SEC Filing | Peloton Interactive, Inc.

View:

pton-20191231

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


☒			QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2019


☐			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 001-39058

Peloton Interactive, Inc.

(Exact name of registrant as specified in its charter)

Delaware

47-3533761

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

125 West 25th Street, 11th Floor

10001

New York, New York

(Zip Code)

(Address of principal executive offices)

(866) 679-9129

(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
Class A common stock, $0.000025 par value per share	PTON	The 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, as amended (Exchange Act) 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. Yes ☒ 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 and post such files). Yes ☒ 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.


Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☒	Smaller reporting company	☐
		Emerging growth company	☒

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 Act). Yes ☐ No ☒

As of January 31, 2020, the number of shares of the registrant's Class A common stock outstanding was 43,848,484 and the number of shares of the registrant's Class B common stock outstanding was 236,819,934.

TABLE OF CONTENTS

Page

Special Note Regarding Forward Looking Statements

Part I. Financial Information

Item 1

Financial Statements

Condensed Consolidated Balance Sheet s as of December 31, 2019 and June 30, 2019 (unau dited)

Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three and Six Months Ended December 31, 2019 and 2018 (unaudited)

Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 31, 2019 and 2018 (unaudited)

Condensed Consolidated Statements of Changes in Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit) for the Three and Six Months Ended December 31, 2019 and 2018 (unaudited)

Notes to Condensed Consolidated Financial Statements (unaudited)

Item 2

Management's Discussion and Analysis of Financial Condition and Results of Operations

Item 3

Quantitative and Qualitative Disclosures About Market Risk

Item 4

Controls and Procedures

Part II. Other Information

Unregistered Sales of Equity Securities and Use of Proceeds

Item 6

Exhibits

SIGNATURES

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements. All statements contained in this Quarterly Report on Form 10-Q other than statements of historical fact, including statements regarding 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.

Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:

• our future financial performance, including our expectations regarding our revenue, cost of revenue, gross profit, Adjusted EBITDA, operating expenses including changes in sales and marketing, general and administrative expenses (including any components of the foregoing), and research and development, and our ability to achieve and maintain future profitability;

• our business plan and our ability to effectively manage our growth;

• anticipated trends, growth rates, and challenges in our business and in the markets in which we operate;

• our international expansion plans and ability to continue to expand internationally;

• market acceptance of our Connected Fitness Products and services;

• beliefs and objectives for future operations;

• our ability to increase sales of our Connected Fitness Products and services;

• our ability to further penetrate our existing Subscriber base and maintain and expand our Subscriber base;

• the effects of seasonal trends on our results of operations;

• our expectations regarding content costs for past use;

• our ability to maintain, protect, and enhance our intellectual property;

• the effects of increased competition in our markets and our ability to compete effectively;

• 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

• economic and industry trends, projected growth, or trend analysis.

We caution you that the foregoing list may not contain all of the forward-looking statements made in this Quarterly Report on Form 10-Q.

We have based these forward-looking statements largely 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, including those described in the section titled “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q. 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. 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.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

PELOTON INTERACTIVE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in millions, except share and per share amounts)


	December 31,			June 30,
			2019			2019
	(unaudited)
ASSETS
Current assets:
Cash and cash equivalents	$	532.8		$	162.1
Marketable securities	954.3			216.0
Accounts receivable, net of allowances	22.0			18.5
Inventories, net	243.6			136.6
Prepaid expenses and other current assets	104.3			48.4
Total current assets	1,857.1			581.7
Property and equipment, net	159.1			249.7
Intangible assets, net	17.0			19.5
Goodwill	38.8			4.3
Restricted cash	1.6			0.8
Right-of-use asset	492.1			—
Other assets	18.5			8.5
Total assets	$	2,584.2		$	864.5
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK, AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Accounts payable	182.5			92.2
Accrued expenses	165.3			104.5
Customer deposits and deferred revenue	159.6			90.8
Other current liabilities	28.4			3.3
Total current liabilities	535.8			290.8
Deferred rent	—			23.7
Build-to-suit liability	—			147.1
Long term lease liability	496.1			—
Other non-current liabilities	7.1			0.4
Total liabilities	1,039.0			462.0
Commitments and contingencies (Note 10)
Redeemable convertible preferred stock, $0.000025 par value, zero and 215,443,468 shares authorized; zero and 210,640,629 shares issued and outstanding as of December 31, 2019 and June 30, 2019, respectively.	—			941.1
Stockholders’ equity (deficit)
Common stock, $0.000025 par value; 2,500,000,000 and zero Class A shares authorized, 43,794,644 and zero shares issued and outstanding as of December 31, 2019 and June 30, 2019, respectively; 2,500,000,000 and 400,000,000 Class B shares authorized, 236,819,934 and 25,301,604 shares issued and outstanding as of December 31, 2019 and June 30, 2019, respectively.	—			—
Additional paid-in capital	2,269.3			90.7
Accumulated other comprehensive income	3.3			0.2
Accumulated deficit	(727.4)			(629.5)
Total stockholders’ equity (deficit)	1,545.2			(538.6)
Total liabilities, redeemable convertible preferred stock, and stockholders’ equity (deficit)	$	2,584.2		$	864.5

See accompanying notes to these unaudited condensed consolidated financial statements.

PELOTON INTERACTIVE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(unaudited)

(in millions, except share and per share amounts)


	Three Months Ended December 31,						Six Months Ended December 31,
	2019		2018		2019		2018
Revenue:
Connected Fitness Products	$	381.1	$	221.3	$	538.7	$	299.2
Subscription	77.1		37.3		144.3		69.1
Other	8.0		4.2		11.3		6.7
Total revenue	466.3		262.9		694.3		375.0
Cost of revenue:
Connected Fitness Products	226.7		126.5		316.5		168.8
Subscription	32.4		20.3		61.9		36.6
Other	10.0		4.6		13.6		6.7
Total cost of revenue	269.1		151.5		392.1		212.1
Gross profit	197.1		111.3		302.2		162.9
Operating expenses:
Sales and marketing	160.5		99.5		238.1		145.0
General and administrative	77.5		55.4		138.5		105.4
Research and development	20.7		12.4		38.1		24.0
Total operating expenses	258.7		167.3		414.6		274.4
Loss from operations	(61.5)		(56.0)		(112.4)		(111.5)
Other income, net:
Interest income, net	5.9		1.2		7.1		2.2
Other expense, net	(0.1)		(0.3)		(0.2)		(0.3)
Total other income, net	5.7		0.9		6.9		1.9
Loss before provision for income taxes	(55.8)		(55.1)		(105.5)		(109.6)
Income tax benefit	(0.4)		—		(0.4)		—
Net loss	$	(55.4)	$	(55.1)	$	(105.2)	$	(109.6)
Net loss attributable to Class A and Class B common stockholders	$	(55.4)	$	(105.2)	$	(105.2)	$	(159.7)
Net loss per share attributable to Class A and Class B common stockholders, basic and diluted	$	(0.20)	$	(4.83)	$	(0.66)	$	(6.83)
Weighted-average Class A and Class B common shares outstanding, basic and diluted	279,974,823		21,780,927		159,214,343		23,390,001
Other comprehensive income:
Change in unrealized gain (loss) on marketable securities	$	(0.2)	$	—	$	(0.2)	$	—
Change in foreign currency translation adjustment	4.7		0.7		3.4		0.6
Total other comprehensive income	4.5		0.7		3.1		0.6
Comprehensive loss	$	(50.9)	$	(54.4)	$	(102.0)	$	(109.0)

See accompanying notes to these unaudited condensed consolidated financial statements.

PELOTON INTERACTIVE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in millions)


	Six Months Ended December 31,
	2019		2018
Cash Flows from Operating Activities:
Net loss	$	(105.2)	$	(109.6)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization expense	17.2		9.2
Stock-based compensation expense	35.8		68.5
Impairment of long-lived assets	(0.2)		—
Amortization of debt issuance costs	0.2		0.2
Amortization of premium from marketable securities	(0.5)		—
Non-cash operating lease expense	21.4		—
Changes in operating assets and liabilities:
Accounts receivable	23.8		(17.4)
Inventories	(94.2)		(82.1)
Prepaid expenses and other current assets	(12.5)		(21.1)
Other assets	(8.1)		(5.5)
Accounts payable and accrued expenses	98.0		122.1
Customer deposits and deferred revenue	68.3		50.0
Operating lease liabilities, net	(17.5)		—
Other liabilities	6.7		6.4
Net cash provided by operating activities	33.2		20.7
Cash Flows from Investing Activities:
Purchases of marketable securities	(973.1)		—
Maturities of marketable securities	141.5		—
Sales of marketable securities	55.4		—
Acquisition of business, net of cash acquired	(45.9)		(0.1)
Purchases of property and equipment	(48.8)		(25.9)
Net cash used in investing activities	(870.8)		(25.9)
Cash Flows from Financing Activities:
Proceeds from issuance of common stock upon initial public offering, net of offering costs	1,195.7		—
Repurchase of common and convertible preferred stock, including issuance costs	—		(130.3)
Proceeds from issuance of redeemable convertible preferred stock, net of issuance costs	—		539.1
Proceeds from employee stock purchase plan withholdings	2.0		—
Proceeds from exercise of stock options	4.2		1.6
Net cash provided by financing activities	1,201.9		410.5
Effect of exchange rate changes	7.1		0.6
Net change in cash	371.4		405.8
Cash, cash equivalents and restricted cash — Beginning of period	163.0		151.6
Cash, cash equivalents and restricted cash — End of period	$	534.4	$	557.5
Supplemental Disclosures of Cash Flow Information:
Cash paid for interest	$	—	$	0.4
Supplemental Disclosures of Non-Cash Investing and Financing Information:
Conversion of convertible preferred stock to common stock	$	941.1	$	—
Property and equipment accrued but unpaid	$	7.7	$	1.6
Building - build-to-suit asset	$	—	$	112.9
Stock-based compensation capitalized for software development costs	$	0.9	$	0.2

See accompanying notes to these unaudited condensed consolidated financial statements.

PELOTON INTERACTIVE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT)

(unaudited)

(in millions)


	Redeemable Convertible Preferred Stock				Class A and Class B Common Stock						Additional Paid-In Capital		Other Comprehensive Income		Accumulated Deficit	Total Stockholders’ Equity (Deficit)
	Shares	Amount		Shares	Amount
Balance – September 30, 2018	214.4	$	945.4	26.1	$	—	$	22.0	$	(0.1)	$	(390.6)	$	(368.7)
Repurchase of common and redeemable preferred stock	(3.8)	(4.3)		(4.8)	—		—		—		(97.8)		(97.8)
Exercise of stock options	—	—		0.8	—		1.6		—		—		1.6
Stock-based compensation expense	—	—		—	—		39.7		—		—		39.7
Other comprehensive income	—	—		—	—		—		0.7		—		0.7
Net loss	—	—		—	—		—		—		(55.1)		(55.1)
Balance – December 31, 2018	210.6	$	941.1	22.1	$	—	$	63.3	$	0.6	$	(543.5)	$	(479.5)

Balance – September 30, 2019	—	$	—	280.3	$	—	$	2,249.1	$	(1.1)	$	(672.0)	$	1,576.0
Exercise of stock options	—	—		0.3	—		2.6		—		—		2.6
Stock-based compensation expense	—	—		—	—		17.6		—		—		17.6
Other comprehensive income	—	—		—	—		—		4.5		—		4.5
Net loss	—	—		—	—		—		—		(55.4)		(55.4)
Balance – December 31, 2019	—	$	—	280.6	$	—	$	2,269.3	$	3.3	$	(727.4)	$	1,545.2

See accompanying notes to these unaudited condensed consolidated financial statements.

PELOTON INTERACTIVE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY (DEFICIT)

(unaudited)

(in millions)


	Redeemable Convertible Preferred Stock				Class A and Class B Common Stock						Additional Paid-In Capital		Other Comprehensive Income		Accumulated Deficit	Total Stockholders’ Equity (Deficit)
	Shares	Amount		Shares	Amount
Balance – June 30, 2018	176.3	$	406.3	25.9	$	—	$	20.5	$	—	$	(336.1)	$	(315.6)
Issuance of Series F redeemable convertible preferred stock, net	38.1	539.1		—	—		—		—		—		—
Repurchase of common and preferred stock	(3.8)	(4.3)		(4.8)	—		—		—		(97.8)		(97.8)
Exercise of stock options	—	—		1.0	—		2.4		—		—		2.4
Stock-based compensation expense	—	—		—	—		40.5		—		—		40.5
Other comprehensive income	—	—		—	—		—		0.6		—		0.6
Net loss	—	—		—	—		—		—		(109.6)		(109.6)
Balance – December 31, 2018	210.6	$	941.1	22.1	$	—	$	63.3	$	0.6	$	(543.5)	$	(479.5)

Balance – June 30, 2019	210.6	$	941.1	25.3	$	—	$	90.7	$	0.2	$	(629.5)	$	(538.6)
Initial public offering, net of issuance costs of $6.3 million	—	—		43.4	—		1,195.7		—		—		1,195.7
Conversion of redeemable convertible preferred stock to common stock	(210.6)	(941.1)		210.6	—		941.1		—		—		941.1
Exercise of stock options	—	—		1.0	—		5.1		—		—		5.1
Exercise of stock warrants	—	—		0.2	—		—		—		—		—
Stock-based compensation expense	—	—		—	—		36.7		—		—		36.7
Other comprehensive income	—	—		—	—		—		3.1		—		3.1
Net loss	—	—		—	—		—		—		(105.2)		(105.2)
Cumulative effect adjustment in connection with adoption of ASU 2016-02	—	—		—	—		—		—		7.2		7.2
Balance – December 31, 2019	—	$	—	280.6	$	—	$	2,269.3	$	3.3	$	(727.4)	$	1,545.2

PELOTON INTERACTIVE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(in millions)

1. Description 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. 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 its Members to be the best versions of themselves.

The Company organizes its business into the following three reportable segments: Connected Fitness Products, Subscription and Other. See Note 15 of the notes to the condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for further discussion of the Company's segment reporting structure.

Initial Public Offering and Concurrent Private Placement

In September 2019, the Company closed its initial public offering ("IPO") and a concurrent private placement, in which it issued and sold 43,448,275 shares of its Class A common stock. The price per share to the public in the IPO and in the concurrent private placement was $29.00 per share. The Company received aggregate proceeds of $1.2 billion from the IPO and the concurrent private placement, net of the underwriting discount and before deducting offering costs of approximately $6.3 million. Prior to the closing of the IPO, all shares of the Company's common stock then outstanding were reclassified into 25,301,604 shares of Class B common stock, and upon the closing of the IPO, all shares of the Company's then outstanding preferred stock automatically converted into 210,640,629 shares of Class B common stock on a one-to-one basis.

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. 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. Therefore, these interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the final prospectus dated September 25, 2019 and filed with the SEC pursuant to Rule 424(b) under the Securities Act of 1933, as amended, (the "Securities Act"), on September 26, 2019 (the "Prospectus"). 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.

The condensed consolidated balance sheet as of June 30, 2019, 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.

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 and six months ended December 31, 2019 are not necessarily indicative of the results to be expected for any subsequent quarter, the fiscal year ending June 30, 2020, 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.

Except as described elsewhere in Note 2 of the notes to the condensed consolidated financial statements in the section titled "—Recently Issued Accounting Pronouncements" in Part I, Item 1 of this Quarterly Report on Form 10-Q, there have been no material changes to the Company's significant accounting policies as described elsewhere in the Prospectus.

2. Summary of Significant Accounting Policies

Use of Estimates

The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, and expenses and related disclosures. On an ongoing basis, the Company evaluates its estimates, including, among others, those related to income taxes, the realizability of inventory, stock-based compensation, contingencies, revenue related reserves, content costs for past use reserve, fair value measurements, the fair values of assets acquired and liabilities assumed in business combinations, the incremental borrowing rate associated with lease liabilities, useful lives of property and equipment as well as intangible assets, and impairment of goodwill, intangible and long-lived assets. The Company bases its estimates on historical experience, market conditions, and on various other assumptions that are believed to be reasonable. Actual results may differ from these estimates.

Stock-Based Compensation

In August 2019, the Board of Directors adopted the 2019 Employee Stock Purchase Plan ("ESPP"), which was subsequently approved by the Company’s stockholders in September 2019. The Company recognizes stock-based compensation expenses related to shares issued pursuant to its ESPP on a straight-line basis over the offering period, which is twenty-four months. The ESPP allows employees to purchase shares of the Company's Class A common stock at a 15 percent discount. The ESPP also includes a look-back provision for the purchase price if the stock price on the purchase date is less than the stock price on the offering date.

Recently Issued Accounting Pronouncements

Accounting Pronouncements Recently Adopted

ASU 2016-02

In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-02, Leases, which introduced and codified new lease accounting guidance under ASC 842. ASU 2016-02 requires a lessee to separate the lease components from the non-lease components in a contract and recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. The Company adopted this ASU and related amendments as of July 1, 2019 under the modified retrospective approach, whereby all prior periods continue to be reported under previous lease accounting guidance. The Company elected the package of practical expedients and, as permitted, the Company did not assess whether existing contracts are or contain leases, the lease classification for any existing leases, and identification of initial direct costs for any existing leases. Adoption of the new standard resulted in the recognition of right-of-use assets and operating lease liabilities on the Company's condensed consolidated balance sheet. In addition, the Company de-recognized a build-to-suit arrangement in accordance with the transition requirements, which resulted in an adjustment to retained earnings. The standard did not materially impact the Company's condensed consolidated statements of operations. See Note 8 for further discussion of the Company's accounting for leases under ASC 842.

ASU 2018-07

In June 2018, the FASB issued ASU 2018-07 to expand the scope of ASC Topic 718, Compensation - Stock Compensation, to include share-based payment transactions for acquiring goods and services from nonemployees. The pronouncement is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted. The Company adopted this ASU on July 1, 2019. The standard did not materially impact the Company's condensed consolidated statements of operations.

Accounting Pronouncements Not Yet Adopted

ASU 2016-13

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments." This standard changes the impairment model for most financial assets. The new model uses a forward-looking expected loss method, which may result in earlier recognition of allowances for losses, and require expected credit losses to be reflected as allowances rather than reductions in the amortized cost of available-for-sale debt securities. The Company expects to adopt this standard on July 1, 2020. The Company is currently evaluating the potential impact of adopting this new accounting guidance on its condensed consolidated financial statements.

3. Revenue

The Company’s primary source of revenue is from sales of its Connected Fitness Products and associated recurring subscription revenue.

The Company determines revenue recognition through the following steps:

•Identification of the contract, or contracts, with a customer;

•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 and discounts. The Company estimates its liability for product returns based on historical return 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.

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 standalone selling price based on prices charged to customers.

Connected Fitness Products

Connected Fitness Products include the Company’s Bike and Tread, related accessories, associated fees for delivery and installation, and extended warranty agreements. The Company recognizes Connected Fitness Product revenue net of sales returns and discounts when the product has been delivered to the customer. The Company generally allows customers to return products within thirty 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 selling and marketing expenses.

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.

Historically, the Company offered a prepaid subscription option where Subscribers earned one free month or three free months of subscription with the purchase of a 12-month subscription or 24-month subscription, respectively. The Company also offered Subscribers the ability to finance the prepaid subscription with the purchase of a Connected Fitness Product as part of its financing program. The associated financing fees were paid to the Company’s third-party partner at the outset of the arrangement and are recorded as a reduction to subscription revenue. The Company terminated both programs in July 2018.

Amounts paid for subscription fees are included within customer deposits and deferred revenue and recognized ratably on a month-to-month basis. The Company records payment processing fees for its monthly subscription charges within cost of revenue.

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 one year 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 is 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. 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.

The Company also offers the option for customers in some markets to purchase a third-party 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 Product for an additional period of 12 to 27 months.

Revenue and related fees paid to the third-party provider are 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 consolidated statement of operations.

Disaggregation of Revenue

The Company's revenue from contracts with customers disaggregated by major product lines, excluding sales-based taxes, are included in Note 15 under the heading "Segment Information".

The Company's revenue disaggregated by geographic region, based on ship-to address, were as follows:

Three Months Ended December 31,

Six Months Ended December 31,

2019