Udemy, Inc. (UDMY) Earnings Call Transcript & Summary

All right. Let's get started. My name is Josh Baer. I'm a software analyst here at Morgan Stanley. And we're joined by Sarah Blanchard, CFO of Udemy. Before we get started, 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. Thanks for joining us today.

Thank you for having me.

Awesome. So I wanted to start with a bit of an overview. Some of you in the room or on the webcast might have taken a course from Udemy, know the company, but it would be great to level set, just given your recent IPO. And so if you could sort of start with addressing what Udemy is, how the marketplace and the platform has evolved over the last 15 years?

Yes. So Udemy has founded in 2010 by a fellow named Eren Bali, who grew up in Turkey, and he didn't have access to -- in a small village, he didn't have access to great education with a one-room schoolhouse. And at some point, his parents got him a used computer and Internet access, and he's a math prodigy, it just opened the world to him. And he realized that there were so many people out across the world with lots of great skills and knowledge that they wanted to share and so many people who needed to learn. So he created this marketplace, he moved to the U.S. and he founded Udemy and he created this marketplace, which after a few years, grew to about 1 million users and then continued on from there. So our foundation is a marketplace where anyone, anywhere can share their knowledge in any language. And then in 2015 -- that continued to grow, in 2015, we curated the best and highest quality content that we were able to see from the users on our marketplace and the feedback that they were given, and we curated it into a catalog and packaged it and started selling it to enterprises. And so we launched Udemy Business, and that's been growing at a phenomenal rate ever since. Last year, we reached 239 million in ARR, growing at 80%. And the foundation really is this marketplace that allows us to see where there's really high-quality content, and it's super broad and it's completely global, and we can package it up for this really differentiated offering.

Great. So I want to definitely dig into Udemy Business and consumer, but maybe to start on the marketplace concept and where the content comes, how do you attract instructors to the platform? What insights or tools do you give them to create that content that's in demand?

Yes. So I think the really brilliant thing that Eren did was really aligning our incentives with instructors. So we have a take rate model. It's uncapped. So there's a percentage of revenue across all the different business lines that the instructors receive, and we provide them the tools that they need through user feedback and reviews and through platform tools where they can see where are people really engaging, where they're bookmarking, where are they dropping off. So maybe there's something not quite right with this part, you're going to need to go back and fix that. Because the incentives are -- it is a revenue take rate, they're really incentivized to continue to upgrade and improve their courses over time.

Got it. And is there a content strategy, meaning is it important to attract instructors from different domains to create content to attract new learners to the platform?

Yes. So we think of our marketplace a little bit as an amoeba that naturally actually goes where learning is going. So we have a market insights tool that shows instructors and potential instructors where there's demand for existing subjects or new subjects and where there's a lot of supply for them or where there's not a lot of supply. So if there isn't a lot of supply, great place to publish content. If there is a lot of supply, you can publish content, but you better bring your A-game. And so we use different tools. There isn't a lot that we actually have to do. Once the -- like marketplace sort of took off in that network effect, there isn't a lot that we actually have to do to make sure we have the content we need because of that tool. Every once in a while, there will be something that the market just -- that the marketplace isn't bringing to us. And so we'll go to instructors. They are our partners. We have a really close relationship with our top instructors and we'll say, "hey, you've published something in an adjacent vertical. Would you mind publishing something here? There's a need for it." And because that incentive model is so strong, they work with us. And so it's more organic, maybe than you'd expect.

Got it. And you mentioned the uncapped revenue share. What are the economics? And how is it different between consumer Udemy business?

Yes. So the consumer transactional model is 37% take rate. For Udemy Business, it's 25%. And we're in beta testing in a consumer subscription and that will also be a 25% take rate.

Great. So I want to start with the consumer segment. Obviously, the consumer segment saw rapid acceleration and demand during COVID. I think you've doubled the number of learners on the platform in just a couple of years. Can you discuss sort of that rapid increase in demand on the platform during COVID and then looking forward, what you're seeing as economies are reopening?

Yes. So COVID really accelerated trends that were already there. The consumer business had been growing, the adoption of online learning and the growth of that space was already happening. It really just pulled forward some of that growth. As we've seen countries open and frankly, they're opening and closing kind of depending on what's happening. As we've seen them opening, sometimes that will give us a little bit of a lull, while other markets because we're completely global and it's so diverse. Other markets are closed rate then and those are growing fast. So what we're seeing really is the emerging markets are growing really, really fast. There's a lot of growth in India. There's a lot of growth actually in Japan. Some of the Western markets are showing -- have been showing signs of fatigue recently. And when we do surveys, that's literally the word that comes up is fatigue. People are zoomed out and they've sort of had enough of video content. So like the U.S., the U.K., Germany is showing that. But in some of these countries, some weeks, they're showing signs of bouncing back and other ones are still struggling a little bit more. So we're just monitoring it carefully. I think we have less kind of visibility into the consumer business, not just because things are opening and shutting and the reactions are different region by region, but also because a lot of our predictive models are now sitting on 2 years of COVID behavior, which is anomalous in and of itself.

Got it. And Speaking of visibility, you did mention that you are rolling out the consumer subscription. What type of contribution or adoption are you seeing or could we expect and the timeline for that?

So we're still in beta testing mode. We're not going to roll it out more broadly, which we expect to do in the back half until we find a sweet spot. We're doing pricing, packaging and positioning, testing. And right now, it's a broad-based offering of curated content, it's called personal plan. But we are also working on more vertical subscriptions over time and actually bringing into the subscription product immersive learning capability. So think of workspaces, lab assessments, learning paths and career path. So for now, we're still testing because this is -- for many of our instructors, this is their livelihood. So we can't make a huge switch and if there's too much cannibalization. But when we find the right place where it's attractive to subscribers, but also isn't overly cannibalizing the transaction, then we'll be able to roll that out more broadly.

You touched on my next question, the lab assessments. And so does it sound like those might be -- only those would be rolled out in the consumer subscription. I guess just thinking about all the courses on the marketplace and the consumer side, is there potential for more products longer term certifications or credentials and other product offerings?

Absolutely. So the immersive learning capabilities we're first building out on the business side, and then we'll port them over to consumer. And from a model perspective, the consumer subscription, you can see how that would fit in. But how we monetize individual labs workspace is a little trickier on the transactional side. Absolutely can be done, but first, we're going to start on the subscription side, do a lot of learning there and then figure out what that offering could look like on a transactional side over time.

Got it. So changing gears to the Udemy Business side, I think. The growth there was over 80% this past year, and that's after 100% plus in 2020 and at some point in the next year or so, it will become a majority of the business. And so I was hoping you could dig into some of the core growth drivers behind this growth and really how investors should think about the durability of Udemy Business growth.

So I think there's a number of drivers. I think first, the adoption of online learning even before COVID was already happening. I think it's a very cost-effective way, and it's more targeted towards our employees instead of a one-size-fits-all. I think fundamentally work has changed. We went remote very, very quickly. And I think people realize, hey, how we used to train is just not the same as how we're going to train in the future. Those budgets are getting bigger. There's more of a focus on employees, it's retention, it's growing the skills you need. In addition to that, the digital transformation, there -- digital transformation initiatives are happening in almost every company right now. And in order for companies to keep up with that, they really need to reskill and upskill their employees. And then that's going to be a continuous loop, right? Because technology changes, it changes so quickly and our marketplace is the only solution that can kind of keep up with that pace of change. So as an example, our instructors know that there's a first mover advantage. If there's a new AWS version that comes out, they know that if they're the first or the second or the third to get a really high-quality course up for that version that they're going to be first kind of in our marketing algorithms and the more feedback, especially if it's good feedback and the more they respond to that feedback, the higher they're going to be raised in our algorithms and so the more money they're going to make. So our marketplace actually supports where the world is going with upskilling, reskilling, with retaining employees and with digital transformation. And we're completely global. So our marketplace allows us to have -- we have content in 75 languages. We have 13 different language packages within Udemy Business and then all of the preorganic -- it's pretty organic how that growth has happened because of our marketplace. So we can support foreign corporations in international in a way that most others cannot.

Great. I wanted to dig into more aspects of Udemy Business, but you brought up sort of the global footprint. And I think that's one of the differentiators when thinking about Udemy is the international playbook. Could you sort of explain how that works, how you build up content and presence in a market and execute to that international playbook.

So first, we'll see that English is taking off in a region. And then we will put a person in to sort of see the local language content. We know the courses that we need to have for you for Udemy Business or for a marketplace to really take off. And so a person -- we'll drop a person in and they will find local instructors that will start creating that content for us. Once we get to a certain number of courses, it starts taking off itself and feeding itself, that person can come out. So it's English getting used, then we start feeding the local, the local content takes off and we put in local currency. Then we put in local payment methods then we start doing local marketing when it gets big enough, and then we bring in our Udemy Business offering team. So it's kind of a land and expand within a region motion that transitions from consumer to consumer plus UB.

Got it. And besides North -- or outside of North America, where are you sort of further along in that playbook? Where is a lot of revenue coming from outside the U.S. today? And then where do you see opportunities that you haven't penetrated yet?

So Udemy Business is about 50-50 North America and outside of North America. We started in North America. So that's the most mature market, although there's still a lot of penetration to do there, then we started building out EMEA, then we went to APAC and recently starting to build out LatAm, but it's still really early days in each one of those. We're seeing a ton of growth in many, many areas across EMEA. Japan is doing really well. We just announced some partnerships with Korea -- with a company called Woongjin ThinkBig in Korea and with a company called Sanjieke in China. And really, it's -- we look at the landscape, and we say in these regions, are we going to be able to grow faster on our own? Or do we need to find the right partner? And if the right partner is there, we'll partner with them and have them take our Udemy Business offering to the market.

Got it. And thinking about these exposures with the war in Ukraine on the top of mind for many investors, just wondering if you do have exposure in Eastern Europe to Russia and Ukraine and how to think about the impact there?

Yes. So pretty small exposure, less than 1% on the consumer side and smaller than that on Udemy Business that hasn't been an area that we've focused on.

Got it. So kind of thinking back to Udemy Business and the offerings there. I was hoping you could dig into Udemy Pro and what -- how those features are different than like the core, what happens from an economic perspective as customers adopt to Udemy Pro.

So the core Udemy business, it's a few things. It's all the content that we've curated so the really high-quality broad content that includes these 13 language packages. And it's these enterprise administrative tools, if you will, where the person who is administering the program for their team or for their company can see where people are learning, and we have all sorts of like automated things to really help them engage their population. What we hear time and time again is how much more engagement we see on our platform than they see on a lot of the competitors. As an example, we ran head-to-head for 12 months in a large multinational company with 1 of our main competitors. We have 9x the learning on our platform. And they ran an NPS study and the NPS from their learners was 84. And they said that's not possible. You don't get an 84 NPS in this space. So they ran it again in the next quarter and it was 86. So that is -- that was just on Udemy Business. Udemy Business Pro is some of those immersive learning capabilities that we are talking about like labs and workspaces. We launched benchmark assessments in Q4. And what we did was we first built out 1 technology vertical, and then we're building out additional technology verticals. And over time, we'll be building out those immersive learning capabilities outside of technology. And then over time, as I said, porting that over to the consumer side. From an -- do you want the economics -- from an economic perspective? So Udemy Business is sold on a per seat basis. And Udemy Business Pro is an additional fee per seat. Right now because it's technology only, it's not -- so we can go wall-to-wall in companies. We have many contracts that are wall-to-wall even though we're only in 10% of the seats in the companies we're in. But the Udemy Business Pro right now because it's only technology, it's only going to be relevant for your tech teams right now. And because it's early, we're kind of feeding the market with it. So I wouldn't expect a lot of impact from that this year, more impact kind of in the future as we really get those customer reference points. But so far, it's been very well received.

Got it. As far as go-to-market on the business side, consumer actually is a good pipeline into enterprises. And so my question is, should investors have any concern around the slowdown in consumer translating to a slowdown on the business side.

Not at all. So really, the consumer business, it creates an amazing amount of content, and it allows us to know what is good so that we're never putting poor quality content in front of an enterprise. More than half of our leads come from the consumer side, but we also, about 2 years ago, started building an outbound motion. So we brought Greg Brown, who's our President Udemy Business in November 2020, and he's really building out that organization. He's professionalizing the organization. But as long as that marketplace is reasonably vibrant, it's going to give us everything that we need on the Udemy Business side. And so we have a lot of room to kind of -- that business can fluctuate quite a bit before I think we would see any impact at all on the Udemy Business side. As Udemy Business continues to grow and become a larger part and, as you said, more than half of our revenue pretty soon, that alone will be a very attractive way to attract kind of top instructors and keep them on board. So I think we're in pretty good shape.

Great. I wanted to touch on competition. There are a lot of vendors that an enterprise could choose to bring content into their organization. Who are your primary competitors? And how are you differentiated? And are you often sitting next to other learning management systems or HCM platforms and where do you fit in?

So we have -- there are a few kind of top competitors that we run into. It's LinkedIn Learning, it's Coursera, sometimes Pluralsight, sometimes Skillsoft. And the larger companies will have multiple solutions. Very often, the smaller companies will pick one. We're happy to sit next to them. We have a very different offering and where we really play is practical skills, highly engaging, we are integrating with all the sort of LMSs in the world so that we're really in that flow of work. And our differentiation is the super high-quality content that's so engaging, it's the global nature and all the languages that we have. And it's the upgrading that's constantly happening and updating. So over 5,000 courses a month are published on Udemy, not including the kind of upgrades and updates. We take the best of the best about 200 a month, go into Udemy Business. And so our product is constantly evolving and constantly keeping up with where learning is going, where technology is going. The other solutions because they're a publisher model, they just can't compete. It can take kind of 6 to 9 months for them to get these courses out. Because of that first-mover advantage that I spoke about, our marketplace, it's within a day or sometimes even before the latest thing comes out. We -- there's a funny story. I wasn't here, but I think back in 2013, there was rising demand in the marketplace for Bitcoin, and no one even knew what that was. And so we had to go in and take our Udemy classes and see what that was. It's just been a great example of how the world knows what it wants and what it needs, way more than we could or any publisher could. And I think that's where our differentiation comes from.

Great. When I talk to customers, they really value the practical nature of the content like real-life solutions from individual instructors who are often...

Practitioners.

Practitioners, right, thank you. Is there a way to keep that advantage in that differentiation in your marketplace model and also build university or industry partnerships potentially to offer certifications or credentials?

So I think of those things as actually separate. And what I mean by that is we have a lot of university -- top university professors already on the platform teaching courses. The acquisition of CorpU. CorpU is a cohort-based leadership training platform that is partnered with top university instructors. So absolutely, we can have those partnerships. Although, again, our focus really is on that practical nature. So we would need to see that social proof, right? That just because you can -- you're great at teaching at a university doesn't necessarily mean that you're super effective kind of on online, but certainly many are. From a certification perspective, we have a large certification business, even though the certifications are not on our platform around some of these technology certificates that are really important. That's always been a foundational part of our platform because it keeps up with the pace of change and the quality is so high. We worked with EY to do a badging program for them. And they're including our content in their MBA program that they're going to be rolling out to their customers. But we are getting asked more and more buy our enterprises to create Udemy badging programs because they're seeing that the learning that is happening and these practical skills that need to be acquired are getting acquired through Udemy. So I think there's a lot that we can do there. I don't think we're going to go into degrees in kind of this really longer form, although we are thinking about career paths and learning paths for specific goals. I want to be a front-end developer. What are the courses and the lectures and the different things that I need in order to accomplish that? And certainly, having some sort of tangible proof point within organizations and then for consumers or to take with you is something that's on our mind.

Great. One more on Udemy Business, and then we'll talk some financials. The net revenue retention, I think, has stabilized around 118% the last couple of quarters. Any insight or context for how that breaks down between gross retention, churn, expansion and sort of the components there?

Yes. So our net retention includes everything from what we call team plan, which is our smaller customers, 5 to 20 licenses, all the way to the enterprise and the strategic accounts. And so when you think about that, we have a large amount of self-service customers. And so we're investing actually in that self-service platform to grow gross retention within self-service. It's not just small customers that are there, but it's actually sometimes really large enterprises that a small team is just like trying to buy Udemy and test it out. So from a growth perspective, we're around 85%, but that's including all these smaller customers. From a net retention for our larger customers, we're well over 120%. And I think there is -- we're not going to guide to anything, but I think there's room to grow that through not just seat expansion. We're only in 10% of the seats in the customers we're in. But also, we just launched Udemy Business Pro. We've got CorpU. And there's a lot that we can build on top of this learning platform. How I think about it is every company has their business outcomes. And in order to achieve those business outcomes, there are skills that you need to have. And we have more learning data than we believe anyone else. And so how do we help companies understand what are the skills that we have, what are the skills they need, very cost effectively, close those gaps for them? And I think there's a lot that we can build on top of this foundational platform.

Perfect. So shifting gears to investments and margins, which I think is increasingly in focus in this environment. You guided to '22 margins lower than 2021. So I was hoping you could, with that in mind, sort of walk through some of the unit economics between Udemy Business and consumer that help provide support for the investment year?

So there's a few things. Let's start with the easy things, which is like G&A, right? G&A, we really started getting ready middle of the year and beefing up those teams from a public company perspective. And so that's the team that's going to more money this year, and we'll be getting leverage over time on that. From an R&D perspective, everything we do is really with unit economics in mind. So building out the immersive learning, it's higher LTV for both our UB business customers, but also, I think, is going to be really impactful on LTV for consumer through consumer subscriptions and ultimately, potentially a transactional model, although we are not there yet. From a sales and marketing perspective, our global go-to-market team expanded rapidly in 2021. As I said, we brought Greg Brown in November of 2020. And really what we wanted to see was making sure that the machine that he was building was really effective. So how is the new sales management doing, the sales processes, sales enablement, all the pieces that you need revenue operations to really have a robust machine. And the individuals that we hired in the first half of 2021 from a field perspective, they hit 103% on average of their quota in the fourth quarter. So I think it's a great sign of that machine, as fast as we were growing, is really working. Our sales enablement is really working. And so we're leaning in because it's a land and expand. It's easier to do greenfield than to rip something out and we do have this really compelling offering with really high net dollar retention and additional products that we can add on, on top.

Great. So maybe digging into gross margins. Can you talk a little bit about the different profiles between consumer and business and how that mix shift toward business is impacting the overall gross margins and if there's any -- if there should be an expectation on a change in margins for each individually as well.

So our instructor take rate is different between the Udemy Business offering and the transactional consumers. So transactional consumer take rate is 37%, Udemy Business is 25% and consumer subscription is 25%. So that 12-point differential is a big difference in the kind of the gross margin that you'll see in consumer, which is almost all transactional right now in Udemy Business. As Udemy Business becomes a larger portion of the business, obviously, that's going to create gross margin expansion. As consumer subscription revenue becomes a meaningful part, that also creates gross margin expansion. We are investing more in our customer success team. And so that might have a very tiny impact in gross margins on the Udemy Business side. But at the same time, we're getting leverage on the hosting costs of some of those things. So that should be pretty smooth. Our gross margin for consumer has some quarter-to-quarter volatility because our revenue recognition policy is we record the revenue on the transactional side over 4 months after a course is purchased, but the instructor costs are recorded in that month. So when we have, for example, Black Friday, Cyber Monday promotion, we have a ton of buying that happens, that creates a lot of gross margin suppression. And then the following quarter, you'll have that revenue that gets recognized and you'll have a gross margin uplift. I think over time -- so our gross margin expansion is going to happen kind of organically. In addition to that, over time, we will be building products that are less of a burden on our instructors and require less from them and are more kind of Udemy-built that will be higher margin and so growing those gross margins over time. Over the long term, we think at a 65% plus is a reasonable target.

Got it. And so with -- maybe the last question I have is with sort of that framework we're thinking about gross margins, combined with the investment year across OpEx, how should we think about the path to profitability, path to breakeven, operating margins or cash flow?

Yes. So our free cash flow margins are better than our EBITDA margins and that kind of continues as Udemy Business continues to grow because you're getting that money upfront for those contracts. We are not putting an exact date in laying down for profitability, but I think it's just a few years out. And this year, even though we're increasing our investment, the increase in cash burn is very modest. So we burned about $25 million last year, and we'll burn just a little bit more than that this year. And still we're making really meaningful investments to drive LTV to drive our global go-to-market team, and we should be seeing leverage on all of that expenditure over time.

Great. A few years out on EBITDA. Talking about EBITDA.

Yes.

Great. Awesome. Sarah, thank you very much. Really appreciate the conversation.

Thanks, Josh. Thanks, everyone.