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

Great. We're going to go ahead and get started. Thanks, everyone, for joining us virtually on the final day of our conference. Before we get started, I just want to quickly mention that we'll take questions from the audience via Zoom. So please go to the Q&A button to submit. So I'm Doug Anmuth, JP Morgan's Internet analyst. It's our pleasure to have with us Dan Rosensweig, CEO of Chegg. Chegg is the leading direct-to-student online education platform, helping millions of students get better grades while saving them time and money. The company had almost 4 million paid subscribers last year with high growth and high incremental margins. CEO, Dan Rosensweig, joined Chegg in 2010. He had the vision of transforming the company from a pure textbook rental model into a digital subscription model, which he's done. So prior to Chegg, Dan served as the CEO of Guitar Hero, and before that, COO of Yahoo!, and CEO of DDNet. So thanks for joining us, Dan.

Thanks, Doug, for having me. How are you?

Very good. Thank you. Thanks for being here. I like the spring-themed collection behind you.

Yes, that's the one room I got to decorate in my house.

Good. All right. All right. So let's start big picture. I just want to get a better sense of your view of the education landscape today. Clearly, we've seen a secular shift here for a number of years, but how does COVID-19 and remote learning change things even more?

So as you know, Doug, because you've been with the company since the beginning, we have always believed that this was inevitable, which is there were going to be more people, different ages, different languages, different socioeconomic backgrounds, different countries, all learning, all having to learn through the rest of their lives, some professional skills, some academic skill. And then it was going to move eventually predominantly online depending on the country. And what COVID-19 seems to have revealed is that the trend that we expected, the trend that we were participating in, accelerated, which is almost overnight, all schools in this country and around the world actually how to go remote. So the bias against going remote is going to have to break down. The reality of what we think is going to happen, at least in this fall, probably even a little bit further, maybe for the following year, is that fewer students will want to physically attend. More students are going to need more help because the schools can't supply the help. They can't scale. They can only work with the tools that they have. They never made the investment in the tools that they needed. So we have been the beneficiary but not in a temporary way like some maybe because we just believe that this is inevitable. We believe this just accelerates multiple years earlier than what we expected to see, and I think our numbers reflect that.

So maybe if you can just talk a little bit more about how you're positioned for these changes in higher learning on the other side here.

So if you think globally, 50% of the world's population is below the age of 30. And I think the other thing that COVID-19 has revealed is that globalization and technology are impossible to ignore, and more importantly, tools for good. They can be used for bad, but they are tools for good. And so I think we are positioned better than anybody, frankly, certainly better than the publisher, certainly better than the bookstores, to be the friend of the student. We put the student first since day one. So when they need help, when they're stuck on something, when they're unsure, they can come to Chegg, subscribe to Chegg for $14.95 a month or now with our new bundle at $19.95, get help in any subject, any question, any country, eventually and shortly, any language, any year at any grade and have step-by-step solutions, have expert Q&A, which we have nearly 40 million answers in our database already. And we're seeing an acceleration of the number of new questions asked because not only are people studying different things in using Chegg now, but on a globalization basis, almost 30% of the questions that we saw in the last 4 months have come from outside the United States. So I think we're not only positioned, we positioned ourselves for the eventuality that students were going to need more help in more formats, on demand, low cost, incredibly high quality, incredibly high integrity and in multiple formats that allow them to learn the way that they learn best.

So let's just talk strategic priorities and how this environment -- I'm curious if it shifts anything. When you saw this when it was clear that the world was changing and that things would be very different, what did you say to your product team, what did you say to your kind of core dev team to say we need to do more of X, we need to get Y? What are those things?

Yes. It's a great question. It's exactly what we're working on now. So let's start with what happened, which is on around March 15, everything accelerated for Chegg. Subscribers, renewal rates, globalization, engagement. So step one was what do we need to fill the holes for this accelerated growth that we didn't originally anticipate this early. And when I mean this early, I don't mean in the year, I just mean the year itself. So the first thing is we need to, and we have been, investing in all the necessary resources to support the current demand that we have. The second thing that it revealed are probably 3 enormous trends. Trend one is globalization, which is we have been telling you all that we've been building our international organization, we didn't need to put people in countries. There was no special launch. And we turned out we were right. It's just as students outside the U.S. were forced to leave their schools, they discovered Chegg. And so we've seen a dramatic acceleration of international business, and not just from one or two countries, I mean, globally. So we've accelerated the internationalization of our business, which is we're accelerating our Q&A into multiple languages, and we're accelerating our interest in accessing additional content. So the content we have is really powerful, particularly for English-speaking students in those countries. But as we expand to the majors that they take outside of STEM and outside of business, we think there's a giant opportunity to not only attract the English-speaking students in their countries but the non-English-speaking students in that country. So everything on internationalization has been moved up in our priority list. The second thing, and we talked about this before, Doug, is account sharing. So we've always known that there's been significant account sharing. We believe there were concentric circles, which is who's paying now, who would pay if we blocked it and who might not pay if they didn't have access and blocked it. We started last year focusing on really bad actors, bad actors meaning people that stole it, people that hacked into it and resold it. Those kinds of people. And we were seeing really valuable improvement in Q1 prior to COVID. I mean we were on a path to do 33% growth in Q1 prior to COVID, which was even better than fourth quarter last year, which is a direct result of account sharing efforts. What we imagined, but could not confirm, was just how many people use Chegg. So your research, other people's research, our own research has suggested for everyone that bought it, 2 or 3 more were using it. Well, that seems to have been true. And what this has done is it accelerated our efforts in account sharing, particularly going to 2-step authentification, which we had been reluctant to do. Our plan and our process had been, get rid of the bad actors and prevent new people that are coming on each new year from having the same ability that people that had been historic subscribers. But now we've accelerated that effort to eliminate it as best as we can by August. Those two things alone, internationalization and account sharing, will account for significant growth and are accounted for significant growth. The third area is the bundle, which is we had always believed the bundle would matter. We had planned for it and discussed that the bundle would matter probably at the end of the year. But we're seeing everywhere in the world similar percentages taking the bundle. And I think what happened was when students were moved off campus, and they had no access to a professor or a friend or the computer lab or the writing lab or in their math lab, our research says that 21% of students had used on-campus support. Well, without any campus support, people started taking the bundle in a much more significant way, even as our volume grew. So those are the trends that we're investing in heavily. So it's infrastructure, it's content, it's internationalization, it's translation and it's anything that we can do to make the bundle even better than it has been in terms of its value to the consumer because we want even more, a larger percentage of them to take it because it's pure profit when they do to us. So those are the areas that we've accelerated. The other area that we're working on, we had it in our plan, which was Thinkful. So with so many students afraid they're not going to get a job that are graduating right now and a lot of people who lost their jobs and then a lot of people who are fearful of their jobs and the recognition that if you don't understand technological skills, doesn't mean you have to be a coder, we don't have a coding boot camp. We have a skills camp. And we're seeing every part of the funnel improving our math business. And as a result of that, we are doubling the amount of courses that we offer. We have been offering 5, by the fall, we expect to have nearly 10. And we have increased the amount of scholarships, which effectively lowers the price. Because there's other people that we compete with are on-campus, which means they're no longer valid, we want to be the biggest brand name with the most content, with the most high-quality content at the lowest price and really start to establish a leadership position in that space. So that's what we've been working on. We're working on all of those things, but we accelerated them all at the front of the line.

Got it. Okay. So there's a lot in there. So I want to dig into a couple of those things. Just on account sharing, in particular, what inning do you think you're in? Just when you think about your account sharing efforts? And then also, how will real device management help, and when do you think you'll have that capability?

So the second part of the question, as I was describing it earlier when I sort of bundled a lot of things into the answer, those efforts, we hope will be ready on device authentification, 2-step authentification by as early as August. It won't be pristine but it will be powerful, and it will eliminate a whole lot of what we call proximity sharing, which is, "hey, just send me your password" or "can I log in" that kind of stuff. So what inning we're in, it's hard to know. What this isn't is a onetime catch-up and then it stops because, unlike people like Netflix or other people who have people forever, we have new students coming in every semester. So what this has done is improve growth rates. What it's done is reduce cancels. What it's done is improve renewals. So every part of our business has benefited. And when you saw what we did in Q2, for a small company, taking up your numbers by as much as $10 million by what analysts have projected is quite significant for a subscription business where not all the revenue gets recognized in the quarter. So it's been meaningful. And so whatever comes on account sharing, our base will be much higher and our growth rates, we think, will be better than they've been, and globalization helps with that also.

Okay. Let's talk more about Study Pack. So this has been highly anticipated really over the last couple of years, clearly contributed to the strong 1Q results. Where are you currently in terms of the rollout of Study Pack? And I guess, how should we think about adoption thus far in terms of kind of new subscribers coming on the platform?

So for those who haven't paid as close of attention as you have, the Study Pack is $19.95 versus $14.95, and it includes the addition of Chegg Writing and Chegg Math, which are also sold separately as independent subscriptions at $9.95 each. So the idea is we take our price from $14.95 to $19.95, combine the assets that we already have, we sell it all for $19.95, and that's pure margin for us. So on average, for everybody that subscribes, and if they stay on for the same 5 months or so that the regular Chegg Study subscriber is, it's $25 more in profit per subscriber. So what's happened is simply because our subscriptions have exploded. We were already growing nearly 30%, it's just accelerated dramatically. And we took our growth rate in Q2 up to 45% net growth, which was over 35% in Q1, which was over 32% in Q4. So it's rare you see a company that's been around as long as we have accelerate growth on top of a higher base and pay less for the customer and have them be more profitable. But that is, in fact, what's happening. So what we did though is we said we're only going to make it available -- market it to new subscribers that have never subscribed to each. The take rate was higher than we thought. Then what happened is, we used the opportunity at the end of the year to offer every Chegg Study subscriber 2 free months of an upgrade, and we'll find out in the fall how much that helps. But the reason we did it is because it was the easiest way to market to our existing customers because our new customers have to come in and sign-on. Our old customers don't, they just go right to the product. So all of those things, we think, we have benefited from pretty significantly as well as what we did with the Verizon deal, which is they were able to notify everyone of their customers about Chegg Study Pack. All those things have conspired in a good way to build the brand recognition for it and the usage for it. What we're paying attention to, as you can imagine, is of those that subscribe, do they use it more or less than those that subscribe to Chegg Study? So far, the usage is a little bit higher. That's exactly what we would hope for. Second, even though it's only been 4 months, what has the monthly renewal rate been versus what we would normally see in Chegg Study? So far, same result. Then the second thing is, internationally, we were surprised by the percentage that took it, and I think it's because these are English-speaking students where writing is helpful and math is ubiquitous. And they -- because they don't pay for their education, $19.95 is a very low cost to pay to absolutely learn the subject. So we have been pleasantly surprised by that. And international customers are acting very similar to U.S. customers. So for 4 -- now 4.5 months of the year, we've been pleased by the speed of the adoption and the usage and all the positive impacts that it's had on our business. And that's why we sort of -- that's that makeup of Q2, which says step function up.

So it sounds like -- just in terms of maybe if there was a change in the rollout strategy from maybe 3 or 6 months ago, that the biggest change might have been moving existing subs quicker, right? I think then 3, 2 months...

Yes. And that's millions of people. That's exactly right. So we made them aware of it when we didn't intend to make them aware of it until Q4. We were planning to do something like that right before finals so they could at least get exposed to it, and there's no cost to us to making it available. What we'll find out, though, is in August and September and October, how many stayed on the upgrade, and we have marketing communications plans and those things. But regardless, what will happen over the next 2 to 3 years is as all the new subscribers come in and the take rate is much higher than we expected, the business gets just that much better. I mean these are meaningful changes to our business, as I think you can see.

Yes, definitely evident in the numbers. What -- is there any kind of target that you have around Study Pack adoption or anything just for when you'd say it's not so much Study Pack anymore, but that's the product, right, where it almost moves to the bundle, basically?

Yes. So that's -- those are -- there's 2 questions packed in there. First one is, I -- yes, we have expectations, and no, I can't share them. But what I can share is that whatever our expectations were, we've beaten them more than we had anticipated. Our internal goals are usually bigger than the external goals. In this case, we beat even our internal goals. But to your question, which is the plan over time, we try to be the one education company that puts the student first, which means we've never raised our prices. 10 years, we've never raised our prices, but we've been able to raise subscriptions, ARPU, yield. It's a phenomenal business, one that I've never run before and gets better at scale. Well, some businesses -- part of it gets better at scale, but part of it -- the cost to acquire new customers becomes more expensive, it's a reverse for us because word of mouth is the way we do it. And I mean, we have 85% organic traffic. So we don't spend very much to acquire a customer. However, there is a belief that over the next couple of years, as a large enough percentage take it that we may shift to strictly the bundle itself and eliminate the $14.95 package, but I would not expect that in '20 or '21 or maybe even in '22 because there's no reason to do it now. Our growth has accelerated. Our revenue growth has accelerated. Our profitability has accelerated. So we don't want to get greedy for no reason. We have that pricing power.

Okay. Understood. So all of that, as you said, obviously, very strong 1Q. You saw kind of the acceleration of 2 points from mid-March and then guiding to a 2Q sub growth of 45%. So has this strength carried through the first half of May thus far?

So I don't know that we can say the answer to that. But what we can say is we reported on May 4, so that should give you an indication of our confidence.

Okay. All right. So how do you think about -- there's less visibility, obviously, into enrollment in macro in the fall. That's pretty clear. We just had Uber's CFO on a few minutes ago. He was fairly cautious about macro in the back half of the year, just broadly speaking. But you didn't guide for the full year. But can you just talk about some of the puts and takes here in terms of how you're thinking about the back half and how that impacts your business?

Yes. So we didn't guide for -- because too many unknowns. So we like to do precision, as you know. We have a subscription business. Precision is good. That's why I think we have beaten for 15 straight quarters. So here are the variables. The variables are how many students will go to school in the fall, how many international students will come. How many schools will open high-grade online and in person, how many will just open online and then switch to in person. So for example, if you take the California community colleges, there's 2.25 million students in that system, which is 10% of the entire student base, they've gone to all online at least through the summer. So being precise the way we like to has been more difficult until we get the full list of what colleges are going to do, and we, of course, collect that. It's actually more complicated for the textbook business, but the way we've prepared for that, since it's a no-money business -- no-profit business for us, is we've been liquidating books rather than just renting them. So we've been selling them to students rather than renting them and then getting them back. And then the second thing is we have an intention to probably buy fewer and be just in time if we continue to blow through textbooks, like we did in the first quarter, which is we were $6 million ahead in revenue on the textbooks alone. So the question that I think goes to the core of everybody's question is could whatever the schools do negatively affect you? And the answer is, it doesn't appear that way at this point because the primary motivation for schools, whether you like it or not, is they have to open because economically, they will go broke. They need tuition revenue. They need food revenue and board revenue, they may not get that. But they have got to open at least for tuition because, one, people need to graduate; two, people need to get those credits; three, there's an economic imperative for them. And so even if enrollment is down by maybe 10% or 15%, which my expectation is international students won't be coming back in person, but they're full payers, so the colleges are going to try to find a way to make sure that they get taught online. That benefits Chegg internationally, believe it or not. We've seen that 20% of college freshmen, or incoming college freshmen are concerned, but all of their schools are going to offer an online alternative. The other thing that most people didn't know and are discovering now is that instead of paying $3,500 for a credit, you can pay $600 for credit at a community college and then transfer it. So what we think is there's going to be a lot of mess for schools, but for Chegg, we'll be the beneficiary of whatever you do because we are -- we have 87% brand recognition, incredible word of mouth, we have an 80 NPS. Our engagement went up 26% alone. That's not -- that doesn't mean more people are using us, it means everybody that's using us is using us more. And so once you get the experience of Chegg, you renew at an extraordinarily high rate because it's really your only learning tool friend.

Okay. That makes sense. Understood. There's obviously kind of a wide range of scenarios in terms of on-campus remote learning enrollment numbers. Cal State School System, my understanding is they were going online for the full, I think 500,000 students. But that's something you believe that -- just kind of as we saw in this spring semester that you're well positioned here either way?

Yes. The interesting thing is two of the areas that we said that where U.S. growth could come from this year was not-for-profit online schools and community colleges. Two places where word of mouth is not as strong because you don't have classmates. I mean there are people in your class, but you don't know them. But what's happened is we've seen an acceleration of our usage from both those audience as well, so -- particularly in community colleges. And I think as more students who are going to 4-year schools, go to 2-year schools for this semester, it even gets better for us, and that just helps our recognition and our word of mouth. And so we're not seeing -- everything we are seeing has been up into the right at this point.

Okay. Great. All right. So let's shift gears a little bit. You talked about Thinkful briefly, I want to dig into that a little bit more. You acquired the business last fall for about $80 million in cash. I think there's another $20 million in potential earn-outs. Can you just talk more about that business, how it expands your current offerings and addressable market?

So there's 3 giant segments of what Chegg can address. The one that everybody knows is academic support, and that's the one we do now. So think about the next big leg or another big leg of Chegg, which will be built through Chegg Study, will be all of those people who need to get a certification or certificate or a license, meaning they have to pass something to be paid, to be employable. So it's the same concept of academics, but it has to do with your professional pathway. So that is a big, giant opportunity for Chegg. I think there's over 750 certificates or certifications that people study for, we're going to help them study for that. We haven't done that yet. That's a whole big market for us. The third one is the one you just addressed, which is skills themselves, which is if you went to a liberal arts college or if you went to a college and your major was unrelated to the company that you want to work for, the industry you're in, or if you're like most of us and accept the fact that what COVID has revealed is if you can't work remotely using technology and access database and know how to market and do those things and understand day to day science that you will become a dinosaur faster than you would like. Those people are in desperate need of job skills. Thinkful is our platform to create curriculum that is a combination of live and self-paced, but it's 100% online, which means we benefited from the fact that our competitors were off-line and online, or just off-line. The second thing is we know the skills that people need because through internships.com, we know everything that people are, in fact, hiring for. And so we're expanding the curriculum. The third thing is, it's in our -- it's on brand for Chegg to be the highest quality, the best support and the lowest price. Thinkful because they were an independent company, had to charge higher prices because they needed the revenue. In our case, we believe by reducing the prices, first through scholarships and then through permanently lowering them, that we can accelerate that rate of growth over time and become the best-known player in the space the way Chegg has in the category of academic help. We can afford to do that and others can't for 2 reasons. First, everybody else has a partner, which they split their revenue with. We do not. So they have to be twice as much, just to be able -- for everybody to get their piece. The second thing is that by replacing the expensive part of Thinkful and all-for-profit and not-for-profit online colleges, which are the telemarketers that encourage you to keep staying in and paying, we're eliminating those roles, and we're backfilling it with the capabilities that are inside Chegg Study, which is expert Q&A and chat-based tutoring. So instead of it costing $600 a month to support a student, it could cost as little as $50 a month, which means there's a lot more margin in the business for us to lower the prices, grow the subscription base and make more money doing it. And that is the plan. We are going to double down on where we think we have advantages because now is the time to do it because our business is performing so well.

Okay. And the way Thinkful works is a little bit different than Study, for example, but...

A lot different.

A lot different. Thank you. how do we think about that impact of Thinkful just on ARPU, on revenue on subscribers this year and going forward?

So I think the way to think about it is differently than we did just 90 days ago, and the reason is because 2 things have happened. First, our core business has dramatically accelerated, which means that no matter what Thinkful does, it's going to be a smaller percentage of the overall revenue, and the other parts of the business have $0.90 of every incremental dollar falling to the bottom line on Chegg Study and Chegg Study Pack. So Thinkful initially will be a smaller percentage than we thought, even though it's growing faster than we thought because the other businesses really just dramatically move forward. So we get this opportunity now to really put the gas on Thinkful. When we have the second set of 5 classes, so we're up to 10, we think that will change it dramatically. I would say that think of Thinkful 2 and 3 years from now as a meaningful contributor, and the reason it's 2 or 3 years is not because it won't get big and it's not because it's not growing, it's because when you look at how fast the rest of the business is growing, that was not expected to grow this fast this soon, it's just not as noticeable as it otherwise would have been. But it's a phenomenal opportunity for us. And we think that space is global, and we think it deserves to be almost exclusively online, and we think it needs to be lower priced with greater support. And we can give the student less risk than they've ever had. We can lower the price, and we're going to give them 2 weeks free to take the course. And then if they continue, it rolls over and they have to pay, but if they find it too difficult or they don't want to do it, they can leave. These are things that none of our competitors can offer: lower prices, greater support, higher quality and no risk. And that is a really big deal in this space, and we're taking advantage of our size here.

How important is income sharing for Thinkful and just in the space in general? I mean, do you think we'll see more of a push in that direction?

I do because it's really about how much it costs and how much risk the student wants to take. So what income sharing agreements do is say to the student, you can take it, but if you don't get a job in this space in 6 months, you don't have to pay it. So there are other ways to accomplish that same thing, lower the price and offer 2 weeks free is another example. Having said that, income sharing agreements generally are favorable at the beginning and less favorable over time to the student. And the reason is because you pay interest, you have to be approved for it, and then you pay interest over time. Chegg does not have a need to do that because when you're purely online, there's almost no incremental cost of taking the risk on an income sharing agreement student because when the cost goes down from $600 a month to $50 you can take a risk on a lot more students and not really hurt your P&L and grow your top line instead. So we also think we have a tremendous advantage there because we don't have to use an outside provider to provide the capital to us. We can just carry it all because there's almost no cost, and we have $1 billion in our balance sheet anyway. So as the movement moves more -- as the market moves more in that direction, we are once again advantaged. I mean, we really find ourselves in a whole new place, Doug, that we imagined being 3, 4 years from now, we're starting to see just now.

Okay. So let's just talk about the bottom line. You -- since you shifted to 100% digital business a few years ago, obviously, gross margins have expanded significantly, EBITDA margins overall. This year there's a little bit of noise just near-term with the transition with Required Materials to FedEx, for example. But just how do you think about your ability to drive further leverage in the business? And any reason you can't be doing 40% EBITDA margins long term?

So let me say we've improved revenue growth on top of a much higher number. We've improved gross margins. We've improved EBITDA margins, and we've improved ratio of EBITDA to free cash flow. So we're also significantly free cash flow. So what I would say is, at scale, our business should get better. And every quarter that our business has grown, we have shown that improvement. So I don't know that I -- as you can imagine, I can't give you a target number, but what I can say is I don't think we've gotten to a number that this company is capable of getting in terms of EBITDA margins, gross margins and free cash flow percentage. The -- this is a weird business, which is -- we've been around for -- I've been here for a little over 10 years, we've been public a little over 6 years. We transitioned the business to a pure digital business, but this is just another platform shift that has opened up just new and more opportunities. And what I think people don't understand is, unlike Spotify or unlike Netflix, which are amazing companies, they have to spend a lot of money on music licenses or they have to spend a lot of money on building content and they have to do it for every country. That's not Chegg's business. We build our content almost in real-time based on what the question is asked, which means there's not a waste depending on content. It's very inexpensive to do it. And then we get to index it in search, which attracts many more customers. That's why we can improve all those margins that you've talked about. It is a phenomenal business model.

Okay. Great. So we're going to wrap up, quick word association. You know the drill because you've done this for a number of years here. Whatever comes to mind. Higher education.

Important, but screwed right now.

Chegg Study.

Beginning to become the de facto standard in homework help.

International growth.

Potentially as large as the U.S.

ARPU.

Up and to the right.

Fall enrollment.

Will be complicated. Unfortunate for many students, but will be fine for Chegg.

Study Pack.

Important contributor.

Favorite Springsteen song.

Depends on my mood. But right now, it's Born to Run or I Believe in the Promised Land. So you can pick either one. That's my current mood.

San Francisco.

My prediction for large cities like San Francisco and New York is as companies are more comfortable letting their workers work remote, that you're going to see a huge exodus of young people with families, leading San Francisco and New York to lower tax places. You're going to see rents fall. You're going to see traffic go down. I think the tax base will go down, but for the people that live there, it will be easier. But I do think you're going to see a mass exodus.

All right. Last one, better grades, less time, less money.

It's -- which one is more important? I think -- look, I think here's what people should understand. The average age of a student is 25, 40% of them work 30 hours a week or more than 26% have children. They need all of those things. They need something that very efficiently, very cost effectively and with super high certainty helps them learn the subject with less stress and less time.

All right. Great. We're going to leave it there. Thank you, Dan. I appreciate it.

Thank you. Thanks everybody.

Thanks, everybody, for joining. Take care.

Bye.