Chegg Inc (CHGG) 2015 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Chegg conference call discussing second-quarter financial results.

During the presentation, all participants will be in a listen-only mode.

Afterwards, you will be invited to participate in a question-and-answer session.

(Operator Instructions).

As a reminder this call is being recorded Monday, August 3, 2015.

I would now like to turn the conference call over to Alex Hughes, Head of Investor Relations for Chegg.

Please go ahead, sir.

Good afternoon, and thanks for joining Chegg's second-quarter conference call.

On today's call are Dan Rosensweig, Chairman and CEO, and Andy Brown, Chief Financial Officer.

In terms of structure Dan will open with a discussion of Chegg's business and Andy will follow with a review of our operating results and our outlook for the third quarter in fiscal year-end 2015.

A copy of our earnings press release along with our investor presentation is available at our investor relations website, investor.

Chegg.com.

A replay of this call will also be available on our website.

We routinely post information on our website and intend to make important announcements on our media center website, at www.Chegg.com/mediacenter, and we encourage you to make use of these resources.

Before we begin, I would like to point out during the course of this call we will make forward-looking statements regarding future events, including the future financial performance of the Company.

These forward-looking statements are subject to material risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements.

We caution you to consider the important factors that could cause actual results to differ materially from those in the forward-looking statements.

In particular we refer you to the cautionary language included in today's earnings release and the risk factors described in Chegg's annual report on Form 10-Q filed with the SEC on May 8, 2015, and our other filings with the SEC.

Any forward-looking statements that we may make today are based on assumptions that we believe to be reasonable as of this date.

We undertake no obligation to update these statements as a result of new information or future events.

During this call, we will also present both GAAP and non-GAAP financial measures.

Any reference to pro forma revenue is non-GAAP.

Our GAAP results and GAAP to non-GAAP reconciliations can be found on our earnings press release.

Now with that I'll turn the call over to Dan.

Good afternoon, everyone.

Our team executed on another great quarter and we are extremely pleased with our updated 2015 outlook.

Our partnership with Ingram has accelerated and we continue to see very strong digital revenue growth, driven by the ramp of our learning services as well as by our ad businesses.

On today's call we will focus on three main areas.

First, the continued momentum that we are experiencing in both our transition with Ingram and in our expanding digital businesses.

Second, the enormous opportunity we have to grow our self-directed Student Hub in a $1 trillion education market that is undergoing massive disruption.

And third, Andy will review our Q2 numbers in greater detail along with our improved 2015 outlook.

With that, let me turn to our Q2 highlights.

Our partnership with Ingram is going better than planned.

For those new to our story, Ingram is the world's largest distributor of physical and digital content.

We entered into a multiyear partnership with Ingram, whereby the end of 2016 they will have taken over purchase and the logistics of all textbooks offered through Chegg.com.

In this partnership we will collect approximately 20% of all gross merchandise value.

The specifics and timing is laid out on page 17 of our investor deck.

As a result of this partnership we dramatically simplify our business model while transitioning to 100% digital business by 2017 with much higher growth, margins and free cash flow.

In addition to freeing up about $100 million a year in gross book investment for Chegg, we are able to maintain all front end benefits of offering required materials to our students such as brand building, acquiring customers, collecting data, marketing additional products and services, and providing surprise and delight products in our iconic orange boxes.

In May of this year, the transition began with Ingram purchasing all new textbooks for our rental catalog.

In addition, the logistical transition of moving books from our warehouse to Ingram's has gone very smoothly putting us on track to exit our Kentucky warehouse by the end of this year.

Because the transition is going so smoothly, we now expect Ingram to purchase a larger percentage of our fall catalog, which has the effect of increasing our digital revenue while reducing print revenue in 2015 and is reflected in our updated outlook.

At the same time, our digital businesses continue to experience great momentum and leverage.

Chegg's revenue increased 30% -- 37% year-over-year on a pro forma basis while Q2 EBITDA doubled over last year.

With the bulk of the Ingram transition near completion, we believe pro forma is a much better reflection of how we run the Company and of our future growth and margin profile.

A key driver of our key to success was 62% year-over-year growth in digital revenue.

We also reached over 700,000 digital subscribers in the quarter, or nearly 35% year-over-year growth.

And this is a great indication of quality and the demand for our services.

With the depth and quality of our services improving, students increasingly embrace them.

Over 70% of our members use Chegg services -- used a Chegg service other than Print.

And we experienced a 35% increase in the number of our Print customers paying for at least one of our digital services.

User engagement is also improving.

Chegg Study subscribers, which represent the largest portion of our subscriber base, increasingly rely on the service to help them with their assignments.

In fact, over 90% of students who use Chegg Study report better grades, and our engagement metrics now show subscribers using Chegg Study weekly on average.

The newest of our digital subscription services, Chegg Tutors, continues to see an increase in the number of students, number of tutors and the average tutoring minutes per tutor.

This indicates the strength and the quality of our tutor network and the number of tutors more than doubled from when we acquired InstaEDU a year ago.

And we are seeing improved traction in our ad business as well.

In particular our enrollment marketing service experienced a 31% increase in total inquiries while the number of brand partners increased over 20% year-over-year.

Chegg is off to a very strong start, and we are excited about our existing businesses and the large opportunity we have ahead.

In fact we believe that our current businesses are in their very early stage and that our Student Hub represents enormous opportunity as education becomes increasingly digital and self-directed.

Education is a $1 trillion industry in the US alone.

It's in the midst of the disruption by the very same dynamics that have impacted many other large segments of our economy.

Although education has been slow to change, it is no longer immune because today's students grew up with the Internet and they have very different expectations for how they should learn.

Chegg is benefiting from the dynamic and will be able to leverage the cash generated from our new business model to offer students more connected services.

Our services leverage each other to build a personalized experience for each student at scale.

Currently these include scholarship matching, college matching, matching students to required materials and using that information to match students to homework help, online tutoring, internships and, ultimately, careers.

No one else is building a platform like this focused exclusively on the needs of today's students.

You can see how students, institutions and partners have responded our platform through our financials, reach an engagement metrics.

As a reminder, Chegg reaches over 50% of all US college students and over 75% of college-bound high school seniors.

The key to Chegg's strong platform is our brand and our ability to utilize data to the advantage of the student.

Chegg is extremely popular on college campuses.

In fact, our brand with students is very strong.

Students indicate on an unaided basis that Chegg is one of the top two brands they think of when it comes to helping them with their studies and school life.

This has allowed us to attract about 85% of our customers organically and making our cost of customer acquisition very low and extremely efficient.

Furthermore, as more students use our services more often, we are able to rapidly improve the quality and relevance of each of our services on a per-student basis.

This student graph creates a powerful virtuous circle which not only improves each service, but also helps us introduce new services to students at the right time at a very low cost.

We anticipate launching newer services in the second half of this year including Test Prep, which we'll initially offer to high school students starting in Q4 and then expand to college students next year who are preparing for continuing education.

This will be an online, adaptive and affordable learning service that furthers our efforts to expand access and democratize quality learning for all students.

One of the great strengths of the Chegg network is that we've been able to leverage the strength of our brand and the power of our internal funnel to grow our existing businesses and introduce new ones at a very low cost.

We made a lot of progress this quarter and we expect to continue this in the second half and into the future.

With that I'll hand it over to Andy.

Andy?

Thanks, Dan, and good afternoon, everyone.

My comments today are on a non-GAAP basis when I discuss our financial performance and updated 2015 outlook.

As Dan mentioned, the Chegg team executed at a high level in Q2 and through the first half of the year, exceeding our financial and operating targets.

As our digital businesses continue to scale and the Ingram partnership ramps, we are seeing a positive mix shift in our revenue from lower margin print-based revenue to higher margin digital revenue.

You can see the full transition period graph on slide 17 in the investor deck on our IR website.

During this transition, which we expect to be complete by the end of 2016, we will also report on our pro forma revenue, which more accurately reflects the growth rate and profitability of Chegg going forward.

In the second quarter, we continue to see the positive effect from this shift in revenues.

Digital revenues grew by 62% year-over-year on increased subscribers, and as expected, print revenue declined due to the Ingram transition.

Digital revenue now comprises 45% of our total revenue, more than doubling in less than two years.

We remain confident in our objective of becoming a 100% digital company by 2017, also as reflected on slide 17.

On a pro forma basis, revenue grew 37% year-over-year to $32.7 million.

In the quarter we saw gross margin improve by 6.7 points year-over-year to 47.1%, reflecting the growth of our higher margin digital businesses as well as the expanding mix shift to our Ingram-based -- Ingram commission-based model.

This resulted in adjusted EBITDA doubling year-over-year to $3.2 million, reflecting our improved business model.

During the quarter, operating expenses came in at $30.2 million, slightly higher than expected due to the timing of textbook liquidations and the associated impact on gain loss.

After the Ingram transition is complete, this will no longer be part of our business model since we will no longer own textbooks.

Looking at the balance sheet, we ended the quarter with cash, cash equivalents and investments of approximately $67.2 million and no debt.

The second quarter is a seasonally low period for cash and we expect to finish the year with approximately $100 million in cash, cash equivalents and investments.

In addition, we started the year with approximately $80 million in textbook inventory, finished the second quarter with $61 million, and were on track in 2015 with less than $40 million.

Any books remaining in our warehouse after the fall rush will move to Ingram's warehouses in Q4, enabling us to exit our Kentucky warehouse and saving Chegg approximately $6 million to $8 million annually starting in 2016.

Looking ahead, let me turn to our third quarter and fiscal 2015 outlook.

There are a few things to note.

Our digital business is currently comprised of two components -- subscription and advertising.

Subscription consists of Chegg Study, eTextbooks and Chegg Tutors, while advertising consists of enrolled marketing, brand partnership and commission-based revenue from partners such as Ingram.

For 2015, we continue to expect the split to be approximately 70% subscription and 30% advertising.

Starting next year, we will begin guiding and reporting on a pro forma basis and thus will not guide on print revenue since we expect to be completely through the Ingram transition by the end of 2016.

With the second half forecast now finalized for the fall rush, we anticipate slight changes to the timing and mix of revenues for the second half.

Overall we remain on track to meet our improved guidance for the year.

While textbook volumes and GMV remain the same as we expected on our last call, we now anticipate that Ingram will fulfill approximately $5 million more GMV, which results in a corresponding reduction of Print revenue, and an approximate $1 million increase in digital revenue from the 20% Ingram commission.

In addition, we now expect a slight revenue shift from Q3 to Q4 to reflect our current assessment of school start days.

Therefore, for the third quarter, we expect total revenue to be between $74 million and $80 million and digital revenue between $34 million and $38 million, gross margin between 23% and 25%, and adjusted EBITDA loss between $12 million and $9 million, a more than 30% improvement from last year.

This loss reflects the seasonality of the Print business where Q3 is impacted by the recognition of expenses associated with the start of the school year, but revenue is recognized ratably over the semester.

As we fully transition to Ingram, this seasonality will lessen because we will recognize commission-based revenue immediately and we will eliminate logistical costs.

For fiscal 2015, we expect total revenue between $295 million and $310 million, and digital revenue between $137 million and $145 million, reflecting the shift of approximate $5 million in GMV to be serviced by Ingram rather than Chegg, as well as improved organic strength of our digital businesses.

On a pro forma basis, we expect revenue to be between $175 million and $180 million, gross margin between 36% and 38%, adjusted EBITDA of breakeven to $5 million, and finally we expect between $15 million and $20 million in free cash flow for the year.

The slight reduction on the high end is the result of one-time costs associated with the Ingram transition.

This is an exciting time for Chegg and we continue to make excellent progress executing on the Ingram transition and expanding our digital revenue.

As a result, during 2017 we expect to reach revenue growth of greater than 25%, gross margins at greater than 60%, and EBITDA margins at greater than 25%.

With that, I will turn it over to the operator for your questions.

(Operator Instructions).

Douglas Anmuth, JPMorgan.

This is Diana on for Doug.

Just wondering if you guys could give a little bit more color on the Test Prep product that you talked about, whether it's content, whether it's licensed or developed in-house and anything you can give on how the economics might work, and just a quick follow-up on what the one-time cost was that you mentioned that's impacting the free cash flow?

I'll take the first part and Andy will take the second part.

We are really excited about this.

Our vision of learning services, which as you can see from our numbers and our second half guidance are going up, is that students are looking for increased ways to get affordable online learning.

Our strategy has always been to do self-help, which is Chegg Study, a human layer, which is Chegg Tutors, and now we are developing an interactive layer and an adaptive layer that we are going to start with the first product which will be Test Prep for high school students, which will start probably in December so it won't have any impact on this year but should be a nice add for 2016.

So the idea is with self-help, every student gets the same experience and they can use it anytime they want, and that's what Chegg Study does, and it's $14.95 a month, and is doing extraordinarily well.

With Adaptive, the goal here is if you know math or if you know English it will adapt to your strength and your weaknesses and make each of those experiences unique.

And in Test Prep, increasingly we want to democratize just like we are doing with Tutors and with Chegg Study, the cost of getting high quality, low-cost Test Prep.

So it's a huge market, and we believe by surrounding it with self help, with human help with tutors and now with adaptive learning that we can be a significant player in a multi-multi-multibillion-dollar market, so I don't want to give too much color.

The content is being a combination of license and created by us, and we are working with a partner and we are doing -- but this will be a product that is being built by Chegg.

It will be a Chegg-branded product, and we think that with our distribution to over 75% of all high school students that intend to go to college that we have the ability just like we did with Chegg studies to introduce these things at a very low cost.

And very affordable prices and really become a significant player very quickly in that market.

So we are very excited.

I'll turn it over to Andy for your second question.

Just all we are doing is, we are tightening up the rates a little bit on the free cash flow, taking the top end of the range down.

As we mentioned earlier, we accelerated that transition to Ingram, and as we've done that and we've looked at some of the cost associated that we believe there some additional tax cuts that will occur during the year.

Doesn't impact EBITDA at all, it's primarily in the restructuring side that we thought we tightened up with public spend, maybe a couple million dollars more in cash cost of the year, but not really that material.

Thank you so much.

Brian Fitzgerald, Jefferies.

Thanks.

I had a question around the seasonality among the semesters or around the semesters.

In general how does that affect the trends around your digital business?

I guess the question there is, does it differ from the traditional seasonality you saw from the rental business in any way?

And then a quick one on the possible sale of Blackboard we have been seeing around in the press a bit, do you think this impacts your partnership with them in any way?

Thanks.

Good questions.

I'll take the first part, this is Dan, on the seasonality issue.

So historically, four years ago when we had zero digital, which we now believe will be as high as $145 million this year, so that's pretty extraordinary growth in four years -- but when it was just textbook rental we would recognize all the costs in one quarter and pretty much all the revenue and profits in the next quarter.

The way we think about seasonality now is kind of diminished in terms of its significance, because once we go pure Ingram, then we just take a 20% commission on whether the book was liquidated, whether was rented, whether it was new, and it will all be within that quarter.

The way to think about the big quarters for Chegg is Q4 will always be our largest because we have three full months of a semester.

We have October, November and December plus we have finals and midterms in the same quarter, and that really helps our digital businesses.

So our Q4, you probably can see by subtracting our second half year guidance and our Q3 guidance is actually higher than people expected because a little bit of a timing of when school starts but also we get the full benefit of three full months and a midterm and a final, and that helps our learning services.

Q1, we give full three months, January, February and March, of textbooks.

But we only get the midterms, we don't get the finals which go into Q2.

So our slowest quarters will be Q2 where we have 1.5 months out of the three, because then summer people are off, and then Q3 is really only a textbook quarter, because during July and August, really nothing happens.

So we have the end of August and September.

And so really the way to think of that is Q4 is the largest, Q1 is the second-largest, then Q3 and then Q2, and it has to do with the makeup of what students buy in a given semester.

But for the second half of this year we are able to accelerate the guidance as a result of the organic growth in the digital business as we just expect we will see it in Q4 because that's when we get midterms and finals.

Does that make sense?

That's clear, Dan, thanks.

And on the Blackboard deal we have obviously heard the same rumors.

We have a multi-year deal with Blackboard, and as we said, when we did the deal that we were not anticipating anything much from the deal this year because of the integration.

So for us, all the information we have given is essentially based on organic success, but if there should be a transaction, whether it goes public or whether it sells itself, we don't know.

But either way, it's a multiyear deal and it's not one that changes with change in control unless we want it to.

Perfect, thank you much.

Aaron Kessler, Raymond James.

Great, thanks.

A couple of questions.

First, Andy, do you have the GMV in the quarter, if you could give us a rough estimate for that.

And second, any thoughts of giving some pro forma revenue guidance in the markets, maybe see if you're reacting to the lower revenue guide after our share; does that make sense or do you have a pro forma revenue guidance number for the year?

And also -- go ahead.

(multiple speakers) so on the GMV, we did actually talk about that and we believe the GMV for the year on a pro forma basis is going to be somewhere between $175 million and $180 million.

And that includes obviously our traditional digital businesses, it takes the print business and it converts it into the commission-based model that we would expect to build going forward, and for those that may have missed it earlier, this is how we will be guiding the Company next year.

Because we look at as we get out of the warehouse in Q3 and shut it down in Q4, [to let us bask] in the rearview mirror.

We are a digital company going into 2016 and that's what you can expect from us.

When you think about sort of the pro forma guidance, we said that we grew 37% pro forma year-over-year, and actually Q4 will be the highest growth rate of the year, and so it will be higher than even at 37% is what our expectations are, so we are actually seeing as we go into the latter part of the year accelerated growth towards the end of the year, and that has a lot to do with the seasonality that I mentioned earlier in Q4.

So, we are seeing absolutely fantastic growth this year, better than we originally planned in all segments of the business.

I know you had another question you wanted to ask.

Just going to follow up on that point.

It looks like your back half guidance implies accelerating digital growth.

Is there any couple of specific segments that are contributing to that accelerated growth in the back half of the year?

Thanks.

There's two parts.

Andy, I think, clearly laid out on the call that $1 million of the increase in digital is directly related to the $5 million decrease in print.

That's good news.

That means we are moving faster to Ingram than we originally expected, and that's because the integration is going much better than expected and much faster than expected, so that is really great news.

And it's the one-to-one correlation, we take the 20% commission instead of what the gross was but the GMV remains the same.

And then what we are seeing is basically we are seeing strength across all the digital businesses, we even mention on the call we saw 31% improvement year-over-year or growth year-over-year of the leads that we delivered for our EDU business.

And so, right now, I can't call out a specific segment of the digital that is doing significantly better than any other because all of them are on or better than plan right now.

Great, thank you.

Good quarter.

Joe Janssen, Barrington Research.

Thanks for taking my question.

Just following up on the guidance, on a full-year basis, so -- just so I'm clear, I think you kind of hit that there on the last question.

But the topline reduced guidance for the $5 million -- essentially really raising your full-year guidance, and it's just the transition from print to digital is going faster.

Is that correct?

You nailed it on the head.

That's exactly what we are seeing.

We are seeing a continued acceleration of the transition to Ingram and that's increasing our digital revenue.

And then just one follow-up.

Maybe on the advertising side, just kind of get a feel for what's going on if you exclude the Ingram commission-based business and kind of how that's trending?

So the way we think about it is we've got Direct to Consumer, and that's the learning services and those are our three subscription businesses and that's eTextbook, Chegg Study and Tutors.

And on the advertising side or the marketing services side, if you will, we have people paying us to reach those students.

We have colleges paying us to recruit students to apply to their college, we've got large brands paying us to market to those students, and eventually as we continue to build out internships and the jobsite we will have corporations paying us to recruit students as they graduate.

That's 2016, 2017, 2018 growth line for us and we are really excited about it.

But on the brand side, I mentioned earlier that we are up 31% leads year-over-year, which is probably the best growth we have seen in that category in a while, and that has to do with the fact that more and more schools are not only signing on but they are buying more and more leads because they see that when they get a lead from us that seems more likely to apply, and if they apply are more likely to get in and if get in, we believe we would need two more years to show this but they are likely to graduate on time.

And so that business is going very well.

And on the brand side, we've seen a 20% increase in renewals year-over-year because bigger brands are really starting to concentrate.

We've had great success with music artists like the U2 promotion we just did, Ed Sheerin, which we just did and we are going to do more of Ed when he comes back in September, we're going to do more of all these bands.

We renewed a little bit with Taylor Swift as well and that's really helped larger brands understand the strength and power that Chegg can offer in the branding category.

So we are beginning to see folks that came into the first half of the year not only renewing but renewing for larger contracts.

S

o the things that we would hope to be working on from last year beginning to bear some fruit.

But those are very early-stage businesses that we believe have lots of growth rate ahead of them in the future.

Great, thanks.

Mike Olson, Piper Jaffray.

Thanks.

Good afternoon.

You've talked about a couple times just the fact that you are feeling good about all the Digital Products, and it's probably hard to pick a favorite child.

But outside of Chegg Study, if you just look at it from a near-term revenue magnitude perspective, which of the digital businesses would you say you're most excited about?

Would it be Chegg Tutors or Enrollment Marketing or Text Prep or eTextbooks or one of the other things?

As the father of two fabulous daughters, Rachel and Samantha, I hate to pick between my children.

But I think it's a fair question.

And the way we thought about this is Chegg Study is likely to be our first digital service to be $100 million.

Chegg Tutors is likely to be the largest digital business at some point, because it obviously translates globally.

It's Uber for tutors and we are building a very large marketplace of tutors.

We already have the demand because we have all the students.

Over 50% of all college students -- as I mentioned earlier, we reach 75% of all high school students who attend to go to college.

The supply of tutoring has more than doubled, nearly tripled since we acquired the Company last year, and I just believe that as we get deeper into verticals and as we get wider into more verticals, and as we get more global that that business over time has the chance to be the largest of our digital businesses, because it's a true marketplace.

And we think we have the leverage to win that marketplace, which is close to supply and demand.

So in the near term, Chegg Study is still going to be the little engine that could, it just keeps doing extraordinarily well.

Tutors is growing at the rate we would've hoped that it's growing at, eTextbooks, as the world transitions from print to eTextbooks, we are picking up, we believe, disproportion market share in that business, and the beauty of our network is that each of those give us the name of the school, the student, what you're studying, your class and then we are able to then introduce you to the new services faster.

On the advertising side, I would say that the EDU business is likely to scale faster than brand ad business simply because we've been in that business longer, and we have more relationships.

And the data can be proven out faster.

But over time, I expect them both to be very large businesses.

Thanks very much.

Jeff Silber, BMO.

Thanks so much.

A few times during your prepared remarks, you pointed out slide 17 in your presentation.

And in looking at it and comparing it to last quarter, I just want to doublecheck something.

It looks like the end of your book investment will now be coming in 2015, I think last quarter you had it coming in 2016.

Can you just confirm that, and is this because of the acceleration of the partnership with Ingram?

Thanks.

I will go online in a second and check to see what you are looking at, but I can absolutely tell you that our plan right now is we've stopped investing in books as of May 1, and we believe we will be out of owning physical textbooks by the end of 2016.

And we will be out of the warehouse by the end of this year.

Appreciate that (multiple speakers)

We will be a 100% digital company by 2017, and like I said earlier, one of the things that we will do as we start 2016 is start reporting on a pro forma basis.

One of the things that may be confusing is one of the things we agreed to do with the Ingram deal was purchase books on their behalf.

And they will pay us for those books 30 days right away for half of it and then they have the delayed billing for the year-and-a-half period, so our cash would actually be much higher probably $20 million to $25 million higher at the end of this year but we gave them extended terms, payment terms simply so they could buy more for us in advance.

So that may be some of what's confusing you.

But we don't buy any more new books for us.

We will not have a warehouse.

And the faster we can move out of it, the better.

Great, that's helpful.

And just to doublecheck, of the digital revenue that you recorded in the second quarter, roughly how much of that were commissions from Ingram?

Yes, so, we don't actually break that out specifically at this point.

We may at some point in the future.

However, if you think about the business, it was very -- it was miniscule, because most of those bookings occurred in the first quarter.

And we recognize that revenue immediately versus how the rental business works, where you recognize it ratably.

So it's a very, very small -- very, very small.

Let me ask the question another way.

In your guidance for the current year, how much of your digital business will be commissions from Ingram?

There's clearly commissions from Ingram.

We don't get into the specific details there, but looking at it just at a very high level, if you take the Print business as it was maybe last year not this year was about $200 million business, about $40 million annually and 20% commission is going to be Ingram.

We may consider breaking that out at some point in the future, but at this point we don't believe it's productive.

But it's not a meaningful judicious number because all we do in textbooks in Q2 is summer school.

And we still owned a lot of the books that we were renting in Q2.

Basically are buying the new books, so it's a very small number, really small number in Q2.

So I'm not sure if that answers your question.

It does, thank you so much.

(Operator Instructions).

Matt Blazei, Lake Street Capital Management.

Hey, guys.

A couple of technical questions.

Your sales and marketing expenses were significantly lower as a percentage of revenues and you've been showing the last few quarters.

Is that an aberration or is that something we should look at going forward as more of a baseline?

I'll get into the general, let Andy get into the specifics.

But one of the great things about our business is 85% of the traffic that comes to Chegg today is organic.

So the need to spend off the site has been going down for years, and because of our revenue growth rate, I think the percentage is just dropping faster.

But we've relatively been flat even as we've introduced new products that have been growing extraordinarily fast.

The digital business has grown over 60% year-over-year.

And that's a result of the organic traffic, plus the integration of the services themselves.

So, because we have all the data, we know your high school, we know your college, we know your class, we know your textbook, we are able to bring you a tutor or Chegg Study or any other service that we bring.

So the cost of customer acquisition has constantly been dropping.

And so, we don't -- we see it as a trend because that's the way we built the Company deliberately.

Those factors, plus one of the other things that you see, particularly in Q2 and Q4 is where you see the same seasonal factors that you're seeing in the bookings that -- but it's on a different scale.

And you're not spending as much money to acquire the customers as you would be, for example, in Q1 and Q3.

I appreciate that.

My other question is to get from $60 million in cash to $100 million by year-end, obviously a portion of that will be continued liquidation of inventory, and I would imagine cash flow from operations.

Could you sort of give us a little more granular detail on how you get $30 million in free cash flow in the back half?

The first thing to understand is that Q2 is traditionally our low for our cash balance because it's one of our lower bookings months.

The second part is you start to look through the year, what you end up seeing is two things.

You're starting to see the businesses become more profitable, it's obviously going to drive more cash and the second part of it is, is the fact that we are no longer buying any more textbooks.

And so, that $60 million to $70 million investment in textbooks that you would normally see in that August-September timeframe no longer occurs for us.

And we are very confident in our ability to drive the cash flow like we have talked about and feel confident barring any other factors that will be something right around $100 [billion] at the end of the year.

Thank you, guys.

At this time, I would like to return the call back over to Dan Rosensweig, CEO, for closing comments.

Thank you, everybody.

As you can imagine we are very proud of the first half of the year and execution of our team as we have been able to set aggressive goals and meet them.

We're also excited that the second half of the year that, because of the organic momentum of the business, that we have been able to improve our guidance yet again, and that the momentum towards digital is very much moving in our favor.

We also set out this year to not only do the Ingram deal but to execute on it and accelerate it as quickly as we could, being able to shift inventory that we once would've had to have had in our warehouse, the inventories that they will buy and ship from their warehouse by $5 million is quite a significant change on the positive for us.

And so, we feel we've worked very hard the last five years to put ourselves in a position to become an all-digital company.

We are clearly on track to do that, hopefully, even faster than we originally had imagined.

And that, we look at the future and the opportunity ahead of us and all of our businesses in our opinion are really at their very early stage, and I think the evidence of that is four years ago our digital revenue was close to if not zero, and we are forecasting now that that digital revenue will be anywhere from $135 million to $145 million this year alone.

So you can see that that is great growth of a market that we think is getting just bigger, and --

Let me just make a correction.

That's $137 million to $145 million.

I want to make sure we get it correct.

Yes.

$137 million to $145 million to be precise.

But the point is it's higher than it was at the beginning of the year and there's a lot of momentum and four years ago it was zero.

For those people, who are waiting to see whether or not students would engage with us with digital products and services, we think that's being answered in a very loud and positive way, and we think with the introduction of new services we have a really bright future ahead of us.

And we thank everyone for joining the call and have a great day.

Thank you.

Thank you.

This concludes today's teleconference.

You may disconnect your lines at this time and thank you for your participation.