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Chegg's Continued Growth Puts Profitability Within Reach

By Asit Sharma - Jul 30, 2019 at 2:43PM

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Rapid top-line expansion and an improving gross margin are bringing the company closer to sustained bottom-line profits.

Educational content provider Chegg's ( CHGG -1.35% ) second-quarter 2019 earnings report demonstrated that its suite of learning tools, Chegg Services, which encompasses live and video-based tutorials, artificial intelligence (AI)-powered writing and math aids, question-and-answer knowledge databases, and other services, still enjoys growing demand among high school and college students. Released on Monday after the close of trading, the company's filing also illustrates its slow but steady progress toward profitability by generally accepted accounting principles, or GAAP. As we dig into the quarter below, note that all comparative numbers are presented against those of the prior-year quarter.

Chegg: The raw numbers

Metric Q2 2019 Q2 2018 Change
Revenue $93.9 million $74.2 million 26.5%
Net income (loss) ($2.0 million) ($3.9 million) 48.7%
Diluted earnings (loss) per share ($0.02) ($0.03) 33.3%

Data source: Chegg.  

What happened at Chegg this quarter?

College students study together underneath a tree on campus.

Image source: Getty Images.

  • Keeping within a recent trend, vigorous top-line growth was led by the Chegg Services segment, which increased sales by 30% to $80.3 million and comprised 86% of total company revenue during the quarter. Chegg Services subscribers increased by 30% to 2.2 million, while Chegg Study content views rose 25% to 198 million.
  • The balance of growth was supplied by "Required Materials," the company's textbook and e-textbook sales and rental service. The division is currently renegotiating agreements with suppliers during the slow summer season, and management plans to provide information on pricing outcomes next quarter.
  • The company continued to test a bundled Chegg Services subscription to expand its total addressable market, and plans to update investors on results of the pilot next quarter as well.
  • Gross margin rose by 210 basis points to an extremely healthy 78.1%. Chegg generated $31.1 million in adjusted EBITDA.
  • The company achieved operating income of $6.8 million, versus an operating loss of $711 thousand in the comparable prior-year period. Even though Chegg is improving operating margin, it's still losing money. This is due primarily to interest expense, which has more than tripled since 2018 as Chegg has taken on $780 million in new debt. The borrowings, along with stock issuances, have funded a $1.1 billion war chest between cash and investments that management plans to use for future strategic acquisitions. Interest expense jumped to $13.5 million versus $3.7 million in the second quarter of 2018. 
  • Despite the higher interest burden, the company is inching ever closer to GAAP-basis profitability. Through the first six months of 2019, Chegg's total net loss of just $6.3 million indicates that with a bit more top-line growth, the company has the potential to finally land in the black on a recurring basis.  
  • Cash flow continued to improve thanks to higher sales and rising margins. Chegg generated roughly $30 million in operating cash flow during the second quarter, bringing its six month total to $47.8 million, in comparison to $23.5 million of operating cash produced in the first six months of 2018.

Management's perspective

In prepared remarks during the earnings conference call, Chegg CEO Dan Rosensweig outlined the importance of the flagship service Chegg Study to the company's growth prospects, as well as the offering's competitive advantages and near-term focus:

Chegg Study remains our largest service and serves as the center of our growth funnel. It provides students with the essential support through their academic journey and does so online, with high-integrity content, in multiple formats, and meets them at whatever academic level they are at...We continue to expand the subject matter we cover, thereby increasing the number of students who can use the platform. Our library of content now has a record 30 million proprietary, expert answers and textbook solutions, which has doubled in just the last two years.

It's not only the amount of content but the quality of content, that drives our value, as is evidenced by the 200 million pieces of content students accessed via Chegg Study this quarter. And video is becoming a much more important component of our learning services, along with the addition of practice test problems. For the second half of this year, we will continue to expand the amount of video content we offer and increase the categories of practice and self-assessment capabilities, so students can better understand where they need help to be successful in their courses.

Looking forward

As is customary, Chegg provided investors with a financial outlook for the following quarter. The company anticipates third-quarter revenue of $88 million-$90 million, and it aims to achieve a gross margin of 74%-75%. Management expects that adjusted EBITDA will land between $19 million and $20 million.

Chegg also raised full-year guidance, upping its revenue projection to $398 million-$402 million, against a prior band of $393 million-$398 million. The organization's full-year gross margin target remains at 76%-77%, while adjusted EBITDA is now projected at $121 million-$123 million, versus the prior $117 million-$120 million range. Shareholders likely grasp the company's high probability of hitting these full-year targets: Including this quarter, Chegg has now raised its own forward guidance for 10 consecutive quarters. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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