Chegg, Inc Q1 FY2024 Earnings Call

Greetings. Welcome to Chegg, Inc. First Quarter 2024 Earnings Conference Call. Please note, this conference is being recorded. I will now turn the conference over to Tracey Ford, Vice President of Investor Relations and ESG for Chegg. Thank you. You may begin.

Good afternoon. Thank you for joining Chegg’s First Quarter 2024 Conference Call. On today's call are Dan Rosensweig, Co-Chairperson and CEO; Nathan Schultz, incoming President and CEO; and David Longo, 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. 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 20, 2024, 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.

Thank you, Tracey, and welcome, everyone, to Chegg's Q1 2024 Earnings Call. It's an exciting day for Chegg, and I'm thrilled to announce that Nathan Schultz is being promoted to Chegg's President and CEO effective June 1. The Board and I have been focused on succession planning for the last several years to put Chegg in the best position to continue to drive the future of education. Nathan has spent the last 16 years helping build Chegg into the leading global online learning platform that it is today. From our earliest days as a textbook rental company to leveraging AI today, Nathan has been at the core of our success. Nathan has always led with a student-first mindset and a passion for innovating how, when, and where people learn. I will be stepping into the role of Executive Chairman and working with Nathan and the Board during the next exciting phase of the company. Over the last few years, Nathan has worked to bolster our leadership team by adding a new Chief Marketing Officer, a new SVP of Business Operations, and a new Chief Product Officer to work alongside Chuck Geiger, our Chief Technology Adviser. The Board and I are excited about this management team and the future of the business under Nathan's leadership. We see the proliferation of AI and our ability to uniquely harness its potential in education as a transformative moment for Chegg. We've embraced AI and have completely rebuilt our user experience and services, rolling out a multiyear, product-led growth plan to emerge from the post-COVID period and return to revenue and profit growth. The transition will take time, but we are already seeing encouraging signs of how our new AI-enabled platform will serve more students in more ways than ever before. This makes this the right time for Nathan to step into this new role and write the next chapter of the Chegg story.

Thank you, Dan. I want to take a moment to acknowledge the tremendous impact you have had over the last 14 years, both on Chegg and on me personally. I'm grateful for your leadership, your wisdom, and your counsel as we refounded the company so many years ago, expanding the vision for how Chegg could serve learners around the world from print textbooks to our IPO, from homework help to becoming a fully digital learning platform. You have helped steer us through so many critical transitions, and we would not be where we are today without you. And where we are today is a company that is truly revolutionizing how we serve students around the world. We have rolled out a new interface for Q&A and developed a proprietary AI platform, including our own 26 large language models, uniquely verticalized for education. We are only just starting to realize our vision for Chegg as a personalized learning assistant and will continue to iterate and develop how we bring a best-in-class learning experience to our customers. We had a productive first quarter continuing to roll out and improve upon our AI-enabled experiences that will strengthen our product-market fit in '24 and beyond. Executing against a multiyear product roadmap is essential to returning to subscriber growth as we continue to cycle through the customer expansion we experienced during the pandemic. We are focused on increasing our relevancy with students and getting Chegg back to consistent positive growth in total revenue, adjusted EBITDA, and free cash flow. We are already seeing encouraging trends at two important and early indicators: retention rate, which for Q1 is up over 100 basis points year-over-year, and engagement. We have designed the Chegg platform with students at the center, focusing on providing a learning experience that capitalizes on immediacy, accuracy, and quality. To give you a sense of how quickly this is scaling in Q1 of this year, we had over 9 million questions asked compared to 3.9 million questions asked at the same time last year. And as more questions are asked, it generates more content, which has more traffic, which we believe will lead to new customers in future quarters. This is the power of the Chegg flywheel. In fact, the increase in questions asked in Q1 has already driven a return to growth in the U.S. new customer funnel for Chegg Study. There is a growing opportunity to reach more customers with our new and expanded user experience made possible by proprietary AI technology that is resonating with students and delivering real value. As we develop an education-focused AI platform, we believe it is essential to own our large language models and quality assurance layer. This allows Chegg to verticalize our AI for education specifically and is essential in our pursuit to control quality and accuracy at a lower cost leveraging generic AI platforms. Chegg was built for this moment. Our unique assets such as our 100 million pieces of education content, our reach with learners around the globe, and our 150,000 subject matter experts come together to deliver the most effective learning experience possible. Over the next few quarters, we are focused on rolling out enhancements and features that will deliver an even richer personalized learning experience. Whether that means real-time conversational support with our AI tutor generating flashcards, generating practice problems, or creating a focused study guide. Our platform is designed to anticipate, generate, and deliver personalized solutions, which we expect will increase our value to students and expand the audiences we can serve in a cost-efficient way. We have been testing pricing and packaging in the U.S. and internationally. In the U.S., we'll continue to test different options throughout 2024. Outside the U.S., where we have tested for almost a year now, our pricing and packaging strategy has solidified. We are focused on seven key markets for education that represent an incredible opportunity for Chegg with an addressable market larger than the United States. In these priority markets, we've seen an increase in new accounts, which grew 2.3% year-over-year. Internationally, we will continue to roll out pricing and packaging optimizations as well as strength in our product-market fit through continued content and product localization. As we look ahead, I could not be more excited for the future and the path Chegg is on. Reimagining and reinventing how we can best serve learners around the world is our mission at Chegg and the opportunity to deliver a truly personalized learning experience has never been bigger nor more critical. I am grateful to have this opportunity to expand where, when, and how we serve learners because of Dan's leadership. On behalf of our employees, the Board, and our leadership team, I want to take a moment again to thank you, Dan, for everything you've done for Chegg over the last 14 years. Your legacy will always be the way you care deeply for people around you and how you always rooted for their success. Whether that is championing an employee to reach their potential or encouraging a student to realize their dreams, you have changed many lives during your tenure at Chegg, including mine, and we are all deeply indebted. And with that, I will turn it over to Dave.

Thank you, Nathan, and congratulations. Dan, I also want to thank you, and I look forward to your continued guidance as you transition to your Executive Chairman role. Today, I will present our financial performance for the first quarter of 2024 as well as our outlook for Q2. As Nathan mentioned, we had a very productive quarter. We were acutely focused on delivering our new AI-driven experience to global learners and making progress on crucial metrics like engagement and retention. We believe these actions will support both revenue and adjusted EBITDA growth over time. We continued to deliver strong profitability and cash flows in the quarter, and our balance sheet remains very healthy. We are prioritizing creating shareholder value and emphasizing prudent expense management as we navigate the path back to growth. Focusing on our first quarter performance. Total revenue was $174 million, down 7% year-over-year, including subscription services revenue of $154 million. We had 4.7 million subscribers in the quarter, with 25% coming from international. Skills and other revenue was $20 million, an increase of 6% year-over-year. First quarter adjusted EBITDA of $46.7 million represented a margin of 27%. We maintained a prudent approach to expense management and offset some of the year-over-year revenue decline with lower expenses. We are working on aligning our expense base relative to the current revenue trends. We expect to accelerate our efficiency efforts as we progress through the year with the goal of stronger margins in the second half leading to a 30% or greater adjusted EBITDA margin for 2025. Free cash flow was $25.3 million in the first quarter, representing a 54% conversion from adjusted EBITDA. As a reminder, while interest income continues to contribute positively, adding $7 million in the quarter, we are comping against higher cash balances in 2023. Looking at the balance sheet, we ended the quarter with cash and investments of $612 million and a net cash balance of $12 million. During the quarter, we completed the previously announced $150 million accelerated share repurchase with approximately 86% of the shares delivered back to us in the fourth quarter of 2023. Our end of quarter share count was down 15% year-over-year, as we have continued to return capital to shareholders. In 2023 alone, we returned over $300 million to investors through equity repurchases and $597 million through convertible debt repurchases. The progress we are making with the product experience and refueling the flywheel starting with automated solutions and engagement will take time to build our new account acquisitions and renewal base before we see a positive impact on total subscribers and revenue. As a reminder, our unique subscription business model is reliant on two large customer acquisition periods, Q1 and Q4, as well as the student life cycle. Meanwhile, as previously mentioned, we will increase our focus on efficiently managing expenses to maintain strong profitability and cash flows. With respect to Q2 guidance, we expect total revenue between $159 million and $161 million, the subscription services revenue between $144 million and $146 million, gross margin to be in the range of 70% and 71%, and adjusted EBITDA between $38 million and $40 million. In closing, we are seeing encouraging signs in the business and are excited about the continued development of our personalized and interactive student interface. We believe we are well positioned to meet the current and future needs of learners. The opportunity ahead for Chegg is tremendous, and I am confident in our team and our ability to execute.

Our first question is from Bryan Smilek with JPMorgan.

Congrats, Nathan as well. Can you just talk a bit more about the next steps in your strategy across the application layer for generative AI and potentially across both product and marketing and how it can translate to subscriber growth? And then just more near term, too. The Q2 guide was a bit below where we had expected. So can you just help us with some puts and takes around anything that stands out there, especially as you see good momentum on return to new sub growth within the U.S. Chegg Study Pack?

Thank you for the question. I will address the first part and then let David follow up. Regarding our products, we are on a multi-year journey with a product-led growth strategy that we have been developing for some time, focused on enhancing the value we offer students by increasing the relevance of our offerings. We are very excited about the initial steps we've taken in our AI vision, reflected in the language models we've implemented. We've also seen our Q&A growth increase nearly 150% year over year just in the first quarter, which indicates that what we are building is resonating with students. They see value in it and are engaging with our service. We will continue to push forward with innovation at Chegg, and we see considerable opportunities emerging from the thoughtful integration of AI across our products. Owning our AI platform is a cornerstone of this strategy. On the marketing front, it's crucial to get the product right and fulfill the promise that our customers expect. Our service helps save them time and enhances their academic effectiveness, which is exactly what we're committed to delivering. Our priority is to serve our customers well, and then we can start to expand beyond Chegg. The good news is that in the last year, we attracted over 30 million visitors to our site, providing a significant opportunity to enhance the value we deliver to students.

Bryan, this is David. With respect to the question on the Q2 guidance, a quick reminder, the math on our revenue for any quarter as a component of how many subs you have at the beginning of the period, plus how many you add in the current period. And we began Q2 with lower subs than we did in the prior year. So as Nathan mentioned before, we're super excited about the product direction that we're heading. It's just going to take some time for us to fill up that funnel to get back to sub growth. And over time, we're optimistic that we'll get there as an entire company.

Our next question is from Eric Sheridan with Goldman Sachs.

Maybe just following up on those two with a single question about the coming months. When you think about the education cycle going into the fall of this calendar year, what do you guys see as the most critical investments to make and positioning of the product as you think about that education cycle for September through the remainder of the calendar year and into the first part of next year?

Thank you for the question, Eric. I'm glad to see you're tracking the cycles. We have two main opportunities each year, in January at the start of the semester and in August at the beginning of the fall semester. We've been focused on developing our language models, which are fundamental to our proprietary AI platform. We will continue to roll those out and improve the accuracy, quality, and completeness of the models. You'll start to notice additional personalization features, especially regarding the conversational capabilities during Q&A moments, which aim to enhance the experience for students when they have questions. This approach allows us to better anticipate student needs and create a more tailored experience. We will keep progressing with these initiatives and ensure they're ready for the rest of this year.

Our next question is from Ryan MacDonald with Needham & Company.

I really wanted to ask around the pricing strategy, and you talked about sort of already solidified the plans there internationally in the seven key markets, but still testing domestically. Can you give us a sense of sort of the magnitude on the pricing discounts you're testing? And then when we should start to see that layer into ARPU assumptions as we go into the remainder of the year?

Thank you, Ryan. I appreciate the question. Pricing and packaging are vital tools for us at Chegg, and we have consistently aimed to optimize and understand this area. After over a year of testing internationally, we reached a point where we felt confident in our pricing and packaging strategy. We are starting to see positive impacts in our new customer growth numbers. Domestically, our objective remains to reach the widest possible audience. We will keep using pricing and packaging to achieve this, including testing different price points. Our aim is to strategically consider when and how to use pricing and packaging effectively, targeting the right customer segments and timing throughout the year. We will continue to optimize and test this strategy throughout 2024.

Our next question is from Josh Baer with Morgan Stanley.

Congratulations to Nathan and Dan on your new roles. I wanted to follow up on engagement. You mentioned some interesting data points regarding the number of questions asked. What about the time spent on the platform from an engagement perspective? I’m also curious about the average duration that a student might have the subscription active during a month or quarter.

Thank you, Josh. That's a great question. As you would expect, our journey to creating sustainable programs for new acquisitions, total subscribers, and positive revenue growth begins with our engagement on the platform. We're seeing an increase in the number of questions, which indicates that more students are engaging with the platform and actively asking questions, leading to an increase in total time spent on the platform. Overall, we're feeling optimistic. We believe that enhancing the conversational aspect will further extend those sessions and provide more value to the students. Currently, we are focused on utilizing our strengths, which is delivering high-quality learning solutions tailored to the student. This is the foundation we were built on, and it's now functioning more effectively than ever. We are very encouraged by this momentum, and we anticipate that this engagement will continue to extend students' usage.

Our next question is from Brent Thill with Jefferies.

I guess, Dan, the question of why now? And I guess just as a quick follow-up, having covered tech for a long time, given the deceleration of revenue growth, a few companies are preserving margins, maybe at the same level, why not choose to make some more investments in broadening the platform and adding additional modules on rather than focus on just margins?

Brent, that's a great question. This is Nathan. I'll address it. We are continuing to invest in our platform, and I want to emphasize that point. We've already accounted for our investments in AI in our financials, and we plan to expand those investments as we gain traction. We aim to accelerate the rollout of our personalization platform. There's no slowing down on our end. What we’re conveying in our prepared remarks is that we recognize we're undergoing a transition. We understand that we are on a long-term journey to restore growth to the company, which will take time. During this phase, we want to be cautious and ensure our expenses align with our current performance.

Brent, it's Dan. I just want to, again, congratulate both David and Nathan. So why now is pretty easy. The company is ready. The company is ready for this transition, which is Nathan and I have been working together for a long time with the Board on a really well-prepared transition with David stepping into the role as the CFO and with the hiring of all the senior leadership team now is the right time. In addition to that, the company has gone through a series of transformations since we've been here for the last 14 years, from almost going bankrupt several times to a point where we're profitable and generate free cash flow. The AI opportunity is so powerful and has the chance to be so big that having this new team in place to drive it for the next 5 to 10 years is exactly what we want to have happened because the TAM should expand, and the margins can expand. So we want this new team to really take this and drive it. And after 14 years, I thought this was the exact right time, so did the Board. And I just couldn't be more proud of Nathan. I mean, I'm really excited about the company's future, and I will be remaining involved with Nathan. And so let's go.

Our next question is from Devin Au with KeyBanc Capital Markets.

Great. David, with the second quarter EBITDA margin guide implying, I think, 24% at the midpoint. And in your remarks, you kind of talked about the expectations of second half margins to be stronger through accelerating efficiency efforts. Could you just elaborate on what these efforts are and without the top-line leverage, what's giving you the confidence that you can protect your margins in the second half?

Sure. Thanks, Devin. We believe we've always been efficient with our spend. If you look at our spend in Q1 this year versus last year, we were $10 million better this year than last year; the full year 2023 was better than the full year of 2022. We expect that we're going to look under every rock we can find and keep being efficient so that we keep driving EBITDA and cash flow to create shareholder value, and I look forward to continuing to report that later this year.

Our next question is from Alex Sklar with Raymond James.

I want to follow up on Ryan's question around the pricing and packaging test internationally. It sounds like you found the right balance there. And I was just hoping you could elaborate a little bit more on how that average pricing and conversion rates look like now relative to a year ago? And you also talked about seven markets. Any new countries you're investing behind or pulling back on relative to Europe as well?

I appreciate the question, Alex. I'll begin by discussing the market. There are no new markets at this time. The ones we have identified show a lot of potential. We see many similarities in the student experience, which gives us significant advantages as we localize our offerings for each country. Even though some will be in specific languages, the core needs of the students and their reasons for using the Chegg platform enable us to leverage our technology effectively. I don't want you to think that we have completed our work on pricing and packaging. We have made progress there, with new customer growth up 2.3% year-over-year. However, we are still working on optimizing pricing and packaging internationally to ensure we can reach the widest range of customers.

Our final question is from Alex Fuhrman with Craig-Hallum Capital Group.

Just wanted to drill into the target for 30% EBITDA margins a little bit more. How exactly should we expect to get there as we think about potentially pulling back on sales and marketing or G&A or research and development? Is there some level of growth internationally or elsewhere that you would need to hit that target for next year? And then I think you alluded to seeing some cost cuts in the back half of this year that should get the margins going. Are we going to see kind of a path to that 30% by the end of this year? Or is that really more something that we'll see when we get further into next year?

Thank you, Alex, for the question. It's really about us continuing to manage our expenses carefully. We are hopeful that we can drive the company back to growth. Achieving growth will certainly help, but we have shown consistent cost management. While I can't provide specific details at this moment since we're only giving guidance for the next quarter, when I report back in August on our Q2 performance, I believe we will have a clearer understanding of how everything unfolds for the remainder of the year.

We have reached the end of our question-and-answer session. I will now turn the call over to Nathan Schultz, incoming CEO, for closing remarks.

Thank you very much for your questions today, and warm wishes on the job ahead. I want to thank you all for the time. Questions were great. I am honored that the Board has given me the opportunity, and I am incredibly excited about the power of the platform, the proprietary AI that we're building, and the opportunity that's in front of us. I'm very excited to do it with my partner, David Longo, and I wish you all the best of the day. Have a great day.

Thank you. This will conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.