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

Josh Baer, I'm a software analyst here at Morgan Stanley, and we have the CEO of Chegg, Dan Rosensweig. I have some disclosures. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. All right. Dan, thanks for joining us.

Welcome.

And I think maybe to provide a bit of an overview, I was hoping you could dig into some of the biggest trends going on in the higher education space and really how Chegg is positioned to address them?

Yes. I suppose that's probably the most important question because of what happened when we reported November 1, just as sort of a background for it. We got caught by surprise that -- so a large percentage of students in community colleges in particular or 4-year state schools that most people don't graduate from, opted out of going back at all. And then those that went back, you can just -- if you follow college football, you could watch every one of them at stadiums without masks on resocializing. And then the third variable was -- of those that went back, they took fewer courses per student and they took easier classes not in their majors to sort of reintroduce themselves to school. And believe it or not, 17% took more pass fail courses than they had previously. So those were the dynamics that were entirely unknown to us and then revealed themselves to us. The next quarter we did really well. And in order for a subscription company to beat as much as we beat by, which was like $10 million or $12 million on the top line and then $10 million on the bottom line, which is a great business model, by the way. Three things had to happen: one, suddenly, people are like, oh, s***, even though they're pass/fail, we've still going to pass. And so somewhere around mid-November, the subscriber base just flew. The second thing, and this is good for permanency, is a much higher percentage of students took the Chegg Study Pack versus the basic Chegg Study. And so you can assume that's $5 more a month. So assume it's $25 more a student over the course of the semester that we get. Third is enrollment at community colleges is open. So more people did start to come back, and we started to say that all of that revealed itself in the quarter, and that momentum continued, which is why we felt comfortable about giving not just Q1 guidance, but '22 guidance. Historically, we gave the year before guidance in November, we didn't. Weirdly, we're the only company that gave guidance in '21, which was great until it wasn't. So we -- what we say now after the fact is the bottom was not as bad as we thought it could be and the return came sooner than we thought it would come. And that's all good news for us. So what's happened in those dynamics? Well, here's what you're betting on as it relates to enrollment. In higher education, enrollment goes up when the economy goes down because it's not the schools that you go to or if you have kids that they go to. The majority of Americans go to state schools, and 30-plus percent of them go to community colleges. When the economy is up and they can make a lot of money, they're ripe to take it, and they do. You have to decide whether or not you think in the second half of the year where the economy will be and whether or not supply chain issues will be cleared up and whether or not people are going to be paying 3x the salaries for those jobs. What did we assume? We assumed, and this was our wordle of the day, prudent. Our second half of the year guidance is prudent. We don't assume anything. We assume no improvement. So -- but what I think gets lost in the shuffle there is our international business is on fire. And we grew from 0 subscribers 3 years ago to 1.5 million subscribers in 3 years. There is no other consumer education company globally that have that many subscribers. That's just what happened in 3 years outside the United States. The other variable that's really good news for Chegg is not only are more people taking the bundle, but we also said there were record renewal rates. So of those that are Chegg subscribers, they are really Chegg subscribers. And internationally, the retention rates and the take rates are approaching that of the U.S. So over time, our margins just get bigger. And then the last thing I would say and then go to the next question is, we bought Busuu, which I think is an extraordinary acquisition. The history of Chegg is we bought Cramster, which became Chegg Study. We bought Mathway, which we accelerated its growth when we bought Writing and accelerated its growth and profitability for all of those things. Chegg does really well when we buy companies in really strong verticals. We grow them faster. We make them more profitable. When they are older companies that are actually businesses as opposed to sort of the new tech stuff. So Busuu adds 500,000 more non-U.S. subscribers, 26% of them are in college and 50% of the U.S. college market says they want or need to learn a language. Up to this point, Busuu really has not been in the United States. So we have all of our audience to market it through with no cost of customer acquisition. So that in our balance sheet put us in a phenomenal position as we go into '22 and '23 and '24.

Great. All right. Probably have time for one more. So I think pick it...

22 more minutes.

No, I'm just kidding. So wanted to...

Or should I be talking about it in 2 years. No.

All of those points are great and want to dig in to all of them if we do have time. I did want to follow up on the reinvigoration of the academic intensity at this point in the semester, what are you seeing?

What is this? March? So midterms are coming soon. So it's premature to tell you. But what we did say was we felt really good about giving strong Q1 guidance because whatever positive momentum happens in Q4 rolls over to Q1. So the way a subscription business works. So what I would say is we love our audience, we love our business. We feel good about what we've said. And I think we'll continue to distance ourselves from the Pack. See that was faster.

Great. Before we dig in, I wanted to ask you about Learn with Chegg, Uversity, Chegg Life. Broadly, what are the key takeaways from these personalization efforts and new types of content?

So each one does a different part. Let's take the furthest from what we do, which is Chegg Life. It turns out if any of you -- look, during the pandemic, if you were being honest, I think many of us struggled with anxiety, depression, confusion, other things. Imagine you're a college student. And imagine you're not a rich kid college student. Imagine you're actually America's college student. So 3 things that have become crystal clear to us through surveying our audience: one, mental health is a crisis, and it's like a real crisis. And I don't know about the rest of you, but the Stanford goalie killing herself devastated me personally. Like that just hit hard. That's such a successful human being with everything before them would pull the final trigger. That is not unusual on college campus, is an epidemic now. So mental health, financial health. Other than Bitcoin, they don't know anything about money because they don't have checkbooks, they don't have anything. They just have massive loans that they're going to have to pay off once they graduate. So mental health, financial health and then soft skills. Chegg Life is designed to do the other half of the student, the nonacademic half. And we believe, over time, we will either partner where they have services that will allow us to either sell as a package or include in our Study or Study Pack for higher prices. So that's the business reason for it. The emotional reason is what I said earlier. The second one is Uversity. So Uversity, what is it? The more Chegg spends on content, the better our business is. Unlike Spotify or Netflix, which are remarkable companies run by people way better than me, our content is profitable. So for every piece of content we have, if the question has been asked, it's asked by a paying customer, which improves retention. Second, that question gets indexed in every search engine around the world, which increases the amount of customer acquisition and lowers the cost to nothing because it's in free search. So the more we spend on CapEx, the better our business grows. Uversity is an acknowledgment that if you're a student and you can get content from a professor at your school, that should increase both acquisitions and retention. And, of course, the quality of what we do and over time, allow us to raise prices, which we already know we have the pricing power, but we like to go in providing overwhelming value when we do it. So what is Uversity? Uversity is Chegg's -- really our first ever reach out to academic institutions and professors. Now you may not know, and we had this conversation earlier, that 1.2 million professors in this country are adjunct professors, which means they get hired annually. They're nontenured. They probably work 2 to 3 jobs a day, and they don't have time to build curriculum. So Chegg now has the opportunity for every professor in this country in categories that we want, either to deepen the category or to expand to a new category to provide their practice tests, their study guides, their syllabus, their lectures. We now have video capability where they can actually provide their live lecture if they want, their lecture notes. So you occasionally hear about academic integrity for us. You hear it from the same 5 people and the same short-sellers. But we have now, in 3 months, in 90 days, we had over 1,300 universities, professors at universities participate with the Uversity, and we paid out $14 million to them, which means that they've given us 80,000 pieces of content. And we expect, and we said this on the earnings call, over 150,000 by the time we launch it to students. So we're going to have more content, higher quality content, more relevant content. So then the next part, which you asked about is Learn With Chegg. Learn With Chegg is just code for personalization. So 2 things you want. You want to be able to continue to offer content and you need to make it much more discoverable. And then you need to make it as part of discoverability rather than them look for it, us push it to them. That should help in word of mouth of new customer acquisition, but it absolutely helps them with retention. And you saw in Q4, we said we had the highest retention we ever had since we started to roll it out. The more -- we had 75 million questions already asked and answered in our database. There's no way for a student to even comprehend that. So the ability for them to not only discover it faster, but have it pushed to them, really adds value and retention and increases profitability for Chegg. So they're all dots that connect.

To follow up on Uversity. If you put that kind of together with Honor Shield, your academic advisory board, and these are multiple kind of, in my view, like strategic moves to get closer to the university that were not there a couple of years ago. Like how should we -- what should our takeaway be from kind of those partnerships and getting closer to the university and staff?

Well, I think you said it. The takeaway is we're not looking for a fight with the academic institutions. You have to appreciate the perspective of the student, which is what we care about. Take away the schools that you all went to. The graduation rates in this country are below 50%. That means every one of these schools has you pay to apply. If they accept you, they know 1 out of every 2 is not going to pass, then they tell you to go get a loan that you may never be able to pay back. So the good guys are depending on your perspective. But where we're in alignment in this? If a student does not pass the institution's financial go down. The reason that the costs go up in college is because retention is so low that you have all these empty beds and all these empty chairs sophomore year, junior year and senior year. So think about them all as planes that leave with empty seats. So your top of the funnel is freshman year. So everybody now knows. Plus they're in COVID, what do they figure out? Their budgets -- you're in a red state in particular, who knows what the blue states are going to do. But if you're a red state in particular, people are choosing health care over college funding because the budgets have only so much budget. These are all state schools, giant state schools. So they're all government employees. So here, that means the thing that gets cut first are all of the services designed to support students. So increasingly, what we do is being desired by universities. So we -- what we believe is over time, if we build a relationship with the professors first. And honestly, it's through their publicity of their stuff plus the money we pay them. Then we start building a relationship where we can offer the services through the school. It's just a way to low-cost expand who we can serve. And we've been -- look, I don't know how big that will be or when it will be, but we are in discussions with schools now because the reality is they don't have any way to help these students and we do. They rather just take from it.

Right. So I want to move on to international. I think one of the biggest growth drivers for you and starting to get some metrics there, 1.5 million subscribers, I think 11% of total revenue. Any context for how we should think about growth or really where that opportunity is coming from, from a country or geographic perspective and kind of what's next near term?

Yes. You could see I have a lot of pent-up demand to tell this story. So let me just start with the obvious. 3 years ago, Chegg had 0 non-U.S. subscribers. So in 3 years, we went from 0 to 1.5 million. I think we could stop doubting the growth rate because there is no other education company that is anywhere near that number of subscribers globally. That's just non-U.S. Second thing is does it continue? And how does it continue? And then what is the business model around in terms of profitability compared to the U.S.? So we were not prepared for that level of growth outside the U.S. We have not built all the necessary infrastructures. We've been -- the one place Chegg benefited from COVID was outside the U.S. because when everybody was forced out of their schools, they went to the Internet for the first time and they discovered us. And that's actually how it happened. We have been indexing for years, but we had never spent a marketing dollar outside the U.S. So when that happened, we immediately -- and we said you can check our earnings calls, we are accelerating the investment in our commerce platform. Why? We actually could not take a non-U.S. credit card at that point; two, only in 4 countries today, can we take -- can we present in local currency and take a local credit card. So we're now expanding the number of countries that we can present in local currency and take a local credit card. And that should all be done in '22, like that'll clean through in '22. The last part of that is for those of you that track our traffic, and I know there's some very smart people in this room that do, you will see we have massive traffic from big places, the Philippines, India, Indonesia, Mexico. The top of the funnel is not a problem for Chegg outside the United States. What is the problem is if you don't present it in local currency, you don't get -- take a local credit card and your prices are too high for those local markets, the conversion is really low. So everything we are doing this year is to learn the right price point. Now the good news is it's all margin. There's no incremental cost of delivering Chegg outside the United States versus the United States, which is different than Spotify, which has music licenses in every country or Netflix, which has to pay for local content as well as the global content. That's not our issue. So because it grew so quickly, we were not yet prepared to handle it. That should all bode really well for '23, '24 and '25 because we know the demand is there because it's all stamped. We're not in those problems where we're dealing with politics or religion or other things or even literature at this point, which you can -- a really complicated issue as it relates to religion in certain places. So if we can get the cost down -- which we can because it's literally pure margin. And when we put out our earnings, as I said earlier, you can see the core Chegg before Busuu has 36.5% EBITDA margins. And we said that 58% to 60% of our EBITDA goes to free cash flow. So we're the strongest by far, and we'll continue to grow top line and bottom line. So on international, we just think it's massive, and it could ultimately be bigger than the U.S., which is what our objective is. And then you add Busuu on top of it, which is 500,000 more subscribers actually paying more. And so we reported 11% without Busuu, it's going to be closer to 15% with Busuu. So it's exciting.

Got it. And so your comments on the strong top of funnel, you're basically saying that you'd expect once you figure out some of the local currency and payments and set it up that way that from a customer acquisition perspective, it should be -- kind of resemble the U.S.?

Well, in some cases, remember it will resemble the early U.S. where the growth is just a lot higher. The other good news, at least what we're seeing so far -- so the bundle was -- turned out to be brilliant by accident for us. We had high expectations for the bundle, but I don't think we thought the take rate was going to be that high. You can assume everybody that takes the bundle over the base, they're worth about $25 more to us per year, and it's all margin. There's no incremental cost because it's just bundling, Writing and Math inside of Chegg Study. It has been phenomenal for us. What we're seeing internationally is as many people are taking the bundle as they are in the U.S., which is a shocker to us in a good way. And the second thing is, over time, retention and renewals will start to mirror the United States, which are at their all-time high. So all of those things bode really well for '23 and '24 and '25 and honestly, for '22, which is why we put out strong guidance for '22 versus what I think people thought we were going to do.

Great. On Busuu, I just want to be clear on the strategic fit. And like should we think of that as a new content domain getting into language through -- kind of roll into Chegg Study and increase the value there? Or should we think of that on this like as entree into the skilling side of your initiatives?

So if you know my family, we're not an [indiscernible] family, we're an [ end ] family. So I don't know why you wouldn't think of it as those plus more. So let me just give you the rationale. And I gave some of it earlier. First, we do really well with businesses that have been underfunded, that have been around for a long time. That seems to be the core of what Chegg buys well. Two, when we can leverage our audience and their audience, we can accelerate ours in their growth, 26% of Busuu's customers are students outside the U.S. and 50% of our U.S. students want language. And so those are obviously, business rationale strategy of how you can accelerate their growth and decrease their costs, which increased their profitability. And we showed that they were losing $18 million. Even though they're losing $18 million, if you look at Chegg, our margins are going up. That's how good our core business is. You can assume we're going to take those losses away at the end of this year, right? That's the plan, and we felt comfortable in saying that. So we'll just get more profitable. The third thing is the skill space. So what's the difference in Busuu and Duolingo. Duolingo is an amazing company. He's an amazing CEO. Duolingo is for the more casual learner and has gamification and really high churn. Busuu is for the person that needs to learn it. Everything Chegg does for the person that needs to learn it. So it adds to our skills portfolio because in the United States, it won't surprise you after I said it, but the overwhelming majority of what they want to learn is English and Spanish. So we now have the ability. 25% of all college students English is their second language. So we think we have a really good opportunity in the United States given how popular language is and particularly on college campuses. Plus, our relationship on skills with Guild, which I think is going to be a really big deal over time. We want to become their language partners. So they already have access to 3.5 million corporate learners at Walmart and Chipotle and big medical companies and Target. So that business is picking up really well for us. It's what we hoped it would be. And then when you can add language to that, that's more in the portfolio. And then honestly, it's a great stand-alone business like Writing was and Math was growing on their own. Now you asked the fifth part, which is could we include it in the bundle. Nathan believes we can, but that's not going to be our priority. Our priority is going to continue to accelerate its growth right now. I think there are other things we'll add to the bundle first as we build from a monthly membership to annual membership.

Great. I wanted to talk about skilling you brought up and mentioned Guild partnership, language and then you have the Thinkful asset. Just more broadly, is skilling still a top priority for you? And how are you looking to address that, whether through current assets, future partnerships or even M&A?

Yes. Look, it's a really fair question because when we bought Thinkful, we only paid $80 million for it. So it's not one of these multibillion-dollar transactions. What we thought at the time, it turned out to be wrong. We thought it would be a big direct-to-consumer business. As you've seen, if any of you follow Udemy, their direct-to-consumer business has gone down, not up. The reason is because unemployment is so low; and two, corporations are willing to pay. So them and Coursera and 2U, they're all building sort of corporate sales forces. The challenge that we have with that is none of them are profitable. And there's no guarantee that any of them will get profitable. We like profits as a company. So their growth is slowing, their profits are getting worse. We're going the other way, where our profits are getting better. So we saw that coming. And we approached Guild, who is a phenomenal company run by a phenomenal CEO. Their vision was help corporations get their employees, particularly frontline workers college degrees. Our view was that is wonderful. But we believe that in addition to that, what frontline workers really want is to get more job security, get paid more and get better jobs. So we work with them to put skills through Guild, which is so we transform Thinkful from a direct-to-consumer sort of like for-profit learning to a content creation and distribution through Guild. Yes, we still have the direct marketplace. And over time, skills will get bigger and bigger and bigger, bigger for us because we'll have both the direct-to-consumer marketplace, market skills directly to Chegg customers, but Guild is our first priority this year. And so the way that model works is we build the content, we write it once, use many times. The corporation says, this is what I want you to build. They promote it and market it. We have no cost of marketing, and we keep the overwhelming majority of the revenue. So that alone could be massive over time. We only started in December, and I really feel good about it because the future right now is corporates paying for it, not direct-to-consumer. And if we don't have a cost of a sales force and we have access to the biggest corporations on the planet and we're only providing what they ask us to provide, this is as good as it gets because employees would rather take this then get a college degree because the college degree isn't going to get them a better job in Arkansas, if they're working at Walmart. This will get them a better job at Walmart, which they love. Walmart is a great place to work, believe it or not. And they're just an example because they have all these other companies, but I also happen to -- the Head of HR, who put this together at Walmart used to be the Head of HR for Adobe and she and I have been friends for 13 years and her son Kyle was an intern at Chegg. So she reached out to Chegg and said, can you go through Guild? So it's exciting for us. And yes, we expect to get bigger in the space, but we're going to be very patient with these other companies to shake out what their real business models are.

Great. I'll ask another one and then see if anyone in the audience has questions. I mean I think in this environment, margins and margin expansion is important.

So how come you don't write about that in your report when you write us?

We do, we do.

Is there any other education company profitable? No. Is there anyone increasing their margins? No. Is there anyone who has 50% to 60% free cash flow? No. Okay. I said what I came to say. What's your question?

Question is, with that in mind, and you're delivering there that you talked about ARPU, bundle adoption, all these other ways to increase the lifetime value of the subscribers.

Our ARPU went up 5% each quarter for the last 2 quarters.

So with that increase in LTV in mind, are there ways to spend more on customer?

To grow faster?

Yes.

It's a really fair question. We've never spent a lot for customer acquisition. We just don't. It's not obvious where you would spend except on ourselves. We have 87% name recognition in the United States. We have incredible virality. It cost us $3.50 in total to acquire a customer. The content is the way we do it. So what I would say to you is we have been by adding more content. That is actually a better way for us to spend to acquire customers because it's used once -- it's right once used many times. It's -- that piece of content is valuable for everybody for years and globally. So we've increased that. Uversity is a good example. So whether you want to call it a marketing dollar or a content dollar, I don't know, but spending more money -- look, anybody who's got a direct-to-consumer company trying to spend on Facebook right now, I think you see what they're up against. Thank goodness, that's not one of the problems we have. It's like 99 problems, and that's not 1 of them.

That's great.

Only CEO to quote Jay-Z in this meeting. All right. Other questions? Nobody? Come on. I may never talk to anybody for 2 more years. This is my one shot.

All right. I can finish it off with one more. The required materials strategic review, if you could just touch on that. Why is now the time to think about alternatives? Any updates there in regard to supply chain or just the strategic review there?

Yes. So as those of you who follow us for a long time, the whole company was textbook rental. We had always said, that's not the business we want to be in because logic would tell you 3 things: one, it's a commodity business; two, it takes a lot of cash; and three, print shouldn't be around for this long. It shouldn't even be around now. But it was always something students valued. It was always a way for us to keep the publishers honest. And to some degree, it was a good form of customer acquisition for Chegg Study. But honestly, when the textbook business is this size and Chegg Study this size, it's not. It's not a thing. So we did it as a courtesy because we still ship millions of books. So what finally happened? What finally happened was shipping costs got ridiculously high; two is textbooks are less and less and less popular among students of any kind. And it went from a flat business and breakeven to a shrinking revenue business and losing money. So that's where I draw the line. If it's not a business -- I mean, this is a great Henry Kissinger quote, it was like what you know you need to do ultimately, you should do immediately. And we now hit that tipping point where we're going to do immediately. So if you modeled our company and you said, what is Chegg's actual growth rate, not including textbooks, our growth rate is higher. If you look at our margins, our margins are higher. So we'll come out of that. It's just a much stronger company. And my update is I have confidence that what we said on the last call by the end of this year, we'll have resolved that issue in a very positive way for Chegg. Our goal is to continue to offer it to students without owning it because we still want to keep everybody honest. It's still something they love us for. It's our sort of our core brand with older students. So that's it.

Awesome. Thank you, Dan. Really appreciate it.

Great to see you.