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CHGG > SEC Filings for CHGG > Form 10-Q on 12-May-2014All Recent SEC Filings

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Form 10-Q for CHEGG, INC


12-May-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion of our financial condition and results of operations in conjunction with our condensed consolidated financial statements and the related notes included in Part I, Item 1, "Financial Information" of this Quarterly Report on Form 10-Q and our audited financial consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2013 filed with the SEC. In addition to historical condensed consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. See the "Note about Forward-Looking Statements" for additional information. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Quarterly Report on Form 10-Q, particularly in Part II, Item 1A, "Risk Factors."

Overview

Chegg is the leading student-first connected learning platform, empowering students to take control of their education to save time, save money and get smarter. We are driven by our passion to help students become active consumers in the educational process. Our integrated platform, which we call the Student Hub, offers products and services that students need throughout the college lifecycle, from choosing a college through graduation and beyond. Our Student Graph builds on the information generated through students' and other participants' use of our platform to increasingly enrich the experience for participants as it grows in scale and power the Student Hub. By helping students learn more in less time and at a lower cost, we help them improve the overall return on investment in education.

We have an extensive print textbook and eTextbook library available for rent and sale. Our Chegg Study service helps students solve problems and master challenging concepts on their own. We also offer free services to students, such as helping high school students find colleges and scholarship opportunities and helping college students decide which courses to take and find supplemental materials. These and other free services we offer are designed to round out the Student Hub as a one-stop destination for critical student needs. We intend to expand our user base to reach students beyond college, including graduate and professional school students and other lifelong learners.

We partner with other key constituents in the education ecosystem, such as publishers, colleges and brands, to provide a comprehensive, student-first connected learning platform. We currently source print textbooks, eTextbooks and supplemental materials directly or indirectly from thousands of publishers in the United States, including Pearson, Cengage Learning, McGraw Hill, Wiley and MacMillan. We are working to become the digital distribution platform of choice for these publishers. We also partner with approximately 875 colleges in the United States to help them achieve greater efficiency in student recruiting by offering connections to interested students. We offer leading brands compelling marketing solutions for reaching the college demographic. As we continue to grow our platform, we believe it will become increasingly valuable to the education ecosystem and benefit publishers, content providers, colleges, educators and brands as they connect to our student user base.

Our digital learning and advertising offerings, which we refer to as "digital offerings" are experiencing rapid growth. During the three months ended March 31, 2014 and 2013, we generated net revenues of $74.4 million and $61.0 million, respectively. During the same periods, we had net losses of $25.8 million and $17.8 million, respectively. We plan to continue to invest in the long-term growth of the company, particularly further investment in the technology that powers the Student Hub and the Student Graph and in the development of products and services that serve students. On March 7, 2014, we acquired Bookstep LLC to expand our technical resources and research and development capabilities and on April 9, 2014, we acquired The Campus Special, LLC and The Campus Special Food, LLC (together, Campus Special), a company offering local campus deals, serving students at over 500 universities nationwide. We plan to rebrand Campus Special as Chegg Campus Deals. We see the acquisition of Campus Special as a future growth opportunity to expand into local and national advertising. The acquisition also fits into our long-term strategy to save students money by providing a way for students to save an average of $2,500 a year. We cannot assure you that our newer products and services, or any other products and services we may introduce or acquire, will be integrated effectively into our business, achieve or sustain profitability or achieve market acceptance at levels sufficient to justify our investment.

Our strategy for achieving and maintaining profitability is centered upon our ability to expand the number of students using our products and services and increase student engagement with our connected learning platform. For the foreseeable future we expect to continue to invest in our print textbook business as a means of expanding student acquisition and generating operating cash flow. To deepen student engagement we will continue to invest in the expansion of our digital offerings to provide a more compelling and personalized solution. We believe this expanded and deeper penetration of the student demographic will allow us to drive growth in our enrollment and brand marketing services. In addition, we believe that the investments we have made to achieve our current scale will allow us to drive increased operating margins over time that, together with increased contributions of higher margin digital offerings, will enable us to accomplish profitability and become cash-flow positive for the long-term. Our ability to accomplish these long-term objectives is subject to numerous risks and uncertainties, including our ability to attract, retain and increasingly engage the student population, intense competition in our markets, the ability to achieve sufficient contributions from our digital offerings and other factors described in greater detail in "Risk Factors."


Our Print Textbook Business

With our print textbook business, we purchase textbooks, rent them to students for the academic term at a substantial discount from list price to attract volume and realize return on our investment by renting the same book over multiple academic terms.

Our print textbook rental business is highly capital intensive. While we generate positive cash flows from operations on an annual basis, this has been more than offset by the cash we use for our investing activities, primarily due to the purchase of print textbooks. We expect this trend to continue in the foreseeable future. We capitalize the investment in our textbook library and record depreciation expense in cost of revenues over its useful life using an estimated liquidation value. During the three months ended March 31, 2014, our investment in print textbooks, net of proceeds from textbook liquidation, was $31.7 million.

We also increasingly use our website to liquidate textbooks from our textbook library, which allows us to generate greater recovery on our textbooks compared to bulk liquidations, while at the same time providing students substantial savings over the retail price of a new book. We are able to adjust what we liquidate based on expected rental demand. As an example, in the second half of 2013, we elected to optimize our textbook library more for rental than liquidation in anticipation of greater rental demand for the winter rush cycle. This decision led to less site liquidations in that quarter of the books that typically have higher source cost recovery but also increased our available inventory of books for rent. We source both new and used print textbooks for rental or resale from wholesalers, publishers and students. Purchasing used textbooks allows us to reduce the investments necessary to maintain our textbook library while at the same time attracting students to our website by offering them more for their textbooks than they could generally get by selling them back to their campus bookstore. Through these refinements to our model, we have achieved greater overall efficiency, enabling us to lower our per unit rental rates, which has driven revenue growth and, to a greater extent, print textbook unit volumes beginning in 2012.

Our Digital Offerings Business

Our digital offerings for students include the Student Hub, our connected learning platform, our web-based, multiplatform eTextbook Reader, eTextbooks and supplemental materials from approximately 120 publishers, which we offer as a rental-equivalent solution and for free for students awaiting the arrival of their print textbook rental, our Chegg Study service, College Admissions and Scholarship Services and free course planning and internship services. In addition, we offer enrollment marketing services to colleges, allowing them to reach interested college-bound high school students that use our College Admissions and Scholarship Services. We also work with leading brands, such as Adobe, Microsoft, Red Bull and Serve from American Express, to provide students with discounts, promotions and other products that, based on student feedback, delight them. For example, for Red Bull, we inserted a free can of Red Bull in select textbook rental shipments to students, and Microsoft sponsored a "Free Study Week," which included free access to our Chegg Study service as well as additional free study materials. All of our brand advertising services and the discounts, promotions and other products provided to students are paid for by the brands.

Students typically pay to access eTextbooks for the academic term or subscribe for other services such as Chegg Study on a monthly or annual basis, while colleges subscribe to our enrollment marketing services and brands pay us depending on the nature of the campaign. While none of our digital offerings individually has amounted to more than 10% of our net revenues to date, in the aggregate these offerings amounted to 24% of net revenues during the three months ended March 31, 2014, up from less than 1% in 2010.

Seasonality of Our Business

A substantial majority of our revenue is recognized ratably over the term the student rents our textbooks or has access to our digital offerings. This generally results in our highest revenue in the fourth quarter as it reflects more days of the academic year and our lowest revenue in the second quarter as colleges conclude their academic year for summer and there are fewer days of rentals. The variable expenses associated with our shipments of textbooks and marketing activities are highest in the first and third quarters as shipping and other fulfillment costs and marketing expenses are expensed when incurred, generally at the beginning of academic terms. As a result of these factors, the most concentrated periods for our revenue and expenses do not necessarily coincide, and comparisons of our quarterly operating results on a sequential basis may not provide meaningful insight into our overall financial performance.


Results of Operations

The following table summarizes our historical consolidated statements of
operations (in thousands):



                                                Three Months Ended March 31,
                                                  2014                 2013
    Net revenues                             $       74,393       $       61,015
    Cost of revenues (1)                             65,485               49,454

    Gross profit                                      8,908               11,561

    Operating expenses(1):
    Technology and development                       11,320                9,553
    Sales and marketing                              15,027               13,748
    General and administrative                        9,840                6,709
    Gain on liquidation of textbooks                 (1,678 )             (2,279 )
    Total operating expenses                         34,509               27,731
    Loss from operations                            (25,601 )            (16,170 )
    Interest and other income (expense), net             59               (1,470 )
    Loss before provision for income taxes          (25,542 )            (17,640 )

    Provision for income taxes                          217                  185
    Net loss                                 $      (25,759 )     $      (17,825 )

    (1) Includes stock-based compensation
    expense as follows:
    Cost of revenues                         $          178       $          154
    Technology and development                        2,382                1,614
    Sales and marketing                               1,332                1,049
    General and administrative                        3,038                1,333
    Total stock-based compensation expense   $        6,930       $        4,150

The following table summarizes our historical condensed consolidated statements of operations data as a percentage of net revenues for the periods shown:

                                                       Three Months
                                                           Ended
                                                         March 31,
                                                      2014       2013
              Net revenues                              100 %      100 %
              Cost of revenues                           88         81

              Gross profit                               12         19

              Operating expenses:
              Technology and development                 15         16
              Sales and marketing                        20         23
              General and administrative                 13         11
              Gain on liquidation of textbooks           (2 )       (4 )
              Total operating expenses                   46         46
              Loss from operations                      (34 )      (27 )
              Interest and other expense, net             -         (2 )
              Loss before provision for income taxes    (34 )      (29 )
              Provision for income taxes                  -          -
              Net loss                                  (34 )%     (29 )%


Three Months Ended March 31, 2014 and 2013

Net Revenues

The following table sets forth our net revenues for the periods shown, in
addition to revenue details for our print textbook business and digital
offerings business (dollars in thousands):



                                   Three Months Ended
                                        March 31,                 Change
                                    2014          2013          $          %
               Print textbooks   $   56,625     $ 50,295     $  6,330       13 %
               Digital offerings     17,768       10,720        7,048       66
               Net revenues      $   74,393     $ 61,015     $ 13,378       22 %

Net revenues in the three months ended March 31, 2014 increased $13.4 million, or 22%, compared to the same period during 2013. The year-over-year increase in net revenues was the result of a 66% increase in digital offerings due to growth in new memberships for our Chegg Study service, an increase in eTextbook volumes, growth in brand advertising and growth in our enrollment marketing services. Digital offerings represented 24% of net revenues during the three months ended March 31, 2014 and 18% of net revenues during three months ended March 31, 2013. The increase was also the result of a 29% increase in print textbook rental volumes, partially offset by a reduction in price per rental unit. We anticipate that our digital offerings will continue to grow at a rate greater than our overall revenue growth in future periods.

Cost of Revenues

The following table sets forth our cost of revenues for the periods shown
(dollars in thousands):



                                                 Three Months Ended
                                                      March 31,                 Change
                                                  2014          2013          $          %
 Cost of revenues(1)                           $   65,485     $ 49,454     $ 16,031       32 %

 (1) Includes stock-based compensation expense $      178     $    154     $     24       16 %

Cost of revenues in the three months ended March 31, 2014 increased $16.0 million, or 32%, compared to the same period during 2013. The increase in absolute dollars and as a percentage of revenues was primarily due to an increase in order fulfillment and payment processing costs of $4.5 million, textbook depreciation of $3.6 million, write-off of our textbooks of $2.4 million and cost of digital content of $0.8 million. The increase in order fulfillment costs, in particular eTextbook fees and payment processing fees, is directly attributable to the increase in textbook unit volumes during the three months ended March 31, 2014. Textbook depreciation increased primarily due to the year-over-year growth in our textbook library. The cost of digital content increased during the year due to our expansion of digital content solutions made available to students. In addition, we experienced an increase in the cost of textbooks purchased on a just-in-time basis of approximately $3.9 million, which was primarily driven by an increase in the number of units sold. We also experienced increased costs of approximately $0.8 million associated with hiring temporary personnel to assist with higher transaction and textbook volumes during the three months ended March 31, 2014.


Operating Expenses

The following table sets forth our operating expenses for the periods shown
(dollars in thousands):



                                       Three Months Ended
                                           March 31,                       Change
                                      2014            2013            $              %
  Technology and development(1)    $    11,320     $    9,553     $    1,767             18 %
  Sales and marketing(1)                15,027         13,748          1,279              9
  General and administrative(1)          9,840          6,709          3,131             47
  Gain on liquidation of textbooks      (1,678 )       (2,279 )          601            (26 )
                                   $    34,509     $   27,731     $    6,778             24 %

  (1) Includes stock-based
  compensation expense of:
  Technology and development       $     2,382     $    1,614     $      768             48 %
  Sales and marketing                    1,332          1,049            283             27
  General and administrative             3,038          1,333          1,705            128
  Stock-based compensation expense $     6,752     $    3,996     $    2,756             69 %

Technology and Development

Technology and development expenses during the three months ended March 31, 2014 increased $1.8 million, or 18%, compared to the three months ended March 31, 2013. During the three months ended March 31, 2014 our employee-related expenses and stock-based compensation expenses both increased $0.8 million compared to the same period in the prior year. Stock-based compensation expense increased primarily due to expense associated with restricted stock units (RSUs) for which there was no expense prior to our IPO. In addition, we experienced an increase in web hosting costs of $0.3 million. Technology and development as a percentage of net revenues decreased to 15% of net revenues in the three months ended March 31, 2014 compared to 16% of net revenues in the three months ended March 31, 2013.

Sales and Marketing

Sales and marketing expenses during the three months ended March 31, 2014 increased by $1.3 million, or 9%, compared to the three months ended March 31, 2013. Sales and marketing expenses as a percentage of net revenues decreased to 20% during the three months ended March 31, 2014 compared to 23% of net revenues during the three months ended March 31, 2013. The increase in absolute dollars is primarily attributable to an increase in advertising and marketing expenses of $1.1 million as a result of search engine marketing to increase customer acquisition during the quarter compared to the three months ended March 31, 2013. In addition, during the three months ended March 31, 2014 our employee-related expenses and stock-based compensation increased $0.7 million and $0.3 million, respectively, compared to the same period in the prior year. The increase in employee related expenses increased primarily due to a higher average headcount and stock-based compensation increased primarily due to expense associated with RSUs for which there was no expense prior to our IPO. These increases were partially offset by a decrease of $0.5 million in amortization of intangible assets as intangibles acquired during 2011 became fully amortized.

General and Administrative

General and administrative expenses in the three months ended March 31, 2014 increased $3.1 million, or 47%, compared to the three months ended March 31, 2013. General and administrative expenses as a percentage of net revenues increased to 13% during the three months ended March 31, 2014 compared to 11% of net revenues during the three months ended March 31, 2013. The increase in absolute dollars and as a percentage of net revenues was due to an increase in stock-based compensation expense of $1.7 million primarily due to expense associated with RSUs which did not incur expense prior to our IPO. In addition, employee-related and benefit expenses, audit and legal fees, and insurance increased by $1.3 million, driven by the expansion of our capabilities in our organization to support public company readiness.

Gain on Liquidation of Textbooks

In the three months ended March 31, 2014 and 2013, we had a net gain on liquidations of $1.7 million and $2.3 million, respectively, resulting from proceeds received from liquidation of previously rented print textbooks on our website and through various other liquidation channels. The number of textbooks liquidated during the three months ended March 31, 2014 decreased compared to the volumes during the same period of 2013 due to our decision to limit our liquidation catalog to drive students to textbook sales and rentals during the three months ended March 31, 2014.


Interest and Other Income (Expense), Net

The following table sets forth our interest and other income (expense), net, for
the periods shown (dollars in thousands):



                                      Three Months Ended
                                          March 31,                        Change
                                    2014              2013            $              %
Interest expense, net            $       (61 )     $   (1,173 )   $    1,112            (95 )%
Other income (expense), net              120             (297 )          417           (140 )
Total interest and other income
(expense), net                   $        59       $   (1,470 )   $    1,529           (104 )%

Interest expense, net decreased by $1.1 million during the three months ended March 31, 2014 primarily due to the pay-off of our outstanding loan balance in 2013.

Other income (expense), net was a net income during the three months ended March 31, 2014 primarily due to the interest earned on our investments compared to a net expense during the three months ended March 31, 2013 which resulted from an increase in the fair value of our preferred stock warrants prior to their conversion into common stock warrants.

Provision (Benefit) for Income Taxes

The following table sets forth our provision (benefit) for income taxes for the periods shown (dollars in thousands):

Three Months Ended March 31, Change 2014 2013 $ % Provision for income taxes $ 217 $ 185 $ 32 17 %

We recognized income tax expense of $0.2 million during the three months ended March 31, 2014 that was comprised of state and foreign income tax expense. We recognized income tax expense of $0.2 million during the three months ended March 31, 2013, which was comprised of state and foreign income tax expense.

Liquidity and Capital Resources

As of March 31, 2014, our principal sources of liquidity were cash, cash equivalents and investments totaling $130.5 million, which were held for working capital purposes. Our cash equivalents and investments are composed primarily of commercial paper, corporate securities and money market funds. We have $50.0 million available for draw down under our revolving credit facility with an accordion feature subject to certain financial criteria that would allow us to draw down to $75.0 million in total, which expires in August 2016. As of March 31, 2014, we were in compliance with all financial covenants.

Our print textbook business is highly capital intensive, and we typically use cash for our investing activities while we generate positive cash flows from operations. We capitalize the investment in our print textbook library and depreciate the value of our textbooks over their useful life as cost of revenues. During the three months ended March 31, 2014 and 2013, our investment in print textbooks, net of proceeds from textbook liquidations, was $31.7 million and $19.2 million, respectively. To the extent our business continues to grow, or as new textbook versions are published, we anticipate we will continue to purchase additional textbooks, resulting in a use of cash from investing activities. As of March 31, 2014, we have incurred cumulative losses of $230.9 million from our operations, and we expect to incur additional losses in the future. Our operations have been financed primarily by net proceeds from the sales of shares of our convertible preferred stock, through various debt financing activities and our IPO.

We believe that our existing sources of liquidity will be sufficient to fund our operations, debt service and repayment obligations for at least the next 12 months. However, our future capital requirements will depend on many factors, including the level of investment in textbooks to support our print textbook business and our ability to recover our source costs through the rental of textbooks and as we liquidate textbooks at the end of their lifecycle, our rate of revenue growth, our sales and marketing activities and the timing and extent of our spending to support our technology and development efforts. To the extent that existing cash and cash equivalents, investments and cash from operations are insufficient to fund our future activities, we may need to raise additional funds through public or private equity or debt financing. Additional funds may not be available on terms favorable to us or at all. If adequate funds are not available on acceptable terms, or at all, we may be unable to adequately fund our business plans and it could have a negative effect on our business, operating cash flows and financial condition.


The following table sets forth our cash flows (in thousands):

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