Chegg, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Unaudited results; amounts below are in U.S. dollars unless noted. Chegg operates as a single segment and describes itself as a student-focused connected learning platform. The company is transitioning from owning print textbook inventory toward digital services and commission-based textbook rentals fulfilled by Ingram.
Key financial results
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net revenue | $53.0m | $67.1m | $119.7m | $151.9m |
| Gross profit / margin | $31.6m / 60% | $30.8m / 46% | $59.4m / 50% | $50.2m / 33% |
| Operating loss | $8.4m | $9.7m | $23.7m | $38.0m |
| Net loss | $9.0m | $10.1m | $24.7m | $38.7m |
| Basic and diluted loss per share | $0.10 | $0.12 | $0.28 | $0.45 |
| Operating cash flow | Not separately reported for the quarter | $(7.1)m | $(13.1)m |
- Q2 revenue declined 21% year over year. Rental revenue fell 63% to $12.0m, services revenue increased 29% to $37.7m, and sales revenue declined 33% to $3.4m.
- For the first half, services revenue rose 27% to $77.0m while rental revenue fell 62% to $26.6m and sales revenue fell 23% to $16.1m. Chegg attributed much of the rental-to-services mix shift to Ingram commissions replacing gross rental revenue on books owned and fulfilled by Ingram.
- Gross margin improved substantially, principally because of lower textbook depreciation, fulfillment costs, textbook write-offs, and warehouse costs as the Ingram transition advanced. Operating expenses remained significant; technology and development and general and administrative expenses increased year over year in Q2.
- First-half investing cash flow was $(3.1)m, including $25.2m for the Imagine Easy acquisition and $14.2m for property and equipment, partly offset by investment maturities and textbook liquidation proceeds. Financing cash flow was $(7.1)m, primarily reflecting $8.2m of taxes paid on net share settlement of RSUs.
Financial position and liquidity
- At June 30, 2016, cash and cash equivalents were $49.7m, down from $67.0m at December 31, 2015. Current assets were $108.4m and current liabilities $67.1m.
- Total liabilities were $71.2m; stockholders’ equity was $221.7m. Chegg had no borrowings under its $30.0m revolving credit facility and stated it was covenant-compliant. The facility was due to expire in August 2016; its accordion could permit borrowing up to $65.0m subject to financial criteria.
- Chegg reported a $36.2m reimbursement balance due from Ingram in other current assets, compared with $28.9m at year-end. The company continued to provide Ingram extended payment terms during 2016 and expected to move to normal terms in 2017.
- Management said existing liquidity was expected to fund operations for at least the next 12 months, while noting future capital needs depend on growth, technology investment, acquisitions, and marketing. Chegg reported accumulated losses of $353.8m and expected additional losses.
Material changes, outlook, and notable items
- Business-model transition: Required Materials revenue declined 48% in Q2 and 40% for the first half; Chegg Services revenue grew 33% and 23%, respectively. Management expected Required Materials revenue to keep declining as commissions from Ingram replace revenue from Chegg-owned textbook rentals. The remaining print library was expected to be substantially liquidated by year-end 2016, with the transition to a fully digital company expected by 2017.
- Profitability outlook: Management said it planned to continue investing in technology, products, services, and the Ingram partnership. It expected the partnership and greater Chegg Services contribution to support higher margins over time and eventual profitability and long-term positive cash flow, but gave no specific earnings or revenue guidance in the supplied filing text.
- Imagine Easy acquisition: Acquired in May for purchase consideration of $42.3m, including $16.4m present value of deferred cash consideration. The agreement also provides for contingent payments of up to $18.0m, subject to conditions including continued employment; $1.0m was accrued at June 30. Acquisition-related expenses were $1.0m in Q2. Goodwill increased by $23.7m.
- Unusual items: Chegg recorded a $2.2m Q2 gain on liquidation of textbooks, versus a $2.4m loss in Q2 2015. First-half textbook liquidation gains were $3.2m versus $1.7m. Share-based compensation was $11.2m in Q2 and $22.5m for the first half.
- Contingency: Kentucky’s Court of Appeals ruled in Chegg’s favor over a textbook property-tax assessment, but the state sought discretionary review by the Kentucky Supreme Court. Chegg said a loss was reasonably possible but it could not estimate a range of potential losses. The filing identified no other pending legal matters expected to have a material adverse impact.
- Principal risks: Execution and economics of the Ingram transition, partner performance and reimbursement, seasonal demand and peak-period fulfillment, competition and pricing pressure, uncertain adoption and profitability of digital services, acquisition integration, privacy and cybersecurity, publisher content rights, and continuing operating losses. Chegg also highlighted the difficulty of forecasting results ahead of the fall academic-term rush.
Important facts for investors to verify
- Whether the August 2016 credit facility was extended, replaced, or otherwise addressed after the reporting date, and the resulting covenant and liquidity position.
- Collection timing and recoverability of the $36.2m Ingram reimbursement balance, and the effect of extended payment terms on working capital and operating cash flow.
- Whether Chegg Services growth and margins can offset lower reported Required Materials revenue as the Ingram transition and textbook liquidation proceed.
- Actual acquisition performance, integration progress, and any contingent consideration payable for Imagine Easy.
- Developments in the Kentucky tax case and any resulting financial exposure.