2U, Inc. (NASDAQ:TWOU) Q4 2022 Earnings Call Transcript

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The transcript of the earnings call for 2U, Inc.

Operator: Greetings ladies and gentlemen. Today, I will be your conference operator. I would like to invite everyone to the earnings call. A call is being made. I would like to thank you. The conference will be turned over to Steve. You might start.

Steve said thanks to the lady. Please join us for 2U's fourth quarter and full year earnings conference call today. Paul Lalljie is our Chief Financial Officer and Chip Paucek is our Co-Founder and Chief Executive Officer. We will take questions after our comments. A replay of our earnings press release can be found on the Investor Relations website. Statements made on this call may include forward-looking statements, including our financial and operating results, plans and objectives of management for future operations, including our strategic realignment plan, anticipated trends for learners and university partners, and other matters.

The statements are made with care. We have no duty to update any of the forward-looking statements we made on this call. Please refer to the earnings press release and the risk factors described in the documents we filed with the Securities and Exchange Commission, as well as our annual report on Form 10-K for the year ended December 31, 2021, for information on risks, uncertainties and assumptions that may cause our actual results to be different We will discuss non- GAAP financial measures which we believe are useful as supplemental measures of 2U's performance during today's call. The non- GAAP measures should be considered in addition to the GAAP results.

Reconciliations with comparable GAAP results can be found on the Investor Relations page of our website. I am happy to let you know that we will be holding an Investor Day event on March 21 at the New York market site. We are going to give more information about our strategy, business trends, financial performance and our plan for the future. Let's talk to Chip.

Steve, thanks for your kind words. Executing our platform strategy has resulted in meaningful profitability improvements across our business. We ended the year with strong results, including $58 million of adjusted EBITDA for the quarter or growth of 178%), beating our guidance by $10 million. We delivered $125 million of adjusted earnings last year. Unlevered free cash flow became positive. Our team answered the call after we realigned our company and accelerated our platform strategy. The Alternative Credentials segment has delivered $400 million of revenue in the last four years.

The boot camp growth is the main driver of this, with contributions from both consumer and enterprise. As more learners opt for shorter, less expensive and more career specific training, we expect this growth to continue. We think that continued growth will offset the decline in the Degree business. After 6 years of building the business, the Alt Cred segment is expected to cross over into profitability. This is a significant event. Revenue for the top line of our degree business slowed by 3% over the past year. The impact of our new framework on unprofitable spend and a strong labor market increased the opportunity cost of higher education.

We are focused on enabling great outcomes and delivering strong profitability. There are new degree programs and a cooling labor market that we believe will set the degree segment back to top line growth. The response to the new degree offering has been very positive. A lower revenue share for a different bundle of services is included in the flexible offering. Revenue per degree is expected to be between 15% and 20%, on average. These programs are designed to have a low cash burn. In the second half of the 20th century, we launched four full degree programs and began to build a line of new flexible degree offerings.

Both of these are being sold effectively, both full and flex, with a focus on cash flow generation. There will be a similar number of degree programs, 4 or 5 full degrees and a limited number of flex degrees. We plan to launch at least 7 new full degrees, 3 of which have already been signed, and 25 flexible degrees by the year 2024. The launch schedule will help us get the degree segment back to top line growth in the next two years. We combined the edX platform with the core capabilities of 2U just over a year ago. Fast forward to today and we are using an industry-leading platform to offer everything from degrees to boot camps to professional certificates, all in one place and easily accessible to millions of learners around the world regardless of where they are on their learning or career journey.

Proof points are being generated by the combination. Thanks to the power of the edX platform and our overall scale, we are creating a sustainable marketing advantage that should last a long time. Reducing paid marketing spend is part of the plan. The marketing and sales expense as a percent of revenue fell to 34% in the fourth quarter, the lowest it has ever been. Despite lower marketing spend and a strong labor environment, we generated revenue above our expectations even though we reduced paid marketing. 37% of our organic leads in the fourth quarter came from edX.

Our ability to leverage the power of the edX platform and trust in the quality of organic leads give us confidence. We are gaining steam when it comes to learner growth. Increasing high-quality content will attract more learners and more learners will drive more partners who want their content on the edX platform. In order to bring that to life, our community increased by 6 million. The number of people joining in Q4 was 2 million. New and existing partners are helping us grow the catalog. Over 600 free online courses were added to the edX platform after we launched a dozen microcredentials.

The American Psychological Association and the University of California Davis were added to edX during the year 2020. There is some good news for you. The two new members will be announced soon. We are launching innovative in-demand offerings. The Masters of Science in Artificial Intelligence with the University of Texas, Austin, a partner of edX's for the last decade and a top 10 computer science school is an example. This is a great example of a program that addresses a skills gap in our workforce.

For the whole degree, it's only $10,000. Within 48 hours of our announcement, we generated over 3000 organic or free leads through edX. We are excited to announce a new degree with the University of North Carolina at Chapel Hill. A doctorate of education in organizational leadership will be launched by us. There's some news on this call. The University of California Davis is going to offer a Masters of Science in Management degree. We feel good about our ability to grow our learner base and improve our platform with new high-quality content. We are focused on growing our business.

The photo was taken by Chris Montgomery.

Huge progress is being seen here. The company secured new customers and increased enterprise revenue during the year. This part of the business is where we see a lot of potential. The full strategy will be revealed at our upcoming investor day event. There is a quick note on international affairs. Market-specific pricing for our offerings is one of the new tactics we are implementing. We are excited about the potential for adding new content from new partners that appeal to learners outside of the US and Europe. We will be able to generate high margin revenue by utilizing India's infrastructure.

We will drive platform innovation and deliver world-class outcomes proving that high-quality online education can be done well at scale. We are driving to higher and more sustainable profitability due to our new marketing framework which uses the high domain authority of edX and ongoing cost discipline measures, such as managing headcount and third-party spend. We are excited to advance the utility of the edX platform and create shareholder value. The highlights are a range of $155 million to $160 million for adjusted EBITDA with positive EBITDA from our Alternative Credentials segment in the second half of the year and our first ever year of positive levered free cash flow.

There are platforms in education. Our platform strategy is working and we are in a good position to create value for learners, partners and shareholders. Our goal is to drive higher profitability and deliver positive cash flow. I believe that my goal is doable given the positive leverage we are seeing in the business. We are confident about what's to come and look forward to sharing more at our investor day. I will let Paul take care of it.

Thank you, Chip, and good day everyone. We delivered revenue of $236 million and earnings before interest, taxes, depreciation and amortization of $58.4 million in the fourth quarter. The net loss was $11.8 million and the free cash flow was positive at $11.5 million. The early returns of our best-in-class platform are demonstrated by the significant improvements across all of our profitability measures. In the second half of the year, our team responded to a difficult macro environment and delivered, giving us the confidence to deliver strong profits, cash flows and outcomes for our partners. The results for the quarter and the year will be discussed today.

I will give an update on our balance sheet and cash flow, as well as give our thoughts on our financial outlook for 2023. For a better look at revenue. The revenue for the quarter was $236 million, a 3% decrease from the fourth quarter of the previous year. Revenue increased 2% for the full year. Degree segment revenue fell 10% to $137 million in the fourth quarter due to a decline in FCE enrolls, with average revenue per FCE remaining relatively unchanged. Degree segment revenue decreased due to a 2% decrease in FCEs and an average revenue per FCE. In the fourth quarter, revenue increased to $98.9 million, up 8% from the third quarter.

For the quarter, FCEs increased 15% and average revenue per FCE decreased. The strength of coding, cyber, web development and enterprise has led to strong revenue growth from our boot camps. The revenue from legacy edX offerings came in at $5.9 million. Lower revenue per FCE due to geographical pricing strategies drove our ad revenue decline. The revenue of the Alternative Credentials segment increased over the course of the year. The Legacy edX offerings contributed $22 million and the rest of the increase was driven by FCEs. The operating expense for the quarter was $230.6 million, a decrease of $62.7 million from last year's fourth quarter.

The significant improvement was driven by a decline in marketing expenses and a reduction in personnel and related costs. When we acquired edX, we emphasized the value creation potential from improved marketing and sales efficiency due to edX's large global audience and massive library of educational content. We are beginning to see this pay off with an increasing percentage of organic leads coming from edX and these leases have a greater propensity to purchase. Marketing and sales accounted for 45% of revenue in the fourth quarter of 2021.

We identified enterprise as a key growth opportunity when we acquired it. We increased our enterprise revenue by 81%. On a year-over-year basis, enterprise revenue grew in the fourth quarter. The stock-based compensation expense for the quarter was $17.5 million, down from the fourth quarter of the previous year. The restructuring charges related to the strategic realignment plan were recorded during the quarter. Profitability measures need to be looked at. The adjusted earnings before interest, taxes, depreciation and amortization increased 178% to $58.4 million, a margin of 25% compared to the fourth quarter of last year. The strategic realignment plan accelerated our platform strategy and resulted in a significant increase in adjustedEBITDA.

The seasonal decline in marketing spend helped us with our fourth quarter adjustedEBITDA. Lower operating expense and lower transaction and integration expense resulted in an improvement in the company's net loss for the third quarter. The Degree segment's segment profitability was $60.5 million, a margin of 44%, compared to $39.4 million in the fourth quarter of the previous year. The segment loss for the Alternative Credentials segment was $2.1 million, compared with a segment loss of $18.6 million in the fourth quarter of the previous year. This segment is expected to be profitable on anEBITDA basis for the full year in 2023. The balance sheet and cash flow statement are topics to discuss.

We ended the year with cash and cash equivalents of $182 million, a decline from the third quarter. Unlevered free cash flow was $11.5 million for the 12 months ending December 31, 2022, an improvement of 45% compared to the 12 months ending December 31, 2021. $567 million of term loan and $380 million of senior convertible notes were included in gross debt. We were able to improve our credit profile by changing our term loan. The maturity date was extended by 2 years and we paid off some of the outstanding balance. The term loan was reduced by $187 million thanks to the use of $104 million from the balance sheet and the issuance of new senior convertible notes.

We have gross debt of $914.2 million, which includes a $380 million term loan and two different types of convertible notes. Cash interest savings from this transaction are expected to be $10 million annually. Three objectives were achieved by these transactions. We lowered our secured debt to $380 million, a reduction of nearly one full turn. We pushed out the maturities of our debt. The majority of our debt will mature in the next 20 years. A $40 million revolving credit facility has been put in place. I'm proud of the team for getting this transaction across the finish line in a difficult macro environment and for being able to focus on executing on our plan.

We are still looking for ways to further balance sheet maximization. There is a discussion of the guidance in the years to come. Our guidance calls for adjusted EBITDA to be between $150 million and 160 million, representing growth of 26%. For revenue, which we view as an output for our model, we expect revenue to range from $985 million to $995 million. The net loss is expected to be between 95 million and 90 million. Underlying our outlook is a change in the financial profile of our business as we expect Alternative Credentials revenue to grow to nearly half of the consolidated revenue. As we add more programs, including flexible degrees, and as macroeconomic factors move in our favor, we believe this change will give us flexibility in continuing, positioning our Degree business for accelerated profitability.

We expect sequential revenue growth every quarter and year-over-year growth in the second half of the year. We expect to reduce stock-based compensation to $70 million from $80 million in 2022. Capital expenditures are expected to be $65 million compared to $75 million in 2022. The acceleration of our platform strategy and strategic realignment plan resulted in a nice finish to the year for us. This year, we expect to build on that success to deliver strong adjustedEBITDA, which is a growth of 26% and positive free cash flow as we set up 2024 for profitable top line growth

Let me return the call to chip.

Thank you, Paul. I would like to say how proud I am of the entire team for their constant focus and dedication in delivering outstanding results this year. Strategic realignments are hard. The team stayed focused on what matters most, doing what's best for universities and their students, even though they delivered. I will return it to the operator for Q&A.

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