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

Hello there. This is Josh Baer, research analyst on the software team. Happy to introduce the CEO of Chegg, Dan Rosensweig. Welcome, Dan.

Thanks, Josh. How are you?

I'm doing very well. A quick disclosure before we begin. For important disclosures, please see the Morgan Stanley research disclosures website at www.morganstanley.com/researchdisclosures. So thanks again for joining. Really appreciate your time. Fascinating story and year for Chegg.

Actually, I wanted to start with the topic of COVID beneficiaries. I think today, with the stock trading down, is a good timely time to ask that question. Is trading kind of in line with other names that are traditionally in the work-from-home, stay-at-home basket with airlines and OTAs up today? So I wanted to ask you to frame for investors why is Chegg, or why is Chegg not, a COVID beneficiary? And what are the most important trends in education that Chegg is aligned to that will really help check sustain growth no matter what the environment looks like?

Yes. So great question and a question that we get a lot for obvious reasons. And because of the really positive announcement over the vaccine distribution yesterday, I think people are raising this question again. And the thing to think about here is there are 3 kinds of buckets. There's companies that were doing poorly before COVID and COVID accelerated them doing even worse. And I think we could talk about retail companies in that category. Then there were companies that were doing spectacularly well, but COVID shut them down. And so you're looking at the travel companies or theme parks at the runway, companies like this. And then there's the category that we think Chegg is in, which is companies that were doing extraordinarily well before COVID and COVID just accelerated the trends and took a step function up because it just proved out the thesis and more so created a sense of permanence in what we do. So we have -- we see ourselves as a high-growth, high-margin company for years to come because those were the trends prior to COVID. So if people remember, we grew 29% a year ago in the December quarter. Then in the first quarter, we actually grew 35% before COVID. So we had already started to reaccelerate our growth because we had fixed some things around account sharing, and we started our international efforts, and we started to see the beginning of the success of the bundle. Those things are not going to stop regardless of where the student is physically located. So I can understand people saying, "Well, gee, if you are home, you have plenty of time to Peloton or plenty of time to watch Netflix. When you go back to the office, you may not use it as much." I don't think you mean people will stop subscribing or using it. They may not use it as much, but I don't think it should hurt their numbers. But for somebody like Chegg, we have always been agnostic of where the physical seat of the student is. Plus, trends are going to go where there's going to be more hybrid learning, more online learning, and Chegg is going to be the beneficiary of those things. So 3 things happened since COVID: One, on the domestic front, we already started to see reacceleration before COVID; second, we've been working on account sharing efforts, which were accelerated by COVID, meaning because students couldn't proximity share, be in the same norm, be in the same room, they couldn't share as much, that you really saw the full usage of Chegg, and those students started to pay. At the same time, we accelerated our technology efforts to block those kinds of things. We did it in August and October of last year, and they are holding. Many students are back on the physical campus now, particularly globally. We are not K through 12. We are higher education. It behaves very differently than K through 12. So we -- around the world, except for maybe the U.K., people went back to school, and our international growth has continued to accelerate. Domestically, even with 500,000 students not going to school, our growth continued to accelerate. So we -- that's why we felt comfortable in putting out numbers as early as November, and that's why we not only reaffirmed them, but raised them when we gave our last guidance because those are the trends that we see.

Yes. That was going to be my next question, on guidance. And despite all this uncertainty, you were able to give guidance for 2021 back in Q3 for near 30% services growth at the high end, and that's off of 57% growth in 2020 for services. I mean, like -- and we're going to dig into all the different growth drivers that you went through that give you confidence, but what gives you the visibility to be able to look ahead and give that type of guidance so early?

Yes, it's a fair question because when COVID first happened, nobody gave guidance even for the next quarter, let alone for the rest of the year, let alone have the courage to give it in November. For the following year, we were one of the few companies that can do it, and that is because we are not a COVID-stuck. If we were a COVID-stuck, we would have to question the behavior that happens post-COVID. But because we are not a COVID-stuck, we don't have the question it. We have the trends. We have the patterns. We are a very data-driven company. We track every single action, every single sale, every single renewal. We do it domestically, we do it globally. So we can see trends in advance. And because we're a subscription company, we can see when we have success in the quarter, it rolls over to the next quarter, which rolls over to the next quarter. And so we continue to see positive trends. And once we realize schools were not going to shut down, our confidence in being able to estimate and forecast our business went way up. If people just stopped teaching, that would have hurt us. But that isn't what happened. They just stopped teaching on a physical premise, and so we were fine, is really what we ended up discovering. We just didn't know that last month.

Got it. So toward the end of the discussion, I definitely want to spend time on skilling. But I do want to start on some of the maybe near-term, medium-term drivers, some of which you've mentioned. So starting with shared accounts, is there a way to measure how much that impacted subscriber growth in 2020? And how do you measure that? And how much is left?

Yes. There is a way to acknowledge that it was significant, in that we know the second that students had to leave campus, we saw the rise of our subscription numbers. All of our internal forecasts and other external research companies and investors that we've been working with for years, who understand just how big and powerful Chegg can become, all research suggested that for everyone that paid, there were about 2, 2.5 that were using it through someone else's account. There were 3 levels of account sharing in that category. There were people that were stealing it and reselling it. And that was our first effort over a year ago that we started, and that's when we started to see reacceleration of at least 3% or 4% of growth just by blocking people stealing and reselling it on the dark web. The second one were people that were stealing passwords, which is at no risk to the students, just a risk to Chegg. And they were selling access to other people's accounts, and that's when we started blocking password sharing and things of that nature. And then there's the third category, the biggest category, the one that we're experiencing now, which is people that were just casualty sharing it. People that really loved it, wanted it, needed it, but didn't feel like they needed to pay because their roommate, girlfriend, boyfriend, whatever was using it, or classmate. And that is the work that we did in August and October. So what we know is it's insignificant. We don't know where we are in the curve, but what we do know is they won't be able to go back and do it. That's what we blocked. So we're not worried about going back to old behavior because that's the investment that we pulled forward in here. And the second thing is all future subscribers won't be able to share it, which means that will be the beneficiary for years to come. And mostly, that will help in renewals. So renewals will stay extraordinarily high. Our renewal numbers are way up. Our cancel numbers are way down. Our new subscribers numbers are way up. All 3 variables are strong, and that will ensure not just the top line growth rate, which you pointed out, but I think it's also important to point that we also continue to grow our bottom line. Even giving out early guidance and took it up 200 basis points, and that is even with the fact that our logistics provider is costing us 200 more basis points, which they shouldn't have been able to do. So if you -- so we really thought the profitability would go up substantially, which it had anyway.

Got it. Makes sense, and that's clear. So moving on to the bundle and ARPU uplift. I mean, what's the latest as far as adoption? And also wondering, on the $29.99 bundle that includes some tutoring services, like how are those trials performing?

So for people who don't follow the company as well as you do, Chegg, essentially -- we have a lot of services. We have Mathway now, which is $9.95 a month. We have Writing services, which is $9.95 a month. But the big driver of Chegg's revenue growth, profitability and subscriber growth has always been Chegg Study at $14.95 a month. And we've not raised our prices for 10 years, even though we have plenty of pricing power should our growth rates begin to slow, which we don't see any time in the near future. But then we added a $19.95 bundle, which combined Chegg Study plus Writing plus Math. A year ago, Chegg really was in the international and hadn't launched the bundle yet, so you got to see how much we've done since that point. It's been pretty extraordinary, and all of them are exceeding our expectations. So what do I mean by that? So there were things that we didn't know about the bundle: What percentage of new subscribers -- we only marketed to new subscribers because we really don't want to interfere with the auto renew of the existing subscribers. And over time, the old ones will go away, new ones will come in. And so for '22 and '23 and 24, you're going to see a real acceleration in profitability and a revenue growth because a higher percentage of the renewals will be the $19.95 versus the $14.95. It's a built-in growth rate, which is pretty great. But what we're seeing is significantly more, and I mean significantly more new subscribers take the bundle than we expected. That was a big positive surprise. And the second big positive surprise is that we had no idea if anybody outside the U.S. can take it. And with the accelerated growth of international to begin with, we weren't really sure -- because we charge $14.95 and $19.95, we don't have different prices for different countries because we grew into it faster than we expected, that approximately the same percentage of international subscribers are taking the bundle as U.S. subscribers. And that's another big positive uplift and surprise for us. So we see all of those trends up into the right beyond what our expectations is. And again, you asked, why do we feel comfortable in giving guidance last November and then upping it this February. It's because those are the trends that we not only saw, but have sustained over the course of nearly a year.

Got it. And just to clarify, you -- at this point, you're still not marketing the bundle to existing subscribers, that it's just for new subscribers?

Correct. And we don't really plan to, because one of the great things about having an app and about having the web is that most of these students, even though their monthly subscriptions auto renew. And because they auto renew, introducing an unexpected experience -- because they just go right into the service. So we would have to block them when they go into service and ask them if they wanted to upgrade. And what you know about students is, they can be fickle, and introducing something that interrupts their flow is not a good idea. And because the new subscribers were so much more than we thought, both in terms of total volume and the percentage taking the bundle, we didn't feel a sense of urgency to do that for any particular reason, and our numbers are still outperforming significantly.

Got it. And you mentioned increasing retention rates, and we're on the topic of ARPU uplift. Within Chegg Services, there are other revenue streams, some ad revenue, Thinkful, tutoring, I guess, historically. So is there any more -- like, I guess, it's hard to really piece out what's happening as far as pricing -- like strict pricing in ARPU versus retention students staying on for longer periods of time within the quarter. Is there any more context that you can provide to help dissect the components of -- broadly.

Yes. I can give some good color on it, and I think it will make it clear to people. So first of all, last year, RPS and ads went down. We're seeing a recovery in that. And I think ad companies are seeing that in general. And you're going to see that with Google and other people. So that's been a good trend. But the reason that our ARPU really looked down last quarter, even though it's up, is because we had such an acceleration of Mathway subscribers, and Mathway subscribers are only $9.95. So the ARPU of Chegg Study subscribers is going up because they're coming on earlier, staying longer, and that's what we mean by increased renewals. And it's going up because it's a large percentage that are taking the bundle. So if we were to just parse out Chegg Study and Chegg Study Pack, you'd see the ARPU going significantly up. And you're going to see that probably for years to come because as I said, next year, a large percentage of the base will be $19.95 instead of $14.95, and they'll start renewing every month. So you'll start to see this transition where a smaller percentage of $14.95 and a larger percentage of $19.95. So we expect to see ARPU growth in all of those things. But if you look right now, ARPU -- Math and Writing ARPU is about, say, $9.95 a month. Just more of that. And then in Chegg Study, ARPU is up, and Chegg Study Pack, obviously, is higher. So every trend is the ones we want to see. And that's again why profitability is going up so nicely, even though we're making real significant investments in technology and platform as well as content. We're just in a very good position to be able to invest and grow and increase profitability where other companies may not be in that position.

That makes sense. I guess the other thing from my view to consider is if with such rapid growth in subscribers, if you had them joined in December in the last month of the quarter, that subscriber growth would inherently be higher than that ARPU piece, and that would translate to looking pretty good for the following quarter.

That's correct. It catches up over the course of the year. It really depends on timing. So if you think about timing, we see -- in the first quarter, we see the majority of -- we see a big bump in late February and early March because of midterms. And then we see another one around May or June, which gives us the rollover into Q3. And then in the fourth quarter, we see them starting around Thanksgiving. So you're right. I mean it's hard for everybody to time all these things, and honestly, for us, because international is becoming a significant part of our business, their timing is new to us also. So time of day is new, when their midterms are new, when their finals are new, when they use us are new. But the good news is their renewal behavior seems very, very, very similar to what we're accustomed to.

Got it. A few more questions on international. Can you talk a little bit about brand awareness internationally? It's obviously really strong in the U.S. Wondering how important it is internationally, if you're trying to replicate that kind of success globally. Also wondering, do you have like the EasyBib, sort of high school presence at all internationally? And like is that an effective pipeline for customer acquisition to paid subscription?

Yes. I'll answer the second one first. So for those of the people who don't know what EasyBib is, we have the largest writing services. So if you have a teenage child in high school or college-age kid, they have all used and are using EasyBib, our citation machine. We have 30 million users of it. It is global, but it's not as big globally as in the U.S. So we cover like 75% of high school students in the U.S., and it is a good theater and a good brand builder, as you pointed out. Internationally, the brand is being built the old-fashioned way. It's actually being built the way Chegg Study was built in the U.S., which is through search. So we are really good at SEO, and we are really good at performance marketing. We don't spend brand marketing or those things. Because what ends up happening, which was a big surprise for us 7 years ago when we realized this, is it was not clear to me as a parent that a student using a service like ours, which all their friends were using a service like ours, it's just you don't know that people talk about what they do for homework online. It turns out they do. And so what ends up happening is word of mouth is pretty extraordinary. So what we see -- what we're seeing internationally is pretty similar to what we saw 6, 7 years ago in the United States, just faster than we saw it grow in the United States. Which is when every student was forced to leave campus, almost the same week around the world, most of them had not looked at services online to be helpful to them because there really weren't any. So if you look around the world, all the big ed tech players are either in China and India. You don't really know very many, at least for college-age students. And so they weren't comfortable or familiar doing it. What ended up happening was when they went off-campus, they didn't have campus support. They started to search. When they searched, they discovered us because for years, we have been quietly indexing in search globally the same way we've done domestically. So we've been preparing for this growth, and I think we talked about it on earnings calls in the past. So they discovered us, and we saw this giant spike. Then what happens is you can see it by school. Once you get a few students at school, it explodes. It's a giant network effect by school first and then it goes by country, because then, students go home and they tell their friends. That's the exact same way that it happened in the U.S. And so we're seeing unabated growth, even though everywhere in the world, with the exception of the U.K., they went back to school last year. So it's been just a -- we knew this would happen. We were just talking about betting on the inevitable, and we knew that what we do was global. It's STEM. We're not into politics or literature or other things. This is about business and math and science, and that is a global language produced by the same publishers almost everywhere in the world. So we knew that what the service that we had was right, but what we've done now is we've invested in international commerce, ability to take local credit cards, charge local tax. And our expert Q&A networks are beginning to be able to not only translate the content we have into local languages, but answer questions in any language and have them come back in every language. So this is all investments that Chegg has been making. That's all part of our expenditures, even though our profitability is going up. And so we just -- we feel fortunate to be in this position and that we expect it to be significant for a while.

That's helpful. And from my view, it's one of the biggest opportunities out of these different growth drivers just when you think about TAM expansion. One question I did have on realizing that addressable market, there's some big numbers, 190 countries around the world with subscribers, and now, a target for 1 million subscribers internationally. I'm just wondering...

More than 1 million.

More than 1 million. Okay. Good. I'm wondering how you break it down between international -- students that are now in different countries around the world, but were going to U.S. schools, and they're just not in the U.S., which would be slightly less potential maybe for that viral effect of spreading around international schools. So like is there some context for how many of these are just -- are domestic U.S. students, who are now home in different countries versus the potential to penetrate international schools?

Yes. It's a very fair question and one that we didn't know the answer to because international just exploded on us. Like I said, we had done the work. We've built the commerce systems. We've built the payment systems, the tax systems, the SEO. We built all the technology, but hadn't yet really begun to promote it in any significant way. Then everybody went off-campus, and so we didn't know the answer to that question. Two things. The number of international subscribers that we had in the U.S., the number that we all receive far exceeds that number to begin with. So we know that, that's not an issue. But we went 1 step further and we surveyed. We asked the subscribers, "Have you ever been to school in the U.S. or gone to a U.S. school?" And that number was [indiscernible]. So these are all non-U.S. people going to school not in U.S.

Perfect. Really interesting. So with 5 minutes left, wanted to shift over to skilling, which I think -- I mean, so far, I haven't let you talk about skilling. But normally, that's where a lot of your passion is and definitely like the future. And so for an investor that has a longer time horizon, 3 to 5 years, it seems like it's a very important area to understand for that investor. And so with this in mind, like how should investors get comfortable with Chegg's position in the skilling market to new market. Why is your company positioned to succeed there?

It's a very fair question. So the first thing I would say to our existing investors and potential new investors and to our company and my team and my Board is the existing Chegg business, as you know it, is going to be a significantly larger company doing what we do on a global basis for many, many years. It is extraordinarily profitable. It gives us the premium to invest in smart things for future growth. But that business -- we're not looking for another business because the core business isn't great. The core business is spectacular. But what we see and what our students are asking for and what -- the numbers are just obvious, and I'll just give a couple of the numbers. 50% of high school students do not go to college in the U.S. Let's just talk U.S. only. Of the 50% that do, which now becomes 100% base, 43% of them don't get a degree. And of those that do get a degree, on average, it takes 6 years. So what investors know is where they went to school and where their kids go to school, and that is not American. What we saw in the pandemic was many things. We saw institutionalized racism. We saw institutionalized poverty. We saw increased poverty by student debt. We saw the failings of the education system that Chegg has been trying to bring to visibility for years. We saw the schools being unprepared to teach online, unprepared to assess online. But the one thing that stood out from the economy standpoint, which I think investors see every day, and to your very first question, are you a pandemic-stuck or not a pandemic-stuck, is the tech-enabled economy accelerated during the pandemic and the service economy collapsed. And so 25 million people in the U.S. got hurt badly from something they had nothing to do with. But what it did was reveal the fact that if you were a young person, your future is being in tech-enabled jobs. That does not mean everybody needs to learn to be an engineer. We need to separate out a coding boot camp from what we are talking about. Amazon itself has said they're going to try to train 29 million people over the next couple of years to learn how to put their companies on the cloud or use the cloud. In other words, these are not consumer services that they have to learn. So if you're an IT in a company, you're now figuring out how to put your company on to the cloud. Those are brand-new skills, whether it's Azure or Google or Amazon or in financial cloud like Anaplan, or a HR cloud like Workday. These are all new skills. These are not ones that people are required to go to college to learn; these are ones that you can learn in 6 months and with very little or no debt and be employable after 6 months. Chegg sees a massive opportunity for those that choose not to go to college, those that drop out of college, or those who have gone, but didn't get these skills and now realize that they want those skills. That market will be bigger. So the market that you see Chegg performing in today is mostly domestic, educational support. That is huge. International will likely be bigger because there's more people. The skills economy will even be bigger. So we just continue to see opportunities for growth. And when you realize more than 50 million people over the last 10 years that paid Chegg for something, our brand into the workplace is absolutely really high even though we're not used there. So we're seeing people come to us and asking us, "Can I learn these skills?" Thinkful acquisition was a toe in the water where we wanted to understand, if we double the curriculum, lower the price, offer alternative forms of payment and build in the Chegg IP that no other skills company has -- because people have asked this, it's more competitive than learning support. That's true. But nobody in the skill space has the learning support that Chegg built that we plug into the skill space. So the primary reason, other than money, that people drop out is because they get stuck. Our 24/7 skills-based support and our learning support prevents you from getting -- from staying stuck. It gets you unstuck. And our logic is everything is figure out-able. And so when a student, when we plugged it into Thinkful, over 75% of the students already have used our 24/7 on-demand support built into the curriculum, and we've seen an improvement in graduation rates. So the more people that graduate, the more people that employ. So what our premise was when we bought Thinkful, we needed to prove it out, and we proved it to ourselves, which is why we see a really big opportunity for our investors and for the country, frankly, to be able to build tech-enabled skills into the future employment economy. And that's what companies are asking. So I think investors should feel, if Chegg's core business is great and will be great, this is not to replace it. We're not looking to like we did in textbooks, try to get out of a business to get into a new one, which we did quite successfully. This is additive to the great business we already have.

Perfect. I think that answered a lot of questions on scaling the opportunity, increasing the lifetime of a customer and why Chegg is positioned to be successful there. I think we're out of time. So I really want to thank you, Dan, for taking the time and providing us with all your insights on the business. I really appreciate it.

And I want to thank you for your thoughtful coverage and support of Chegg because I think most people don't understand how big the academic support and skills economy is. And I think they're just beginning to realize it now. And so we welcome people to the journey because this is going to be an important one and a profitable one. So thank You.

Awesome. Thanks.