Chegg, Inc. (NYSE:CHGG) Q2 2023 Earnings Call Transcript

Chegg, Inc. (NYSE:CHGG) Q2 2023 Earnings Call Transcript August 7, 2023

Chegg, Inc. beats earnings expectations. Reported EPS is $0.4812, expectations were $0.28.

Operator: Greetings, and welcome to the Chegg Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [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.

Tracey Ford: Good afternoon. Thank you for joining Chegg’s Second 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 at our Investor Relations website, investor.chegg.com. A replay of this call will also be available on our website. We routinely posted 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 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 Q2 earnings call. Our team executed well, outperforming guidance for both revenue and adjusted EBITDA. As the second quarter progressed, we saw year-over-year trends for customer acquisition and retention rates improve, which drove the upside in our results. We are entering an exciting new chapter for Chegg catalyzed by the advances in artificial intelligence. To take advantage of these new opportunities, Chegg is rapidly pivoted because we believe that category-defining companies with strong brand loyalty, sought after services and highly valuable data sets can leverage AI to grow and will create outsized returns. It is still early and since we last reported, we gained greater insights into students use and perceptions of AI and how it relates to Chegg.

Our recent survey shows student see ChatGPT and Chegg as complementary with very different use cases. The latest wire poll survey states that while Gen Z students are using AI to improve their education, they are not comfortable with the exact information ChatGPT could tell. And it’s become clear to us that a simple, high-quality, accurate personal learning assistant is needed and we feel we are uniquely positioned to deliver a world-class personal learning system. We are moving fast and launched the beta version of our initial generative experience in May. Feedback has been very positive. Specifically, our students like our simple user interface, which is conversational, and they have always trusted the quality, accuracy and relevance of our proprietary step-by-step solutions.

Our research also shows that 86% of students say that they prefer study help that is reviewed by human subject matter experts, and 85% say they wanted to be personalized to their individual learning needs. So it is no surprise that engagement from our beta testers is extremely high, and they are interacting more with each question and are staying for significantly longer sessions. We appreciate that speed and execution are critical to our success. Our partnership with Scale AI announced today will allow us to accelerate our ability to deliver the new Chegg experience starting in the Fall and rolling out over the course of the next two semesters. The new Chegg will combine the best of generative AI, with Chegg’s proprietary high-quality solutions and demonstrated ability to improve student outcomes.

They can expect to see a much simpler conversational user interface, personalized learning pathways, more in-depth content and the ability to transform it automatically into innovative study tools such as practice tests, study guides and flash cards. In order to further enhance our competitive moat and lower our costs, we are building our own large language models, which gives us the ability to train them specifically for education. Our LLMs will be trained with our unique data sets and with the help of our 150,000 subject matter experts, we expect to deliver a significantly enhanced and differentiated learning experience for students compared to the generic models that are available today. And this is just the beginning. I want to give you a sense of how big we believe this TAM expanding opportunity can be and how we plan to capture it.

We intend to build the largest connected community of learners around the world. With a truly scalable, affordable adaptive learning assistant by combining the tools, pathways and the accuracy that students depend on. Chegg’s proven learning taxonomy, along with our deep history of data from schools, classes and professors sets us apart. We have said for years that students challenges go way beyond the academic need and now by leveraging advancements in artificial intelligence, we believe we can make a significant impact on reducing the nearly 40% of students who drop out of the higher education system and the more than 50% that never enter. Increasingly, students are connecting their academic journey with their skills-based needs in order to be employable in today’s economy.

Chegg is developing integrated skills pathways that will help students assess their current proficiency, identify their gaps and then help them acquire those skills. We are in a great position to do this by leveraging our skills offerings, where we continue to see excellent growth. We also appreciate that students today face a wide variety of personal challenges that can get in the way of graduating on time or at all. We know that if we can connect students to solutions that address some of these issues, such as mental health, food and security and financial barriers, we can improve their chances of finishing their education and thriving. We have created a concept video for you, which illustrates how this may all come together, which you can review within our investor deck posted on our IR website.

More than 50% of the world’s population is below the age of 30 and they have increasingly turned to online to advantage themselves academically and professionally. Now aided further by the proliferation of AI, the opportunity for Chegg to serve them is bigger than ever. And with that, I will turn it over to Andy. Andy?

Andrew Brown: Thanks, Dan, and good afternoon everyone. Q2 was a good quarter as we exceeded our revenue and adjusted EBITDA guidance and also delivered strong cash flow. Total revenue was $183 million, driven by subscription services revenue of $166 million. During the quarter, we had approximately 4.8 million subscribers on our platform. Sales and other revenue was $17 million, driven by strong growth in skills, offset primarily by the change in the required materials model, which is now a revenue share. Gross margin of 74% came in slightly higher than expected. This, along with the revenue beat contributed to adjusted EBITDA beating guidance, which came in at $60 million or 33% margin. Free cash flow was $56 million, the result of strong operating performance and higher interest rates with interest income contributing $10.7 million in the quarter, an increase of $8.7 million from last year.

We had several items that impacted our GAAP net income for the quarter. These included a gain of $53.8 million from the repurchase of some of our outstanding convertible debt, which was partially offset by a restructuring charge of $5.7 million we announced during the quarter and a loss contingencies of $7 million we accrued related to a previous gain taken on an equity investment. We continue to have a strong balance sheet and drive significant free cash flow. We ended the quarter with $808 million of cash and investments, with total convertible debt outstanding of $773 million at par value, representing $35 million of net cash. As mentioned earlier, we repurchased $427 million of our outstanding convertible debt of $369 million and use some of the net savings to retire 3.4 million shares of our common stock for approximately $35 million.

We continue to believe the combination of our operating model, balance sheet and cash flows are among the strongest in the education industry and will allow us to deliver attractive results to our shareholders. As Dan mentioned, we are rapidly realigning our resources around AI efforts, including partnering with scale AI to develop large language models required for students to have a fully generated conversational experience rolling out over the next two semesters. We believe our approach of developing and owning these models versus solely relying on third-party providers will create a truly differentiated and better experience with students at a lower cost. Now moving on to guidance. For Q3, we expect total revenue to be between $151 million and $153 million with subscription services revenue between $135 million and $137 million, gross margin between 68% and 69% and adjusted EBITDA between $34 million and $36 million.

It is worth noting that we typically experience seasonally lower revenue and margins in Q3. We also have an elevated level of content depreciation from recently acquired Professor-led material, which is impacting gross margins. We expect the impact of this to moderate in Q4 and margins improve. 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 for proprietary data, strong operating model and a balance sheet to extend our leadership into the future. With that, I’ll turn the call over to the operator for your questions.

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Q&A Session

Operator: At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Doug Anmuth with JPMorgan. Please proceed with your question.

Douglas Anmuth: Thanks for taking the questions. Can you just talk about how the new AI experience with Scale AI will differ from CheggMate and kind of the path that you’ve been going down? And then, I guess second, if you could also just talk about the drivers you think of the 2Q improvements around customer acquisition and retention as you went through the quarter. Is that just distance, you think, from the ChatGPT launch or more of the students recognizing perhaps some of the deficiencies on that side? Thanks.

Dan Rosensweig: Yes. No, great question. I’ll take the second question first, which is I think it’s what you said, which is — and the research seems to indicate that, which is once students recognize that they do very different things, and that what we do, they can’t do and what we do is actually what they need because it’s been built directly and specifically for students that they will use ChatGPT, but they’re not going to try to use it for the things that they use Chegg for. And our current research seems to indicate that the overwhelming majority of those that use both plan to remain with Chegg. So I think that’s very good news, and it’s an update on what we’ve seen, and I think the results seem to suggest that. So that’s really good news for us.

The second thing — the first question that you asked, which is how does it differ? Really, what it is, is instead of building a separate product, we have in our ripping Chegg down to its does and completely rebuilding the user experience so that it’s available to everybody that uses CS and CSP. So it is the same vision, and that’s why we supplied a concept video for people to really get an understanding of just how great that this can be and how different it is from the existing experience, how much more conversational, how much more simple, easy interface, conversational in nature. And one of the really cool things that we’ll be able to do differently than anybody else would be able to do is take the 100 million-plus questions that we have and all the data we’ve been able to collect and create completely personalized learning experiences on a per user basis based on knowing not only the history of that particular student, but others that have gone to that school, that class and with that professor.

So that is not something that any generalist AI can do or frankly, anybody else in the education space could do because we have the largest direct-to-consumer list. So that’s pretty exciting. And then to take the way they learn best and actually build study tools out of the content they’re using without them having to do anything. So I think our ease of use and the difficulty in using ChatGPT, the fact that it’s overwhelmingly for writing and not for learning. I think those things were pretty significant in affecting those trends to the positive which is great for us and great for our shareholders. And then instead of it just being CheggMate, it’s just going to be Chegg. What Scale AI does is something very different. We continue to work with ChatGPT just as we announced and that’s all the conversational nature and the descriptions and explanations and things of that nature, which is what it does well.