Item 7. Management’s Discussion and Analysis
ITEM 7. 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 audited consolidated financial statements and the related notes included in Part II, Item 8, “Consolidated Financial Statements and Supplementary Data” of this Annual Report on Form 10-K. We have omitted discussion of the earliest of the three years of financial condition and results of operations and this information can be found in Part I, Item 7, “Management's Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, filed with the SEC on February 21, 2023, which is available free of charge on the SEC's website at sec.gov and on our website at investor.chegg.com. 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 Annual Report on Form 10-K, particularly in Part I, Item 1A, “Risk Factors.”
Overview
Millions of people all around the world learn with Chegg. No matter the goal, level, or style, Chegg helps learners learn with confidence. We provide 24/7 on-demand support, and our personalized learning assistant leverages the power of artificial intelligence (“AI”), more than a hundred million pieces of proprietary content, as well as a decade of learning insights. Our platform also helps learners build essential life and job skills to accelerate their path from learning to earning, and we work with companies to offer learning programs for their employees.
Our long-term strategy is centered upon our ability to utilize Subscription Services to increase student engagement with our learning platform. We continue to invest in the expansion of our offerings and technology platform to provide a more compelling and personalized solution and deepen engagement with students. As AI technologies continue to advance, we are taking advantage of the increased opportunities by leveraging new tools to better serve our students. We realigned our investments and resources around AI early in 2023, and have redesigned our user experience, developed our own large language models, launched automated answering and built proprietary algorithms to optimize the quality and accuracy of our content to build our personalized learning assistant. We remain focused on rolling out the next phase of our personalized learning assistant, including integrating pathways for students with assessments and other tools. We believe the investments we have made will allow us to maintain strong operating margins and cash flows and enable us to return to revenue growth over time. Our ability to achieve these long-term objectives is subject to numerous risks and uncertainties, which are described in greater detail in Part I, Item 1A, “Risk Factors.”
During the years ended December 31, 2023, and 2022, we generated net revenues of $716.3 million and $766.9 million, respectively, and in the same periods had net income of $18.2 million and $266.6 million, respectively.
We have presented revenues for our two product lines, Subscription Services and Skills and Other, 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 “Subscription Services” and “Skills and Other.”
Subscription Services
Our Subscription Services can be accessed internationally through our websites and on mobile devices and include Chegg Study Pack, Chegg Study, Chegg Writing, Chegg Math, and Busuu. Students typically pay to access Subscription Services on a monthly basis. Our Chegg Study subscription service provides access to personalized, step-by-step learning support powered by AI, computational engines, and subject matter experts. 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 subscription service, including Mathway, helps 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 services. Subscribers to Busuu have access to a premium learning language platform that offers comprehensive support through self-paced lessons, live classes with expert tutors and a huge community of members to practice alongside.
Subscription Services revenues were 89% and 88% of net revenues during the years ended December 31, 2023 and 2022, respectively.
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Skills and Other
Our Skills and Other product line includes revenues from Skills, advertising services, print textbooks and eTextbooks. Our skills-based learning platform offers learning experiences focused on the latest technology skills. We work with leading brands and programmatic partners to deliver advertising across our platforms. We also provide a platform for students to rent or buy print textbooks and eTextbooks, which helps students save money compared to the cost of buying new.
Skills and Other revenues were 11% and 12% of net revenues during the years ended December 31, 2023 and 2022, respectively.
Seasonality of Our Business
Revenues from Subscription Services are primarily recognized ratably over the subscription term, which has generally resulted in our highest revenues and profitability in the fourth quarter as it reflects more days of the academic year. Certain variable expenses, such as marketing expenses, 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.
Components of Results of Operations
Net Revenues
We recognize revenues net of allowances for refunds or charge backs from our payment processors who process payments from credit cards, debit cards, and PayPal. Revenues from Chegg Study Pack, Chegg Study, Chegg Writing, Chegg Math, and Busuu are primarily recognized ratably over the monthly subscription period. Revenues from Chegg Skills are recognized over the delivery period, adjusted for an estimate of non-redemption. Revenues from advertising services are recognized upon fulfillment. Revenues from print textbooks and eTextbooks are recognized immediately.
Cost of Revenues
Our cost of revenues consists primarily of expenses associated with the delivery and distribution of our products and services. Cost of revenues primarily consists of content amortization expense related to content that we develop, license from publishers, or acquire through acquisitions, web hosting fees, customer support fees, payment processing costs, amortization of acquired intangible assets, employee-related expenses, which includes salaries, benefits and share-based compensation expense, and other direct costs related to providing content or services. In addition, cost of revenues includes allocated information technology and facilities costs.
Operating Expenses
We classify our operating expenses into three categories: research and development, sales and marketing, and general and administrative. One of the most significant components of our operating expenses is employee-related expenses, which include salaries, benefits, and share-based compensation expense. We expect to continue to hire new employees in order to support our business. In any particular period, the timing of additional hires could materially affect our operating expenses, both in absolute dollars and as a percentage of revenues. Our operating expenses also contain information technology expenses such as technology costs to support our research and development, sales and marketing expenses, depreciation expenses, amortization of acquired intangible assets, and outside services. We allocate certain costs to each expense category, primarily based on the headcount in each group at the end of a period. As our business grows, our operating expenses may increase over time to expand capacity and sustain our workforce.
Research and Development
Our research and development expenses consist of employee-related expenses, which includes salaries, benefits, and share-based compensation expense for employees on our product, engineering, and technical teams who are responsible for maintaining our website, developing new products, and improving existing products. Research and development costs also include technology costs to support our research and development, and outside services. We expense substantially all of our research and development expenses as they are incurred. Our research and development expenses continue to support new products and services as well as expand our infrastructure capabilities to support back-end processes associated with our
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revenue transactions and internal systems. We intend to continue making significant investments in developing new products and services and enhancing the functionality of existing products and services.
Sales and Marketing
Our sales and marketing expenses consist of user and advertiser-facing marketing and promotional expenditures through a number of targeted online marketing channels, sponsored search, display advertising, social media campaigns, and other initiatives. We incur employee-related expenses, which includes salaries, benefits and share-based compensation expenses for our employees engaged in marketing, business development and sales and sales support functions, and amortization of acquired intangible assets. Our marketing expenses are largely variable and to the extent there is increased or decreased competition for these traffic sources, or to the extent our mix of these channels' shifts, we could see a corresponding change in our sales and marketing expenses.
General and Administrative
Our general and administrative expenses consist of employee-related expenses, which includes salaries, benefits and share-based compensation expense for certain executives as well as our finance, legal, human resources and other administrative employees. In addition, general and administrative expenses include outside services, legal and accounting services, and depreciation expense.
Interest Expense, Net and Other Income (Expense), Net
Interest expense, net consists primarily of interest expense on the amortization of debt issuance costs related to the convertible senior notes. Other income (expense), net consists primarily of interest income, gains on early extinguishment of the convertible senior notes, realized gains/losses on the sale of our investments, and foreign currency gain on purchase consideration.
(Provision For) Benefit From Income Taxes
(Provision for) benefit from income taxes consists primarily of federal and state income taxes in the United States.
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Results of Operations
The following table presents our historical consolidated statements of operations (in thousands, except percentage of total net revenues):
Years Ended December 31,
2023 2022
Net revenues $ 716,295 100 % $ 766,897 100 %
Cost of revenues (1)
225,941 32 197,396 26
Gross profit 490,354 68 569,501 74
Operating expenses:
Research and development (1)
191,705 27 196,637 26
Sales and marketing (1)
126,591 18 147,660 19
General and administrative (1)
239,783 33 216,247 28
Total operating expenses 558,079 78 560,544 73
(Loss) income from operations (67,725) (10) 8,957 1
Total interest expense, net and other income (expense), net 118,037 17 94,989 13
Income before (provision for) benefit from income taxes 50,312 7 103,946 14
(Provision for) benefit from income taxes (32,132) (4) 162,692 21
Net income $ 18,180 3 % $ 266,638 35 %
(1) Includes share-based compensation expense as follows:
Cost of revenues $ 2,256 $ 2,484
Research and development 44,103 41,335
Sales and marketing 9,524 13,857
General and administrative 77,619 75,780
Total share-based compensation expense $ 133,502 $ 133,456
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Years Ended December 31, 2023 and 2022
Net Revenues
The following table presents our total net revenues for the periods shown for our Subscription Services and Skills and Other product lines (in thousands, except percentages):
Years Ended December 31, Change in 2023
2023 2022 $ %
Subscription Services $ 640,520 $ 671,968 $ (31,448) (5) %
Skills and Other 75,775 94,929 (19,154) (20)
Total net revenues $ 716,295 $ 766,897 $ (50,602) (7)
Subscription Services revenues decreased by $31.4 million, or 5%, during the year ended December 31, 2023, compared to the same period in 2022. The decrease was primarily due to a 6% decrease in subscribers who have paid to access our services. Subscription Services revenues represented 89% and 88% of net revenues during the years ended December 31, 2023 and 2022, respectively. Skills and Other revenues decreased by $19.2 million, or 20%, during the year ended December 31, 2023 compared to the same period in 2022. The decrease was primarily due to lower revenues of $26.5 million from print textbooks and eTextbooks as a result of recognizing revenue on a net basis from our partnership with GT Marketplace, LLC that began in April 2022, offset by growth in our Chegg Skills offering of $13.0 million. Skills and Other revenues represented 11% and 12% of net revenues during the years ended December 31, 2023 and 2022, respectively.
Cost of Revenues
The following table presents our cost of revenues for the periods shown (in thousands, except percentages):
Years Ended December 31, Change in 2023
2023 2022 $ %
Cost of revenues (1)
$ 225,941 $ 197,396 $ 28,545 14 %
(1) Includes share-based compensation expense of:
$ 2,256 $ 2,484 $ (228) (9) %
Cost of revenues increased $28.5 million, or 14%, during the year ended December 31, 2023, compared to the same period in 2022. The increase was primarily attributable to content and related assets charge of $38.2 million and higher other depreciation and amortization expense of $7.4 million partially offset by the absence of print textbook and eTextbook related costs of $11.0 million, lower employee-related expenses, including share-based compensation expense, of $2.6 million, and lower transitional logistic charges of $2.2 million. The $38.2 million content and related assets charge primarily comprised of accelerated depreciation expense recorded as we realign our resources around our AI strategy. See Note 6, “Property and Equipment, Net” of our accompanying Notes to Consolidated Financial Statements included in Part I, Item 8, “Consolidated Financial Statements and Supplementary Data” of this Annual Report on Form 10-K for additional information. Gross margins decreased to 68% during the year ended December 31, 2023, from 74% during the same period in 2022.
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Operating Expenses
The following table presents our total operating expenses for the periods shown (in thousands, except percentages):
Years Ended December 31, Change in 2023
2023 2022 $ %
Research and development (1)
$ 191,705 $ 196,637 $ (4,932) (3) %
Sales and marketing (1)
126,591 147,660 (21,069) (14)
General and administrative (1)
239,783 216,247 23,536 11
Total operating expenses $ 558,079 $ 560,544 $ (2,465) 0
(1) Includes share-based compensation expense of:
Research and development $ 44,103 $ 41,335 $ 2,768 7 %
Sales and marketing 9,524 13,857 (4,333) (31)
General and administrative 77,619 75,780 1,839 2
Share-based compensation expense $ 131,246 $ 130,972 $ 274 0
Research and Development
Research and development expenses during the year ended December 31, 2023 decreased by $4.9 million, or 3%, compared to the same period in 2022. The decrease was primarily attributable to lower employee-related expenses, including share-based compensation expense, of $2.1 million, and lower contractor spend of $1.5 million, partially offset by restructuring charges of $1.7 million. Research and development expenses as a percentage of net revenues were 27% during the year ended December 31, 2023 compared to 26% of net revenues during the same period in 2022.
Sales and Marketing
Sales and marketing expenses during the year ended December 31, 2023 decreased by $21.1 million, or 14%, compared to the same period in 2022. The decrease was primarily attributable to lower paid marketing expenses of $9.8 million, primarily due to Busuu, lower employee-related expenses, including share-based compensation expense, of $5.7 million, and lower other depreciation and amortization expense of $1.2 million, partially offset by restructuring charges of $1.2 million. Sales and marketing expenses as a percentage of net revenues were 18% during the year ended December 31, 2023 compared to 19% of net revenues during the same period in 2022.
General and Administrative
General and administrative expenses in the year ended December 31, 2023 increased by $23.5 million, or 11%, compared to the same period in 2022. The increase was primarily due to higher employee-related expenses, including share-based compensation expense, of $14.7 million, a loss contingency accrual of $7.0 million, restructuring charges of $2.8 million, an impairment charge related to our intangible asset of $3.6 million, which was part of the content and related assets charge as we realign our resources around our AI strategy, partially offset by the absence of the impairment on lease related assets of $5.2 million. General and administrative expenses as a percentage of net revenues were 33% during the year ended December 31, 2023 compared to 28% during the same period in 2022.
Interest Expense, Net and Other Income (Expense), Net
The following table presents our interest expense, net, and other income (expense), net, for the periods shown (in thousands, except percentages):
Years Ended December 31, Change in 2023
2023 2022 $ %
Interest expense, net $ (3,773) $ (6,040) $ 2,267 (38) %
Other income (expense), net 121,810 101,029 20,781 21 %
Total interest expense, net and other income (expense), net $ 118,037 $ 94,989 $ 23,048 24 %
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Interest expense, net decreased by $2.3 million, or 38%, during the year ended December 31, 2023, compared to the same period in 2022. The decrease was primarily due to partial early extinguishments of our convertible senior notes.
Other income (expense), net increased by $20.8 million, or 21%, during the year ended December 31, 2023, compared to the same period in 2022. The increase was primarily due to a $85.9 million gain on early extinguishments of a portion of the 2026 notes and 2025 notes and an increase in interest income of $25.0 million, partially offset by the absence of the $93.5 million gain on early extinguishment of a portion of the 2026 notes that occurred in August 2022 and the absence of the $4.6 million gain on foreign currency remeasurement of purchase consideration related to our acquisition of Busuu.
See Note 8, “Convertible Senior Notes,” of our accompanying Notes to Consolidated Financial Statements included in Part II, Item 8, “Consolidated Financial Statements and Supplementary Data” of this Annual Report on Form 10-K for additional information on the gain on early extinguishment of a portion of the 2026 notes and 2025 notes.
(Provision for) benefit from income taxes
The following table presents our (provision for) benefit from income taxes for the periods shown (in thousands, except percentages):
Years Ended December 31, Change in 2023
2023 2022 $ %
(Provision for) benefit from income taxes $ (32,132) $ 162,692 $ (194,824) n/m
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*n/m - not meaningful
The change in (provision for) benefit from income taxes was primarily due to the absence of a valuation allowance benefit as a result of releasing our valuation allowance against a substantial amount of our U.S. deferred tax assets in 2022 and the current year provision for income taxes.
Liquidity and Capital Resources
The following table presents our cash, cash equivalents and investments and convertible senior notes as of the periods shown (in thousands, except percentages):
As of December 31,
Change in 2023
2023 2022 $ %
Cash, cash equivalents and short-term and long-term investments
$ 579,561 $ 1,273,883 $ (694,322) (55) %
Convertible senior notes, net (1)
599,837 1,188,593 (588,756) (50)
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(1) Consists of the current and long-term portion of convertible senior notes, net.
Cash, cash equivalents, and investments decreased $694.3 million during the year ended December 31, 2023 primarily due to the early extinguishments of our convertible senior notes of $506.0 million, repurchase of shares of our common stock of $334.8 million and purchases of property and equipment of $83.1 million, partially offset by the net cash provided by operating activities of $246.2 million.
Convertible senior notes, net decreased $588.8 million primarily due to early extinguishments. 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. Holders of the 2026 notes and 2025 notes may convert their notes at any time on or after June 1, 2026 and December 15, 2024, respectively, until the close of business on the second scheduled trading day immediately preceding the respective maturity dates. See Note 8, “Convertible Senior Notes” of our accompanying Notes to Consolidated Financial Statements included in Part I, Item 8, “Consolidated Financial Statements and Supplementary Data” of this Annual Report on Form 10-K for additional information on our notes.
As of December 31, 2023, our principal sources of liquidity were cash, cash equivalents, and investments totaling $579.6 million, 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. 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
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acquisition of new products and services and our sales and marketing activities. To the extent that existing sources of liquidity are insufficient to fund our future operations, 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. As of December 31, 2023, we have incurred cumulative losses of $52.4 million from our operations and we may incur additional losses in the future.
Most of our cash, cash equivalents, and investments are held in the United States. As of December 31, 2023, our foreign subsidiaries held an insignificant amount of cash in foreign jurisdictions. We plan to repatriate a portion of the earnings from our subsidiary in India in the future and therefore accrued the tax expense related to such future distributions during the year ended December 31, 2023. As a result of the Tax Cuts and Jobs Act, we anticipate the U.S. federal impact for the remaining foreign jurisdictions to be minimal if these 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.
In August 2023, our Board of Directors approved a $200.0 million increase to our existing securities repurchase program authorizing the repurchase of up to $2.2 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. As of December 31, 2022, we had $642.6 million remaining under the securities repurchase program. During the year ended December 31, 2023, we increased our existing securities repurchase program by $200.0 million, repurchased shares of our common stock for $334.5 million and a portion of our notes for $504.4 million. As of December 31, 2023, we had $3.7 million remaining under the securities 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. See Note 8, “Convertible Senior Notes” and Note 13, “Stockholders' Equity” of our accompanying Notes to Consolidated Financial Statements included in Part I, Item 8, “Consolidated Financial Statements and Supplementary Data” of this Annual Report on Form 10-K for additional information on our repurchases.
The following table presents our contractual obligations and other commitments as of December 31, 2023 (in thousands):
Total Next 12 Months Beyond 12 Months
Convertible senior notes (1)
$ 604,066 $ 449 $ 603,617
Purchase obligations (2)
44,812 33,837 10,975
Operating lease obligations (3)
28,006 8,084 19,922
Total contractual obligations $ 676,884 $ 42,370 $ 634,514
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(1) Consists of the remaining principal amount due upon maturity and semi-annual cash interest payments. Our convertible senior notes are recorded on our consolidated balance sheets at the carrying amount. As of December 31, 2023, the carrying amount of the 2026 notes and 2025 notes was $242.8 million and $357.1 million, respectively. The 2025 notes are classified as a current liability as holders may convert the 2025 notes at any time within twelve months after the reporting date, however they mature on March 15, 2025.
(2) Represents contractual obligations primarily related to information technology services.
(3) Our corporate offices are leased under operating leases, which expire at various dates through 2028.
In addition, we are also subject to certain legal proceedings and claims in the ordinary course of business and record a liability when we believe that a loss is probable and reasonably estimable and during the year ended December 31, 2023, we recognized an estimated loss contingency accrual of $7.0 million related to one of our legal proceedings. The timing of such payment is uncertain and we are unable to reliably estimate the timing and therefore have not included in the above table. See Note 10, “Commitments and Contingencies” of our accompanying Notes to Consolidated Financial Statements included in Part I, Item 8, “Consolidated Financial Statements and Supplementary Data” of this Annual Report on Form 10-K for additional information on our legal proceedings.
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The following table presents our consolidated statements of cash flows data (in thousands, except percentages):
Years Ended December 31, Change in 2023
2023 2022 $ %
Consolidated Statements of Cash Flows Data:
Net cash provided by operating activities $ 246,198 $ 255,736 $ (9,538) (4) %
Net cash provided by investing activities
268,673 104,891 163,782 156
Net cash used in financing activities
(852,770) (744,803) (107,967) 14
Net cash provided by operating activities decreased $9.5 million, or 4%, during the year ended December 31, 2023, compared to the same period in 2022 and was primarily driven by lower billings.
Net cash provided by investing activities increased $163.8 million, or 156%, during the year ended December 31, 2023, compared to the same period in 2022 and was primarily related to the absence of acquisitions of $401.1 million, which was partially offset by lower cash from investment maturities of $287.7 million.
Net cash used in financing activities increased $108.0 million, or 14%, during the year ended December 31, 2023, compared to the same period in 2022 and was primarily related to higher repurchases of our convertible senior notes of $104.8 million.
Critical Accounting Policies, Significant Judgments and Estimates
Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States (U.S. GAAP). The preparation of these 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. Our actual results may differ from these estimates under different assumptions or conditions.
An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, if different estimates reasonably could have been used, or if changes in the estimate that are reasonably possible could materially impact the financial statements. We believe that assumptions and estimates of the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our financial condition and results of operations. For further information on all of our significant accounting policies, see Note 2, “Significant Accounting Policies”, of our accompanying Notes to Consolidated Financial Statements included in Part II, Item 8, “Consolidated Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.
Revenue Recognition and Deferred Revenue
For sales of third-party products, we evaluate whether we are acting as a principal or an agent. Where our role in a transaction is that of principal, revenues are recognized on a gross basis. This requires revenue to comprise the gross value of the transaction billed to the customer, after trade discounts, with any related expenditure charged as a cost of revenues. Where our role in a transaction is that of an agent, revenues are recognized on a net basis with revenues representing the margin earned. Our determination is based on our evaluation of whether we control the specified goods or services prior to transferring them to the customer. There are significant judgments involved in determining whether we control the specified goods or services prior to transferring them to the customer including whether we have the ability to direct the use of the good or service and obtain substantially all of the remaining benefits from the good or service. We have concluded that we control our Subscription Services and therefore we recognize revenues and cost of revenues on a gross basis. For print textbooks and eTextbooks, we have concluded that we do not control the service and therefore we recognize revenues on a net basis based on our role in the transaction as an agent.
Some of our customer arrangements include multiple performance obligations. We have determined these performance obligations qualify as distinct performance obligations, as the customer can benefit from the service on its own or together with other resources that are readily available to the customer, and our promise to transfer the service is separately identifiable from other promises in the contract. For these arrangements that contain multiple performance obligations, we allocate the transaction price based on the relative standalone selling price (SSP) method by comparing the SSP of each distinct
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performance obligation to the total value of the contract. We determine the SSP based on our historical pricing and discounting practices for the distinct performance obligation when sold separately. If the SSP is not directly observable, we estimate the SSP by considering information such as market conditions, and information about the customer.
Some of our customer arrangements may include an amount of variable consideration in addition to a fixed revenue share that we earn. This variable consideration can either increase or decrease the total transaction price depending on the nature of the variable consideration. We estimate the amount of variable consideration that we will earn at the inception of the contract, adjusted during each period, and include an estimated amount each period. In determining this estimate, we consider the single most likely amount in a range of possible amounts. This estimated amount of variable consideration requires management to make a judgment based on the forecasted amount of consideration that we expect we will earn as well as the time period in which we can reasonably rely on the accuracy of the forecast. Our estimate of variable consideration is constrained to only include the amount of variable consideration for which it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur, as the amounts that we could potentially earn in outer years can change significantly based on factors that are out of our control. If our forecasts are inaccurate, the estimated amount of variable consideration could be inaccurate, which could impact our revenue recognition in a given period.
Impairment of Acquired Intangible Assets and Other Long-Lived Assets
We assess the impairment of acquired intangible assets and other long-lived assets at least annually and whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Factors that we consider in determining when to perform an impairment review include significant negative industry or economic trends or significant changes or planned changes in the use of the assets. When measuring the recoverability of these assets, we will make assumptions regarding our estimated future cash flows expected to be generated by the assets. If our estimates or related assumptions change in the future, we may be required to impair these assets. We did not record any impairment charges related to acquired intangible assets or other long-lived assets during the years ended December 31, 2023 and 2022.
Goodwill and Indefinite Lived Intangible Asset
Goodwill and our indefinite lived intangible asset are tested for impairment at least annually or whenever events or changes in circumstances indicate that their carrying values may not be recoverable. We first assess qualitative factors to determine whether it is necessary to perform a quantitative impairment test. In our qualitative assessment, we consider factors including economic conditions, industry and market conditions and developments, overall financial performance and other relevant entity-specific events in determining whether it is more likely than not that the fair value of our reporting unit is less than the carrying amount. Our qualitative assessment requires management to make judgments based on the factors listed above in our determination of whether events or changes in circumstances indicate that the carrying values may not be recoverable.
If our qualitative assessment concludes that it is more likely than not that the fair value is less than the carrying amount, a quantitative assessment of impairment is performed. Performing a quantitative impairment test includes the determination of fair value and involves significant estimates and assumptions including, among others, forecasted revenue growth rates, operating margins and capital expenditures, and discount rates used to calculate projected future cash flows, as well as the determination of appropriate market comparable companies, metrics and multiples. If the carrying value exceeds the fair value, an impairment loss is recognized in an amount equal to the excess. If estimates or related assumptions change, this could have a significant impact on either the fair value of our reporting unit, the amount of any goodwill impairment charge, or both. We have not recognized any goodwill impairment charges since our inception. During the year ended December 31, 2023, as part of the design and build of our new generative AI experience, we streamlined our product experiences and recognized a $3.6 million impairment charge on our indefinite-lived intangible asset. See Note 6, “Property and Equipment, Net” of our accompanying Notes to Consolidated Financial Statements included in Part I, Item 8, “Consolidated Financial Statements and Supplementary Data” of this Annual Report on Form 10-K for additional information.
Share-based Compensation Expense
We measure and recognize share-based compensation expense for all awards made to employees, directors and consultants, including restricted stock units (RSUs), performance-based RSUs (PSUs) with either a market-based condition or financial and strategic performance target and our employee stock purchase plan (ESPP) based on estimated fair values.
We estimate a forfeiture rate to calculate the share-based compensation expense related to our awards. Estimated forfeitures are determined based on historical data and we continue to evaluate the appropriateness of the forfeiture rate based on actual forfeiture experience, analysis of employee turnover and other factors. Quarterly changes in the estimated forfeiture rate can have a significant impact on our share-based compensation expense as the cumulative effect of adjusting the rate is
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recognized in the period the forfeiture estimate is changed. If a revised forfeiture rate is higher than the previously estimated forfeiture rate, an adjustment is made that will result in a decrease to the share-based compensation expense recognized in the financial statements. If a revised forfeiture rate is lower than the previously estimated forfeiture rate, an adjustment is made that will result in an increase to the share-based compensation expense recognized in the financial statements.
Share-based compensation expense for PSUs with a market-based condition is recognized regardless of whether the market condition is satisfied subject to continuing service over the requisite service period. Share-based compensation expense recognized related to PSUs with a financial and strategic performance target is subject to the achievement of performance objectives and requires significant judgment by management in determining the current level of attainment of such performance objectives. Management may consider factors such as the latest financial forecasts and general business trends in the assessment of PSU award attainment. Subsequent changes to these considerations may have a material impact on the amount of share-based compensation expense recognized in the period related to PSU awards, which may lead to volatility of share-based compensation expense period-to-period. If the performance objectives are not met or service is no longer provided, no share-based compensation expense will be recognized, and any previously recognized share-based compensation expense will be reversed.
We will continue to use judgment in evaluating the assumptions related to our share-based compensation expense on a prospective basis. As we continue to accumulate additional data related to our common stock, we may refine our estimates, which could materially impact our future share-based compensation expense.
Provision for Income Taxes
We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in our consolidated financial statements or tax returns. In estimating future tax consequences, we generally consider all expected future events other than enactments or changes in the tax law or rates. In assessing the realization of deferred tax assets, we consider whether it is more likely than not that all or some portion of deferred tax assets will not be realized. The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Valuation allowances are provided to reduce deferred tax assets to the amount that is more likely than not to be realized. In assessing the need for a valuation allowance, we consider all available evidence including future reversals of existing taxable temporary differences, projected future taxable income, taxable income in prior carryback years if permitted under the tax law, and tax-planning strategies. In the event that we change our determination as to the amount of deferred tax assets that can be realized, we will adjust our valuation allowance with a corresponding impact to the provision for income taxes in the period in which such determination is made.
We record uncertain tax positions on the basis of a two-step process in which (1) we determine whether it is more likely than not that the tax positions will be sustained on the basis of technical merits of the position and (2) for those tax positions that meet the more likely than not recognition threshold, we recognize the tax benefit as the largest amount that is cumulative more than 50 percent likely to be realized upon ultimate settlement with the related tax authority.
The calculation of tax expense and liabilities involves dealing with uncertainties in the application of complex global tax regulations. We recognize potential liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes will be due. Significant judgment is required in determining our provision for income taxes and evaluating our uncertain tax positions. To the extent that the final tax outcome of these matters may differ from the amounts that were initially recorded, such differences will impact the income tax provision in the period in which such determination is made. As a result, significant changes to these estimates may result in an increase or decrease to our tax provision in a subsequent period.
Recent Accounting Pronouncements
For relevant recent accounting pronouncements, see Note 2, “Significant Accounting Policies”, of our accompanying Notes to Consolidated Financial Statements included in Part II, Item 8, “Consolidated Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.
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