NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Background and Basis of Presentation

Company and Background

Chegg, Inc. (Chegg, the Company, we, us, or our), headquartered in Santa Clara, California, was incorporated as a Delaware corporation in July 2005. Chegg is the smarter way to student. As the leading direct-to-student learning platform, we strive to improve educational outcomes by putting the student first in all our decisions. We support students on their journey from high school to college and into their career with tools designed to help them pass their test, pass their class, and save money on required materials. Our services are available online, anytime and anywhere, so we can reach students when they need us most.

Basis of Presentation

The accompanying condensed consolidated balance sheet as of  March 31, 2018 , the condensed consolidated statements of operations, the condensed consolidated statements of comprehensive loss and the condensed consolidated statements of cash flows for the  three months ended   March 31, 2018  and  2017 and the related footnote disclosures are unaudited. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments, including normal recurring adjustments, necessary to present fairly our financial position as of  March 31, 2018 and our results of operations and cash flows for the  three months ended   March 31, 2018  and  2017 . Our results of operations and cash flows for the  three months ended   March 31, 2018  are not necessarily indicative of the results to be expected for the full year.

We operate in a single segment. Our fiscal year ends on December 31 and in this report we refer to the year ended  December 31, 2017  as  2017 .

The condensed consolidated financial statements and related financial information should be read in conjunction with the audited consolidated financial statements and the related notes thereto that are included in our Annual Report on Form 10-K for the year ended  December 31, 2017  (the Annual Report on Form 10-K) filed with the U.S. Securities and Exchange Commission (SEC).

We have changed the caption on our condensed consolidated statements of operations from “technology and development” to “research and development.” This change does not impact any current or previously reported amounts.

Except for our policies on revenue recognition and deferred revenue, there have been no material changes to our significant accounting policies as compared to the significant accounting policies described in our Annual Report on Form 10-K.

Revenue Recognition and Deferred Revenue

We recognize revenues from our Chegg Services and Required Materials offerings when control of the goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services.

We determine revenue recognition through the following steps:

• Identification of the contract, or contracts, with a customer

• Identification of the performance obligations in the contract

• Determination of the transaction price

• Allocation of the transaction price to the performance obligations in the contract

• Recognition of revenue when, or as, we satisfy a performance obligation

We generate revenues from our Chegg Services product line including our Chegg Study service, our Chegg Writing service, our Chegg Tutors service, Test Prep, through our partnership with Kaplan Test Prep (Kaplan), Internship services, Brand Partnership services that we offer to brands and Enrollment Marketing services to colleges, through our strategic partnership with the National Record Center for College and University Admissions (NRCCUA). Chegg Services are offered to students through weekly, monthly or annual subscriptions, and we recognize revenues ratably over the respective subscription period. Enrollment Marketing services and Brand Partnership services are offered either on a subscription or on an a la carte

basis. Revenues are recognized ratably or as earned over the subscription service period, generally one year. Revenues from Enrollment Marketing services or Brand Partnership services delivered on an a la carte basis, without a subscription, are recognized when delivery of the respective lead or service has occurred. Historically, under previous revenue recognition guidance, revenue recognition was delayed for certain contracts with extended payment terms. For these services, we bill the customer at the inception, over the term of the customer arrangement or as the services are performed. Upon satisfactory assessment of creditworthiness, we generally grant credit to our Enrollment Marketing and Brand Partnership customers with normal credit terms, typically 30 days.

Some of our customer arrangements for Brand Partnership and Enrollment Marketing services 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 distinct performance obligations, we allocate the transaction price based on the relative standalone selling price method by comparing the standalone selling price (SSP) of each distinct 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. Additionally, we limit the amount of revenues recognized for delivered promises to the amount that is not contingent on future delivery of services or other future performance obligations.

We also generate revenues from our Required Materials product line including revenue share earned on print textbooks for rental or sale transactions, owned by Ingram and other partners, which are recognized immediately when a book ships to the student. Revenues from the rental or sale of eTextbooks is recognized ratably over the contractual period, generally two to five months, or at time of the sale, respectively. Our strategic partnership with Ingram includes 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. Under the new revenue recognition guidance, 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 as opposed to the contractual amount earned under the previous revenue recognition guidance.

For sales of third party products, we evaluate whether we are acting as a principal or an agent, and therefore would record the gross sales amount as revenues and related costs or the net amount earned as a revenue share from the sale of third party products. Our determination is based on our evaluation of whether we control the specified goods or services prior to transferring them to the customer. For our strategic partnership with Ingram and our agreements with other textbook publishers, we have concluded that we do not control the use of the print textbooks, and therefore record net revenue only for the revenue share we earn upon the shipment of a print textbook to a student. For the sale of eTextbooks we have concluded that we control the service, therefore we recognize revenue and cost of revenue on a gross basis.

Revenues are presented net of sales tax collected from customers to be remitted to governmental authorities and net of allowances for estimated cancellations and customer returns, which are based on historical data. Customer refunds from cancellations and returns are recorded as a reduction to revenues.

Contract assets are contained within other current assets on our condensed consolidated balance sheets. Contract assets represent the goods or services that we have transferred to a customer before invoicing the customer. Contract receivables are contained within accounts receivable, net on our condensed consolidated balance sheets and represent unconditional consideration that will be received solely due to the passage of time. Contract liabilities are contained within deferred revenue on our condensed consolidated balance sheets. Deferred revenue primarily consists of advanced payments from students related to rentals and subscriptions performance obligations that have not been satisfied, and Brand Partnership and Enrollment Marketing performance obligations that have yet to be satisfied. Deferred revenue is recognized as revenues ratably over the term for subscriptions or when the services are provided and all other revenue recognition criteria have been met.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles in the United States (U.S. GAAP) requires management to make estimates, judgments, and assumptions that affect the reported amounts of assets and liabilities; the disclosure of contingent liabilities at the date of the financial statements; and the reported amounts of revenues and expenses during the reporting periods. Significant estimates, assumptions, and judgments are used for, but not limited to: revenue recognition including variable consideration, recoverability of accounts receivable, restructuring charges, share-based compensation expense including estimated forfeitures, accounting for income taxes, useful lives assigned to long-

lived assets for depreciation and amortization, valuation of goodwill and long-lived assets, and the valuation of acquired intangible assets. We base our estimates on historical experience, knowledge of current business conditions, and various other factors we believe to be reasonable under the circumstances. These estimates are based on management’s knowledge about current events and expectations about actions we may undertake in the future. Actual results could differ from these estimates, and such differences could be material to our financial position and results of operations.

Recent Accounting Pronouncements

Recently Issued Accounting Pronouncements not yet Adopted

In February 2016, the FASB issued ASU 2016-02,  Leases (Topic 842) . ASU 2016-02 requires an entity to recognize a right-of-use asset and lease liability for all leases with terms of more than 12 months. Recognition, measurement, and presentation of expenses will depend on classification as a finance or operating lease. The amendments in this update also require certain quantitative and qualitative disclosures about leasing arrangements. Early adoption is permitted, and the guidance requires a modified retrospective adoption. The guidance is effective for annual periods beginning after December 15, 2018 and we plan to adopt the guidance on January 1, 2019. We plan to elect the package of transition practical expedients which include not reassessing whether any expired or existing contracts are or contain leases, not reassessing the lease classification of expired or existing leases, and not reassessing initial direct costs for existing leases. We will continue to evaluate ASU 2016-02 as we near our adoption date.

Recently Adopted Accounting Pronouncements

In February 2018, the FASB issued ASU No. 2018-02,  Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income . ASU 2018-02 allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. We adopted the guidance on January 1, 2018 recording an immaterial reclassification from accumulated other comprehensive income (loss) to the opening balance of accumulated deficit.

In January 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2017-04,  Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment . ASU 2017-04 eliminates step 2 from the annual goodwill impairment test no longer requiring the comparison of the implied fair value of a reporting unit's goodwill with the carrying amount of goodwill. We early adopted the guidance with a prospective application on January 1, 2018 and will apply the guidance starting with our 2018 annual goodwill impairment assessment.

In January 2017, the FASB issued ASU No. 2017-01,  Business Combinations (Topic 805): Clarifying the Definition of a Business . ASU 2017-01 clarifies the definition of a business to assist entities with evaluating whether a transaction should be accounted for as acquisitions of assets or businesses. We adopted the guidance with a prospective application on January 1, 2018. We will analyze the clarified definition of a business to determine whether transactions from our application date should be accounted for as an asset acquisition or business combination under the new guidance.

In November 2016, the FASB issued ASU 2016-18,  Statement of Cash Flows (Topic 230): Restricted Cash . ASU 2016-18 requires an entity to explain the change during a period in restricted cash equivalents on the condensed consolidated statements of cash flows and include such amounts when reconciling beginning-of-period and end-of-period total amounts shown on the consolidated statements of cash flows. We adopted the guidance with a retrospective application on January 1, 2018 and have adjusted our beginning-of-period and end-of-period amounts on our condensed consolidated statement of cash flows to include restricted cash with the change in restricted cash included within the other assets line on our condensed consolidated statement of cash flows.

In January 2016, the FASB issued ASU 2016-01,  Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities . ASU 2016-01 requires entities to measure equity investments at fair value and recognize any changes in fair value within the statement of operations. We have a strategic investment of $3.0 million recorded in other assets on our condensed consolidated balance sheets that falls under this guidance update. The guidance provides for electing a measurement alternative for equity investments that do not have readily determinable fair values. We have elected the measurement alternative for our strategic investment as there is not a readily determinable fair value, which we will apply to our strategic investment starting with our adoption date of January 1, 2018. This investment will be measured at cost, less any impairment, plus or minus adjustments resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer , with any changes in the value of the investment recorded within the statement of operations.

In May 2014, the FASB issued ASU No. 2014-09,  Revenue from Contracts with Customers, as amended (Topic 606)  (ASC 606), which changes the way we recognize revenue and significantly expands the disclosure requirements for revenue arrangements.

We adopted ASU 2014-09 under the modified retrospective application, recording the cumulative effect of adoption as an adjustment to the opening balance of accumulated deficit on our adoption date of January 1, 2018. We have not adjusted previously reported amounts. Adoption of the new standard resulted in changes to our accounting policies for revenue recognition, and trade and other receivables. See note 2 for more information.

Note 2. Revenues

Adoption of ASC Topic 606, Revenue from Contracts with Customers

On January 1, 2018, we adopted the new revenue recognition guidance using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning January 1, 2018 are presented under the new revenue recognition guidance, while prior period amounts were not adjusted and continue to be reported in accordance with the previous revenue recognition guidance.

We recorded an immaterial net increase to the opening balance of accumulated deficit as of January 1, 2018 due to the cumulative impact of adopting the new revenue recognition guidance. The two primary impacts of the new revenue recognition guidance are for our Enrollment Marketing services where revenue is recognized earlier in the contract life under the new revenue recognition guidance than under the previous guidance and for our strategic partnership with Ingram where we are required to estimate variable consideration under the new revenue recognition guidance, which we were not previously required to estimate. Both of these changes had an immaterial impact on our revenue under the new revenue recognition guidance during the three months ended March 31, 2018 as compared to the previous revenue recognition guidance.

Revenue Recognition

Revenues are recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. The majority of our revenues are recognized over time as services are performed, with certain revenues, most significantly the revenue share we earn from Ingram and other partners, being recognized at the point in time when print textbooks are shipped to students.

The following table sets forth our total net revenues for the periods shown disaggregated for our Chegg Services and Required Materials product lines (in thousands, except percentages):

⁽¹⁾ As noted above, prior period amounts have not been adjusted under the modified retrospective method.

During the three months ended March 31, 2018 , we recognized $9.6 million of revenues that were included in our deferred revenue balance as of December 31, 2017 . During the three months ended March 31, 2018 , there were no revenues recognized from performance obligations satisfied in previous periods. The aggregate amount of unsatisfied performance obligations is approximately $27.1 million as of March 31, 2018 , of which a majority is expected to be recognized into revenues over the next year and the remainder within three years. As a practical expedient, we do not disclose the value of unsatisfied performance obligations for contracts with an expected duration of one year or less.

Contract Balances

The following table presents our accounts receivable, net and deferred revenue balances (in thousands, except percentages):

During the three months ended March 31, 2018 , our accounts receivable, net balance decreased by $2.8 million , or 26% , primarily due to an improvement in cash collections. Deferred revenue balance increased by $5.2 million , or 39% , primarily due to increased bookings for our Chegg Study service and eTextbook rentals.

Our contract assets balance was immaterial as of March 31, 2018 and December 31, 2017 .

Note 3. Net Loss Per Share

Basic net loss per share is computed by dividing net loss by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share is computed by giving effect to all potential shares of common stock, including stock options, warrants, restricted stock units (RSUs), and performance-based restricted stock units (PSUs), to the extent dilutive. Basic and diluted net loss per share was the same for each period presented as the inclusion of all potential common shares outstanding would have been anti-dilutive.

The following table sets forth the computation of historical basic and diluted net loss per share (in thousands, except per share amounts):

The following potential weighted-average shares of common stock outstanding were excluded from the computation of diluted net loss per share because including them would have been anti-dilutive (in thousands):

 

The cost and fair value of available-for-sale investments as of  March 31, 2018  by contractual maturity were as follows (in thousands):

Investments not due at a single maturity date in the preceding table consist of money market fund deposits.

As of  March 31, 2018 , we considered the declines in market value of our investment portfolio to be temporary in nature and did not consider any of our investments to be other-than-temporarily impaired. We do not intend to sell the investments nor is it more likely than not that we will be required to sell the investments before recovery of their cost bases. We typically invest in highly-rated securities with a minimum credit rating of A- and a weighted average maturity of  four  months, and our investment policy generally limits the amount of credit exposure to any one issuer. The policy requires investments generally to be investment grade, with the primary objective of preserving capital and maintaining liquidity. Fair values were determined for each individual security in the investment portfolio. When evaluating an investment for other-than-temporary impairment, we review factors such as the length of time and extent to which fair value has been below its cost basis, the financial condition of the issuer and any changes thereto, changes in market interest rates and our intent to sell, or whether it is more likely than not it will be required to sell, the investment before recovery of the investment’s cost basis. During the  three months ended March 31, 2018 and 2017 , we did not recognize any impairment charges.

Restricted Cash

As of  March 31, 2018 and December 31, 2017 , we had approximately  $0.5 million of restricted cash that consists of security deposits for our offices. These amounts are classified in either other current assets and other assets on our condensed consolidated balance sheets based on the remaining term of the lease from the balance sheet dates.

Strategic Investment

We previously invested  $3.0 million  in a foreign entity to explore expanding our reach internationally. Our investment is included in other assets on our condensed consolidated balance sheets. We did not record an impairment charge on this

investment during the three months ended March 31, 2018 and 2017 , as there were no significant identified events or changes in circumstances that would be considered an indicator for impairment. Further, there were no observable price changes in orderly transactions for the identical or a similar investment of the same issuer during the three months ended March 31, 2018 .

Note 5. Fair Value Measurement

We have established a fair value hierarchy used to determine the fair value of our financial instruments as follows:

Level 1—Inputs are unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2—Inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the assets or liabilities, either directly or indirectly through market corroboration, for substantially the full term of the financial instruments.

Level 3—Inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value; the inputs require significant management judgment or estimation.

A financial instrument’s classification within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.

Financial instruments measured and recorded at fair value on a recurring basis as of March 31, 2018 and December 31, 2017 are classified based on the valuation technique level in the tables below (in thousands):

 

We value our marketable securities based on quoted prices in active markets for identical assets (Level 1 inputs) or inputs other than quoted prices that are observable either directly or indirectly (Level 2 inputs) in determining fair value. Other than our U.S. treasury securities, we classify our fixed income available-for-sale securities as having Level 2 inputs. The valuation techniques used to measure the fair value of our financial instruments having Level 2 inputs were derived from non-binding market consensus prices that are corroborated by observable market data, quoted market prices for similar instruments, or pricing models such as discounted cash flow techniques.

The methods described above may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while we believe our valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement at the reporting date.

 

Intangible assets as of March 31, 2018 and December 31, 2017 consist of the following (in thousands, except the weighted-average amortization period in months):

During each the three months ended March 31, 2018 and 2017 , amortization expense related to our acquired intangible assets totaled approximately $1.4 million .

As of March 31, 2018 , the estimated future amortization expense related to our finite-lived intangible assets is as follows (in thousands):

Note 7. Debt Obligations

In September 2016, we entered into a revolving line of credit, which was amended in March 2018, with an aggregate principal amount of  $30.0 million  (the Line of Credit) with an accordion feature that, subject to the lender's discretion, allows us to borrow up to a total of  $50.0 million . This new line of credit replaced the previous line of credit that expired in August 2016. The Line of Credit matures September 2019 and requires us to repay the outstanding balance upon maturity. We will pay a fee equal to  0.25%  per year on the average daily unused amount of the Line of Credit and a base interest rate equal to the LIBOR. In addition, we will pay a fee for each issued letter of credit which will be determined based on our current leverage ratio at the time the letter of credit is issued. If our leverage ratio is less than  1.00% , we will pay a fee equal to  1.50%  per year and if our leverage ratio is greater than or equal to  1.00% , we will pay a fee equal to  2.50%  per year. Our leverage ratio is a ratio of all obligations owed to the bank divided by our consolidated EBITDA. EBITDA for the purposes of calculating our leverage ratio is defined as net profit (loss) before tax, plus interest expense and amortized debt issuance costs, plus non-cash stock compensation (net of capitalized interest expense), plus depreciation expense, plus amortization expense and other non-cash expenses (assuming there are no future cash costs), plus expenses incurred in connection with permitted acquisitions (including without limitation accrued acquisition-related contingent expenses) in an amount not to exceed  $6.0 million  per calendar year, plus non-recurring expenses in an amount not to exceed  $2.0 million  per calendar year. We must maintain financial covenants under the Line of Credit as follows: (1) maintain a balance of unrestricted cash at the lender of not less than  $30.0 million  at all times, other than the three months ending March 31, 2017 and June 30, 2017, and not less than  $25.0 million  during the three months ending March 31, 2017 and June 30, 2017; and (2) achieve EBITDA, on a trailing 12 month basis, of not less than (i)  $25.0 million  for the period of time from September 30, 2016 through June 30, 2017, (ii)  $30.0 million  for the period of time from September 30, 2017 through June 30, 2018, and (iii)  $35.0 million  for the period of time from September 30, 2018 through the maturity of the Line of Credit. As of March 31, 2018 , we were in compliance with the financial covenants of the Line of Credit. Further, we had no amounts outstanding and were able to borrow up to $30.0 million under the Line of Credit.

Note 8. Commitments and Contingencies

We lease our offices under operating leases, which expire at various dates through 2022. Our primary operating lease commitments at March 31, 2018 are related to our headquarters in Santa Clara, California and our office in San Francisco, California. We recognize rent expense on a straight-line basis over the lease period. Where leases contain escalation clauses, rent abatements, or concessions, such as rent holidays and landlord or tenant incentives or allowances, we apply them in the determination of straight-line rent expense over the lease term. Rental expense, net of sublease income, was approximately $0.6 million and $0.7 million in the three months ended March 31, 2018 and 2017 , respectively.

From time to time, third parties may assert patent infringement claims against us in the form of letters, litigation, or other forms of communication. In addition, we may from time to time be subject to other legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of trademarks, copyrights, and other intellectual property rights; employment claims; and general contract or other claims. We may also, from time to time, be subject to various legal or government claims, disputes, or investigations. Such matters may include, but not be limited to, claims, disputes, or investigations related to warranty, refund, breach of contract, employment, intellectual property, government regulation, or compliance or other matters.

We are not aware of any other pending legal matters or claims, individually or in the aggregate, that are expected to have a material adverse impact on our consolidated financial position, results of operations, or cash flows. However, our determination of whether a claim will proceed to litigation cannot be made with certainty, nor can the results of litigation be predicted with certainty. Nevertheless, defending any of these actions, regardless of the outcome, may be costly, time consuming, distract management personnel, and have a negative effect on our business. An adverse outcome in any of these actions, including a judgment or settlement, may cause a material adverse effect on our future business, operating results, and/or financial condition.

Note 9. Guarantees and Indemnifications

We have agreed to indemnify our directors and officers for certain events or occurrences, subject to certain limits, while such persons are or were serving at our request in such capacity. We may terminate the indemnification agreements with these persons upon termination of employment, but termination will not affect claims for indemnification related to events occurring prior to the effective date of termination. We have a directors’ and officers’ insurance policy that limits our potential exposure up to the limits of our insurance coverage. In addition, we also have other indemnification agreements with various vendors against certain claims, liabilities, losses, and damages. The maximum amount of potential future indemnification is unlimited.

We believe the fair value of these indemnification agreements is immaterial. We have not recorded any liabilities for these agreements as of March 31, 2018 .

There was no capitalized share-based compensation expense as of March 31, 2018 or 2017 .

As of March 31, 2018 , our total unrecognized share-based compensation expense related to RSUs and PSUs was approximately $81.3 million , which will be recognized over the remaining weighted-average vesting period of approximately 1.9 years .

Note 11. Income Taxes

We recorded an income tax provision of approximately $0.5 million and $0.6 million for the three months ended March 31, 2018 and 2017 , respectively, primarily due to state and foreign income tax expense and federal tax expense related to acquired indefinite lived intangible assets.

On December 22, 2017 , Staff Accounting Bulletin No. 118 (SAB 118) was issued to address the application of US GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed in reasonable detail to complete the accounting for certain income tax effects of the Tax Cuts and Jobs Act (Tax Act). In accordance with SAB 118, as of March 31, 2018 , we had not yet completed our accounting for the tax effects of the enactment of the Tax Act. Our estimate of the effects the Tax Act have not materially changed from the amounts recorded during the year ended December 31, 2017.  We will continue to analyze certain aspects of the Tax Act and the newly issued Internal Revenue Service notifications and we expect future notices may continue to impact and refine our estimates.

Note 12. Restructuring Charges

2017 Restructuring Plan

In January 2017, we entered into a strategic partnership with NRCCUA where they will assume responsibility for managing, renewing, and maintaining our existing university contracts and become the exclusive reseller of our digital Enrollment Marketing services for colleges and universities. As a result of this strategic partnership, approximately 50 employees in China and the United States supporting the sales and account support functions of our Enrollment Marketing offering were terminated. Costs incurred to date are expected to be fully paid within 6 months.