Chegg, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; unaudited results compared with Q1 2015. Chegg operates as a student-focused connected learning platform, with Required Materials and Chegg Services product lines.
Financial performance and liquidity
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net revenue | $66.7 million | $84.9 million | Down 21% |
| Gross profit / margin | $27.7 million / 42% | $19.4 million / 23% | Margin up about 19 percentage points |
| Operating loss | $15.3 million | $28.3 million | Improved |
| Net loss | $15.7 million | $28.5 million | Improved |
| Net loss per share, diluted | $0.18 | $0.34 | Loss per share narrowed |
| Operating cash flow | $(19.2) million | $6.7 million | Decreased |
Revenue by reported category was $14.6 million rental, $39.4 million services and $12.7 million sales. Product-line revenue was $41.1 million from Required Materials, down 34%, and $25.6 million from Chegg Services, up 14%. Services were 38% of revenue versus 26% a year earlier. The filing attributes much of the rental decline and services increase to the shift to Ingram commissions; these category comparisons therefore reflect a changed business model as well as demand.
Operating cash flow included a $16.8 million increase in prepaid expenses and other current assets and a $16.8 million decrease in accrued liabilities, partly offset by an $11.8 million increase in deferred revenue. Investing cash flow was approximately positive $0.04 million; financing cash outflow was $6.3 million, mainly taxes on net share settlement of vested RSUs. Cash and cash equivalents were $41.5 million at quarter-end, down from $67.0 million at year-end. Cash, cash equivalents and investments totaled $64.4 million.
At March 31, current assets were $124.1 million and current liabilities $50.4 million. Total liabilities were $54.3 million and stockholders’ equity $220.4 million. No revolving-facility borrowings were outstanding. The $30 million facility (potentially expandable to $65 million subject to conditions) expires in August 2016; Chegg reported compliance with its covenants.
Material changes and business developments
- Total revenue fell $18.2 million year over year, primarily as print rental revenue shifted to commission-based revenue under the Ingram partnership. Chegg Services growth, including Chegg Study, partly offset the decline.
- Cost of revenue decreased 41%, mainly due to lower textbook depreciation, fulfillment costs, textbook write-offs and warehouse personnel costs. The resulting gross-margin improvement reflects the transition of inventory and fulfillment responsibilities to Ingram.
- Sales and marketing expense declined 32%; technology and development expense increased 5%, and general and administrative expense increased 8%.
- Chegg had stopped investing in its own print textbook library and expected to liquidate the remaining library during 2016; management expected the transition to be complete by 2017. The filing says print rental revenue would become commission-based as Ingram-owned inventory is used.
Outlook, risks and unusual items
- No specific quarterly or annual revenue or earnings guidance is provided. Management said existing liquidity should fund operations and debt service for at least 12 months, while noting anticipated future losses and continued investment in technology, products and services. Its long-term goal is profitability and positive cash flow, dependent on growth and engagement in Chegg Services and successful execution of the Ingram transition.
- Management expects seasonality to remain significant and cautions that quarterly comparisons may be misleading. Ingram’s commission model changes the timing of print-rental revenue, and the second quarter has historically been seasonally weaker.
- On May 1, 2016, after quarter-end, Chegg acquired Imagine Easy Solutions for $25.7 million cash at closing, with another $17.0 million due by April 2017 and potential contingent payments of up to $18.0 million over three years.
- Kentucky’s Court of Appeals ruled in Chegg’s favor in a textbook property-tax dispute, but the state sought discretionary review by the Kentucky Supreme Court. Chegg said a loss was reasonably possible but could not estimate a range of potential losses.
- Other principal risks include dependence on Ingram for textbook inventory and fulfillment, competition and pricing pressure, execution of the shift to digital and services, seasonal demand and peak-period operations, student data privacy and security, and continued operating losses. Chegg reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of the reported revenue decline reflects Ingram-related presentation and timing changes versus underlying demand, and whether Chegg Services growth continues.
- Whether Ingram performs reliably, reimburses Chegg for textbook purchases made on its behalf, and supports the expected margin and working-capital benefits.
- Cash burn, the recoverability and timing of the $39.1 million Ingram reimbursement balance, and liquidity after the revolving facility expires in August 2016.
- Integration, performance and total cost of the Imagine Easy acquisition, including the deferred and contingent consideration.
- Outcome and potential financial impact of the Kentucky tax appeal, which the filing does not quantify.