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

Excellent. Let's get started. My name is Josh Baer, a software analyst at Morgan Stanley. We're joined here by Dan Rosensweig, CEO of Chegg. First, disclosure announcement. Please note that all important disclosures, including personal holdings disclosures and Morgan Stanley disclosures appear on the Morgan Stanley public website at morganstanley.com/researchdisclosures or at the registration desk. Thank you for joining us today.

Also full disclosure, I just had a full physical, I have nothing.

Excellent. Good to know it.

But I'd like to see all of your physicals.

I think it might be helpful for those investors that are new to the story, to maybe get a brief overview of Chegg from your perspective.

Okay. Just to get a sense of the room, do any of you feel like you know it reasonably well? Okay -- other than my banker. So for those of you who are very new to the story, think about it this way. What does Chegg do? So we provide academic support for high school students and college students, initially, domestically, but increasingly globally. So 50% of the world's population is below the age of 30. So just if you're -- we have a philosophy of betting on the inevitable. Do you think more people are going to have to learn more things over the course of their life and their careers to be able to be employable? If you do, do you believe that they're more likely to do it online or need online support for things that they do? And if you do, then think of Chegg as the person that says, we're just focused on the students' needs, not the institutions. So we don't have relationships with the institutions, although we could. And everything we do is direct to the consumer. And we own the customer. Therefore, we own the data. We own the channel of distribution. We depend on nobody for a partnership. We own 100% of our content. So that we are in the single best position to serve the needs of the students on demand, at a really low cost, really high quality, with proprietary support capabilities of, for example, online on-demand chat-based tutoring. You can get a live tutor for less than $0.50 a minute. The largest database of Q&A. So if you know Quora or you think of search, or you think of any of the legal databases, Chegg already has 35 million academic questions asked and answered. You can get an instantaneous step-by-step solution. We have 30,000 videos. You can watch a video, if you prefer. You could ask a question that hasn't been asked, and we can answer it, and the longest time it takes to answer it is 4 hours. We have 70,000-plus experts around the world. Think about it as Uber. I want a car, I click a thing, tells me there's 5 cars available, finds the nearest one. Ours, you ask a question, if it isn't in the 35 million, gets sent out to tutors that are available around the world, that are available now, that have already been tested and proven, can answer that question. They answer the question, it comes back, usually in less than an hour, but the KPI is 4 hours. And we get about 7 million to 9 million new questions that we don't have in our database asked a year. So it's a giant moat. So regardless of what country you're in, what academic class you're in, what school you're in, Chegg is there to support you. Why are we necessary? If you just take the domestic situation here in the United States, of the 20-plus million people that go to school on an annual basis, 70% of them go to a state school. On average, if they graduate at all, it takes 6 years, 40% of them work 30 hours a week or more while they're in school full time. The average age of an online student, which is increasing every year, you can read the latest report that came out. There are over 2.5 million people going to online not-for-profit schools, right? "Not the bad ones." That's a whole new vector for Chegg to support, the state of California alone has 2.5 million students going to 115 community colleges. So your world, my child's world is the 4-year institution residential. That's about 20% of America. So if you think how big this is? It's massive. So what Chegg does is we provide online, on-demand, high-quality, multi-modality support. You want to watch a video, you want to ask a question, you want to work through it step by step, you need an online tutor, boom, and we do it for as little as $14.95 a month. Last year, we got -- we had nearly 4 million paying subscribers. And we [ add ] on average about 1 million net new subscribers a year. Without taking our prices up in 10 years, our ARPU has increased. Why? Because students know us better. We have 87% brand recognition. If you have a student in high school or college, I promise you just text them, they will know Chegg. I was just at a meeting at Deer Valley for another bank, [ sorry, Lee ], and one of these guys, one of these Stanford guys, who owns all these companies everywhere, he's like, I've never heard of Chegg. I was like you have a kid? He said yes, she's a Brown. Text her. She immediately texted back and said, "Oh, my God, I want to have an internship at Chegg. I use the product and have so many great ideas." So you probably never heard of EasyBib. 30 million students use EasyBib. If your kids are in high school or college, and they write papers, and they want to do -- they have to do citations and bibliographies, we do it for them. So that's what we do. And what I would say is if you believe that more and more people as we get more diverse, as we have more economic diversity, and we have more people who speak different languages. And by the way, by 2022, 25% of anybody in college or high school, English will be their second language in the United States alone, as an example. And it turned out, because we focus mostly on STEM and business, that this is expanding even faster than we imagined outside the United States, and we don't have to do what Netflix does or what Disney does, just pay billions of dollars for content. Our content bill is literally to pay the answer to that question. And that question, we own it, and then it gets used many, many times and indexed into SEO. So what that's netted in as a business, and you don't cover us but you follow us, is that we have been growing over 30% a year. Our EBITDA, I think if we just -- I think, we're in the 30-plus percent range. It grows 100 basis points per year, even though we continue to invest in future growth of the company with it. And 50% of our EBITDA already falls to free cash flow. So that's the basic overview of the company. 6 years ago, when we went public, 80% was textbooks, 20% was digital. We were minus $18 million in adjusted EBITDA. Last year, we ended up being $125 million-plus in adjusted EBITDA. So that's sort of been the turnaround of the company. So we're now on the ascendancy after having done all the hard work to change to pure digital.

Thanks, great background and a lot to dig into. And you mentioned some pieces of a competitive moat, especially around the quantity and the quality of content. I was hoping if you could speak a little bit on the go-to-market, the efficiencies in your customer acquisition, how important is that EasyBib and the free writing tools from high school students? How important is the textbook side of the business as far as the funnel to the subscription service?

It's a really good question. So as we started to build the company to become an online student hub, which is if you have a question, if you want to know what school to go to, if you need a textbook, we invented the textbook rental model. If you want an online textbook, if you need homework help, if you need an internship, and now we're starting to move from internships into getting you your first job. We just keep solving the biggest problems that students have. The moat gets a lot bigger. Because at best, if we have a competitor, they're usually ones that don't have a good business model, but are great products. So if you have high school kids, I'm sure they all use Quizlet. It's a phenomenal product, great CEO, great team. But -- it's got 65 million users, but it's basically ad-supported because high school kids can't pay for those things. So for us, we built this giant platform, and then the idea is to cross-sell across the things. So rather than push people from point A to point B, although we do that well, what we've really done is move towards the bundle strategy, which is, if you've been following us, we have Chegg Study, which is $14.95 a month, then we took Chegg Writing, which is EasyBib, the 30 million-user product, Chegg Math, when we said you can buy those points or we can bundle it all for $19.95. It's pure profit for us because we've already paid the expense to build those products. So it's $14.95 for Chegg Study and then $19.95 for Chegg Study Pack. So what we've said is, rather than necessarily try to push you from point A to point B because what students want to do is they just want the answer to that problem right now. If you have a kid, that's all they want, right? Fix this problem right now. I have immediacy, 2 in the afternoon, 4 in the morning, whenever it is. So the bundle is really a better strategy. Having said that, 15% of our textbook customers have become Chegg Study customers. So of course, we do that. And increasingly, we're seeing writing, which is -- reaches about 70% of high school students, becoming a reason for people to start using Chegg when they get to college sooner because they're much more familiar with the brand. So we've done well with that also. But really, the strategy is how do we bundle things, charge you slightly more for the collection of things. And that's -- that was something we started this year, as you know, and it's working very, very well.

Excellent. So on the topic of the bundle, I believe it's available for new subscribers currently and then in the fall with the next semester, it will be available more broadly?

Yes. So the reason for that because if you don't follow Chegg, it's hard to -- the earnings call is not the easiest place to explain these things. Chegg has millions of subscribers who auto renew every month. So they don't have to come back to the site and re-up. So we don't have the opportunity to go and say to them, hey, upgrade to the bundle unless we interfere with the homework that they're doing. So everybody who's new to us, which we get, like I said, 1 million net new subscribers a year, all of those are now being shown, the opportunity to pick either the base or the bundle. And now we're starting to show that not only to the people who come in to the desktop or the people who are coming into mobile, which is harder to show more than 1 option. So we're learning how to do all those things. And the idea is, over time, as our subscribers move on, every new subscriber will become that base subscriber and they'll auto renew into the bundle. So it's been -- right now, it's been really, really, really effective. But what that means is you'll start to see -- we started to include in our guidance for '20, but you'll start to see even significant more in '21 and '22 because a larger percentage of the base will become people that are already using the bundle.

Got it. And one question I get from investors is, there are a lot of subscribers that are already paying for math and writing. Do they -- and I guess, if so, will it be kind of a loss? And if not, then what value will they get from those additions?

Yes, it's a great question. It's the one that we ask, which is -- so is it accretive versus -- so you're taking somebody paying $9.95 and putting them into something where they're paying $19.95 when they were already paying for the bundle, so they're actually paying $5 less. That's the question that gets asked, the answer is no. There's very, very, very, little overlap of existing things because we only built math in the last 1.5 years. And the reason that we built it was to put it in the bundle. So it does fine as an individual business, but it was never designed to be an individual business. So the bigger one is writing and the 30 million people that use writing, use it for free. We only started building math subscription service 4 years ago, and it's doing very well. It will be 50% of the revenue in the next year or 2, it's going that well. But it turns out that's more high school than college and the bundle is more college than high school. And so when we look at the overlap, we're seeing -- at least in the first few months, we're not seeing any degradation of writing in favor of the bundle. So at the moment, it looks like what we believe it to be, which is all accretive.

Excellent. And just the nature of a student, they might turn off their subscription during the summer, for instance. Does the -- having math and writing in the bundle, is there a potential that, that actually improves retention? Because there's more likelihood in a given semester that, that student will have a relevant course.

We don't know the answer to that yet. What we know is that it's not going to lose retention. So what we now believe is that by offering 2 items instead of 1, there's no reduction in conversion. So offering more than 1 thing can temporarily reduce conversion, hasn't been the case for us. That's great news. The second thing is that a larger percentage of the people than we originally thought are already taking it. That's also good news. The next set of news that we look at is, how do they behave in terms of usage and how do they behave in terms of renewal rates compared to the people that only have the base. Now it's early. It started in the end of the fourth quarter. So we now have a couple of months. So far, looks the same. So everything that we tested for the last 1.5 years is turning out to be as good as we hoped. And we were -- had high hopes because -- so right now, it looks like the usage, they use Chegg Study, and they use writing. They use Chegg Study, and they use math. It's too early to tell if they use all 3. But what's wonderful is, is think of this as software. All these things have 90% margins. It's write once, use many times. We don't have to rewrite math. Math is math. We've to have to rewrite all the technology we've done for bibliography, citation, plagiarism checker, grammar checker, spelling checker. So it's -- we think of this as just a giant ARPU growth engine for the next several years because there's no reason that it wouldn't be.

Excellent. So I want to stay on subscription services because it's definitely the most important part of the story, but shift from ARPU over to the subscriber side. Could you talk a little bit about the international opportunity, sort of where are we? And the brand awareness is excellent in the U.S., what's it like abroad? Is there any changes to that go-to-market internationally?

So the -- I'll answer all that directly. I'll also add the question that we also get asked, which is, do you have to make a significant investment in either building content or your brand that we don't know about yet. And what is fabulous about our business and unique to our business. And nor did I know that this was part of the business when we started to build it. So it's sort of brilliant by accident, which is, it turns out math is math, right? Physics is physics. It's not like a movie company or an entertainment company that has to have local content because we like Swedish music in Sweden, and we don't like American music in Sweden. So -- or Netflix, where you want to have the catalog that everybody loves, but then you have to have a lot of local content. And it's hit or miss, if it works and takes a long time, and it's very expensive. Our content is write once, use around the world. So all the costs associated with us growing internationally are assumed in our current plan because really, the cost becomes, do they ask different questions than U.S. students do. And so as the U.S. questions decline, global questions go up. Because we have a lot -- we have 35 million domestic questions already asked. So it's not going to be 7 million new domestic questions. It will be 3 million new domestic questions and 5 million international questions. So we're seeing questions from Saudi Arabia, from South Korea, from everywhere in South America, from, obviously, Canada, U.K., Australia. It's not just English-speaking countries, because it turns out the rare scenario that we're benefiting from is that the major publishers who produce the curriculum in the U.S. are the same ones that do it for almost everywhere around the world. So we don't actually have to create a whole new curriculum support because it's almost identical. Now if we did politics or we did religion, it would be very different, but we don't. This is all business and STEM. And so what's happened is the same way we built the business in the U.S., if you followed our business, you'll notice that our cost of marketing not only has gone down as a percentage, but it's actually gone down period. Because it's really students typing in the question in to search, Chegg having that question, no one else able to have that question, and then they automatically come to Chegg. And so when Google crawls us here, they crawl us everywhere. So we're seeing great growth already in at least 5 countries. So where are we? We're at -- I guess, we're at spring training, if you want to do it as a baseball thing. We're just at the beginning, but it's already making an impact on our ability to continue to grow at the rates that we've been growing. And so it's between the bundle, which is an ARPU increaser, the 2 new U.S. vectors of growth, which are online not-for-profit schools that need support and the community college, right? Everybody wants to do free community college. So there's a lot of people that are going into that. Those are domestic vectors. And the international vector, collectively, will be as big as the U.S. What I would tell you is if you just want to size it, Canada, the U.K. and Australia are just 3, the ones everybody knows in English-speaking markets, they're about 50% of the size of the U.S. And so there's no reason we shouldn't see incredible penetration, and we're starting to see really good pickup. So we don't have to have any local management in any country. In fact, we do have 600 people in India. They support our content work. We have 65 people in Israel, they support our engineering work, particularly for mobile, but we don't have anybody in any of those countries because we don't need it. It's literally all search based and then word of mouth. So we're obviously seeing substantially higher growth rates outside the U.S. than in the U.S. because of the size of it. But right now, it looks like it's just a really huge win for us going forward.

Excellent. And should investors think about international as a steady, gradual expansion and penetration? Or is there some catalyst that would cause an inflection?

It's just awareness, so what shocked us in the U.S. to our benefit. So everybody, years ago, was like, do you have a network effect. And of course, we do. The more questions that we have posted, the more people who ask questions, the more they come in and more they subscribe and more questions they ask, and the more it gets indexed in search, and then the more new people come in, and then it was virality. And Chegg didn't imagine we'd have any virality, which is why would I be bragging when I use Homework Help. But it turns out they do. Just follow us on Twitter. We have a massive Twitter following, people who all the time talk about it. So what ends up happening is that word of mouth is phenomenal. So as we get deeper, so -- I can't say that there's a specific inflection point that I know the date will hit it. But if I look at our international penetration, it starts at a school, and then that school goes like this, and then they go home for break and they tell their friends. And then it goes on like this. And so it's a little bit how Facebook formed. I just was surprised at how powerful the word of mouth is. So we're a company that's going to do $570 million or something in revenue, our total marketing spend is $18 million. And it was last year and the year before. And it's because it's not paid marketing that makes this, it's literally high-quality, answering the questions, keeping the prices low, indexing and search. And so people say, well, do worry about Google and all those things. Of course, it's the existential question everybody worries about. But if you looked at the end of last year, the travel sites got crushed when Google changed its algorithm. Chegg did not. And the reason is because nobody does -- we don't have 50,000 competitors. Only Chegg does what we do. And so Google actually increasingly searches as we continue to go up in search. So every -- they do it about every September, you can see that our results go through them, you wouldn't even know it. We have a whole team dedicated to this. One of the benefits of having been the COO of Yahoo! is we owned 5 search engines, something I'm reasonably familiar with. So we're just -- we're at the stage of, it's just got to be smart, focused execution. We don't have to worry about product market fit in these countries. It fits itself. They ask the question, we just respond. So every year, we build a bigger moat, gets more relevant, it's more contextual, it's been great.

Excellent. I wanted to ask one more on the subscriber opportunity before moving on to what's to come in the future. So one other growth vector that I see potentially is addressing shared accounts. And I guess there's 2 perspectives. On the one hand, some investors might think that penetration rates domestically must be higher. On the other hand, you have an opportunity to monetize users that are already engaged with the platform. I guess, how do you think about shared accounts? And it seems like there's a shift in the philosophy as far as 2020 and addressing that, if you could explain that?

So if anybody follows any subscriber company, this is sort of the bane of our existence collectively, which is -- so there's fraudulent accounts, there's stolen accounts that have been hacked and then there's sharing accounts. And each one requires a different thing. So we have very long term, very large investors who have been great to us. They also do their own research and their own surveys. What they know, what we know is that for everyone that pays, there's 2 others that use, which means we have this whole market that's already familiar with our product and we're still able to grow at the rates that we've been growing because what we've really chosen to do is not necessarily crackdown on the ones that have been using us for years but make it harder for the new subscribers to be able to do the things that the old subscribers were able to do. Because it really benefited us, to your point, for the first few years, which is if everybody uses, it became ubiquitous. That's how you get 87% brand recognition without spending a lot of money on marketing. So we thought of it as a marketing cost. But each year, each semester of each year, I should say, we continue to turn the screws just a little bit more, and a little bit more, and a little bit more because we also don't want to destroy the relationship that we spent 10 years building of being student-first. So if you go to Twitter, which is the best way to see when we do it, you'll see we -- periodically, we started with things like, gee, you're the hardest working kid in college because we noticed you've read 102 textbooks this semester. Perhaps you should take a break, we're going to shut down your account, right? It started that way. Now it's a little bit tighter than that, which is, gee, you have 27 different devices and you live in 4 countries, probably want to relax a little bit. So the technology continues to improve, but what we're really trying to do is just do it little by little by little, to not freak out our audiences. Like, we could see a giant boost if we wanted to around midterms or finals, but we could destroy the brand forever. So it's just a little bit more each month, a little bit more each month. And the idea is not to end it with the current group of subscribers, but the new group of subscribers, make it a lot more difficult. But I have to tell you, one of the great things that I realized was just how much people depend on Chegg. Because whether it's through LinkedIn or Twitter direct message or Facebook Messenger or WhatsApp, which I don't even use, or Snapchat, which I don't even have, the number of notes that I get that said, holy crap, you turned off my account, I beg you to turn it back on. It's in the thousands that find their way to me. So yes, it is an opportunity. It is a growth opportunity. We do have a way scientifically to calculate it, and it's assumed in our growth rates this year. How good a company that's been doing this, this long and continue to grow at the rates we've been growing. One, 2 new vectors in the U.S., online and community college, international growth and account sharing are the big ones. And all of this bodes well for Chegg as a business and Chegg shareholders. And I think, like I said, it's not lost on us that we have a lot of really smart investors that own a lot of shares and they do a lot of surveys, and they're like, did you know we're like, yes, we knew. And ours is -- we don't have it like, you can only log in from a single device. That's sort of a Netflix thing, which is not. So we're trying to reduce the number of simultaneous devices. Why? Because some kids don't have computers, they go to the computer science lab, right? So we're trying not to screw the good kids because of a few bad kids. And so it's just a delicate balance. There are some very entertaining back and forth though when we sit there. It's literally like an episode of like Star Wars, where you see the device, and then you see the proliferation, and then you send a little private notes if you want to. I don't have much to do at night, and this is what I do.

Great. That's very, very helpful. So wanted to...

It's helpful, it's entertaining to me.

It is. The last couple of minutes on skilling, Thinkful acquisition. What's next? What do you want to highlight about the skilling opportunity?

So Chegg, up to this point, and the overwhelming majority of what you're investing in right now for Chegg is the existing academic support business. But one of the things that we got from incredible surveys, you have to understand, we have 15 million people a month that use us. We have 100-plus million people uniquely over the course of the year. We have -- nobody has more direct relationships with students than we do. And we do a lot of surveying and the #1 thing that -- the 2 things that students desperately wanted that they didn't have was teach me Personal Finance. They have no idea of money, and we're building that. And that's not something we necessarily plan to make money on. But the second one is, I went to these schools, and I can't get hired because I don't have this job skill. So what I say to all of you is, if I said to you, you're either -- when you hire an analyst, what's the #1 thing you want. You all say, critical thinking and the ability to do this. And I was like, well, if they can't use Excel, would you hire them, like no. So there's a lot of general skills that young people need to learn to be more employable faster. But that's a separate set that we plan to work on. But the set we're working on now is, if you have a child or if you're a young person, or if you're a 30-year-old person with a child, and you want to improve your career, how do I get into digital marketing? How do I get in data science? It's not coding. So for 6 months for $4,000 to $6,000, you can actually get proven skills that make you employable right now, and that's why we acquired Thinkful because the other thing they ask for is, I got all these academic stuff. I don't know how to turn into a resume. I don't actually have an employable skill. And so if you think about it, the average online student is 30 years old, and it's a woman with a child who's trying to improve her life. And so we bought Thinkful. The vision we have is to reduce the prices because we don't have to share with any institution. We reduced the prices. We increased the support through the things that Chegg's already built, so there's no incremental cost of it. And we're able to provide thousands upon, thousands upon, thousands of students an opportunity to get employable skills right now. And so we think that, that's critically important.

Great. I think we're out of time. I really appreciate it, Dan.

Thanks for inviting us. Thanks, everybody, for showing up. I didn't cough once, neither did you. So thank you.