Chegg, Inc. (NYSE:CHGG) Q3 2023 Earnings Call Transcript

Chegg, Inc. (NYSE:CHGG) Q3 2023 Earnings Call Transcript October 30, 2023

Chegg, Inc. beats earnings expectations. Reported EPS is $0.18, expectations were $0.17.

Operator: Greetings and welcome to the Chegg’s Third Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Tracey Ford, Vice President of Investor Relations and ESG. Please go ahead.

Tracey Ford: Good afternoon. Thank you for joining Chegg’s third quarter 2023 conference call. On today’s call are Dan Rosensweig, Co-Chairperson and CEO and Andy Brown, Chief Financial Officer. A copy of our earnings press release, along with our investor presentation, is available on our Investor Relations website, investor.chegg.com. A replay of this call will also be available on our website. We routinely post information on our website and intend to make important announcements on our media center website at chegg.com/mediacenter. We encourage you to make use of these resources. Before we begin, I would like to point out that during the course of this call, we will make forward-looking statements regarding future events, including the future financial and operating performance of the company.

A student in a classroom with a computer, reflecting the technology degree programs offered.

These forward-looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. We caution you to consider the important factors that could cause actual results to differ materially from those in the forward-looking statements. In particular, we refer you to the cautionary language included in today’s earnings release and the risk factors described in Chegg’s annual report on Form 10-K filed with the Securities and Exchange Commission on February 21, 2023, as well as our other filings with the SEC. Any forward-looking statements that we make today are based on assumptions that we believe to be reasonable as of this date. We undertake no obligation to update these statements as a result of new information or future events.

During this call, we will present both GAAP and non-GAAP financial measures. Our GAAP results and GAAP to non-GAAP reconciliations can be found in our earnings press release and the investor slide deck found on our IR website, investor.chegg.com. We also recommend you review the investor data sheet, which is also posted on our IR website. Now I will turn the call over to Dan.

Dan Rosensweig: Thank you, Tracey, and welcome, everyone, to our 2023 Q3 earnings call. Chegg had a good quarter, delivering better-than-expected results as we saw stabilization in new accounts and increases in overall retention and in the take rate of Chegg Study Pack. In addition to our academic services, we continue to invest in skills where we are seeing very strong growth, all of which is good for the future of Chegg. Six months ago, leveraging the breakthroughs of artificial intelligence, we began to completely reinvent what we offer, how we offer it and to whom we offer it. New technology platforms create a lot of hype and noise. But as the hype gives way to facts, we believe Chegg is in a great position to build the most impactful, scalable, AI-enabled personal learning assistant, which will expand our opportunities to serve more students in more ways and at a lower cost per customer.

The history of the Internet has shown us that verticals win. Leading companies with a strong brand, category expertise, scale and resources can invigorate growth and create new opportunities when they move quickly and embrace change. In the world of AI, Chegg is particularly valuable and proprietary assets for education and learning, including our student-first brand, our reputation for quality and accuracy and our unique content and data set. Chegg also has a proven track record for improving student outcomes. And now by combining the best of what Chegg has to offer with the advancements in artificial intelligence, we are creating new opportunities to better serve our students. It has been nearly a year since ChatGPT launched. We have all learned a lot and are experiencing how AI is impacting our lives.

We know that students are using ChatGPT, but what is interesting is that they are using it for a variety of things, in addition to education. Because Chegg is verticalized for learning, what isn’t surprising is that when students try us and compare us to more general AI solutions, Chegg outperforms. That has led to incredibly high retention rates, and we are maintaining high customer satisfaction, such as 91% of students report that when they use Chegg, they get better grades, 89% say Chegg helps them learn their course material and 90% say they work more efficiently when using Chegg to understand their coursework. And we are now introducing new AI capabilities and features, which we expect will do even more for students. We are excited about what we are building and we are moving quickly and rolling out the first phase of our new user experience.

In September, we started to show our first cohort of users the updated capabilities with a new simple interface and a unified asking experience. This means Chegg can provide answers from our proprietary database of more than 150,000 subject matter experts and now with generative AI. We are focused on usage, quality, accuracy and speed and are on track to introduce our own large language learning models trained on Chegg’s unique data. In the coming months, you will see us offer more features, including multi-turn chat, which will create a simple and conversational experience and introduce personalized AI-enhanced learning aids such as practice tests, assessments, study guides and flash cards. We also plan to let students connect to each other and share content.

Over time, all of this is designed to expand our TAM and increase our relevancy to millions more students than we serve today. It’s truly an exciting time at Chegg. We are executing well against our plan, and we are on track to roll out even more features to more students in Q1 of 2024. We have only one agenda, to serve the student. What we do is incredibly hard to replicate, giving us a powerful moat. The combination of our successful learning taxonomy, our over 100 million solutions generated by Chegg’s subject matter experts and now the ability to leverage artificial intelligence means we can do what generic AI platforms cannot do. Our vision for a truly personalized learning system is coming to life. To make it easier for you to see what we are building, we’ve created a video for you that is available on our IR website, where you can see how the product is evolving.

We believe this will give you a sense of just how powerful Chegg can become, including our ability to blend our academic support and skills efforts by integrating career pathways into the student experience. We are beginning to see the investments we’ve made in skills pay off. By leveraging the latest advances in AI to accelerate our program development, we are able to create relevant, customized, high-impact programs faster and at a lower cost. We will also be releasing a suite of AI training programs over the coming months through our B2B partnership and direct-to-student efforts we continue to see Chegg skills grow and expect it to become a meaningful contributor in the years ahead. We are widening the aperture for Chegg, and we hope to reach a much larger audience of learners, one that historically we have been unable to serve before.

This is where much of the future growth will come from, and our plan is to continue to execute each quarter towards this vision. And before I turn it over, I want to acknowledge Andy as he plans to retire once we hire his replacement early next year. I am deeply grateful for the incredible contributions Andy has made during his 12-year tenure at Chegg. Under his leadership, we have grown from a physical textbook rental business to a global online learning platform that has supported more than 22 million students over the last decade. He guided us through our transition to a fully digital business and, in doing so, grew our digital revenue from 0 to over $700 million annually. In fact, when Andy took on the role of CFO, Chegg was unprofitable.

But today, Chegg is profitable and is expected to generate nearly $220 million in adjusted EBITDA and approximately $170 million in free cash flow this year. These are remarkable accomplishments, and none of them would have been possible without Andy’s leadership and vision. On a personal note, I want to thank Andy for his partnership, guidance and friendship over the last decade. He has truly left an indelible mark on this company and will forever be part of the Chegg and Rosensweig family. And with that, I will turn it over to Andy.

Andy Brown: Thanks, Dan, for those kind words. It’s been an amazing journey over the past 12-plus years, and I’m extremely thankful to you and the Chegg team and proud of what we have collectively accomplished. Also, a big shout out to Tracey and Diana, you are the best IR team I’ve had the pleasure to work with. You guys are just awesome. Our company has become an industry leader, a cherished brand that is loved by millions of students worldwide with a future that is incredibly exciting. Having the opportunity to work for a mission-driven company that is integral to helping students learn has been super rewarding, and I thank you. Now back to business. Q3 was a good quarter, exceeding our revenue and adjusted EBITDA guidance and, as Dan mentioned, we are encouraged by the continued positive trends such as increasing retention rate and Chegg Study Pack take rate.

Total revenue was $158 million, driven by Subscription Services Revenue of $140 million, where we had 4.4 million subscribers during the quarter. Skills and Other Revenue was $18 million, driven by strong growth in Skills, offset primarily by the change in the required materials model, which is now a revenue share, as well as some advertising softness. We remain disciplined on the expense side, aligning investments with our AI-focused strategy, which supported another adjusted EBITDA beat this quarter versus guidance, coming in at $39 million or 25% margin. We had 2 onetime items that impacted our GAAP gross margin and net income for the quarter. First, during the design of our new generative AI experience, we determined that certain content and system types were no longer necessary.

As a result, we have taken a charge of $41.8 million, of which approximately $38.2 million was included in cost of goods sold, which impacted gross margin, and $3.6 million included in G&A. The second item is we recorded a gain of $32.1 million from the repurchase of some of our outstanding convertible debt at a discount during the quarter, which was recorded in other income. We have a strong balance sheet and drive significant free cash flow, which we expect will continue. And for full year 2023, we now expect free cash flow to be approximately $170 million. We have opportunistically retired both convertible debt and equity, returning approximately $1.2 billion and $800 million, respectively, to investors through repurchases over the last 3 years.

We ended the quarter with $674 million of cash and investments, with total convertible debt outstanding of $603 million at par value. We continue to believe that the combination of our operating model, balance sheet and cash flows sets us up to deliver on our mission to serve students across the world, leverage AI to expand our offerings and our TAM and ultimately return to growth while maintaining strong profitability. Now moving on to guidance. For Q4, we expect total revenue to be between $185 million and $187 million, with Subscription Services Revenue between $164 million and $166 million, gross margin between 73% and 74% and adjusted EBITDA between $62 million and $64 million or 34% margin. In closing, we expect the development of AI will allow Chegg to embrace a much larger opportunity over time.

We believe there is nobody better equipped to meet the current or future needs of students than Chegg. We have an industry-leading brand, proprietary data, strong operating model and a balance sheet to extend our leadership in the future. With that, I’ll turn the call over to the operator for your questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Your first question comes from Jeff Silber with BMO Capital Markets. Please go ahead.

Jeff Silber: Thanks so much for that taking my question. In your prepared remarks, Dan, you talked about the new user experience and how you started with the first cohort in September. I was hoping you could tell us a little bit about that cohort, how large it is and what’s the planned roll-out from here to reach your entire user base?

Dan Rosensweig: Yes. Thanks. So the rollout goes to two groups, obviously, it goes to existing customers and it goes to new customers. So we started at 1% rollout. We went to 10% rollout. We’re already now at 25% rollout. So it continues to go up because the response has been really positive. So you can expect – well, what we’ve done – and we have a video coming out for you to be able to see it. What we’ve done is we’ve improved – two things to begin with, which is the user interface is much simpler, much more into the easy to use; and then we are now also able to generate answers to questions using generative AI in addition to the 150,000 experts in our database of over 100 million. So that is what we are rolling out now.

The next big phase where the user experience will change even more dramatically when we do multi-turn chat, which will be coming closer to the end of this year and then to the first quarter of next year. So it’s been really positive. Feedback has been really positive, which is why we’ve gone to – from 1% to 25%. And we think it’s going to make a massive difference in future growth and we are incredibly happy about it. Hello.

Jeff Silber: Yes, I am sorry. I must have lost you there. So I’ll just read the transcript. You don’t have to repeat anything. Actually, let me just ask my follow-up question. I apologize. You mentioned in terms of existing and new customers, I just was wondering if we can get a little bit more color from a subscriber perspective. I know initially when ChatGPT was kind of called out and was hitting new customers, are you seeing any difference between existing and new customer signing?

Dan Rosensweig: Well, what we said in the prepared remarks was we’re seeing record retention. So when students use Chegg and they use generative AI, ChatGPT and others, we win handily. And that is because we have a proven experience that actually improves outcomes, teaches the student, doesn’t just give the answer and is designed specifically and exclusively for the learning experience. And so when students see that, plus you combine with the accuracy and quality, we win handily, and that’s why our retention is doing extraordinarily well. So the battle is going to be messaging for new customers. And we’re already seeing from the roll-out test that you talked about earlier, we’re already seeing very positive response from new customers as they start to see the new user interface and the first part of the experience.

So we’re extraordinarily optimistic right now because, really, it’s just a matter of getting the message – getting the product out, executing well on that, getting it communicated. And then we continue to improve all of our metrics, including getting close to where we wanted to get to a new account growth, so we can start to expand new account growth and grow again. So we’re really excited about where we are and the plan seems to be working so far.

Jeff Silber: Alright. Thanks so much for the color.

Dan Rosensweig: Yes.

Operator: Next question, Kunal Madhukar with UBS. Please go ahead.

Kunal Madhukar: Hi, thanks for taking my question. A couple, if I could. One, on the international side, could you give us a sense of what you’re seeing on the international front in terms of growth? And second would be, again, on the international side would be competition. So how is your content relevant to customers or students internationally? And what kind of competitive landscape do you face in places like Brazil and India and Mexico? Thank you.

Dan Rosensweig: Sure. So on the international front, as you recall, in 2019, we really didn’t have an international business. Now it’s over 10% of our business. So we’ve made substantial progress. Similar to the U.S., when COVID came and we peaked COVID, we almost doubled the number of new accounts that we would be doing in the course of the year during peak COVID. But then, of course, as COVID has gone away, those numbers have gone down. And so we are now beginning to start to look to return to growth of new accounts, and we’re seeing great progress in that. And international is actually one of the places where we’re really seeing great progress. The relevancy goes up because of AI. We’re able to translate better, translate less expensive.

And we’re able to build out more categories faster, so that’s a really positive step. And we’re also finding the right pricing. So as cost per customer goes down, margins will go up even if we reduce pricing internationally. So that’s all been really positive. And so I would say, we’re making really great progress in international, even more so than the U.S. right now, and the U.S. is making really good progress.

Operator: Next question, Ryan MacDonald with Needham & Company. Please go ahead.

Ryan MacDonald: Hi. Congrats on a nice quarter. And thanks for taking my question. Andy, best of luck. Dan, maybe just can you dig into the subscriber trends and what we’re seeing on a quarter-over-quarter basis more? And maybe just sort of clarify on what you mean on the retention side versus what you’re seeing in terms of net new subscriber growth. And when do you think maybe we start to see that subscriber number or count sort of trough and start to show growth as we look over the next few quarters here?

Dan Rosensweig: Yes. So Andy has coined the phrase, subscription math, so in his honor upon his retirement. I’ll sort of walk us through this a little bit, which is, when an account comes up for renewal, what we mean by we’ve seen incredibly high renewal rates is of those that come up for renewal, they are renewing at a much higher rate and staying on longer than they ever have. And we’re also seeing a significant improvement in take rate, which is almost one out of every two new customers now is taking the more expensive version. And they are retaining at the same rate as the less expensive version. So those mechanisms are all extraordinarily positive and is why we’re able to improve our profitability and generate a lot of free cash flow, and it’s really positive for the business.