Chegg, Inc. (CHGG) Q3 2016 Earnings Report, Transcript and Summary

Greeting, and welcome to the Chegg Third Quarter 2016 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 remainder, this conference is being recorded. I would now like to turn the conference call over to Tracey Ford. Thank you, Ms. Ford, you may begin.

Good afternoon. Thank you for joining Chegg third quarter 2016 conference call. On today’s call are Dan Rosensweig, Chairman 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 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 quarterly report on Form 10-Q filed with the Securities and Exchange Commission on August 3rd, 2016, 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. Now, I’ll turn the call over to Dan.

Good afternoon everyone and thanks for joining the call. Before we get started, I'll like to welcome Tracey Ford our new Vice President of Investor Relation. Tracey Ford joined Chegg following more than 13 years at eBay and PayPal and we couldn’t be happier to add her to our team. Welcome, Tracey. On today's call, we will cover the continued strong performance in Chegg services and our key growth drivers, update you on our textbook transition which we are excited to say is finally coming to an end, preview our first ever Analyst Day and finally, Andy will walk you through our financials and outlook. Chegg is a platform for student success, focused on providing products and services that improve outcome. This means we offer direct to student services that are on-demand, adaptive, personalized, affordable and entirely online. Importantly, all of our services are interconnected and benefit from one other. We believe students already consider us an indispensable learning tool in and out of the class room with proprietary tools that are backed by live human health. We believe we are building the brand and platform at students from middle school into their early careers, we'll turn to first because we help enable a much broader set of improved outcome that include accelerated learning, less chat and of course better jobs. Our goal is to reach more students and no more about them than any other brand. As more students use Chegg more often, we are able to rapidly improve the quality in relevance of each of our service and on a per student basis. This creates a powerful virtuous circle which we believe improves each service and helps us introduce new offerings for students at the right time at a very low cost. The ongoing momentum in our business is evident that our vision has already begun taking shape and we are on track for our most successful year yet. In fact, in Q3, our Chegg services subscriber base totaled more than 800,000 in the quarter, a new record for Chegg representing more than 40% growth over last year. For all of 2016, we expect to end the year with about 1.5 million Chegg service subscribers. The largest of these services Chegg Study, continues to show significant growth and most importantly is positively impacting academic performance. The efficacy of this service is evident in its increasing reach and engagement which we continue to see year-over-year growth in both frequency of subscriber, visits, as well as total questions asked and solutions viewed per subscriber. Furthermore, Chegg Study continues to have monthly renewable rate of about 80% and students consistently report in our user surveys that Chegg Study helps them master their subjects, do better on exams, and pass their classes. Even in a world of technology and personalization, not all students can learn with technology alone. Some students need human help as well. That is why we are building what we believe to be the largest online marketplace for highly qualified low cost tutors who can help students learn on demand in real-time via video, audio or text in any subject in any language. And we continue to see very strong momentum in this business with significant growth in students, tutors and in overall tutoring minutes. The last of which grew over 65% in Q3, year-over-year. Writing is one of the most challenging areas for students in high school and college as demonstrated by the fact that in the last 12 months about 30 million visitors used our writing services including EasyBib. We are very pleased with the progress we made integrating these services into the Chegg platform and we are very excited by the potential they have to enhance and extend the power of the Chegg brand to students beginning as early as junior high school. As a platform business, an important measure of performance is our ability to attach customers to multiple services. We believe we are continuing to demonstrate success here as the attach rate to Chegg Study from our textbook customers grew another 25% year-over-year in Q3. In addition, about 50% of Chegg Tutors customers are continuing to come directly from Chegg study, which we believe reinforces the fact that each of our services are even more powerful as a platform. Textbooks remain a significant pain point for students and a low cost customer acquisition channel for Chegg that helps us build our brand, add to our data, and ultimately attach students to Chegg, and with Chegg's multiple services. We are able to do this officially through our partnership with Ingram. And I'm happy to tell you that this semester is the last in which Chegg will own any of the books we are marketing directly to students. It's been a long two year journey but the transition is finally reaching conclusion. Our textbook service also provides a channel for advertising partners. Chegg's iconic orange brand which have been arriving in dorm rooms across America are delivering textbooks along with more than 6 million product samples and inserts - a record for Chegg in the quarter. From brands such as Coke, DirecTV, RedBull, Shutterfly, Starbucks, Tide, and others all of who are discovering Chegg as a way to provide unique opportunities to reach their most coveted audience which is young people. We have had an outstanding 2016 and we continue to invest in and build towards our long-term vision to help students their outcomes and gain more productive careers. This brings us to a very exciting moment, Chegg's first ever analyst day and let me walk you through our agenda for next week. With the US and global education markets undergoing widespread disruption at every level, we will discuss the impact on the education industry, and in student behavior and how Chegg is leveraging these dynamics to serve students - on their own terms - with a modern education platform that uses technology and the Internet to connect students to the resources they need. I'm very much looking forward to introducing you to the key members of our management team who will be presenting our strategic overview, product roadmap, advances in the student graph, addressable market sizes, along with an early view of some of the future services that we have been developing. And of course, Andy will walk you through greater detail of our business model and our key drivers. If you have not yet received a formal invitation and you'd like to come, I encourage you to email Tracey. And with that let me turn it over to Andy who will provide you more details on Q4 and a look into next year. Andy?

Thanks Dan and good afternoon everyone. Today I will discuss our financial performance for the third quarter and our outlook for the remainder of 2016, as well as our initial outlook for 2017. The momentum we saw in the first half of the year continued into Q3. The investments we are making in our platform, brand, student-first services and the student graph are paying off as our topline and EBITDA came in at the higher end of our expectations. For Q3, non-GAAP revenue of $55.5 million was driven primarily by 44% year-over-year growth of Chegg Services revenue to $29.7 million. As Dan mentioned earlier, we continue to see strong subscriber growth and engagement, particularly in Chegg Study, resulting in growth rates similar to fiscal 2015, but on top of a much larger user base. For those investors new to the Chegg story, when we entered 2016, we modeled our revenue on a non-GAAP basis. We did this to make it easier for investors to monitor the underlying growth of the business, despite declining GAAP revenue. This is due to our transition from owning print textbooks, where we recorded 100% of the transaction value, to a more, to a new, more profitable revenue model where our partner Ingram will own the print textbook inventory, and we will record an approximate 20% commission from each transaction. Importantly, this partnership has allowed us to transform from using cash to generating cash. And as planned, we expect that this textbook ownership transition, which started in 2014, will be completed by the end of this year, at which time, both revenue and non-GAAP revenue will be the same. The financial benefits of this transition have been meaningful for Chegg, freeing up capital once used to purchase print textbooks and allowing us to invest in future growth opportunities, which we believe can drive greater shareholder value. At the same time, we continue to reap all of the advantages of delivering millions of textbooks to students, including low cost customer acquisition, expanding the Chegg brand and awareness, adding to our Student Graph, all while attaching students to our high growth, high margin services. In fact, our Q3 gross margins were higher than expected at 45.8%, as a result of increased benefits and synergies from our learning services. Notably, much of the incremental revenue goes straight to the gross margin line, as digital services like Chegg Study and our writing tools have a relatively fixed cost structure. In other words, as the services grow and achieve scale, our margins should continue to increase. As a result of the strong revenue and gross margin performance, we generated a positive adjusted EBITDA of approximately $200,000. This is notable as it marks the first time in our history that we have been profitable in Q3 on an adjusted EBITDA basis. As you can see, we are realizing the benefits of our improved business model. Looking at the balance sheet, we ended the quarter with cash of $90 million. In addition, the balance owed to us by our partner Ingram was $29 million, much of which will convert into cash in early 2017 per the contract terms. We also put in place a new credit facility of $30 million, which is expandable to $50 million, and replaces the asset backed facility that expired during the quarter. This puts us in a strong position to expand our current business and take advantage of strategic growth opportunities that may arise. As expected, Chegg's legacy print textbook inventory declined to $4 million from $30 million when we entered 2016, and we expect the balance to be very close to zero by the end of the year, as we successfully complete the textbook transition on time. Based on the strength of our performance year-to-date and the strong start that we have seen in the fall semester, we remain confident in meeting our financial objectives that we guided to earlier this year. As Dan mentioned, we are hosting our first-ever Analyst Day next week. Typically, we would not provide next year's guidance until our 4th quarter earnings call, however, due to the Analyst Day and to the textbook transition, we are providing you a preview of our 2017 expectations and the expected seasonality, which is included in the press release. For 2017 we currently expect revenue to be approximately $230 million, with Chegg Services revenue growing 35% to approximately $172 million and adjusted EBITDA growing to approximately $35 million, a 75% increase over 2015. Given our 2016 performance to date, combined with this outlook, we believe we're on track to meet our operating model targets for 2018. Specifically, for all of 2016, we expect: total revenue between $246 and $251 million, non-GAAP revenue between $191 and $195 million with Chegg Services revenue between $126 and $129 million. Gross margin between 51 and 53%, and adjusted EBITDA between $18 and $20 million, more than tripling from 2015. Therefore our ranges, our Q4 ranges are: total revenue between $55 and $60 million, non-GAAP revenue between $48 and $52 million, with Chegg Services revenue between $41 and $44 million. Gross margin between 65 and 67%, and adjusted EBITDA between $12 and $14 million. In closing, it's been another great quarter, but more importantly we have seen our company complete a monumental transition in the past three years, from being primarily a textbook renter to a platform of interconnected services that benefit each other, resulting in a stronger business model, a model that is high growth, high margin, generates strong cash flows and is capital light. I look forward to seeing many of you at our Analyst Day on November 16, where we will discuss in more detail our current and future growth opportunity. With that, I'll turn the call over to the operator for your questions.

Thank you. [Operator Instructions] Thank you. Our first question comes from the line of Brian Fitzgerald with Jefferies. Please proceed with your question.

Hi guys. This is Alex on for Brian. I was just wondering what the feedbacks been from student's on testing so far and just kind of remind us what differentiated from the standard options out in the market, whether it's the link is to tutoring, the adaptive nature of the product and then just lastly what's the attach rate at of test prep in the tutor. Thanks.

Yes. So, Test Prep is to remind everybody as something we launched at the just a few months ago, towards the end of the summer. And we don’t have any expectations toward for '17 and we expect to start to become a business in '18 and '19. And the goal is to create low cost high quality differentiated products that are used by millions. And so, step 1 was to launch it with ACT, we subsequently launched it with SAT. And it's not yet integrated into the other services yet because we're learning getting the feedback for the efficacy. So, we've had 100s of 1000s of students try it, which is what we wanted to do, now we're going back and we're evaluating their usage patterns, where they spend their time, what their feedback is and then for percentage of them, now that they've taken the test to come back and give us the grades and get the feedback. So, it’s well, it's way early to give you the answers to those really good questions because that is the model. But in terms of the most likely pathway would be from tutors to test prep and test prep to tutors, but it's too early for us to be talking about that stuff because literally we just launched the thing.

Great. Thank you, very much.

Thank you.

Our next question comes from the line of Corey Greendale of First Analysis. Please proceed with your question.

Thanks, this is Ken Wang for Corey. Thanks for taking my question. And great job on the quarter.

Thank you.

So, just to begin. Any update on Chegg Tutors offering a tiered pricing model, I know there's been a little bit of talk on this in the past. Just want to see if there'd been any developments there.

Chegg Tutors as you know because you've done a good job following the company. It's something we are hugely bullish on and that we imagine over the next couple of years it's likely to be our fastest growing business. And we're building a two sided marketplace obviously because of the size of our network now reaching 40 million users a year and as many as 10 million a month. We're able to drive demand and we're matching that to the right tutor at the right time and the right subject matter and using up our student graph and our technology to do really excellent matchings. So, step one is to build that into a very large vibrant marketplace before we think about different tier pricing models. The second thing is we mentioned when we started talking about those questions, in fact that we needed to install a net suite which is what we've been studying this year doing. And as we will give us the capability to do things like tier pricing based on quality, based on subject matter and also group pricing to in essence more in line with Uber which is you can do higher tier pricing, you can do group pricing, you can tutor pool. So, we'll have a lot of those capabilities but again those are all premature and not assumed they're all into this year or even into next year. So, those are all big opportunities for us to continue to grow access both in the gross margins by raising the prices and in tutor pool by getting greater access to people at lower prices. But flexibility to make more money each time we do it. So, it's very much in line with our thinking, it's just way too early for that for us.

Perfect, thanks. That's very helpful. And then just one more quick one from me. For EasyBib and the other writing services, I think you had mentioned being able to bring in students as early as junior high. Just wondering can you provide any kind of directional indication or perhaps more color around the portions that are coming from college high school and even junior high?

No. but we will be able to in the future. So, as some of you may know, we've been spending a lot of time implementing adobe's platform which will help us analyze with different age groups of the different students. What we are able to do though is based on the paper they're writing, we can link it back at the older ages to textbooks we know and the year that you would normally get that textbooks. So, we're working on all that data. That's part of the student graph which will make us something very difficult for anybody else to compete with because we'll be able to not only know things but infer things. But the way we think about it is when we acquired EasyBib that expanded our reach to 40 million users on an annual basis. We had 20 million on our own, there were 10 million overlap and we've seen the majority of that overlap with late high school and in college. So, we're not prepared to break it out yet, just because we've only owned it since June and it takes some time to know that.

Thank you.

Our next question comes from the line of Doug Anmuth with JP Morgan. Please proceed with your question.

Hi, this is [Leonoda Chelsea] on for Doug. Thanks for taking our question. We are wondering, can you give us some more color on the increase in the attach rate specifically on what do you think is driving in more and then like year-over-year growth?

Yes, the attach rate had a great year and had another great quarter and we expect that to continue. And the reason for that is because of the way we're building the company, which is Chegg is always going to be designed to be a large platform with a large brand interconnected services and using the proprietary data in our student graph to be able to not only know things specifically but infer things as a result of that make logical connections. So now, when we know your textbook and your college which we know if you go through there, we could obviously align you with any one of the 23,000 ISBN that are currently in the service or in the future with any of the nearly 5 million questions that are currently in essay queue. So, that's just getting better and better, then our ability to be able to put it in the right places at the right time. We know when your midterms are, we know when your finals are, we know when homework is assigned. And each time we do that, and each time we personalize it, we get a better attach rate. And we've seen that in textbooks. In the case of tutoring, and again if you come to out with then you'll see exactly where we laid out in the products. We're getting really sophisticated with tutoring, so if you're inside of Chegg's Study, we not only know who you are, we not only have your credit, we not only know your school, we not only know your class, we not only know your textbook but we actually know the exact problem you're on, the chapter you're on and we can connect you to a tutor that may be about the book, the chapter, or the specific question that you're struggling with. That's the kind of differentiation that our student graph allows us to do that nobody else can do, and that’s why we're seeing nearly half the customers in tutors coming from Chegg Study. This was the goal when we started to build Chegg six years ago, and we're starting to see those result and you see it allows us to grow faster, lower the cost. And so, you're beginning to see it would be profitable each quarter, not just certain quarters. So, it’s a big transformation for us. So, we could expect that, we believe those will just get better overtime. But they had a great quarter.

Thank you.

Thank you.

Thanks.

Our next question is from the line of Jeff Silber with BMO Capital Markets. Please proceed with your question.

Thanks so much. I'm assuming you're going to be talking about at the Investor Day next week, I don’t want to steal your thunder. But are there any holes in your portfolio, anywhere that you'd like to expand where you're not yet?

So, let me tell you this way, because yes of course we will be talking about that. What we will be showing is with the current naming services that we have, if you take the three that we currently have, Chegg Tutors, Chegg Study and writing, we'll be -- we'll show that existing term for just those three. And the large terms opportunity that we've yet to address. So, obviously we've articulated that we plan to address test prep and that we plan to address careers, two giant market that are not built into any of our revenue numbers for this year or next year, could they take on to build and make great and differentiate and really leverage the graph and nobody else we think is in the markets to do it the way we're doing it. But you'll see that there are significant opportunities within the verticals we're currently in and in verticals that just make commonsense to get in, just like writing made a lot of sense to get in when you realize the 25% of all students have to take remedial writing in order to start the freshman when you're at college. Well, the same exists for math. And so, we will highlight without being specific on any of our plan but if you look at the term for just the businesses they're in, they're growing really fast and they're really early. And we will also highlight because we've been asked that question a lot particularly with Chegg Study, just how bit is that market. We think that that market is significantly large in a way we've already done and that's why we don’t haven't seen a growth rate for down in that business. So, we will lay out both, I guess you I don’t want to give out the thunder other than the ones we mentioned before which is careers and test prep and math.

Okay. That makes sense. Looking forward to next week.

Thank you.

And Andy, for you. You mentioned in your remarks that revenue and non-GAAP revenue will be the same. Is that by the end of 2016 or by the end of 2017?

It'll likely by the beginning of 2017, both GAAP and non-GAAP will be, just saying. We won't even talk about non-GAAP starting in 2017.

Okay. Just wanted to clarify that. Thanks so much.

You got it. Thanks. But the comparison will be GAAP to pro forma, both of the '16 because that would have been our GAAP number in '16.

Yes. Today I'm point -- yes, we will continue to compare it to our non-GAAP revenue at this year but in fact revenue will be, they'll be identical in '17.

All right, that's helpful. Thanks, so much.

You bet, Jeff. Thank you.

Then next question is from the line of Alex Paris of Barrington Research. Please proceed with your question.

Hi, good afternoon. This is Chris Howe sitting in for Alex Paris. I had a question in regard to imagine easy, is this still the right way to think of it as $10 million in annual revenues and adjusted EBITDA of $4 million as we look at it on a full-year basis?

Yes. So, we talked about that on our May call. And you've got it right in the ballpark.

Okay, thank you. And one more if I may, just in regard to some of your comments around the predicted data and analytics that are part of the student graph and how it relates to writing services. How does this fit into your internal expectations for the attach rate that you expect out of this product moving forward?

So, the every time that we add a service either organically or through acquisition, we're able to take all of that data and build it into our matching algorithms and our product improvement algorithms. So, we're able to know certainly much better than imagine ever was because they didn’t have this technology. We're able to know usage, frequency of usage, what part of the product works best, what's the most used product, what part of the products are not used as well, where people gets stuck. But we're also able to take the match from the 2.4 billion citations that are already in there and be able to match it for example to our textbook catalogues, we're able to match when you're writing a paper, what textbooks you may be writing it for which then allows us to match it to what year you are, what your major is and what your class is. And of course once we know the paper and we know your citing, we're also able to match you to a logical tutor who's an expert not only in writing but perhaps in the subject matter for those particular books because of the way we've begun to tag tutors. So, everything just gets better which should help us continue to grow at the accelerated rate in which we've been seeing and be able to do it really profitably. So, you continue to see our gross margins improve, you continue to see our overall marketing dollars not just as a percentage of revenue continue to decline. That's a result of having the enormity of the brand, the reach, the trust, and the data. So, if you take imagine easy, there is so many logical ways to integrate it into what we do including eventually using their proprietary ad network to be able to be use on the rest of Chegg Services we're appropriate. Because we want to continue to grow fast, keep the prices down but continue to get better yield per customer. So, it's really exciting and powerful, it's rare to be able to get an asset that reaches 30 million users a year where it has as treasure trove of data where you're going to identify the age, you can identify the class, you can identify the textbooks, you can identify the subject matter, all of these things are things that will advent to shape over anybody else.

Thank you. I appreciate the color.

Yes. Thank you for asking. It's been a really exciting year so far.

Thank you. Our next questions from the line of Aaron Kessler with Raymond James. Please proceed with your question.

Okay, thanks. Couple of questions. Firstly, from the guidance for 2017, or think in the Chegg Services in place pretty strong growth about 33%. Possible could you break that down a little bit kind of between Chegg learning and advertising services or within learning. Does that imply most of that growth is coming from Chegg space when you get a better view for kind of where thinking that growth is like most coming from for next year? Thank you.

Yes. Thanks, Aaron. Yes, so, as what we said on the call was that it was a 35% growth but yes we do see strong growth really across most of our product portfolio. Dan has mentioned earlier that we expect Chegg Tutors to be our practice going over time. But once again, we continue to speak, we anticipate we'll see strong growth in Chegg Study, in writing tools and we call when we purchase writing tools we said he was growing basically at the average and that's what we're seeing. So, yes, we think we got a strong portfolio of products that will contribute to the 35% growth in 2017.

Good. And it's from the stock based count that goes for 35 million. Can you just update us maybe that interest goes just kind of one time as we see within that amount. Can you just give us a sense of might what a normalized level is going forward?

I presume you're talking about 2017 or 2016?

Yes, I think that's all probably a little bit heightening the result.

Yes. So, our anticipation as we roll out of 2016 into 2017 is that we'll start to see a meaningful decline in our stock based compensation. For really a couple of reasons but one main reason on that it is that we had a significant amount of stock options that were granted at the IPL in the expense for those while a significant there's been no real benefit to either employees or a shareholders that rolls up. And so, as result, we do anticipate that we see a 13%, possibly more decline in our stock based compensation in 2017 and that's what we articulated in the press release.

Yes, got it. Thank you.

Thank you.

Then next question is coming from the line of Matt Blazei with Lake Street Capital. Please proceed with your question.

Hey guys, good afternoon. A couple of things, I just wanted a clarification, I think Dan said that you had little over 800,000 subscribers as of the for the quarter which was a record high. And you mentioned a 1.5 million number for the end of the year. Is that the total number of different subscribers who have used that, who could used that platform in 2016?

Yes. So, Matt, yes. So, we had for the quarter there was 800,000 subscribers. It was a record. And when you look at the 1.5 million, compare that with a million subscribers that we have for 2015. Right. We had a million in 2015, all of 2015, this is all of 2016 so it's about a 50% growth.

Got it, perfect. And then obviously I'd like to get some more clarity on you’re the significant amount of cash you generated in the quarter up to $90 million. And sort of get an idea of if there was any particular one-time event there for the quarter?

Well, that's the big, the good question and the big one time event is we go through a textbook rushie at September. It's fairly normal that we actually accumulate a lot of cash in the September quarter as you can imagine. Because we are on most of the textbook revenue now its commission based. We take 20% of it, Ingram gets 80%, we're on 30 day payment in terms of the Ingram seller. Significant portion of that cash will actually go to Ingram in October. But probably more importantly is where will exit at the end of the year. And we do anticipate that we'll exit at the end of the year somewhere between $50 million and $60 million of cash of which is pretty consistently what we've been saying for the year.

But it's exciting that we're a cash generating company. When three years ago, we were using so much cash and now we have a lot of positive cash while the operating side and we're deploying it way to go the company past. So, it's really exciting time and we're incredibly appreciated in the fact that we're ending the textbook transition on such a high note.

Good job, you guys. I appreciate it. Thank you.

Thank you.

Thanks, Matt.

Thank you. At this time, I'll turn the floor back to management for concluding remark.

Okay. Well, thank you everybody for joining the call. As you can see, the textbook transition is at a conclusion. And we for the first time we're able to provide an expectation for 2017 this early, because the business is more predictable. We're really excited about the direction that company is going. We're seeing extraordinarily high growth rates in the Chegg Services business where generating cash flow, we're EBITDA positive. So, the things that we imagined three years ago when we came public, are really beginning to come through even in more significant ways than we would imagine. We're very excited about our Analyst Day. And again if you've not receive the invitation or did not responded, please do. To Tracey Ford and we think we're going to have packed house because a lot of people are really getting interested and excited about the Chegg story. Because in the education space there aren’t a lot of growth companies. And we are, we believe the leading growth company, specially for direct to consumer. So, we appreciate your time and attention today. And we're very excited about the future. And we'll see most of you, hopefully all of you next week. Thank you.

Thank you. This concludes today's conference. Thank you for your participation, you may now disconnect your lines this time.