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

Okay. We'll get kicked off here. My name is Josh Baer, software analyst at Morgan Stanley. We have the CEO of Chegg, Dan Rosensweig, here. Thank you for joining us. First, research disclosure. For important disclosures, please see the Morgan Stanley research disclosure website, www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representatives.

Dan, will jump right in. I wanted to ask you about what you're seeing in the higher ed environment in regard to student behaviors, enrollments, academic intensity. So maybe to start on the enrollment side, there was some data that showed some more modest declines year-over-year, thinking about the fall semester and actually improvement in the freshman cohort. So I wanted to ask you how this impacts your business if enrollments do stabilize following the last few year period? Should that help stabilize the Chegg Services business and return to subscriber growth?

Yes. The answer is we are seeing some version of return to normalcy. But I have to just continue to remind people, the big issue wasn't so much that it was 1.5 million people leaving the higher education market, almost all at once. And you're all experiencing it now with inflation, which is this is the group that got wage inflation. This is the group that was being hired during COVID, where they could get 2x to 3x what they were earning before. So they're working at Starbucks and Amazon and Walmart. And the higher education market in the U.S. is 70% state schools, less than half of them graduate. And so these are people that go to online schools, go to community colleges or go to 4-year schools, but will never likely get a degree of any kind, let alone a 4-year degree. That's the whole that -- as COVID started to ease, the freshman cohort did stabilize. And our year is August to May. So the thing is when people look to is January going to be better, January is never better than the fall because it's just an extension of the fall. So the question is going to be what's going to happen next fall? So if we hit a recession, next fall will be higher than people think because during a recession, more people are unemployed, more people go to college or go to school or go to online or whatever they learn more. If it doesn't, then we'll see the continuation of the normal cohort that we've been seeing, which is sort of 0% to 4% on the freshman class. We are still cleansing all of that out to your question. The issue around if there's a recession, what does it do historically, as I said, it grows our market. So those 1.5 million people that left, some percentage of them will have to come back because -- so that would help us. It's not what I'm rooting for as a human being, but that would help us. Also, because we're global now, we've got U.K., Canada, Australia, the English-speaking countries are our largest, and then we have growth in India and other places. And those economies also affected it last year. So the good news about the resiliency of our company, which I don't think we have done the job necessary to explain it is, there -- I don't -- if you know another profitable company in the education space, let me know. We make a lot of money. We have a lot of EBITDA, we have 33% to 35% EBITDA margins, and we pushed through over 60% to free cash flow. So we generate a lot of cash. That maintained even when the growth stopped. So we have the resources, the capability, the profitability we can control our costs as we need to. It also gives us a lot of chance as things pick up to be more aggressive. So that's part of the resiliency. The second thing is, there was a giant leap from 2019 to 2020 in our new customer base, which we all experienced. Then '21 sort of hit the peak, '22 dropped from the peak, and that's what Chegg experienced. So that drop was a drop of new accounts and people that dropped out and didn't go. And that is when we took our guidance down a year or so ago by like $50 million. And so that $50 million, if we had it, would have rolled over to at least half that this year. So that's the whole that we talked about on the last call that we're making up from. And so as we continue to experience growth in new accounts again, that hole starts to get made up. And so you can look at '24 and '25, and you say, okay, I can see how the growth returns and how the EBITDA margins expand. So that's what's got to happen and that's what's happening. And -- but there's 2 parts to this year. There's -- this is the rollover from the first half. And then there's -- I mean, from last year's. And then we have the second half of this year. So we're just being hopefully cautious and smart and controlling the things in our control.

Great. Great intro and a lot to dig in there. One question. When you refer to Chegg is the only ed tech -- profitable ed tech company. Are you thinking about it on a GAAP basis?

GAAP basis, EBITDA basis, free cash flow basis, net income basis, [ pick a basis ], right? So you've got the skills companies that are all losing $20 million to $25 million, and we'll make over $200 million in EBITDA. It'd be nice if you wrote this stuff. But from my perspective, if you think about what your big question is going to be, I don't know if anybody's heard of ChatGPT, is there on anybody's mind. The big question is who can compete in a world of AI? Well, you have to have resources. We have them. You have to have audience. We have them. You have to have a data set, we have them. So if we execute a big fair question, we should be advantaged by it. So I look at a lot of these companies, and we've done the transition of our model. What we got to do is fill that hole. That is really the core issue for us is fill that hole of the drop of new accounts from the peak to last year, which we hope was the trough. And then grow it back again. And if we do that, things will be great. And if we don't, then things will not be.

Got it. And I will be asking the big question on ChatGPT. Just wanted to first...

You said ChatGPT, I did. I've said, can you just compete with you? It says I can. Mentioned me by name, I did. Didn't you guys ask it?

On the topic of academic intensity and student behaviors are we normalized there?

Intensity is back and has been back. And I think -- there was just -- there's so much noise in the education space right now for legitimate reasons. There's just a lot of noise. It's hard to focus on the different elements. But we saw over the course of '22, that begin to return. I don't see a scenario where it goes down. I do see a scenario where schools are finally going to have to get the message that the Internet is here and students will use it. And ChatGPT-3 is just a good example of that. But -- so the way people assess will have to change. The way people learn will have to change, and like every institution or large institutions or government institutions, which most state schools are, it will take a long time for them to do it. But that's going to be their focus more than intensity. It's how do you assess people. The intensity has to be there now.

Great. So Chegg certainly can compete with ChatGPT. But how do you think about ChatGPT as a competitive threat? And has it impacted your business so far?

It is very early, and there will be more than just them. So I can't make the kinds of predictions I'd like to be able to make because I've been through -- for those of you who don't know, I've been in the tech industry since 1983. So I know when a platform shifts come, this is one of them. Mobile is the last one. The Internet was the one before that. All the other stuff like cloud computing is not a platform shift. For those of you -- I mean I ran Yahoo! for 5 years. For those of you who ever used Yahoo! Finance or Yahoo Mail, that was the cloud. because you can access it from anywhere. It's just became a great thing to put a high multiple on. So this one is going to be how people do things. It's designed -- this current version is designed to be a tool. We have always been using it internally to increase the quality of our content responses and the speed of our answers and lower the cost. That's why you've seen our margins expand. We've always used machine learning and AI on the cost side. What we're seeing now is the consumer-facing version of it and a very early one. It is a generalist site. It cannot sustain itself being free. It has really 2 models. It's going to either be a subscription or it's going to be [ ads ]. So it's going to be hard for it to be ads like Google would have been hard for it to be as if it didn't generate traffic to other people. So the cost of building these things is astronomical without revenue coming in, they won't make it. At the moment, it's impossible for me to know whether or not there's an impact. All I can do is compare what we thought was going to happen before we did -- before it came out to what's happening. So what I said on the call is it's not obvious to me yet, because I would see it in retention. I would see it in cancellations, and I would see it accounts. That doesn't mean it isn't affecting me. It's just I can't see it in what I expected to happen versus what's happening. But to some degree, it may. We survey our students. We know that a bunch of them have tried it. The overwhelming majority of students won't use it because it's not that easy to use, maybe for all of you. But remember who the college students are, it's not that they're technologically savvy or not, but would you rather go to a Chegg where you just put in the question or do you have to figure out all the prompts. And then do you have to guess if it's right. So at the moment, it can't compete with what we do. It can do things that we cannot do. It just turns out that when we put in our top 2 questions into it, 96% of them had no answer for. Of the 4% that it did, 50% of them were inaccurate. That's not where it's going to stay. So I'm not sitting here going up, the ship doesn't work. I can pay for that. But it will get better. But it also needs to be trained on data sets. The other thing that people don't give Chegg credit for is we have the largest learning data set in the world. We have over 100 million questions that have been asked and answered. We have 13 million to 15 million new ones a year. So the scenario that we envision, the one that we believe wins. So my experience -- all of our visions are based on what we've experienced in life. So having run a giant portal, what I learned was verticals beat the generalist because you've got to tune it towards the specific needs. So very few use Google for travel, you still use the travel sites. Very few of you, Google for Commerce, you use Amazon or Walmart or your favorite brand commerce site. So verticals ultimately win because they're tuned towards this specific action. So our expectation is they'll have what they have. We'll have what we have and what they have because that's their model. But the difference is our stuff won't be available in their marketplace. Their capability will be able to be tuned against our marketplace, but only exclusively inside of Chegg. So that proprietary data that we have, those 100 million-plus questions growing at 13 million to 15 million a year is our competitive advantage. If you can come to Chegg and pay your subscription and get the best of Chegg and the capabilities of AI, the conversational real-time capabilities to take our solutions and ask your questions, ask it definitions, ask it to do practice tests. These are things that we'll be able to do that generalist AI will not be able to do without our data set. So to some degree, we're actually really excited about it. Because the vision has always been to be the ultimate learning tool. And this is the ultimate learning tool. The magic of Chegg is it's instantaneous and you can guarantee the quality. There, accessibility is a question and quality is a question at the moment. But if you can take what the dream of being, which is the conversational aspect to ask questions, trained on our data set, we become the ultimate learning tool. And that's pretty exciting. So we're jazzed by it. Our teams are working. We're -- we've seen 4, right? We're in there early. We won't have the capability or the resources to even attempt to do this. They'll put out PR releases, but use the product and decide for yourself what is it? So at the moment, we feel good. But there's no guarantees when there's a new platform. We'll see what happens. They can't guarantee it. They can't guarantee whether or not it's good for humanity or going to eat us alive. So -- but in the short it should be an advantage for us if we execute.

Okay. That's very, very helpful. And then related to your use of AI, you mentioned the cost efficiencies. Any more context for how your content costs change?

At the moment, they don't. But we've talked about expanding to the other 10 million students in the U.S. that we don't really serve with what we have. This is a much more efficient form of being able to do that because that's more [ A-ish ] writing, political science, those things. Second is, it should substantially increase engagement without us having to pay for those content costs. So -- but it's way too early for me to give you that level of specificity.

Got it. And then to that point on addressing the rest of the domestic market, you're over 6 million subscribers domestically so far. Between ARPU and subscriber growth domestically, how should investors think about the growth algorithm there?

I think it's smart for me to say, let us come through this year and fill that hole. If we fill that hole successfully, which is what our objective is and what we've articulated, that will be quite robust actual new account growth. And so that will show that, that market is still there. And then on top of that, you have all the ARPU growth, which we've said for the first time, 1 out of every 2 new accounts is now taking the more expensive version, which is great. And we still -- we took a price increase and lost 7,000 accounts out of [ 6 million ]. So what that tells you is we have a lot more price elasticity. I think we've just got to just be smart and recognize we've got to get through this exit of COVID, but we feel very comfortable that we have that pricing capability. We feel very comfortable that we'll continue to see high renewals and high take rate of our more expensive package. And those all bode well for ARPU increases, yield increases. But I just don't want to get ahead of ourselves because we had 19 straight quarters of beat and raise and then 2 out of 4 were like a mystery to everybody, including us. So we just want to get back to that rhythm before we start making any bold prediction.

Makes sense. On the ARPU, so I think the last quarter, you mentioned 40% of all study subscribers were on the bundle and sort of maybe...

We average that in Q4. That's good. That means it's way up.

In thinking about where that can go? Like you just referenced closer to 50%. Like is that a good proxy for where the base could go? Or could it be higher?

Well, I think you -- I think let's combine 2 things together, which is what is our price capability, and what is the value proposition that Chegg brings and what can we bring? So one way to think about it is a higher and higher percentage, we'll take it. The other way to think of it is it just may be the base price in the future. So one way to look at it is there will just be on Chegg and it will all be [indiscernible], and then the bundle could be [ $24.95 ]. We -- I realize everybody's attention span is very short. But we think about these things in multiple years. So the bundle has only been there for 2 years or 2.5 years, and now 1 out of every 2 takes it. So where we can go would be when you start adding what AI can do and you start adding the things like we're doing with DoorDash or with Calm or with other people we're likely to announce with the value of what we offer, both in terms of what people will pay to begin with and how long they'll stay on, both have the opportunity to increase. And that's been the plan. It just takes time to roll it through a whole system of 6 million U.S. customers. right? That's -- so we don't want to screw the whole thing by trying to be in a rush to do it.

Great. I wanted to ask you on the partnerships. Right now, Chegg Study subscribers get access to the com premium app and student DoorDash, one of those things. It seems like a win-win for you and your partners. So 2 questions here. Of course, a lot of value for students. Is that the core strategic rationale from your perspective, giving value to students hoping to help with retention maybe through summer break so that you're not turning off the subscription?

Absolutely, yes. So there's 2 parts. Why did we do Calm? We did Calm because there's a crisis in this country. Student mental health, and that's why Chegg 2 weeks ago, launched the first ever global Student Mental Health Week at lobby Congress. I was very happy to know that all 10 Congress people I saw every one of their staffers had been a Chegg customer. So we're good with the government. I'm not good with the government, but Chegg is good with the government. Calm was to test the concept. How could we market it, could we get people to upgrade, how do we get people to activate it. And because there is this mental health crisis on college campuses that is should scare everybody in this room, in this country. That led to our ability to do DoorDash, which is more one that should affect our business. So DoorDash can affect it in a couple of different ways. It's way too early to know how many of those ways. First one is since it's only in the bundle, did help take rate. We believe that it has. The second one is, will it help retention? We're not going to know that until we monitor those that activated it and what they do over the summer. So I cannot tell you that I know the answer to that question, but it's absolutely part of the objective. The third thing is will it increase overall conversion in the funnel. I don't know that yet. Now that it has affected take rate. That's the first obvious one because we can see that we expect 40% to take it and the 42% took it after we put it in, then we know that. It is too early to know which of all of those things that it can affect, but it is being activated by more people than we thought, and that should be good news for DoorDash for sure and for us.

Great. And right now, is it a meaningful expense for you? And then the second part of the question is, when thinking about these types of partnerships, is there an opportunity to monetize from your perspective to provide access to your valuable base?

Yes, I think, at the moment, there's no negative impact whatsoever on our cost, 0. So to your point, the value to DoorDash and companies like DoorDash, let's not just talk about DoorDash, right? Companies tbey want to work with us is they get millions of dollars' worth of value of being marketed to every college student in the country without them having to write a check. Therefore, we don't have to write a check. So for us, the upside will become one of the following. It will either increase take rate, increase conversion, increase retention or some of all of those things. That will have a material impact. Or if it doesn't work, it won't, but it won't have cost us anything to do it. For them, it's millions of dollars worth of visibility in Chegg's endorsement versus somebody else who could have had that slot. So it is a win-win for both companies. And Tony is a phenomenal CEO. Dara is a phenomenal CEO. I've known Dara, and I've known Tony, but they're very excited. We're very excited because it's very hard college kids. So this is a way for them to do it without them having to write a check. And the expense to them is well worth it because they now got an active customer who's ordering food. So it's only the cost of the past that they wouldn't -- that they're not getting but they're getting customers using it for delivery. So at the moment, we all feel very good. So for people wondering like are we buying them like are we like Verizon buying them in bulk and paying them? The answer is no, we're not.

Okay. Very helpful. I want to see if we can cover international and margins in about a minute each.

Sure. Let's go country by country.

So on international, I guess the -- we've seen the increase in revenue percent contributed to your company, increase in subscribers. Some of that has been aided by the Boost acquisition. So I guess, just the question is, how should we assess the -- your progress expanding internationally?

Yes. If you look at it as a whole, it's hard to do it. So let me break it down into different components. You have the developing world and you have the 3 large English-speaking countries, Canada, U.K. and Australia. The same hole that we saw in the U.S. market, we saw in those 3 markets because they behave the same as the U.S. market. So that hurt. That created a whole in international growth, but that doesn't mean the other parts of international aren't growing. So that was unexpected, and we're growing out of that, too. So that's good. The second thing is we made a technical error, if you will, on one of the largest growth opportunities, which is India. India should be and will be a very large country for us, strictly based on the numbers. For those of you who follow it, they have a lot of people there. I don't know if you know if you do that. But on top of that, they have the largest English-speaking audience outside the U.S. as exemplified by the Indian Times, right, is, I think, the largest English newspaper in the world. So there's a large even English speaking because there's like 120 different dialogues, very hard to do in all the different dialogues. So we said all along, we were building technology that allowed us to present in local pricing. We have done that. That has been helpful. What we didn't do was recognize that in India, the overwhelming majority of people would rather pay by debit than credit. So our partners were credit, not debit. So we've met with the Indian government who's trying to push this decentralized platform. That is something that we are working on, and I expect that, that will unleash India in a way that we just need to do it, with credit cards, but we still have to build that. And then we're working on it now, obviously. But -- so I would say that we are very confident over the long term international. We have to dig out of the English-speaking holes in the more developed or the wider countries, if you want. But other countries, I mean, so here's a challenge. Turkey was going great. They had 2 earthquakes like that's not something we can do anything about. But one of the first apps that we built fully in a local language was Turkish, like hard. So that's small blip for now but won't be a blip forever. The second one we built was Spanish in Mexico. That, of course, is not impacted by that. So just think -- just you either believe in the inevitable like we do, which is that more people are going to learn online and need more help, and we're going to be that place to do it with what we do plus AI, which is conversations. Just think of it as conversational capabilities to ask more real-time questions against our data set. If you believe that, then we are a very good bet. If you don't believe that, then we're not a very good bet. And nobody can predict the absolute future of these things right now. But for the moment, we feel good about ourselves and about the future. And as I said, we have capital. We generate free cash flow. We generate EBITDA. We are GAAP profitable. So if you're looking for any existing competitor to take us on, it would be very hard to do.

Okay. Great. We are over time. So really appreciate it, Dan. Thank you.

I appreciate you. Thank you.