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Chegg, Inc. (NYSE:CHGG)

Q4 2013 Results Earnings Conference Call

February 13, 2014 5:00 PM ET

Executives

Alex Hughes - Head, Investor Relations

Dan Rosensweig - Chairman and CEO

Andy Brown - Chief Financial Officer

Analysts

Diane Kruger - J.P. Morgan

Matt Schindler - Bank of America Merrill Lynch

Aaron Kessler - Raymond James

Jeff Silber - BMO

Mike Olson - Piper Jaffray

Joseph Garner - Emerald Advisers

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Chegg’s Conference Call Discussing Fourth Quarter and Fiscal Year End 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, Thursday, February 13, 2014. I would now like to turn the conference over to Alex Hughes, Head of Investor Relations for Chegg. Please go ahead, Mr. Hughes.

Alex Hughes

Good afternoon. And thanks for joining Chegg’s fourth quarter and fiscal year 2013 conference call. On today’s call are Dan Rosensweig, Chairman and CEO; and Andy Brown, Chief Financial Officer and that’s the structure. Dan will open with his brief discussion of Chegg’s business and Andy will follow with the review of our operating results and outlook for the first quarter and fiscal year 2014.

A copy of our earnings press release is available at our Investor Relations website, ir.chegg.com. A replay of this call will be available on our website. We routinely post information on our website and intend to make important announcement 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 that during the course of this call we will make forward-looking statements regarding future events and 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 risk factors that cause actual results to differ materially from those in the forward-looking statements.

In particular, we refer you to the risk factors described in the final prospectus from our initial public offering that was filed with the SEC on November 13, 2013, and our other filings with the SEC.

Any forward-looking statements that we 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. Our GAAP results and -- to non-GAAP reconciliations can be found in our earnings press release.

Lastly, please note that this conference call is the property of Chegg and any recording, reproduction or rebroadcast of this conference call without expressed written permission of Chegg is strictly prohibited.

With that, I will now turn the call over to Dan.

Dan Rosensweig

Thank you, Alex. Good afternoon. And welcome everybody to Chegg’s first quarterly earnings call. We’ve certainly learned a lot in the past three months as a public company and we are focus daily on creating shareholder value.

Today’s call will focus on our digital business which we are very excited about. We will then review the print textbook business as we feel its important and powerful opportunity for Chegg even though the market has gotten a lot more competitive. Finally, we will cover our focus on 2014 and Andy will walk you through our financials and our guidance for 2014.

With that, let’s get started. Our evolution from textbook renter to connected learning platform allows us to better connect students with the services and skills they need for academic and career success. Key growth drivers for our business continued to be reach, our data, engagement and the launch of new high margin digital services on top of the platform.

As many of you maybe new to Chegg, let me just take a moment to take you to the brief history of my time at Chegg. When I joined Chegg four years ago, my eldest daughter had just started the college application process. We saw first hand help needlessly complicated, stressful, expensive and time consuming the whole process was, the system daunting and seen design for everyone but the student, a real conundrum.

So we set out the change from simply a fast growing textbook rental service into a much larger connected learning platform that put students first. Today we work with students from the time they are in high school, through college and beyond, and as the platform grows, we will continue to be there to help student save time, save money and get smarter.

To illustrate just how far we have come, when my eldest daughter got in the college three years ago, all she could do with Chegg was rent her textbooks. Three years later, my youngest daughter has used Chegg to match to the right college and scholarships, pick the right classes, get the required learning materials, new, used, rental and now digital.

She has used our mobile app to prepare for classes, paper and test, and with our newest digital service internship matching she is already looking for the right summer job. Each student who interacts with our service, whether it’s renting books, reviewing courses, asking questions, or whatever they may do, informs the Student Graph. That’s the data and relationships that allows us to continually improve how every student can discover relevant opportunities to learn and succeed. This is Chegg’s virtuous cycle.

In Q4, we had two significant advancements to our technology. First, we improved discovery for all services, but in particularly for our digital services, which helped double the Q4 attach rate of Chegg study among textbook customers versus just a year ago and you can see that in our results.

Second, we made enhancements to our platform architecture enabling us to quickly and efficiently launch new digital services on mobile and desktop that takes full advantage of the Student Graph.

As an example, Chegg internship launched at scale with over 70,000 jobs from 40,000 companies, because of our data every Chegg member who uses it automatically gets matched to opportunities specific to their school, their nature and themselves.

This is a huge opportunity for Chegg and of course, an opportunity for employers and students in particular, as research shows that students are almost twice as likely to get a job offer if they’ve had paid internship.

The popularity of our service is clear, with students already spending an average of 11 minutes per visits to our internship matching service and viewing almost five internship opportunities per student visit.

This also shows the importance of the service and the power of Chegg’s brand, reach and platform to build an audience quickly. Using technology, data and our reach allows us to watch highly personalized new products and services at scale, which is an important competitive advantage and differentiator as we go forward. We believe nobody else in the world can offer students this kind of value.

Coming into 2013, we want to deliver the value created by our textbook business to expand Chegg reach, graph and drive higher engagement with our students. And we want to translate our increase membership base and data to accelerate the launch of new margin digital services that continue to grow our relevance, business and profitability. We experienced excellent momentum in each of these areas.

First, active members and customers growth overall were very strong. We finished the year with nearly 7 million active members and have already converted 35% of them to a paid customer.

Student have shown great interest in our new digital learning services and from us and our partners. So you can expect us to launch more of them in 2014. The success of Chegg study which grew 66% year-over-year and has climbed to 464,000 paying subscribers shows the opportunity we have to offer more digital services.

We can do this and continue to grow our textbook business at a very strong pace. Students trust Chegg to focus on helping them whether in school and provide the best relevant learning opportunities.

We are equally excited to see that our Student Graph kept growing enabling us to make Chegg services increasingly relevant to each student and the entire network. The power of our data had led to increased engagement with both our free and paid members.

Mobile has been a real boon to engagement as students can take Chegg with them anywhere, including their classroom. We now have more than 25% of our members accessing us via mobile, doubling year-over-year. Mobile is our friend because it allows for even greater daily engagement and personalization with each student.

Two notable examples of the power of increased engagement are in the areas of our course reviews and Chegg Study. Year-over-year the number of courses reviewed grew by 640,000 to more than 1 million total reviews, which shows you how engagements are with the network beyond just textbooks. Students have seen that the more they personalize Chegg, the better we can serve them and the entire network.

The success of Chegg Study is due to the integration with our textbook catalogue and our ability to serve students in real-time. We mentioned earlier that Chegg Study has seen substantial subscriber growth. In addition to that fact, we are seeing students interact with the product more than they did last year, which means that they log in more often than they did previously, which means they are really seeing value in the product.

Because Chegg Study is interactive and online, we continually improved the product in real-time and as a result, 71% of the students surveyed who use Chegg Study report getting better grades in that class. In fact, 91% said they had a better mastery of the subject. Our digital businesses are succeeding and we’ve always surpassed $50 million annually, growing to 21% of total revenue in 2013, up 8 points from 2012. It’s important to note that less than three years ago we had virtually zero revenue in these businesses.

Turning to 2014, we are even more excited about our business. First, we will continue to operate the textbook rental service as a way to acquire students and reach the Student Graph while we keep our focus on managing our overall business to approximately free cash flow breakeven. We will focus on renting the books that offer the best return at a high interaction with our suite of digital services throughout the student lifecycle.

We expect the overall cost of running textbook business to continue to decline allowing us to spend less but not at the pace consistent with decline in textbook pricing. We are growing units by more than 20%, which is important because we believe Chegg print textbooks will be around for many years, giving Chegg a treasure trove of data that expands our Student Graph, the ability to launch new higher margin digital businesses faster. It is clear, however, that textbook prices continue to decline, which is good for students.

This impacts our short-term profit margins, and at the same time we are seeing increased organic demand, so textbook units and customers are actually growing faster than we anticipated. So we are picking up market share despite increased competition. We believe the short-term trade-off of using more cash strengthens Chegg’s position, even though we're getting less revenue per textbook. Textbooks help us to reach customers, brand and data positioning us to grow the digital businesses even faster. We can control the size of our catalogue and pricing, so we are able to optimize during each rush.

For now we think it’s to our advantage to continue to take share at the current pace. We think this makes our long-term prospects even stronger that we imagined just three months ago. The good news is the more services we offer, the more ways we can acquire and retain new customers, even more efficiently. Second, we will engage in this earlier and stay with them longer. This will mean integrating existing Chegg under single platform and brand so we provide a common experience to the student throughout their educational journey.

With this we will aggregate greater data in the Student Graph making it possible to offer new digital study tools and content that help prepare students for standardized tests before and after college and build their skills to the workforce and shift a few examples of what’s possible for Chegg’s offer.

We have a strong pipeline of new offerings from Chegg and from our partners, launching them on our platform using data from our Student Graph allows deliver these services with personalized experiences that we believe no one else can offer, making us a very important distribution partner for companies, educators and large brands looking to reach students in the United States. The number of services we can offer over the next many years keeps expanding because we believe that the terms of student is extending to a learn forever, earn forever lifecycle, meaning that stay relevant in their careers, today student will need to constantly develop new skills not just in college but over their careers to attain new opportunities and Chegg plans to help them throughout their lives.

The power of the Chegg brand is scale, our Student Graph and technology and that enables us to improve increased discovery and personalization. The reach and relevance of our connected learning platform now extends from high school when students and parents first explore higher education, take a learning and skill building needed for academic and career success. Our brand is built on delivering tangibles outcomes for students. We believe we are poised for growth in revenue, membership, customers and the number of services offered. Our Student Graph and platform technology are continually improving discovery and engagement to yield higher revenue growth, margin and expansion.

And with that, let me turn it over to Andy to give you update on Q4 and 2014. Andy?

Andy Brown

Thanks, Dan, and good afternoon, everyone. As a reminder my comments today are on a non-GAAP basis as I review our fourth quarter and full year results and then provide an outlook for Q1 and fiscal 2014.

We experienced strong revenue growth in the fourth quarter and the full year largely driven by robust growth from our digital businesses. Total revenue was $77.1 million in the fourth quarter, up 13% year-over-year and $255.6 million in the full year, up 20%. Print revenue was $60.5 million in the fourth quarter, up 3% year-over-year and $203.1 million for the full year, up 10%. For the full year print textbook units and customers grew 17% and 18% respectively. We believe this is a better indicator of the growth and vitality of the print textbook business since prices come down each semester.

Digital revenue grew to $16.7 million in the fourth quarter, up 70% year-over-year and grew to $52.5 million for the full year, up 86%. As a percentage of total revenue, digital continued to expand, representing 22% of total revenues in the fourth quarter and 21% for the full year, compared to 13% in 2012. We saw a robust growth across all our digital products and continue to see momentum as we enter 2014.

Chegg Study in particular was strong with bookings higher than expected during Q4. Since Chegg Study is a subscription service, success in Q4 builds a great face of deferred revenue for 2014.

Overall gross margin in Q4 came in as expected at 52% with gross margin improving significantly over Q3 due to seasonality. As a reminder, our business is driven by the student lifecycle where a significant portion of our bookings occur during the early part of each semester.

Most of the revenue therefore is deferred and recognized over the rental or subscription term while most of the cost and expenses to fulfill the demand are expensed as incurred. This results in much lower gross and operating margins in Q1 and Q3 where textbook volumes are highest with higher margins in Q2 and Q4 where costs are much lower.

Turning to expenses, Q4 operating expense was $23.1 million or 30% of net revenues, improving 3.9 percentage points year-over-year. For the full year, operating expense was $91.4 million or 36% of net revenues, improving 5.8 percentage points from 2012.

We are starting to see the operating leverage as a scale of business. Chegg’s growing brand with high school and college students has led to increased organic traffic and helped reduced direct marketing cost from 2012.

Operating expenses for the fourth quarter included a loss of $1.8 million from the liquidation of certain textbooks. This was the result of our decision to optimize our textbook library more for rental than liquidation because we anticipated greater rental demand during the upcoming winter rush, which have materialized.

While our strategy resulted in less site liquidations in Q4, which typically have higher [source cost] recovery, we believe it will result in a better overall outcome as we expect to get a greater return on those books than we had originally thought.

Without the loss from textbook liquidations, Q4 operating expense would have been $21.3 million or 28% of net revenues. For the full year, we experienced a gain of $1.2 million from the liquidation of textbooks consistent with our goal of being close to breakeven on liquidations over time.

Turning to profitability. Fourth quarter adjusted EBITDA without textbook depreciation was $18.6 million compared to $18.5 million in 2012. For the full year, we recorded an adjusted EBITDA loss without textbook depreciation of $4 million compared to a loss of $15.8 million in 2012, which reflects the increased leverage of our higher margin digital businesses.

Looking at the balance sheet, we ended the quarter with cash, cash equivalents and long-term investments of $138 million, much of this is from the IPO in November and we believe our cash position along with the available data from our revolver positions us very positively for the future.

With that, let me turn to offering our outlook. As we focus on driving continued growth for our digital businesses, our goal is to operate at approximately free cash flow breakeven in 2014, building on the improvement in 2013 when we reduced free cash flow used to $28 million. Rapid growth of our high-margin digital businesses, combined with great optimization in the print textbook business is driving this improvement.

Given the back to school for the winter semester takes place in January, we are well into the winter rush season. We are seeing excellent organic growth for our textbook business with over 25% unit growth year-over-year through January, which is faster growth than we experienced last year.

This has happened while we continue to reduce performance marketing spend over the winter rush in 2012. However, as Dan mentioned earlier, we have seen a greater decline in textbook rental pricing than originally anticipated. This will be reflected in lower bookings growth and gross profit.

With that, let me turn to more specific guidance for the first quarter and for 2014. For the first quarter, we expect total revenue to be between $70 million and $72 million. We anticipate digital revenue as a percentage of overall revenue to be approximately 24%.

With overall gross margin between 7% and 9% and we expect adjusted EBITDA loss without textbook depreciation to be between $22 million and $20 million. For fiscal 2014, we expect total revenue to be between $310 million and $320 million with digital revenue as a percentage of overall revenue to be between 27% and 29% for the year.

Overall gross margin is expected to be between 25% and 27% and we expect an adjusted EBITDA loss without textbook depreciation between $10 million and $15 million with free cash flow in the range of negative $5 million to positive $5 million consistent with our goal to be breakeven.

In summary, we plan to drive continued growth from our digital businesses while managing our overall business to free cash flow breakeven. We are excited about our future and we believe our student-first focus is the best way to build the lasting student and shareholder value.

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

Question-and-Answer Session

Operator

(Operator Instructions) Thank you. Our first question comes from the line of Douglas Anmuth with J.P. Morgan. Please proceed with your questions.

Diane Kruger - J.P. Morgan

This is Diane Kruger on for Doug. I just want to get a sense if you can put some numbers around how much on textbook prices went down in the quarter and then maybe just a little bit on talking about the digital content going forward, if you could help us prioritize would that be developing internal content or licensing? Thanks.

Andy Brown

Yeah. So this is Andy. Thank you for the questions. So when you look at textbook pricing, one of these things. I mean, Dan has been here four years now. I think its four years in February and we’ve seen textbook pricing come down throughout that full years. Clearly, we see that -- we continue to see that. We’ve seen it accelerate a little bit more over the winter rush more than we originally anticipated. For competitive reasons, we don't want to get into the specifics. We did see some additional pricing. Having said that, we do anticipate that as we get two to three more semesters out, we will continue to see service cost reductions, which will likely offset some of those pricing declines.

Dan Rosensweig

This is Dan. I will take the second question of the new products and services. So as you know, we have a team in India who helps us develop content and we are able to leverage that team to develop a combination of organic contents as well as content licensees that we already have from the publishers that we work with.

So we will be doing a combination of building some of our own as well as integrating in publisher content, similar to the way we build Chegg Study, which makes it a very high gross profit margin business. And we also content for partners, it’s significantly higher gross profit because we already have the region, the distributions. So we are able to offer more and more kinds and formats of content directly to students as it becomes more relevant.

Diane Kruger - J.P. Morgan

Thank you. That’s helpful.

Operator

Thank you. Our next question comes from the line of Brian Fitzgerald with Jefferies. Please proceed with your question.

Unidentified Analyst

Hi. This is (inaudible) in for Brian. Can you discuss or give any comments on any new brand partnerships in Q4 and how does your pipeline look like?

Dan Rosensweig

The pipeline for brand partnerships?

Unidentified Analyst

Yeah.

Dan Rosensweig

So, brand partnerships has seen significant growth. We are seeing growth in probably different ways. More overall advertisers, we have over 90% renewal rates and on average, each advertiser is right with us, increases the amount of money they spent on their new campaigns

We are continuing to see new advertisers coming all the time. The once that we closed in Q4, you will start to see running in January, so the once that we had in Q4 were effectively the ones that we had in the pipeline are these that are buying these ads. So you are going to see a lot of the old ones and some really big new ones that are coming out January, which is still (inaudible) they are prior to actually running their campaigns.

Unidentified Analyst

Okay. Great. And you just quantitatively, what’s the number of the new brand partners?

Dan Rosensweig

Well, we doubled last year the number of brand partners that we had from 2012 to 2013. And I think you can expect to see something similar to that. We are seeing not only more partners. See, we are at the very beginning of that business. That’s an organic business that we started only two years ago and we’ve seen substantial growth. So we're extremely pleased with that business and one of the great benefits of being on the textbook business to grow that business faster is we believe, once we get to 50% reach, which should come in the next few years. It’s very easy for us to walking to a client saying, do you want to reach one out of every two college kids in the country. So that business just keeps looking better and better.

Unidentified Analyst

Great. Appreciate the answers.

Dan Rosensweig

Thank you.

Operator

Thank you. Our next question comes from the line of Matt Schindler with Bank of America Merrill Lynch. Please proceed with your questions.

Matt Schindler - Bank of America Merrill Lynch

Yes. Hi, guys. Couple of questions. One, revenue per textbook is falling as you said and your gross profit is not really going up with your strong showing in high gross profit digital revenue. Can you give a little bit more color there? Perhaps, where do you see the gross profit of the textbook business falling our after I think historically over the 20% to 25% business? And then I have a couple of others.

Dan Rosensweig

Yes, I will start with the first part of that question, which is we are actually seeing new higher margin business having a really positive impact on overall gross profit margins because we are seeing as you look at the textbook business as we try to describe, the unit volume is growing much faster, so that’s the short-term gross profit margins because we buy more books at that time and then we have depreciations over the long-term. We think we get the majority of that.

So two things, one is the efficiency of our ability to acquire customers and deliver the resolute units at a much lower cost, is actually happening but not at the pace at which the price dropped in the short-term. But as Andy mentioned over time, we think that catches up. And then second is the new businesses are growing faster than we thought. As you see, we did better in Q4 and our guidance suggest that we the digital business streams are fastest. So they are having an impact. As to the overall textbook gross margins, I will turn it over to Andy.

Andy Brown

Yeah. So, like I had mentioned earlier, when we look at the textbook, we look at -- we don’t necessarily look at textbooks in isolation. I mean, I think part of what you got to look at is Chegg as a connected learning platform and where our textbooks actually, how they play. They play across the spectrum, right. So we are talking about high-school students all the way through, people who are out of college and textbooks is an important part of that for many reasons.

One is it drives client preference, it drives customers. It fuels the data and so when we look at the gross margin, we look at the overall gross margin. We do believe in the short-term as it impact because of the pricing. The books that we have already purchased clearly we can’t change the cost structure of those. But as we -- what we’ve experienced in the past is that we will start to see pricing declines in textbooks, maybe one, two and three semesters out and we would expect to have some positive impact on the overall textbook margins.

Matt Schindler - Bank of America Merrill Lynch

Okay. Great. And then on the digital business, I was wondering if you could give any additional color on how it broke down and where you were seeing the most growth. Additionally, on Chegg’s internships, can you talk a little bit about how you are monetizing that or how you envision monetizing that business in the future?

Dan Rosensweig

Yeah. I will take the first stab at both of those. Our digital businesses as we’ve said over the course of the roadshow, where they currently are, they all seem to be growing around the same pace. So, brand advertising as a percentage is not growing the fastest because it’s off a smaller base.

But they are all growing. I mean, I think overall our digital revenue grew 86% year-over-year. So we continue to see them range in 70% to 110% to 120% to 130%, which it is. But, right now, since they all have the same gross profit profile, we grouped up together because I think they are reflective of universally of overall growth. So as we look in 2014, we don’t see any of them necessarily slowing down over what we’ve seen. In fact, we see them equal or in some cases growing faster. And I’m sorry, what’s the second question?

Matt Schindler - Bank of America Merrill Lynch

On Chegg internship monetization.

Dan Rosensweig

So that helps us in a number of ways. So as you know, we’ve been involved with the company for as long as you’ve been involved with the company that. We try to move from four years ago being two days of relevance to now 365 days of relevance. And internship is one of the most important areas.

So the areas for monetization are more in long-term in terms of how we can ultimately, who will get the charge that obviously will be free for students, but the ways it’s working now is we have a series of marketing partners that want us sponsor, a lot of these areas.

So you are likely going to see the early revenue associated with it over time to be in the brand partnership area, but over a longer period of time, having all of that data from now where Chegg has is, where you went to high school, what’s your interest are, what’s your grades are, which schools you are interested in, which school are interested in you, what classes you take, what your major is, who are your classmates are and credit card? Now we are going to have what careers you are interested in starting out at the internship level.

So you can imagine over time the opportunity for Chegg to continue to provide services and now into the career area. So long term, we think it’s a very big money maker for us. Short term, we just want to grow the things as big as we can, get as many customers register and the money we make in the short term will be mostly around employers who look to sponsor parts of the site and we expect to see some of that in 2014 and beyond. Does that help?

Matt Schindler - Bank of America Merrill Lynch

Yes. Great. Thank you.

Dan Rosensweig

It’s been a really successful early launch. I mean when you see 11 minutes and 5 jobs, when you see the number of pages that are viewed and all of this is in January season when students just got back to school and were reading textbooks. So we are working with internships.com, they have been an impressive partner and the magic that we can offer that no one else can is we can take all of that data that we just talked about and automatically matches, so that the student has a clear path and a higher likelihood of getting the job and that’s really what makes Chegg anything special versus anybody else that could offer these sites.

Matt Schindler - Bank of America Merrill Lynch

Great. Thank you.

Operator

Thank you. Our next question comes from the line of Aaron Kessler with Raymond James. Please proceed with your question.

Aaron Kessler - Raymond James

A couple questions. First on going back to the price cut on the textbooks, how much, I know it’s quite tough as exactly but how much room do you think price can continue to go down, obviously to make lot of other players can be profitable if continuously price increases, but do you think we have much left to go on the down side. And can you also give just a little more color, I think you mentioned at the beginning call, you doubled Chegg Study attach rates, was that during this quarter or is that over the last year? It is for any Andy maybe if he can give us an update on where you think you can share count lines up Q1 and for 2014 as well?

Dan Rosensweig

On textbook pricing, its market based pricing. And so what Andy referred to earlier is at the moment in the market, prices may go down, but we have bought the books previous, but then once prices go down our actual efficiency is being able to buy these books cheaper happens over time. So what happens is, it takes a quarter or two for the -- our costs are going down anyway, but our source cost will continue to go down further and that will even out over time.

As to where the price ends up, it’s difficult to know, right. Really we know one large competitor exited the space a year ago. We are gaining market share despite that and our pricing strategy has actually not been to price below them. So we don’t really know where the bottom is, I don’t imagine it’s too much further it is now, otherwise you know we speak other people in the space wouldn’t be in the space. So I think we look at it as stabilizing in a reasonable period of time, but most importantly, our organic growth is growing so much that it’s clear that whatever is happening in the market has been to check the advantage.

You asked also about the attach rates. So the attach rates doubled in Q4 year-over-year. And if December -- sorry timeframe or that fourth quarter was really just, we really launched our check site in January of the same year. So we see this as a continued growth opportunity and one of the things combining the textbook and Chegg Study in the same conversion is harder what we do going forward when we chose the books we want to have in the catalogue are the ones most likely to be associated with Chegg Study offerings. So it’s really starting to come together nicely. So we imagine the attach rate is going to be picking up continually. We don’t think we are anywhere near matched out on that area.

Andy Brown

So Aaron let me jump in on a couple of things here. I think I just add a couple of things. First thing is, when you look at the textbooks, I mean Dan has mentioned this earlier and that is we are seeing the cost of textbook, as the text book business come down, whether it’s the warehousing, whether it’s shipping or whether it’s the cost to acquire customers. So they are just not coming down right now while as fast as the ARP. From a guidance standpoint, we’re anticipating that the textbooks come down even further in the fall. So we’ve incorporated that into our guidance for the fall, obviously the first half, much of the first half is done from the textbook standpoint.

The second thing is I think you had asked the question on share count. Our share count at the end of the year was I think 81.7 million, on this call its 82 million I will round up for you a little bit here. It’s hard to gauge exactly where that goes from a diluted share standpoint because as you are aware, stock price has a fairly big factor in that depending upon how many stock options are above or below order. Most of them are right now are below order unfortunately. So I would say it’s going to be somewhere in the mid-80s. If the stock price increases dramatically, then it would -- it’s the diluted shares outstanding would clearly rise.

Aaron Kessler - Raymond James

Great, thank you.

Dan Rosensweig

Which we were hoping for.

Andy Brown

Which we were hoping for, yes.

Operator

(Operator Instructions) Our next question comes from the line of Jeff Silber with BMO. Please proceed with your question.

Jeff Silber - BMO

You mentioned that the Student Graph and on the IPO, it was the major issue as well. What else do you think you need to fill out that Student Graph?

Dan Rosensweig

So that’s a great question. So in the current businesses we are in, we don’t think we need much more, but the opportunities ahead of us are so significant that there is a lot more to get. So as an example, obviously we want to get more students into the graph and that’s why using the textbook as a way to grow that business in teen, 25% unit growth in January is a really good time for us and the growing of 648,000 reduce. We only really just started asking for reviews now and you will start to see us exposing more and more on the site.

What we are really excited about is taking a look at internships as an example. So today, what we have is expressions that where students want to go to school, what their gender is, what their age is, what their majors are. Now that we have the opportunity to understand what they are interested in do professionally, that opens up whole new opportunities in the categories of skills and ultimately careers and so our next step in data collection will be around that area. So it’s not that we need more to do really well with what we have. I mean, the graph is growing out quite nicely.

But keeping on the site, you have seen that each page now is personalized to the user. We have launched a beta version of something called [full stream], which now sort of a news feed inside each student’s individual site. So we are beginning to know what students are interesting in, what they click on, where they want more information. As we launch more types of Chegg Study products, it will be the same kind of information but very different, which is in the high school category.

We begin to offer a single digital service. And so we think that’s an enormous opportunity. So from there, we are going to start to learn where students are struggling, whether they are struggling, not only are they struggling in math but where in math, those kinds of things. So the graph which is build forever, similar to a LinkedIn and Facebook’s graph is build, but to be successful in the short term we have more than enough information.

Jeff Silber - BMO

Okay. That’s great. And I guess this one is for Andy. You mentioned a few times that the cost at least from a textbook side will be coming down. Can you give us some rough estimate in terms of how much of that is coming down so we could see what’s incorporated in your guidance? Thanks.

Andy Brown

Yes, Jeff. So we have already started to see the cost come down particularly around sourcing, around in marketing. We have some source costs -- anticipated source cost reductions coming in the fall. I understand. We kind of step back a second, we runoff from that. So it’s a kind of a first half and then a second half and then another first half and a second half. We do a significant portion of our buying in the fall semester around the new terms.

We do anticipate some moderate pricing reductions there and an increase in some of our lower cost sources of books, things like buyback. While this one of those things that is little as two and half, three years ago, we weren’t doing buyback which is our bullet source of sourcing and we are increasing the -- we will continue to increase the buyback. The other part is, when you look at the economics of the textbook business, it’s not just about the cost of the book. It’s also about how you utilize it, how many times you turn the book and we continue to turn these books more and more.

In another works, the utilization of the books continue to, will continue to increase and so there is. So that element also goes into the overall cost. So we have factored those in, not very aggressive into the second half. We are trying to be conservative and so it reflects a conservative guidance but we do have some of those in the second half forecast.

Dan Rosensweig

And I think you can see just over time, if you look at the use of cash, two years ago, use of cash last year and the use of cash now even though, we are going to be growing faster in the text book business and delivering more than we ever have on top of our record number, we are talking about close to 6 million books. You can see that the efficiencies that we have been able to get out of the years have been pretty substantial. The fact that we can run the business overall, we believe in the neighborhood of cash flow positive.

Andy Brown

Yes, Dan brings up a very good point that I was reminiscent and maybe just talking about this. One of things that we anticipate -- our guidance anticipate is that in fact we buy less books this year than we did last year, so it contemplates that as we look into the second half.

Jeff Silber - BMO

Okay. Great. That’s helpful. Thanks so much.

Operator

Thank you. Our next question comes from the line of Mike Olson with Piper Jaffray. Please proceed with your question.

Mike Olson - Piper Jaffray

All right. Thanks. Good afternoon. You’ve had greater demand as you mentioned in this winterless period where the household pricing has come down. So, are there any promos or other kind of incentives beyond pricing that you have done, or are doing like a kind of on a loyalty program or something like that that to potentially drive volume without ASP itself coming down and then other than kind of a monetary value of lower pricing or other such incentives. Do you feel like there are other ways to make the textbook rental offering list commoditized versus other players in the space?

Dan Rosensweig

Yeah. This is Dan. The promotion pricing is just at the market base pricing and essentially it looks like it come down to two large players in the space. And it advantaged us because of the unit growth in shares. So we’re not offering lower prices than others. The promotion that we have been using, which we think will slower our overall cost is if the student were to rent more than $85 at a time then they would get two day free shipping.

And what that effectively did for us was raise books per order, which mean they were able to ship more books in one box which lowers the cost of shipping. And we were able to do fewer transactions to get the same number. So we had lower overall cost. So that was something that we did rollout in Q1 and it was remarkably successful. So we see opportunities like that but the goal there is to do it where we think is an advantage of lowering our overall cost.

And second in terms as not being a commodity, the whole concept of Chegg is to not be a commodity, meaning, when you come to Chegg the fact that we do all these other things for you, means you are more likely to come to us than towards somebody else. And that’s why we’re seeing such dramatic organic growth and we’ve been lowering our overall marketing cost not just as a percentage but it’s actually real dollars year-over-year.

It wasn’t that we expected to do that, it’s just the result of the rest of the concept of the Chegg platform working. So if we know your class and we help you pick their class, why would you go to another site to go get their textbook, so we automatically tell you we’re doing that plan, here is your rental. That’s not commoditize versus anybody else. And that’s allowed on the pricing standpoint to not be the lowest cost provider in this space, so it seems like that.

Now that we’ve decided we’re going to, to come back regularly to Chegg for internships and those things. We think great -- improve the efficiency of not just textbook business but all of our businesses. And if you’ve been only getting Chegg Study on Chegg, that is a non-commoditize.

Now to the bigger question, we do believe and we are looking into areas where we can bundle the textbook and Chegg study, where it’s appropriate which again would be a non-commodity situation. But overall the fact that we have so much traffic, the fact that even a big competitors have entered the space. We grew our market share. We think it’s a reflection that the students are giving us credit for doing more then just a commodity textbook rental.

Mike Olson - Piper Jaffray

Yeah. Hope they make sense. And then secondly on enrollment marketing, would you be willing to the share kind of where we are on number of Universities using the offering and any sort of metrics around, like average number of lease you provide to the schools or what the average revenue per leaders. And ultimately, is there any reason that your offerings that don't apply to essentially every university in the U.S. or has there been anything you need about your University customer base so far?

Dan Rosensweig

Yes, I think, we close the year at about 875 schools that are currently under paying contract with us. So that is an area where we are really excited about. So the specific answer to your question is we don’t see any reason, why any institution wouldn’t use us. Large or small, we’re seeing really great uptake kind of largest institutions because for them -- it’s easier for them to see why large institution was having trouble of attracting the students that they want, where we can find them directly for them.

So, in fact to your question was specifically two examples of why we think it could be across all 4000 and ultimately will be closed. We were invited to the White House as the only commercial, we think the only commercial company to be invited to White House with President Obama’s meeting on how to attract low cost, low-income higher performing students because we have incredibly large database and reach and could build a relationship on behalf of college.

Those Universities that are trying to attract them are amongst the best in the country. So that helps us be in a position to get sort of small or large colleges, as an example. The second thing, as I just met with 30 more chairs of the liberal arts colleges in the east coast. And their challenges are different than the larges challenges which they are really trying to shape classes correctly and they’re trying to lower their cost of student acquisition.

So you hear that they get innovated by students applying, they do. But those aren’t the once they necessarily want to apply. So how do they find them, how do they get there to them directly and how do they convince them to come to their school versus somebody elses. That’s where Chegg plays a substantial role. So there is nothing unique about the 875 that we have. When we bought the company, we closed two years ago in November, we had below 500.

So you’re seeing substantial growth already. We don’t imagine that growth will slow down.

Mike Olson - Piper Jaffray

All right. Thank you.

Andy Brown

By the way, that’s also the first service that we brought out through this. There are many more services that both students and school want us to offer. And I mentioned in the prepared remarks that we see a lots of opportunities and they keep expanding. We want offer to many at one time. We will be systematic to make sure that they keep getting the same MTS benefit that the products that we’ve already rolled out to get it. But schools are depending more and more on us for these kinds of services. And certainly we don’t really have a significant competitor in that space.

Operator

Thank you. Our next question comes from the line of Joseph Garner with Emerald Advisers. Please proceed with your question. Mr. Garner your line is now live. Have your questions?

Joseph Garner - Emerald Advisers

Yes, sorry about that. Good afternoon guys.

Andy Brown

Hi, Joe.

Joseph Garner - Emerald Advisers

Couple of question for you, number one, you talked a good bit about Chegg study. I’m wondering if you could maybe give us a sense of how you’ve been expanding that in terms of the number of textbooks courses that have Chegg Study available to it. And then also, have you been seeing any changes in terms of the composition of the subscriptions in terms of annual versus monthly subscription that we’ve seen more people migrating to the annual one?

Dan Rosensweig

Yeah. So I’ll -- this is Dan. I’ll start. Joe, the Chegg Study product, we continue to add more and more textbooks. The interesting thing is we get the contracts. We have contracts for many more than we’ve already been able to put in. We then have the digitizing included in correctly.

We then have to do some work to scrub it. So there is always a lag time for freaking when we get this agreement and we’re rationally able to make it available. So we continue to look to climb towards 25% or 30% coverage over the course of this year and really depends on when you get in versus when we can promote it.

So fairly right now, we’re pretty much are working with the percent that we have in because right now the Chegg Study season has started. Right, once textbooks are gone. And then the next big push will be in August and we expect a big -- the timeframe between March and August give us a chance to really substantially up that.

So we’re adding more and more content. We’re also -- because of the interactive nature and because of the fact that students are using it more frequently than they did even a year ago, we’re really able to see the time-to-time print that we’re looking for, that perhaps we don’t currently have. And that is allowing us to go and either build a content or get it directly from a publisher. So we’re actually getting more and more targeted.

And the second thing we’re doing Joe is we are now part of the catalog selection that we do in the print textbooks is directly related to where we have that connection between work and Chegg Study. We’re doing a lot of work in that space because we think it’s a really big opportunity for us.

Joseph Garner - Emerald Advisers

Okay. And then in terms of the competition, annual versus monthly, have you seen any notable changes there?

Dan Rosensweig

Yeah. No, not through the course, not through the end of 2013 and it will be interesting to see in this first semester why wouldn’t it matter because when a student comes in August, the annual sales makes a lot more sense to them and they are allowing probably because they have exams from August and school in May or June.

So this January semester will be really the first one, we had on the site and scale. So we’ve got to study what the results are. We are not causing behavior one way or the other. We’ve been testing different pricings. As I think, we mentioned what we were going to do on the road show but this will be our learning semester versus -- versus a knowing semester and that will really impact what we do in August and then again in fall of January.

Joseph Garner - Emerald Advisers

Okay. And one final thing, if I could, just wondering if you, if there are any development from the eTextbook side, you have even more option from the students or if you’re seeing anything in terms of development of the business model relationships with the publishers?

Dan Rosensweig

Yes. The relationships with the publishers have gone very well for us. We have all the agreements for all the major publishers and for those who don’t know, major publishers represent 80% of the overall volumes. So we have access to all that.

In addition, we have access to the non-required textbook, the interactive learning systems. Those will be rolling out probably later in this year and the only reason I’m not rolling that out is because the format in which it comes requires us to do engineering work to be able to do single sizing.

So having no trouble getting access to eTextbook content and more learning content from the publishers. We are seeing increased percentage pickup of eTextbooks to print textbooks. One other things we learned depending on the price of the textbook, eTextbook converging goes up or down. So at the current stake, we don’t expect to see a breakout in eTextbooks because print prices are so much cheaper when compared to the higher where people take eTextbook.

So interesting to that is beginning to become noticeable. One of the great parts, we see really good growth year-over-year for us, right. And it’s becoming a significant line of business for us. But it’s just not -- it's not going to break out and suddenly become 25% of our business in the next year or so that we imagine.

But it is climbing up within overall percentage. One of the other really great benefits that we have learned is when -- our Chegg Study which I know, we are really interested in, we actually have a higher attach rate, eTextbook subscribers versus print and that is part of our whole business premise. If the more we’re active with them digitally all line engaged, the more opportunities we can to expose them to saying that we benefit them and we’re really beginning to see that play out at a little bit larger scale.

So I think, Joe, is that it?

Joseph Garner - Emerald Advisers

Perfect. That is it. Thank you very much.

Dan Rosensweig

All right. Well I think we’re out of time. So I want to thank everybody for joining us. We are very excited about 2014. I think you see even as the world gets more competitive in the textbook space that we’re running our business really efficiently and it’s really a competitive advantage for Chegg versus anybody else in the space.

And we’re excited about the business going forward. We have a really great pipeline of products and services, all in the digital space that we think really do talk to the opportunity that Chegg has. And we’ll continue to be hard work building shareholder value. So we look forward to seeing many of you on the road and to continue to engage you as we go forward. Thanks everybody for joining the call.

Operator

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time and thank you for your participation.

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