2U, Inc. (NASDAQ:TWOU) Q4 2023 Earnings Call Transcript February 12, 2024

2U, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by, and welcome to the 2U, Inc. Fourth Quarter 2023 Earnings Call. I would now like to welcome Steve Virostek, Senior Vice President of Investor Relations to begin the call. Steve, over to you.

Stephen Virostek: Thank you, Mandeep, and good afternoon, everyone. Welcome to 2U's fourth quarter 2023 earnings conference call. Joining me on the call this afternoon are Paul Lalljie, Chief Executive Officer; and Matt Norden, Chief Financial Officer. We will share our prepared remarks and follow it by questions. But first, I'd like to cover a few housekeeping items. 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. Commentary made on this call will include forward-looking statements regarding our financial and operating results, plans and objectives of management for future operations, including our performance improvement initiatives plans and ability to refinance our debt, anticipated trends for learners and university partners, changes in laws, regulations and agency guidance for our industry 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 the risk factors described in the documents filed with the Securities and Exchange Commission, including our annual report on Form 10-K for the year ended December 31, 2022, 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 as 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. With that, let me hand the call to Paul.

Paul Lalljie: Thank you, Steve, and good afternoon, everyone. I step into the CEO role with immense pride and a sense of profound responsibility. Over the past four years, I've been privileged to witness firsthand how we impact lives with the educational offerings we power. Now it's time to sharpen our focus on fundamentals to develop financial resilience while continuing to deliver on our mission. In the last two months, I've delved into the intricacies of 2U viewing our operations through a new lens and with a broader remit, identifying our strengths and recognizing opportunities for further improvement. Today, I will share some of my observations acknowledging that we are in the early stages of this journey. 2U has a distinctive leadership position in the education sector, backed by a robust network of university partners expansive global reach and the team whose industry acumen is unmatched.

The top line growth that we've enjoyed in the past has been no fluke. We have consistently worked to ensure alignment between market needs and our offerings. Now we need to focus on refining our business model to ensure we are not just delivering the most in-demand offerings but doing so efficiently. My immediate focus has been to strengthen bonds with our internal team and external partners, engaging in meaningful conversations to set a new course and move to execute it quickly. We've embraced transparency and accountability, delineating our business into two distinct lines with each dedicated leadership to ensure full accountability. But before I get into the details, the most important thing we want you to hear from us today is that we know we need to improve our performance and to do it quickly.

We must increase our EBITDA margin in order to generate stronger cash flows. This will support our plan to extend our debt maturities in the short term and achieve our long-term goal of profitable revenue growth. Therefore, we need to adopt a shrink-to-grow mindset and take the necessary measures to date, to set ourselves up for success long term. We started 2024 with a clear sense of our objectives, which I'll walk you through today. But before we talk about where we're going, let's first look at how we got here. In 2023, we took some initial steps to reduce cost and to make our marketing strategies more efficient. Throughout the year, these improvements resulted in $90 million of savings on a run rate basis. We also introduced four new lower-price degree offerings, reimagine our content delivery process for further efficiency and added some key members to our management team.

These actions are crucial for our future success. In addition to these accomplishments, 2023 provided many takeaways that should inform our path forward. While it's not helpful to Monday morning quarterback, I believe our organizational structure and strategic alignment will allow us to respond more quickly to market demands going forward. And I want to reiterate that our approach to growth will not compromise our profitability. We're committed to making the best strategic decisions for the business and will practice radical transparency in explaining these decisions and their impact on the business. We won't dwell in the past. We will carry forward our strengths but recognize that change is necessary at this juncture. As my leadership team has heard me say repeatedly, we'll be doing a lot of things differently.

Now for a discussion of where we're going. We plan to focus on three areas: product, cash and organization to drive profitable growth, increase EBITDA margins and cash flows and shift towards a more cost-efficient model. I'll now add some color to each of these areas, starting with product. We have refined our approach to selecting degree programs by adopting a more rigorous criteria that prioritizes profitability and aligns with the proven strengths of our marketing and operational strategies. As a result, we are revising our launch cadence to 60 programs for 2024. For new degrees that we expect to sign in 2024 and the launch in 2025, we are focusing on licensure and STEM verticals. Our new framework is designed to ensure chosen programs embody the essential characteristics of success, including competitive pricing, strong organic appeal and minimal capital requirements.

All of which should result in strong contribution margins and cash flows. This focus will enhance our overall portfolio and aligns with our commitment to deliver high quality and market relevant education. For alternative credentials, we plan to improve the delivery model with a focus on efficiency. We will consider adding a asynchronous and non-cohort-based learning options to give learners the flexibility they desire. We will align program start dates and content creation cadence to leverage resources more effectively. We believe these efforts will drive efficiency in the business and help us expand our reach. Next, cash. We will continue to prioritize marketing effectiveness. Our first step was to set and maintain high hurdle rates for paid marketing.

Now we will work on utilizing AI and automation to increase the number of leads generated and ultimately converted. Progress will be measured by an increase in conversion rates across key marketing channels. We have also identified several areas for potential improvement. For example, in light of the new organizational structure, we will review all functions to eliminate redundant costs and will automate repeatable back-office processes and consider outsourcing or offshoring where appropriate. Our operational improvements will be geared towards reducing fixed costs, ensuring flexibility and scalability. We believe these efforts will result in a business that can consistently generate sufficient cash to fund operations and will support the discussions with our lenders to reach a resolution on extending our debt maturities.

Moving on to organization. At an organizational level, we now have a structure that reflects our focus on alignment, accountability and efficiency. There are eight business leaders who report to me, including a head of marketing, two lines of business heads, a head of technology and three G&A function leads. Our aim is to foster strategic alignment across the company guided by a culture of curiosity. We'll rely on objective data to make decisions, prioritize high-caliber talent and embrace radical transparency. Our strategy based on these three objectives, will help us pursue a shrink to grow approach in the short term and with a clear vision of the future of the company. It is important to note that the initiatives we are discussing today are just the beginning.

We will continue to evolve and develop our plan for the long term over the coming months. Before I turn things over to Matt, I want to briefly discuss our results for the year. Our revenue for 2023 was approximately $946 million with an adjusted EBITDA of around $170 million. It is worth noting that $88 million of this revenue came from exiting certain degree programs or portfolio management. We do not expect to have additional portfolio management activities in 2024. We are optimistic about our degree business and expect enrollment to grow this year by single digits looking at the current portfolio. We also expect that our 2024 launches will generate up to $100 million in revenue at steady state, which is between 2.5 to 3.5 years from launch.

We expect our executive education business to continue its strong growth while we will continue to manage the coding boot camp business reflect the current demand levels. We anticipate that coating boot camp environment will continue to remain in its current state throughout 2024. Furthermore, we expect our enterprise business, which includes both executive education and boot camps to continue its strong growth. However, it is a lumpy business, and we are setting realistic expectations at the outset of the year. To summarize, I'd like to emphasize the important points we discussed today. We are committed to facing our current challenges head on. We're taking bold steps to reduce expenses and improve our performance quickly. in order to extend our debt maturity as soon as possible.

To all of our stakeholders, partners, employees, equity holders and debt holders, we're embarking on a 12-quarter journey to reset and enhance our operations. And we need your support in this journey. We are committed to earning that support quickly, and I believe that we will become a stronger company. With that, let me turn the call over to Matt.

Matthew Norden: Thanks, Paul, and good afternoon, everyone. Before walking through the results, I'd like to say how honored I am to step into Paul's shoes to lead the world-class finance team that he built. And to work with Paul and the entire team even more closely on making 2U the resilient and sustainable company we know it can be. While we have a lot to do ahead of us, I'm confident that the operating plan that Paul mentioned, which is rapidly progressing, will set us up to fix the balance sheet and deliver profitable growth in the future. With that, let's get started. I'll begin by walking through our fourth quarter and [Audio Gap]

Operator: We are experiencing technical difficulties and will resume momentarily. Audios back. I just want to confirm speakers.

Paul Lalljie: Yes.

Matthew Norden: Where did we drop?

Operator: Roughly about 15 to 20 seconds just as you're beginning your...

Matthew Norden: Apparently, we were having some technical difficulties, so I'm going to start over. Apologies if this is duplicative for anybody. Thanks, Paul, and good afternoon, everyone. Before walking through the results, I'd like to say how honored I am to step into Paul's shoes to lead the world-class finance team that he built and to work with Paul and the entire team even more closely on making 2U the resilient and sustainable company that we know it can be. While we have a lot to do ahead of us. I'm confident that the operating plan that Paul mentioned, which is rapidly progressing, will set us up to fix the balance sheet and deliver profitable growth in the future. With that, let's get started. I'll begin by walking through our fourth quarter and 2023 full year results.

Then I'll discuss our outlook for 2024, along with some key assumptions underlying our expectations. Starting with revenue. In Q4, we generated total revenue of $255.7 million, up 8% from $236 million a year ago. This increase was driven by 19% growth in the degree segment, partially offset by a 7% decline in off cred. The growth in the degree segment included $54.6 million of revenue recognized from portfolio management activities in the quarter. Note that this is approximately $25 million less than we expected at the time of our Q3 call as we decided not to move forward with certain portfolio management opportunities given that we were able to make the necessary course corrections in those programs while continuing to run them. Alt Cred revenue in the fourth quarter was impacted by similar factors to those we experienced in the third quarter, continued softness in boot camps, particularly coding, and we saw continued strength in our exec ad offerings driven by particularly strong performance in our AI offerings, a trend that has continued into 2024.

Looking at the full year, revenue was $946 million, a 2% decline from $963.1 million in 2022. Of this, degree segment revenue of $561 million decreased $10.6 million or 2% when compared with the prior year and included $88 million of portfolio management related revenue. In 2023, our portfolio management activities introduced complexities when comparing year-over-year performance within our degree segment. To gain a better perspective on the segment's performance, we recommend evaluating the segment excluding the impact of portfolio management. This analysis reveals that our current portfolio of programs generated $389.9 million in revenue, which is a 9% decrease compared to the full year of 2022. The primary factor behind this decline is a high number of graduates from some of our larger programs that were launched during the pandemic, which surpassed the number of new student enrollments in these programs.

However, as I'll discuss more when we get into our outlook, we are observing positive trends in key leading indicators, especially in new student enrollments. We anticipate these trends to start positively impacting our revenue in the latter part of this year and continue into 2025. Alt Cred segment revenue of $384.9 million decreased $6.6 million for the year or 2% over 2022, driven by similar factors that we saw in Q3. Moving on to operating expenses. In 2023, we took initial steps towards optimizing our cost structure, focusing our marketing activities on more efficient spend and eliminating $90 million of run rate costs. You'll see the impact of these actions in our results. Operating expense for the fourth quarter, excluding a $62.8 million noncash impairment charge was $215.4 million, a 7% decrease over Q4 of 2022.

This decrease was primarily driven by a $27.2 million decrease in personnel and personnel-related expense, which included a $13.8 million decrease in stock compensation expense. We also saw continued improvement in our marketing and sales expense for the fourth quarter. As a percent of revenue, marketing and sales declined to 31% from 34% in the prior year period. During the quarter, we also recorded $13.7 million in restructuring charges. Regarding the impairment charge, as a result of our stock price performance in the quarter and refinement of our long-term financial projections, we determined that an interim impairment assessment was necessary. This evaluation led to a $62.8 million reduction of goodwill. For the full year, operating expense, excluding noncash impairment charges, was $974.9 million, a decrease of $108.1 million or 10% over 2022.

Turning now to our profitability measures. Net loss for the quarter totaled $42.4 million compared to $11.8 million in the fourth quarter of 2022, reflecting the revenue and operating expense drivers I mentioned previously. Adjusted EBITDA for the quarter increased 54% and to $90.2 million, a margin of 35%. This was largely driven by the same factors that I mentioned earlier. Portfolio management revenue of $54.6 million, flowing mostly to the bottom line and the benefit of our cost optimization activities executed throughout the year. Fourth quarter adjusted EBITDA also benefited from the seasonal decline in marketing spend, which is a typical pattern for our business. Net loss for the year totaled $317.6 million compared to $322.2 million in 2022.

And adjusted EBITDA for the year was $170.8 million, an improvement of 37% over 2022. Looking at profitability by segment. Degree segment adjusted EBITDA was $90.7 million for the quarter, a margin of 56% and compared to a margin of 44% in the fourth quarter of 2022. For the Alt Cred segment, adjusted EBITDA loss was $553,000 compared with a loss of $2.1 million in the fourth quarter of 2022. For the full year, degree segment adjusted EBITDA was $214.7 million, a margin of 38% compared to a margin of 32% in 2022. For the Alt Cred segment, adjusted EBITDA loss was $43.9 million compared with a loss of $55.6 million in 2022. Now let's turn to the balance sheet and cash flow statement. We ended the year with cash and cash equivalents of $73.4 million, including a $40 million drawdown of our revolver, which was needed to manage fluctuations in working capital.

We delivered adjusted unlevered free cash flow of $45.2 million for the 12 months ending December 31, 2023, compared to $31.9 million for the 12 months ending September 30, 2023. From a liquidity standpoint, I want to highlight that in late January, we entered into a receivables factoring arrangement to sell up to $86.2 million of receivables related to our portfolio management activities. We have already sold $75.9 million of these receivables for proceeds of $66.7 million. We have also kicked off working capital improvement initiatives to further enhance liquidity. When combined with the approximately $73.4 million we had in cash on hand at the end of Q4, these actions should put us in a strong liquidity position to operate the business going forward.

Before I discuss our outlook, as you may have seen in our press release today, we expect to have a going concern qualification in our upcoming 10-K due to potential and pending maturities of our term loan. We expect to continue to have a constructive dialogue with our lenders to find the best solution to position 2U for the long term. Also, we are in active discussions with our term loan lenders to reduce our recurring revenue covenant in exchange for paying down a portion of the term loan. We expect to enter into an amendment to our credit agreement reflecting these changes in the coming weeks. And I want to reiterate that we are taking aggressive action to optimize cash and enhance liquidity. We are laser-focused on addressing our balance sheet and are confident that we can resolve our debt maturities in the near term.

We look forward to providing updates as appropriate. Now turning to our financial outlook. Please note that we are adjusting our guidance practices to give guidance for the first quarter and full year 2024. Our guidance for the first quarter calls for revenue to range from $195 million to $198 million. For the year, we expect revenue to range from $805 million to $815 million. We expect adjusted EBITDA for the first quarter to range from $10 million to $12 million and from $120 million to $125 million for the year. I now want to provide some insight into the assumptions underlying our outlook, the composition and pace of the business and ongoing trends in the education industry. This should help you better understand how we're viewing the future and our go-forward plan.

First, at this time, our outlook does not take into account the impact of the operating plan that Paul mentioned, which is rapidly progressing. Early in 2024 and building on the initial actions we took last year, as Paul mentioned, we began digging into our business to identify areas for cost optimization and operational improvement across the board. That process is still underway, and we expect to have a fulsome plan ready to implement early in the second quarter. Our guidance could change materially depending upon the outcome of that plan but again, it's not included in what we've shared today. Second, to help you bridge our first quarter and full year guidance. We expect Alt Cred revenue to be more heavily weighted towards the back half of the year with a larger number of exec had courses occurring later in the year and enterprise deals executed in the first half of the year, delivering revenue later in the year.

On the degree side, I wanted to quickly remind you of the typical economics of the segment. Most of the revenue in a given period will come from marketing dollars spent seven to 12 months prior and new programs typically contribute very little revenue in their early operating quarters. Given that dynamic and given that most of our revenue from the degree segment this year will come from existing programs, at this time, we have visibility into well over 50% of revenue for the year. But on top of that, 39 of the new programs we expect to launch in 2024, our takeovers from another provider with students currently enrolled. As a result, we have better visibility into the revenue impact these programs will have once students enroll later in the year.

All this gives us confidence in the degree segment's trajectory for the year. It's also important to keep in mind these degree segment dynamics when thinking about our Q1 EBITDA expectations, which at the midpoint of our current ranges reflects an EBITDA margin of around 6%. Given that our expected new degree launches are back-end weighted in the year, we have already begun spending marketing dollars to find students for these programs with adjusted EBITDA in Q1. More specifically, we expect to spend $23 million on new program launches in 2024 with $5 million of that coming in Q1, but with no corresponding revenue. However, we expect to get the revenue and EBITDA benefits from those students later in 2024 and more so into 2025. Also, Q1 is typically our highest quarter from a marketing spend standpoint, as we spend to find students for already operating programs.

1/3 of our annual marketing expense is typically incurred in the first quarter of the year. This also impacts EBITDA in Q1, again, with an expected increase in revenue and EBITDA as students' progress through their classes throughout the year. We also expect the cost optimization activities completed and currently underway, have an increasing benefit as we proceed throughout the year. We expect that all of this will cause EBITDA to increase throughout the year, with approximately 70% of our full year EBITDA generated in the second half of the year. Finally, our 2024 full year expectations are underpinned by a mixed shift in our business. For the first time, we expect Alt Cred revenue to comprise around half of our consolidated revenue. On the Alt Cred side, we expect this to be driven by continued growth in our executive ed offerings and the enterprise channel, partially offset by continued declines in boot camps.

On the degree side, we expect 2024 revenue to be largely driven by the trends we have discussed on this call. The 2024 revenue does not tell the full story of the degree segment. When you look at the current portfolio, excluding programs we no longer operate. We anticipate total enrollments in these programs to increase approximately 3% year-over-year, and we expect new enrollments in these programs to increase approximately 11% year-over-year. And as is typical in the degree segment, we expect these enrollments to only modestly impact revenue in 2024, with expected revenue growth of the current portfolio, just over 1% due largely to much of the enrollment being back-end weighted in the year. But importantly, based on these trends and the 60 new programs we expect to launch in 2024, we do expect to see increasing growth in 2025 and thereafter.

To be clear, we believe that what we're seeing in the degree segment is not unique to or disproportionately impacting 2U. It is indicative of larger trends in the industry. While fewer students are learning online today than during the height of the pandemic, there are more students taking classes online now than pre-pandemic in 2019. As discussed earlier, that's why the current degree portfolio declined 9% year-over-year as the pandemic enrollment rolled off. But if you compare the degree portfolio today to 2019, you'll see that FCEs grew approximately 21%. Overall, we think that demand for online education is beginning to improve and the key leading indicators we're seeing corroborate that story. To conclude, we are laser-focused on taking action to position the company for long-term success.

We are approaching the future with renewed financial discipline to build an even stronger business that will thrive well into the future and deliver value to all of our stakeholders. And with that, let me hand the call back to the operator to begin the Q&A session.

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