CHGG - NYSE

Greetings and welcome to Chegg, Inc. Third Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] 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. Thank you. You may begin.

Good afternoon. Thank you for joining Chegg's third quarter 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 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 and 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. 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.

Thank you, Tracey. Hello, everyone and thank you for joining Chegg's third quarter 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 million and $22 million in adjusted EBITDA. 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 phase of adversity, there continues to be a large market of students looking for high-quality, proven learning experience that Chegg provides. We continue to enthusiastically serve this audience and I remain optimistic in the outlook for us to extend our brand, individualize our products 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 keep users on Google search results page instead of leaving them on to third-party sites such as Chegg. This rollout has been rapid and while we've been monitoring the 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 and shifting from being a search origination point to the destination, disintermediating content sites like Chegg. Second, across our industry, there has been a continued increase in the adoption of free and paid generative AI products. This has been widely reported and substantiated in the industry research, students are increasingly turning to generative AI for academic support to homeworking exams. This issue impacts the education ecosystem at large, including universities and education technology companies broadly. Where student see generative AI products like ChatGPT, a strong alternative to very specialized solutions for education such as Chegg. These factors, the speed and scale of Google AIOs 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. Global nonsubscriber traffic to Chegg declined year-over-year, 8% in Q2, 19% in Q3 and we exited Q3 with trends looking even more unfavorable and 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 million 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. Effective immediately, we are initiating a broad restructuring that will impact all groups across the company, where 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 million to $70 million in 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 million to $120 million in 2025. Even with this, we remain optimistic that there is an audience for Chegg. While it's clear that some students will favor generative AI options, we believe our sale is a large market of students who care about learning and are seeking products that improve their competency and outcomes. In an August 2024 point-data 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 assumed audience that's looking for high-quality content and proven learning expertise. This is what differentiates Chegg from other generative AI tools today and why millions of learners depend on Chegg to provide meaningful early experiences with the highest quality content possible. 15 years of deep expertise in understanding students, applying advanced learning science to subjects and topic students learn, providing an archive of 132 million high-quality solutions and human support output that has created a deep trust and awareness to Chegg. 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 support 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 third quarter. We launched our small step Big Win brand marketing campaign which is showing early signs of progress with year-over-year improvements and conversion rate across many of our paid marketing channels. We introduced a content quality and satisfaction guarantee, differentiating our service against generative AI and building trust and loyalty with subscribers. While it's still early, it is driving a lift in new subscriber conversion rate. We implemented an AI arena that allows us to evaluate, 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&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. 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 study activities across sites, engage them with our products 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 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 and revenue streams while strengthening Chegg's role in improving student learning outcomes. 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 in connection and ultimately drives emerging. 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. 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, due to durable needs and corollary behaviors and support learning. While we acknowledge the significance of the headwinds we covered earlier, Chegg has a deep legacy of serving students and we believe our brand and product experiences are reselling it. We remain optimistic and we'll 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. This is a multiyear plan and will require patients and we'll 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 students 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 talent have helped support students and bring learning to life. 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 Dave.

Thank you, Nathan and good afternoon. Today, I will present our financial performance for the third quarter of 2024 and the company's outlook for Q4. We delivered a solid third quarter. During the quarter, we remain 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. In the third quarter, total revenue was $137 million, down 13% year-over-year including subscription services revenue of $120 million which was down 14% year-over-year. We had 3.8 million subscribers in the quarter, representing a decline of 13%. Subscription services ARPU was down 2% year-over-year, a 1 point improvement from Q2 2024. Overall, monthly retention for Chegg Study and Study Pack remained strong and was up 30 basis points year-over-year. Still and other revenue was $17 million, a decrease of 6% year-over-year. And we delivered adjusted EBITDA of $22 million 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 million noncash impairment charge that was excluded from our Q3 adjusted EBITDA. Second, we reached a settlement agreement to resolve Leventhal class action securities lawsuit. We recorded $55 million for the estimated contingent liability for the loss, along with a $55 million receivable for the insurance proceeds we expect to see. 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 are happy to have this matter result. Free cash flow was $24 million in the third quarter. Capital expenditures were $15.8 million in the quarter, down 32% year-over-year, of which $10 million were content costs. 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 million and a net cash balance of $30 million. Today, we announced that our Board of Directors has authorized an increase of $300 million 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 $3.7 million 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. 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 319 employees or approximately 21% of the company. In 2025, the company expects to realize non-GAAP expense savings of $60 million to $70 million from these employee departures, real estate savings as well as other cost rationalizations. Chegg expects to incur a $22 million to $26 million charge related to the restructuring. Of this charge, $18 million to $22 million will be incurred in cash, representing mostly severance payments with the remaining amount representing noncash charges. We expect that a substantial portion of the cash and noncash charges will be incurred in the fourth 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 million to $120 million in 2025. Moving on to Q4 guidance. We expect total revenue between $141 million and $143 million, with subscription services revenue between $126 million and $128 million. Gross margin to be in the range of 67% to 68% and adjusted EBITDA between $32 million and $34 million. 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 ad-tech space, we are dealing with the challenges of a dynamically changing AI landscape. 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 Instructions] Our first question comes from Eric Sheridan with Goldman Sachs.

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 not sort of abandon any of the longer-term growth dynamics against some of the near-term headwinds you might be facing.

Thank you, Eric, for the question. 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 we rolled out in June of this year. We still very much believe that, that is a winning strategy. 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 our -- of where we're going to put our priorities, we're going to work on first 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 rate and conversion rate across our paid marketing channels. 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.

Our next question comes from Ryan MacDonald, with Needham & Company.

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 [ph] that you're going to have to replace moving forward? And then, what channels thus far as we've gone into the fall semester as you 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?

I appreciate the question, Ryan. Surely, I 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, it does not mean we lose all of the SEO traffic that has historically come to us. And it's just that our organic listings are now below the AIO review that Google is presenting the user with. As we see our -- 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. We had 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 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 a 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.

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 in conversion.

Yes, I love that question because I think one of the viewpoints people have with students as they're a little bit one dimensional and they're not, frankly, a student throughout a semester is going to need sometimes to really dive deep into becoming confident and competent in 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 from our data, we can clearly see -- we've said in our prepared remarks, more than 75% of high school -- U.S. high school and college students are willing to pay for a service that service is really designed to produce better outcomes and confidence. And so that's what we're geared towards around all of our brand campaigns of really expressing the students when do you use Chegg, how do you use Chegg? And we know that students are going to use a basket of services when we want to -- so when they're really going for that learning and really going to get prepared for those exams, you're we want them to choose Chegg and that's why you see our product going into that more practice area, that solution comparison area and not just the next word and that next solution.

Our next question comes from Alex Fuhrman with Craig-Hallum Capital Group.

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. 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?

It's a great question. Appreciate it. And you're right, questions were up 79% year-over-year in Q3 and we continue to -- this is kind of a trend that we can see continue as we invest in that Q&A experience that I talked about in the prepared remarks, us really revamping again, that Q&A experience as we want to pivoted away from being just about that solution or that next word which we don't can get elsewhere to really a learning experience and taking that student which may start with a question but lead them into a flash card, leave 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? What we've got to do now and which is why I was very encouraged with the early trends of the small-step Big Wins campaign. If 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.

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

This is Ryan [ph] on for Jeff. Similar to the 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 AI enhancements. Just wondering if you could give any thoughts on that. And where you're losing in the funnel as well.

Yes, I appreciate the question and the 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 the place to come to for learning and for improvements in your confidence and your competency, our brand campaigns are all around that. So when you hit the funnel now on Chegg, it is all about making sure you can understand the trust in our content. 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 than just having to opt out if they're truly just looking for an answer, they're going to go somewhere else. We know that and we're going to look to get those students were looking to learn.

Our next question is from Josh Baer with Jefferies.

This is Ryan [ph] on for Josh from Morgan Stanley. Just curious if you guys could provide some further details on the softening in nonsubscriber 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?

Ryan [ph], I appreciate the question. And I think you heard some of this in the prepared remarks and really, the softness and the traffic which therefore, it goes to the 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 are seeking immediate solutions versus trying to dive deeper into the learning and 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. 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 students, no, what it checks and for where we really sit in that comparison set to come and when to come to us.