CHEGG, INC 10-Q

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 Statements (unaudited)” of this Quarterly Report on Form 10-Q. In addition to historical 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 section titled “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 a Smarter Way to Student. As the leading direct-to-student learning platform, we strive to improve educational outcomes by putting the student first in all our decisions. We support students on their journey from high school to college and into their career with tools designed to help them pass their test, pass their class, and save money on required materials. Our services are available online, anytime and anywhere, so we can reach students when they need us most. Students subscribe to our subscription services, which we collectively refer to as Chegg Services. Our primary Chegg Services include Chegg Study, Chegg Writing, Chegg Tutors, Chegg Math Solver, Thinkful, and Mathway. Our Chegg Study subscription service provides “Expert Answers” and step-by-step “Textbook Solutions,” helping students with their course work. When students need help creating citations for their papers, they can use one of our Chegg Writing properties, including EasyBib, Citation Machine, BibMe, and CiteThisForMe. When students need additional help on a subject, they can reach a live tutor online, anytime, anywhere through Chegg Tutors. Our Chegg Math Solver subscription service helps students understand math by providing a step-by-step math solver and calculator and we expect to incorporate Mathway into Chegg Math Solver. Our Thinkful skills-based learning platform offers professional courses focused on the most in-demand technology skills. In June 2020, we completed our acquisition of Mathway, an online, on-demand math problem solving company that provides a vast range of subject areas in mathematics, including pre-algebra, algebra, trigonometry, pre-calculus, calculus, and linear algebra, and related disciplines. Required Materials includes our print textbook and eTextbook offerings, which help students save money compared to the cost of buying new. We offer an extensive print textbook library primarily for rent and also for sale both on our own and through our print textbook partners. To deliver these services to students, we partner with a variety of third parties including Cengage Learning, MacMillan, McGraw Hill, Pearson, and Sage Publications. During the three and nine months ended September 30, 2020, we generated net revenues of $154.0 million and $438.6 million, respectively, and in the same periods had net losses of $37.1 million and $32.3 million, respectively. During the three and nine months ended September 30, 2019, we generated net revenues of $94.2 million and $285.4 million, respectively, and in the same periods had net losses of $11.5 million and $17.8 million, respectively. During the three and nine months ended September 30, 2020, the COVID-19 pandemic continued to have a positive impact to our business and results of operations as we saw an increase in the acceleration of subscriber growth and engagement with our learning platform. In the near-term, we currently expect it to continue to positively impact our business and results of operations and have expanded our efforts to meet the increase in demand for our services including, but not limited to, hiring and customer support measures. However, the COVID-19 pandemic also subjects our business to numerous risks and uncertainties, most of which are beyond our control and cannot be predicted, including when colleges will resume in-person classes, whether they will successfully transition to online education, or how well they will overcome the impacts of the COVID-19 pandemic. 28 Table of Contents Our long-term strategy is centered upon our ability to utilize Chegg Services to increase student engagement with our learning platform. We plan to continue to invest in the expansion of our Chegg Services to provide a more compelling and personalized solution and deepen engagement with students. 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 Chegg Services, will enable us to become profitable and remain cash-flow positive in the long-term. Our ability to achieve 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 to revenue from Chegg Services, and other factors, such as the COVID-19 pandemic. These risks and uncertainties are described in greater detail in Part II, Item 1A, “Risk Factors.” We have presented revenues for our two product lines, Chegg Services and Required Materials, based on how students view us and the utilization of our products by them. More detail on our two product lines is discussed in the next two sections titled “Chegg Services” and “Required Materials.” Chegg Services Our Chegg Services product line for students primarily includes Chegg Study, Chegg Writing, Chegg Tutors, Chegg Math Solver, Thinkful, and Mathway. Students typically pay to access Chegg Services on a monthly basis. We also work with leading brands to provide students with discounts, promotions, and other products that, based on student feedback, delight them. In the aggregate, Chegg Services revenues were 77% and 79% of net revenues during the three and nine months ended September 30, 2020, respectively, and 74% and 79% of net revenues during the three and nine months ended September 30, 2019, respectively. Required Materials Our Required Materials product line includes revenues from print textbooks and eTextbooks. Revenues from print textbooks that we own are recognized as the total transaction amount ratably over the lease term, generally a two- to five-month lease period. Revenues from print textbooks owned by a partner are recognized as a revenue share on the total transactional amount of a rental or sale transaction immediately when a print textbook ships to a student. Additionally, Required Materials includes revenues from eTextbooks, which are recognized ratably over the contractual period, generally a two- to five-month period. In the aggregate, Required Materials revenues were 23% and 21% of net revenues during the three and nine months ended September 30, 2020, respectively, and 26% and 21% of net revenues during the three and nine months ended September 30, 2019, respectively. Seasonality of Our Business Revenues from Chegg Services, print textbooks that we own, and eTextbooks are primarily recognized ratably over the term a student subscribes to our Chegg Services, rents a print textbook or has access to an eTextbook. This has generally resulted in our highest revenues and profitability in the fourth quarter as it reflects more days of the academic year. Our variable expenses related to marketing activities remain highest in the first and third quarters such that our profitability may not provide meaningful insight on a sequential basis. As a result of these factors, the most concentrated periods for our revenues and expenses do not necessarily coincide, and comparisons of our historical quarterly results of operations on a sequential basis may not provide meaningful insight into our overall financial performance. 29 Table of Contents Results of Operations The following table summarizes our historical condensed consolidated statements of operations (in thousands, except percentage of total net revenues): Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Net revenues $ 154,018 100 % $ 94,151 100 % $ 438,617 100 % $ 285,422 100 % Cost of revenues (1) 62,370 40 22,164 24 148,284 34 66,017 23 Gross profit 91,648 60 71,987 76 290,333 66 219,405 77 Operating expenses: Research and development (1) 44,041 29 36,442 39 123,956 28 101,199 35 Sales and marketing (1) 24,625 16 16,822 18 60,621 14 47,334 17 General and administrative (1) 40,784 26 23,752 25 98,221 22 70,044 25 Restructuring charges — — 28 — — — 97 — Total operating expenses 109,450 71 77,044 82 282,798 64 218,674 77 (Loss) income from operations (17,802) (11) (5,057) (6) 7,535 2 731 — Total interest expense, net and other (expense) income, net (18,272) (12) (5,797) (6) (36,924) (8) (16,723) (6) Loss before provision for income taxes (36,074) (23) (10,854) (12) (29,389) (6) (15,992) (6) Provision for income taxes 1,066 (1) 623 (1) 2,875 (1) 1,832 — Net loss $ (37,140) (24) % $ (11,477) (13) % $ (32,264) (7) % $ (17,824) (6) % (1) Includes share-based compensation expense as follows: Cost of revenues $ 262 $ 96 $ 644 $ 295 Research and development 8,433 5,741 23,044 15,876 Sales and marketing 2,431 1,843 7,053 5,405 General and administrative 10,403 9,185 28,668 25,779 Total share-based compensation expense $ 21,529 $ 16,865 $ 59,409 $ 47,355 30 Table of Contents Three and Nine Months Ended September 30, 2020 and 2019 Net Revenues The following tables set forth our total net revenues for the periods shown for our Chegg Services and Required Materials product lines (in thousands, except percentages): Three Months Ended September 30, Change 2020 2019 $ % Chegg Services $ 118,895 $ 69,304 $ 49,591 72 % Required Materials 35,123 24,847 10,276 41 Total net revenues $ 154,018 $ 94,151 $ 59,867 64 Nine Months Ended September 30, Change 2020 2019 $ % Chegg Services $ 345,258 $ 224,903 $ 120,355 54 % Required Materials 93,359 60,519 32,840 54 Total net revenues $ 438,617 $ 285,422 $ 153,195 54 Chegg Services revenues increased $49.6 million, or 72%, and $120.4 million, or 54%, during the three and nine months ended September 30, 2020, respectively, compared to the same periods in 2019, primarily due to a 69% increase in subscriber growth, during the three months ended September 30, 2020 compared to the same period in 2019, driven by increased global penetration, our efforts to reduce account sharing, the widespread transition to remote learning as a result of the COVID-19 pandemic, and subscribers from our recent acquisitions. We currently expect a positive impact to our business and results of operations in the near term as a result of the aforementioned drivers in subscriber growth. Chegg Services revenues were 77% and 79% of net revenues during the three and nine months ended September 30, 2020, respectively, and 74% and 79% of net revenues during the three and nine months ended September 30, 2019, respectively. Required Materials revenues increased $10.3 million, or 41%, and $32.8 million, or 54%, during the three and nine months ended September 30, 2020, respectively, compared to the same periods in 2019 primarily due to revenues from print textbooks that we own which are recognized as the total transaction amount ratably over the lease term as opposed to a revenue share on the total transactional amount of a rental or sale transaction immediately when a print textbook ships to a student. Required Materials revenues were 23% and 21% of net revenues during the three and nine months ended September 30, 2020, respectively, and 26% and 21% of net revenues during the three and nine months ended September 30, 2019, respectively. Cost of Revenues The following tables set forth our cost of revenues for the periods shown (in thousands, except percentages): Three Months Ended September 30, Change 2020 2019 $ % Cost of revenues (1) $ 62,370 $ 22,164 $ 40,206 181 % (1) Includes share-based compensation expense of: $ 262 $ 96 $ 166 173 % Nine Months Ended September 30, Change 2020 2019 $ % Cost of revenues (1) $ 148,284 $ 66,017 $ 82,267 125 % (1) Includes share-based compensation expense of: $ 644 $ 295 $ 349 118 % Cost of revenues increased and gross margins decreased during the three and nine months ended September 30, 2020, compared to the same periods in 2019, primarily attributable to costs associated with our ownership of print textbooks. 31 Table of Contents Cost of revenues increased $40.2 million, or 181%, during the three months ended September 30, 2020, compared to the same period in 2019. The increase was primarily attributable to higher order fulfillment fees of $19.6 million, higher cost of purchased textbooks of $7.1 million, higher depreciation of print textbooks of $3.6 million, higher employee-related expenses of $2.9 million, higher amortization of content of $2.6 million, higher customer support fees of $2.1 million, and higher payment processing fees of $1.4 million. Gross margins decreased to 60% during the three months ended September 30, 2020, from 76% during the same period in 2019. Cost of revenues increased $82.3 million, or 125%, during the nine months ended September 30, 2020, compared to the same period in 2019. The increase was primarily attributable to higher order fulfillment fees of $39.3 million, higher depreciation of print textbooks of $10.7 million, higher cost of purchased textbooks of $9.1 million, higher amortization of content of $6.6 million, higher employee-related expenses of $6.5 million, higher customer support fees of $4.2 million, higher payment processing fees of $3.7 million, and higher payments made to tutors of $1.0 million, partially offset by the net gain on textbook library of $2.0 million . Gross margins decreased to 66% during the nine months ended September 30, 2020, from 77% during the same period in 2019. Operating Expenses The following tables set forth our total operating expenses for the periods shown (in thousands, except percentages): Three Months Ended September 30, Change 2020 2019 $ % Research and development (1) $ 44,041 $ 36,442 $ 7,599 21 % Sales and marketing (1) 24,625 16,822 7,803 46 General and administrative (1) 40,784 23,752 17,032 72 Restructuring charges — 28 (28) n/m Total operating expenses $ 109,450 $ 77,044 $ 32,406 42 % (1) Includes share-based compensation expense of: Research and development $ 8,433 $ 5,741 $ 2,692 47 % Sales and marketing 2,431 1,843 588 32 General and administrative 10,403 9,185 1,218 13 Share-based compensation expense $ 21,267 $ 16,769 $ 4,498 27 % Nine Months Ended September 30, Change 2020 2019 $ % Research and development (1) $ 123,956 $ 101,199 $ 22,757 22 % Sales and marketing (1) 60,621 47,334 13,287 28 General and administrative (1) 98,221 70,044 28,177 40 Restructuring charges — 97 (97) n/m Total operating expenses $ 282,798 $ 218,674 $ 64,124 29 % (1) Includes share-based compensation expense of: Research and development $ 23,044 $ 15,876 $ 7,168 45 % Sales and marketing 7,053 5,405 1,648 30 General and administrative 28,668 25,779 2,889 11 Share-based compensation expense $ 58,765 $ 47,060 $ 11,705 25 % _______________________________________ n/m - not meaningful 32 Table of Contents Research and Development Research and development expense increased $7.6 million, or 21%, during the three months ended September 30, 2020 compared to the same period in 2019. The increase was primarily attributable to an increase in employee-related expenses of $3.1 million, higher share-based compensation expense of $2.7 million, and higher technology expenses to support our research and development of $2.2 million, compared to the same period in 2019. Research and development expense as a percentage of net revenues were 29% during the three months ended September 30, 2020 compared to 39% during the same period in 2019. Research and development expense increased $22.8 million, or 22%, during the nine months ended September 30, 2020 compared to the same period in 2019. The increase was primarily attributable to an increase in employee-related expenses of $10.0 million, higher share-based compensation expense of $7.2 million, and higher technology expenses to support our research and development of $6.7 million, compared to the same period in 2019. Research and development expense as a percentage of net revenues were 28% during the nine months ended September 30, 2020 compared to 35% during the same period in 2019. Sales and Marketing Sales and marketing expense increased by $7.8 million, or 46%, during the three months ended September 30, 2020, compared to the same period in 2019. The increase was primarily attributable to higher streaming radio and display advertisement marketing expense, including our international marketing spend, of $4.9 million, higher employee-related expenses of $2.1 million, and higher share-based compensation expense of $0.6 million, compared to the same period in 2019. Sales and marketing expense as a percentage of net revenues were 16% during the three months ended September 30, 2020 compared to 18% during the same period in 2019. Sales and marketing expense increased by $13.3 million, or 28%, during the nine months ended September 30, 2020, compared to the same period in 2019. The increase was primarily attributable to higher streaming radio and display advertisement marketing expense, including our international marketing spend, of $8.3 million, higher employee-related expenses of $3.1 million, and higher share-based compensation expense of $1.6 million, compared to the same period in 2019. Sales and marketing expense as a percentage of net revenues were 14% during the nine months ended September 30, 2020 compared to 17% during the same period in 2019. General and Administrative General and administrative expense increased $17.0 million, or 72%, during the three months ended September 30, 2020 compared to the same period in 2019. The increase was primarily due to an impairment charge on our investment in WayUp, Inc. of $10.0 million, which was the result of the uncertainty around WayUp's ability to raise additional funding to support their future operations., higher employee-related expenses of $5.1 million, and higher share-based compensation expense of $1.2 million, compared to the same period in 2019. General and administrative expense as a percentage of net revenues were 26% during the three months ended September 30, 2020 compared to 25% during the same period in 2019. General and administrative expense increased $28.2 million, or 40%, during the nine months ended September 30, 2020 compared to the same period in 2019. The increase was primarily due to an impairment charge on our investment in WayUp of $10.0 million, which was the result of the uncertainty around WayUp's ability to raise additional funding to support their future operations., higher employee-related expenses of $10.0 million, higher professional fees of $3.0 million largely driven by expenses related to our acquisition of Mathway, and higher share-based compensation expense of $2.9 million, compared to the same period in 2019. General and administrative expense as a percentage of net revenues were 22% during the nine months ended September 30, 2020 compared to 25% during the same period in 2019. The increases in employee-related expenses during the three and nine months ended September 30, 2020, compared to the same periods in 2019, are largely driven by employees from our acquisition of Thinkful. 33 Table of Contents Interest Expense and Other (Expense) Income, Net The following tables set forth our interest expense and other (expense) income, net, for the periods shown (in thousands, except percentages): Three Months Ended September 30, Change 2020 2019 $ % Interest expense, net $ (17,468) $ (13,548) $ (3,920) n/m Other (expense) income, net (804) 7,751 (8,555) n/m Total interest expense, net and other (expense) income, net $ (18,272) $ (5,797) $ (12,475) n/m Nine Months Ended September 30, Change 2020 2019 $ % Interest expense, net $ (44,320) $ (31,294) $ (13,026) n/m Other (expense) income, net 7,396 14,571 (7,175) n/m Total interest expense, net and other (expense) income, net $ (36,924) $ (16,723) $ (20,201) n/m _______________________________________ n/m - not meaningful Interest expense, net increased during the three months ended September 30, 2020, compared to the same period in 2019 as a result of interest expense related to the 2026 notes. Interest expense, net increased during the nine months ended September 30, 2020, compared to the same periods in 2019, as a result of interest expense related to the 2026 notes and 2025 notes. Other (expense) income, net, decreased during the three and nine months ended September 30, 2020, compared to the same periods in 2019, as a result of lower interest income earned on our investments due to lower interest rates and the $3.3 million loss on early extinguishment of debt primarily related to the partial exchange of the 2023 notes. Provision for Income Taxes The following tables set forth our provision for income taxes for the periods shown (in thousands, except percentages): Three Months Ended September 30, Change 2020 2019 $ % Provision for income taxes $ 1,066 $ 623 $ 443 71 % Nine Months Ended September 30, Change 2020 2019 $ % Provision for income taxes $ 2,875 $ 1,832 $ 1,043 57 % We recorded an income tax provision of approximately $1.1 million and $2.9 million during the three and nine months ended September 30, 2020, respectively, and an income tax provision of approximately $0.6 million and $1.8 million during the three and nine months ended September 30, 2019, respectively. The increase during the three and nine months ended September 30, 2020 compared to the same periods in 2019 was primarily due to an increase in foreign profits. Liquidity and Capital Resources As of September 30, 2020, our principal sources of liquidity were cash, cash equivalents, and investments totaling $1.8 billion, which were held for working capital purposes. The substantial majority of our net revenues are from e-commerce transactions with students, which are settled immediately through payment processors, as opposed to our accounts payable, which are settled based on contractual payment terms with our suppliers. In June 2020, our board of directors approved a securities repurchase program pursuant to which we may, from time to time, repurchase up to $500.0 million of our common stock and/or convertible notes, through open market purchases, block 34 Table of Contents trades, and/or privately negotiated transactions or pursuant to Rule 10b5-1 plans, in compliance with applicable securities laws and other legal requirements. The timing, volume, and nature of the repurchases will be determined by management based on the capital needs of the business, market conditions, applicable legal requirements, and other factors. The repurchase program will end on December 31, 2021. There were no securities repurchased during the three months ended September 30, 2020. In August 2020, March/April 2019 and April 2018, we closed offerings of our 2026 notes, 2025 notes and 2023 notes generating net proceeds of approximately $984.1 million, $780.2 million and $335.6 million, respectively, in each case after deducting the initial purchasers’ discount and estimated offering expenses payable by us. The 2026 notes, 2025 notes and 2023 notes mature on September 1, 2026, March 15, 2025 and May 15, 2023, respectively, unless converted, redeemed or repurchased in accordance with their terms prior to such date. As of September 30, 2020, we have incurred cumulative losses of $448.6 million from our operations and we expect to incur additional losses in the future. Our operations have been financed primarily by our initial public offering of our common stock (IPO), our 2017 follow-on public offering, our 2023 notes, 2025 notes and 2026 notes offerings, and cash generated from operations. We believe that our existing sources of liquidity will be sufficient to fund our operations and debt service obligations for at least the next 12 months. Our future capital requirements will depend on many factors, including our rate of revenue growth, our investments in research and development activities, our acquisition of new products and services and our sales and marketing activities. To the extent that existing cash 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. Most of our cash is held in the United States. As of September 30, 2020, our foreign subsidiaries held an insignificant amount of cash in foreign jurisdictions. We currently do not intend or foresee a need to repatriate some of these foreign funds, however, as a result of the Tax Cuts and Jobs Act we anticipate the U.S. federal impact to be minimal if these foreign funds are repatriated. In addition, based on our current and future needs, we believe our current funding and capital resources for our international operations are adequate. The following table sets forth our cash flows (in thousands): Nine Months Ended September 30, 2020 2019 Condensed Consolidated Statements of Cash Flows Data: Net cash provided by operating activities $ 168,655 $ 86,575 Net cash used in investing activities (750,942) (610,384) Net cash provided by financing activities 722,445 599,627 Cash Flows from Operating Activities Net cash provided by operating activities during the nine months ended September 30, 2020 was $168.7 million. Our net loss of $32.3 million was increased by the change in our deferred revenue of $32.2 million and accrued liabilities of $34.3 million. Additionally, we had significant non-cash operating expenses including print textbook depreciation expense of $10.7 million, other depreciation and amortization expense of $33.1 million, share-based compensation expense of $59.4 million, the amortization of debt discount and issuance costs of $42.9 million, the loss from impairment of strategic equity investment of $10.0 million and the loss on early extinguishment of debt of $3.3 million, partially offset by repayment of convertible senior notes attributable to debt discount of $14.9 million and gain on textbook library, net of $2.0 million. Net cash provided by operating activities during the nine months ended September 30, 2019 was $86.6 million. Our net loss of $17.8 million was offset by significant non-cash operating expenses including other depreciation and amortization expense of $21.4 million, share-based compensation expense of $47.4 million, and the amortization of debt discount and issuance costs related to the notes of $30.1 million. 35 Table of Contents Cash Flows from Investing Activities Net cash used in investing activities during the nine months ended September 30, 2020 was $750.9 million and was related to the purchases of investments of $968.1 million, the purchases of textbooks of $49.6 million, the purchases of property and equipment of $57.5 million, the acquisition of business of $92.8 million and the purchase of strategic equity investment of $2.0 million, partially offset by the maturity of investments of $412.0 million and proceeds from the disposition of textbooks of $7.0 million. Net cash used in investing activities during the nine months ended September 30, 2019 was $610.4 million and was related to the purchases of property and equipment of $31.5 million and the purchases of investments of $822.9 million, partially offset by the maturity of investments of $190.7 million and proceeds from sale of investments of $53.3 million. Cash Flows from Financing Activities Net cash provided by financing activities during the nine months ended September 30, 2020 was $722.4 million and was related to the proceeds from issuance of 2026 notes, net of issuance costs, of $984.1 million, proceeds from 2023 notes capped call instruments of $57.4 million, and proceeds from the issuance of common stock under stock plans of $9.2 million, partially offset by repayment of a portion of our 2023 notes of $159.7 million, purchase of the convertible senior notes capped call instruments related to our 2026 notes of $103.4 million and payment of $65.2 million in taxes related to the net share settlement of equity awards . Net cash provided by financing activities during the nine months ended September 30, 2019 was $599.6 million and was related to the proceeds from issuance of 2025 notes, net of issuance costs, of $780.2 million and proceeds from the issuance of common stock under stock plans of $27.7 million, partially offset by purchase of the convertible senior notes capped call instruments related to our 2025 notes of $97.2 million, the payment of $91.1 million in taxes related to the net share settlement of equity awards, and the repurchase of common stock of $20.0 million done in connection with the issuance of the convertible senior notes. Contractual Obligations and Other Commitments In August 2020, we issued $ 1.0 billion in aggregate principal amount of 2026 notes and exchanged $ 172.0 million aggregate principal amount of the 2023 notes. See Note 8, “Convertible Senior Notes,” of the Notes to Condensed Consolidated Financial Statements of Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information. There were no other material changes in our commitments under contractual obligations, as disclosed in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K for the year ended December 31, 2019. Off-Balance Sheet Arrangements Through September 30, 2020, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Critical Accounting Policies, Significant Judgments and Estimates Our condensed consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. These estimates form the basis for judgments we make about the carrying values of our assets and liabilities, which are not readily apparent from other sources. We base our estimates and judgments on historical experience and on various other assumptions that we believe are reasonable under the circumstances. On an ongoing basis, we evaluate our estimates and assumptions. The current COVID-19 pandemic has caused uncertainty and disruption in the global economy and financial markets. We are not aware of any specific event or circumstance that would require updates to our estimates or judgments or require us to revise the carrying value of our assets or liabilities. These estimates may change as new events occur and additional information is obtained. Our actual results may differ from these estimates under different assumptions or conditions. 36 Table of Contents Except for our critical accounting policy on textbook library, there have been no material changes in our critical accounting policies and estimates during the nine months ended September 30, 2020 as compared to the critical accounting policies and estimates disclosed in Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K for the year ended December 31, 2019. Textbook Library We write down textbooks on a book-by-book basis for lost, damaged, or excess print textbooks. Factors considered in the determination of write-downs for print textbooks include historical experience, management’s knowledge of current business conditions, and expectations of future demand. The consideration of these factors requires management to make significant judgments in the determination of our write-down for print textbooks in any given period which could have a material impact on our result of operations. We depreciate our print textbooks, less an estimated salvage value, over an estimated useful life of four years using an accelerated method of depreciation, as we estimate this method most accurately reflects the actual pattern of decline in their economic value. The salvage value considers the historical trend and projected proceeds for print textbooks. The useful life is determined based on the estimated time period in which the print textbooks are held and rented. We review the estimated salvage value and useful life of our print textbook library on an ongoing basis. We review the accelerated method of depreciation to ensure consistency with the value of the print textbooks to our customers during their useful life. Based on historical experience, we believe that a print textbook has more value to our customers and us early in its life and therefore an accelerated depreciation method best reflects the actual pattern of decline in economic value and aligns with the print textbooks’ deteriorating condition over time. In addition, we consider the utilization of the print textbooks and the revenues we can earn, recognizing that a used print textbook rents for a lower amount than a new print textbook. Should the actual rental activity or deterioration of print textbooks differ from our estimates, the gain or loss on print textbooks liquidated or the net book value of print textbooks purchased by students at the end of the term or on a just-in-time basis could differ in any given period, which could have a material impact to our results of operations. In addition, we evaluate the appropriateness of the estimated salvage value and useful life estimates based on historical transactions with both vendors and customers and reviewing a blend of actuals and estimates of the lifecycle of each print textbook. Our estimates utilize data from historical experience, including actual proceeds from print textbooks as a percentage of original sourcing costs, channel mix and the projected value of a print textbook in relation to the original source cost over time. As we continue to accumulate additional data related to our print textbook library, we may make refinements in the estimated salvage value, method of depreciation, or useful life. Any potential refinements could impact our print textbook depreciation expense, the gain or loss on print textbooks liquidated, or the net book value of print textbooks purchased by students at the end of the term or on a just-in-time basis and could have a material impact to our results of operations. Recent Accounting Pronouncements For relevant recent accounting pronouncements, see Note 1. Background and Basis of Presentation of our accompanying Notes to Condensed Consolidated Financial Statements included in Part I, Item 1, “Financial Statements (unaudited)” of this Quarterly Report on Form 10-Q.