Chegg, Inc. (CHGG) Earnings Call Transcript & Summary

Great. Let's make a start. My name is Katherine Tait. I am an analyst at Goldman Sachs and leading work through Future of Learning work that we've done within global investment research. And it is an absolute delight to welcome Dan Rosensweig, CEO and Chairman of -- President of Chegg...

I've got all the titles.

All the titles, yes, I mean, I can keep reading off, but I'm pretty sure people would actually want to hear from you today. So I will leave it at that. Dan you've been at Chegg now for a decade. You've led a massive transition within the company from being, sort of, primarily tech rental service to the, sort of, the online platform it is today. Maybe you can just start by talking you through some of that history and where you're looking to go next?

Sure. So I don't know how many of you are familiar with Chegg or the -- sort of the arc that we've been on. But interestingly enough, just the timing-wise, I think last week was Heather and mine actual 10-year anniversary at the company. When we joined the company, it was about $5 million in revenue, 50 employees and did 1 thing and didn't do it well, which was textbook rental. We were inventing a service that had not been invented yet, which, not with the expectation to, but ultimately, the realization is, we did really hurt the major publishing companies. So if any of you have been following them. You've seen what's happened in, sort of, the disruption of their business. Pearson said they use to sell 21 million print textbooks a year in the United States, now they do 4 million. And that's all a result of Chegg having created a textbook rental business and changing the economic model. It's now down to Chegg and Amazon are really the only 2 players in the textbook distribution business. If you continue to watch the public reporting of Barnes & Noble College, you put themselves up for sale. You'll see students just don't go there for those things anymore because they can't meet our prices or our service. But that's not the company, that's how the company started 10 years ago. So we went public 6 years ago, we were -- 80% of our revenue was textbooks, 20% was this nascent digital business. We were a minus 18% in EBITDA, and we were using $120 million in cash that we actually didn't have. Amazon entered the market and our world changed, and it was unpleasant. And our stock priced to $12.50, first traded at $11.25, first day closed at $9.68. The worst 25th anniversary of anybody's life, which was my anniversary. My wife actually asked me on the flight back, whether or not she needed to return the necklace I had bought her. It was that bad of a day. And then, as if it could only get worse, which it did, Amazon entered the textbook rental business. And they lowered the prices. So -- but we always had a vision to recognizing that print textbooks were going to go away. It was not going to be our business, but we wanted to build on a large brand, name recognition, overwhelming value for the students and be the first education company to go exclusively and uniquely, directly to the student, not through the institution, not through the parent, directly to the student. And so that's where the journey started. Fast forward 6 years later, textbooks are about 20% of our revenue. We no longer have to own them. We don't have our warehouses, but we've become the largest direct-to-student homework help support service companies. So we offer homework help, we offer tutoring, we offer getting you a job, getting you an internship. We continue to expand and solve the biggest problems for today's students domestically, and it turns out they're the same problems globally. And so where we are today is, we're 100% digital, which we weren't. Instead of using $120 million in cash, 50% of all of our EBITDA becomes free cash flow now. This has happened just in the last 4 years, that I think we closed the year instead of minus $18 million in EBITDA, 6 years ago, we were plus $125 million this year. I think the latest analyst expectations for '20 have us going up to $164 million something like that. And so we have one of the fastest growing. We grew our subscription service, which is primarily what we are over 32% in the fourth quarter. And we're already in excess of 30% EBITDA margins, 50% of the EBITDA goes to free cash flow. We continue to improve our EBITDA margins every year, while investing in the future. Because we have a unique business that others don't have. So when you think about the subscription business, that we all use, and we all know, and we all love. Think about Netflix, you think about Spotify, you think about Apple Music, think about those things. The difference is, they have to either pay licenses for content or they have to own that content. Chegg owns 100% of our content. Two, they need to localize that content for every country because not only just U.S. stuff travel, but it's not uniquely, it's not what's going to get somebody in Sweden to watch Netflix, they have to do local language things. They spend billions of dollars a year. It turns out for good fortune for Chegg and as for our shareholders, is the same major publishers in the United States are the same ones for Africa, South America, the Rest of The World, Asia. It's the same content for STEM and for business. So the content that we've spent all the money developing actually travels around the world, which is why we're seeing international growth now, where it was not one of our vectors before. So the difference is essentially what we currently do, is we solve the biggest problems that students have. And I just want to take time to help you understand what the actual student in the United States is because it's almost none of you, and it certainly isn't my children, which is the average age of the student in the United States, 25, not 18 to 22. 70% of them go to state schools. In the state of California alone, where you are now, 2.5 million students go to community colleges. There's 115 community colleges in this state alone. California, Texas, Illinois and New York are the biggest for community colleges. 85% of them never get a degree. 43% of college students do not graduate. If you do graduate, the average time it takes you to graduate is 6 years. What Chegg does is, we supply all the academic support to make sure that you can master the subject, learn your subject, do better on your grades and graduate. The second leg of Chegg is now Thinkful, which is beginning to be skills. So we are not building a company to reskill people who are 50 years old and put out of work in the Midwest. There are other companies to do that. And honestly, it's a government scam, which is they take government money, they fund it through the state, they put it into community colleges, and it hasn't helped. Chegg is going to go -- continue to go direct to the student, people who want to invest in themselves. So these -- what we're doing is people who recognize their college degree may not be enough, or that they've graduated, and they need to learn skills to become a data scientist or digital marketer. It's not to become a coder. That isn't what we're entering. We're entering the phase where we're recognizing that technology is changing what you need to know and the speed in which you need to know it through the majority of your career. Most of the companies in this space are all good, are doing it through corporations. So LinkedIn or Lynda, they do it through a corporation. Pluralsight is a public company, they do it through corporations. We continue to go direct. That means we can lower the prices, the student can pick the content they want. So we own the customer, we own the data, we own our content, we own the distribution channel. So we have the ability to personalize it and improve it to the way the actual user wants it that no one else does. That was the benefit of having chosen gone direct. If you could own your customer, the credit card, the data, the channel and your content, the only thing that prevents you from being successful is execution. And we work very hard on that. And you've seen our numbers reflect that we have become a pretty good executor in the business model. So that's the current Chegg today. And there are growth vectors in the United States, there are now growth vectors outside the United States, there's growth in academic support, there's growth in professional support for skills and then there's a whole another leg that will come several years down the road. We actually just don't see an end when you recognize that over 50% of the world's population is below the age of 19, and all of them are learning through technology. So that -- what I always say to people is, if you believe that more people need to learn more things over the course of their life and career in order to succeed, if you believe that's more likely to have to get cheaper, if you believe it's more likely to have to become more relevant, if you believe it's more likely to be online, then Chegg is the company that you should be thinking about. Because we're the only ones that do that. That focus exclusively on the student, and that's the premise that we're building the company on. And even though it's been 10 years. It honestly feels like we finally built a larger enough platform, where the things that need to be done, can be done through Chegg at high margins. So I'm super excited. Sorry, if that was too long of an introduction.

No. All good stuff. Let's talk about your most popular product, Chegg Study. Is there still penetration growth for that product here in the U.S. Have you kept pricing at the sort of same level since inception? How should we think about the different growth levers there?

So what you're referring to is a product that we have called Chegg Study. And as an investor and as a CEO, you always want to be able to raise your ARPU and raise your yield, as you continue to grow your subscribers. We have been able to do so, even though we've never raised the prices in 10 years. And the way we've been able to do that is because we are expanding the length of time in which those students start with us earlier, stay with us longer. Also, the growth vectors in North America continue to expand, not decline, which is actually a surprise to us. So let me give you some examples. Chegg, we grew in the fourth quarter, I think, our subscriber numbers were something like 32%, which is a pretty good number for a company that's 10 years old. And that's actually higher than we did, I think, almost all year. And the reason is because international is beginning to take off. But also in North America, a couple of things are happening. One, we have 87% brand awareness. And so more and more students are using us. But there's 2 categories where we're significantly under-penetrated that are both growth categories that we're starting to penetrate. The first is the not-for-profit online universities. So we all think of online universities as being the for-profit universities, Phoenix as the -- one that everybody knows But when you look at schools like Western Governors, if you look at school like Arizona State University, or you look at schools like Southern New Hampshire University, if you've seen their commercials. How many of you seen the Southern -- you all watch CNBC, so you've seen them. I saw the commercial, cried, called up their President, and he's now on our Board. Because he sees the world like we do, which is people are getting older, they are overwhelmingly women, they are women that have jobs and have children and cannot leave either their home or their workforce to go get a degree. And so they're building it for veterans and for women and for older people, who never had a chance to get a degree at an affordable price. And they're recognizing that they can bring education to you, instead of you having to go to education. We don't go to the movies anymore. It comes to us. We don't go find the cab, the cab comes to us. Everything in our life is now being brought to us, except traditional education. So logic, even our health care, we're wearing watches and fitbits and medical information is being transmitted to people. Education is the one that has taken the longest to serve people the way they want to be or need to be served. So by putting Paul on the Board, we've become really much more cognizant of the growth of online not-for-profit universities. And how to build a relationship with those students. So that's a North America growth vector. On top of the fact that we're still underpenetrated in all the schools that we're in. The highest penetration we have at any school, which is the second largest school in the country. So it's huge, is 36%. So we still have room to grow there, but the other schools were in the 20s and 15s and 25s, but we just keep growing. The second one is community colleges, which is -- these are people not going for degrees. They're going to learn specific things. The disadvantage that Chegg has had by going direct in the 2 categories of online university and community colleges is word of mouth. When you're in a dorm, when you're in a class, everybody knows, right? You see the Chegg box arrived, if it's textbooks or you're studying with people and you're like, oh, can I help, can I -- you got Chegg Study. I mean, we are pervasive everywhere. But with online schools, we are not sitting next to somebody, you don't have a study group, you don't necessarily know about Chegg or even that there's online homework help, same with community colleges. So we are doing many things starting this year to start penetrating those markets, and we're beginning to see it. So we have the international growth, we have the regular growth, and we have those 2 vectors in the United States. So we sort of feel like we have lots of viable, significant, highly profitable growth ahead.

And then moving to one of the other legs of the business, and your acquisition of Thinkful last year. Opened you up to the sort of, broader skills and segment and an increasing demand from individuals to upskill and reskill throughout their careers. Can you talk a bit about why you wanted to take Chegg into that market? How you see that overall product and market segment evolving over the next 5 years?

Yes. So we spent a lot of time looking at that space. Before we buy anything, we actually spend years. We're very fortunate. This was not 4 years ago. But in the last 4 years, we've been fortunate that we haven't had to do something to make a number, right? Or survive. The core business is executing extraordinarily well. And so we can take our time and really do the research about what we want to be in, and which companies we want to buy, if we want to buy a company, get the price we want. We haven't overpaid for any company, paid $80 million for it, as an example, where it's next nearest competitor went for $750 million. So you see, we -- and in a perfect world, we wish we didn't have to do it. But we don't live in a perfect world, which is we ask students, what are the top things they would like us to do that we don't currently do for them? One surprised me, 1 didn't surprise me. One, they are beginning to recognize, not only those that are currently in school, but those that have recently graduated, because remember, we've probably served over 50 million people over the course of time. So the ability to constantly research them is they are scared that what they've learned is in an unemployable skill. And if you're a parent, you're worrying about that with your own kid, when they say they want to take literature. But it's a very real scenario for the majority of people who don't have 2 parents, they don't have support in home, or doing something on their own or who are immigrants. And that's who Chegg really serves, which is the overwhelming majority. We have 14% penetration at Dartmouth, while we have 36% of penetration in Arizona State University. I'd rather have 36% of the school with 72,000 people. So it -- a curriculum, when the curriculum is about getting a job, Chegg becomes much more important. So the 2 things that we ask for is, how do we get them really employable skills at a very low price. And two, personal finance. Because most of you grew up with a checkbook and things like that. They -- everything is on their phone. They don't even know, what they're buying, right? So we actually did a reality TV show, Ashton Kutcher was the Executive Producer. And I did it as the CEO in the show. And crazy enough we've seen almost 15 million streams and over 5 million people watch it. And it's on the Crackle network, which none of you have ever heard about. That's how important kids in today's world. And that's the primary reason they support Bernie Sanders is because of free college because it is devastating them. So those 2 things. So Thinkful was an answer to people who are becoming juniors or seniors, or an alternative to go into a community college or support of a community college to get absolutely employable skills, digital marketing, data science, analytics. It's not coding. Right? Not everybody wants to be a coder, or can be a coder, or should be a coder. It's about the employable skills. So most of you are geniuses in the financial world, and I always ask our investors, what's the #1 skill of somebody knew you're going hire a junior into your team. And they say, we want him to be a critical thinker. I was like, so if they're a brilliant critical thinker, but they can't use Excel, you'll hire them, they're like, no. So the things that Chegg are going to work on are preskilling, which we don't have, which is how to use Adobe, how to use Excel, how do you use Anaplan, how do you use Office, right? Those are things that we can build into a subscription service at a really low price, where the software, they'll give it to us. I'm on the Board of Adobe, I know this for sure. My friends run Cisco and ServiceNow. And they all are dying to educate college students on how to use their stuff. Why? Because they want to sell on the corporation and say the next-generation of college kids know how to use us. So we're already working with Amazon and Salesforce and people like that. So that's another big leg that we plan to offer down the road. We do not offer it today, don't look for it today, we do not have it today. So it's preskilling and actual employable skills, and then the third category of skills that we're interested in, are ones that are like on Udemy, which is, that has to be the price of an audio book, which is individuals paying for themselves, they're willing to pay $20 or $40 to get better at their job when the corporation won't pay for it. Then there's advanced skilling and reskilling. And those are categories Chegg's not likely to get into because they involve a lot more work and they involve generally going through corporations. They're going through the government, and that's not our business. But Thinkful is the beginning of that journey for us.

And taking a bit of a step back. I mean, why do you think education has been quite slow to adopt and be disrupted by technology compared to other industries. And how do you see that shifting over time? Do you think that will accelerate? Or do you think it's not going to be a slow burn?

Well, everybody you cover is going out of business, right? So it's happening. I'm not making that up, am I? There are 105 companies that have called us in the last 4 months to sell themselves in the education space. We, 6 years ago, may not have survived. That's how quickly it's changed. It's taken this long because of a lot of things. One, there's the perception that the ticket to the middle class used to be owning a home, driving a car, getting an education. You saw what happened in the housing industry, saw what happened in the auto industry. Now you're seeing it with college loans, what's happening in the education industry. It has been propped up. So if you're at school, how can you raise the price when no one has any money. It's because 90% of the loans are coming from the government. The government is giving you a loan, would any -- should anybody be giving a young person an $80,000 loan at 18. Your assumption is, that individual is going to be able to pay back because the education they're getting is going to make them employable, and at a high price. The average salary of a college graduate in the United States of America is $25,000. So it's been with good intent, a Ponzi scheme, which is colleges raise their prices, people borrow more money. The curriculum doesn't change, the graduation rate doesn't change. Because you know what, it's not just the cost of college, which they're not paying at that moment, it's the cost of life, housing, transportation. When you go to a community college, take a single class. You say, how much of a disruption could that be in your day. It's half the day. 36% of college students report that they go hungry at least once a month. So what's changing now is students and parents are beginning to understand the institution is not working in their favor, the institution like any government institution -- and by the way, I'm generally considered a left-wing commie liberal. So this isn't a political stance. This is an economic stance, right, which is you go to a college. Any of you have kids in college? Ask them what it costs to go to the ATM machine. The average kid takes out $10. They have to pay $3.50 to take out $10. It's a rip off. Why is the bookstore charging 30% profit margin over the cost of a textbook they require you to buy? Why do the schools force you to use the financial aid, they give you to buy your learning material only at the bookstore, which is the highest price for any learning material you could possibly buy? It's because the school is supporting themselves financially. And so that's why the system has been designed to preserve what's been. And what's happening now, is they are not producing results that employers are okay with, and that's the big change. And how long it takes, I don't know, but I know that by going direct, by keeping our prices low, our quality high, our integrity high and serving the student, you see our numbers, and you see -- try to find another education company who's accelerated its growth, just Chegg. And it's not that we're brilliant. It's that we, by accident after getting hundreds of e-mails from people and parents thanking us for creating textbook rental, began to understand that nobody put the student first. And that's our -- that's how we built this business, and we're exceptionally proud of it. Because we now have almost 6 million paying customers for a company, that almost went out of business 6 years ago. So that transition is happening. We're just leveraging it. And that's why we kept our prices low. Now we'll be able to get higher ARPU because we've created a bundle. And that bundle instead $14.95 is $19.95, but it has the same $0.91 of every incremental dollar falls to the bottom line because it's combining products we already have. And we're like software, right? Once use many times, which is very different than other people who have to constantly update their stuff. The curriculum doesn't change. We're the only company that owns the customer, the data, the credit card, the channel of distribution and the content. And that's why we've been able to both increase our margins as well as make significantly higher investments in future growth opportunities. And we can only -- I'm very aggressive with this because it's 10 years in, and I really thought about the journey that we've been on, whereas 6 years ago, our market cap dropped down to less than the value of the textbooks we owned, which, by the way, if you've ever seen a mid-50-year-old man curled up in his bed, sucking his thumb, that was the moment. So now, by focusing on the student by keeping the high -- quality high. So the bundle will allow us to get $25 more per student per semester to the degree that anyone takes the $19.95 over $14.95. And we're slowly rolling that out, and we're seeing really good take rate because now includes writing, it includes math, includes more videos, the ability to ask more questions, is real value that the student not only perceives, but utilizes. And we know that because we know exactly what they use because we own that relationship. We can watch everything they use. That's how we know over 2 million pieces of content are viewed in that 1 service, every day of Chegg. Pretty -- it's pretty remarkable to look back.

Absolutely. Are there any questions from the audience before I carry on? Yes, at the back.

You can't relate [indiscernible] is really interesting because they're basically spending the time with their customer, the average price here further on down that career.

That's the hope.

Is there any thought to extending the funnel down market for high school or middle school. I know that you guys have that bibliography program that may help somewhat. But in terms of --

It helps a lot.

[indiscernible] the companies down there that may have better penetration or brand recognition...