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

Welcome back, everyone, to the Jefferies Software Conference. Pleased to have with us a long-time guest, and we're big fans of the Chegg story. Andy Brown is with us. Andy, thanks for joining. And I know this is probably not the way we wanted to start the conference, but it is topical. And I think Tracey and the rest of the team will appreciate if we kind of knock this out early. But there was some news this morning with Pearson, and I think everyone would just like to hear your perspective. I know there's probably not much you can say as it relates to cases, but there's been a lot of questions we've had, in general, just about how you license content versus your created own content. And I know there's been a trend over time that you are effectively creating more of the content and populating this with your own team rather than licensing. So I think a good opportunity to maybe just level set how this works and where you're at today and then also kind of if you can fill in what this means on Pearson.

Yes. I guess that is the right beginning question at this point. So yes, first thing is, it's great to be here at the conference. And like we were mentioning in the pre-conference, I also kind of like these virtual conferences, right? I don't have to fly all over the place. But with respect to Pearson and Chegg's content, I think it's superimportant for folks to understand that we have 66 million pieces of content on our site for Chegg Study and Chegg Study Pack. So that's what we're specifically what we're talking about. Of those 66 million pieces, approximately 5 million are what we call textbook solutions. And that is really what all this is about from Pearson. And so less than 10% of all of our content is related to textbook solutions. And of those 5 million questions, approximately, the answer is, and they're not questions, it speaks to the questions of approximately of all of the questions that we have answered in textbooks, about 25% of those are actually from Pearson. So it's a very, very small amount of content on our site when you actually do the math. So that's one thing to understand. And the second thing is that when we look at how we acquire students, it's primarily through actually our expert Q&A, which is the other 60 million questions, right? And so we get less than 10% of our actual acquisitions come through textbook solutions. And once again, Pearson is only 25% of the 5 million, so once again, a fairly small number. And so when you look at it from a purely business standpoint, and that's the only way I can answer it because I'm not a lawyer, is from a purely business standpoint, it's not that large. In fact, it's small, I think, is the first thing. So the second thing to note on this is, and I think you had alluded to this, about licensing content or whatever we do. So when you look at the 66 million pieces of content, the vast majority of that, I'll call it, 98% or even closer to 99% of that content is actually generated by Chegg. We don't license much of the content. We have a few videos on the site that are, I believe, licensed not from Pearson, but from somebody else. But the vast majority of our content is owned by us. When we do license things from publishers, and I think we've talked about this in the past, we have licensed the question. And so then the question becomes, is why would you license the question? And we've licensed the question primarily so we can SEO. And we've done that with several publishers over the years. We started that with McGraw-Hill 8 years ago. And we've done it with other publishers. We also did it with Pearson, and that contract ended at the end of May of this year. So that contract expired, and we pulled down those questions because we didn't have the license to them. So that's where we are. It's a very small piece of our business, textbook solutions. And once again, for those of you that have some history, and Brent, I know you do, if you went back 10 years ago, textbook solutions was all of Chegg Study. But today, once again, less than 10% of the content on our site and certainly less than 10% of how we acquire customers. So for us, it's a nuisance, obviously. I don't like to be woken up in the morning to 50, 60, 70 e-mails saying, what's happening? But from a purely business standpoint, it's not that big a deal.

And I guess for those that haven't examined this, what are they accusing you of just to set the record, just what is the concern?

Okay. So the best I can tell, once again, not a lawyer. So we did take down all of the questions that they had licensed to us, what I call the verbatim questions that we had license to. Those got taken down from our site because the license expired. I believe, once again, I believe, not a lawyer, I want to be really clear, I'm a finance geek, is that it's more around the paraphrasing of the questions. Students ask those questions. So that's my understanding, but I'm going to let my legal team be more definitive on that at some point. This is still very early.

And just to go back to I think the way that some of these solutions worked in the past, as I understand it, was that you signed kind of a master agreement where it was like you would pay a dollar value and ultimately would give you kind of unlimited use based on a dollar value that you were willing to pay that you could use that. Is that how it worked in the past?

Yes. So how it worked in the past is we, so there's a couple of things maybe. First thing is on that, yes, we would license the question. It's licensing the question at the end of the textbook. And we would use it primarily for SEO purposes. So we would index that question in the search engines. That's the primary reason we use it. It has been typically a fixed annual fee. But the text, once again, those textbook questions have just become much, much less relevant for us in acquiring customers. Like I said, it's less than 10% of our customer acquisitions come through that type of source. Most of them come through the expert Q&A. And I think the other thing to note is that as far as the answer to the questions, we have full rights to answer the questions. So whether or not it's a Pearson question or an MGH question or a Wiley question, we can answer that. From what I understand, there's no legal right that we can't actually answer that question. So this is really just about the question itself.

Got it. Let's go back to the core part of the business, which is the funner topic, which is helping learn to earn. And when you think about what's happening, I think last year, you obviously saw a massive surge. And you've been seeing great growth, but there's been this overhang and concern of the back-to-school bogeyman that ultimately, as students go back to school, that they're going to go to the help desk and they're going to go to their buddies that are in the Starbucks and help them kind of answer the questions. What does this mean for Chegg? And you've been pretty clear that it doesn't matter. You're going to be with them anywhere, whether it's in school, out of school, remote, wherever you're at. If you could just kind of set your view of what you're seeing straight of what's actually happening on the demand side in a world that's reopening and we're starting to see, obviously, everyone is going back to campus.

Well, yes, it seems that way, the vast majority are going back to campus. I think it's becoming clear that it's going to be more of a hybrid model from a learning standpoint. Even if you're back on campus, some of those classes may be remote. The thing that we saw in our business, and it really was driven by us, really 2 things. And the first one, we've talked about this many times, and that is the account sharing issue that we've had for many years. That is something that, to your point, if we haven't solved the technological problem there as far as creating it very hard to do account sharing, that may have been an issue going back into the fall. But one of the things we did about a year, I guess it was right about a year ago where we implemented technologies around device management and then MFA technologies. And so that, what we called proximity sharing, when kids were on campus, right, where they say, can I just use your Chegg account for an hour. We've eliminated much of that ability. So as kids are going back on to campus now, we've got very different protections with respect to our subscriptions than we had just 12 months ago. And so I think that has a big impact on us. And the other thing that you're aware of, and we've been investing heavily in this and really leaning into it is on the international side of things. We continue to see great expansion internationally. We put out a number there back in February saying we'd have more than 1 million subscribers from international sources. I think people thought that was a little bold at the time. We reiterated on the last earnings call. So we're seeing some really, really nice traction internationally. And so those are the things that we're seeing at this point, and we're early into this fall season as it were. And it's what I'll call transitioning as pretty much as we would have expected. Like you said, most kids are going back on to campus, and that's exactly what we expected.

There's an opportunity for clients to ask questions. You can join the portal and ask questions. You can also e-mail me. Happy to ask any questions throughout the day. There was a question as it relates to just other textbook publishers and those content deals you have in place, for example, McGraw-Hill and others. Are those, it seems like there's a rolling kind of thunder of expirations. They don't all have the same expiration date. But ultimately, how that works? And are you in the process of kind of unwinding those relationships across the board? Or is this just a one-off with Pearson?

Well, I'm not sure unwinding. But you're absolutely right, there's kind of a rolling thunder. We started just for some history. We started at our very first license was with McGraw-Hill pre going IPO. So it would have been 8 years ago. And these are typically multiyear contracts, call it, 2 to 5, I think maybe 5.5 years. And 7 or 8 years ago, they were very valuable to us. They just become less valuable over time given the fact that we, once again, with the expert Q&A that we implemented 7 years ago, that is, by far, the biggest source of our new subscriber acquisitions. And so as they come up, we always evaluate the cost/benefit of being able to use those questions and indexing them in the search engines to acquire customers because that's really what it's about with those contracts. It's all about customer acquisition. It has almost nothing to do about the content. So we evaluate them as they come up and from a cost/benefit standpoint and they've just become, they're not irrelevant, but they're less relevant to us because like, once again, we do the same thing every time a student asks a question on our site. We actually take that question. We do the same thing we did with the textbook solution questions if we have them, and we index it in the search engine. So if there's a similar question, we get the free, potentially the free search or top 1, 2 or 3. So that's why we always evaluate them on an ongoing basis, and once again, just become less relevant over time.

Many in the industry talk about a rule of 40. I think you had a rule of 73 last quarter with 30% top line, 43% bottom. You've got a very fortunate business model. And I think Dan said this earlier in the year that there are kind of 2 public companies in edtech, and there'll probably be 8 to 10. We certainly have seen the rush of IPOs that have validated how good your model is. Many ask, how do you pull this off? What has been the secret sauce to have that type of top line and that type of bottom line, which is very rare in the industry?

Well, I think it's interesting. The bigger question we've been getting more recently is, are we not investing enough, right? Is the model too good? But if you think about it, we do have a unique model in the sense that we're, I think, the only public company that is actually direct to student, right? And that's created a brand. And what's that allowed us to do is to really, unlike a lot of other companies, and not even in the education space, even subscription companies where our cost of customer acquisition is ridiculously low for a variety of reasons. The way we do SEO. We index the questions that are generated by students. And our content is renewable. It's write once read many times. And that's applicable not just in the U.S. but across the globe because physics is physics, math is math, accounting is accounting for the most part. And so when we start to expand beyond the U.S., much of that content is relevant. We don't have to generate gobs of new content. So what it allows us to do is fairly, allows the model is to have fairly significant leverage. Now having said that, we continue to invest heavily in future growth opportunities. And you've seen some of those. And you don't see them when we're doing the investment. You see it when the actual, the product comes to life. For example, we've done really 2 major kind of what I'll call faculty type expansions this year, right? One, we announced earlier in the spring, and that was Honor Shield. And the second more recent one that we announced just this last quarter was Uversity. And that allows professors and teachers to actually make money by uploading content on to our site. So we are making pretty significant investments. And so like I said, the question I've had more often than not over the last couple of quarters is, are we investing enough? The answer is yes. We do continue to invest heavily. We just have a very unique model in the sense that a lot of what we develop, it gets leveraged over multiple things.

There's another couple of client questions, and I'll read through them. You have $2.5 billion of cash. And the question was, are you earmarking this just for M&A? Or if the stock continues to stay weak, would you be open on the buyback?

Yes. So both, right? So we've done both over time, right? So the initial intent for adding capital to our balance sheet really was, was primarily, was for us to be able to potentially do more transformative acquisitions if they became available at the right price. And we can go through all of that. As you alluded to earlier on, the IPO market is hot. There seems to be, private companies seem to have fairly premium valuations at this point. So there haven't been a lot of opportunities recently. Having said that, one of the things we did announce, and I have to think when this was, maybe 1.5 years ago. And that was, we did announce a buyback program. And it was a securities buyback program. And so it allowed us to buy back at opportune times, whether it be the stock or whether it be some of the underlying convertible debt securities that we have outstanding because those can become dilutive at certain prices. And so we have done that over time. So we evaluate at times of dislocations whether or not it makes sense to be buying back the underlying convertible debt that potentially have dilutive impacts to them or whether it could be the stock, but we do have a buyback program in place, and we evaluate it continually.

Great. There was another question. I don't think we can answer this, but I'll read it. The question was just, how do you expect this case to play out? What prevents students from copying and pasting questions from Pearson textbooks going forward? I'm not sure there's much we can add there, but I figured it's on the minds of investors so I'll have to ask.

Yes. I think how it plays out, I don't know, obviously. That's a legal question. This just came up in the last 12 hours. So that's hard too, less than 12 hours, actually. So that's hard too. As questions get asked, we do screen if there's things that are being asked that are proprietary, copyrighted content. So that is stuff that we do on the front.

Yes. Can I ask you a question as it relates to, I think many have viewed others in the education industry as not being super innovative. So typically, when you watch a football game, and if you're up 49 to 4, you tend to see theatrics from the losing team. Is there a little bit of theatrics going on from your perspective in the industry that's going on that's a little kind of...

Well, I do think, I think it's fair to say. And this is something that I've had a dialogue inside the company for some period of time. And Brent, you've been with us for a long period of time. We're a different Chegg today than we were just 5 years ago, right? If you think about it, 5 years ago, we had a sub-billion-dollar market cap. Today, clearly, it's much higher than that. We've become a bigger player in the industry. And anytime you, and I've been through this at other companies before. Anytime you become a bigger player in the industry, you become a target, and that's part of doing business. And it's not something that we like. Obviously, finding out at 10:00 or 11:00 last night that we were being, that suit, but the fact of the matter is we are a target. We are a leader in this industry. We are an innovator. I mean, if you think about what we're, of all of the edtech companies or even go education companies out there, how many have done what we've done where we've created a massive brand, gone direct to the student? And by the way, we're doing what students and even you and I do, and that is we want on-demand services. So yes, we have been an innovator in the education space. That does, unfortunately, at times make us a target, but that's okay. We're going to continue to innovate. We're going to continue to serve the students directly. What's in the best interest of the students, that's what we're focused on. And if that ruffles feathers along the way, so be it. But in our mind, it's more important that we serve those students the way they want to be served and allow them to get better outcomes, hopefully, better jobs as they go through their academic or their skills process. And once again, that's who we are, and we'll continue to do that.

There was a question, just how is the general academic year trending and kind of how you think about what you're seeing so far as students have come back? And then I guess there was another question as it relates to just thinking about seasonality for subscribers. The question was, should we think about third quarter as a sequentially down quarter for domestic? Can international grow to overcome? How should we think? Any color you could add would be helpful.

Well, a few questions there. I think we've got a couple of minutes left. So how is that? We're early in the fall semester. It's kind of trending like we'd expect. Kids are going back. Students are going back to campus, which is different than it was a year ago. So that's completely as expected. As far as seasonality goes, we're a seasonal business. I mean, if you think about how Chegg is, I mean, our year really is the school year. And that is the last week or so of August all the way through kind of the middle to the end of May. As a result, when you look at Q3, for example, that we're in right now, it's the low. From a seasonality standpoint, it's the low point because the students are, there's less students. Student, I'll call it less student weeks in Q3 than any other quarter. Whereas Q4, there's more student weeks. And so we have more subscribers, more months of subscriptions. And so that's just a normal cycle. And for those that are listening, you can go back to the last many years to see the seasonality, and I don't think it's going to be materially different by, I call it, fiscal quarter than we've seen over the last several years.

Andy, always appreciate you having us. Wish we had more time, but thanks for joining the conference.

Okay. Awesome. Thank you, Brent. Take care.