Nerdy Inc. Q1 FY2023 Earnings Call

Good afternoon. Thank you for attending the Nerdy First Quarter 2023 Earnings Call. My name is Elisa, and I will be your moderator for today's call. All lines will be muted during the presentation portion of the call, with an opportunity for questions and answers at the end. I would now like to pass the conference over to your host, Charles Cohn with Nerdy. Mr. Cohen, you may proceed.

Good afternoon, and thank you for joining us for Nerdy's First Quarter 2023 Earnings Call. With me are Charles Cohn, Founder, Chairman, and Chief Executive Officer of Nerdy, and Jason Pello, Chief Financial Officer. Before I turn the call over to Chuck, I'll remind everyone that this discussion will contain forward-looking statements, including, but not limited to, expectations with respect to Nerdy's future financial and operating results, strategy, opportunities, plans, and outlook. These forward-looking statements involve significant risks and uncertainties that could cause actual results to differ materially from expected results. Any forward-looking statements are made as of today's date, and Nerdy does not undertake or accept any obligation to publicly release any updates or revisions to any forward-looking statements to reflect any change in expectations or any change in events, conditions, or circumstances on which any such statement is based. Please refer to the disclaimers in today's shareholder letter announcing Nerdy's first-quarter results and the company's filings with the SEC for a discussion of the risks. Not all of the financial measures that we will discuss today are prepared in accordance with GAAP. Please refer to today's shareholder letter for reconciliations of these non-GAAP measures. With that, let me turn the call over to Chuck.

Thanks, TJ, and thank you to everyone who has joined us today. One year ago, we unveiled an ambitious plan to evolve our products and revenue model toward long-term, recurring, always-on relationships with our customers. We created new subscription and recurring revenue products, including learning memberships for consumers and teachers, and on-demand products for institutional customers that were designed specifically to address the ongoing support we believe both types of customers needed and desired. We shared that we believe these new models would provide a superior platform for innovation by allowing us to bring together multiple different product capabilities we have developed into a comprehensive all-access offering that enables learners to receive the help they need across multiple learning formats, thousands of subjects, and multiple academic calendar years. In addition to allowing us to provide a better and more personalized experience to learners, the new operating model would be far more efficient to operate, allowing us to drive operating leverage, simplify our sales model, and shift additional resources toward net new innovation, including the application of AI for HI or artificial intelligence for human interaction. To get to this evolved state, we shared that this new model would require trading off revenue recognition in the short term because our package model had a more front-loaded revenue recognition than the learning membership model, where subscription revenue is recognized linearly over time. We expected that by the start of the second quarter of 2023, the cumulative build of recurring revenue from learning membership customers would cause us to return to growth in our consumer business and for the total company, but now with the product suite and revenue model, we believe would position us for higher levels of growth, profitability, and predictability in the years to come. We stated that we expected our new business model to deliver substantial operating efficiencies and that we anticipated achieving adjusted EBITDA profitability by the end of 2023. I am pleased to share that in the first quarter, we exited the J-curve business model transition to subscription and returned to year-over-year growth, delivering $49.2 million of revenue, which was above our guidance range of $45 million to $47 million. Learning membership subscriptions accounted for 60% of total company recognized revenue, up from nearly 0% in the first quarter last year, demonstrating strong product market fit. On the institutional side of the business, we delivered record revenue of $8.5 million, an increase of 32% year-over-year, representing 17% of total recognized revenue in the first quarter. In combination, our consumer subscription and institutionally contracted revenue accounted for 77% of total company revenue recognized in the quarter, a dramatic increase over the past year, which we believe speaks to the power of our platform-oriented approach to growth and how we can efficiently go to market with all-access solutions that provide more value to customers. The rapid business model evolution of learning memberships and recurring revenue, as well as our continued application of AI to the customer experience and operational processes, drove continued growth and improvement in customer lifetime values relative to our package model, as well as operating efficiency improvements. Together, they were key contributors to our strong operating results and improved profitability. We are pleased to share that we achieved adjusted EBITDA profitability in the first quarter, nine months earlier than our target of the fourth quarter of 2023, delivering nearly 1,700 basis points of improvement year-over-year and $1.4 million of adjusted EBITDA. The improvement in adjusted EBITDA represents an annualized improvement of approximately $32 million. We also realized $6.8 million of positive operating cash flow and $5.8 million of free cash flow in the quarter. I'm pleased to share that we made substantial progress on accelerating the use of generative AI around our business, including launching two new customer-facing products as well as accelerating the use of AI and machine learning to drive substantial operating efficiencies and internal productivity improvements. As we shared with you in our prospectus two years ago, we've long believed that AI can fundamentally transform how people learn. We've been applying AI to our business, products, and operational processes for over six years, and AI has been foundational to our ability to improve quality, enhance personalization, and decrease the cost of our offerings. AI powers our ability to identify the highest quality experts, assess learners' foundational knowledge to help ensure the right expert-learner match, and drive operational efficiency among many other use cases. In our prospectus, we described the proprietary technology infrastructure we're building as AI for HI or artificial intelligence for human interaction and outlined the core foundational capabilities we apply to live learning to enhance the interaction in ways that were not previously possible. Through the application of AI, we aim to provide experts and learners with superpowers that transform live online learning. We credit our orientation around AI for HI for allowing us to recently deliver our ten millionth hour of live one-on-one tutoring on our live learning platform and more broadly for allowing us to deliver high-quality relationship-based live online learning available at scale. We've used this data and the insights we garner from having instrumented every part of the learning journey to drive real-world practical value in our business. We credit AI for enhancing our customer lifetime values, helping us identify when each student does or doesn't know about a particular subject, when to reach out to a customer to drive engagement and retention, and how to make operational processes far more efficient. We believe we stand to benefit tremendously from the latest advancements in generative AI and further drive revenue growth and cost reduction through its application. What has been especially exciting is seeing what our internal teams have been able to accomplish over the last 90 days regarding the overall pace of innovation internally. As internal access to generative AI tools has expanded, we are seeing it enhance our team's quality of work, the speed it takes to complete set work, and open up new possibilities for product and process improvement in a way that previously would not have been feasible or that would have been cost prohibitive. To illustrate the speed of innovation, I'll cover some of the progress we've made leveraging AI in just the last quarter. We've continued to improve our expert-learner matching algorithms. As a reminder, we started applying machine learning matching algorithms over six years ago to detect patterns that no human possibly could to better inform the match between a learner and an expert. With thousands of experts available for a given learner, taking a technology-first approach to programmatically identifying patterns that were predictive of better learning experiences and outcomes has proven highly effective. Today, we simultaneously test competing machine learning algorithms until one is named the statistical victor and flipped to 100% of the volume for a given segment, and then the process repeats. As we capture and better leverage data to inform the learner-expert match, the quality of the match will continue to improve for both learners and experts, leading to a far better learning experience, ultimately driving better customer satisfaction, better learner outcomes, and ultimately, higher customer lifetime value. In the first quarter, we also further expanded learning formats and content. Our growth flywheel, which we first shared publicly in January of 2021, reflects additional learning formats beyond one-on-one as a key contributor to what attracts new learners to the platform. These additional learning formats, combined with relevant content to the subject being learned, create personalized learning experiences that drive engagement and retention of learners on the platform. During the first quarter, we leveraged generative AI to launch two previously announced products, AI-enabled chat tutoring and AI lesson plan generator, both of which we believe will further accelerate our growth flywheel. Additionally, we have steadily enhanced the availability of asynchronous content on the platform in areas like self-study and computer adaptive diagnostic testing, which has driven higher levels of engagement and customer satisfaction. However, due to the unlimited possibilities of subject and age complexities and the nuances between school curriculums, it just wasn't feasible to have rich levels of content in every single subject that someone could conceivably want to learn on the platform. Thanks to advances in generative AI, that has now changed. We stand to be a huge beneficiary of being able to infuse high-quality, hyper-personalized content that has historically been expensive and time-consuming to develop into every learning experience. We believe this hyper-personalization will allow us to further meet the needs of our learners on a recurring basis over time. We're also seeing significant improvements to productivity and operational efficiency through the application of generative AI. Today, approximately 30% of our software code is being written by AI. All of our employees have access to in-line generative AI capabilities like GPT-4 and are encouraged and expected to use it in their work. We're now using generative AI to more efficiently solve customer support interactions and automate operational processes, including broadly leveraging AI-powered support parts across learner-facing, expert-facing, and even internally-facing interactions, and we expect to see further wins in driving both conversion and retention as well as improvements in operational efficiency as a result of continued investments in generative AI across the business. Let's move on to learning memberships, which are scaling ahead of expectations. We continue to see substantial evidence that validates our belief that the learning membership model leads to more attractive unit-level economics, longer duration and higher lifetime value customer relationships, higher gross margins, and a more scalable and efficient operating model. We are also able to provide an improved and more comprehensive learning experience for learners and more consistent earning potential for experts. We remain convinced that this all-access, always-on business model serves as a better platform for innovation and growth. It allows us to better capture and then apply our proprietary data across product interactions over time to drive deeper personalization for learners across many different learning formats and subjects. We're able to easily incorporate new products that add more value to the learning membership experience over time. Learners have a better experience on the platform, engage more frequently and for longer periods of time, and are ultimately rewarded in the form of higher customer lifetime values. Learning membership revenue continued to grow at a rapid pace during the first quarter and reached an annualized run rate of approximately $143 million as of March 31, an increase from $87 million as of year-end and nearly $0 in the first quarter of 2022. Active members grew to nearly 33,000 as of March 31, up from approximately 20,000 at year-end. During the first quarter, we expanded learning memberships to new customer audiences by fully transitioning all purchases by existing package customers into learning memberships, as well as moving all of our new test prep audience customers into learning memberships. As we look ahead, we plan to transition the professional audience to learning memberships by the end of the year, which would represent a transition for 100% of new customers in our consumer business to always-on recurring revenue products. This past quarter, we introduced month-to-month learning memberships, which are driving higher levels of conversion by alleviating friction in the member experience while increasing the average monthly subscription fee and accelerating the marketing payback period. We also enhanced the value provided in learning memberships by providing unlimited access to two new products. Our AI-enabled chat tutoring enables learners to receive help from an AI tutor and also involves a live human tutor with a click of a button. After piloting this capability in early Q1 and receiving positive feedback and engagement data, we've recently expanded access to all owners on the platform. The primary use case so far involves quick Q&A and homework help in between live recurring one-on-one tutoring sessions. It's a good example of how generative AI has enhanced our ability to build a product that would have historically required substantial investments in content but now can be done at effectively no cost and served up to the customer in-line at the right moment in the learning journey to keep them learning efficiently and effectively. The second product we added to learning memberships was our AI lesson plan generator. We went from idea to minimum viable product to a fully built and value-added capability deployed across our entire platform and available to all experts as of late April. With this product, we use generative AI to pre-generate lesson plans, including practice problems and other curriculum content in advance of tutoring sessions. The lesson plan generator is embedded in the user interface as a dynamic and editable pane that is ever-present during live tutoring sessions. We consider the ability to create hyper-relevant hyper-personalized content spanning any subject, any age level that is personalized for the unique needs of the specific learner to be an example of the sort of superpower we have made available to experts and learners that previously would have either been impossible or cost prohibitive. With the addition of these new products, we continue to grow the percentage of learning membership customers engaging in a non-tutoring format during the first quarter to over 27%, the highest of any quarter yet. The multi-format engagement has historically been highly correlated to lifetime value extension. Looking ahead, we're working to make it easier for learners to more fully engage with our learning membership by improving discovery in an all-new member portal. This will include personalized AI-generated learning recommendations that predict and suggest the next product interaction across learning formats and subjects that is most likely to drive engagement and customer value. As we head into the slower summer months, we've created compelling content for learning members to keep learning over the summer through increased engagement with academic, college prep, and enrichment subjects. Turning our attention to our institutional business of Varsity Tutors for schools, enhancements to our product suite of high-dosage tutoring, teacher-assigned, and on-demand, coupled with prior investments in Varsity Tutors for Schools sales and go-to-market strategies resulted in record institutional revenue of $8.5 million in the first quarter, an increase of 32% year-over-year and representing 17% of total revenue in the first quarter. Varsity Tutors for schools executed a record 97 contracts totaling $6.3 million of bookings during the first quarter. Varsity Tutors for schools engagement trends, including our new teacher-assigned products, significantly exceeded our expectations and provide us with confidence that the solutions we have built have a strong product market fit and are well suited for meeting the needs of school district partners, teachers, and students, helping students learn on an unprecedented scale. Teacher-assigned continues to deliver against our vision for delivering personalized live learning at a district-wide scale while providing unparalleled support to educators. These high levels of engagement are occurring across a wide variety of grade levels and subjects, and teacher feedback has been enthusiastic, especially regarding how they leverage our solutions in the classroom. These strong results and continued momentum to start the year give us increased confidence that Varsity Tutors for Schools is well positioned to provide solutions that administrators, teachers, and students alike are seeking to support their evolving needs. In closing, live human instruction that inspires and motivates when coupled with AI is enhancing the state of learning. With recent advances in generative AI, the ability to deliver personalized live instruction at scale for all students is within reach. We're proud of our progress to date, growing our learning membership count to 33,000 active members. However, with more than 50 million students in the United States alone, we're just getting started. We look forward to remaining at the forefront of product innovation and enhancing our ability to meet the needs of both consumer and institutional learners. With that, I'll hand the call over to Jason to discuss the financials in more detail.

Thanks, Chuck, and good afternoon, everyone. I'm pleased to be speaking with you today about another strong quarter for Nerdy. We previously shared that we expected our evolution towards learning memberships would lead to longer duration and higher lifetime value customer relationships, enhanced gross margins, provide for more attractive unit-level economics, and drive higher levels of growth and profitability. I'm pleased to report that during the first quarter, our team's hard work on the evolution to recurring revenue offerings pulled through, delivering a return to growth and positive adjusted EBITDA of $1.4 million, a nearly 1,700 basis point improvement year-over-year and more than nine months ahead of our stated target. Looking ahead, we expect to yield additional efficiency improvements through scaling learning memberships, driving additional automation and self-service features, and the continued application of AI throughout our business. Turning to Q1 results. In the first quarter, we delivered revenue of $49.2 million, results that were above our guidance range of $45 million to $47 million. These positive results reflect the continued growth in active memberships, which totaled nearly 33,000 as of March 31, up from 20,000 at year-end. Learning memberships revenue grew to $29.7 million during the quarter and represented 60% of consumer revenues in the quarter, up from nearly 0% in the first quarter last year, demonstrating a strong product market fit. Our institutional business delivered record revenue of $8.5 million, representing 17% of total revenue during the first quarter, and delivered bookings of $6.3 million. On a combined basis, learning memberships and institutional revenues delivered 77% of total revenue, a substantial change from just two years ago when the business was a 100% package business and 0% institutional revenue business. Moving down the P&L, gross profit of $33.9 million for the first quarter represented an increase of 3% compared to the same period last year. Gross margins of 68.9% for the first quarter were approximately 90 basis points lower than 69.8% in the same period last year. The increase in gross profit was driven by gross margin expansion across our consumer audience, which was offset by higher-than-anticipated engagement with our new products in our institutional business. As we evolve towards a greater mix of learning membership revenue, we expect consumer gross margin to expand throughout 2023. Sales and marketing expenses on a GAAP basis were $15.6 million in the first quarter, a decrease of $7.4 million compared to the same period in 2022. Non-GAAP sales and marketing expenses, excluding non-cash stock-based compensation, were $14.7 million or 30% of revenue in the first quarter. This compares to 47% of revenue in the same period last year, an approximately 1,700 basis point improvement year-over-year. Sales and marketing spend and efficiency improvements were driven by the transition to learning memberships, including the continued expansion of lifetime value, our focus on optimizing the level of marketing spend, and a more efficient operating model in our consumer business. We also delivered substantial Varsity Tutors for Schools revenue growth, yielding efficiencies from prior investments in the institutional sales and go-to-market organization. As learning memberships become a greater percentage of total revenue, and the institutional business continues to scale, we expect to yield durable sales and marketing improvements. G&A on a GAAP basis was $29.7 million in the first quarter, a decrease of $800,000 compared to the same period in 2022. Non-GAAP G&A expenses, excluding non-cash stock-based compensation, were $19.5 million or 40% of revenue in the first quarter. This compares to 41% of revenue in the same period of last year, an approximately 100 basis point improvement year-over-year. Combined with our ongoing efforts in automation, self-service capabilities, and the application of AI, we've been able to generate operating efficiencies and remove significant costs from the business. As noted, we reported adjusted EBITDA of $1.4 million, a nearly 1,700 basis point year-over-year improvement in the first quarter, beating the guidance range we provided of an adjusted EBITDA loss of $3 million to break even. Cash provided by operating activities was positive $6.8 million in the first quarter of 2023 compared to cash used in operating activities of $0.9 million in the prior year period, resulting in cash and cash equivalent balances increasing by $5.8 million during the quarter ended March 31. With no debt and $96.5 million of cash on our balance sheet, we believe Nerdy has ample liquidity to fund the business and pursue growth initiatives. Turning to our business outlook. Today, we're providing second-quarter and updated full-year 2023 guidance. We saw positive new customer addition and engagement trends in the first quarter that have continued into April and May and compared favorably to our normal seasonality and internal expectations. For the second quarter and full year, we expect revenue growth will be driven by the continued evolution towards recurring revenue streams, the corresponding build in the number of learning membership subscribers, and higher institutional revenues. Our positive momentum provides us with increased visibility and confidence in our expectation that we will deliver sequential year-over-year revenue growth each quarter as we move throughout 2023. For the second quarter of 2023, we expect revenue in the range of $45 million to $47 million. For the full year 2023, we are raising our revenue targets to $193 million to $200 million, representing 21% growth at the midpoint versus our 2022 revenue of $162.7 million. For the full year, revenue guidance reflects our decision to shift 100% of the consumer business to learning memberships by the end of the year, including the remaining professional audience. Revenue guidance reflects normal summer seasonality, including anticipated lower levels of new customer acquisition, consumption, and learning membership retention during the summer months when K-12 schools and universities are out of session. Additionally, revenue guidance reflects a higher level of high-dosage tutoring program utilization by school districts in the spring semester and a return to the normal seasonal pattern of starting new implementations in the fall when school starts, thus slightly shifting revenue into the first two quarters versus our prior expectation of consistent use throughout the summer. Our adjusted EBITDA guidance for both the second quarter and full year reflects the continuing benefits from our recurring revenue products, which focus on long-term relationships with higher-value customers and an improving consumer gross margin profile, along with operating efficiencies stemming from our continued shift to recurring revenue business models. For the second quarter of 2023, we expect a non-GAAP adjusted EBITDA loss in the range of $3 million to break even. For the full year 2023, we are raising our targets to an adjusted EBITDA loss in the range of $7 million to breakeven. Full-year adjusted EBITDA guidance reflects the impact of normal summer seasonality and higher variable costs in the third quarter as we ramp into the back-to-school selling season, followed by a return to positive adjusted EBITDA in the fourth quarter consistent with prior guidance. Thank you again for your time. And with that, I'll turn the call back over to Chuck.

Thanks, Jason, and thanks again to all of you for joining us today. As always, we appreciate your interest in Nerdy and look forward to continuing the dialogue during this exciting time for the company. With that, I'll turn it over to the operator for Q&A.

Our first question comes from the line of Ryan MacDonald with Needham.

Congrats on a great quarter. Maybe I just want to start first on the institutional business. Clearly, some really great momentum there with the record number of deals. I would just like to understand sort of how you foresee the demand environment on the institutional side progressing as we kind of get into the heart of the selling season here in Q2 and Q3. And then as we look at the total contract value or the value of the deal count, obviously, it's down on a sequential basis. Just curious what you're seeing in terms of deal trends in terms of sizing around a number of modules or offerings being adopted or the size of deals in the pipeline.

Thanks, Ryan. This is Chuck. As you know, we landed our first teacher-assigned contract. The momentum right out of the gate is super strong, and the feedback has been really encouraging, and engagement was much higher than we anticipated, which is excellent to see, demonstrating a strong market fit. We can now go out and kind of talk and demonstrate just how powerful tutoring can be when teachers across the entire school district are able to help students at a district-wide scale in a highly individualized manner tailored to their unique knowledge of a particular student and the curriculum that's being taught. So that was a huge accomplishment there. We obviously had a strong quarter in totality in terms of revenue as well. And as we head into summer and then back to school, what we're seeing is that the pipelines are continuing to grow. These are very large and very lumpy deals and conversations that we're having. Our last teacher-assigned contract, as you know, was approximately $5 million per year as a SaaS license that entitles the school district to district-wide tutoring that teachers can prescribe. These conversations involve many different stakeholders. They tend to be oriented around the start of the school year. Given the magnitude involved, we wouldn't want to kick these off for just a few weeks or months because you really want teacher support and future buying, so we are very focused on making sure that teachers actually understand how to leverage the tools, leading to a series of opportunities that would start at the beginning of the new year. We feel good about the pipeline value that's growing. We feel good about the bundled offerings and how together we're able to provide immense value and serve a multitude of district needs. As we head into the summer back to school, I think we feel good about how many of the conversations we're having set us up for significant scale and opportunity this back-to-school season.

Super helpful. Great. I appreciate the commentary there. And then maybe just on the learning memberships, awesome to see the continued progress there. I guess I'd just be curious, as you continue to grow that member count, what you're seeing in terms of the makeup of those members, whether they were previous Nerdy Tutors customers previously? Or if the learning memberships are sort of bringing net new learners to the platform.

Sure. Yes, we feel great about the fact that the business has grown about 63% from the fourth quarter to the end of the first quarter. So great progress there. In total, approximately 75% were new to Nerdy, and about 25% were legacy customers who have been using us historically in a package model. We're seeing a good distribution among student ages, and we're seeing it resonate for different levels of subject usage across various grades. In general, the idea of a comprehensive offering with live tutoring at the center, surrounded by classes and different learning styles, really resonates. We feel great about the progress and offerings, and engagement differs a little bit by age. Overall, we're seeing it resonate across all audiences, and it’s a more efficient go-to-market strategy that allows us to easily add additional product capabilities.

Yes, Ryan, the only thing I'd add there, and we mentioned this on our last call, during the first quarter, we transitioned the entire existing customer base within our academic subjects, which we feel really good about. We also transitioned the test prep audience. In our commentary, we shared that we're accelerating the transition of the professional audience, given the positive feedback we've seen from customers regarding higher conversion and retention. From a business perspective, it just allows us to drastically simplify the operating structure, which we feel really good about. Yes. During the back-to-school season, we'll have an opportunity to reintroduce learning memberships for customers who previously used package models and are currently inactive.

Our next question comes from the line of Doug Anmuth with JPMorgan.

It's Bryan Smilek on for Doug. I guess just to start on the membership model. Can you just talk about the pricing strategy and structure over time? For example, should we expect a tiered strategy as the membership strategy proliferates over time? And then, I guess, just on the investment cadence, can you talk about any needs around AI and generative AI holistically going forward?

Sure. Thanks, Bryan. Good questions. We started with a simple approach to learning memberships, wanting effectively to have one tier of offerings to allow for effective go-to-market strategies as we started leaning into memberships aggressively. Initially, that was largely just one-on-one tutoring. Over the subsequent months, we began introducing additional value-added formats, including live classes in hundreds of subjects. We've been adding in other modalities like the AI tutor and chat-based tutoring. It allows us to have these compelling offerings that support our customers throughout the academic year across a variety of subjects while learning how they prefer to. We've seen significant conversion wins through adjusting the frequency and offerings based on audience needs. As for generative AI, it has enabled us to create hyper-personalized content efficiently across many subjects and complexity levels, ensuring we can meet learner needs reliably. We're excited about our efforts to leverage generative AI to deliver comprehensive and personalized experiences. We're actively working on more products and enhancing our capabilities in this area.

Our next question comes from the line of Brett Knoblauch with Cantor Fitzgerald.

Congrats on the quarter. I guess could you maybe just give us a reminder on how the seasonality of the business is going to work now with the relationship model and how that might differ from the package model? And I guess, as we look at the second quarter, what should we be expecting from a membership count perspective in the change? Also, I guess you talked a bit about the institutional seasonality gearing up for the back-to-school season. Should we be expecting institutional revenue to sequentially decline in the second quarter before ramping back up in the back half of the year?

Yes. Great question, Brett. Yes. So consistent with prior years and seasonality trends, Q2 revenue is going to be lower than Q1. As discussed, we haven't yet transitioned to learning memberships from one scale to the next at scale. Our Q2 guidance reflects typical seasonality, resulting from school calendar trends and consumer purchasing patterns. It's also important to acknowledge the significant pull forward we're seeing in our institutional business. We have a legacy package business that we expect to sequentially decline as we progress through the summer months. All in all, we’re cautiously optimistic about retention levels in our forecast and guidance. In terms of active learner count, by June 30, we anticipate roughly 26,000 active members as we transition through the summer. This should begin to re-accelerate as we enter the back-to-school period, consistent with historical trends leading into the fourth quarter.

Perfect. And I want to make sure that I understood you guys correctly on the gross margin decline. So that was largely due to the institutional mix being a large quarter in the institutional product, keeping in mind that it may not be at scale enough where the gross margin will align closely with the rest of the business?

Yes, that's right. If you dissect the business into two parts, on the consumer side, we saw continued gross margin accretion as we continue to mix shift towards a higher proportion of learning memberships. On the Varsity Tutors for Schools side, our new teacher-assigned product provides all-access and unlimited support for the entire student population; we saw substantial levels of engagement during the first quarter into the second quarter, which impacted gross margins about 150 basis points relative to our expectations during the quarter. However, we believe this sets us up strongly for expanding this product to more school districts and increasing retention long term. Although revenue is recognized on some of these institutional SaaS products, the engagement looks high during the school year, particularly during peak periods, leading us to feel positive about the growth in this product line.

Our next question comes from the line of Eric Sheridan with Goldman Sachs.

Maybe two follow-ups on some of the comments that have already been made, just so we better understand. As you move towards the exit velocity this year and the rate of membership you're talking about, can you help us unpack how we should be thinking about sales and marketing efficiencies, not only this year, but as an exit velocity into next year? How do you think about either harvesting some of those efficiencies from sales and marketing as you get bigger in memberships versus possibly accelerating membership adoption and investing them back into the business? That would be topic one. The second topic, you called out deploying capital behind AI. Can you help us better understand how much of these investments might be transient in 2023 to reposition the platform for a different steady state or steady run-rate investment in AI over the long term?

Thanks, Eric. Good questions. As it relates to sales and marketing efficiency, we've driven 1,700 basis points of sales and marketing efficiency year-over-year in the first quarter. The primary reason for this was the move to the learning membership model, which is significantly extending the lifetime value to our customers. We continuously see LTV increasing on average compared to the old package model. In parallel, we focused on targeting those customers who seek recurring support across multiple academic subjects, allowing us to better appeal to their needs rather than focusing solely on hyper transactional bookings. Currently, we're targeting very efficient marketing payback periods, aiming for six months or less. As we review our LTV trends in due course, we may adjust that payback strategy, increasing our growth as our economics allow. The key is balancing sales and marketing efficiency and aggressive growth; both are critical for our trajectory. Regarding capital investments in AI, significant groundwork has been laid in terms of infrastructure and data. We've captured extensive data and built a robust platform over many years, ensuring we're able to push increasingly personalized solutions to our clients. While we’ll continue to add personnel, projections indicate it will largely self-fund. We will invest heavily in AI and engineering in this next period to maintain our innovative pace and streamline operations.

Our next question comes from the line of Andrew Boone with JMP Securities.

This is Matt on for Andrew. Just wanted to ask, with Comiga being offered for $20 a month, is there something that you guys are going to have to do with pricing or packaging? Is the competitive set evolving around AI? And maybe a second one just on institutional. Are schools just asking for anything on AI-based tutoring offerings? Or is this something that you guys are looking at on a product roadmap? Any color there would be super helpful.

Sure. Good question. Champions tutoring has been around for many years at a $20 monthly price. We're excited to incorporate it as one of many modalities. As for our AI tutor, it currently provides homework help and Q&A services and aggregates various online resources. We view it as an additional content delivery method—people are utilizing it to supplement their live, recurring tutoring sessions. Our strategy is to expand AI capabilities across multiple dimensions—content personalization, expert-learner matching, and operational efficiencies. In regards to schools, this is an exciting opportunity. We're actively getting inquiries about how we can provide tailored offerings to teachers, creating individualized education plans at scale thanks to generative AI. This was previously unattainable and we'd like to extend our capabilities into schools to empower teachers and help solve student challenges.

There are no additional questions waiting at this time. So I would like to pass the conference back over to the management team for closing remarks.

We'd just like to thank everyone for their time on the call today. As you can tell, we feel really good about the business while the transition, the learning memberships, and the expansion of Varsity Tutors for Schools as well as the application of AI throughout our business to drive continued growth and cost efficiency.

That concludes today's call. Thank you for your participation.