Chegg, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Unaudited results; amounts below are in U.S. dollars. Chegg operates as a single segment and describes its business as a student-focused connected learning platform.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $71.3m | $81.3m | $191.0m | $233.2m |
| Gross profit / margin | $32.6m / 46% | $19.6m / 24% | $92.0m / 48% | $69.8m / 30% |
| Operating loss | $15.3m | $23.8m | $39.0m | $61.8m |
| Net loss | $16.1m | $24.2m | $40.8m | $62.8m |
| Diluted loss per share | $0.17 | $0.28 | $0.45 | $0.73 |
| Operating cash flow | Not separately stated for the quarter | $30.7m | $18.1m |
At September 30, cash and cash equivalents were $90.2m; current assets were $139.3m and current liabilities $97.0m. Chegg had no outstanding borrowings on its $30m revolving credit line, with an accordion feature allowing up to $50m subject to lender discretion. Total liabilities were $101.1m. Nine-month investing cash flow was $0.4m and financing cash flow was negative $7.9m. Operating cash flow included substantial non-cash expenses, including $32.7m of share-based compensation.
Material changes versus the prior comparable periods
- Q3 revenue declined 12%; nine-month revenue declined 18%. The mix shifted sharply: services revenue rose 49% in Q3 and 35% year to date, while rental revenue fell 76% and 66%, respectively, and sales revenue fell 36% and 30%.
- Chegg Services revenue grew to $49.8m in Q3 and $126.8m year to date. Required Materials revenue fell 31% in Q3 and 37% year to date. Management attributes much of the change to the Ingram partnership, which shifts print rental revenue toward commissions reported in services and reduces Chegg’s inventory and fulfillment burden.
- Gross margin improved to 46% in Q3 from 24%, and to 48% year to date from 30%, primarily due to lower textbook depreciation, fulfillment costs and warehouse expenses associated with the Ingram transition.
- Net losses narrowed in both comparisons. Nine-month operating expenses were approximately flat at $131.0m versus $131.5m; technology and development and general and administrative expenses rose, while sales and marketing expense declined.
Outlook, management commentary, risks and unusual items
- Management expects to continue investing in technology, products and services, and the Ingram partnership. It expects the print textbook library to be substantially liquidated by the end of 2016 and the transition to a fully digital model to be completed by 2017. The filing provides no specific revenue or earnings guidance.
- Management believes existing liquidity is sufficient to fund operations for at least the next 12 months, while noting expected future losses and that additional financing may be needed if cash and operating resources prove insufficient.
- The new $30m revolving credit facility matures in September 2019. It requires minimum unrestricted cash balances—generally $30m, with a temporary $25m threshold in specified 2017 quarters—and minimum trailing-12-month EBITDA targets rising from $25m to $35m over time. Chegg reported compliance at quarter-end.
- Imagine Easy Solutions was acquired in May 2016 for purchase consideration of $42.3m, including $16.7m present value of deferred cash consideration. The agreement also provides for up to $18m of contingent payments, subject to conditions including continued employment; $2.5m was accrued at quarter-end. The acquisition added $23.7m of goodwill.
- Q3 included a $2.7m loss on liquidation of textbooks, compared with a $0.9m gain in Q3 2015. The filing also reports $1.5m of nine-month expense from modification of certain 2015 performance-based stock awards.
- Key risks include execution and economics of the Ingram transition, textbook demand and pricing, seasonality and peak-period fulfillment, competition, student engagement and acquisition integration, and privacy, cybersecurity and regulatory exposure. The Kentucky textbook property-tax dispute was resolved in Chegg’s favor, with no tax due. Management reported no other pending legal matter expected to materially affect the company, while cautioning that litigation outcomes remain uncertain.
Important facts for investors to verify
- Whether services growth, including Chegg Study and acquired writing tools, can offset declining Required Materials revenue and support sustainable margins.
- Whether the Ingram transition and liquidation of Chegg-owned textbooks proceed on schedule, and how commissions, working capital and cash conversion develop as payment terms normalize in 2017.
- Whether Chegg can meet the credit facility’s cash and EBITDA covenants while continuing to report losses; the filing does not provide a clear standalone calculation of covenant EBITDA.
- The cash collection and timing of the $28.7m Ingram reimbursement balance, the $16.7m deferred acquisition consideration and potential contingent acquisition payments.
- How much reported operating cash flow depends on non-cash compensation, deferred revenue and accrued liabilities, and whether cash generation persists as textbook liquidation declines.