Along with slight revenue growth and a greatly reduced net loss, troubled connected fitness company Peloton (NASDAQ: PTON) managed to produce positive free cash flow in the fourth quarter of fiscal 2024. Free cash flow came in at $26 million, a $100 million swing from the prior-year period.
While having a balance sheet that's no longer bleeding cash is inarguably a good thing, free cash flow is a metric that often comes with some dirty secrets.
Picking apart free cash flow
Free cash flow , cash generated from operations minus any capital expenditures , can be a useful metric. However, it's important to remember that it's often not a great measure of profitability. Free cash flow can be volatile, impacted by the timing of payments both in and out. Other items can provide a short-term benefit that can't go on forever, and a heavy use of stock-based compensation muddles the numbers.
As I write this, Peloton hasn't yet filed its quarterly 10-Q, and the only cash flow statement it provided in its letter to shareholders was for the full fiscal year. Peloton reported a free-cash-flow loss of about $86 million in fiscal 2024, but that represented a massive improvement over the $470 million loss in fiscal 2023.
Cost-cutting drove some of this improvement. Peloton has completed multiple rounds of layoffs as part of its turnaround effort, and operating expenses have dropped considerably as a result. Peloton is spending less on just about everything, with a significant drop in sales and marketing costs.
Another big chunk, though, was driven by the company's efforts to reduce inventories. Peloton was stuck with too many pricey exercise bikes and other products as booming pandemic-era demand gave way to tumbling sales. The company has been bringing inventory levels down, which has the effect of converting inventory into cash. This provided a $163 million benefit to free cash flow in fiscal 2024.
This benefit can't go on indefinitely. Eventually, the company will reach healthy inventory levels relative to demand, at which point this significant free-cash-flow tailwind will disappear.
A rising share count
The biggest item of them all on the cash flow statement is stock-based compensation. Peloton recorded $312 million in stock-based compensation charges in fiscal 2024, all of which were backed out of the free-cash-flow calculation.
On the one hand, stock-based comp isn't a cash expense, but on the other hand, it certainly is a real expense. This is a big reason Peloton's free cash flow is a poor proxy for true profitability.
Peloton's heavy use of stock-based compensation does have a cost for shareholders. The company's outstanding share count has been on the rise, diluting existing shareholders in the process. Over the course of fiscal 2024, Peloton's outstanding share count jumped by about 5%.
That may not seem like all that much, but it adds up over time. If Peloton's share count rises by 5% annually through dilution, a 1% stake in the company today will only be a 0.6% stake after 10 years.
Plenty left to prove
Peloton's balance sheet is no longer under nearly as much pressure as it has been over the past few years. That's a good thing, but the company's fourth-quarter report isn't really a sign that the turnaround is working. The company is still losing money on a generally accepted accounting principles (GAAP) basis, equipment sales are expected to decline this year, and the subscriber base is melting away.
If there's an attractive turnaround story here, I'm struggling to find it.
Timothy Green has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Peloton Interactive. The Motley Fool has a disclosure policy .
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