Nov 12, 2019
Operator
Ladies and gentlemen, thank you for standing by, and welcome to the 2U, Inc. 2019 Third Quarter Earnings Conference Call.
At this time, all participants are in a listen-only mode. After the speaker's presentation, there'll be a question-and-answer session.
. I would now like to hand the conference call over to your speaker today, Ed Goodwin, SVP, Investor Relations.
Please go ahead sir.
Ed Goodwin
Thank you, Operator. Good afternoon, everyone, and welcome to 2U's third quarter 2019 earnings conference call.
On the call we have Chip Paucek, our CEO and Paul Lalljie, our CFO. Following Chip and Paul's remarks we will take questions.
Christopher Paucek
Thanks Ed. 2U is founded on the belief that the great university can and will remain a powerful engine for social and economic mobility in the digital age.
Our partnerships fuel that engine. They enable universities to sustainably meet the growing demand for higher education by developing a diverse portfolio of online and blended offering that are relevant to the evolving needs of lifelong learners.
2U remains the partner of choice for top university which is evident in our tremendous progress over the past quarter. We launched over 30 new offering and maintain our high bar student retention across the portfolio.
The Trilogy integration is progressing nicely. We've realigned the organization to better serve students and our partners, drive efficiency and position 2U for where the market is going.
Some great new executives joined the team. We're set up for a run a profitable growth driving to free cash flow.
Our original belief remains as true as it was back in 2008. As more universities launched digital offerings, the value proposition of our partnership model is stronger than ever.
2U is uniquely positioned to capitalize on this powerful secular tailwind based on our 11-year track record of successfully working with university partners.
Paul Lalljie
Thanks Chip and good afternoon everyone. Let me start off by saying how thrilled I am to be in the 2U team.
I joined 2U because it is a mission-based and leading – and has the leading position in a transformational market segment. I see 2U leading the way and capitalizing in the opportunity to offer high-quality online education for the best educational institutions in the world.
I look forward to making an impact as we focus the company on scalable growth and free cash generation. 2U's performance this quarter reflects strong topline growth, important pipeline win, the progress made on integrating our recent acquisition and relentless focus on organizational efficiency.
I'll start with the discussion of revenue followed by a discussion of cost and how I think we can drive efficiency then touch on the balance sheet before finishing up with a discussion of guidance. Revenue for the quarter totaled $153.8 million, up 44% from last year.
In the graduate program segment, revenue grew 15% over the third quarter of last year. You may recall, we previously disclosed that there were headwinds in our largest program.
Excluding the impact of that program, revenue in the graduate segment would've gone 25%.
Operator
And our first question is coming from the line of Brad Zelnick with Credit Suisse. Your line is open.
Brad Zelnick
Excellent. Thank you so much.
Chip, congrats on a good quarter. Nice to see some stability in the business and a warm welcome to Paul, Jennifer and Luyen as well.
Christopher Paucek
Thank you, Brad.
Brad Zelnick
For sure. You mentioned that you continue to see plenty of growth opportunities with both business segments, but are also becoming more disciplined on expenses as you adjust for the new competitive environment.
How you think about balancing growth versus cost savings between each segment? And any insight into how we should think about revenue growth for DGP in Alternative Credentials for this year and next?
Christopher Paucek
Thanks Brad. So, I would say, when we think about across the segments, we are focused on our ROIC and how we think about returning – how we think about profitable growth and the best use of cash across both segments.
We think the alternative credential segment clearly from a strategic standpoint is where universities are going to need to boost their offerings and candidly the STEM category something that you really can't expand into without an opportunity like Trilogy, without the boot camp offering and the tie to industry that Trilogy brings to you. So, we will continue to expand the portfolio.
I mean, just to frame it for you, when we IPO-ed the company we had six partners and 10 grad degrees and today we have 72 partners and over 300 offerings. So just think about that.
10 degrees to over 300 offerings across a whole variety of different types of subject and we continue to expand that today. So I think the discipline that we need to bring to the table is just to continue to be a strong as possible, picking the best programs and driving the best opportunity for both student outcomes and for the company.
And our Alternative Credential segment is part of that. Now, at the same time, I think you can see that Paul provided the segments and we were pleased with the grad program segment when you got one of our legacy programs declining our largest program and are still able to see 15% growth in that segment and without that one program you would have seen 25% growth.
And then on top of that, the 2015 to 2018 programs grew at 54%. You're talking about still very strong offerings that are growing not only above the rest of the overall OPM segment, but online education overall.
We are still at the top of growth expectation. So we're pretty pleased with the quarter and we look forward to giving you more detail at our Investor Day which to be clear we will do as early as possible in the new calendar year and we'll be back to this community with a more specific date as we get closer.
Brad Zelnick
Thanks. That makes perfect sense.
And maybe just a quick follow-up. Can you share any feedback you received on your zero interest deferred tuition plan with Simmons?
And might we expect to see other programs jumping on board as well? Thanks.
Christopher Paucek
Yes. We thought that was -- one of the first times that we've seen across all of higher ed that anyone has offered a deferred tuition program.
What I love about it is it aligns our university partner with the long-term outcome of the student. As in the student the first half of the tuition in the nursing program until they've graduated from the program and they're in a job with a minimum floor and there is no interest at all in the program.
So I do believe it's driving down the cost of education overall. We're excited about rolling it out.
It's an early pilot to be clear and so we do expect to have another announcement shortly from another university that was particularly interested in rolling out to their students. So we think it shows where our scale can really benefit not just our university partners but the world, the student body.
So we think it's a great opportunity.
Brad Zelnick
Awesome. Thanks for taking my questions.
Operator
Our next question is coming from the line of Jeff Meuler with Baird. Your line is open.
Jeff Meuler
Yes. Thanks.
Chip, hoping you could talk more broadly about I guess price elasticity on the student side and how it impacts CAC and your economic model just with I guess picking up off the last question, the zero interest deferred tuition and the other two data points from the call, they increased scholarships and the outsized growth. So just would love your thoughts on price elasticity and how it impacts your financial model?
Thanks.
Christopher Paucek
Well, clearly over -- as we provide greater value to the student we do think conversion improves. So it's all about the value proposition.
We've always played at the premium end of the market. That's no surprise.
The largest cost to graduate education is the opportunity cost of the lost income. At the same time as we start to think about various prices, various lengths and different types of certification across a much broader spectrum of what is now – I mean, we are a much bigger company than we were in back in 2014 across many different segments.
And one of the things I thought was notable about the quarter is you've got obviously average FCE came down in grad, but average FCE was way up in an Alternative Credential. Why?
Because we've got programs that start as inexpensively as a $1000 with a short course and we have programs that go all the way up to a $150,000 on the degree side. And over time, we need to have price points across the entire spectrum.
We need to offer students options to further their educational goals whether they're looking for skills attainment from something like a short course to learn how to use AI in their job or something like a doctor of physical therapy which is like a three-year life changer. So there are certain disciplines like licensure where we're up double digits in enrollments.
And I do think we're building a pretty deep moat. Those require more credit.
So inherently those tend to have a higher cost. There's certain things like STEM offerings where on the STEM side candidly if we hadn't gone down the path of short courses and boot camps we'd be at a very significant competitive disadvantage to the rest of space.
That's where we need to be is lower priced faster options for STEM. But at the same time drive quality.
Like I do feel like something that has not been talked about enough is we are we are driving the kind of quality that universities respond to, quality of the content itself, quality of the student body and ultimately the quality of the student outcome most importantly. And I thought interestingly this quarter it was right after our last call, but we announced the London School of Economics with our first undergraduate program, like LSE really got on board after having an incredibly high quality experience in the short course business with excellent enrollments in which students are now like literally physically at times coming to LSE for in-person immersion because they experience a really high quality short course.
We don't think that happens across all of higher ed. And then they got excited about what improved engagement and retention could do for a legacy program that they've been offering all over the world.
And we think it's a huge opportunity for us going forward. And we've got a launched period for 2020.
So lot going on there and a lot of opportunities for 2U to continue pursuing quality at scale.
Jeff Meuler
And when you do the graduate programs or the undergrad programs at lower price points, do you make up for it with lower CAC and or increased scale that the target financial model still holds? Thanks.
Christopher Paucek
Yes. I mean, if you're -- if you start thinking about as we scale programs to a much larger size and we have larger expectations for those programs, clearly the students on the most outer ring end up from just -- purely from that perspective end up being more expensive.
So I think having good geographic balance, having reasonably sized expectations, working with our partners to identify the best opportunities for a full investment program. And we'll talk more about that over time as we develop more models for our university partners to drive new program growth.
It's all about the sort of combination of the ROIC and the quality we can achieve for our partners and we think we're on the right track here.
Jeff Meuler
Okay. Thanks Chip.
Operator
Our next question is coming from the line of Corey Greendale with First Analysis. Your line is open.
Corey Greendale
Thanks. Good afternoon.
So, focused on the efficiency topic, a couple questions on the program marketing and sales. So the first is to the extent it makes sense to sort of intentionally decrease the amount you're spending in some programs that are already in place.
What kind of constraints are in place? Are there any contractual constraints on lowering that or for programs have been launched in last few years?
Do you have some in any cases performance requirements? You need to meet certain enrollment thresholds or anything like that would artificially constrain what you can do on that front?
Christopher Paucek
So here's what I would say, Corey, appreciate the question. We, first of all, just the general practice going forward, we're too large of a company with too many offerings to be talking about any individual university or any individual contract.
We're just not going to do it. It's not wise for the company.
It's not wise for the relationships. With that said, in general that's not a concern.
Corey Greendale
Okay. And the question maybe for Paul which is a two-part question.
I understand and applaud the focus on efficiency given the fact that in the graduate program business there is a two-year sales cycle. How does that affect how much?
And how quickly you can effect change to make things more efficient on the program in marketing side? And secondly, I just wanted to clarify your comment about early in the 2020 planning process, but lowering the quarterly burn.
I just make sure I understand that. Are you – I know you're not giving guidance.
But are you suggesting that free cash flow in 2020 should be less negative than it is in 2019?
Paul Lalljie
So, a couple of things. Let me let me start off by providing a framework of how we will look at the programs we launched in the coming years and going forward.
We want to look at it from three perspectives. We want to look at it from an ROIC perspective.
We want to look at it from a cash flow perspective and we want to look at it from a quality perspective. So essentially, we're going to choose -- we're going to select programs and the timing of program launches, so that we can choose programs that are reaching our ROIC targets that we have.
We want to make sure we optimize our cash flows and we want to make sure we maintain the quality of the program. So if we think of it from that perspective then as we get into 2020 and 2021 we will launch the programs that are most impactful to our financials particularly our free cash flow and our profitability measures.
That's point number one. Point number two, the measures that you've seen us taken in the third quarter whether it's the restructuring charge that we've taken, whether it is the integration of the Trilogy business, whether in the alignment of the organization.
We are doing that with an eye towards improving our free cash flow performance as we get into next year and going forward.
Corey Greendale
So I think – So, maybe you're just not answer the question yet, but already answered the question. But is it fair to say you will plan in a way that you would expect free cash will be less negative in 2020 than 2019?
Paul Lalljie
Yes absolutely yes.
Corey Greendale
Okay.
Paul Lalljie
We intend to have free cash flow as a dilution to our cash balance. The less and less as we go through the quarters and we will come back to you at a specific timing on when it will be accretive.
So the answer is absolutely yes.
Corey Greendale
Good. Well, thank you for the clarity.
Appreciate it.
Paul Lalljie
Okay.
Operator
Our next question coming from the line of Stephen Sheldon with William Blair. Your line is open.
Stephen Sheldon
Good afternoon and appreciate all the additional detail this quarter. I wanted to ask a little bit more on the scholarship front.
You've been talking about that more frequently which I think is a great initiative. Can you maybe help frame how much you pay down in scholarships this quarter?
And did that help a broader funnel conversion? And then how are you thinking about spending on scholarships as we look forward?
Christopher Paucek
So, I guess I would say, we're not at point where we're going to get into any additional detail around how we deploy the scholarships not only from the standpoint of just – we've given quite of additional clarity on this call, but also just on a competitive standpoint. We do believe its part of our strategy.
It is clear that lower prices drive conversion and the most successful students have a lot of option. That just a reality across all of our segments.
I would say, notably in the campus space in the professional programs in particular you've seen it would be tough sledding for campus programs right now in professional programs, given something we're getting our arms around the impact economic is having a very significant impact on campus programs overall. And our professional programs are really holding their arm where we are still seeing growth.
So at various stages of student journey scholarship comes really important when their high quality students and we have high quality program, so high quality students are a factor.
Stephen Sheldon
Got it. Is it offer to both to existing students and to those that are in the funnel?
Christopher Paucek
I'll just not going to get into additional detail around scholarship.
Stephen Sheldon
Okay. That's helpful.
And then just if you think through kind of program launches for next year and with the ones that have been announced so far, is there any way to roughly frame what type of capital commitment you'll need to get those programs up and running this point. And just – any way to frame it?
Paul Lalljie
Let me see if I can take a stab at this one. Look, as I've gotten up to speed here and start looking at how we're going to plan for next year.
I mean, I mentioned the three pieces that we look at. We look at our hurdle rate.
We look at the cash flow commitments and we look at the quality of programs. If we take 2019 as an example, doing back of the envelope math, we've launched about 19 programs and at an average of back of the envelope math about $5 million of cash usage.
If we think of 2020, we will absolutely want to launch programs in a way that allows us to be that have a better performance on the profitability measure so we can pick a number. It's not going to be 19, but it's going to be something that allows us to reduce the expenditures that we spent.
And on the year to-date spend we can we can look at $70 million, $75 million that we've spent so far. So if we think of that on a basis for next year, we can we can think of numbers back in the envelope around 10, that allows us to optimize that.
That's point number one. Point number two, we do have that the business has grown.
We now have the short course business, the Alternative Credential segments that are more capital light if you will. So we do have the alternative of launching programs across the spectrum not only in the great degree segments, but also in the Alternative Credential segment which allows us to optimize our performance on an annual basis.
Christopher Paucek
And if I could jump in Paul I would add. We were very fortunate and excited to bring Paul in as our new CFO.
And candidly we're fortunate to have it happen quickly. And Paul's been with us for months and I think it's pretty impressive on his back that he's been here a month and he's this engaged in where the business is going and getting a real perspective on us going forward.
But with that said, we will provide a lot of additional detail on how we think about ROIC and capital allocation at our Investor Day. And as I said earlier it is our goal to have that as early as possible in the New Year.
We just need a little bit more time for Paul to get through his process and we're off to a great start here.
Stephen Sheldon
Great. Thank you very much.
Operator
Our next question comes from the line of Jeff Silber with BMO Capital Markets. Your line is now open.
Jeff Silber
Thanks so much. Just a follow up that last question, Paul.
You had mentioned and forgive me if I'm putting words in your mouth, but it sounds like we're going to have fewer program launches next year than in 2019. Would we also expect the cost or the cash burn for each program launch to be less as well based from some of the efficiency focus that you have?
Paul Lalljie
The short answer is yes and we will redeploy capital spend -- some of the capital spend into some of the more capital light programs in the Alternative Credentials segment. But the bottom line is we are going to look across the portfolio applying to three -- the framework I mentioned earlier and then optimizing the performance.
Jeff Silber
Okay, great.
Christopher Paucek
And just to be clear Jeff and we're not at a point yet where we've got our ready to present our plan in terms of what next year looks like specifically, but we'll get there soon.
Jeff Silber
I understand. Appreciate that.
And I'm apologizing for asking this question but unfortunately I cut out towards the end of the call when you started to talk about some of the media speculation about the activists. I'm not going to ask about a specific investor, but having somebody or a firm like this involved, does it at least you know maybe change your mindset about either pursuing strategic alternatives or other options?
Thanks.
Christopher Paucek
Jeff. We're not going to comment on speculation or media reports related to the company.
We're focused on creating value for shareholders through creating long-term value for our partners and student students.
Jeff Silber
Okay. fair enough.
Thanks.
Operator
Our next question coming from the line of Ryan McDonald from Needham & Company. Your line is open.
Ryan McDonald
Hi. Good afternoon.
Thanks for taking my questions. Chip, I'll start with you.
It's great to see the strong results in Trilogy particularly with the additional university ads. Can you talk about what you're seeing in terms of demand environment from students in that business?
And then how price sensitive do you expect that market to be? Now that we're beginning to see other vendors like Chegg with its Thinkful acquisition, talking about lowering prices for its boot camp offerings?
Christopher Paucek
Well, so I feel like it is encouraging to see as following our announcement of our acquisition of Trilogy. Many others in the space sort of jumping into the space validating this is a bit where the puck is going.
I would tell you our business with Trilogy is at a scale and doing it with university partners in a way that no one else in the market is doing. We think the university partners are huge win from that perspective.
To be clear, it is running above our expectations. We have now that we're integrating the business, we have found that there are -- there's some real efficiencies we can gain as we originally integrated our marketing of GetSmarter, our marketing competency into GetSmarter, we found a lot of success in not only improving scale, but also improving efficiency and we see the same thing indicates a Trilogy.
We do think that there's quite a bit of expense on the marketing side that we will improve. And on top of that, we did pull back a little bit there online offering because we obviously have a lot of experience doing online and are excited to relaunch that here in 2020 and we think that's a really big opportunity.
And finally in a future call we will talk about the enterprise opportunity. We just didn't have time on this call.
We'll talk about that more in our Investor Day. But we do think enterprise as a channel is a real part of both our short course and our boot camp business and we do think even has a role on the grad side with degrees particularly with our LSE degree.
Ryan McDonald
Got it. And then just a quick follow up on the grad program business.
It's great to see the first announced program between 2U and Keypath during the quarter. I guess given the commentary around limiting cash burn next year as we launch programs, how should we think about the role that a 2U and Kepath partnership plays in terms of additional program launches moving forward?
Christopher Paucek
We're excited about Keypath and we think they're a great business. We've gotten to know them even more since the announcement as you would expect.
We were thrilled to have our first one. There are certainly more to come.
We do think more flexible partnership options are a reality of where we're going. We think that there are a variety of ways we can offer smaller programs that are still really high quality and Keypath is very much part of that story.
So we'll provide more color over time. The reality is it's a combination of sort of ROIC and quality and I do think ultimately, Steve Fireng and the team at KeyPath are doing a great job and we're excited about the strategic relationship.
So more options for high quality programs and more flexible approaches to the market is something you will hear a lot more about at our upcoming Investor Day.
Ryan McDonald
Great. Thank you very much.
Operator
And our next question comes from the line of George Tong with Goldman Sachs. Your line is now open.
Unidentified Analyst
Good evening. This is Blake on for George.
Thanks for taking my question. Given the evolving competitive landscape discussed last quarter how should we think about your steady state program sizes going forward.
I know its 300, 500 previously, but how do you see that range trending over time? And related to that do you continue to expect to see high 30% margins for cohorts older than four years or will we see that trend down a bit at some of the smaller sized programs age?
Christopher Paucek
So, the latter is fairly easy. We still believe we've got a great strong margin business in the grad side and that doesn't change.
Obviously, as we've discussed in the past we have seen the overall size of the largest programs come down. As we talked about in this call just the impact of one program took growth in the segment from 25 to 15.
That was a very significant part of our business. But just to give you an example of the sort of development of the business is when we were when we IPO-ed the company we had 10 programs -- 10 degree programs.
Today, we have 300 plus offerings across a variety of different product types. But how that's relevant to your question is at the time we IPO-ed 69% of our revenue came from one client.
And today we have one client above 10%, that same client, only one. So revenue concentration risk has come way down in the company.
And so this is all about the diversifying of the business. And over time, we're focused on driving quality for our partners with the best return on capital we can and approaching the market with enough flexibility that solves the long-term needs of the university and drives high quality student outcomes.
And that's our story. So I wanted to -- as we end the call.
That's our last question, Operator. I wanted to thank Paul Lalljie for his arrival and we're excited to get out on the road and look forward to talking to everyone in more detail over the next couple of weeks.
Operator
Thank you ladies and gentlemen this concludes today's conference call. Thank you for participating.
You may all disconnect. Everyone have a great day.