Online study and academic help platform Chegg (NYSE:CHGG) beat analysts' expectations in Q2 FY2023, with revenue down 6.09% year on year to $182.9 million. The company also expects next quarter's revenue to be around $152 million, roughly in line with analysts' estimates. Chegg made a GAAP profit of $24.6 million, improving from its profit of $7.48 million in the same quarter last year.
Chegg (CHGG) Q2 FY2023 Highlights:
- Revenue: $182.9 million vs analyst estimates of $176.5 million (3.59% beat)
- EPS (non-GAAP): $0.28 vs analyst expectations of $0.29 (2.35% miss)
- Revenue Guidance for Q3 2023 is $152 million at the midpoint, roughly in line with what analysts were expecting
- Free Cash Flow of $55.8 million, similar to the previous quarter
- Gross Margin (GAAP): 74.1%, down from 76.5% in the same quarter last year
- Services Subscribers: 4.8 million, down 0.5 million year on year
Started as a physical textbook rental service, Chegg (NYSE:CHGG) is now a digital platform addressing student pain points by providing study and academic assistance.
Today, the textbook rental part of the business has been deemphasized, and Chegg Services is the key product. Chegg Services, which is a subscription offering, includes Chegg Study, Chegg Writing, and Chegg Math. Chegg Study allows students to ask questions digitally and receive explanations from subject matter experts. Chegg Writing offers plagiarism detection scans, expert writing feedback, and citation generation. Chegg Math provides step-by-step problem solving so students can get the right answers but also can understand the problem solving process. Tutoring and language learning are emerging areas of focus.
Chegg addresses the high cost of educational resources. Originally, the company offered textbook rentals because the cost of buying, especially for budget-conscious college students, could put a dent in the wallet. From there, the company added subscription services to digitize the business and generate recurring touch points with customers rather than just when textbooks are acquired. The more subjects Chegg adds, the more it becomes a one-stop academic shop.
One growing priority for Chegg is to follow students beyond their educations. The company has begun offering career services such as internship resources and interviewing guides. It has also expanded into financial literacy and other life skills.
Consumers today expect goods and services to be hyper-personalized and on demand. Whether it be what music they listen to or what movie they watch, or finding a date, online consumer businesses today are expected to delight their customers with simple user interfaces that magically fulfill demand. Subscription models have increased usage and stickiness of many online consumer services.
Competitors offering streaming entertainment platforms include Coursera (NYSE:COUR), Udemy (NASDAQ:UDMY), and private company Khan Academy.Sales Growth
Chegg's revenue growth over the last three years has been mediocre, averaging 16.8% annually. This quarter, Chegg beat analysts' estimates but reported a year on year revenue decline of 6.09%.
Chegg is expecting next quarter's revenue to decline 7.73% year on year to $152 million, a further deceleration of the 4.19% year-on-year decrease it recorded in the same quarter last year. Before the earnings results were announced, Wall Street analysts covering the company were projecting revenue to decline -5.3% over the next 12 months.
Usage Growth
As a subscription-based app, Chegg generates revenue growth by expanding both its subscriber base and the amount each subscriber spends over time.
Over the last two years, Chegg's users, a key performance metric for the company, grew 5.87% annually to 4.8 million. This is average growth for a consumer internet company.
Unfortunately, Chegg's users decreased by 0.5 million in Q2, a 9.43% drop since last year.
Revenue Per User
Average revenue per user (ARPU) is a critical metric to track for consumer internet businesses like Chegg because it measures how much the average user spends. ARPU is also a key indicator of how valuable its users are (and can be over time). 
Chegg's ARPU has declined over the last two years, averaging 5.95%. Although the company's users have continued to grow, it's lost its pricing power and will have to make improvements soon. This quarter, ARPU grew 3.69% year on year to $38.09 per user.
Pricing Power
A company's gross profit margin has a major impact on its ability to extert pricing power, develop new products, and invest in marketing. These factors may ultimately determine the winner in a competitive market, making it a critical metric to track for the long-term investor. Chegg's gross profit margin, which tells us how much money the company gets to keep after covering the base cost of its products and services, came in at 74.1% this quarter, down 2.5 percentage points year on year.
For internet subscription businesses like Chegg, these aforementioned costs typically include customer service, data center and infrastructure expenses, and royalties and other content-related costs if the company's offering includes features such as video or music services. After paying for these expenses, Chegg had $0.74 for every $1 in revenue to invest in marketing, talent, and the development of new products and services.
Gross margins have been trending up over the last 12 months, averaging 73.8%. Chegg's margins are some of the highest in the consumer internet sector, enabling it to fund large investments in product and marketing during periods of rapid growth to stay one step ahead of the competition.
User Acquisition Efficiency
Unlike enterprise software that's typically sold by dedicated sales teams, consumer internet businesses like Chegg grow from a combination of product virality, paid advertisement, and incentives.
Chegg is very efficient at acquiring new users, spending only 25.2% of its gross profit on sales and marketing expenses over the last year. This efficiency indicates that it has a strong brand reputation and customer acquisition advantages from scale, giving Chegg the freedom to invest its resources into new growth initiatives while maintaining optionality.
Profitability & Free Cash Flow
Investors frequently analyze operating income to understand a business's core profitability. Similar to operating income, adjusted EBITDA is the most common profitability metric for consumer internet companies because it removes various one-time or non-cash expenses, offering a more normalized view of a company's profit potential.
Chegg reported EBITDA of $59.8 million this quarter, resulting in a 32.7% margin. Additionally, Chegg has demonstrated extremely high profitability over the last four quarters, with average EBITDA margins of 32.5%.
If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills. Chegg's free cash flow came in at $55.8 million in Q2, up 55.8% year on year.
Chegg has generated $181.5 million in free cash flow over the last 12 months, an eye-popping 24.1% of revenue. This robust FCF margin stems from its asset-lite business model, scale advantages, and strong competitive positioning, giving it the option to return capital to shareholders or reinvest in its business while maintaining a healthy cash balance.
Key Takeaways from Chegg's Q2 Results
With a market capitalization of $1.26 billion, Chegg is among smaller companies, but its $385.1 million cash balance and positive free cash flow over the last 12 months give us confidence that it has the resources needed to pursue a high-growth business strategy.
It was good to see Chegg beat analysts' revenue expectations this quarter, although paying subscribers missed slightly. That really stood out as a positive in these results, especially given the very low expectations going into the quarter. As a reminder, the market was very worried about Chegg as a business and going concern, thinking that AI would decimate demand for the product. On the other hand, the decline in its user base was concerning and its revenue growth was quite weak. Overall, this was a mixed quarter for Chegg on an absolute basis, but again, compared to the low expectations, the results seemed solid. The stock is up 26.2% after reporting and currently trades at $12.65 per share.
Is Now The Time?
Chegg may have had a bad quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity. We think Chegg is a solid business. Its revenue growth has been decent, and that growth rate is expected to increase in the short term. And while its ARPU has been declining, the good news is its powerful free cash flow generation enables it to stay ahead of the competition through consistent reinvestment of profits and its user acquisition efficiency is best in class.
At the moment Chegg trades at 6.2x next 12 months EV/EBITDA. There are definitely things to like about Chegg and looking at the consumer internet landscape right now, it seems that the company trades at a pretty interesting price point.
Wall Street analysts covering the company had a one year price target of $13.1 per share right before these results, implying that they saw upside in buying Chegg even in the short term.
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