Chegg Q3 2024 Earnings Call Transcript

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November 12, 2024

There are 7 speakers on the call.

Operator

Greetings and welcome to Chegg Incorporated Third Quarter 20 24 Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Tracey Ford, Vice President of Investor Relations.

Operator

Thank you. You may begin.

Speaker 1

Good afternoon. Thank you for joining Chegg's Q3 2024 Conference Call. On today's call are Nathan Schultz, President and CEO and David Longo, Chief Financial Officer. A copy of our earnings press release along with our presentation is available on our Investor Relations website, investor. Chegg.com.

Speaker 1

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 site@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.

Speaker 1

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 ks filed with the Securities and Exchange Commission on February 20, 2024 Chegg's quarterly report on Form 10 Q filed with the Securities and Exchange Commission on November 12, 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.

Speaker 1

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 Nathan.

Speaker 2

Thank you, Tracy. Hello, everyone, and thank you for joining Chegg's Q3 earnings call. I'll start today by walking you through our Q3 results and then discuss important shifts in our competitive landscape and what they mean for our business going forward. In Q3, while the global education industry continues to experience tremendous change, we have shown early progress against strategic plan we outlined in June. As a result of this work, in Q3, we delivered better than expected revenue of $137,000,000 $22,000,000 in adjusted EBITDA.

Speaker 2

Engagement remained high with the number of questions asked in the quarter up 79% year over year and our Q3 Chegg Study and Chegg Study pack monthly retention rate increased 30 basis points year over year. However, technology shifts have created headwinds for our industry and Chegg's business specifically. Recent advancements in the AI search experience and the adoption of free and paid generative AI services by students have resulted in challenges for Chegg. These factors are adversely affecting our business outlook and require us to refocus and adjust the size of our business. Even in the face of adversity, there continues to be a large market of students looking for high quality proven learning experience that Chegg provides.

Speaker 2

We continue to enthusiastically serve this audience and I remain optimistic in the outlook for us to extend our brand, individualize our product and weather these challenges. The first impact I'd like to discuss is Google's broad rollout of its AI overviews search experience or AIO, which displays AI generated content at the top of the search results page. This experience keeps users on Google search results page instead of leaving them on to 3rd party sites such as Chegg. This roll up has been rapid and while we've been monitoring development of AIO all year, it was not until mid August that the search experience significantly expanded. It's our belief that the prevalence of AIO will only continue to increase and that Google, in an attempt to maintain market share, is shifting from being a search origination point to the destination, disintermediating content sites like Chegg.

Speaker 2

2nd, across our industry, there has been a continued increase in the adoption of free and paid generative AI products. It's been widely reported and substantiated in industry research as students are increasingly turning to generative AI for academic support such as homework and exams. This issue impacts the education ecosystem at large, including universities and education technology companies broadly, where students see generative AI products like ChatCPT as strong alternatives to vertical specialized solutions for education such as Chegg. These factors, the speed and scale of Google AIO's rollout and student adoption of generative AI products have negatively impacted our industry and our business. We have seen a sharp decline in overall traffic and therefore a decline in our outlook on revenue.

Speaker 2

Global non subscriber traffic to Chegg declined year over year 8% in Q2, 19% in Q3 and we exited Q3 with trends looking even more unfavorable at negative 37% year over year for the month of October. We've taken all this into account and consequently we do not expect to meet our 2025 goals of 30% adjusted EBITDA margin and $100,000,000 in free cash flow. Earlier this year, we undertook a strategic restructuring based on the environment in which we are operating. Since then, these new factors have come into play with immense speed and impact. As a result, we are undertaking an additional restructuring to further manage costs and align with the market.

Speaker 2

Effective immediately, we are initiating a broad restructuring that will impact all groups across the company. We will reduce headcount by an additional 21%. We anticipate that these actions, along with additional operating expense savings, will result in an annualized non GAAP cost savings of $60,000,000 to $70,000,000 in 2025. The cost savings from the restructuring announced in June coupled with restructuring announced today will result in a combined non GAAP savings of $100,000,000 to $120,000,000 in 2025. Even with this, we remain optimistic that there is an audience for Chegg.

Speaker 2

While it's clear that some students will favor generative AI options, we believe there's still a large market of students who care about learning and are seeking products that improve their competency and outcomes. In an August 2024 quantitative study, we found that over 75% of high school and college students in North America show a high to medium willingness to pay for online educational tools if they significantly improve academic performance. Therefore, we believe there continues to be a student audience that's looking for high quality content, improving learning expertise. This is what differentiates Chegg from other generative AI tools today and why millions of learners depend on Chegg to provide meaningful learning experiences with the highest quality content possible. 15 years of deep expertise in understanding students, applying advanced learning science to subjects and topics students learn, providing an archive of 132,000,000 high quality solutions and human support output that has created deep trust and awareness of Chegg.

Speaker 2

That's why students continue to come directly to Chegg even as competitive environments evolve. We've taken steps towards the strategic plan we laid out in June. We remain committed to developing a verticalized and individualized experience for education and supporting students throughout the entire learning journey, starting with academic support and eventually functional support. Let me acknowledge the progress we have made on our strategic plan in the Q3. We launched our Small Step Big Win brand marketing campaign, which is showing early signs of progress with year over year improvements in click through rate and conversion rate across many of our paid marketing channels.

Speaker 2

We introduced a content quality and satisfaction guarantee, differentiating our service against generative AI and building trust and loyalty with the subscribers. While still early, it is driving a lift and new subscriber conversion rates. We implemented an AI arena that allows us to evaluate and introduce new frontier AI models in real time to deliver the most accurate solutions for students and integrate AI into the full learning journey. We upgraded our Q and A experience to align with our drive towards providing an individualized and adaptive learning solution. This effort has already shown an improvement in user engagement retention.

Speaker 2

We launched an app on Discord as well as an extension on Chrome to reach students where they're already spending time. These efforts connect student study activities across sites, engage them with our product and create new pathways for product driven growth, which we expect will reduce our reliance on SEO. We moved to a new vendor based commerce platform, which will reduce our costs, provide flexibility and allow us to move faster as we continue to evolve our pricing and packaging programs. And finally, we launched 4 direct to institutional partnerships, providing access to Chegg Study, paid for by the institutional partner. These pilots allow us to gather valuable insights on how Chegg can enhance classroom learning, supporting our goal of diversifying our customer acquisition revenue streams, while strengthening Tague's role in improving student learning outcomes.

Speaker 2

As we head into the spring semester, you will continue to see our commitment to building and generating momentum with our brand, traffic and product capabilities. We will continue to raise brand awareness with a new spring brand campaign. Our creative strategy built on Chegg's long legacy of empowering students and our unique caring approach. The plan will activate across the full funnel, which we believe will bring new users in, create strong consideration and connection and ultimately drive conversion. Based on what we learned this fall from the Small Steps Big Wins program, we believe this strategy will bring both audience expansion and acquisition efficiency.

Speaker 2

On the product front, we will continue delivering individualized learning solutions, specifically focusing on expanding into 2 of the most highly relevant use cases, practice and solution comparison. These are durable needs and core learning behaviors that support learning. While we acknowledge the significance of the headwinds we've covered earlier, Chegg has a deep legacy of serving students and we believe our brand and product experiences are resilient. We remain optimistic and will continue to be there for students who have grown to rely on us. And as you've heard, we've already taken steps to strengthen our experience and increase efficiencies across the business.

Speaker 2

This is a multiyear plan and will require patience. We will continue to manage our expenses prudently as the competitive landscape evolves. We will keep focused on doing the right things for our investors, our team and the students we serve. Before I end, I want to thank our employees around the world for their hard work and dedication. Their efforts and talents have helped support students and bring learning to life.

Speaker 2

And while this is a trying time for us all, I'm confident we will get through it. With that, I'll turn it over to David.

Speaker 3

Thank you, Nathan, and good afternoon. Today, I will present our financial performance for the Q3 of 2024 and the company's outlook for Q4. We delivered a solid Q3. During the quarter, we remained focused on executing our strategic plan to deliver our AI driven experience to students around the world, while we continue to prudently manage our expenses. We exceeded our Q3 guidance on both revenue and adjusted EBITDA, and our balance sheet remains healthy.

Speaker 3

In the Q3, total revenue was $137,000,000 down 13% year over year, including subscription services revenue of $120,000,000 which was down 14% year over year. We had 3,800,000 subscribers in the quarter, representing a decline of 13%. Subscription services ARPU was down 2% year over year, a one point improvement from Q2 2024. Overall, monthly retention for JEGSEDI and Study PAC remained strong and was up 30 basis points year over year. Sales and other revenue was $17,000,000 a decrease of 6% year over year.

Speaker 3

And we delivered adjusted EBITDA of $22,000,000 which represented a margin of 16%. We had 2 notable items this quarter. First, we recorded an impairment charge against our goodwill As a result of continued industry pressure and declines in our market capitalization and as required by accounting rules, we completed an impairment test on our goodwill, which resulted in a $196,000,000 non cash impairment charge that was excluded from our Q3 adjusted EBITDA. 2nd, we reached a settlement agreement to resolve the Levert Hall class action securities lawsuit. We recorded $55,000,000 for the estimated contingent liability for the loss along with a $55,000,000 receivable for the insurance proceeds we expect to receive.

Speaker 3

These amounts had no impact on our Q3 adjusted EBITDA. While we strongly disagree with the premise of the case and deny all allegations of wrongdoing, the decision to settle the lawsuit was driven by the cost and burden of ongoing protracted class action litigation and the monetary costs of defending the case. We're happy to have this matter resolved. Free cash flow was $24,000,000 in the 3rd quarter. Capital expenditures were $15,800,000 in the quarter, down 32% year over year, of which $10,000,000 were content costs.

Speaker 3

As we harness the power of AI, CapEx content costs were down 28% year over year, while the number of questions asked increased 79%. Looking at the balance sheet, we ended the quarter with cash and investments of $631,000,000 and a net cash balance of $30,000,000 Today, we announced that our Board of Directors has authorized an increase of $300,000,000 as part of our securities repurchase program. The program will allow us to buy back our convertible notes and or common stock. Chegg had approximately 3,700,000 remaining from its previously announced program. As Nathan discussed earlier, we are executing a restructuring plan to better align our cost structure with recent industry challenges and the negative impact on our business.

Speaker 3

While these difficult decisions are essential for Chegg's future, we recognize the unfortunate impact they may have on many of our employees and their families. Our restructuring will impact 3 19 employees or approximately 21% of the company. In 2025, the company expects to realize non GAAP expense savings of $60,000,000 to $70,000,000 from these employee departures, real estate savings as well as other cost rationalizations. Chegg expects to incur a $22,000,000 to $26,000,000 charge related to the restructuring. Of this charge, $18,000,000 to $22,000,000 will be incurred in cash, representing mostly severance payments with the remaining amount representing non cash charges.

Speaker 3

We expect that a substantial portion of the cash and non cash charges will be incurred in the 4th quarter. We anticipate these activities and substantially all charges will be completed by June 30, 2025. The cost savings from the restructuring announced in June coupled with the restructuring announced today will result in a combined non GAAP savings of $100,000,000 to $120,000,000 in 2025. Moving on to Q4 guidance, we expect total revenue between $141,000,000 $143,000,000 with subscription services revenue between $126,000,000 $128,000,000 gross margin to be in the range of 67% to 68% and adjusted EBITDA between $32,000,000 $34,000,000 In closing, while our business outlook has significantly softened versus our prior expectations and these numbers are not where we want them to be. Like many companies in the EdTech space, we are dealing with the challenges of a dynamically changing AI landscape.

Speaker 3

We are working to expand our best in class verticalized experience for students focused on improving their outcomes. However, it will take time to adjust to the new opportunity and see the benefits in our business results. In the meantime, we are committed to maintaining transparency about the industry and our business trends. With that, I will turn the call over to the operator for your questions.

Operator

Our first question comes from Eric Sheridan with Goldman Sachs. Please proceed with your question.

Speaker 2

Thanks so much for taking the question. When you look out to not just Q4, but over the medium term and you're trying to think about what are the key investments that have to be made in your longer term initiatives when balanced against trying to reduce the overall cost structure of the company. Can you talk a little bit about striking that balance with an emphasis on what you see as some of the most critical investments that need to be made to not sort of abandon any of the longer term growth dynamics against some of the near term headwinds you might be facing? Thanks so much. Thank you, Eric.

Speaker 2

Thanks for the question. This is Nathan. Happy to answer it and happy to talk more about the differentiation that we're going to be building into our product. I want to go back to our shareholder letter that we rolled out in June of this year. We still very much believe that that is a winning strategy.

Speaker 2

And as I mentioned in that letter and on subsequent calls that the plans that we have to support students both academically and eventually functionally is going to be a multiyear journey. Our core efforts and even with the reduction, it's really just a refocusing of where we're going to put our priorities and we're going to work on 1st and second and third. And they are still very much around creating points of differentiation against generic free AI products. You saw us already do some of this with the satisfaction guarantee content satisfaction guarantee that we rolled out this August that created some elbow room as we started to really stand behind the content and learning experiences that we supply. You saw that with the brand campaign Small Steps Big Wins, which we're going to continue to build on, which created some really nice year over year improvements in click through rates and conversion rate across our paid marketing generals.

Speaker 2

As we go into the winter semester, you'll continue to see the product evolve, particularly in the areas of practice and solution comparison. These are 2 high value programs that are high value use cases. We know students are leading into and truly help us to build into that personalized learning journey that we know students are willing to pay for. Thanks very much. Appreciate the question, Eric.

Operator

Our next question comes from Ryan McDonald with Needham and Company. Please proceed with your question.

Speaker 4

Hi, thanks for taking my questions. Maybe just focusing on the Google update, obviously, quite a bit of a change there. As you've looked at trying to find new channels to market to the student population. Can you one just talk about sort of the how much of the traffic came from Google that you're trying going to have to replace moving forward? And then what channels thus far as we've gone into the fall semester or as you've started to test out new channels, maybe you're seeing the most success or giving you the best chance of maybe replicating or refilling the bucket that you might lose from the Google side?

Speaker 2

I appreciate the question, Ryan. Surely want to make sure I do not leave today without explaining AIO reviews a bit more and making sure you understand that just because it is on the page does not mean we lose all of the SEO traffic that has historically come to us. It is just that our organic listings are now below the AI overview that Google is presenting the user with. As we see ourselves as with any company where SEO is a factor, it is not a factor in generating customers. It is not the only one for us.

Speaker 2

We have very strong direct channel and we have been stepping out broadly over the last 18 months with the work we've done on TikTok to really become a significant educational partner there. You heard in our prepared remarks, we're very excited about the launch of the app on Discord and the Chrome extension, really trying to put Chegg integrated into the student workflow and on surfaces where the students already are and we can introduce our products to them there. We can actually give them pseudo experiences that drive some new product driven growth right from those channels. And so we're going to continue to have kind of a holistic marketing strategy across multiple funnels. We're going to continue to see us push that out in our brand campaign coming this winter, and we're going to continue to find ways to attract the strongest audience we possibly can.

Speaker 4

Appreciate the color on that, Nathan. Maybe just as a follow-up, as you look across the subscriber base today and student cohorts, what segment of the student population do you feel like you're having the most traction? And maybe perhaps what areas do you feel like you need to do incremental work in terms of driving, let's call it brand awareness and conversion? Thanks.

Speaker 2

Yes, I love that question because I think one of the viewpoints people have with students is they're a little bit one dimensional and they're not frankly. A student throughout a semester is going to need some time to really dive deep into becoming confident and competent in a subject. And there are times where they're just going to turn to generic AI to get an answer. We are targeting that student. And at the moment when that student needs to really learn and from our data, we can clearly see, we said in our prepared remarks, more than 75% of high school U.

Speaker 2

S. High school and college students are willing to pay for service as if that service is really designed to produce better outcomes and competency and confidence. And so that's what we're geared towards around all of our brand campaigns of really expressing the students when to use Chegg, how to use Chegg. And we know that students are going to use a basket of services. So when they're really going for that learning and really going to get prepared for those exams, you're going to we want them to choose Chegg.

Speaker 2

And that's why you see our product going into that more practice area, that solution comparison area and not just that next word and that next solution.

Operator

Our next question comes from Alex Fuhrman with Craig Hallum Capital Group. Please proceed with your question.

Speaker 5

Hey guys, thanks for taking my question. If I heard correctly in your prepared remarks, it sounds like the number of questions asked through Chegg was up pretty substantially versus last year. I'm just curious how you really reconcile how subscribers are down so much and yet it seems like just by the metric of questions asked engagement is actually quite strong and wondering if there's any better way to take advantage of that and monetize your core users going forward?

Speaker 2

That's a great question. Appreciate it. And you're right, questions were up 79% year over year in Q3. And we continue this is kind of a trend that we can see continue as we invest in that Q and A experience that I talked about in the prepared remarks, us really revamping again that Q and A experience as we want to pivot it away from being just about that solution or that next word, which we know students can get elsewhere to really a learning experience and taking that student, which may start with a question, but lead them into a flashcard, lead them into the bookmarking, the content for a study guide, lead them into prompting them into another question. And clearly from the engagement you're seeing, that's working, right?

Speaker 2

What we've got to do now, which is why I was very encouraged with the early trends of the Small Steps Big Wins campaign, we got to amplify that in our winter branding program and really get our students who love us really behind us and really as vocal advocates for us.

Speaker 5

Okay. That's really helpful. Thank you very much.

Speaker 2

Appreciate the question.

Operator

Our next question comes from Jeff Silber with BMO Capital Markets. Please proceed with your question.

Speaker 4

Hey, this is Ryan on for Jeff. Similar to last question, I was just wondering on the retention rate. It seems like your retention is trending reasonably well and you're having some difficulty getting the new subs in the door because of the new GMAI enhancements. Just wondering if you could give any thoughts on that and where you're losing in the funnel as well. Thank you.

Speaker 2

Yes, I appreciate the question and retention and the product experience certainly go hand in hand. Again, this is just a moment where there's clearly turbulence in the market around students and when to use certain tools. We're really stepping out and establishing ourselves as a place to come to for learning and for improvements in your confidence and your competency. Our brand campaigns are all around that. When you hit the funnels now on Chegg, it is all about making sure you can understand the trust in our content.

Speaker 2

And so, we're going to continue to push on those packaging programs, those opportunities for students to explore our product a bit more before they're immediately hit with the paywalls and really get them into the product versus then just having to opt out if they're truly looking for an answer, they're going to go somewhere else. We know that and we're going to look to get those students who are looking to learn.

Speaker 4

Great. Thank you very much.

Operator

Our next question is from Josh Bair with Jefferies. Please proceed with your question.

Speaker 6

Hi. This is Ryan on for Josh from Morgan Stanley. Just curious if you guys could provide some further details on the softening in non subscriber traffic trends through October. I guess just like what are the primary drivers and kind of with this in mind, what gives you guys confidence that this can stabilize over time? Thank you.

Speaker 2

Ryan, appreciate the question. And I think you heard some of this in the prepared remarks and really the softness in the traffic, which therefore it goes into subscriber trends is really a reflection of, in my opinion, the Google AIO experience, the Google AI overviews experience is that, is now kind of rolled out and pretty pervasive. Obviously, students are getting those who are seeking immediate solutions versus trying to dive deeper into the learning are getting what they need right there on the screen. So that's going to drive obviously some softness in traffic. What we're doing about it, which is the important part, is making sure we really diversify how we get in front of students and where we get in front of students.

Speaker 2

So you're seeing that specifically in the Discord app. We've got the work we're continuing to do on TikTok and the broad kind of big push we're doing on the brand side, really stepping out there and getting out there. So students know what Shake stands for, where we really sit in that comparison set and when to come to us.

Speaker 6

Great. Thank you.

Operator

This concludes our question and answer session and concludes our conference call for today. You may disconnect your lines at this time and we thank you for your participation.

Speaker 1

Goodbye.

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