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. Overview Millions of people all around the world Learn with Chegg. Our mission is to improve learning and learning outcomes by putting students first. We support life-long learners starting with their academic journey and extending into their careers. The Chegg platform provides products and services to support learners to help them better understand their academic course materials, and also provides personal and professional development skills training, to help them achieve their learning goals. Students subscribe to our subscription services, collectively referred to as our Chegg Services, which can be accessed internationally through our websites and on mobile devices. Our primary Chegg Services include Chegg Study, Chegg Writing, Chegg Math Solver, Chegg Study Pack, Busuu, Mathway and Thinkful. Our Chegg Study subscription service provides “Expert Questions and Answers” and step-by-step “Textbook Solutions,” helping students with their course work. When students need writing help, including plagiarism detection scans and creating citations for their papers, they can use our Chegg Writing subscription service. Our Chegg Math Solver and Mathway subscription services help students understand math by providing a step-by-step math solver and calculator. We also offer our Chegg Study Pack as a premium subscription bundle of our Chegg Study, Chegg Writing, and Chegg Math Solver services, which also includes additional features such as flashcards, concept videos, and practice questions and quizzes. Our Thinkful skills-based learning platform offers professional courses focused on the most in-demand technology skills. 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. We partner with a variety of third parties to source print textbooks and eTextbooks directly or indirectly from publishers. In April 2022, we entered into definitive agreements with BBA such that we will continue to offer our Required Materials offering on our website and maintain relationships with the students, however, BBA has purchased our existing print textbook library and will continue to make print textbook investments and provide fulfillment logistics for print textbook transactions. We expect that we will continue to fulfill eTextbook transactions through the end of 2022, at which point BBA will fulfill eTextbook transactions. We expect that our partnership with BBA provides an opportunity to grow faster with higher margins. In January 2022, we completed our acquisition of Busuu Online S.L. (Busuu), an online language learning company that offers a comprehensive solution through a combination of self-paced lessons, live classes with expert tutors and the ability to learn and practice with members of the Busuu language learning community. During the three months ended March 31, 2022 and 2021, we generated net revenues of $202.2 million and $198.4 million, respectively. We continue to experience a slowdown in the education industry as a result of the COVID-19 pandemic and macroeconomic conditions, such as inflation, which resulted in a decline in traffic to education technology services, such as the ones we provide. A combination of increased employment opportunities and compensation, along with students taking less classes, all led to significantly fewer enrollments than expected. Those students who have enrolled are taking fewer and less rigorous classes and are receiving less graded assignments. As a result, we are experiencing a deceleration in the growth rates of our services and revenues that may continue. 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 22 Table of Contents contributions of Chegg Services, will enable us to sustain profitability 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, reduced traffic to our services, 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, which continues to evolve and affect our business and results of operations. The COVID-19 pandemic subjects our business to numerous risks and uncertainties, most of which are beyond our control and cannot be predicted, including post-pandemic enrollment trends and student behaviors, such as the number and intensity of the courses selected. These risks and uncertainties are described in greater detail in Part I, Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021. 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 Math Solver, Chegg Study Pack, Busuu, Mathway, and Thinkful. 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 91% and 82% of net revenues during the three months ended March 31, 2022 and 2021, respectively. Required Materials Our Required Materials product line includes revenues from print textbooks and eTextbooks. Revenues from print textbooks that we own are primarily recognized as the total transaction amount ratably over the rental term, generally a two- to five-month period. Revenues from print textbooks owned by a partner are recognized as a revenue share on the total transactional amount immediately when a print textbook ships to a student. Additionally, Required Materials includes revenues from eTextbooks, which are primarily recognized ratably over the contractual period, generally a two- to five-month period. As a result of the partnership with BBA, revenues from print textbook transactions will consist of a revenue share of the total transactions recognized immediately rather than the total amounts recognized ratably over the rental term, generally a two- to five-month period. Revenues from eTextbook transactions will continue to be recognized at the gross amount ratably over the contractual period, generally a two- to five-month period, through the expected transition period, at which point they will be recognized as a revenue share immediately. In the aggregate, Required Materials revenues were 9% and 18% of net revenues during the three months ended March 31, 2022 and 2021, 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 cost of revenues and 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. 23 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 March 31, 2022 2021 Net revenues $ 202,244 100 % $ 198,378 100 % Cost of revenues (1) 55,085 27 71,384 36 Gross profit 147,159 73 126,994 64 Operating expenses: Research and development (1) 52,415 26 46,131 23 Sales and marketing (1) 42,498 21 26,214 13 General and administrative (1) 46,870 23 37,870 19 Total operating expenses 141,783 70 110,215 55 Income from operations 5,376 3 16,779 9 Total interest expense, net and other income (expense), net 4,583 2 (79,137) (40) Income (loss) before provision for income taxes 9,959 5 (62,358) (31) Provision for income taxes (4,217) (2) (2,821) (2) Net income (loss) $ 5,742 3 % $ (65,179) (33) % (1) Includes share-based compensation expense as follows: Cost of revenues $ 623 $ 362 Research and development 11,776 7,959 Sales and marketing 4,386 2,919 General and administrative 16,299 11,860 Total share-based compensation expense $ 33,084 $ 23,100 24 Table of Contents Three Months Ended March 31, 2022 and 2021 Net Revenues The following table sets 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 March 31, Change 2022 2021 $ % Chegg Services $ 184,812 $ 162,351 $ 22,461 14 % Required Materials 17,432 36,027 (18,595) (52) Total net revenues $ 202,244 $ 198,378 $ 3,866 2 Chegg Services revenues increased $22.5 million, or 14%, during the three months ended March 31, 2022, compared to the same period in 2021. The increase was primarily due to the introduction of enhanced and new offerings, including our acquisition of Busuu, which closed in January 2022, and increased global brand awareness and penetration. Chegg Services revenues were 91% and 82% of net revenues during the three months ended March 31, 2022 and 2021, respectively. Required Materials revenues decreased $18.6 million, or 52%, during the three months ended March 31, 2022 compared to the same period in 2021. The decrease was primarily due to various print textbook logistics challenges and lower unit volumes driven by decreased college enrollments. Required Materials revenues were 9% and 18% of net revenues during the three months ended March 31, 2022 and 2021, respectively. As a result of our partnership with BBA, we expect Required Material revenues to decrease due to recognizing a revenue share of the total transaction amount rather than the total transaction amount. Cost of Revenues The following table sets forth our cost of revenues for the periods shown (in thousands, except percentages): Three Months Ended March 31, Change 2022 2021 $ % Cost of revenues (1) $ 55,085 $ 71,384 $ (16,299) (23) % (1) Includes share-based compensation expense of: $ 623 $ 362 $ 261 72 % Cost of revenues decreased $16.3 million, or 23%, during the three months ended March 31, 2022, compared to the same period in 2021. The decrease was primarily attributable to lower order fulfillment fees of $12.3 million driven by lower unit volumes, lower net loss on textbook library of $4.6 million, primarily due to a reduction in write-downs, lower cost of textbooks purchased by students of $3.3 million, lower print textbook depreciation expense of $2.2 million, and lower customer support fees of $1.9 million, partially offset by higher other depreciation and amortization expense of $4.1 million, higher web hosting fees of $2.4 million, and incremental cost of tutors, as a result of our acquisition of Busuu, of $2.2 million. Gross margins increased to 73% during the three months ended March 31, 2022, from 64% during the same period in 2021. As a result of our partnership with BBA, we expect cost of revenues to decrease and margins to improve over time. 25 Table of Contents Operating Expenses The following table sets forth our total operating expenses for the periods shown (in thousands, except percentages): Three Months Ended March 31, Change 2022 2021 $ % Research and development (1) $ 52,415 $ 46,131 $ 6,284 14 % Sales and marketing (1) 42,498 26,214 16,284 62 General and administrative (1) 46,870 37,870 9,000 24 Total operating expenses $ 141,783 $ 110,215 $ 31,568 29 % (1) Includes share-based compensation expense of: Research and development $ 11,776 $ 7,959 $ 3,817 48 % Sales and marketing 4,386 2,919 1,467 50 General and administrative 16,299 11,860 4,439 37 Share-based compensation expense $ 32,461 $ 22,738 $ 9,723 43 % Research and Development Research and development expenses increased $6.3 million, or 14%, during the three months ended March 31, 2022 compared to the same period in 2021. The increase was primarily attributable to higher employee-related expenses, including share-based compensation expense, of $5.5 million and higher technology expenses to support our research and development of $1.5 million. Research and development expenses as a percentage of net revenues were 26% during the three months ended March 31, 2022 compared to 23% during the same period in 2021. Sales and Marketing Sales and marketing expenses increased by $16.3 million, or 62%, during the three months ended March 31, 2022, compared to the same period in 2021. The increase was primarily attributable to increased international marketing spend, including incremental marketing spend from Busuu, of $10.0 million, higher employee-related expenses, including share-based compensation expense, of $3.0 million, and higher other depreciation and amortization expense of $2.1 million. Sales and marketing expenses as a percentage of net revenues were 21% during the three months ended March 31, 2022 compared to 13% during the same period in 2021. General and Administrative General and administrative expenses increased $9.0 million, or 24%, during the three months ended March 31, 2022 compared to the same period in 2021. The increase was primarily due to higher employee-related expenses, including share-based compensation expense, of $8.6 million. General and administrative expenses as a percentage of net revenues were 23% during the three months ended March 31, 2022 compared to 19% during the same period in 2021. The increases in employee-related operating expenses during the three months ended March 31, 2022, compared to the same period in 2021, are largely driven by incremental employees from our acquisition of Busuu. Interest Expense and Other Income (Expense), Net The following table sets forth our interest expense and other income (expense), net, for the periods shown (in thousands, except percentages): Three Months Ended March 31, Change 2022 2021 $ % Interest expense, net $ (1,597) $ (1,929) $ 332 (17) % Other income (expense), net 6,180 (77,208) 83,388 n/m Total interest expense, net and other income (expense), net $ 4,583 $ (79,137) $ 83,720 n/m ______________________________________ *n/m - not meaningful 26 Table of Contents Interest expense, net decreased $0.3 million, or 17%, during the three months ended March 31, 2022, compared to the same period in 2021, primary due to the full redemption of the 2023 notes in 2021. Other income (expense), net increased $83.4 million during the three months ended March 31, 2022, compared to the same period in 2021, primarily due to the absence of the $78.2 million loss on early extinguishment of debt of a portion of the 2025 notes and the $7.1 million net loss on the change in fair value of derivative instruments. 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 March 31, Change 2022 2021 $ % Provision for income taxes $ (4,217) $ (2,821) $ (1,396) 49 % Provision for income taxes increased $1.4 million, or 49%, during the three months ended March 31, 2022 compared to the same period in 2021 primarily due to base erosion and anti-abuse taxes partially offset by a decrease in withholding taxes. Liquidity and Capital Resources As of March 31, 2022, our principal sources of liquidity were cash, cash equivalents, and investments totaling $1.6 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 November 2021, our board of directors approved a $500.0 million increase to our existing securities repurchase program authorizing the repurchase of up to $1.0 billion of our common stock and/or convertible notes, through open market purchases, block 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. During the three months ended March 31, 2022 and year ended December 31, 2021, we entered into accelerated share repurchase programs to repurchase a total of $600.0 million of our outstanding common stock. Additionally, in 2021 we have repurchased $57.4 million and $100.0 million of aggregate principal amount of the 2023 notes and 2025 notes, respectively, in privately negotiated transactions for an aggregate consideration of $149.6 million and $184.9 million, respectively. $65.5 million remains under the repurchase program, which has no expiration date and will continue until otherwise suspended, terminated or modified at any time for any reason by our board of directors. In February 2021, we completed an equity offering in which we raised net proceeds of $1,091.5 million, after deducting underwriting discounts and commissions and offering expenses (2021 equity offering). In August 2020 and March/April 2019, we closed offerings of our 2026 notes and 2025 notes, generating net proceeds of approximately $984.1 million and $780.2 million, respectively, in each case after deducting the initial purchasers’ discount and estimated offering expenses payable by us. The 2026 notes and 2025 notes mature on September 1, 2026 and March 15, 2025, respectively, unless converted, redeemed or repurchased in accordance with their terms prior to such dates. As of March 31, 2022, we have incurred cumulative losses of $331.4 million from our operations and we may 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 convertible senior notes offerings, our 2021 equity offering, and cash generated from operations. There were no material changes in our commitments under contractual obligations, as 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, 2021. 27 Table of Contents 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, cash equivalents, and investments are held in the United States. As of March 31, 2022, our foreign subsidiaries held an insignificant amount of cash in foreign jurisdictions. We currently do not intend or foresee a need to repatriate 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): Three Months Ended March 31, 2022 2021 Condensed Consolidated Statements of Cash Flows Data: Net cash provided by operating activities $ 80,035 $ 73,573 Net cash used in investing activities (363,072) (764,952) Net cash (used in) provided by financing activities (307,461) 867,600 Cash Flows from Operating Activities Net cash provided by operating activities during the three months ended March 31, 2022 was $80.0 million. Our net income of $5.7 million was increased by the change in our prepaid expenses and other current assets of $21.7 million. We also had significant non-cash operating expenses including share-based compensation expense of $33.1 million and other depreciation and amortization expense of $20.3 million. Net cash provided by operating activities during the three months ended March 31, 2021 was $73.6 million. Our net loss of $65.2 million was offset by significant non-cash operating expenses including print textbook depreciation expense of $3.8 million, other depreciation and amortization expense of $14.8 million, share-based compensation expense of $23.1 million, the loss on early extinguishment of debt of $78.2 million, the net loss on the change in fair value of derivative instruments of $7.1 million, and the net loss on textbook library of $4.0 million, which was primarily due to increased write-downs, partially offset by the gain on sale of strategic equity investment of $5.3 million. Cash Flows from Investing Activities Net cash used in investing activities during the three months ended March 31, 2022 was $363.1 million and was related to the acquisition of a business of $401.1 million, the purchases of investments of $273.3 million, the purchases of property and equipment of $29.5 million, and the purchases of textbooks of $3.7 million, partially offset by the maturity of investments of $342.1 million and proceeds from the disposition of textbooks of $2.5 million. Net cash used in investing activities during the three months ended March 31, 2021 was $765.0 million and was related to the purchases of investments of $925.7 million, the purchases of property and equipment of $19.0 million, the acquisition of business of $7.9 million and the purchases of textbooks of $4.5 million, partially offset by the maturity of investments of $181.3 million, proceeds from the sale of strategic equity investment of $6.8 million, and proceeds from the disposition of textbooks of $4.0 million. Cash Flows from Financing Activities Net cash used in financing activities during the three months ended March 31, 2022 was $307.5 million and was primarily related to the repurchases of common stock of $300.5 million and payment of $7.5 million in taxes related to the net share settlement of equity awards. 28 Table of Contents Net cash provided by financing activities during the three months ended March 31, 2021 was $867.6 million and was related to the net proceeds from our equity offering of $1,091.5 million, proceeds from 2023 notes and 2025 notes capped call instruments of $24.8 million, and proceeds from the issuance of common stock under stock plans of $0.3 million, partially offset by the repayment of a portion of our 2023 notes and 2025 notes of $189.8 million and payment of $59.2 million in taxes related to the net share settlement of equity awards. 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. There have been no material changes in our critical accounting policies and estimates during the three months ended March 31, 2022 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, 2021. 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. 29 Table of Contents ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There have been no other material changes in our market risk during the three months ended March 31, 2022, compared to the disclosures in Part II, Item 7A, “Quantitative and Qualitative Disclosures about Market Risk” contained in our Annual Report on Form 10-K for the year ended December 31, 2021.