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

2U, Inc. (NASDAQ:TWOU) Q4 2022 Earnings Call Transcript February 2, 2023

Operator: Ladies and gentlemen, good afternoon. My name is Abby and I will be your conference operator today. At this time, I would like to welcome everyone to the 2U Inc. Fourth Quarter and Full Year 2022 Earnings Call. Today’s call is being recorded. Thank you. And I will now turn the conference over to Steve Virostek, Head of Investor Relations. You may begin.

Steve Virostek: Thanks, Abby. Good afternoon, everyone and welcome to 2U’s fourth quarter and full year 2022 earnings conference call. Joining me on the call this afternoon are Chip Paucek, our Co-Founder and Chief Executive Officer; and Paul Lalljie, our Chief Financial Officer. Following our prepared remarks, we will take questions. Our earnings press release and slide presentation are available on the Investor Relations website and a replay of this webcast will be made available later today. 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, the integration of edX and transition to a platform company, anticipated trends for learners and university partners, and other matters.

These statements are subject to risks, uncertainties and assumptions. Any forward-looking statements made on this call reflect our analysis as of today and we have no plans or duty to update them. Please refer to the earnings press release and to the risk factors described in the documents we filed with the Securities and Exchange Commission, including our annual report on Form 10-K for the year ended December 31, 2021 and other SEC filings for information on risks, uncertainties and assumptions that may cause our actual results to differ materially from those set forth in such statements. In addition, during today’s call, we will discuss non-GAAP financial measures which we believe are useful as supplemental measures of 2U’s performance. These non-GAAP measures should be considered in addition to and not a substitute for or in isolation from GAAP results.

You can find additional disclosures regarding these non-GAAP measures, including reconciliations with comparable GAAP results in our earnings press release and on the Investor Relations page of our website. Before handing the call to Chip, I am pleased to share that our plans for an Investor Day event on March 21 at the NASDAQ market site in New York. We are planning to provide additional details and insights about our strategy, business trends, financial performance and our roadmap for future value creation. With that, let me hand the call to Chip.

Chip Paucek: Thanks, Steve. Executing our platform strategy drove meaningful profitability improvements across our business and it’s creating opportunities to accelerate our profitable growth trajectory. We concluded 2022 with strong results, including $58 million of adjusted EBITDA for the quarter or growth of 178%, beating our guidance by nearly $10 million. For the full year, we delivered $125 million of adjusted EBITDA or growth of 88%. In addition, unlevered free cash flow turned positive. These excellent results were made possible by our team, who answered the call after we made a midyear decision to accelerate our platform strategy and realign our company. Our Alternative Credentials segment is doing very well, delivering almost $400 million of revenue in 2022.

This is driven primarily by boot camp growth of 18% versus the prior year, with contributions from both consumer and enterprise. We anticipate this growth will continue as more learners opt for shorter, less expensive and more career specific training to reach that next job, promotion or bump in salary. And we expect that continued growth will offset the near-term declines in the Degree business. Most notably, in 2023, we expect the Alt Cred segment to cross over into profitability for the first time after 6 years of building that business. This is a big deal. No more €œempty calories.€ Looking at the top line of our degree business for 2022, revenue slowed by 3% year-over-year to $572 million. We saw the near-term impact of our new marketing framework, which reduced unprofitable spend combined with a strong labor market that increased the opportunity cost of higher education.

However, we remain focused on enabling great outcomes, delivering strong profitability and signing new degree programs. We believe that these new degree programs and a cooling labor market will setup the degree segment to return to top line growth in 2024. Client satisfaction is high and the response to the new flexible degree offering has been great. As a reminder, the flexible offering includes a lower revenue share for a different bundle of services, including very limited paid marketing and no CapEx for course build. We expect revenue per degree for those to be 15% to 20% on average of the revenue generated for our full degrees. However, these programs are designed to have minimal cash burn and similar profitability. For year-on-year comparisons, we launched four full degree programs in 2022 and began building a pipeline of new flexible degree offerings in the second half.

We are selling both of these effectively, both full and flex with a greater focus on cash flow generation. While in 2022 and 2023, we launched or expect to launch a similar number of degree programs, 4 or 5 full degrees and a limited number of flex degrees. In 2024, we expect to increase that sizably, launching at least 7 new full degrees, 3 of which have already been signed and 25 flexible degrees. We believe this robust launch schedule will help us get the degree segment back to top line growth in 2024 and more momentum in 2025. Taking a broader look, it’s been just over a year since we combined the edX platform with the core capabilities of 2U, including our digital marketing expertise, scale and services. Fast forward to today and we are leveraging an industry-leading platform offering everything from degrees to boot camps to professional certificates to free courses, 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.

The combination is generating tangible proof points. We are driving meaningful cost efficiencies, thanks to the power of the edX platform and our overall scale, which should create a sustainable marketing advantage long-term. More specifically, this means reducing paid marketing spend while growing organic inflow. On Slide 10 of the earnings deck, you will see that marketing and sales expense as a percent of revenue declined to 34% in the fourth quarter, the lowest it’s ever been. In 2022, we reduced paid marketing by $47 million when compared to 2021 and we generated revenue above our expectations despite lower marketing spend and a strong labor environment. Our organic lead generation from edX is strong, accounting for 37% of organic leads in the fourth quarter.

The quality of organic leads provides confidence in the sustainability of our marketing efficiencies and our ability to leverage the power of the edX platform to drive enrollments. When it comes to learner growth and new content, we are gaining momentum. Put differently, we are in the early stages of igniting the flywheel or the premise that increasing high-quality content will attract more learners and more learners will drive more partners who want their content on the edX platform. To bring that to life our learner community increased by nearly 6 million during 2022 to 48 million at year end. 2 million learners joined in Q4 alone. On the content side, we are growing the catalog with the help of both new and existing partners. In 2022, we launched a dozen micro credentials and our partners added over 600 free online courses to the edX platform.

We also added 16 members to edX during 2022, including the American Psychological Association, Baylor University, Oracle, Russell Sage College, the University of California Davis and Wesleyan University. We have some news for you. Pepperdine and Lehigh just joined and will be announced shortly. We are expanding our relationships with current partners to launch innovative in-demand offerings. A great example from last week is the disruptively priced 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. This is a near perfect example of a well-timed, relevant and accessible program that addresses a large and growing skills gap in our workforce.

It’s also only $10,000 for the entire degree. As a real-time proxy for interest, within 48 hours of our announcement, we generated 3,400 organic or free leads all through edX. In addition to UT, this week, we are excited to have announced a new full degree with our longstanding partner, the University of North Carolina at Chapel Hill. We will be launching a Doctorate of Education in Organizational Leadership. We also have some news on this call. We have signed a contract to launch a new flexible degree with the University of California Davis, a Masters of Science in Management. Overall, we feel really good about our ability to grow our learner base and our ability to continue to enhance our platform with new high-quality content. We also remain focused on continuing to grow our enterprise business.

Photo by Chris Montgomery on Unsplash

We are seeing tremendous progress here. During 2022, enterprise revenue increased 86% versus the prior year, while securing new customers and building a pipeline of opportunities. We see a lot of potential here and are leaning heavily into this part of the business. Investors have high appetite here and we will unveil the full strategy at our upcoming Investor Day event in March. A quick note on the international front. As we look for ways to expand our geographic reach, we are implementing new tactics such as market-specific pricing for our offerings. In addition, we are excited about the potential for adding new content from new partners like Emeritus that appeal to learners outside the United States and Europe. Beginning with India, we will leverage their infrastructure and localization to generate high margin revenue.

We will also continue to improve and differentiate the learner experience, drive platform innovation and deliver world-class outcomes proving that high-quality online education can be done well at scale. And finally, as promised, we are driving to higher and more sustainable profitability due to our new marketing framework, which leverages the high domain authority of edX, our strategic realignment completed last summer and ongoing cost discipline measures, such as managing headcount and third-party spend. Looking forward, we are excited about our plans and opportunities to advance the utility of the edX platform while creating both learner and shareholder value. Paul will cover the 2023 outlook in more detail, but the highlights are a range of $155 million to $160 million for adjusted EBITDA with positive EBITDA from our Alternative Credentials segment in the back half of the year and our first ever year of positive levered free cash flow.

Platforms are the future of education. We are confident that our platform strategy is working and that we are well positioned to create value for learners, partners and shareholders. By executing our strategy, we are focused on driving higher profitability and delivering positive cash flow. My goal is to deliver positive EPS during 2024, a goal, I believe, is achievable given the positive leverage we are seeing in the business. Transformation isn’t easy, but we are confident about what’s ahead and look forward to sharing more in March at our Investor Day. With that, I will turn it over to Paul.

Paul Lalljie: Thanks, Chip and good afternoon everyone. As you have seen from our press release, we had a strong finish to the year, delivering revenue of $236 million and EBITDA of $58.4 million in the fourth quarter. Net loss came in at $11.8 million and free cash flow on a trailing 12-month basis was a positive $11.5 million. The significant improvements across all of our profitability measures demonstrate the early returns of our best-in-class platform and organizational realignment. Our team responded to a difficult macro environment and delivered, particularly in the second half of the year giving us the confidence to deliver strong profits, cash flows and outcomes for our partners in 2023. Today, I will discuss our results for both the quarter and the year.

Then I will provide an update on our balance sheet and cash flow, including recent financing activities and conclude with our thoughts on our financial outlook for 2023. Now for a closer look at revenue. Revenue for the quarter totaled $236 million, down 3% from $243.6 million in the fourth quarter of 2021. For the full year, revenue grew 2% to $963.1 million from $945.7 million. Degree segment revenue decreased 10% to $137.1 million for the fourth quarter reflecting a 9% year-over-year decline in FCE enrollments, with average revenue per FCE remaining relatively flat. On a full year basis, Degree segment revenue decreased 3% to $571.6 million, driven by a 2% decrease in FCEs and average revenue per FCE. The Alternative Credentials segment continued to deliver strong revenue growth in the fourth quarter, with revenue increasing to $98.9 million, up 8%.

FCEs for the quarter increased 15% and average revenue per FCEs declined 11% over the prior year. We continue to experience strong revenue growth from our boot camps, which grew 18% on a year-over-year basis on the strength of coding, cyber, web development and enterprise. Revenue from legacy edX offerings contributed $5.9 million for the quarter. Our exec ad revenue declined 11% year-over-year, driven by lower revenue per FCE due to geographical pricing strategies. On a full year basis, the Alternative Credentials segment revenue increased 11% to $391.5 million. Legacy edX offerings contributed $22 million and the remaining increase was driven by a 9% increase in FCEs. Turning to operating expenses, operating expense totaled $230.6 million for the quarter, a decrease of $62.7 million or 21% compared to last year’s fourth quarter.

This significant improvement was primarily driven by a $26.3 million decline in paid marketing expense and a $24.2 million reduction in personnel and related costs associated with headcount reduction and lower performance-based compensation. As Chip mentioned earlier, when we acquired edX, we emphasized the value creation potential from improved marketing and sales efficiency due to edX’s large global audience, a massive library of educational content and brands with consumer and Google credibility. 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, driving higher conversion rates. As a result, marketing and sales as a percent of revenue declined to 34% from 45% in the fourth quarter of 2021.

Also at the time of acquisition, we identified enterprise as a key growth opportunity. And in 2022 we increased our enterprise revenue by 86% to $44.8 million. In the fourth quarter, enterprise revenue grew 183% on a year-over-year basis. Stock-based compensation expense for the quarter totaled $17.5 million, down $5.5 million or 24% from the fourth quarter of 2021, primarily due to headcount reductions. During the quarter, we recorded $4.1 million in restructuring charges related to the 2022 strategic realignment plan, bringing the total to $33.2 million for 2022. Turning to profitability measures. Adjusted EBITDA for the quarter increased 178% to $58.4 million, a margin of 25% compared to a margin of 9% for last year’s fourth quarter. This significant increase in adjusted EBITDA was primarily the result of accelerating our platform strategy and executing the strategic realignment plan.

Our fourth quarter adjusted EBITDA also benefited from the typical seasonal decline in marketing spend. Net loss for the quarter totaled $11.8 million, an improvement of $55.4 million from last year, primarily due to lower operating expense and lower transaction and integration expense. Segment profitability or adjusted EBITDA for the Degree segment came in at $60.5 million, a margin of 44% compared to $39.4 million in the fourth quarter of 2021. For our Alternative Credentials segment, segment loss or adjusted EBITDA loss came in at $2.1 million compared with a segment loss of $18.4 million in the fourth quarter of 2021. In light of this trend, we expect this segment to be profitable on an EBITDA basis for the full year 2023. Now for a discussion of the balance sheet and cash flow statement.

We ended the year with cash and cash equivalents of $182.6 million, a decline of $2.6 million from the third quarter of 2022. And we delivered unlevered free cash flow of $11.5 million for the trailing 12 months ending December 31, 2022, an improvement of $45.4 million compared to the 12 months ending December 31, 2021. Gross debt at year end totaled $953.8 million, including $567 million of term loan and $380 million of senior convertible notes. In January, we significantly improved our credit profile by refinancing our term loan. We paid off a portion of our outstanding balance and extended the maturity date by 2 years. We used $104 million from the balance sheet and the proceeds from the issuance of new senior convertible notes to reduce the term loan by $187 million.

After this transaction, we have gross debt of $914.2 million, including a $380 million term loan and $527 million of two tranches of senior convertible notes. On a steady-state basis, we expect cash interest savings from this transaction to be approximately $10 million per year. These financing transactions achieved three objectives. First, we reduced our secured debt to $380 million, a secured debt leverage ratio of 1.9x 2023 EBITDA guidance, a reduction of nearly one full turn. Second, we pushed out the near-term maturities of our debt. Nearly 60% of our total debt now matures in 2026 and beyond. And third, we’ve put in place a revolving credit facility of $40 million to manage working capital. These activities enable us to focus on executing on our plan, and I’m proud of the team for getting this transaction across the finish line in a difficult macro environment.

We remain opportunistic with respect to further balance sheet optimization. Now for a discussion of the 2023 guidance. Our guidance for 2023 calls for adjusted EBITDA to range from $155 million to $160 million, representing growth of 26% at the midpoint. For revenue, which we view as an output for our model, we expect revenue to range from $985 million to $995 million, reflecting the market trends that Chip described. We expect net loss to range from $95 million to $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 and deliver positive adjusted EBITDA in 2023. We believe this change will provide flexibility in continuing, positioning our Degree business for accelerating profitability €“ profitable growth in 2024 and beyond as we add more programs, including flexible degrees and as macroeconomic factors move in our favor.

Concerning revenue pacing for 2023, we expect sequential revenue growth every quarter, while year-over-year growth is expected to return in the second half. In addition, as we continue to focus on net loss for 2023, we expect to reduce stock-based compensation to $70 million compared to $80 million in 2022. We also expect capital expenditures of $65 million versus $75 million in 2022 and weighted average shares outstanding of 82 million. To conclude, the acceleration of our platform strategy and the strategic realignment plan in 2022 resulted in a nice finish to the year particularly in our profitability. This year, we expect to build on that success to deliver strong adjusted EBITDA, which is a growth of 26% and positive free cash flow as we set up 2024 for profitable top line growth.

And with that, let me hand the call back to Chip.

Chip Paucek: Thanks, Paul. Before we open it up to Q&A, I’d like to take a quick moment to say how proud I am of the entire team for their unwavering focus and dedication in delivering outstanding results this year. Strategic realignments are never easy. The team not only delivered but did so while staying maniacally focused on what matters most, doing what’s best for universities and their students. With that, I’ll turn it back to the operator for Q&A.

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Q&A Session

Operator: Thank you. And we will take our first question from Ryan MacDonald with Needham. Your line is open.

Ryan MacDonald: Hi, thank you for taking my question and congrats on a great quarter.

Chip Paucek: Thanks, Ryan.

Ryan MacDonald: Maybe this is for Chip and Paul. As you think about the degree launch cadence, interesting to hear of the 7 to 8-degree €“ full degrees or sevenfold degrees and then 25 flex degrees. First, Chip, how do you expect sort of enrollments to trend or to progress on the new flex degrees given the attractive price point? And then for Paul, perhaps you can talk about sort of just to remind us on the investments upfront required to launch the flex degrees relative to the full?

Chip Paucek: No problem, Ryan. So yes, flex is going incredibly well. We still have a good number of full and as you heard, we expect full to not quite double year-on-year once you get to €˜24, but going from 4 or 5 to 7, and we still have plenty of folks interested in that offering. Flex is a great response to the market. And we think that, that 25 is realistic. You heard me mention for the first time that we think it’s roughly 15% to 20% from the standpoint of what these programs will look like on a revenue basis, which you can apply on an enrollment basis. We’re obviously not doing paid marketing in every one of those cases. It’s notable that if you look at the flexible offering, while it starts at 35% and has a very limited amount of high intent marketing, mostly organic.

If you add €“ if a client chooses to add paid marketing for an additional 15%, the programs will be a lot bigger. So TBD in terms of what percentage of overall flex, we will have the additional marketing in it. A lot of that depends on the desire of the school, interest in scaling the program. One of the great things about the flex offering is not every school wants to scale its programs. Many of the schools want to go online and offer high quality to their student base without scaling the program. And in the past, that would have been very problematic for 2U. And therefore, we wouldn’t be able to launch those programs. And in this model, we can really work with the clients and allows us to just launch many more degrees. And we think over time that should get really attractive for the segment.

As you know, with our Degree business, if it goes down or up, it takes time to feel it through the financials. So we’re excited about what that could mean for €˜24 growth. In addition to getting to 25%, and we do think, overall, the macro should start to favor Degrees more. It’s notable that while our Degree business declined and we expect it to decline this year, if you look across the space, ours held up, we think, better than most. We think our Degree business is pretty resilient. So ultimately, being able to offer quality to our partners, high-quality outcomes to the learners, which is kind of table stakes for 2U and a model that ultimately gives greater flexibility to the university partner. We didn’t announce it until whatever it was 6 months ago, and it’s very €“ creating a very attractive pipeline.

So pretty strong.