Chegg(US:CHGG)2020-10-26 20:10PART I - FINANCIAL INFORMATION Item 1. Financial Statements (unaudited) This section presents Chegg, Inc.'s unaudited condensed consolidated financial statements for Q3 and YTD September 30, 2020, including balance sheets, statements of operations, comprehensive loss, stockholders' equity, and cash flows, with accompanying notes detailing accounting policies and significant events Condensed Consolidated Balance Sheets Total assets significantly increased to $2.34 billion as of September 30, 2020, from $1.49 billion at year-end 2019, driven by higher cash, investments, and goodwill, while total liabilities also grew substantially to $1.70 billion from $990 million due to new convertible senior notes Condensed Consolidated Balance Sheet Highlights (in thousands) | Account | September 30, 2020 | December 31, 2019 | | :--- | :--- | :--- | | Total Current Assets | $1,299,496 | $807,267 | | Cash and cash equivalents | $527,541 | $387,520 | | Total Assets | $2,341,657 | $1,488,998 | | Total Current Liabilities | $142,955 | $71,389 | | Convertible senior notes, net | $1,536,984 | $900,303 | | Total Liabilities | $1,696,265 | $990,169 | | Total Stockholders' Equity | $645,392 | $498,829 | Condensed Consolidated Statements of Operations Net revenues grew significantly year-over-year for both the third quarter and the first nine months of 2020, though net loss widened due to increased cost of revenues, higher operating expenses including an impairment charge, and greater interest expense from convertible notes Statement of Operations Summary (in thousands, except per share data) | Metric | Q3 2020 | Q3 2019 | YTD 2020 | YTD 2019 | | :--- | :--- | :--- | :--- | :--- | | Net Revenues | $154,018 | $94,151 | $438,617 | $285,422 | | Gross Profit | $91,648 | $71,987 | $290,333 | $219,405 | | (Loss) from Operations | $(17,802) | $(5,057) | $7,535 | $731 | | Net Loss | $(37,140) | $(11,477) | $(32,264) | $(17,824) | | Net Loss Per Share | $(0.29) | $(0.10) | $(0.26) | $(0.15) | Condensed Consolidated Statements of Cash Flows For the nine months ended September 30, 2020, net cash from operating activities nearly doubled to $168.7 million, investing activities used $750.9 million primarily for investments and acquisitions, and financing activities provided $722.4 million mainly from convertible notes issuance Cash Flow Summary (Nine Months Ended Sep 30, in thousands) | Activity | 2020 | 2019 | | :--- | :--- | :--- | | 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 | - Key financing activities in 2020 included $984.1 million in proceeds from issuing convertible senior notes, offset by a $103.4 million purchase of a capped call, $159.7 million repayment of other notes, and $65.2 million for taxes on equity awards36192 - Key investing activities in 2020 included $968.1 million in investment purchases, $92.8 million for the acquisition of Mathway, and $49.6 million for textbook purchases36190 Notes to Condensed Consolidated Financial Statements The notes detail significant accounting policies and events, including the company's transition back to owning its print textbook library, the $101.0 million acquisition of Mathway, the issuance of $1.0 billion in 0% convertible senior notes due 2026, and ongoing legal matters such as an FTC inquiry and arbitration demands related to a 2018 data incident - In January 2020, Chegg began transitioning back to print textbook ownership, classifying the library as a long-term asset, with the net textbook library valued at $34.6 million as of September 30, 20204852 - On June 4, 2020, Chegg acquired Mathway, LLC for a total purchase consideration of $101.0 million to strengthen its math services, adding $70.2 million in goodwill9597 - In August 2020, the company issued $1.0 billion of 0% convertible senior notes due in 2026, concurrently exchanging $172.0 million of its 2023 notes54105109 - The company is facing a Civil Investigative Demand (CID) from the FTC regarding data privacy and security practices, as well as over 16,000 arbitration demands related to a 2018 data incident125126 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses significant revenue growth driven by subscriber increases and acquisitions, particularly a 72% rise in Chegg Services revenue in Q3 2020, while net loss increased due to higher costs from print textbook ownership, an investment impairment, and increased operating expenses, with strong liquidity maintained by $1.8 billion in cash and investments from recent convertible notes issuance Results of Operations Total net revenues for Q3 2020 increased 64% year-over-year to $154.0 million, primarily driven by a 72% increase in Chegg Services revenue, while gross margin decreased from 76% to 60% due to higher costs from print textbook ownership, and operating expenses rose 42% due to a $10.0 million impairment charge on an investment and increased employee-related costs Net Revenues by Product Line (Q3, in thousands) | Product Line | Q3 2020 | Q3 2019 | Change ($) | Change (%) | | :--- | :--- | :--- | :--- | :--- | | 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% | - The increase in Chegg Services revenue was primarily due to a 69% increase in subscriber growth, driven by global penetration, reduced account sharing, the transition to remote learning due to COVID-19, and recent acquisitions159 - Cost of revenues increased 181% in Q3 2020 YoY, primarily due to costs associated with the ownership of print textbooks, including higher fulfillment fees, textbook costs, and depreciation160162 - General and Administrative expenses increased 72% in Q3 2020 YoY, largely due to a $10.0 million impairment charge on the company's investment in WayUp, Inc170 Liquidity and Capital Resources As of September 30, 2020, Chegg's principal sources of liquidity totaled $1.8 billion in cash, cash equivalents, and investments, bolstered by $984.1 million in net proceeds from its August 2020 convertible notes offering, with management believing existing liquidity is sufficient to fund operations for at least the next 12 months, despite no repurchases under the $500.0 million securities repurchase program in Q3 2020 - Principal sources of liquidity as of September 30, 2020, were cash, cash equivalents, and investments totaling $1.8 billion178 - In August 2020, the company issued 2026 convertible notes, generating net proceeds of approximately $984.1 million182 - A securities repurchase program of up to $500.0 million was approved in June 2020, with no repurchases made during the three months ended September 30, 2020179181 Item 3. Quantitative and Qualitative Disclosures About Market Risk The company's primary market risk exposure relates to its convertible senior notes, particularly the $1.0 billion 2026 notes which do not bear interest but whose fair value may fluctuate with changes in interest rates and the company's stock price, with no other material changes in market risk during the first nine months of 2020 - The company issued $1.0 billion in 0% convertible senior notes due 2026, which do not have economic interest rate exposure, but their fair value can fluctuate with interest rates and the company's stock price205 Item 4. Controls and Procedures Management, including the CEO and CFO, concluded that the company's disclosure controls and procedures were effective at a reasonable assurance level as of September 30, 2020, with no material changes to internal control over financial reporting during the third quarter despite the transition to remote work due to the COVID-19 pandemic - Management concluded that disclosure controls and procedures were effective as of the end of the period210 - No changes in internal control over financial reporting occurred during Q3 2020 that materially affected, or are reasonably likely to materially affect, internal controls211 PART II - OTHER INFORMATION Item 1. Legal Proceedings Chegg is involved in several legal matters, including a Civil Investigative Demand (CID) from the FTC regarding data privacy and security, over 16,000 arbitration demands related to a 2018 data incident, and an ongoing patent infringement lawsuit, with no loss accruals recorded as a loss is not deemed probable - Received a Civil Investigative Demand (CID) from the FTC on June 18, 2020, to investigate potential violations related to consumer privacy and data security214 - As of August 2020, faces a total of 16,691 arbitration demands from individuals alleging damages from the 2018 Data Incident215 - A patent infringement lawsuit by NetSoc, LLC, initially dismissed, was appealed by NetSoc and is currently held in abeyance217 Item 1A. Risk Factors This section details numerous risks that could adversely affect Chegg's business, including the uncertain effects of the COVID-19 pandemic, the company's limited operating history with a digital-first model, intense competition, potential disruptions to technology infrastructure and cyber-attacks, reliance on third-party partners, evolving government regulations on privacy and education, and challenges of international expansion and integrating acquisitions, alongside the substantial cash requirements for servicing convertible senior note debt - The full effect of the COVID-19 pandemic is uncertain and could adversely affect business operations, partner stability, and employee efficiency, despite a near-term positive impact on subscriber growth221223 - The company's limited operating history, particularly with its evolving digital offerings and recent transition back to owning print textbooks, makes it difficult to evaluate future prospects229230 - Significant cybersecurity risks exist, including data breaches, hacking, and phishing, with the company having experienced past incidents (2018 Data Incident, Thinkful Data Incident) and facing increased risk with a remote workforce243286 - The business is subject to evolving government regulations, particularly concerning student data privacy (e.g., CCPA, GDPR) and education-specific laws, which could increase compliance costs and liability333336 - Servicing the company's significant convertible senior note debt requires substantial cash, and there is a risk of not having sufficient funds to settle conversions or repurchase notes upon a fundamental change406408 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds In August 2020, Chegg issued $1.0 billion in aggregate principal amount of its 2026 convertible senior notes in a private placement under Rule 144A, and while the board approved a $500.0 million securities repurchase program in June 2020, no shares were repurchased under this program during the three months ended September 30, 2020 - In August 2020, the company issued $1.0 billion of convertible senior notes due 2026 in a private placement to qualified institutional buyers416 Share Repurchase Activity (Q3 2020) | Period | Total Number of Shares Repurchased | Average Price Paid Per Share | Maximum Dollar Amount Remaining for Repurchase | | :--- | :--- | :--- | :--- | | July 2020 | — | $ — | $500,000,000 | | August 2020 | — | $ — | $500,000,000 | | September 2020 | — | $ — | $500,000,000 | Item 6. Exhibits This section lists the exhibits filed with the Form 10-Q, including the indenture for the 2026 notes, forms of capped call and exchange agreements, and officer certifications as required by the Sarbanes-Oxley Act