Nerdy Q1 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 9, 2023

There are 9 speakers on the call.

Operator

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

Operator

Mr. Cohn, you may proceed.

Speaker 1

Good afternoon and thank you for joining us for nerdy's Q1 2023 earnings call. With me are Chuck Cohn, Founder, Chairman and Chief Executive Officer of nerdy and Jason Pelop, Chief Financial Officer. Before I turn the call over to Chuck, I'll remind everyone that this discussion will contain forward looking statements, including but not limited to expectations with respect to nerdy's future financial and operating results, strategy, opportunities, plans and outlook. These forward looking statements involve significant risks and uncertainties that could cause actual results to differ materially from expected results. Any forward looking statements are made as of today's date and nerdy does not undertake or accept any obligation to publicly release any updates or revisions to any forward looking statements to reflect any change in expectations or any change in events, conditions or circumstances on which any such statement is based.

Speaker 1

Please refer to the disclaimers in today's shareholder letter announcing Nerdy's Q1 results and the company's filings with the SEC for a discussion

Speaker 2

of the risks. Not all of

Speaker 1

the financial measures that we will discuss today are prepared in accordance with GAAP. Please refer to today's shareholder letter for reconciliations of these non GAAP measures. With that, let me turn the call over to Chuck. Chuck?

Speaker 3

Thanks, TJ, and thank you to everyone who has joined us today. 1 year ago, we unveiled an ambitious plan to evolve our products and revenue model toward long term, recurring, Always on relationships with our customers. We created new subscription and recurring revenue products, including learning memberships for consumers And teacher assigned an on demand products for institutional customers that were built specifically to address the ongoing support We believe both types of customers needed and desired. We shared that we believe these new models would provide a superior platform for innovation By allowing us to bring together multiple different product capabilities we had developed into a comprehensive all access offering that enabled learners to receive the help they need across multiple learning formats, thousands of subjects, and multiple academic calendar years. In addition to allowing us to provide a better and more personalized experience to learners, the new operating model would be far more efficient to operate, Allowing us to drive operating leverage, simplify our sales model and shift additional resources toward net new innovation, including the application of AI for HI or artificial intelligence for human interaction.

Speaker 3

To get to this evolved state, we shared that this new model would require trading off revenue recognition in the short term because our package model had a more front loaded Revenue recognition, the learning membership model where subscription revenue is recognized linearly over time. We expected that by the start of the Q2 of 2023, the cumulative build of recurring revenue from Learning membership customers Would cause us to return to growth in our consumer business as well as for the total company, but now with the product suite and revenue model we believe would position us for operating efficiencies and that we anticipated achieving adjusted EBITDA profitability by the end of 2023. I am pleased to share that in the Q1, we exited the J curve business model transition to subscriptions And returned to year over year growth, delivering $49,200,000 of revenue, which was above our guidance range of $45,000,000 to $47,000,000 Learning membership subscriptions accounted for 60% of total company recognized revenue, up from nearly 0% In the Q1 last year, demonstrating strong product market fit. On the institutional side of the business, We delivered record revenue of $8,500,000 an increase of 32% year over year, representing 17% of Total recognized revenue in the Q1.

Speaker 3

In combination, our consumer subscription and institutionally contracted revenue Accounted for 77% of total company revenue recognized in the quarter, a dramatic increase over the past year, which we believe speaks to the power of our platform oriented approach to growth and how we can efficiently go to market with all access solutions that provide more value to customers. The rapid business model evolution of learning memberships and recurring revenue And our continued application of AI to the customer experience and operational processes drove continued growth and improvement in customer values relative to our package model as well as operating efficiency improvements. Together, they were key contributors to our strong operating results We are pleased to share that we achieved adjusted EBITDA profitability in the Q1, 9 months earlier than our target of the Q4 of 2023, delivering nearly 1700 basis points of improvement year over year and $1,400,000 of adjusted EBITDA. The improvement in adjusted EBITDA represents An annualized improvement of approximately $32,000,000 We also realized $6,800,000 of positive Operating cash flow and $5,800,000 of free cash flow in the quarter. I'm pleased to share that we made progress on accelerating the use of generative AI throughout our business, including launching 2 new customer facing products, As well as accelerating the use of AI and machine learning to drive substantial operating efficiencies and internal productivity improvements.

Speaker 3

As we shared with you in our prospectus 2 years ago, when we made our intention to become a publicly listed company known, We've long believed that AI can fundamentally transform how people learn. We've been applying AI to our business, products and operational processes For over 6 years, an AI has been foundational to our ability to improve quality, enhance personalization And decrease the cost of our offerings. AI powers our ability to identify the highest quality experts, Assess Werner's foundational knowledge, help ensure the right expert learner match and drive operational efficiency among many other use cases. In our prospectus, we also described the proprietary technology infrastructure we're building as AI for HI We're artificial intelligence for human interaction and outline the core foundational capabilities we apply to live learning to enhance the interaction In ways that were not previously possible. Through the application of AI, we aim to provide experts and learners with superpowers The Transform Live Online Learning.

Speaker 3

We credit our orientation around AI for HI for allowing us to reach the milestone Of having recently delivered our 10 millionth hour of live 1 on 1 tutoring on our live learning platform And more broadly for allowing us to make good on delivering high quality relationship based live online learning available at scale. We've used this data and the insights we garner from having instrumented every part of the learning journey to drive real world practical value in our business. We credit AI for enhancing our customer lifetime values, helping us identify what each student does or doesn't know about a particular subject, When to reach out to a customer to drive engagement and retention and how to make operational processes far more efficient. We believe we stand to benefit tremendously from the latest advancements in generative AI and further drive revenue growth and cost reduction through its application. What has been maybe most exciting is seeing what our internal teams have been able to accomplish over the last 90 days And the overall piece of innovation internally.

Speaker 3

As internal access to generative AI tools has expanded, We are seeing it enhance our team's quality of work, the speed it takes to complete said work and open up new possibilities for products And process improvement in a way that previously would not have been feasible or that would have been cost prohibitive. To illustrate the speed of innovation, I'll cover some of the progress we've made leveraging AI in just the last quarter. We've continued to improve our expert learner matching algorithms. As a reminder, we first started applying machine learning matching algorithms 6 plus years ago to begin to detect patterns that no human possibly could To better inform the match between a learner and an expert. And with thousands of experts available for a given learner, taking a technology first approach to programmatically identifying patterns that were predictive of better learning experiences and outcomes has proven highly effective.

Speaker 3

Today, we simultaneously test competing machine learning algorithms until one is named the statistical victor and flipped to 100% of the volume for a given segment, And then the process repeats. And as we capture and better leverage data to inform the learner expert match, the Quality of the match will continue to improve for both learners and experts, in turn leading to a far better learning experience, Ultimately driving better customer satisfaction, better learner outcomes and ultimately higher customer lifetime value. In the Q1, we also further expanded learning formats and content. Our growth flywheel, which we first Shared publicly in January of 2021 reflects additional learning formats beyond 1 to 1 as a key contributor to what attracts new learners to the platform. These additional learning formats combined with relevant content to the subject being learned create personalized learning experience that drive engagement And retention of learners on the platform.

Speaker 3

During the Q1, we leveraged generative AI to launch 2 previously announced products, AI enabled chat tutoring and AI lesson plan generator, both of which we believe will be further accelerant to our growth flywheel. Additionally, we have steadily enhanced the availability of asynchronous content on the platform in areas like self study and computer adaptive diagnostic testing, which has driven higher levels of engagement and customer satisfaction. However, due to the unlimited possibilities of subject And age complexity and the nuances between school curriculums, it just wasn't feasible nor possible to have rich levels of content in every single subject Someone could conceivably want to learn on the platform. Thanks to advances in generative AI, that has now changed. We stand to be a huge beneficiary of being able to infuse high quality, hyper personalized content that has historically been expensive and time consuming to develop Into every learning experience.

Speaker 3

We believe this hyper personalization will allow us to further meet the needs of our learners on a recurring basis Over time. We're also seeing significant improvements to productivity and operating efficiency through the application of generative AI. Today, approximately 30% of our software code is being written by AI. All of our employees have access to in line Generative AI capabilities like GPT-four and are encouraged and expected to use it in their work. And we're now using generative AI to more efficiently solve customer support interactions and automate operational processes, Including now broadly leveraging AI powered support bots across learner facing, expert facing and even internally facing interactions, And we expect to see further wins on driving both conversion and retention as well as improvements in operational efficiency as the result Continued investments in generative AI across the business.

Speaker 3

Let's move on to learning memberships, which are scaling ahead of expectations. We continue to see substantial evidence that validates our belief that the learning membership model leads to more attractive unilevel economics, Longer duration and higher lifetime value customer relationships, higher gross margin and a more scalable and efficient operating model. We are also able to provide an improved and more comprehensive learning experience for learners and more consistent earning potential for experts. We remain convinced that this all access always on business model Serves as a better platform for innovation and growth. It allows us to better capture and then apply our proprietary data Across product interactions over time to drive deeper personalization for learners across many different learning formats and subjects.

Speaker 3

And we're able to easily incorporate new products that add more value to the hoarding membership experience over time. Learners have a better experience on the platform, engage more frequently and for longer periods of time, and were ultimately rewarded as a form of Learning membership revenue continued to grow at a rapid pace during the Q1 And reached an annualized run rate of approximately $143,000,000 as of March 31, an increase from $87,000,000 as of year end And nearly $0 in the Q1 of 2022. Active members grew to nearly 33,000 as of March 31, Up from approximately 20,000 as of year end. During the Q1, we expanded learning memberships to new customer audiences by Fully transitioning all purchases by existing package customers in the learning memberships as well as moving all of our new test prep audience customers As we look ahead, we plan to transition the professional audience to learning memberships by the end of the year, which would represent a transition to 100% of new customers to our consumer business To always on recurring revenue products. This past quarter, we introduced month to month learning membership, which are driving higher levels of conversion by alleviating friction in the member experience while increasing the average monthly subscription fee and accelerating the marketing payback period.

Speaker 3

We also enhanced the value provided in learning memberships by providing unlimited access to 2 new products. Our AI enabled chat tutoring enables learners to receive help from an AI tutor and also involve a live human tutor with a click of a button. After piloting this capability in early Q1 and receiving positive feedback and engagement data, we recently expanded access to all learners on the platform. The primary use case so far involves quick Q and A and homework help in between live recurring 1 on 1 tutoring sessions. It's a good example of how generative AI has enhanced our ability to build a product, in this case, one encompassing Q and A and homework help That historically would have required substantial investments in content, but now can be done for effectively no cost and served up to the customer in line At the right moment in the learning journey to keep them learning efficiently and effectively.

Speaker 3

The second product we added to learning memberships Was our AI lesson plan generator. We went from idea to minimum viable product to a fully built and value added capability Deployed across our entire platform and available to all experts as of late April. With this product, we use generative AI to Pre generate lesson plans, including practice problems and other curriculum content in advance of tutoring sessions. The lesson plan generator is embedded in the user interface as a dynamic and editable pane that is ever present during live tutoring sessions. We consider the ability to create hyper relevant, hyper personalized content spanning any subject, any age level That is personalized for the unique needs of the specific learner to be an example of the sort of superpower we have made available to experts and learners That previously would have either been impossible or cost prohibitive.

Speaker 3

With the addition of these new products, We continue to grow the percentage of learning membership customers engaging in a non tutoring format during the Q1 to over 27%, The highest of any quarter yet. Multi format engagement has historically been highly correlated to lifetime value extension. Looking ahead, we're working to make it easier for learners to more fully engage with their learning membership by improving discovery in an all new member portal. This will include personalized AI generated learning recommendations that predict and suggest the next product interaction Across learning formats and subjects that is most likely to drive engagement and customer value. As we head into the slower summer months, We've created compelling content for learning members to keep learning over the summer through increased engagement with academic, College Prep and Enrichment Subjects.

Speaker 3

Turning our attention to our institutional business of Varsity Tutors for Schools, Enhancements to our product suite of high dosage tutoring, teacher assigned and on demand, coupled with prior investments in Varsity Tutors for Schools, sales and go to market, Resulted in record institutional revenue of $8,500,000 in the first quarter, an increase of 32% year over year And representing 17% of total revenue in the Q1. Varsity Tutors for Schools executed a record 97 contracts totaling $6,300,000 of bookings during the Q1. Varsity's tutors for schools engagement trends including our new teacher assigned product Significantly exceeded our expectations and provide us with confidence that the solutions we have built have strong product market fit and are well suited for meeting the needs of school district partners, Teachers and students and helping students learn in an unprecedented scale. Teacher Assign continues to deliver against our vision for These high levels of engagement are occurring across a wide variety of grade levels and subjects, and teacher feedback has been enthusiastic that they love In particular, teachers see teachers assigned as a co teacher in the classroom, empowering them to help more students. Each feature's unique insights of individual students, including that student's understanding of the classroom curriculum are incorporated in the tutoring sessions.

Speaker 3

These strong results and continued momentum to start the year Give us increased confidence that Varsity Tutors for Schools is well positioned to provide solutions that administrators, teachers and students inspires and motivates when coupled with AI is enhancing the state of learning. With recent advances in generative AI, The ability to deliver personalized live instruction at scale for all students is within reach. We're proud of our progress to date growing our learning membership count to 33,000 active members. However, with more than 50,000,000 students in the United States alone, we're just getting started. We look forward to remaining at the forefront of product innovation and enhancing our ability to meet the needs of both consumer and Institutional Earnings.

Speaker 3

With that, I'll hand the call over to Jason to discuss the financials in more detail. Jason?

Speaker 2

Thanks, Chuck, and good afternoon, everyone. I'm pleased to be speaking with you today about another strong quarter for nerdy. We previously shared that we expected our evolution towards learning memberships would lead to longer duration and higher lifetime value customer relationships, Enhance gross margin, provide for more attractive unit level economics and drive higher levels of growth and profitability. I'm pleased to report that during the Q1, our team's hard work on the evolution to recurring revenue offerings pulled through Delivering a return to growth and positive adjusted EBITDA of $1,400,000 a nearly 1700 basis point improvement year over year And more than 9 months ahead of our stated target. Looking ahead, we expect to yield additional efficiency improvements through scaling learning memberships, Driving additional automation and self-service features and the continued application of AI throughout our business.

Speaker 2

Turning to Q1 results. In the Q1, we delivered revenue of $49,200,000 results that were above our guidance range of $45,000,000 to $47,000,000 These positive results reflect the continued growth in active memberships, which totaled nearly 33,000 as of March 31, up from 20,000 at year end. Learning memberships revenue grew to $29,700,000 during the quarter and represented 60% of consumer revenues in the quarter, up from nearly 0% in the Q1 last year, demonstrating strong product market fit. Our institutional business delivered record revenue of $8,500,000 representing 17% of total revenue during the Q1 And delivered bookings of $6,300,000 On a combined basis, learning memberships and institutional revenues delivered 77% of total revenue, A substantial change from just 2 years ago when the business was a 100% package business and 0% institutional revenue business. Moving down to P and L.

Speaker 2

Gross profit of $33,900,000 for the Q1 represented an increase of 3% compared to the same period last year. Gross margins of 68.9 percent for the Q1 were approximately 90 basis points lower than 69.8% in the same period last year. The increase in gross profit was driven by gross margin expansion across our consumer audience, which was offset by higher than anticipated engagement with our new products in our institutional business. As we evolve towards a greater mix of learning membership revenue, We expect consumer gross margin to expand throughout 2023. Sales and marketing expenses on a GAAP basis were $15,600,000 in the 1st quarter, A decrease of $7,400,000 compared to the same period in 2022.

Speaker 2

Non GAAP sales and marketing expenses, Excluding non cash stock based compensation were $14,700,000 or 30% of revenue in the Q1. This compares to 47% of revenue in the same period of last year, an approximately 1700 basis point improvement year over year. Sales and marketing spend and efficiency improvements were driven by the transition to learning memberships, including the continued expansion of lifetime value, Our focus on optimizing the level of marketing spend and a more efficient operating model in our consumer business. We also delivered substantial Varsity Tutors for Schools revenue growth, yielding efficiencies from prior investments in the institutional sales and go to market organization. As learning memberships become a greater percentage of total revenue and the institutional business continues to scale, We expect to yield durable sales and marketing improvements.

Speaker 2

G and A on a GAAP basis was $29,700,000 in the 1st quarter, A decrease of $800,000 compared to the same period in 2022. Non GAAP G and A expenses, excluding non cash stock based compensation, were $19,500,000 or 40 percent of revenue in the Q1. This compares to 41% of revenue in the same period of last year, an approximately 100 basis point improvement year over year. Combined with our ongoing efforts in automation, Self-service capabilities and the application of AI, we've been able to generate operating efficiencies and remove significant costs from the business. As noted, we reported adjusted EBITDA of $1,400,000 a nearly 1700 basis point year over year improvement in the Q1, Beating the guidance range we provided of an adjusted EBITDA loss of $3,000,000 to breakeven.

Speaker 2

Cash provided by operating activities Was positive $6,800,000 in the Q1 of 2023 compared to cash used in operating activities of $900,000 in the prior year period, Resulting in cash and cash equivalent balances increasing by $5,800,000 during the quarter ended March 31. With no debt and $96,500,000 of cash on our balance sheet, we believe nerdy has ample liquidity to fund the business and pursue growth initiatives. Turning to our business outlook. Today, we're providing 2nd quarter and updated full year 2023 guidance. We saw For the Q2 and full year, we expect revenue growth will be driven by the continued evolution towards recurring revenue streams, The corresponding build in the number of learning membership subscribers and higher institutional revenues.

Speaker 2

Our positive momentum provides us with increased visibility into in confidence in our expectation that we will deliver sequential year over year revenue growth each quarter as we move throughout 2023. For the Q2 of 2023, we expect revenue in the range of $45,000,000 to $47,000,000 For the full year 2023, We are raising our revenue targets to $193,000,000 to $200,000,000 representing 21% growth at the midpoint versus our 2022 revenue of $162,700,000 For the full year, Revenue guidance reflects our decision to shift 100 percent of the consumer business to learning memberships by the end of the year, including the remaining professional audience. Revenue guidance reflects normal summer seasonality, including anticipated lower levels of new customer acquisition, consumption and learning membership retention During the summer months when K-twelve schools and universities are out of session. Additionally, revenue guidance reflects a higher level of high dosage Tutoring program utilization by school districts in the spring semester and a return to the normal seasonal pattern of starting new implementations in the fall when school starts, Thus slightly shifting revenue into the 1st two quarters versus our prior expectation of consistent use throughout the summer. Our adjusted EBITDA guidance for both the Q2 and full year reflects the continuing benefits from our recurring revenue products, which focus on long term relationships with higher value customers and improving consumer gross margin profile and operating efficiencies stemming from our continued shift to recurring revenue business models.

Speaker 2

For the Q2 of 2023, we expect a non GAAP adjusted EBITDA loss in the range of $3,000,000 to breakeven. For the full year 2023, we are raising our targets to an adjusted EBITDA loss in the range of $7,000,000 to breakeven. Full year adjusted EBITDA guidance reflects the impact of normal summer seasonality and higher variable costs in the 3rd quarter as we ramp into the back to school selling season followed by a return to positive adjusted EBITDA in the 4th quarter consistent with prior guidance.

Speaker 3

As always, we appreciate your interest in nerdy and look forward to continuing the dialogue during this exciting time for the company. With that, I'll turn it over to the operator for Q and A. Operator?

Operator

We will now begin the question and answer session. We will pause here briefly as questions are registered. Our first question comes from the line of Ryan MacDonald with Needham. Your line is now open.

Speaker 4

Hi, Chuck and Jason. Thanks for taking my questions and congrats A great quarter. Maybe just want to start first on the institutional business. Clearly, some really great momentum there with the record number of deals. We'd just like to understand sort of how you foresee the demand environment on the institutional side progressing as we Get into the heart of the selling season here in 2Q and 3Q.

Speaker 4

And then as we look at the total contract value or the value of The deal count, obviously, is down on a sequential basis. Just curious what you're seeing in terms of deal trends of in terms of sizing around Number of modules or offerings are being adopted or size of deals in the pipeline. Thanks.

Speaker 3

Thanks, Ryan. This is Chuck. We've as you know, we've landed our 1st teacher signed contract. The momentum right out of the gate is Which is excellent to see demonstrates strong market fit and we can now go out and kind of talk and demonstrate just how powerful Live tutoring can be when teachers across the entire school district are empowered to be able to help students at district wide scale in a way that's highly takes into account their unique knowledge of that particular student and the curriculum that's being taught in the class. So that was a huge accomplishment there.

Speaker 3

We obviously had Strong quarter in totality in terms of revenue as well. And as we head into summer and then back to school, what we're seeing is that the pipelines These are very large and very lumpy deals and conversations that we're having. So Our last teacher signed contract, as you know, was approximately $5,000,000 per year as a SaaS license that entitles the school district to district wide tutoring that teachers can prescribe. And so these conversations involve many different stakeholders. They tend to be oriented around the start of the school year.

Speaker 3

So given the kind of Magnitude involved, you wouldn't want to kick these off for just a few weeks or a few months because you really want teacher support, teacher buy in. We kind of are very focused on making sure that teachers actually understand how to leverage the tools. And so all of that That lends itself to a series of opportunities that would start at the beginning of the full year. So We feel good about the pipeline value that's growing, feel good about the bundled offerings and how together we're able to provide immense value and Serve a multitude of district needs. And then as we head into the summer back to school, I think we feel good about how many of the conversations we're having set us up for Significant scale and opportunity this back to school season.

Speaker 4

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

Speaker 4

Thanks.

Speaker 3

Sure. Yes, we feel great about the fact that the business has grown about 63%, I believe is the number from the Q4 to the end of the Q1. So great progress there. In totality of the active members, ballpark 75% were new to nerdy and about 25% were Legacy, folks who have been using us historically in a package model. And we're seeing it feel to all audiences.

Speaker 3

There's kind of a good distribution among student ages and we're seeing it resonate for different like high levels Subject usage in K-five that are a little bit different than middle school or high school or college or beyond. But in general, this idea of a Comprehensive offering with live at the center that is then surrounded by classes and a variety of forms of async content and different Modalities engaging, we think really, really resonates here. So feel great about the progress And the offerings and engagement differ a little bit by age. But in general, we're seeing it resonate across all audiences and it's just a more efficient go to market And one that makes it really easy to add additional product capabilities like whether it's an AI tutor or Some other form of content like we did when we integrated Code First, we think it's a very easy and effective way that our customers understand

Speaker 2

Yes, Ryan, the only thing I'd add here, we mentioned this on our last call. During the Q1, we transitioned successfully the entire existing Customer base within our academic subjects, which we feel really good about. We also transitioned the test prep audience. And then in our commentary, we shared that we're accelerating Transition of Professional Business, given the positive feedback we've seen from customers as it relates to higher conversion, higher engagement, higher retention. And then from a business perspective, it just allows us to drastically simplify the operating structure, which we feel really good about.

Speaker 3

Yes. During the back of school season, we'll have an opportunity to Reintroduce order memberships for customers who have used the package model in the past but currently aren't active.

Speaker 4

Excellent. Congrats again on a great quarter.

Speaker 1

Thanks, Ryan.

Operator

Thank you. Our next question comes from the line of Doug Anmuth with JPMorgan. Your line is now open.

Speaker 5

Hey, it's Brian Smialek on for Doug. Thanks for taking my questions. I guess just to start on the membership model, can you just talk about the pricing strategy and structure over time? For example, should we expect a tiered strategy as the membership strategy proliferates over time? And then I guess just on the

Speaker 3

Sure. Thanks, Brian. Good questions. So we started off with a very simple kind of plain vanilla approach to learning memberships where we wanted to Just effectively have one tier of offerings that would allow for us to go to market effectively Last call it May June as we started leaning into memberships aggressively. And initially that was Largely just 1 on 1 tutoring.

Speaker 3

And then over the course of the next couple of months, in the fall, as you know, we started introducing all of these additional learning formats Provided more value including live classes and hundreds of subjects every week. We have A variety of different asynchronous formats, computer adaptive testing. We have code versus video game creation. And we started adding in other modalities like the AI tutoring and chat based tutoring and A couple of other things as well. And so that then allowed for us to have all these different ingredients or LEGO blocks that We created a really, really compelling offering for our customers that can allow for us to support them over any academic calendar year Across a variety of different subjects and then allowing them to learn how they want, when they want to live as the cornerstone.

Speaker 3

So in general, there's different Amounts of 1 on 1 tutoring that you can get with your package and one of the things that we've experimented with that has driven both conversion and retention Was changing up the frequency, so you could appeal to people that are maybe a little bit more academically focused and are very concentrated in their efforts versus, say, a more Casual burner in an area like foreign languages for adults. And so in totality, we are trying to take Each of these underlying products capabilities and then find the content and the frequency That then allow us to really appeal to a given segment. And so we've seen tremendous conversion wins through pulling on that lever year to date and I would expect that we continue to Optimize those forgiven audiences over time. And then pairing that with your second question, the amazing thing here with generative AI As we are now able to create hyper personalized content for effectively free for a given learner In a given subject across thousands of subjects and all different levels of complexity. So if you think about live at the center, The superpower we have as a company, high quality live learning at scale and then surrounding it these other forms Of content that can drive engagement that are highly additive that we could serve up in real time in line, there's all sorts of different ways that generative AI can allow for you to The exact right piece of content in the moment that you need it so you can continue on your version journey.

Speaker 3

So we talked about this idea of comprehensive version destination And our ability to really live up to that vision and fill in any potential content pools that existed Just became dramatically easier. So we are super excited about our ability to leverage generated by AI to create really comprehensive, Really personalized experiences and we're actively working on it today. We've announced a couple of those products thus far, but we have many more in flight.

Speaker 2

Yes, I would just echo that. We're going to deploy increased levels of capital against AI and engineering that cap in the near term to maintain the lead we've established in the space, innovative speed and drive,

Operator

Thank you. Our next question comes from the line of Brett Knoblauch with Cantor Fitzgerald, your line is now open.

Speaker 6

Hi, guys. Thanks for taking my question and congrats on the quarter.

Speaker 5

I guess, Could you maybe just

Speaker 6

give us a reminder on how the seasonality of the business is going to work now with the earnings Membership model and how that might differ from the package model. And I guess as we look at the Q2, like what should we be expecting from A membership count perspective in the change. And also, I guess, you talked a bit about the institutional seasonality kind of gearing up for The back to school season and the start in the 3rd quarter, should we be expecting maybe institutional revenue to sequentially decline In the Q2 before kind of ramping back up in the back half of the year?

Speaker 2

Yes, great question, Brett. Yes. So consistent with prior years and seasonality trends, Q2 revenue is going to be lower than Q1. And as we previously discussed, we haven't Yes, gone through a transition of learning memberships from one school year to the next at scale. So we're being cautious with respect to learning membership retention And new customer acquisition during the summer months.

Speaker 2

So our Q2 guide reflects typical seasonality, which is the result of a School calendar and consumer purchasing consumption pattern. I think it's important to also acknowledge the significant pull forward that we're seeing Varsity Tutors for Schools high dosage tutoring business. We also have a portion of our business that's on the legacy package That we expect to sequentially decline period over period as we end the summer months. So net net, we feel good about The anticipated levels of retention that are included in our forecasted guide, but we are cautiously optimistic there. And then from an active learner count, As of June 30, that would incur about 26,000 active members as we move through the summer, And which would then reaccelerate in the back to school period consistent with historical norms in well into the Q4.

Speaker 2

So we feel good about those trends That we're seeing, especially given, as Chuck mentioned on the call, the high levels of engagement in new adds in both Q1 April and through May to date.

Speaker 3

Yes. So as Jason mentioned, we had really strong engagement on the school side. We did a great job on the implementations. And we had previously assumed Some of that revenue would kind of be peanut butter across the 1st three quarters. We're just now assuming that it's a little more condensed than the first two.

Speaker 3

So we feel really good about the engagement there and then how it bodes for renewals, kind of this back to school season.

Speaker 6

Perfect. And I just want to make sure that I kind of understood you guys a bit correctly on The gross margin decline. So that was largely due to the institutional mix and that being such a large quarter in the institutional front That's maybe not at scale enough where the gross margin is going to be kind of similar to the rest of the business?

Speaker 2

Yes, that's right. So if you dissect the business into 2 parts, on the consumer side, we saw continued gross margin accretion, especially as we continue to mix And then on the Varsity Tutors for School side, if you remember, our new teacher assigned product provides All Access and unlimited support for the entire student population with the implementation that took place during the Q1 into the second quarter, We saw substantial levels of engagement, which frankly we feel great about that there's product market fit there. And But it did compress gross margins about 150 basis points relative to our expectation during the quarter, although we believe it sets us up strongly for Expanding that product to additional school districts on the one hand and driving increased retention over time.

Speaker 3

Yes. I think the important thing to remember is that while the revenue is recognized linearly on some of these VT4S SaaS products, What actually happens from an engagement perspective is the consumption goes up during the school year, particularly a period like January, February, March, where it's all in the school year. And then as you go into the summer, you actually have lower levels of utilization, higher gross margin. So we think it's a great product overall. And then as Jason pointed out, the fact that the engagement So high on this brand new product.

Speaker 3

It's a really, really encouraging sign for other opportunities out there. And then, learning memberships continues to drive significant gross margin accretion.

Speaker 6

Perfect. Thanks guys. Really appreciate

Operator

it. Thank you. Our next question comes from the line of Eric Sheridan with Goldman Sachs. Your line is now open.

Speaker 7

Thanks so much and thanks for taking the questions. Maybe 2 follow ups on some of the comments that have already been made just so we better understand. As you move towards The exit velocity this year and the rate of membership you're talking about, can you just help us unpack a little bit of how we should be thinking about sales and marketing Not only in this year, but as an exit velocity into next year and how you think about either harvesting some of those efficiencies from sales and marketing As you get bigger in memberships versus possibly accelerating membership adoption and investing them back in the business, that would be topic 1. And then topic 2, you called out deploying capital behind AI. Can you help us better understand how much of these investments might be Transient in 2023 to reposition the platform for what might be a different steady state Or steady state run rate of investments in AI over the long term and any help you can in terms of comparing those 2 buckets?

Speaker 7

Thanks so much.

Speaker 3

Thanks, Eric. Good questions. So as it relates to sales and marketing efficiency, we drove 1700 bps of sales and marketing efficiency year over year in the Q1. And the reason we were able to do that was a couple of things. First, we Have the new learning memberships model, which is significantly extending lifetime value with the shareholder letter, you can actually see just how much LTV has gone up on average relative The old package model, but it's a ton and it's continuing to increase.

Speaker 3

Secondly, we focused our marketing efforts on appealing to customers who are looking for recurring support over multiple academic subjects, multiple academic calendar years Where we could serve them in a comprehensive way. And so by doing so, in fact, you're not focusing on what we previously as you know, call it, the 7% of hyper transactional net bookings and you're really optimizing for the 93% that we think are the customers that want To be supported with tutoring and a comprehensive set of solutions like we have. Right now, we've been targeting marketing payback periods that are very efficient, call it, 6 months or less payback periods. And as we get through the summer and see how we're looking on those LTV curves as we head into Full year, there's going to be an opportunity to potentially change that payback period a little bit and see if We're so excited about the deal of economics and have an update and we can lean in a little bit more aggressively. So the other factor here is not just Getting more sales and marketing efficiency, obviously, but rather accelerating growth through changing that payback period a little bit And then acquiring a much larger number of users.

Speaker 3

So we're actively focused on things that we think will Allow for us to do that, not baked into the plan, but we're focused on driving improvements to conversion, making our product more appealing, Expanding the amount of content and offerings that are embedded within it and then separately driving retention over time and through those two factors, Conversion retention, those are the things that also would allow for us to fundamentally open up the spigot on marketing in a very efficacious way. So I think we feel really good about the model today and the new customer trends. The new customer trends are pretty consistent throughout the first 4.5 months of the year and are doing well in April May, but there's definitely going to be an opportunity As we see some of that data to potentially lean in a little bit further to drive higher levels of revenue growth. And on the second part, yes, on the capital side, I think the way I think about the deployments in AI, a lot of the infrastructure has been built, a lot of Data has been captured and we've had more than 10,000,000 hours of live instruction on the platform.

Speaker 3

Every part of that customer journey is instrumented. The learning itself occurs In a video session on the platform that then has computer adaptive testing and Q and A and other forms of content that you can engage in, all of which is kind of Captured and fed into our data lake. And so a lot of the work has been done and the plumbing has been built over many years To ensure that we're capturing right information and then can use it to drive higher levels of personalization and engagement. So we have been adding to the team, But that's relatively modest in the scheme of things. And thus far, based on what I've seen, it's largely been self funding.

Speaker 3

So we would expect to make Some investments in Persadol in particular over the course of the next quarter or 2, but we're getting incredible yields Our efforts and would expect that as we get into the Q4 and beyond that it's fully self funding, if not more.

Speaker 1

Great. Thanks, Sachin. I really appreciate it.

Operator

Thank you. Our next question comes from the line of Andrew Boone with JMP Securities. Andrew, your line is now open. Moving on to our next question from the line of Mario Lu with Barclays. Your line is now open.

Speaker 2

Great. Thanks, guys. This is Alex Hughes on for Mario. Just two quick questions, if I can. On the Active Experts side, looks like it was down about 10% this past quarter.

Speaker 2

And you made comments previously that You're focusing on allocating more work to fewer active experts. So just wondering if there's been any Incremental changes in terms of how you're identifying and acquiring those experts. And if your Current AI products or future AI products shifts that philosophy even more. And then second question, just Is there any update on the American Rescue Plan dollars being deployed to nerdy services? And if so, what does that look like for the rest of the year?

Speaker 2

Thanks.

Speaker 3

Great questions. And I can take the first one and then hand it over to Jason for the second one. So we have made a conscious effort to focus on acquiring and retaining top experts who do a disproportionately good job And making sure that they get a great experience in the sense that they're getting kind of consistent earning opportunities over time. So in that regard, our new memberships Has been terrific for the expert experience because they're meeting with students on a recurring basis typically, call it, 1 to 2 times a week For the entire semester of school year in pursuit of a goal or skill. And as a result, they're able to count on The earnings associated with that.

Speaker 3

So one of the things that we tried to do is rather than more kind of randomly or democratically distribute The different opportunities, we've continued to lean further into our machine learning matching algorithms that then disproportionately Send opportunities to top experts. And by doing that, we're then able to retain them longer, which of course that leads to A much better customer experience over time. So there's kind of a compounding flywheel aspect to this. And one of the things that we've also been able to do is also Start getting better at predicting who won't be likely to get work on the platform and be as successful and using AI and predictive algorithms To try to predict upfront before somebody even joins the platform who's likely to be a consistent Expert who then drives high levels of customer satisfaction and takes on a number of students versus those that say maybe a little bit more transient, Interested in a short amount of work, smaller amount of work, we'd rather concentrate the relationships a little bit more so we could deliver a better customer experience. Of course, There's cost associated with bringing on experts.

Speaker 3

So it's terrific for the business to be able to decrease the number of people who might join and not actually work with students. So this is a conscious effort. We feel great. So this is a conscious effort. We feel great about it and you're seeing it pull through to operating leverage.

Speaker 2

Yes. And then just on your question related to ESSER funding, one thing to keep in mind, unlike the B2B space where companies are pulling down third party spending, All the government funding for schools has already been provided. The money is in the market and schools are seeking out our solutions like ours to address the student and teacher shortage That we're seeing in the marketplace. So as of January 31, only about 28% of the funding has been spent according to the DEA I start with DOE. And administrators are looking for long term solutions like ours because learning loss and teacher shortages are long term issues.

Speaker 2

We believe our new per student per year programs like teacher assigned and on demand allow for long term durability as the product offerings evolve to meet both those needs Support teachers as co teachers in the classroom and their normal daily workflows. So just a small amount of money still in market Still needs to be spent by September of 2024, but even beyond Esser, because of that support for teachers and their daily workflow, we've got normal operating School budgets, which are all running surpluses. And then beyond that, you've also got Title 1 funding, which was $19,000,000,000 in the most recent omnibus bill, And those funds are evergreen. So we feel like there's plenty of funding in the market to support continued growth in our institutional schools.

Speaker 3

Yes. We feel really good about momentum there. We've obviously evolved our offerings from what had initially just been high dosage tutoring to one that's much more comprehensive And to these new staff models of teacher assigned where the teachers really are at the center of the offering and we think that's really powerful here. So The fact that schools have been a little bit slower and more concerning and spending in totality, we think bodes well for us because it's given us an opportunity to build this exceptional product That is highly relevant to the scale. We think we're uniquely qualified to deliver high quality live emerging at scale In a way that hasn't been done before through our district partners and really help them accomplish things that might otherwise have been more difficult for them to accomplish as it relates to helping students.

Operator

Thank you. Our next question comes from the line of Andrew Boone with JMP Securities. Your line is now open.

Speaker 8

Hi, guys. Thanks for taking my question. This is Matt on for Andrew. Just wanted to ask on with Conmigo being Offered for $20 a month. Is there something that you guys are going to have to do with pricing or packaging as the competitive set evolves around AI?

Speaker 8

And then maybe a second one just on institutional. Are school districts asking for anything on AI based tutoring offerings? Or is this something that you guys are looking at on a product

Speaker 3

Chegg based tutoring has been around for 27 years and it's been $20 a month and we're excited about incorporating it as a modality of offering, But it's one of many, many different ways that you can learn. So as we think about our AI tutor and what it's able to accomplish, It's something that is being used today for, call it, homework help, it's being used for Q and A and it's kind of taking the place All these content resources that historically had existed online. What we're seeing is that people are using it to engage Additionally, beyond their live recurring face to face tutoring sessions that are in pursuit of the goal, And so we see it as another form of content creation and another modality of interaction. So from our perspective, like We're going to be adding all sorts of different ways to engage. And this is one of them that happens to be in the press a lot, we think is exciting, but we're applying AI across a wide variety of different forms of both content personalization, expert learner matching And then also applying it to drive operational efficiencies.

Speaker 3

And so as we think about schools, I mean, this is a really exciting opportunity. So if you think about all the technology that we've built And our application of AI to drive human interaction and give what we describe as superpowers to tutors and now educators, This is an area where we're actively seeing schools ask about it and ask really how can we allow for their teachers to drive higher levels of personalization in their day. As an example, the idea of an IUP or individualized education plan has been tossed around for decades as something that In an ideal world, schools would be able to provide to each and every student, but they can't. They can only do it for a small subset of students. Now thanks to generative AI, that's the sort of thing where you could actually do it at scale in a way that's hyper personalized and aligns to both the state standards Within a given state and the specific curriculum requirements of a given school and that would never have been possible.

Speaker 3

So we're super excited about our ability Take some of the products we're building and then extend them into schools in ways that are kind of wrapped around live and provide additional

Speaker 8

Thank you. Super helpful.

Operator

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

Speaker 2

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

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Earnings Conference Call
Nerdy Q1 2023
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