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2U Inc (TWOU) Q2 2019 Earnings Call Transcript

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2U Inc (NASDAQ: TWOU)
Q2 2019 Earnings Call
Jul 30, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the 2U, Inc.'s 2019 Second Quarter Earnings Conference Call.[Operator Instructions] .

I would now like to introduce your host for today's conference, Mr. Ed Goodwin, SVP, Investor Relations. Mr. Goodwin, you may begin.

Ed Goodwin -- Senior Vice President, Investor Relations

Thank you, operator. Good afternoon, everyone, and welcome to 2U's Second Quarter 2019 Earnings Conference Call. By now, you should have received a copy of the earnings release for the company's second quarter 2019 results. If you have not, a copy is available on our website, investor.2u.com. The recorded webcast of this call will be available in the Investor Relations section of our website. Also, we routinely post announcements and information on our website, which we encourage you to access and make use of. One announcement before we begin. 2U will host an Investor Day at our headquarters on November 6, 2019. We'll share more details in the coming months, and we look forward to spending the day with you in November.

Today's speakers are Christopher "Chip" Paucek, Co-Founder and CEO; and Cathy Graham, CFO. During today's call, we may make forward-looking statements, including statements regarding the company's future financial and operating results, future market conditions and the plans and objectives of management for future operations. These forward-looking statements are not historical facts but rather are based on our current expectations and beliefs and are based on information currently available to us.

The outcome of the events described in these forward-looking statements is subject to known and unknown risks and uncertainties that could cause actual results to differ materially from the results anticipated by these forward-looking statements. This includes, but is not limited to, those risks contained in the Risk Factors section of the company's annual report on Form 10-K for the year ended December 31, 2018, and other reports filed with the SEC as well as our ability to successfully integrate the operations of Trilogy, achieve the expected benefits of the acquisition and manage, expand and grow the combined company.

All information provided in this call is as of today. Except as required by law, we undertake no obligation to update publicly any forward-looking statements made on this call to conform to statements or actual results or changes in our expectations. Also, it is 2U's policy not to update our financial guidance other than in public communications. Non-GAAP financial measures discussed during this call are reconciled to the most directly comparable GAAP measures in the tables attached to our press release.

I would now like to turn the call over to Chip.

Christopher Paucek -- Chief Executive Officer and Co-Founder

Thanks, Ed. Over the past 11 years, we built the most important business in the online higher education ecosystem. When we started 2U, the market was in its infancy. The core thesis of the company was that online programs could drive a similar quality to campus programs and that the company's scale and unique platform characteristics would build a competitive moat around the business over time. Today, the online education market is evolving. Secular forces are pushing more schools online. Indeed, it's becoming obvious that all schools are going online. We're calling it the mainstreaming of online education.

We believe this represents a new reality in the marketplace and requires us and others to adjust to it. We also believe that this new reality is one that 2U is uniquely positioned to benefit from due to our size and comprehensive product set. So we're adjusting our executional model against the dynamic of this mainstreaming of online education in a way that meets this new market dynamic. Competition for students has increased. Programs will be slightly smaller than they were in the past, but the scale benefits of 2U's overall operating model, a combination of 2UOS and products across the career curriculum continuum become even more important as more schools come online.

The evolving market dynamic creates some short-term pressure, but the importance of 2U's scale is more valuable to our clients than ever. We're moderating our outlook for the business in the short term, but the long-term secular drivers are in our favor. We know what is challenging us, how the market is changing and most importantly, what we're going to do about it. Let's start with Q2 results. They were solid. Second quarter revenue was $135.5 million, up 39% over last year. Cathy will give you more detail shortly. Our full year 2019 guidance reflects our moderated outlook given the shifting market dynamic. On the top line, we now expect revenue to be $565.7 million to $575.7 million, a growth of 39% at the midpoint.

Excluding the expected financial impact of Trilogy, this implies a step down in revenue expectations for the rest of the business. So why have our revenue expectations gone down excluding Trilogy? Let's first talk about our graduates. As I've mentioned before, we're coming to some conclusions about the overall online education marketplace. It's evolving. Decline and program-specific issues we talked about so much over the past year were masking this broader trend of the mainstreaming of online education. In 2008, there were very few high-quality online options. As we've grown the business since then, new online options for students have expanded significantly. Today, most schools are going online in some form.

There are now many more offerings and more competition to enroll students. What does this mean to us? We need to shift our expectations per program, which results in a smaller average steady-state program size than what we would historically expect. That note, investors want to unpack the funnel, and we tried that in the past. What we're saying here is our guidance presumes lower conversion rates on a go-forward basis. The reality is this is the case of small differences in part to the funnel across the multitude of different programs in many different disciplines with a multitude of structures, it's overall trend analysis and conclusion about the market.

It's an evolving market and one that we believe we will continue -- one we believe will continue to see more offerings. This mainstreaming of online education means increasingly regional competition. While brands still win, they win in smaller circles of dominance. Regional bias impacts enrollment decisions. For example, a student in Philadelphia has online options locally that they didn't have back in 2014. Program quality and brand strength both matter in the long run, but you need it be for students, and more options simply means it's somewhat harder. So in light of this new reality, we changed our outlook.

In the grad business, we tempered our enrollment and revenue expectations. We expect the average program enrollment at steady-state to come down from what we previously expected. We've accounted for the largest programs regressing toward the mean. Some of that was program-specific issues. However, we think it's prudent to expect fewer programs to substantially outperform these averages long term. Fewer super large programs does create less single program exposure or revenue concentration risk for 2U. We're shifting our expectations per program going forward, but our scale becomes even more important as the market evolves.

Our overall leverage increases as our platform builds across each business competency we provide our clients. Our scale creates marketing efficiencies and opportunity, drives clinical placements across the bigger platform and creates operational leverage across 2UOS. In this new reality, single program operators or companies without the scale benefits that 2U sees will struggle. Many smaller competitors in our space are seeing this realtime. One other important comment about the grad business. We do not believe we have a unit economic problem.

Our mature cohort margins remain strong. By lowering enrollment expectations, we expect a more efficient marketing spend over the long term helping to alleviate some of the pressures from our need to compete with other online education offerings. Scale helps here. We've seen that we can properly spend for smaller steady-state enrollments to drive sustainable business. So what are we seeing in the short course business? We expect the short course business to continue growing nicely, but we're learning: number one, what courses work with which school brands; and number two, that matching courses would lead professors take more time than expected even after we signed a deal with the university.

We'll build more moderation into our expectations to account for these factors. This is unrelated to the new normal, just some executional issues we need to get right. Before I move on to talk about our plan going forward, I wanted to touch on some regulatory developments related to recent guidance issued by the Department of Education. This is a complicated issue, but technically, this guidance would prohibit residents of California enrolled in distance education programs at out-of-state public and nonprofit institutions from receiving federal student aid funds. While we're optimistic that the impacts will be broken soon, considering that the Department of Education has not yet endorsed California student complaint process, we thought it was prudent to reflect this uncertainty in our current guidance.

Given these overall trends and the increasing complexity of our business, we've tempered our expectations for the remainder of 2019 and widened our guidance ranges. So let's pull back and talk about the plan going forward. First, we control our destiny. We continue to have growing cohorts in our grad business that we believe we can run profitably. We have a short course business that we believe can be self-sustaining while growing over the long term. We have a boot camp business that is offering some of the most in-demand course topics in the world. At the end of Q2, we had almost $220 million in the bank. If we manage our overall business for moderating growth by adjusting our new program cadence and operating expenses, we believe we will drive toward positive free cash flow.

So how are we going to do this? First, we will moderate our grad program launch cadence. We look at 2020 and early 2021 as a time period to deliver on what we have with a smaller amount of new program launches. To be clear, what we're doing here is proactively adjusting the velocity of new program launches to support our path to profitability and positive free cash flow. This will allow us to shift more focus to optimizing the performance of our existing programs while we continue to add programs but at a smaller rate. We have a lot of the optimization projects under way and are seeing some fruits of our efforts there even with this current outlook.

I'm not yet ready to tell you how many programs we will do as it's still a work in progress. That will have to wait for Investor Day on November 6, but I expect it to be substantially fewer than 21, probably less than half of that. This cadence recalibration is simply the right thing to do right now for the business, for the students and our partners, both financially and operationally. But to put the strength of the grad model in perspective, if we do not sign any additional programs beyond what we have today, we currently project the grad business to grow in the mid to high teens in 2020 from our current 2019 expectations. And in that scenario, the growth should remain solid for a few years with no new signings and operating within this new reality of smaller steady-state program enrollments.

But of course, we will sign new programs, and our competitive positioning remains incredibly strong, as indicated by the announcements I will cover shortly. We intend to give you our updated launch cadence and the impacts on growth rate in the bottom line at Investor Day. So what else are we doing? We're focusing on better efficiency for the business and its costs overall. We have a bunch of projects under way on this effort. Scale clearly helps here. These efforts combined with the cadence slowing should put us on a path to free cash flow. The new path is intentional, one we're driving with clarity and purpose. Now on to pipeline. We talk a lot about competition for enrollments earlier in the call, but when it comes to competition for partnerships, we're still winning new deals.

Demand is there and is exciting. We're laser focused on winning the right deals. I'm proud of our work here. So 2 relevant announcements for you. First, our entrance into the pharmacy vertical. 2U continues to lead in disciplines with complicated clinical characteristics, which is where we built the widest moats. I'm excited to announce the doctor of pharmacy with St. John Fisher College in Rochester, New York. This is a much anticipated new discipline for 2U that will require advanced pharmacy practice experience consisting of 7 clinical rotations. St. John Fisher is still going through a few internal steps related to the program but it's signed. Second, our first-ever institutional suite.

The mainstreaming of online education means that institutions are now asking for a more comprehensive solution across a broader set of programs. We're able to meet that demand due to the breadth of offerings across the career curriculum continuum and the scale benefits of 2UOS. I'm proud to announce we've been awarded a competitive RFP to become UNC Chapel Hill's exclusive Pan University digital education collaborator for program spanning the entire career curriculum continuum. We expect no fewer than 10 offerings with the first few launching in 2020. In addition to offering our full service model for graduate degrees, the institutional suite includes a new fee-for-service model to power smaller size programs.

This is the type of arrangement that will be very difficult for competitors to replicate and couldn't have happened if we hadn't become more comprehensive, in part by acquiring Trilogy and GetSmarter. This is the future. We'll have much more on this deal and its impact at Investor Day. Finally, I want to give a word or 2 on the Alternative Credential segment and specifically, the acquisition of Trilogy. First, our short course business had a big win. Today, we announced a 10-year contract expansion with the University of Cape Town to deliver new short courses across the university. UCT is a critical partner for 2U, and we're excited about what's ahead.

With Trilogy as part of the team, we're now meeting the evolving needs of the workforce, particularly in STEM subjects, which evolve at a faster pace than other disciplines. Our overall business outlook increases this year from the addition of Trilogy in a variety of ways. We expect to expand the Trilogy core business substantially over the next few years. You can see many competitive wins in our press release. But Trilogy also creates great opportunity for our other business lines. In a few months since we announced the acquisition, we've already met with a number of Trilogy partners who are interested in expanding their relationship with 2U across the career curriculum continuum. We'll talk about this more in November as there's too much to cover here.

One new exciting development for 2U related to the impact of Trilogy across our business, 2U enters the enterprise channel. Trilogy combined with GetSmarter creates a significant enterprise opportunity in selling our offerings to companies looking to upscale their workforce and attract more technical talent. This is already a real business line today. We're seeing demand per seat for the short courses and boot camps, and we'll expand those efforts next year. Overall, while we're moderating our outlook for our legacy business short term, our core thesis remains intact, and we will differentially benefit long term from accelerating secular trends.

Our competitive positioning is very strong due to our scale advantage, breadth of our 2UOS platform and confidence of product line across the CCC. We're adjusting to meet the new market dynamic and program size and making an executional change over the next couple of years to address the financial and operational needs of the business. We will slow program cadence, still grow nicely, get to free cash and most importantly, win for students and universities while we do it.

With that, I'll turn it over to Cathy.

Cathy Graham -- Chief Financial Officer

Thanks, Chip. Before moving to our revised view for the remainder of 2019, let me first do a quick review of second quarter results. Second quarter revenue of $135.5 million exceeded the same period in 2018 by 39%. Business combination accounting rules required us to exclude $3.3 million in second quarter revenue. Revenue prior to this adjustment was $138.8 million, representing growth of 42.5% year-over-year. In our graduate program segment, revenue was $101.4 million or 24.9% year-over-year growth for the quarter. In the Alternative Credential segment, including a partial quarter of revenue from the Trilogy acquisition, revenue was $34.1 million or 110.1% year-over-year growth.

And prior to the purchase accounting adjustment, revenue was $37.4 million or 130.7% year-over-year growth. In the graduate program segment, revenue growth continued to be driven by an increase in full course equivalents. For the second quarter, FCE showed a year-over-year increase of 28.3% offset by a 2.6% decline in average revenue per FCE. The decline in average revenue per FCE is based largely on program mix and academic calendar changes. In our Alternative Credential segment, we are seeing the impact of rolling a partial period of Trilogy boot camp performance into this segment. The result was a year-over-year increase of 64% in FCEs and 49.8% in average revenue per FCE.

This reflects the addition of a somewhat longer delivery period but higher-priced product into this segment's mix. You should expect to see a further shift in these metrics in third quarter once a full period of boot camp performance is included. Looking at our second quarter loss measures, all have been skewed versus prior periods and expectations by the acquisition of Trilogy. At $28 million, second quarter net loss improved from our pre-Trilogy expectations primarily because of better-than-expected performance in our pre-Trilogy business and an approximately $19 million onetime tax benefit related to the acquisition. And while at $25.8 million and $15 million, respectively, adjusted net loss and adjusted EBITDA loss were both higher than our pre-Trilogy expectations, they also benefited from earnings overperformance in the legacy business.

From a balance sheet perspective, we ended second quarter with $218.7 million in cash and investments and had $71.6 million in receivables balances. Note that our receivables balances are relatively consistent with the first quarter despite the addition of our new boot camp business. This reflects the reduction of graduate program receivables between the sequential quarters based on academic calendar timing and the related collection cycle. Also note that our long-term debt has increased to $245.5 million in the quarter, reflecting the term loan facility we entered into for the Trilogy acquisition. Now looking forward. We're providing guidance for third quarter and full year 2019 inclusive of the expected results for our new boot camp business.

Before turning to the numbers, I want to reiterate and expand on what Chip discussed earlier. As the mainstreaming of online education has developed and students have more online options, we expect to continue to see smaller average steady-state program sizes across much of our business. As a result, we've updated our expectations based on the evolving business environment where we have to consider higher variability and uncertainty. In our graduate program business, we are reducing our expectations for the ultimate size of programs allowing for the fact that the rate at which programs scale has become more variable and allowing for a slowdown in 2020 launch cadence.

For short courses, we are also moderating our expectations along the lines Chip mentioned earlier. Our revenue guidance now incorporates our continuing expectations for the Trilogy boot camp product line offset by the moderated outlook we have for our legacy business. We now expect revenue of between $147.6 million and $152.6 million for the third quarter and between $565.7 million and $575.7 million for the full year. Adding back solely the Trilogy boot camp revenue that we will not recognize as a part of purchase accounting, these ranges are $153.6 million to $158.6 million and $576.9 million to $586.9 million for the third quarter and full year, respectively.

Our expected earnings measures have now changed as a result of the changes to our expectations and the incorporation of Trilogy into this business. Because of this, I strongly suggest that you read the reconciliation of our adjusted net loss and adjusted EBIT dollar loss guidance to our net loss guidance to better understand the changes. Additionally, I do want to mention that while we do not expect to be able to make up the entire reduction in expected revenue over the remainder of the year, we have slowed the growth of our cost structure. And particularly in our graduate program business, expect to be able to offset some portion of the revenue decline even over the short time period.

We now expect a net loss of between $69.3 million and $66.3 million for the third quarter and between $157.5 million and $151.5 million for the full year. These ranges include the flow-through of $5.9 million and $11.1 million of purchase accounting driven revenue reduction for the third quarter and full year, respectively. These revenue reductions are excluded for the purposes of providing our adjusted loss measure ranges. In thinking of this net loss guidance compared to prior expectations, remember that for the full year, it now reflects transaction costs and the acquisition-related tax benefit booked in the second quarter, which we then exclude from our adjusted loss measures.

Further, for both the third quarter and full year, net loss guidance includes interest expense on the term loan facility we entered into for the Trilogy acquisition, and a step-up in acquired intangible amortization related to that acquisition, both of which we exclude from our adjusted loss measure ranges. We now expect an adjusted net loss of between $33.8 million and $30.8 million for the third quarter and between $76.9 million and $70.9 million for the full year. We also expect an adjusted EBITDA loss of between $18.4 million and $15.4 million for the third quarter and between $28 million and $22 million for the full year.

And finally, I want to reinforce something Chip said earlier. While we are acknowledging an evolving environment and an increasing uncertainty, we do believe we are on a path to continued growth while getting to free cash generation. And we look forward to talking to you more about this and other aspects of our longer-term plan in November. Chip?

Christopher Paucek -- Chief Executive Officer and Co-Founder

I want to close with a note to our 2U team. This year has certainly pushed us, but I want to make it clear to all of you, you're amazing. You have built super high-quality products with excellent outcomes for students. We're positioned for the long-term sustained success. We just announced our first ever exclusive institutionwide deal with none other than University of North Carolina Chapel Hill. We are changing the world.

Let's get to Q and A.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from Sarah Hindlian of Macquarie. You may proceed with your question.

Sarah Hindlian -- Macquarie -- Analyst

All right, great, thank you very much Chip and Cathy, I was wondering if you could help me understand and maybe just size the impacts to the core graduate business, exactly what you're seeing happen, what could happen in the State of California with ships from federal -- for federal loans for students who are doing distant learning. And then I have a follow-up as well.

Christopher Paucek -- Chief Executive Officer and Co-Founder

So -- thanks, Sarah. So on the State of California, obviously, it's an evolving situation, one that we're more optimistic will get resolved. But we felt like, given the fact that it is not yet officially resolved, it could put some uncertainty into certain students' minds or more importantly, certain universities' minds, so we felt like we had to account for it in our forecast. The -- sort of backing up to the grad business overall, we're trying to make sure that folks understand there's significant growth potential in what we've already built, which is why we're trying to sort of give clarity that if we stopped all launches, we would see growth in that business in the mid to high teens and would expect that to continue for some time.

So there's a lot there still for the grad business that we're excited about. And of course, we're not going to end all launches. We do think it's -- right now is appropriate time for us to change the velocity of the launch schedule in order to drive: number one, operational improvement for the business; and number two, better financial performance for the company overall.

Sarah Hindlian -- Macquarie -- Analyst

Okay. Great. Thank you. And I have a follow-up for you, Cathy. In terms of talking about driving toward free cash flow positive numbers, which I do think is fairly important to a number of investors out there, do you have a sense or is it too early to give us a sense of how long that journey will take? And then, Chip, I appreciate your comments that if you shut off new programs, you'd see these certain dynamics, but as you said, you will be doing some new programs. So how do we think about the timing of free cash flow breakeven?

Cathy Graham -- Chief Financial Officer

So Sarah, I think that we are working through a lot of this right now, and it's our intention to be a lot more specific about this on Investor Day. So we'd appreciate the time to be able to get there and put some real thought into being able to give you a plan that you guys will really -- that we can lay out for you.

Sarah Hindlian -- Macquarie -- Analyst

All right, that's fair enough. Thank you.

Operator

Thank you. Our next question comes from Brett Knoblauch of Berenberg Capital. You may proceed with your question.

Brett Knoblauch -- Berenberg Capital -- Analyst

Hi guys, thanks for taking my question. First, is there -- can you guys break out the revenues that were associated with Trilogy in the quarter? Or is that something you guys not plan to do?

Cathy Graham -- Chief Financial Officer

Yes, we're not planning to do that. We're presenting our business on an Alternative Credential and graduate program segment basis so we don't intend to break that out.

Okay. That's fine. And then second question. Just was reading an article about how Boston University is launching a $23,000 degree with edX. Now with the change of structure in your programs, is this something you might expect that you can now offering with universities?

Christopher Paucek -- Chief Executive Officer and Co-Founder

So we are -- is the question are we going to continue to offer a -- well, I'll just go here. We will continue to offer competitive programs in the landscape over the next several years. We have quite a few different MBA programs at different price points, that won't stop so we will continue...

Brett Knoblauch -- Berenberg Capital -- Analyst

My question is from a tuition pricing standpoint, I feel like you're seeing a lot more of these universities move online, and not only move online but move online to cheaper degrees. Your programs are [Speech Overlap] on the higher end of that market.

Christopher Paucek -- Chief Executive Officer and Co-Founder

We do continue to believe that you have to drive a long-term quality and sustainable business and one that doesn't exist off the backs of the campus programs. So we do think, over time, it's really important that both quality and costs will get considered. Now there's no question that we are working on a variety of things to have -- to attack the cost problem very specifically, and we will talk about those in detail at Investor Day.

On this particular call, we felt that given the new outlook that we focus squarely on the outlook, talk about the outlook at whatever detail investors need and not come up with a long list of optimization points we are working on. But I want to be exceptionally clear, we've got some really good plans in tow to attack one of the things that we think is an important component, which is tuition costs. We just didn't plan on this call to unpack the funnel in that way.

Brett Knoblauch -- Berenberg Capital -- Analyst

Okay then. Last question, I'll jump back in the queue. Do you think the university selectivity issue that you guys noted at Q1 is due to the regulatory concerns with I think it's AB 1345? Do you think that's a play into why maybe they're tempering their -- or not just counting the program's success?

Christopher Paucek -- Chief Executive Officer and Co-Founder

No. I mean -- so to be clear, the various aspects of the funnel, I would say having now lived this publicly, I would tell you that there are -- it's a complicated business. The funnel itself is complicated, and there are parts of it that it's noisy, and the admit rate in particular is noisy. While we did have some program-specific issues sort of masking the overall issue, just to extrapolate a little bit more on your last question, the reality is it's not one particular thing that is driving this new sort of reality for us. It's not one particular competitor. It's not one particular program and it's certainly not one particular aspect of a program like cost.

When we look at the decline surveys for folks that come into our programs, it's hard to find a university listed more than once. It's just a longer list of single universities that's expanded pretty dramatically since we IPO-ed. So this is a moment for us to ultimately, at this point, change our outlook, presume that we're going to have lower conversion rates going forward and candidly presume that there will be a lot more competition, not that competition will stay flat today. So while we have to continue to work on a variety of ways to address it, this is us saying that we do think this is a new normal.

Brett Knoblauch -- Berenberg Capital -- Analyst

Okay, thank you.

Operator

Thank you. Our next question comes from Ryan MacDonald of Needham. You may proceed with your question.

Ryan MacDonald -- Needham -- Analyst

Hi, Chip. I guess first question for you, Chip, is really around the expected program launch cadence and just sort of trying to sort of sync up what you were saying in the prepared remarks. You mentioned that university partners are still really willing to sign up with partnerships for you, but then you're obviously moderating that cadence. Is it because you're seeing sort of a shift more from the university partners to a demand for the short course or the Trilogy type content versus full grad program?

Christopher Paucek -- Chief Executive Officer and Co-Founder

No, definitively not. I don't want to put out there that the -- this is an intentional change in our velocity of program launches. What we have seen in terms of -- we spent a fair amount of time over the last year talking about competition for deals. And we thought that the UNC institutional announcement is not only a big one but one that is relevant given that it was a super competitive RFP. We certainly have seen an increase in the number of RFPs given that there are more people chasing after business but feel very confident that we are well positioned to continue to get the programs that we want and get them at a sort of target economics that we like. So it's not because of some retreat to short courses.

We just need to be, during this period, selective about what we're launching, and we need to slow down a little bit and improve the aspects of what we've got, focus on a little bit more internally on what we have, and we think that will serve us well operationally, and the power of that was we're certainly not going to need anybody's money if we do that. So we've got to drive the long-term sustainability of the business. Now one thing I would say, Ryan, is the institutional suite is different, and it's awesome. And we're very proud of the relationship. That relationship has gotten a lot of attention from this community for a bunch of reasons, and the university is very happy with our performance and I would say proud of our team that we were able to be flexible in our approach to the school.

Obviously, it's a top 20 university. There's a ton of really exciting programs in that relationship that will push the boundaries of what's possible to do online. We like it quite a lot. We just didn't think that today was the time for us to be running down a long list of things to tell you how great a variety of things were. We just want to sort of level set with this community that we're dealing with what we do think is a bit of a new reality from a competition per student standpoint and just need to reflect that in our outlook.

Ryan MacDonald -- Needham -- Analyst

Got it. And then just a quick follow-up, I know we've already sort of discussed the California ad nauseam, but just to clarify, with the UC Davis program that you talked about, the delay -- experienced delays in the first -- on the first quarter call, is there potential because of these regulatory changes for additional delays to that program in the back half of '19?

Christopher Paucek -- Chief Executive Officer and Co-Founder

No, that program is up and running. To be clear, the California issue doesn't affect California schools. It's unrelated. It affects all nonprofits that are offering programs in distance education to California students. So this was a careful issue for us to consider as we are putting through guidance. It is all very real time. It's tricky. I can tell you, it is super important to anyone that is in my seat whether that's being discussed or not, it is super important from the standpoint of other nonprofits in the world that are servicing online education because California is, what, the eighth largest country on the planet.

So while regional bias will certainly impact things from the standpoint of California students will actually be focused -- California universities will have more sort of regional bias and therefore have more California students in them. Schools that are outside of California clearly offer distance programs to California, and we're included in that. So we had to sort of take that into account and reflect that in our guidance. Now we are optimistic that it will get resolved. We just don't know how long that's going to take.

Ryan MacDonald -- Needham -- Analyst

Yeah, thanks for that clarification.

Operator

Thank you. Our next question comes from Rishi Jaluria with D. A. Davidson. You may proceed with your question.

Hannah Rudoff -- D.A. Davidson & Co. -- Analyst

Thank you for taking my questions. It's Hannah on for Rishi. First off, I was wondering if you could just talk about institutional suite and what interest is like so far and what your current pipeline looks like?

Christopher Paucek -- Chief Executive Officer and Co-Founder

So the institutional suite is a fantastic opportunity for us to extend to U.S. across full institution. A lot of programs. It's our first one. We've been working it for some time. We do have others like this that are in play. Nothing to announce there yet but they're large. It's one of the most important deals we've ever done. It does have a component associated with it that we are -- we'll be offering for the institutional client, a fee-for-service component that we think is super interesting from the standpoint of better serving the client overall. And in part, that is part of the reason that we now have an exclusive relationship with that school, which we've never had before. So I certainly understand today is a complicated day in terms of explaining our outlook, but this is nontrivial.

Hannah Rudoff -- D.A. Davidson & Co. -- Analyst

Okay. Great. Thank you. And then second, I was wondering if you could talk about how much risk you feel qualitatively is left in this new normal considering a lot of the challenges you're facing are outside of your control.

Christopher Paucek -- Chief Executive Officer and Co-Founder

So I'd say in the past periods, we've -- when we've had challenges, and this is not just as a public company but as a private company, this place is filled with entrepreneurs, and we tend to figure out how to operate our way out of a variety of challenges we're having, and we are often successful. I'm not going to spend a ton of time on the call talking about all the components that are going on, all the projects that are going on to improve our funnel or our student experience. But given the outlook, people are focused on our funnel.

And I would tell you that there's a bunch of projects in terms of helping students that are more self-serve-oriented, and we like some of the proof we're seeing there. There's a bunch of positives. I would say, ultimately, what we had to do here was just pull back, not expect that we'd be able to operate our way out of the problem, look at the market and on top of that, look at what was happening in our newest programs. That is certainly a data point here that gave us the belief that we needed to sort of put out there a new outlook and build up from here. So we now move forward with while a slightly slower scaling practice and is one that we still think has great growth potential and one that strategically is really difficult to compete with.

The market is evolving. This will become more obvious. I would tell you, 2U still today has significantly larger program sizes than anybody else, and we're not guessing, only at the graduate level so far. And at the graduate level, there is no question that more schools are launching programs, and that's not going to stop. So we felt like we needed to reflect that in our outlook.

Hannah Rudoff -- D.A. Davidson & Co. -- Analyst

Great, thank you.

Operator

Our next question comes from Jeff Meuler of Baird. You may proceed with your question.

Jeff Meuler -- Baird -- Analyst

Yeah. Thank you. So it's not 100% clear because we're layering on Trilogy, but if I back out an estimate of Trilogy revenue -- the revenue guidance reduction for the year looks fairly material, and I know you're calling that out as well. But just can you help me kind of understand, I think the 3 factors are the execution challenges in short course California, and then there's kind of broadly weaker enrollment trend competition issue. So just, first, can you help me size up with those 3 factors, and if there's an additional factor, let me know what I'm missing.

Christopher Paucek -- Chief Executive Officer and Co-Founder

I think you first have to start with the one you covered last, which is that -- I mean, Jeff, we are at this point changing our outlook because we believe this is a bit of a new normal. Our programs are individually larger than others, and so I do think we're feeling it first. I think the smaller programs in the universe will feel it. And so not that the other 2 aren't relevant. They certainly are. So I'll get to the short course in a second but first, I would say yes, this is a moment for us to pull back and sort of reset the velocity of the growth of the business from the standpoint of our cadence to better serve what we have today and to better serve the company financially and to make sure that we've got this place guided on a path to free cash flow, number one.

Number two, the short course business. Obviously, our business complexity has increased. Strategically, we think it's been really, really good for 2U, but that has driven complexity in our ability to both operate and forecast the business. I think that's fairly obvious now so I might as well just say it on the call. One of the things in the short course business that has proven to be trickier than expected is aligning not the university deal. On the grad side, when we get a university deal, they take forever, but when we get them, we're done. We then launch them. In this case, when we get them, we didn't have to align faculty to teach the courses.

And I would tell you, we really underestimated that in a substantial way, and that caused us to get behind on the short course side in a way that we felt like we wouldn't be able to catch up in this calendar year. So that was a big part of what happened on the short course business. And of course we talked about California so far in this call. That one is -- it's difficult to estimate but we certainly didn't want to not include it when we're changing our outlook. We felt like it was prudent and smart for us to put a set of projections together that we thought, definitively, we'd be able to improve upon and deliver from here.

Jeff Meuler -- Baird -- Analyst

Okay. And then on the competition or enrollment trend question, so just help me better understand what's happening. There was a part of an answer to a recent question that you said you have to look at what's happening in the newest program. So is it predominantly that the new programs are ramping more slowly? Have you seen the broadening of the decline? Just how broad is the incremental weakness across the portfolio? And is it predominantly new enrollment that we're talking about?

Christopher Paucek -- Chief Executive Officer and Co-Founder

Yes. I think -- so if I could help you think about the way we talked about what a DGP is. And by the way, we're going to get into this in a ton of detail at Investor Day. I mean this stuff is realtime. And at Investor Day, we will sort of unpack the way we're talking about the model when you consider that an institutional suite looks nothing like a DGP. And certainly, there are things like what we announced with our pharmacy program, which you've heard about for a long time. That one obviously looks and feels more like a DGP, but the institutional suite does not. I would say, as more competition comes into play, the outer bands of what you might have brought in on student size they've always gotten more expansive.

By definition, you're at -- more at the efficient frontier when you're at the outer rim of student size so that last 50 students is difficult. And when you start bringing in more competition and there are more choices for people, I think what I said on the call earlier, just to reiterate, is it's rare that a university shows up more than once on the decline surveys. There's just a lot of them. So it's a bunch of different factors across the business. And yes, it is a large enough number that it's certainly worth you focusing on it and why you're asking me questions about it. My point is it's a real change to the outlook. And at this point, we're presuming that it continues. We're not presuming we'll operate our way out of it. And the reality is if some of these pieces were able to improve, we do better than forecast.

Jeff Meuler -- Baird -- Analyst

Okay. Last one for me, please. Just what changed or what specifically are you seeing in the funnel that it seems like the narrative has shifted a bit from last quarter where there was more focus on selectivity and student preference for self-service and less focused on competition. And on this call, competition seems to be much more of an issue. So what specifically are you seeing in the funnel that leads you to that conclusion?

Christopher Paucek -- Chief Executive Officer and Co-Founder

Yes, Jeff, it's tough. There's a lot of factors. There's always been a lot of factors, and what we're saying to you is that some program-specific issues we allowed to mask the broader trend. That's really the problem. We said it on the call, we mean it, and we're not going to allow that to happen anymore. So we're changing the outlook. To be clear, those program-specific issues were big. They were very large, so we were certainly caught up in them. But at this point, we think it's prudent to sort of pull back and get a little bit out of the individual noise of what are very complicated funnels that all look really different and just presume that we're dealing with what is the new normal.

Now you noticed on the call, I didn't talk about the economy, and that is certainly a factor. There's no question. I didn't talk about cost, that is certainly a factor. And obviously, at some point, we'll enter an economy that isn't as strong and we have -- we believe some really good tools coming up to address cost. But for today, we felt like it was better to just level set with this community that we think we're looking at a revised outlook, and we're not going to presume that it improves.

Jeff Meuler -- Baird -- Analyst

Okay, thank you.

Operator

Thank you.Our next question comes from Jeff Silber of BMO Capital Markets. You may proceed with your question.

Jeff Silber -- BMO Capital Markets -- Analyst

Thanks so much. Just wanted to delve a little bit further into Jeff's question. What changed over the past 3 months? I mean, 3 months ago, you came in, you kind of changed the longer-term expectations for the business. Did things meaningfully get worse over the past 3 months?

Christopher Paucek -- Chief Executive Officer and Co-Founder

No. I mean, we're at a pretty critical moment of sort of where the year is, and we had a bunch of new programs that later in the year, as you know, we have a lot of back half launches. And so as we started to get really good data about what was happening realtime, it wasn't what we expected. You couple that with the larger programs regressing from the size they were, I mean, what's tough about it, Jeff, is they're still big. They're not as big as they were, and how much of that was program-specific issues versus what we're really now seeing, particularly when it's not like a single competitor is driving the delta.

And you put it all together and we felt like we're at this point now where that is new data. And then to be fair, on the short course side, as I mentioned, we had some unfortunate -- we had some things that were execution-related that we thought we had better numbers for, and we don't. So that is a factor and then, of course, we talked about California.

Jeff Silber -- BMO Capital Markets -- Analyst

Okay. And actually, my second question was on California. Can you just give us an order of magnitude? If I look at your whole course equivalent enrollment for the graduate programs, roughly what percentage of those are California residents attendings schools outside of California?

Christopher Paucek -- Chief Executive Officer and Co-Founder

Jeff, we can't get into the student body numbers per school. As you know, we do our best to keep our clients out of this, and that's not a point if I started talking about my school student body on a earnings call. I have much bigger problems. We do think we've considered it in our outlook and it's part of the reason we raised it.

Jeff Silber -- BMO Capital Markets -- Analyst

Okay. Thanks.

Operator

Thank you. Our next question comes from Brian Schwartz of Oppenheimer. You may proceed with your question.

Chad Schoening -- Oppenheimer -- Analyst

Hi, this is Chad on for Brian. Thanks for taking the question. You spoke a little bit about the competition for the grad business. I'd be curious to hear about how you view the competitive landscape in the boot camp space. And does that competition differ whether it's classroom or on prem or sort of digital learning? And then how do you think about differentiating those boot camp offerings?

Christopher Paucek -- Chief Executive Officer and Co-Founder

Well, sure. There's a lot of competition in each market we operate in. Schools have done an exceptional job partnering with universities in the way that we think is super responsive to universities' needs. I can tell you that since the acquisition, we continue to be more and more impressed by the health of those university partner relationships and, therefore, the strength of the overall offering. I'm sure other companies in this space will continue to seek out university partnerships so I would expect competition to increase. Trilogy's geographic footprint is getting quite impressive, and we do think it becomes a platform we can roll out quite a few other opportunities across the boot camp space.

Online, it's earlier in their life cycle, and we think that we can be very additive to Trilogy's ability to both market and serve a variety of different online options. Some that will look and feel like they're ground programs and some that won't. There's a lot of expertise in this building for that. And I would say, finally, the institutional suite is a real advantage. Our partnership with Chapel Hill becomes a pretty exciting opportunity for all 3 of our product segments.

Chad Schoening -- Oppenheimer -- Analyst

That's helpful. Thank you.

Operator

Thank you. Our next question comes from Corey Greendale of First Analysis. You may proceed with your question.

Corey Greendale -- First Analysis -- Analyst

Hey, good afternoon. Two real quick questions and a longer question. The quick question. I just want to clarify, on the UNC, the 10 programs, would that be 10 graduate programs or those could include other offerings besides the 3 programs?

Christopher Paucek -- Chief Executive Officer and Co-Founder

Yes, at least. The answer is yes -- sorry. Yes, grad programs, things that you would've considered a DGP. I'm trying not to say DGPs because we think that relationship is going to look different than what a DGP was, and we're going to talk about that quite a bit at Investor Day.

Corey Greendale -- First Analysis -- Analyst

Okay. Another quick question is just to make sure I'm not getting lost in the nomenclature, is there any change in your outlook for Trilogy relative to what you discussed at the time of the acquisition?

Christopher Paucek -- Chief Executive Officer and Co-Founder

No. Our outlook for Trilogy has increased since the time of the acquisition.

Corey Greendale -- First Analysis -- Analyst

Okay. Then the longer question is just translating some of what's happening in the market into kind of your operating decisions. Is the concepts that because there's greater competition therefore you're hitting upon a diminishing return on the incremental dollars spent on marketing earlier and, therefore, all else equal, you're investing less in marketing or tell me how I should think about that.

Christopher Paucek -- Chief Executive Officer and Co-Founder

Yes. The outer range of students are more expensive. Clearly, this may be frustrating to some in this community because last November, we did the opposite. That was a mistake. We've said that before. I will say it more strongly now. What we're doing today is reorienting our spend and our operation off of what is a smaller expected steady state enrollment, and we think that's a more prudent place to be and one that we should build a base from here. If we can get to not only successful sort of business from a strategic standpoint in terms of our footprint but also drive profitability and free cash.

Corey Greendale -- First Analysis -- Analyst

Okay. And lastly, I know you'll probably get into great detail on this at the Investor Day, but I'm guessing this translates into, if we were to look, kind of a single program model that typically you invest less than the $5 million to $10 million that you have historically before hitting breakeven. Is that right without getting into detail? And do you think that it all impacts your differentiation in the market? There's a lot of reasons universities -- a whole bunch of reasons universities would go to you but one of them is how much you invest in the programs upfront?

Christopher Paucek -- Chief Executive Officer and Co-Founder

Yes. So the answer is yes, and I would also say we're so far above everybody else. It's part of the reason I think we're seeing this first, to be honest. If you're launching a program with 100 students, then it's different. It just is. If you launch a program, you're trying to get to 400, it's a different story.

Corey Greendale -- First Analysis -- Analyst

Okay, thank you.

Operator

Our next question comes from Brad Zelnick of Credit Suisse. You may proceed with your question.

Brad Zelnick -- Credit Suisse -- Analyst

Great,thank you so much for fitting me in. I've got one for Chip and a follow-up for Cathy. Chip, we've always loved to use mission. You're a clear visionary in online education. But now with the third time recalibrating expectations and the amount of dramatic change you're seeing in your market, and your stock down over 60% from earlier this year against the backdrop where software is up closer to 30%. Are you and the Board entertaining strategic alternatives for the business at this point?

Christopher Paucek -- Chief Executive Officer and Co-Founder

I'm not going to comment on the business overall from that standpoint. I can tell you that the Board is very supportive and focused on our long-term strategy and very focused on sort of our ability to execute against it.

Brad Zelnick -- Credit Suisse -- Analyst

Okay. And just for Cathy, are you expecting you might need to grant additional equity to employees to encourage retention given the dramatic move in the stock?

Cathy Graham -- Chief Financial Officer

I think we need to look at that through an entire plan, which we are working through.

Christopher Paucek -- Chief Executive Officer and Co-Founder

Yes. I mean I would say, Brad, just to add to that, we're considering this team has delivered for 11 years now against an opportunity that I think people thought was very difficult to -- sort of this whole notion of not letting the skeptic win. I understand right now why we're going to be under the gun. I also understand that I've got to keep this team super motivated and thinking about the long-term future and thinking about being motivated about driving things like free cash. And we'll do so with my Board in a way that we think is appropriate.

Brad Zelnick -- Credit Suisse -- Analyst

Excellent, thanks for taking the questions.

Operator

Thank you. Our next question comes from George Tong with Goldman Sachs. You may proceed with your question.

George Tong -- Goldman Sachs -- Analyst

Hi, thanks. Good afternoon. With respect to the grad degree segment, you mentioned that even if you stopped all launches, you'd see essentially mid to high teens growth. Obviously, you're not going to stop. All your launches, I think, you mentioned you're going to be roughly half of what you had initially guided to in the outer years. So the question is with respect to your guidance, your full year guidance for 2019, what are you essentially incorporating for a grad degree program growth? And then how would you see that evolving over time?

Christopher Paucek -- Chief Executive Officer and Co-Founder

So I think, George, you know that we -- at this point, we're going to hold off until our normal November period to give an estimate of next year's growth rate. We are trying to give some clarity that growth is still built in the system. And obviously, we're not going to end all launches.

George Tong -- Goldman Sachs -- Analyst

Got it. Okay. Then with respect to profitability, you basically said that you're going to strike a better balance between margins, cash flows and growth. So how would you say your EBITDA margins for the full year in the underlying business, if we exclude Trilogy, compares with your initial guidance before?

Cathy Graham -- Chief Financial Officer

So George, what we said was that we did not expect in the pre-Trilogy business to be able to offset all of the revenue -- revisions to revenue that we have built into this current guidance but that we would be able to offset some. So by that, you can infer that we expect our margins in this short term period to be slightly lower as we go through a transition. Somewhat lower.

George Tong -- Goldman Sachs -- Analyst

Got it. Thank you.

Operator

Thank you. Our next question comes from Arvind Ramnani of KeyBanc. You may proceed with your question.

Brian Gehring -- KeyBanc Capital Market -- Analyst

Hi, this is Brian Gehring on for Arvind appreciate you taking my question. Just real quick, you're trying to understand a little bit more the dynamic associated with the short course business. You said that you kind of see what courses work with what schools. Does this sort of imply that you're strategically, I guess, repositioning who you sell this offering into? And does the revision in DGP reflect materially less synergies from the short courses and vice versa as this may impact who you can and cannot sell it into?

Christopher Paucek -- Chief Executive Officer and Co-Founder

So we are definitely spending time thinking about where to deploy capital on the short course business from the standpoint of what might have the greatest impact. We do not believe at this point that we have perfect clarity as to which ones will or which ones won't work. I will tell you that we do believe that there's a bunch of current partners that are working really well, and there are some Trilogy partners that are quite decided about the short course opportunity. I think the big thing for us is making sure that we're not underestimating how long it will take to get the courses actually launched versus getting the deals done.

I will tell you we -- I think as evidenced by what we delivered, there are quite a few universities that want to partner with the schools. And I think we're slowing that down a little bit and learning from -- learning how to appropriately place the emphasis on driving the faculty member alignment with the course. And I do think that there's -- we're excited about widening the aperture of the short course business a little bit from the standpoint of which courses we might launch. So a lot of work going there. Clearly, some executional issues that added to this outlook in a way that's obviously disappointing but still a rapidly growing business that we think is a huge part of our future. So we're no less bullish on the strategy behind it.

Brian Gehring -- KeyBanc Capital Market -- Analyst

Great, thank you.

Operator

Thank you. And I'm not showing any further questions at this time. I would now like to turn the call back over to Chip Paucek for any further remarks.

Christopher Paucek -- Chief Executive Officer and Co-Founder

Okay. Thank you very much. We look forward to seeing you out on the road.

Operator

[Operator Closing Remarks]

Duration: 63 minutes

Call participants:

Ed Goodwin -- Senior Vice President, Investor Relations

Christopher Paucek -- Chief Executive Officer and Co-Founder

Cathy Graham -- Chief Financial Officer

Sarah Hindlian -- Macquarie -- Analyst

Brett Knoblauch -- Berenberg Capital -- Analyst

Ryan MacDonald -- Needham -- Analyst

Hannah Rudoff -- D.A. Davidson & Co. -- Analyst

Jeff Meuler -- Baird -- Analyst

Jeff Silber -- BMO Capital Markets -- Analyst

Chad Schoening -- Oppenheimer -- Analyst

Corey Greendale -- First Analysis -- Analyst

Brad Zelnick -- Credit Suisse -- Analyst

George Tong -- Goldman Sachs -- Analyst

Brian Gehring -- KeyBanc Capital Market -- Analyst

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