2U's (TWOU) CEO Chip Paucek on Q2 2014 Results - Earnings Call Transcript

| About: 2U, Inc. (TWOU)


Q2 2014 Earnings Call

August 6, 2014 5:00 PM ET


Alex Makler – Director of Investor Relations

Chip Paucek – CEO and Co-Founder

Rob Cohen – President and COO

Cathy Graham – CFO


Michael Nemeroff – Credit Suisse

Corey Greendale – First Analysis

Brian Schwartz – Oppenheimer & Co

Michael Tarkan – Compass Point Research & Trading

Andre Benjamin – Goldman Sachs

Michael Huang – Needham & Company


Good evening. And welcome to the 2U's Second Quarter 2014 Earnings Results Conference Call and webcast. This call is being recorded. I would now like to hand the call over to 2U's Director of Investor Relations, Mr. Alex Makler for opening remarks and introduction. Mr. Makler, please go ahead, sir.

Alex Makler

Thank you, hello everyone and welcome to 2U's second quarter 2014 earnings call. Following my introduction, I'll turn the call over to our CEO and co-founder, Chip Paucek, who along with our President and COO, Rob Cohen and CFO, Cathy Graham will walk you through financial results and guidance found in the earnings release distributed this afternoon.

You can find the copy of this earnings release in the Investor Relations section of our website at investor.2u.com. The recorded webcast of this call, will be available in the Investor Relations section of our website for three months from today. Also we routinely post announcements and information on our website, which we encourage you to access and make use of.

Before we begin, I would like to point that during the course of this call. We will make forward looking statements regarding future events and future financial performance of the company. These forward-looking statements are subject to material risk and uncertainties that could cause actual results to differ materially from those in the forward-looking statements.

We caution you to consider the important risk factors that may cause actual results to differ materially from those in the forward-looking statements. In particular, we refer you to the risk factors described in the final perspective of our initial public offering filed with the SEC on March 28, 2014. The quarterly report on Form 10-Q that we filed today and other filings with the SEC.

Any forward-looking statements that we make today are based on this functions that we believe to be useful as of this date. We undertake no obligation to update these statements as a result of new information or future events. During this call, we will also present both GAAP and non-GAAP financial measures.

The non-GAAP measures are in addition to not a substitute or superior to measures of financial performance prepared in accordance with GAAP. The non-GAAP results and the related reconciliations to GAAP can be found in our press release and with that, let me please turn over the call to Chip.

Chip Paucek

Thanks, Alex. As we prepare to become a public company. The most consistent piece of advice I receive was to deliver with consistency, be predictable do what you said you would do. I'm very pleased to report that our Q2 results and updated guidance are represented with that advice.

For the quarter, we exceeded our stated guidance for all of our financial measures. Strong growth in our program delivered $24.7 million in revenue, a 32% increase over the second quarter of 2013. This higher than expected revenue, along with spending efficiencies resulted in $8.5 million and $7.1 million in adjusted net and adjusted EBITDA losses respectively.

Based on these results, we are increasing our revenue expectations for the full year 2014 to a range of $107.1 million to $108.4 million. We are also improving our adjusted EBITDA loss guidance to a range $18.2 million to $17.1 million.

Our new program growth has been robust and a driver of our strong results. At the end of 2012, we had four programs. Our announced program line up now includes 17 programs in 13 verticals for academic disciplines with 12 universities.

Before I review our program line up, let me remind you the way to think about new programs. New programs require heavy investment over 3-year to 4-year period, driving adjusted EBITDA losses before they swing to profitability. This investment is required to produce the course within [ph] technology necessary to launch the program and the marketing assets to build the funnel of prospective students.

New programs come in two forms; a first program in a vertical are academic discipline and the second program in the vertical. Investment required in a new program ranges from $4 million to $9 million in net negative cash over the initial 3 year to 4 years.

First programs in a vertical include program such as our recently announced Master of Arts and Counseling with the family instituted Northwestern University. These programs tend to take longer to breakeven and require higher initial investment. This is because we have the build marketing apparatus required to create a long-term funnel of prospective students that might be interested in the programs.

One could example this market build is our website teach.com. Teach.com was build to provide excellent content to people who are potentially interested in becoming teachers. While this site took time and investment to grow, it's now delivering high quality prospective teachers to our current education partner.

Over the time we expect, it will pick up steam and provide additional enrollment in other programs. Other examples of our marketing investments include socialworklicensemap.com and certificationmap.com.

Second programs in the same vertical tend to breakeven faster and require less investment. This is because of marketing apparatus is already in place to generate the prospective students for that particular disciple.

Second program has allowed 2U, to find a home for perspective students. Who might not be interested in or appropriate for the first program. Remember, 2U's goal is not to find any student, but rather the right student for school, driving the desire long-term outcome.

We also have new offerings in existing programs such as the Master of Legal Studies, with the great law school at Washington University in St. Louis. These offerings typically require minimal additional investment. However, they're important part of strategy to help program to reach their full potential. They leverage the content, lead based or both of the existing program and they can broaden the appeal for potential students for minimal additional investment.

They're important to growth, but do not result in a change to the program mass [ph]. As part of our growth strategy, we committed to all of you, that we will launch no fewer than four new programs per year regardless of how many new offerings and existing programs we launch.

I would like to review 2014 briefly, as the schedule is set, all programs are either launch are on track. The 2014 slide includes the Master of Information in Data Science at Cal, Berkeley. The Master of Healthcare Administration at GW, my alma mater.

The Master of Social Work at Simmons College, our second social work program and R.N to B.S.N to M.S.N at Simmons College are first undergraduate program. At the time of IPO, 2U had no 2015 programs announced.

Now our 2015 slate is set and fully announced, it includes four new programs and several new offerings in existing programs. It's worth noting that all of the programs are with new university partners. We are now far enough along that I can even give you the actual launch schedule. So let's start with the new programs.

In January, we will launch our Master of Business Administration with the Whitman School of Management at Syracuse University. This is our second MBA program in the critical Business Administration vertical. We predict enrollment in this program will be very strong based on the proprietary program selection algorithm results.

We believe this program will get 2015 off to a great start. Also in January, we expect to launch our Master in Data Science with SMU, Southern Methodist University. This our second program in the Data Science vertical and our first degree at SMU and in the State of Texas.

This is the green field for SMU. Meaning this is currently now put down in their campus. While SMU is an excellent and well respected national brand. We think interest will be particularly strong in the South west. We are thrilled to work with Provost, Paul Ludden and this excellent team on this big opportunity.

Before the end of Q2, 2015. We anticipate launching the Master of Arts and Counseling program with the prestigious family institute in Northwestern University. Northwestern is our highest rank university partner to-date. Counseling is a large new vertical with approximately 10,000 conferred in 2013.

This vertical grew approximately 12% in 2013. We believe this makes a sizable new opportunity for the company. We thank Provost, Dan Linzer for his confidence in us. Finally, we expect to close 2015 with the launch of our Master of Communications program with the S.I. Newhouse School of Public Communications at Syracuse.

This is the first program in a large communication vertical, that had approximately 9,000 degrees conferred in 2013 and has had averagely yearly growth of about 6% since 2008. We have a new announcements today making some news on this call. It's a new offering within the existing Syracuse MBA program.

Beginning in mid-2015, the Whitman School of Management will offer a Master of Science and Accounting with 2U. We are excited to expand our relationship with this great institution. And I would like to talk for a moment about profitability.

Currently, we still have more plans in the investment phase and the return phase because of the lag time between marketing spend and revenue generation. The underlying profitability in the model is harder to see in our current financial results.

However, our most matured programs are already demonstrating that even without second program leverage, they move to profitability as they move their life cycle. As programs age, their models move to profitability and begin showing strong margins.

It takes time for students to enroll in programs and they generate revenue for us as they take courses over the programs life. By the time we reach cash flow breakeven in a program. The expected future revenue from already enrolled students is generally greater than the net negative cash we've already invested.

Our earliest programs, show the benefit of time to the financial time. We launched one program in 2009, one in 2010 and two in 2011. A group we refer to as our first launch cohort was a core four. Together these programs became adjusted EBITDA positive in 2013 at single-digit margin on fully allocated basis, but if you assume that they all launched with our first program in 2009. We believe that 2013, adjusted EBITDA margin for this first launch, cohort would have been in the mid-20s while still scaling.

In addition, it's important to note we optimize our marketing spend, based on a ratio of the lifetime value of a student to marketing spend. As we bring an additional program in the same degree vertical. The efficiency of this spend improves dramatically. Another advantage the second programs.

If the existing marketing apparatus allows us to scale them faster and substantially reduce expense. Therefore bringing in revenue earlier and recovering cost more quickly. While we can expect first programs to reach natural scale in an average of 5 years to 6 years. Second programs can generally get there more quickly, perhaps by a 1-year more.

We believe that our first launch cohort clearly demonstrates this path. More recent [ph] launch cohorts, while at earlier stages of growth are showing similar pattern. In addition, recent launch cohort includes second program in the existing vertical, which decreases the average student acquisition cost across our program portfolio.

Proven life cycle profitability and the impact of second programs is expected to drive profitability towards our targeted mid-30s adjusted EBITDA margins. As a management team, we are committed to this path of profitability. We are excited with what we are seeing today. Delivering high growth and a path to profitability.

And while we're still at point in our business life cycle, where we have more programs in the investment phase, than in the return phase. We believe, we've reached that turning point. We now expect that 2014 adjusted EBITDA loss will improve by about 17% compared to 2013 even though we remain in high growth mode.

Our goal is to build the world's best online education, scale our revenue and bring the company increasingly closer to profitability while building the world's best student outcomes. With that, I'll hand over to Rob for some second quarter operating highlights.

Rob Cohen

Thanks, Chip. I want to start off by talking about Net Promoter Score or NPS, which is the key performance metric we use to measure satisfaction across our programs. Our blended student and faculty NPS during Q2 remain strong at 70. Let's remember that NPS is the high bar, anything above zero is good and anything above 50 is world class.

We believe the more satisfied students and professors are, the more likely student outcomes will be excellent. From an operation standpoint, our dedicated team is providing active, ongoing support for our 11 launch degree programs as of June 30.

Here are some quick stats to illustrate this undertaking, 82% of all student have started one of our programs have graduated or are still enrolled as of June 30. We are enabling on average, approximately 1,000 live classroom sessions a week, to remind you these sessions are live interaction between faculty and students in intimate classes that average only 10.4 students.

In June, we announced that our 10,000 students have enrolled in our university program. We are proud of this milestone, not only because we get to be part of providing an outstanding educational experience to an increasing number of students but because it demonstrates another step along the path of driving 2U to scale and profitability.

At the end of June, our partnered programs have enrolled 10,484 students inception to-date, which have resulted in tuition bookings for our university partners through the same period of 582.1 million, but our impact can be still beyond just enrollment numbers.

Last quarter, we had a key milestone with our first program at the USC Rossier School of Education. Five years after our partnership began, the online Master of Arts and [indiscernible] program graduated its 2,000 students.

These graduates now teach at 947 school districts around the world. Across all of our programs, 2U has successfully placed students through onsite and virtual method 18,346 times and have contracts with 10,509 replacement site spread across the world.

These figures are a true testament to the value that this company creating, but it's not all about numbers. So let me touch on a couple of additional highlights from the quarter. In May, we announced a notable development. Our cross university course initiative expanding the course selection available to students in our partner programs.

Students can now take courses in other 2U enabled programs and a feel to study other than their own allowing them to more broadly meet their educational interests. This initiative also creates a differentiating feature for 2U programs that helps that off and their university partners apart from other online offerings as we look to attract high quality students.

Also in May, we hosted our first annual 2U partner symposium. The symposium was a summit for our university partners to collaborate on best practices within the programs we run together. We had over 60 university administrators, faculty and staff in attendance including all current university partners and a few prospective ones.

In fact, two prospective partners who attended the symposium signed with us quickly thereafter. This was a private event, no press or investors were invited. Real challenges and issues were discussed including a panel session called "Organizational Models for Online Programs" which isn't very interesting to most people, but we think is particular useful to this group.

We believe, our schools are embracing the online environment like no one else in higher education. It was probably the best event 2U has ever held. We are very proud of the relations [ph] that we built and the groundbreaking leaders we are working with.

With that, I'll hand things over to Cathy.

Cathy Graham

As Chip mentioned, our second quarter financial results came in strong, showing significant year-over-year revenue growth and coming in ahead of our expectations on all measures. Second quarter revenue was $24.7 million above the top end of our guidance range. This 32% year-over-year increase was driven by a 34% increase in Full Course Equivalent enrollment or FCE.

Offset by slightly lower average revenue per FCE. The FCE increase was generated across our program maturity range from the first launch cohort to new 2014 programs. 81% of FCE's and 84% of revenue came from our first launch cohort. To give you an idea of the rate, at which our program portfolio is diversifying in the second quarter of 2013. The first launch cohort contributed 99% of both FCE's and revenue.

The fluctuation in average revenue per FCE was well within the normal range, we expect to see between year-over-year and sequential periods and does not indicate any change in our revenue share range.

Fluctuations and average revenue per FCE are due to both mix shift driven by new program launches individual program growth rate and changing academic calendars. As well as differences in net course tuition resulting from factors such as tuition increases and scholarship grants.

For additional details on FCE's and FCE trends. We provide a rolling eight quarters of FCE history as part of our earnings release. We also provide our platform revenue retention rate to give you more insight into the performance of our most established programs.

Full explanations of these metrics can be found in the MD&A section of today's 10-Q filing. As is seasonally normal, second quarter revenue did decrease 6% sequentially. Due to the academic calendars of our partner program. The second calendar quarter has the fewest in session days of any quarter in the year.

As we recognized revenue for each program from the first day of classes to the last. This results in lower revenue recognition during this period. Our earnings measures adjusted net loss and adjusted EBITDA loss both came in better than our guidance for the second quarter at 8.5% and $7.1 million respectively.

Over performance on the revenue line, along with expense efficiencies drove with a positive variance. These results were nearly flat with the second quarter of 2013 even though, we continue to invest heavily the launching and scaling new programs.

We said in our first call, that we expected our loss measures to stop accelerating around mid-year and that's proving to be true. On a pro forma per share basis, adjusted net loss for the second quarter was $0.22 a $0.015 better than the midpoint of our guidance range calculated on the same basis.

The material item reconciling net loss attributable to common stock holders to adjusted net loss is stock based compensation expense. It was $2 million in the second quarter, up from $632,000 in the same quarter o 2013. The increase was driven by two factors grants made for new hires, promotions and retention and the increasing valuations attributed to our common shares, as we approach our public offering.

We define adjusted net loss as net loss attributable to common stock holders before preferred stock accretion. The warrant expense portion of net interest expense and stock based compensation expense. Our definition of adjusted EBITDA is net loss before net interest expense, taxes, depreciation and amortization and stock based compensation expense.

Additionally for per share measures, we use a pro forma share count, as though the conversion of all preferred shares to common, which occurred upon the closing of our IPO have occurred on January 1, 2013. Quickly commenting on our balance sheet. Cash position at June 30 was $104.8 million making up the majority of our $108.2 million in current assets.

I want to remind you, that each of our partner programs has a unique academic calendar and that we receive payment after the start of their academic terms. Depending on where our partners are and their academic calendars. At the end of each calendar quarter, we could have live variations in cash, accounts receivables and deferred revenue from quarter-to-quarter.

We suggest that you look at changes in these accounts, as a group to better understand our balance sheet position. Turning to guidance, we expect third quarter revenue to be between $26.6 million and $27.3 million. At the midpoint of this range, this represents 31% growth over the same quarter of 2013.

On a sequential basis, this guidance also demonstrates the expected normal revenue rebound from a seasonally low second quarter. Adjusted net loss for the third quarter is expected to between $7.3 million and $6.7 million or $0.18 to $0.17 per share. We expect our adjusted EBITDA loss for the quarter to be between $5.8 million and $5 2 million.

This guidance reflects startup and marketing expenses that we have shifted from fourth quarter to third related to the just announced SMU data science program. As we now expect this to be the second program to launch in January, 2015. Earlier than our models assume, we need to begin marketing immediately.

Even with the additional expense, third quarter guidance ranges for each of our earnings measures indicate the uptick we expect to see over second quarter results. This gives us further confidence in our view that 2014 losses will improve over the prior year.

For full year 2014, we are increasing our expected revenue range to between $107.1 million and $108.4 million. This includes our expectations for the Simmons Social Work Program launched last month as well as the Simmons R.N to B.S.N and M.S.N program scheduled for October.

Remember that new programs contribute very little revenue in their early operating quarters. The vast majority of revenue in this point in the year forward will come not only from those already launched programs, but from returning students in those programs. Both of these factors provide us with strong visibility into revenue for the rest of 2014.

Despite the fact that we continue to invest heavily in launching and scaling new programs. Our earnings measures for 2014 are trending up, demonstrating that we are on the path to profitability. We are improving our expected adjusted net loss for the year to between $24.1 million and $23.1 million or $0.64 to $0.61 per share.

At the midpoint of the range, this indicates about an 8% improvement over full year 2013. And we now expect adjusted EBITDA loss to be between $18.2 million and $17.1 million. Again at the midpoint, we are now expecting 2014 adjusted EBITDA loss to be 17% improvement over 2013 results.

One additional comment on full year earnings measures, by giving third quarter guidance. We are implicitly providing fourth quarter guidance as well. When you run your numbers, you'll see their annual guidance implies a very strong sequential improvement in adjusted net and adjusted EBITDA losses.

I want to remind you, that we have significant expense seasonality in the fourth quarter of every year. During this quarter, we reduced marketing spend across our program substantially as marketing effectiveness drops during the holiday season, with that color on a great quarter and perspective of what we think are very positive expectations, I'll turn the call back to Chip for his closing comments.

Chip Paucek

So before we wrap up and take questions. I'd like to share a quick story that impact. Let's remember why we are here, mostly online education isn't very good. Why, one reason it often lacks, the person-to-person, face-to-face learning experiences. At 2U, not only do we enable live classes, but we also have programs with nursing, social work and teaching that require field work as a prerequisite for graduation.

Our placement services team, works tirelessly to match students with real work experiences including clinical placements based on their geographical location. Let me tell you about two of these students connecting in a rather unique way. Melissa Wilmart [ph] and Aaron Johnson are both students in Georgetown's, online Nurse-Midwifery mid program.

Fine thing is, they both live far outside the continental US. 4,700 miles from Georgetown's DC campus in Hawaii. Yes, they're Georgetown students who currently live in Hawaii. On June 6, Melissa who's already a mom with young girls, within the Castle Medical Center in Kailua, Hawaii preparing to give birth to her third child.

When Melissa's Nurse-Midwifery arrives to deliver her baby. She introduced Melissa to Aaron, a Georgetown student performing her clinical rotation at yes, you guessed it Castle Medical Center. It didn't take Melissa and Aaron long to realized they were actually classmates in Georgetown's program.

Immediately the two bonded. Moments later, Aaron delivered her classmate's baby. Baby tipped in, Mom Melissa and Midwifery student Aaron are all doing very well. Thank you very much for letting me share your story and build awareness [ph].

The reality is the programs we enable brings students together from all over the world. We aim to do at the highest quality level including physical placements when necessary. Virtual babies wouldn't make the cut, you have to deliver the goods. Live weekly classes, real world experiences like the one you heard from Melissa and Aaron today are normal part of our business.

We like to think, that we are eliminating the back row in every classroom and bringing every student forward to help them realize their full potential, doing what you said, you do. For investors, yes, but of most important doing what we said will do for our University partners and their students after all, outcomes matter more than anything else.

With that Cathy, Rob and I will be happy to take your questions.

Question-and-Answer Session


Thank you, Mr. Paucek. The question-and-answer session will be conducted electronically. (Operator Instructions) and our first question comes from Michael Nemeroff of Credit Suisse. Sir, your line is open.

Michael Nemeroff – Credit Suisse

Congratulations on nice strong quarter.

Chip Paucek

Thanks, Michael.

Michael Nemeroff – Credit Suisse

Just about all of the launches in 2015. I'm noticing that, a couple are going to be a little bit earlier because I think, we had modeled in one per quarter pretty linearly looking at my estimates, I mean does that imply that as these programs launch and you get a little bit more revenue up front that, you feel pretty darn confident and where consensus is for 2015 at this point in time?

Chip Paucek

Well, obviously we are thrilled to watch the year. It is starting in January with the second program in one of the largest verticals that we could operate in, which is business administration with a great school, Syracuse and we are also pretty excited about our January launch of SMU Data Science, while it's not currently a large vertical because it really doesn't exist, we found a lot of success with Berkeley and we are thrilled to have a second program there, but I would just caution you Michael, to remind you that new programs.

As we said in the script earlier, that new programs take a while to mature and do not have a really significant impact on revenue in that year, in the actual year that they're launching. So we do believe, that January is a great start, you know launching two right at the beginning of January is important, but we think you just need to factor that in terms of new programs having a delay to the effect on revenue.

We do like, what it said when we IPO'ed in March, we didn't have any 2015 programs announced and now we got the full slate set. So that's certainly should give an indication of how we feel about pipeline going forward.

Michael Nemeroff – Credit Suisse

Yes, that's very helpful, Chip and then, as I know you track a lot of data about the students that you service and just curious, if there's been in any notable positive or negative in the retention rates on each of the programs that are already launched and then also, if I know it's hard to track, but I know that you try and track the outcomes whether you see an improvement in how and placements oppose to degree.

Chip Paucek

So I would say, answer that in order first; retention currently 82% across our partner portfolio students who are graduate are still enrolled that's more akin to a campus program then it would be to an online program. So I feel like, it's very strong. We do actually feel like as a team. We're improving it by working more closely with our university partners, who care about retention more than just about anything else because it really is where the rubber meets the road in terms of delivering the outcome to the student.

Obviously, if you stay through the program, you gradually. You get a great a degree same degree as you would on campus. Huge value to the student. So we feel like retention is a strong part of the overall to use stories. We indicated in our impact report, which we released in April and will continue to do on an annual basis.

As far as outcomes, the reason I mentioned the impact report is – it is we do believe that there is this long-term correlation between our financial success and the student outcomes and I think, the company is focused on the right things and while we are public company. The DNA of the company is focused much more on outcomes than anything else.

We have one great advisor, who said to us, that they love that we've kind of grown up on a protein diet focusing on what matters, most which is the really the long-term outcome of the student. So we continue to see very strong job placement rates.

I happen to love that story about midwifery because pretty crazy the two students 4,700 miles away from their campus are delivering classmates baby, but we see that kind of stuff all the time. The reality is, if you attend a great institution and you get a great degree from a school like Berkeley or Georgetown and Northwestern.

You typically have a pretty fabulous outcome and we are happy to deliver that in the online environment for the first time.

Michael Nemeroff – Credit Suisse

That's helpful and then one for Cathy, if I may? Nice stab on the managing the expenses and decreasing the loss expectation. Where is that leverage coming from, is it just because that you're launching a few, maybe one or two more complimentary program sooner than expected than we were to expect or are you getting some kind of, are you getting better at the marketing, just give us a sense on where that leverage is coming from?

Cathy Graham

It's really coming from two places and one of which you hit on, which is the second program. As they start to get their stride, that's really what helps us get more efficient and really take the benefit of marketing efficiency and leverage in our programs.

So the second thing is, just we are getting the benefit of time. We have more programs that every quarter that goes by are more and more mature and if you'll remember the discussions about our program lifecycle. As programs mature, as we pass that sort of inflection point, where we are at our peak investment.

Just as time goes on, by nature of the kind of business that we have, time is our friend from having more programs that have been in place for a longer period of time and we are seeing that benefit.

Michael Nemeroff – Credit Suisse

Thanks for taking my questions. I'll pass along.


Thank you and our next question comes from Corey Greendale of First Analysis. Your line is open.

Corey Greendale – First Analysis

Congratulations on a good quarter and some great program addition over the past few months.

Chip Paucek

Thank you.

Corey Greendale – First Analysis

And I have to say, I loved that midwifery story and look forward to hearing stories next year about Syracuse students auditing other Syracuse students.

Chip Paucek


Corey Greendale – First Analysis

So I just had a few questions for you, so first of all the model of adding a second program in a vertical helping improve your economics clearly working. Could you just update, I think you said in the past, that adding the Simmons program doubled your conversion rates? Can you just kind of update that in, what do you think so far in the Simmons nursing program? I assume you started marketing that and what benefit you think, will be there now you're adding second program there.

Chip Paucek

I think, it will be too early for us to give specific guidance around and as you know, we don't disclose on a per program basis. We did for the process for the road show talk about Simmons and the impact it had on our nursing vertical and it has been very strong, but we can't get into details on a per program basis, across the portfolio.

It is notable however, that we now have four distinct verticals with the second program in process.

Corey Greendale – First Analysis

And also if it's all right to comment on this one, either but the SMU and Berkeley obviously both strong brands. Can you talk about the synergies you expect there? I mean do you think, you'll get students in Texas enrolling in Berkeley or in California students enrolling in SMU or do you think, it will be more specific to the geographic, where they're located?

Chip Paucek

I mean, across our portfolio these are all pretty exceptional brands. I mean, you have to think what's pretty amazing, you have to put them in perspective that you're dealing with institutions that have more longevity than anything in our culture. You've got some of the best business brands in the world like Coca Cola founded in 1886 and you have Georgetown in Chapel Hill founded in 1789, they have 100 years on Coke.

I mean these are unbelievably strong brands with that said, we have found in our program selection algorithm, that there is a distinct regional effect to all of higher Ed and higher education is inherently a local business, in many ways.

And so, we have found that you will certainly be stronger a particular region for each university. While they're national and clearly if you look at our program footprint today. If you look core four in example, Dean Karen Gallagher now have students in 56 countries in the Rossier School of Ed.

So it clearly goes global, but the fact is conversion will be more powerful in a particular region, where that brand is stronger and there's a reason, there's 100 of years of brand resonance for a particular brand in that area.

So we do like the line up and Corey, we have talked in the past about the program selection algorithm and that we think, it's a real value to the company in terms of deploying capital in new program simply because we didn't have it until 2014.

So we started using it the select program in 2014 and 2015 and so we are going into, these new programs with quite a bit of confidence that maybe we didn't have in the past.

Corey Greendale – First Analysis

And what the 2015 slate said, clearly the message that you're committed to improving profitability that comes through loud and clear. What would get you to add a fifth program in 2015 and would you do it, if that result in profitability not getting better in, 2014?

Chip Paucek

We promised no fewer than four, obviously that phrase no fewer than four means, that no fewer than four. It's certainly possible, that we could always do more, but the fact is we are committed as a management team to this path of profitability and what we really like in this current quarter, is it we are seeing results of it and we think, we sort of flip. This tipping point has been reached, where you got more programs generating a return.

And you're starting to see some of the programs we launched in earlier, in not the core four, but in a later cohort really start to generate results that hit the financial statement. So some of this Cathy mentioned, is simply time. The reality is, no fewer than four means, no fewer than four and at this point, we are very comfortable telling you that 2015 is set.

Obviously in the future, we'll keep everyone posted if we decide to increase the number, but currently right now we feel very good about where we are and I would, I just would add one additional comment about pipeline. We are actively working on 2016, 2017 and beyond.

I think, I've said in the past we do actually have quite a bit of dialog going on around with different universities and feel pretty confident about our future pipeline.

Corey Greendale – First Analysis

Great, thanks. I'll turn it over.


Thank you. Our next question comes from Brian Schwartz of Oppenheimer. Your line is open.

Brian Schwartz – Oppenheimer & Co

This afternoon, I too will send my congratulations another strong quarter from you.

Chip Paucek

Thanks, Brian. Good to hear you.

Brian Schwartz – Oppenheimer & Co

Great, I've got three questions here for you. Chip, wanted to just ask if you could just talk from a qualitative perspective of the new programs that you signed up in the quarter. When you ran them through the program selection algorithm, are the opportunities when they're at full scale, are they fairly consistent in size with the prior new program?

Chip Paucek

Well, I mean the tough thing about our business, is there really is no average program. They all are very different schools, very different disciplines and even just very different tuition levels. So you have some programs in our portfolio that are around $50,000 for a full program and you have some in our portfolio that are at $100,000 and many in between.

So we did very specifically and somewhat surgically select these opportunities as not just disciplines that we thought and you notice in the commentary we made, we actually gave you some comments around the types of things that we are looking out in the algorithm, where we are looking at the number of degrees conferred.

We are looking at the growth in this phase, we are looking at job prospects in this phase because we think, it's really critical that the company focus on programs that have great job opportunities because ultimately it is about the outcome and then a lot of it comes down to the leadership team at the school and this where the algorithm is of least help, frankly we've gotten into a point now, we actually say no much more often, we say yes and I don't say that to indicate anything about our hubris, so the fact that we think, we are cast me out.

But the fact is, this model takes a leadership team that is committed to driving a really high quality experience and doing it at scale and it's not easy, it's not inexpensive but it's also not easy, it's very hard to do and the reason we mentioned the symposium in our call, is we thought, it was kind of breakthrough moment for a group of people, whose really one common denominator was that they were making online student equal to campus student.

They were sort of ending the segregation of online education. They were sort of doing this in our opinion the right way and so watching them talk together about how to drive the outcome was really powerful, that's all commentary I feel like today we are honoring, what we said to ourselves, which is we will put much more science behind choosing program opportunities.

Now it gets challenging in the case of Greenfields simply because there are no degrees conferred in an area like Data Science, but looking at job prospects and looking at job growth. We thought, that one was a really solid opportunity and frankly we had a Dean, Anna Saxenian at Berkeley that really pushed us hard to do it and convinced us it was a great opportunity, we are very thankful she did.

So it is a two-way street. Qualitatively we feel really strong about the lineup that we are putting forward and do not see, while we understand investor focus on pipeline. It is not a significant management concern.

Brian Schwartz – Oppenheimer & Co

Great. I'll let you catch your breath for a second, Chip. I got a question, maybe this is for a Rob or Cathy, but you kind of, you seem to paint a very clear picture in your commentary here, that the business and the new program wins are quite strong, if not accelerating right now.

Is there anything that we should be aware or anything that's preventing from these new programs [indiscernible] being choke line on your capacity, can you talk through that, just to make sure that we can feel comfortable on that given the $6 rating trend and new program start.

Rob Cohen

This is Rob. The reason we lay out, that we'll launch no fewer than four programs a year, is to that, we continue our path to increase profitability. Our capacity is no limiting us at all. In fact, this year we are launching programs much quicker after deals signature and being able to market programs very, very quickly.

So operationally, we are continuing to have great success serving the university students that we currently serve, have no difficulty quickly launching new programs and that's not holding us back in anyway.

Over the past year, we've added a full time position that is actually beginning implementation of new programs through our sales process. So that we are able to very, very successfully launch these and it's not putting any barrier.

Chip Paucek

I think it's safe to say, Brian we wouldn't have given you a calendar, if we weren't highly confident on the launch schedule itself.

Brian Schwartz – Oppenheimer & Co

That's great and then last question from me, Chip. I would love to get your latest assessment here on where you think, we are in terms of non-profit university these appetites for cloud learning platform. So and maybe if you look at your pipeline here today, what percentage of the opportunity out there, do you feel would viably consider a cloud learning solution for graduate degrees and then, what did that look like say 18 months to 24 months to gap?

Chip Paucek

Well, it is clearly significantly different than 18 months to 24 months, but I'm not sure if that has as much to do with the appetite for cloud as much of it does, frankly that we've kind of delivered on, what we told people we would do and when I say, I don't mean investors I mean, our partners that we've delivered high quality student outcomes in a way, that you don't typically see with online learning and I think in our case.

Part of the special sauce here is that we really gotten great at, these are real Georgetown, Berkley, Chapel Hill, Wash U, G.W. Students. They really are becoming chosen [indiscernible] in a way that you typically don't see in most online programs.

There is a passion for the schools in a way that's very real. So we think that from a 2U has become it certainly is, at the elite level of school, go to option if you're considering going online. I think it should be an indicator of that strength that all of the universities that we announce this year, were actually new universities.

So 2015 is all filled with universities. Now I just cautioned you a little bit, that one of our great Dean's mentioned to me a story of change in high res [ph], the story of turtle being mugged by two snails and somebody asked the turtle, what happened. He said, I don't it all happened so fast.

That was one of my Dean's telling me, it a thoughtful slower process and so we don't believe in the notion of the land grab. Our schools have for good reason been thoughtful about their path and we don't believe its fear of change, we think there's a lot of good justification for when you got and such an incredible brand and reputation that you'd be thoughtful about your path.

The last thing, you want to do is in anyway, hurt the brand. So most schools are still going on a slower pace than I think many folks that we talk to, would expect. We actually think from that standpoint, it's actually for our company a positive because we have certainly proven, we can do this. While there'll be others out there that will try.

We are almost seven years in and it's not easy. So they're going to have to prove, they can deliver the quality before schools will sign up with them.

Brian Schwartz – Oppenheimer & Co

Thank you again for taking my questions today.


Thank you and our next question comes from Michael Tarkan of Compass Point. Your line is open.

Michael Tarkan – Compass Point Research & Trading

I know last quarter, you discussed the amount of revenue that's basically pent up in this model over the next couple of years, based on I guess some nominal retention trends, if you were to shutdown kind of new program investment. I think the number last quarter was around $110 million, do you have an update on that for us? And I guess a follow-up, should we still think about expenses against that in that low 20% range.

Cathy Graham

Hi, Michael. Yes, the update would be that at the moment it's about $114 million for that equivalent number and just to remind everyone, who might not know exactly what we are discussing. This is what we would consider to be our backlog number.

This is, if we were to shutdown marketing today and teach out the students, however the university program teach out the students who are already enrolled and attrition adjusted numbers would be about $114 million of remaining revenue and in the low 20% cost of sales against that number today.

Michael Tarkan – Compass Point Research & Trading

All right. Thank you and then with all of the new launches coming on line and sort of mix of different tuition cost rolled in, different growth rate, how should we think about revenue per I guess full course equivalent for the back half of the year in 2015?

Cathy Graham

We don't expect a significant difference in average revenue per FCE. There is the launches back end of the year, though they maybe we have one program that is probably slightly below our average, the remaining program in 2014 is probably slightly below our average in terms of course tuition, the numbers that it will generate will not change things all of that much in the remainder of the year.

What we should see is just the normal fluctuations we would see because of timing, class mix, things like that.

Michael Tarkan – Compass Point Research & Trading

And then one more, do you guys have a preference from a strategic standpoint right now, in terms of what type of program you'll be launching, whether it's a complimentary program, maybe a completely new program at an existing university partner or a completely new school.

Is there, how do you guys think about that and balance that as you look at new opportunities?

Chip Paucek

That's a great question and it's also very tough question. The reality is, we are looking at the sort of, we have to balance the notion of sort of ploughing virgin[ph] snow in a discipline like communication that we haven't touched yet, which we think creates a lot of long-term opportunity for the company, with building second program that might unlock more leverage, more quickly.

They're both really important and then you also mentioned Greenfields. I mean, Data Science it's not surprise to anyone internally that we are launching our second Data Science program because it's done very well, but it certainly was not on our radar previously. So we have to balance those opportunities, we are obviously looking at IRR's and we are looking at each particular program from the standpoint of what we think, steady state enrollment might be, but that is certainly a tough part of our job is managers, choosing the programs on a go forward basis.

Now I think as I mentioned Michael, we feel like, what says 18 months or 24 months ago, we're choosing with significantly more data. It's less qualitative and more quantitative.

Michael Tarkan – Compass Point Research & Trading

Okay, thank you.

Chip Paucek



Sorry. Thank you. Our next question comes from Andre Benjamin of Goldman Sachs. Your line is open.

Andre Benjamin – Goldman Sachs

We know from Cathy's earlier comments that the pre-2013 programs are about 81% of revenue, so the Rossier 19%. We also know that, given what we've little bit through 2014 or half way most of that's prior to 2013 program. So focusing a bit, closure on those is there any color that you could provide on, how the programs that were launched in 2013 are trending in terms of growth and profitability versus either expectations or how the core four doing at the same time, their life cycle?

Chip Paucek

We do believe that core four are representatives of the future, with one exception there is no second program in the core four. So we do think, that 2013 is showing some similarities, it obviously a lot earlier in the lifecycle. I mean, just have to remember we did launch the Rossier School of Education in 2009, the USC School, Social Work in 2010 and Georgetown, Nursing in Chapel Hill, MBA, UNC in 2011.

So they just have a lot more history, but we do see some similarities. Cathy, would you like to add some?

Cathy Graham

Yes, so Andre just we've centered down in exercise, where we've taken the 2013 launches and tracked them, sort of time zero against the original launches and we are, what we see is them following a very, very similar pattern, if we adjust for sort of changes we've made in our business model and by changes I mean, that you'll learn as you go through this and particularly around had a market for students and how to launch program.

We certainly learned a lot through our first few. So you've kind of normalized those changes you see very, very similar patterns.

Andre Benjamin – Goldman Sachs

Okay, that seems like a lot of things are going very well between a number of additional programs announced raising guidance, a lot of great stories about student outcomes. What isn't going as well as you maybe you would like where you're seeing some of the bigger challenges and what can you share with us regarding, what your partners are telling you about, what maybe you should be working on?

Chip Paucek

Well, I mean the reality is, if you're, all of our partners with what they've done in their history have a very high bar. So while we're telling you that are very pleased with results. The reality is, we can't be satisfied we have to drive higher outcomes, we have to drive higher retention. We have to drive better job placement rate. Placement in programs.

We were happy to talk about, placement on this call because it's actually one of the sort of the unsung jobs even at times within the company because it's very, very difficult to find that local placement for that midwife or too critical care nurse or the family nurse practitioner or a teaching program and so I can assure you, that our schools are always pushing us for more.

So regardless of whether, retention is a solid number. The fact is, we have to try to make it better, that's our job and I would say Andre, a very good question. The hardest thing for 2U without question is preconceived notions of online education, they're bad and so we certainly didn't create those preconceived notions, but they're very real and as you go from here to Europe to Asia, they get worse.

So we sort of battle that every day, most of the people that are considering one of our programs had really never considered an online program before and so they're just inherently pretty skeptical and they have to be really to spend a lot of time, with us and with some of the folks at our schools to really believe, that will get better overtime, we certainly didn't build it into our models, long-term basis, but we do believe that overtime we'll get wind in our back there because that should get better, but it's a daily issue [indiscernible] all the time.

Andre Benjamin – Goldman Sachs

And one last small one, to follow up, on the question about revenue per course, to more explicitly ask, is your thinking still that the average revenue per FCE should grow in the low single digits and are you seeing any change in the sentiment. Your university partners towards ranging tuitions given the state of the economy or debates around affordable education that call down the question?

Cathy Graham

So I'll take the first part of that question and then given it to Chip for the last part. Yes, overtime we do believe that a low single digits is probably the growth rate, the assumption is that as we sort of mature this portfolio of programs, we will be adding programs that will not materially change the average tuition, as we build this portfolio into what we are looking at primarily, is the effective tuition increases.

So the assumption is, as we've discussed valid.

Chip Paucek

So as far as tuition prices, all of our university partners are most concerned about delivering a really high quality outcome and typically do, indeed actually deliver that outcome. So I will tell you, that one of the benefits of the model that we bring to the table, is for the first time in history, you don't have to pick up your life, quit your job and move to attend a top 20 B school, that is a non-trivial change to your expense burden and therefore potentially your student loan burden.

We think, it's a big part of the story. We don't think it's been fully told, we do believe that it is the right decision, by our partners to charge the same tuition. It is ultimately the same quality, the exact same degree, the same faculty in many cases, the same rights and they're foreseeing responsibilities and it's also not easy or in expensive to do it this way, live weekly classes with the real Berkeley faculty member.

It's not easy, so we think it's the right call, but we do believe we are having a pretty profound impact on individual students, act debt burdens.

Andre Benjamin – Goldman Sachs

Thank you.


(Operator Instructions) our next question comes from Michael Huang of Needham. Your line is open.

Michael Huang – Needham & Company

Nice win at Northwestern, was wondering given the strength of brand here in a new vertical. I was wondering, if you talk about the relative length of sales cycle and how to compare to others in the past and at even the day, what was the catalyst for the decision to launch now?

Chip Paucek

Good seeing you, good hearing you again. So the -- I would say every single conversation is different. We've had some extremely fast and we've had some slower. This was maybe our longest, so this is been in process for about 2.5 years. Part of the reasons, the school was going through accreditation and this is the sort of real thing delivered on every level.

So of course, the accreditation is a key component of it. So this particular relationship took a long time, I was really excited to be able to mention Dan Linzer on the call because the Provost there has been real pioneer in this regard, but the family institute Northwestern is a very prestigious school, we are thrill to add Cheryl [ph] and Fran [ph] and their team to our partner list and it did take a while.

Now Mike, the other sort of Syracuse program would be opposite, it was the shortest one on our history, it took a couple of months. So everything – they're all different. Now we have quite a few in our pipeline and one of the reasons, by the way, it will be great, if somebody could, somebody's got background noise, if you can mute your phone.

There you go. So one of the things that it makes tricky about pipeline is that, these conversations all go to different pace and so we do have quite a few conversations going across many different universities and the time to close is going to be different per school.

So really nothing to do with our interest level in the relationship, it just some take more time.

Michael Huang – Needham & Company

Apologies for the background noise, I'm hold up here at the airport, but.

Chip Paucek

Been there many times, no worries.

Michael Huang – Needham & Company

A question about the part of symposium. I think you had mentioned that there were couple process there that had already post that and then I think you threw out a number about, I think it was like 60 attendees, are those all distinct universities or where was at the number of attendees across a smaller set of universities.

And I was wondering, if you could share what kind of process that was there?

Chip Paucek

We – it is not 60 universities. We invite the senior leadership team from each school. It's a small group of people from each school, typically the Dean in many cases the Provost. We were thrilled to have, quite a few Provost actually in attendance. This is really it's a great opportunity for us and for them to frankly learn from one and other in terms of how they're operating their programs.

I thought what Rob said was totally right on with regard to sort of organizational models for online program. He would never see that as an exciting topic, for most people in the world, but to this group that really is because everyone channeling slightly differently and if they can learn how to from their peers in terms of how to better organize themselves.

There were many other example, Chapel Hill let a session on the power of emergence because Chapel Hill has done that incredibly well. So it was 60 different schools and the two partners that we did mention that signed after were SMU and Northwestern. So it's a small group, it's intentionally a small group and I want to emphasize, we didn't talk about this on the call because it's a lead gen opportunity, it is not, we don't view it as lead gen for schools.

We definitely view it as a learning experience and we want to keep it pretty intimate. We would like to about it because we do think, it speaks to the difference in the company that we are really focused on the right thing, which is driving quality.

Michael Huang – Needham & Company

Thanks, so much.


Thank you and at this time, I see no other questions in queue. I would like to turn the call back over to CEO, Mr. Chip Paucek to close the call.

Chip Paucek

Okay, thank you very much everyone. We are happy to conclude a successful quarter and we look forward to continuing to eliminate the back rows all over the country and world. Thank you very much for your time.

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