible leaders and execute or so.
We have high hopes for that but again as you know I mean, we get excited about it.
Digital as an acorn that could go into a big joke, but still the vast vast vast majority of our business on the financials or around the connected fitness business.
Yeah. These churn numbers are unbelievably low I've never seen subscription businesses as such low churn number so kudos to you guys for making the Greg.
Thank you Okay. Thank you next question please.
Our next question comes from Youssef Squali with Suntrust.
Hi, guys two questions for me. Please on the the margin the improving margin leverage.
Seems like you guys are kind of barreling towards profitability potentially earlier then.
We had you are the street as you.
Kind of coming in so maybe John can you just speak to how you look at profitability relative to grow I.
I know that historically, you've talked about growth within the context of margins that you had shared with us in the past seems like the margin profile is changing a bit and then second this is still for John or maybe William maybe can you speak to the difference between build showrooms and the concept store can what's the Genesis of the concept store idea.
What are you trying to do there that you can't do into showrooms and maybe.
Speak to the speak to it in terms of costs, maybe versus our Hawaii. Thank you.
Great Hi, it's Joel I'm actually going to take the first question and and certainly John chime in so.
So we have said previously that we expect to become adjusted EBITDA profitable by 2023.
At this juncture, we are not going to update our view on timing of profitability.
But I think we've also said in the past as well that profitability for US is a managed outcome. We continue to see a massive opportunity in front of us and we're prioritizing our subscriber growth over profitability, but I think what you're seeing in the business stuff is that we have an ability to achieve both growth and profitability.
And there are many reasons for that one is that our U.S. bike business is profitable and still growing at a high rate.
We believe we have a compelling unit economic model with rapid payback of our sales and marketing and we also have a high lifetime value and I think thats underscored by the great low churn that we produced in Q2 and of course that high margin of that subscription business.
And lastly, we do expect a lot of operating leverage in our business overtime on all Opex line trying to hold R&D study, but certainly in gionee and sales and marketing so.
I think the way you can think about it is that 2020 will be our trough year from profitability standpoint, but that's on an adjusted EBITDA margin basis. So.
And obviously with the revised guidance I know, it's it's been improving over the last couple of quarters. So again for us at peloton. We believe we can achieve both growth and profitability over time, but I know I Didnt give you a specific stake in the ground, but Ah. We're just not prepared at this time to do that.
Hey use if this is a William Lynch on your showroom question. We're at 96 doors now globally and we've been building out our retail presence, which we view as a real advantage for US we think connected fitness products are the most suitable people want to see them.
Evidenced by our new tread has a higher penetration retail sales and then bike, which which we think is further evidence of that we have to what what you called concept stores. One we launched in Cleveland the other in San Diego and really the underpinnings strategically for that is to show off products beyond the bike. So we use.
Is that extra footprint to show off Trad show off some new class tightened offerings in fact fastest growing part of our catalog connected fitness catalog with shelf strength, which is up three X year on year, we show up things like meditation.
We discuss yoga and merchandise around yoga content products. So that's what that additional footprint allows us to do I would say we're in test mode. On those two we have three formats now in retail. We also have a smaller store. It's about a third of our fleet called a micro store, which is our highest productivity store and so I think it's just further evidence of our.
Sort of strategic advantage in this very valuable category, where.
We're almost at 100 hundred showrooms now we're learning a lot and we can touch the consumer in really interesting ways and different formats.
Awesome. Thank you.
Operator next question please.
Thank you. Our next question comes from Dana Telsey with Telsey Advisory group.
Good afternoon, everyone. Congratulations on the terrific results.
As you think about your reach and you've obviously had at Amazon fire TV and Apple watch App, along with the new fish fitness options like the total body strength program. What are you seeing in terms of expanding engagement, who that customer is and the ability to expand the community because it certainly seems like it's it's you're capturing a customer.
We are who's also spending more time in your community and then lastly on the content costs what type of leverage do you see on content costs I'm going forward because it seems like those have come down a little bit is there more opportunity there. Thank you.
Hey, Dana its William I'll take the first part of your question then turn it over to Jill.
On the non cycling content overall engagements as John mentioned in his opening remarks, it's up 30% plus 30% year on year, which we feel great about that is archery, north we know that engagement as a leading indicator for retention and so I forgot who congratulated us on or low churn, but that is without question a function of this mass.
<unk> engagement increase and what's driving that is certainly cycling, but non cycling content is actually the fastest growing.
Growing tight workout types, we have so I mentioned that strength is up three next year on year, we have meditations up 22% year on year. If you look December to December in terms of engagement. So we're investing heavily beyond cycling content.
And we think between that and then opening up these new interfaces. John also mentioned Apple TV Amazon fire TV, that's going to continue to drive this engagement more more and so when we say we're just scratching the surface. Both in terms of content offered in interfaces and experiences we we mean it.
And our real good clarification meditations up 22 X X, yet and I will add that in the next.
A couple of months, where commissioning thoughts on studios, New York, which is going to allow us to proliferate. This content, even more with more strength and more yoga and more boot camp and better cycling and so we are investing in content in a way that we're pretty excited about as Jos pointed out a lot of those costs, the capex and opex have been burden.
And burdening the personnel for over a year and so as those things start to come online I think Joe is going to start to talk about the leverage you're going to say, yes. So im just to address hi, Dana the second part of this question.
I wanted just go into some of the drivers on our subscription contribution margin on what you're pointing out is that if you look across all of our our cost of goods for subscription about half of them our fixed in nature. John just mentioned the peloton Studios, New York and obviously.
Our studio that's going to come online in London and that includes all of our instructors all the people that work inside the studios and production all of those fixed costs.
We'll be leveraged overtime, because we only need those two production facilities.
Over the next several years to continue to grow our member base. So we're going to see a lot of fixed.
A fixed cost leverage for about 50% or so of our cost base today and the other half is really very.
Variable cost that include mostly music streaming costs and merchant fees.
Which we are not baking in at this juncture any improvement in those over time, although I will say in Q2 of this year, we did see some streaming cost efficiencies through a contract contract renegotiation, which we've carried through.
For the balance of the year in our guidance for sub contribution margin.
But and I was the last thing I would say is that I do think what you saw in Q2, we did see a nice jump in our subscription contribution margin at 64.4% you know for the full year fiscal 2020, our expectation around.
Contribution margin is 61.5 to 62.5, we did see a benefit in Q2 as well.
In that we were able to push some of our hiring needs for our new studio in New York into Q3.
So we do expect.
That Q2, a number of 64.4, we won't see that type of jumped in subscription margin, but we still feel very good about our long term target of 70 plus percent overtime.
Thank you well take.
Well take the next question. Please. Thank you. Our next question comes from Eric Sheridan with easier.
Thanks for taking my question, maybe going back to the commentary and the letter, but Germany launch obviously, there's some language differential between Germany versus Okay. This is ready to call out some of the investments that might pressuring margins from watching the markets like Germany until it gets to a break even point or point where the.
The initial incremental investments to just put a baseline of of of sort of physical and digital infrastructure in place to launch the market might act as a headwind to cost and how that might come there to what the launch costs were like in a market like the UK over a year ago. Thanks, so much.
Eric I'll take that it's a way in Lynch will at the two biggest sort of buckets of investment are really around sales and marketing. If you I'm sure you've looked at our operating expenses, we make significant invest investments there and when we launch or market like Germany or the UK, we don't apply the same kind of.
Pack, we look at CAC, but we think about it differently, which is trying to get awareness and build demand for our service in that market and so while in the U.S. switch, we've said repeatedly or U.S. core bike business is profitable we continue to see efficiency and CAC and it's been a big driver of this great business model and allowed us to fund one back.
Segments into these growth planks like geographic expansion like tread, we think about that equation differently in Germany from a sales and marketing standpoint, and still the UK, where we want to build demand we want to get leadership, we were tracking awareness overtime. We will we will look at that fact.
Good question, and we do but we expect to see those efficiencies. The other piece of it is on the content side and again it goes back to kind of leveraging the investments. We've made we've got the two studios John mentioned, the new studio launch in New York.
Within a year, we'll have a Pelletized studios, London, but we're able to broadcast content, our German language and.
Classes are out about London studio and so we're able to provide global content, including U.S. instructors UK instructors and German instructors out a two facilities and so it leverages a lot of that fixed costs over time, and and but sure early on what you're seeing definitely through the PML and income.
Axis and investments in marketing logistics and content.
Okay. Thank you much.
Thank you. Our next question comes from John Blackledge with Cowen.
Great. Thanks.
Margins the current bike and tread have different gross margin profiles, how should we think about.
The gross margin profile for lower price upcoming connected fitness products and second question on engagement.
The rising workout frequency seem to drive lower churn than we were expecting just any further color on engagement by cohort tenure.
For the newer subs engaging at different rates than older cohorts. Thank you.
Great. So I'll take the first question certainly as we introduce new products, we naturally will be faced with a higher cost structure until we can achieve the quantities that allow us to.
To take our cost down that said I think we talked about this a lot before we're very focused on gross margin dollars not margin. So we've talked about it in the past with Viking tread.
You know we care about the dollars that we can use from that connected fitness margin to offset our sales and marketing expenses.
So so that from a unit economic perspective, we're sort of paid back day one.
So yes, as we launch new products over time, we will expect some temporary imbalance.
Where the margin may not be able to cover all of those marketing expenses, but in the long run and as a portfolio of products over time, we do believe we can keep these unit economics intact to be profitable day, one and if you if you look at the outlook.
We've provided in terms of just going back to that that net customer acquisition cost again, which is total sales and marketing spend less gross.
Surgeon dollars are that that figure for Q2 was $4 on based on the midpoint of our guidance range for Q3 in fiscal year 20, a essentially for both periods that at the guidance midpoint. If the dollar so again, we're continuing to smartly re.
Invest our sales and marketing dollars off the back of that connected fitness gross profit margin. So and on your engagement question. We were as Joe noted causally surprise, obviously, our retentions incredibly high but we were even surprised by the improvements.
It is true that it's improved across every cohort. So if you look at retention and engagement.
It's actually steady all those gains you're seeing.
Across our older or older members and then the newest members and in fact, notably what as excited as the newest members as we dial in more content as we're getting better at marketing cross marketing that content in the Onboarding process are working out.
In month one.
And 123456 more than a members, we onboarded three and four years ago and so it's just all goodness across the board and it's really something we look at and focus on.
Thank you.
Next question please.
Thank you. Our next question comes from Edward Yruma with Keybanc capital markets.
Hey, guys. Thanks for taking the questions I guess first I know you had some favorable resolution on litigation against flywheel, just trying to understand broadly the implications of it and maybe how it points. The defensibility of your Tech platform and then secondly, obviously when you change credit I think you're able to really.
We capture wider demographic, how did the demographics and with home trial and are they allowing you to catch.
Even broader group of consumers. Thank you.
Good how are you doing as John.
I will take the flywheel, one there's not a ton we can say because it's still loosely.
In the in the legal world, but.
As you heard or GC talk about this week.
In his quotes were very excited to a registered a massive win in our fight to protect I'll talk a little actual property. This result, reinforces the strength of our patent portfolio I think that kind of speaks for itself and why we're excited about the settlement.
I would personally add there were happy to have it resolved as you can imagine.
But thats all I can say at this time that sorry.
On the on the demographics of our new buyers, we haven't updated that since our last call. So we've got nothing that I just a reminder for everyone.
It's true our trends have been our new members are younger and less affluent.
And certainly to your point financing home trial, but things, we're doing the big more retail stores and more areas Thats, all helping for us to penetrate sandwich again.
Has us excited about the future.
Great. Thanks, so much.
Next question. Thank you. Our next question comes from James Hardiman with Wedbush Securities.
Hey, good afternoon. Thank for for me and so I wanted to circle back to the digital subscription obviously not that much time has passed since since the price was lowered I was hoping you could give us a little bit of color.
Sort of before versus after that that price reduction I guess, a have you seen a an acceleration in new digital subs since it was lowered.
Have you seen turn rates come down as a result of that and and lastly here I mean, obviously, but the gap between the connected fitness subscription in the digital subscription is now wider.
Is there any evidence that there's been some cannibalization there and that some connected fitness subscribers of have seen the lower price and decided to switch.
James I'll take a little bit of this and these guys can jump in thank you for your coverage we watched a nice interview a view on CNBC I think that's a appreciate your interest in our visiting I'll take the last question first which is a avenue as anyone downgraded from a connected fitness subscription do a digital subscription we checked with.
Our member experience team in the last couple of months, we've seen a you can count on one hand, the number of people that we've tracked that have a good have made that trade I was actually surprised by that so no no meaningful.
Headwind on on that front.
One thing with the digital business I have to point out is that with this 30 day free trial.
Everyone, who got on board with the free trial in December.
Didnt have the chance to become a subscriber until after the quarter call closed. So the number that you see is artificial from the quarter close a lot of Oh last week for instance was by far our biggest net sub adds in the digital business the biggest weaken history coming out of the.
Excitement about trial so.
It'll be interesting to see this quarter, how we do but we're we're optimistic again all of the metrics are moving in the right direction. It's early to say the impact on LTV, because that's going to play out in the coming quarters.
As we see what it looks like it's so these people just just became subscribers. So we don't have any data yet on how long they are going to last I apologize.
That's helpful. Thank you.
The only other thing I might just add on that point is just to make sure that the terms of service are one.
Member or for each at digital subscription versus our connected fitness, which is a household membership that can have multiple members using the product. We currently average about two members per connected fitness subs, so for that $39, they're getting a lot of.
Oh you.
All right everybody sounds like we're wrapping up I'll give a quick closing.
I do want to thank the entire pellets on team as I did we believe we've got one of the strongest teams and consumer Tech. We're very proud the culture that we are building and all the people who contributed to these Q2 results. So thank you all your hard work. Thank you for any of the members that are listening. We love you you know that you are true north.
We do everything for you.
I know some of you analysts buyside sell side are also public on bike at I'm talking to you.
Mike owners are tread owners and digital he you as well I guess all of you are excited so thank you for your business as members.
Thank you for being a part of our community and I also want to thank all of you investors that are on the call who believe in us.
We will continue to work hard and your honor I think we will continue to put points on the board like we did in Q2 and I'm confident we will not disappoint you.
Anyway have a great rest your week, thanks, everybody for dialing it.
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation you may now disconnect.
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