U.S. markets closed

Edited Transcript of TWOU earnings conference call or presentation 30-Apr-20 8:30pm GMT

Q1 2020 2U Inc Earnings Call

Landover May 18, 2020 (Thomson StreetEvents) -- Edited Transcript of 2U Inc earnings conference call or presentation Thursday, April 30, 2020 at 8:30:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Christopher J. Paucek

2U, Inc. - Co-Founder, CEO & Director

* Ed Goodwin

2U, Inc. - VP of IR

* Paul S. Lalljie

2U, Inc. - CFO

================================================================================

Conference Call Participants

================================================================================

* Brad Alan Zelnick

Crédit Suisse AG, Research Division - MD

* Brian Jeffrey Schwartz

Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst

* Jeffrey Marc Silber

BMO Capital Markets Equity Research - MD & Senior Equity Analyst

* Keen Fai Tong

Goldman Sachs Group Inc., Research Division - Research Analyst

* Rishi Nitya Jaluria

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* Sarah Emily Hindlian-Bowler

Macquarie Research - Senior Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good day, ladies and gentlemen, and welcome to 2U Incorporated 2020 First Quarter Earnings Call. (Operator Instructions) I would now like to turn the call over to Mr. Ed Goodwin, Senior Vice President, Investor Relations. Sir, the floor is yours.

--------------------------------------------------------------------------------

Ed Goodwin, 2U, Inc. - VP of IR [2]

--------------------------------------------------------------------------------

Thank you, operator. Good afternoon, everyone, and welcome to 2U's First Quarter 2020 Earnings Conference Call. On the call, we have Chip Paucek, our CEO; and Paul Lalljie, our CFO. Following Chip and Paul's prepared remarks, we will take questions. This call is being simultaneously webcast on our website where you can find our press release which was issued after the close of the market as well as our earnings presentation. The webcast replay of this call will be available for the next 90 days on our company website under the Investor Relations link. Statements made on this call include forward-looking statements regarding our financial and operating results, the impact of the COVID-19 pandemic, new educational offerings, student and university demand and other matters. These statements are subject to risks, uncertainties and assumptions. Any forward-looking statements made on this call reflect our analysis of today -- as of today, and we have no plans or duty to update them.

Please refer to the earnings press release and the risk factors described in the documents we file with the Securities and Exchange Commission, including our annual report on Form 10-K for the year ended December 31, 2019, and our most recent quarterly report on Form 10-Q for information on risks, uncertainties and assumptions that may cause actual results to differ materially from those set forth in such statements. In addition, during today's call, we will discuss non-GAAP financial measures, which we believe are useful as supplemental measures of 2U's performance. These non-GAAP measures should be considered in addition to and not as a substitute for or in isolation from GAAP results. You can find additional disclosures regarding these non-GAAP measures, including reconciliations with comparable GAAP results in our earnings press release and on the Investor Relations page of our website. With that, let me hand it over to Chip.

--------------------------------------------------------------------------------

Christopher J. Paucek, 2U, Inc. - Co-Founder, CEO & Director [3]

--------------------------------------------------------------------------------

Thanks, Ed. I hope everyone's been safe, healthy and holding up as well as possible during these unprecedented times. It's clearly challenging for all companies to deal with the COVID-19 pandemic and 2U is no exception. With that said, we're in the midst of witnessing a paradigm-shifting moment for online education, from which I believe 2U will emerge substantially stronger.

In some ways, right now, we're at the epicenter of what higher education is dealing with. The last 4 weeks have been intense for the business. As COVID-19 was beginning here in the U.S., 2U had to decide whether to hold our Investor Day. We did it virtually and it went well. As the pandemic continued to unfold, we successfully completed a convertible debt offering. In the context of conducting an offering in this rapidly evolving and unpredictable environment, we provided strong preliminary first quarter results and withdrew guidance. Paul and his team have done a great job of adding liquidity to the balance sheet in a tricky capital markets environment, while providing a more robust capital structure and enhancing our financial flexibility. That's a big win for all of our stakeholders.

Before going into more detail on our results and our business outlook, I want to reiterate our strategy and priorities. Even with significant disruptions across the globe, our strategy is unchanged. We partner with top-tier universities to build, deliver and support world-class digital education offerings that drive strong student outcomes. In light of the pandemic, our financial priorities are unwavering. We're focused on driving our market-leading position, accelerating the growth of the company and driving towards free cash flow and profitability.

On the rest of today's call, I'll address how our business performed in the first quarter. And I'll provide an overview of the trends we're beginning to see in our business that we expect to continue, followed with detail on some of the solutions we're offering to universities in response to the COVID-19 pandemic. I'll then turn it over to Paul, who will walk you through our results with more detail and commentary.

Starting with our first quarter results, which were quite strong. Revenue grew 44% year-over-year to $175.5 million, driven by performance in the Graduate segment and the addition of Trilogy, which we acquired in May 2019. The Grad segment exceeded our expectations, with revenue growth of 14%, a 2-point acceleration over last quarter. As we described to you at Investor Day, this was again driven by the scaling of programs launched over the last 3 years. On the bottom line, we came in significantly above our expectations for adjusted EBITDA with a loss of $4.3 million for the quarter. This outperformance was driven by cost controls implemented last year as well as lower costs due to our teams working remotely. This quarter, our teams delivered strong top line growth, accelerating organic growth with strong bottom line performance, only to be outdone by unlevered free cash flow usage that is the lowest it's been for 6 quarters.

We performed exceptionally well. Our results for January and February exceeded our expectations. And due to the flexibility and variability of our expense base and the resilience of our business model, we were well situated to adjust as social distancing was enacted.

The impact of the COVID-19 pandemic on higher education and our business has continued to evolve week-by-week, even day-by-day. And we like where we sit today, our business is fully operational. Our programs are online. And each day brings greater clarity through the data we're seeing throughout the entire business. Given most recent movements in the business, our confidence is increasing in the longer term impact. As part of this, I want to present some early conclusions as to what we think this impact might be.

First, we all witnessed how COVID-19 created an urgent need for every university to move their programs online. This rush to remote learning happened almost overnight. A lot has changed in the last 6 weeks. And today, we know much more based on the daily conversations we've been having with partners across our portfolio. We now believe that this forced transition online will substantially increase the demand from universities for our core product offerings and new solutions. The need to deliver truly high-quality online programs, not just remote live lectures at a time when universities are facing unprecedented financial constraints and challenges, makes our traditional full investment model even more compelling and valuable. We can call this already. We could not say that 3 or 4 weeks ago, but it's now apparent. We expect to announce our next undergraduate program shortly.

Second, we expect to see increasing student demand for quality online offerings. The data here is early, but our funnels are filling and converting currently at higher rates than before the pandemic. Historically, the higher education market has been negatively correlated to the overall state of the economy. There's a long history here. We've seen some prognosticators question publicly whether this recession could be different for higher education. But based on some leading indicators in our business that have been historically correlated with future demand, we believe that universities with robust online learning offerings will see countercyclical demand.

While it's still in early days in the grand scheme of things, we expect that this trend will increase over time. Notably, prospective students have been easier to get in touch with and have been more receptive to engaging in substantive conversations. One other interesting tidbit. While the initial stages of COVID-19 caused some demand decreases on the boot camp side, the last several weeks have shown even greater conversion as online options became the norm. Clearly, as 2U has seen in its long history, students want online learning even in the boot camp space. We think that this move to online for boot camps will not be temporary.

Third, as online learning becomes the norm now and into the fall, we believe that prospective students will increasingly view online programs as attractive alternatives to campus space programs. Quality will matter here. And when done right, as our recent Gallup study proves, online can be as good or even better than the campus. We expect that, over time, a great percentage -- a greater percentage of total students will enroll in online programs, both degrees and alternative credentials, than what we've seen in the past.

Fourth, we're seeing advertising costs decrease during this time. We have no idea how long this will continue but it is allowing us to drive positive enrollments for our clients right when they need it most. One example, our undergraduate program is seeing double-digit increases in volume on a daily basis. We believe that the launch of these high-quality undergrad online offerings, which occurred right before the outbreak, are now meeting an even bigger need in the market.

Before I turn it over to Paul, I also want to highlight some of the new solutions we're offering based on the trends we've heard from our partners. There's No Back Row PRO, where we provide free training to our university partners' campus-based faculty on best practices for successful online teaching. These efforts continue to raise interest in and awareness of our high-quality learning platform and our significant expertise in this area. We expect that this offering will become even more important as universities and faculty figure out their plans for the fall and how to build online into their go-forward strategy.

Then there's Studio in a Box, our modified course production approach, which allows faculty to record asynchronous content directly from their home with the right tools and virtual assistance from a 2U course designer. We've also deployed 2 new solutions, 2UOS Essential and Plus. These provide a lighter deployment of 2UOS and enable continuity and quality for existing and new university partners in preparation for the fall. We do not yet know how many of these deployments we will have. We expect to offer these on a fee or revenue share basis depending on the interest of a client. We'll provide more information on future calls, but it's going well.

Finally, with increased pipeline opportunities in mind, I want to be clear, we are still focused on continuing our drive to profitable revenue growth. As we gain clarity on these new opportunities, we'll provide more clarity to all of you. But we want to make sure you're aware that regardless of the broader opportunity set, we're being careful in our decisions. To conclude, we delivered strong Q1 results, even in light of the COVID-19 pandemic. For much of our portfolio, there was little or no disruption to operations and through team effort and extraordinary collaboration, all 2U-powered offerings remain up and running and continue to enroll new students. I'd like to thank our partners and employees for the dedication they've shown over the past 2 months. 2Utes have been incredible, even though they've all been remote. It makes me very proud. The COVID-19 pandemic created an urgent need for every university to up its game on online education and we are uniquely positioned to help them meet this increasing need. With that, I'll turn it over to Paul.

--------------------------------------------------------------------------------

Paul S. Lalljie, 2U, Inc. - CFO [4]

--------------------------------------------------------------------------------

Thanks, Chip, and good afternoon, everyone. I'd like to start by saying that the fundamentals of our business are strong. We had a good first quarter in the face of the COVID-19 pandemic with execution of business continuity plans limiting disruption. We recently issued $380 million in convertible notes which lowered our cost of capital while giving us increased liquidity and financial flexibility, and we continued to see strength in our university pipeline. As the world responds to the crisis, we're in an excellent position to be a solution for our university partners and their students in a variety of ways.

On this call, I'll go over our results for the quarter in more detail, discuss our recent capital raise then give some color on how we're thinking about the rest of the year. Now I'd like to go through the results for the quarter. Revenue for the first quarter totaled $175.5 million, a 44% increase from $122.2 million. Organic revenue growth was 15%, an acceleration of 2 percentage points from last quarter, driven primarily by strength in the Grad segment. In the Graduate Program segment, revenue grew 14% over the first quarter of last year. This was driven by a 16% increase in full course equivalents partially offset by a 2% decline in revenue per FCE year-over-year. Revenue per FCE was essentially flat versus last quarter. For the first quarter, revenue in the Alternative Credential segment totaled $57 million, which includes $35.4 million from Trilogy. FCEs for the segment were up 66% while revenue per FCE was up 90%. Short Course revenue increased 20%, with programs launched in the past year, contributing nicely to the growth.

Let's look at costs and expenses. Total operating expense for the quarter came in at $229.4 million, a 56% year-over-year increase. Total marketing and sales expense grew 29% year-over-year. In response to COVID-19, we spent less than we had originally planned, which speaks volumes to the variable nature of our marketing spend. Looking forward, we continue to adjust our marketing spend on what we're seeing in the market with a goal of spending to the efficient marketing frontier. Net loss for the quarter was $60.1 million compared to net loss of $21.6 million for the first quarter of 2019. This was driven in part by an incremental $11.3 million in stock-based compensation due to changes in our compensation structure and additional headcount from Trilogy. There was also an incremental $9.4 million in amortization of acquired intangible assets related to the Trilogy acquisition. Adjusted net loss for the quarter totaled $21.3 million when adjusted for $20.9 million in stock-based compensation, $10.8 million in amortization of acquired intangible assets as well as certain nonordinary course items.

Now for a discussion of the balance sheet. We ended the quarter with a cash balance of $157.5 million, a decrease of $32.4 million from $189.9 million at the end of the December quarter. This decrease was primarily driven by use of cash from operations of $9.9 million and CapEx of $18.2 million as well as cash interest payments of $4.9 million. Unlevered free cash flow for the trailing 12 months was a use of $58.5 million, a $21.7 million improvement from the December quarter. This highlights our commitment to drive towards positive free cash flow and puts us ahead of our initial plan. This performance was driven by more efficient use of net working capital, and we expect this improvement to continue.

Accounts receivable was $75.4 million at the end of this quarter, up $41.7 million from the end of 2019. This is typical for us in the first quarter. The seasonal increase in accounts receivable in the first quarter relative to last year, is due to the timing of the academic calendar. Of note, 86% of the accounts receivable balance is current. This increase in AR is offset by a $23.8 million increase in accounts payable and accrued expenses and a $21 million increase in deferred revenue from last quarter as we continue to manage net working capital.

At the end of the first quarter, we had outstanding long-term debt of $254.1 million, principally related to our term loan facility which had a maturity of May 2024. We recently issued $380 million in 5-year convertible notes with a coupon of 2.25%, including the over-allotment option, which is expected to close tomorrow. We have since repaid all outstanding amounts under our term loan, with the remaining net proceeds going towards purchasing a capped call and funding net working capital and other general corporate purposes.

We are fortunate to execute on this opportunistic financing, which offers us a number of benefits as compared to the term loan. It reduces our annual cash interest expense by around $11 million, it eliminates restrictive covenant, it extends the maturity date to 2025 and it enhances our financial flexibility. We are well funded to execute against our strategic priorities as we view our capital allocation decisions through the lens of balancing growth, return on invested capital and cash generation.

Now for a discussion of how we're thinking about the rest of the year. We're in an unprecedented environment with uncertainty about the future progression of the COVID-19 pandemic, actions taken by the government and how they will respond to the pandemic, what this means for the economy in the coming months. The prudent thing to do in this environment is to maintain our disciplined approach to managing capital and expenses. We have continued to constrain any unnecessary spending and tighten our use of cash even further without impacting growth. This will give us the greatest possible strategic and financial flexibility in this environment to further cement our market-leading position.

While our first quarter results showed the strength of our business, given the environment that we're in, it is not possible with reasonable accuracy to estimate the positive or negative impact of the pandemic on our 2020 financial performance. To that end, in connection with our convertible offering, we have withdrawn our financial guidance for the fiscal year, and we intend to defer providing new guidance until there is a clearer outlook on the duration and magnitude of the pandemic.

To summarize, we got off to a strong start to the year, building on the momentum from the fourth quarter of last year. We successfully shifted to working from home without disruption, and we're helping our partners lead the way for online education going forward. We are especially well positioned to help because we came into this pandemic as a market leader with momentum. We are investing, and we are well capitalized: $175.5 million in revenue, adjusted EBITDA loss of $4.3 million, unlevered free cash flow usage of $17.6 million for the quarter and an improved capital structure. We are proud of our teams for delivering such strong results and we are confident that they will continue to make us proud. And with that, we're happy to take your questions. Operator?

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) Your first question comes from the line of Mr. Brad Zelnick from Credit Suisse.

--------------------------------------------------------------------------------

Brad Alan Zelnick, Crédit Suisse AG, Research Division - MD [2]

--------------------------------------------------------------------------------

Great. Thank you so much, guys. I know this is an earnings call, but I just want to start by acknowledging how fantastic your mission is and especially how you're helping the world during the current crisis. I think it's just really, really important to say that.

--------------------------------------------------------------------------------

Christopher J. Paucek, 2U, Inc. - Co-Founder, CEO & Director [3]

--------------------------------------------------------------------------------

Thank you, Brad. Really appreciate it.

--------------------------------------------------------------------------------

Brad Alan Zelnick, Crédit Suisse AG, Research Division - MD [4]

--------------------------------------------------------------------------------

You're quite welcome. I've got question?

--------------------------------------------------------------------------------

Christopher J. Paucek, 2U, Inc. - Co-Founder, CEO & Director [5]

--------------------------------------------------------------------------------

Yes, go ahead.

--------------------------------------------------------------------------------

Brad Alan Zelnick, Crédit Suisse AG, Research Division - MD [6]

--------------------------------------------------------------------------------

Yes, no, please. You go ahead.

--------------------------------------------------------------------------------

Christopher J. Paucek, 2U, Inc. - Co-Founder, CEO & Director [7]

--------------------------------------------------------------------------------

No, it's just -- it's been an unbelievable 6 weeks. I will tell you, we've been -- we really -- I feel like we are a microcosm a little bit of what's happening in higher ed and everything from our [ELPA] program, where you've got people on the front lines to our nursing programs, to our public health programs. You've got -- it does -- it is super motivating to the employees, and it should be and I'm very proud of the work they're doing, but thank you for saying it.

--------------------------------------------------------------------------------

Brad Alan Zelnick, Crédit Suisse AG, Research Division - MD [8]

--------------------------------------------------------------------------------

For sure, I really mean it. I had a question for you, Chip, and a quick follow-up for Paul. So Chip, in an earlier press release, you mentioned the company has begun developing solutions to enable continuity for universities on-campus and online efforts in the fall. Can you expand on this a little bit more and how we should think about this from a monetization standpoint as well as new partner relationships?

--------------------------------------------------------------------------------

Christopher J. Paucek, 2U, Inc. - Co-Founder, CEO & Director [9]

--------------------------------------------------------------------------------

Well, we have 73 partners. So there's a lot to do just within our partner base. So the first step was just to make sure everybody was up and running and doing as well as possible, and that's why we rolled out the training and all of that. For the fall, we think by the next call, we'll be able to give a better estimate as to what the new solutions will look like, how they'll be structured. So 2UOS Essential, as we're calling it, is, we think does allow the company to potentially open the door to some new university partners. And it's a combination of our technology and our support and we've had a really good response to it. Unfortunately, as you know, this is rapidly evolving and not much time has passed. So we're not yet at a point where we can give you too much clarity on exactly how many schools and what it looks like. But we do think it's a different model than the J-curve that you see in the investment programs.

Now separately, what's also become clear, and this part, we can say strongly, is that pipeline for our existing model will increase because of this. We're being careful and thoughtful about what we choose to do. And as a company, we have not made a decision to increase the number of sort of traditional investment-based model programs that will run yet. But there's no doubt that demand has picked up. I think the pandemic has sort of multi-dimensional impact to our partners. And it's clear that the investment model will be in more demand. So Brad, I think by the time we get to the next call, we'll have a lot more to say. Schools are in the decision-making period in terms of how they're going to handle fall. Studio in a Box is pretty interesting because I think the notion of -- what people really need right now, it's a little bit less about the technology. The technology is the enabling function, but it's the pedagogy, the expertise of how to drive high-quality online instruction and how to do it in an environment where you can't go to a studio easily.

And so very proud of the innovation that's occurred there. We've got a bunch of these being deployed right now, and we really like what it means for the company, go forward. But in the short term, we're thinking much more about just how to support the schools, not necessarily focused on the financial benefits of it. We do think long term, it will have great financial benefits. But net-net, we're thinking more about the people. These are relationships we've had for a very long time. And in some cases, we've had quite a bit of inbound of folks that are interested in us helping them figure out how to build something positive going forward. So it's just been an extraordinary 4 to 6 weeks, and we obviously had to convert during the process. So no shortage of activity going on here, that I will tell you.

--------------------------------------------------------------------------------

Brad Alan Zelnick, Crédit Suisse AG, Research Division - MD [10]

--------------------------------------------------------------------------------

That all makes a lot of sense. And maybe just for Paul, does the convertible note transaction and in particular, upsizing the initial deal, in any way, change the way you're thinking about program launches or future investments?

--------------------------------------------------------------------------------

Paul S. Lalljie, 2U, Inc. - CFO [11]

--------------------------------------------------------------------------------

Brad, one of the main things we wanted to -- we set out to do here at the beginning of the year is to give ourselves flexibility. We want to focus on positive cash flows. We want to focus on positive EBITDA, and we wanted to ensure that we had the financial flexibility. This transaction allowed us to do that. I mean, I listed some of them, right? Let me revisit them for you. The first one is financial covenants. The second one is $11 million savings on free cash, if you will, because we're not going to pay that much of interest expense anymore. It does give us the latitude. However, all of this is governed by the framework that we outlined back in the fourth quarter of '19 which is we're going to manage by ROIC. We're going to choose and select the programs as we optimize cash, and we're going to do it for the same quality that our partners have accustomed receiving from us. The bottom line is we want to set ourselves up as well as possible to do as many as we can if the opportunity presents itself, but they have to fit our mold of what we're trying to accomplish as a company. Once we're disciplined, I think we will have the flexibility to increase cadence if we need to.

--------------------------------------------------------------------------------

Operator [12]

--------------------------------------------------------------------------------

Your next question comes from the line of Jeff Silber from BMO Capital Markets.

--------------------------------------------------------------------------------

Jeffrey Marc Silber, BMO Capital Markets Equity Research - MD & Senior Equity Analyst [13]

--------------------------------------------------------------------------------

Chip, I think you might have alluded to this in your earlier response, but I'm just curious in terms of the types of the conversations that you're having with the university partners, either the ones that are your current partners or potential partners. What are they looking for near term? What are they looking for longer term?

--------------------------------------------------------------------------------

Christopher J. Paucek, 2U, Inc. - Co-Founder, CEO & Director [14]

--------------------------------------------------------------------------------

I mean, Jeff, so something we've been doing that, first of all, I would say, in 4 weeks, we've had more Chancellor, Provost, President, CFO conversations than we had in 12 years. I don't think that's an overstatement. It's been extraordinary. And one of the things we've been doing, we've -- our -- the President of our Program Management Group, of our partner relationships, Andrew Hermalyn, has been hosting these social hours that are fascinating. It's just Andrew and a variety of a really cross sort of functional group of presidents and provosts that wouldn't normally be in a room together, from a variety of different types of our partners, big state schools, elite private institutions, liberal arts schools, and it's been really something. This is a moment in time where I do feel like we have a point of view about what's going on across higher ed that I think is pretty unique because of the broad sort of scope of our partner base and they definitely are looking for solutions to help drive quality online. I think everybody recognizes what happened in the fall won't cut it on a go-forward basis.

And so there is some -- and not for the fall, I'm sorry, for the spring. So there is some shorter-term needs in terms of just getting a higher quality online course up and running. And really, that's about the pedagogy. That's about being intentional about learning outcomes with each lesson and it's not just about sort of a remote Zoom lecture. I think we've all become -- we're all in Zoom meeting after Zoom meeting. And creating a high-engaging environment is, of course, Zoom is a great partner of ours. And we're thrilled to have them as a partner. But you've got to drive a higher quality overall online learning experience. So that's been one conversation. And then we have engaged just really over the last couple of weeks on sort of more forward-looking, whether this lasts -- this -- how long this lasts in the current state, we obviously all will start to get out of the immediate stage of the pandemic where we can have some -- get back to offices and schools.

But schools, to give them credit, are dealing with not only something unprecedented, but you can -- what I think is happening right now is the pure hybridization of all online -- of all higher education. This is the hybridization of higher ed overnight. And people see the need for it. And I do feel genuinely blessed to be in the seats that we're in right now. We are at the sort of crux of the whole thing, and we're really well positioned. But right now, the key is just delivering for the partners. And I would say, of course, the first stage is just making sure that everybody is in a good place. Everybody is healthy and that our employees -- we start with our employees, but as you move through this, it also became very clear to me as CEO, to our executive team, to our Board that we have a massive responsibility right now to deliver for these schools right when they need it most. And not just to deliver for them for next week, but to think about this over a multiyear period and how we can be uniquely beneficial.

And if you think about it, we -- some people saying, higher education won't get a countercyclical benefit, we can already throw that out the window. That's super clear that if you have high-quality online programs based on what's happened in the last just 2 weeks, that the demand is going to go up. But those that were saying that were saying it's because of the alternative credentials. Well, we're one of the only companies that offers boot camps and short courses, and we've got a decade-plus track record of doing this. So I just feel like this all happened and we are the company that needs to be there and is being there for our partners. So you're hearing maybe some sense of personal responsibility that we deliver for folks at this moment. And I'm proud to tell you that we do feel that we are delivering.

--------------------------------------------------------------------------------

Jeffrey Marc Silber, BMO Capital Markets Equity Research - MD & Senior Equity Analyst [15]

--------------------------------------------------------------------------------

Great. Let me just drill down a little bit further. And again, I think you alluded to this a little bit earlier. Do you think you're going to see more demand on the undergraduate side? I know we've already had strong demand on the graduate side. But is that an area we think you'll have further penetration?

--------------------------------------------------------------------------------

Christopher J. Paucek, 2U, Inc. - Co-Founder, CEO & Director [16]

--------------------------------------------------------------------------------

Yes. As a result of this, one of the things that has happened is you will hear us very soon announce our second undergrad program. We are -- we will get the announcement out as soon as we can. We do think there is real demand for undergrad, and we're very pleased with the initial results of our first undergrad program, which obviously was done before any of us had heard of coronavirus. So it happens to be good timing, but a thoughtful plan is to how to drive a high-quality online undergrad experience. It has been well underway at 2U now for a long time, and that's becoming certainly more relevant. Now I think what we want to make sure we emphasize to this community is that, that doesn't mean that we're sort of throwing out the window, all the things we said to you over the last 9 months, about how we're thinking about our investments and how we're thinking about guiding the company's financial picture. So we have to be able to balance the agenda, but there is no doubt, to answer your question directly, that demand is up.

--------------------------------------------------------------------------------

Operator [17]

--------------------------------------------------------------------------------

Your next question comes from the line of Ms. Sarah Bowler from Macquarie Group.

--------------------------------------------------------------------------------

Sarah Emily Hindlian-Bowler, Macquarie Research - Senior Analyst [18]

--------------------------------------------------------------------------------

Hi, great to hear everybody's voices and happy to hear you're all safe and well. Chip, I wanted to start with a question for you around the competitive environment out there. Are you seeing anything from your competitors or any shifts in the landscape like has happened over the past several years that you think is worth pointing out at this time?

--------------------------------------------------------------------------------

Christopher J. Paucek, 2U, Inc. - Co-Founder, CEO & Director [19]

--------------------------------------------------------------------------------

I mean, I guess I would say, I think we're uniquely positioned. From a competitive standpoint, you've got this career curriculum continuum that we have the sort of breadth of the offerings that I just don't think anybody else really has. And combine that with when you look at what happened with remote learning, it was interesting that prior to COVID, we had passed 700,000 live classes, like we've done this at a scale that I don't think anybody else has. And our Gallup study, I thought was real interesting because we debuted it for the investor -- the virtual Investor Day. And it should put a nail in the coffin of any question whether online can be as good as the campus.

If you do it right, it's really good. And we know how to do it right. And so from a competitive standpoint, we do feel like quality is going to continue to matter here. So the idea is higher education should be blended and connected, it should be -- the hybrid is real, and we're good at that. And I feel like the -- we haven't had 10 seconds to think about competition in the last 6 weeks, that I will tell you. So it's sort of just back to our conversations with our partners in terms of how to support them. And we are excited that it does look like what will come out of this is a broader partner base.

--------------------------------------------------------------------------------

Sarah Emily Hindlian-Bowler, Macquarie Research - Senior Analyst [20]

--------------------------------------------------------------------------------

Awesome. That's really helpful, Chip. And then, Chip this might be for you or for Paul, I'll let you guys decide. But I'm just wondering, I think it's really great that you discussed on this call balancing positive free cash flow with the need to invest with these partners at such a critical time in the world and with such an opening for distance learning. How do you think about potentially balancing, adding more new grad or undergrad programs in the 5 we were discussing most recently about, if you really do see windows and opportunities for spikes in demand? In my opinion, it's -- those are worth going after. So I'm wondering how you're balancing, thinking about free cash flow positive -- being positive, with also the need to really take advantage of this opening for distance learning.

--------------------------------------------------------------------------------

Paul S. Lalljie, 2U, Inc. - CFO [21]

--------------------------------------------------------------------------------

Let me see if I can start off here, and Chip can jump in after. Look, at the end of the day, I think we have -- we provide a benefit to society here in the offerings that we provide. At the same time, we are in an environment where these things are needed, that societal benefit is needed. So to some extent, we have to balance with an eye towards, we are needed. Society needs us, and we have to be there for them during that period of time. At the same time, I think we can -- we were talking internally today about various opportunities. And one of the questions was, should we say, yes, or should we say no. And I said there is a third answer. The third answer is, we can say, yes, but it's about how we say yes. What does yes mean?

Does it look and feel like one of our normal programs? Does it look and feel like something different? So we are in the process of looking at everything through the framework of return on invested capital. We're looking at it from the perspective of how do we optimize the cash and the liquidity position that we have. And at the same time, how do we fulfill our duty to society because they're looking for us at this time of need. So it is a balance across the 3. And I think opportunities are not going to wait for us. I think we have to take advantage of opportunities when they present themselves. So I think we will lean towards helping as best as we can and as quickly as we can because I think we're in a position to do so, particularly with the capital structure flexibility that we just got ourselves in the last month or so.

--------------------------------------------------------------------------------

Operator [22]

--------------------------------------------------------------------------------

Your next question comes from the line of Rishi Jaluria from D.A. Davidson.

--------------------------------------------------------------------------------

Rishi Nitya Jaluria, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [23]

--------------------------------------------------------------------------------

2 Two here. First, wanted to ask with the go-to-market being virtual, obviously, in this environment and some of the dialing back of advertising spend. Just how are you thinking about sales and marketing efficiency from here, especially as we think about optimizing the model for the balance of growth and profitability? And then the other question was just in terms of thinking about payments from university partners? Any color that you can provide in terms of are there university partners looking for extension on payment terms or restructuring or anything like that?

--------------------------------------------------------------------------------

Christopher J. Paucek, 2U, Inc. - Co-Founder, CEO & Director [24]

--------------------------------------------------------------------------------

So on the second one, easy answer, that, that's not been an issue. On the first, I would say the -- as Paul mentioned in his script, we are pushing the benefit of lower advertising costs to drive towards the efficient frontier of these individual marketing funnels and individual marketing opportunities. And effectively, what that means is our partners need us right now. You're talking about significant dislocations to things like international students in each of these universities. And so the fact that we're very clearly up and running, the fact that even our boot camps, which was the one part of our business that was physical, now, not only are they online, but they might always be online because it's going really, really well. So that is of importance to the partners.

So we are pushing forward aggressively right now because we can. We're open, and these are strong high-quality options for people. And I would also say, options that can help people have a more productive life once they graduate. Like right now, the rescaling opportunity on the boot camp side has never been more needed. I mean, you're talking about people that with the number of dislocations for individuals in terms of the unemployment rate, we think this is a moment in time where people need to reskill and so we are continuing to drive the outcomes. And obviously, the marketing is part of that. And we're using this opportunity to create sort of more robust funnels for the university partners, not less.

--------------------------------------------------------------------------------

Operator [25]

--------------------------------------------------------------------------------

Your next question comes from the line of Mr. Brian Schwartz from Oppenheimer.

--------------------------------------------------------------------------------

Brian Jeffrey Schwartz, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [26]

--------------------------------------------------------------------------------

Chip, wanted to ask you a question on a different topic and subject. It's about your portfolio of products and services. Really, it's about the future and capitalizing on the elevated lead flow that you're seeing. So can you share with us how you plan to cross-sell to these students and learners as they enter the 2U universe here from different front doors? I know it's early here, but I'm just wondering if you're seeing any monetization synergies with the 3 different product offerings? For example, are you seeing a short course student maybe continuing on their curriculum, signing up for the boot camp or the DGP business? And just was hoping if you could just provide a little more color into the strategy around that. And it sounds like you are seeing some early traction. Then I have a follow-up for Paul.

--------------------------------------------------------------------------------

Christopher J. Paucek, 2U, Inc. - Co-Founder, CEO & Director [27]

--------------------------------------------------------------------------------

Yes. We are definitely -- we think the value of share across the portfolio is very significant. We think the value of the content across the portfolio is significant. We have more schools that are embedding technical training into their various programs. We think that over time, offering technical training for credit is really appealing. And clearly, from a marketing synergy standpoint, I think people do forget that when we acquired GetSmarter a couple of years ago, you had a pretty small overall core space. And now we're getting to the point where we've got a broader portfolio of individual courses. And so you obviously can't cross-sell when there's not a lot to cross-sell. And now that we've got more options for people, the CCC is pretty fluid.

Some people enter the career curriculum continuum because they're -- they've graduated from high school and they want to go right to learn to become a coder. And then they eventually may take a short course. Some people like me might progress from undergrad to eventually a master's degree, and I might need a blockchain course because I'm not entirely sure what it is. You've got different people entering at different stages, and it just creates an opportunity for us to meet the student where they are and to provide that learning experience to the student. That was a big part of the reason that we actually acquired the 2 companies we did. So early days still on share, but it's attractive.

--------------------------------------------------------------------------------

Brian Jeffrey Schwartz, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [28]

--------------------------------------------------------------------------------

And then Paul, the follow-up question that I had -- it's maybe a follow-up on the earlier question, but maybe I'll just ask it a little bit differently tactically. When you scrubbed and looked over the cost structure of the business, where did you see the most opportunity to kind of cut back to protect cash flows?

--------------------------------------------------------------------------------

Paul S. Lalljie, 2U, Inc. - CFO [29]

--------------------------------------------------------------------------------

So I mean, I think there are a couple of things. We have some natural levers as we think of the integration of the 3 businesses over time. As we continue to bring together GetSmarter, Trilogy and traditional 2U, that was one of the things that we started doing midway through last year, and we saw a lot of that type of savings as we got into the fourth quarter. But those happens to be run rate savings, meaning they continue and build upon themselves over time. In addition to that, as we become a larger company, having centralized procurement and sourcing and doing things in a centralized fashion and benefiting from volume scale, those types of things are the traditional things that we've put in place so far that are getting us the type of synergies that we expect to see as we move forward. And then in today's environment, as we go through working from home, we see the benefits of P&E, travel-type savings.

And then at our technology platform, our technology build, how do we build technology consistently across the 3 offerings? And then marketing, as we bring the marketing teams together, and think about, while we may not have one marketing algorithm that goes across all 3 of our offerings, we can at least have a consistency of methodology, a consistency of the way of doing business, things like that. So we're seeing benefits also in that environment. And as we sit here today and look forward in 2020, as Chip alluded to in his prepared remarks, we are seeing lower cost per lead. So that is giving us some benefits on the marketing side. However, we will spend on the marketing side because at the end of the day, the marketing side is more driven and governed by the marketing frontier and it's more governed by yield and conversion.

But those are some of the areas. We are still -- we have several plans. Our Chief Operating Officer, Mark Chernis, spends time with the organizational structure, the organizational design, how we do things. We're not building a company to cut cost. We're building an organization to operate efficiently and serve our partners better so that the students can have a better experience. And if we continue to refine the organizational design and how we do things, then we will generate efficiency through that, and it becomes more sustainable type of cost structure. So those are some of the areas that I touched on there, and I think we will continue to see this type of efficiency as we go through time.

--------------------------------------------------------------------------------

Operator [30]

--------------------------------------------------------------------------------

Your next question comes from the line of George Tong from Goldman Sachs.

--------------------------------------------------------------------------------

Keen Fai Tong, Goldman Sachs Group Inc., Research Division - Research Analyst [31]

--------------------------------------------------------------------------------

You talked a bit about marketing costs that are decreasing in the current environment. And just overall, a more thoughtful approach to launching programs that have a higher ROIC, which over time should have positive implications for free cash flows. Can you discuss your broader expectations for free cash flow performance and when you might expect to breakeven?

--------------------------------------------------------------------------------

Paul S. Lalljie, 2U, Inc. - CFO [32]

--------------------------------------------------------------------------------

Yes. So I mean, I think if we -- let me speak of this from 2 components. On our fourth quarter call, I talked about, our goal was to have a crossover somewhere midway through 2021, the first half of 2021, meaning crossing over to a quarter where we are cash flow-accretive versus a use of cash in that particular period. And then probably until the next calendar year to have a full year of free cash flow positive. The performance we had this quarter, I would break down the performance in 3 components. I mean, part of it is the cost savings and the activities that Mark and his organization are leading in the company. But then we have also the component of lack of travel and other savings around working remotely, things like that.

If we split those 2 things, I would say we have us a real sustainable improvement in the free cash flow that we saw this quarter, and that puts us ahead of plan. So I'm providing a response that is more aligned with the things we said pre-COVID because in this environment that we're in, it's harder for me to predict when this is going to end, what the top line is going to be like, what are the new opportunities, what are some of the impact, if any, that is negative and how long that is going to last. So it's hard for me to predict in this current environment. But I can -- what I can say to you, the trends are looking good given what we delivered in the first quarter here. And we have no reason to doubt that, that will not continue as we go through the year.

--------------------------------------------------------------------------------

Keen Fai Tong, Goldman Sachs Group Inc., Research Division - Research Analyst [33]

--------------------------------------------------------------------------------

Got it. Very helpful. And then just stepping back broadly, you mentioned that the pandemic can have both a positive and a negative impact on the business. Can you just elaborate on the factors that could cause the growth to decelerate, so the downside factors? I know boot camps were previously thought to be a risk. Now it could potentially be an opportunity. Placements on the grad side, also another swing factor. So can you maybe elaborate on some of the things that you do see as downside risks to growth?

--------------------------------------------------------------------------------

Christopher J. Paucek, 2U, Inc. - Co-Founder, CEO & Director [34]

--------------------------------------------------------------------------------

Right. So an example of something that we had to do in Q1 is immersions, are physical moments where a student goes to be together with their classmates somewhere in the world, very often on-campus, but not always. So there's a lot of global immersions. And before COVID, the only time we ever sort of had a moment where we lost -- we lost revenue from an immersion that got canceled was you might have remembered when Mexico City had that huge earthquake. There was actually quite a large immersion for one of our partners that was there, and it got canceled like urgent, and we had to deal with that. And obviously, that was lost revenue. So we had some immersions in Q1 that we just couldn't replace. There was no option of replacing them. It was urgent, and we had to cancel them, and that was it. So we had that impact in Q1 but obviously delivered Q1 even with that impact.

What's good about the immersions go forward is that the students can receive their credit in a variety of different ways, not just from virtual immersions, but from additional classes that can fill that credit void. Placements is another one, where there is some potential impact from placements. Once again, placement credits can be replaced with other types. Now the work that's been done here has been awesome, like the partners did a variety of virtual placements. So in our social work programs, we have virtual field practicums where people are -- where students are with faculty live in a Zoom Room and they are live with an actor that is portraying somebody that has a particular condition. And it's actually really good because when the student is with a faculty member, they can learn in a way that is harder to do when they're actually in the field with that live person who might have returned from the war with PTSD.

And you see these faculty jump in, in these incredible moments where they're really teaching like live. At some point, obviously, if you're in a program like Midwifery, you have to go deliver the babies. And so you can push the physical part towards the end of their placement. And at the end of the day, that needs to be done at some point. Now what's been positive is, as an example, our [ELPA] program, we've been able to keep placements running the entire time during this. So when placements were canceled in a particular spot because of what was going on with the pandemic, we were able to replace somebody. And I give a tremendous shout out to our placement team for that because it's been stressful, but it's really worked. And I do think that as the world does come to some form of normal, the types of places where people are being placed actually are more likely to be emergency designation and more likely to be open or open quicker than other things.

So we think we can mitigate that impact pretty well. And you did mention, George, boot camps. When this first happened, we did see a dip in demand. And we're kind of in the opposite stage now. We're seeing -- that's become a positive, and you might have heard me mention in my prepared remarks that we weren't online with all the boot camps. And to give our boot camp team -- when this happened, our COO, very focused on, "Okay, we've got to get everything -- we've got get all these boot camps online." And Greg Calverase, our Managing Director for boot camps, got everything online and 5 days later, it's all online. And I will tell you what's happened since is not only high satisfaction, but a broader sort of catchment area for the boot camp and we think that, that is something that's really more likely to be something that sticks around with us. So obviously, it's early days, but it's positive so far.

So there are clearly impacts but once we got through, in some ways, the sort of urgent trying to figure out the world toilet paper stage, where you were dealing with the basic necessities and have gotten into a period where people have a little bit more time on their hands, it's clear that things like our shared courses are going to be in heavy demand. So excited about what the opportunity lie ahead for the company.

--------------------------------------------------------------------------------

Operator [35]

--------------------------------------------------------------------------------

That concludes the Q&A session. I will now turn the call over to Mr. Chip Paucek, CEO, for closing remarks.

--------------------------------------------------------------------------------

Christopher J. Paucek, 2U, Inc. - Co-Founder, CEO & Director [36]

--------------------------------------------------------------------------------

Thank you, operator. I would just end the call with a shoutout to the 2Utes all over the world, whether you're in Cape Town or you're in London or you're in L.A. or here in the D.C. area or in our Denver or New York offices or you're one of the 300 to 400 people that we have remote or the instructors that are working on behalf of our students and our short courses and our boot camps, incredibly proud of the work you've done, and we very much appreciate as you dealt with the complexities and the daily ups and downs of what is just a crazy moment in our society and one that has its own stress. As a human being, net-net, I am incredibly proud of what you have done. So thank you very much, and we look forward to seeing our investors out on the virtual road.

--------------------------------------------------------------------------------

Operator [37]

--------------------------------------------------------------------------------

This concludes today's conference call. Thank you everyone for joining. You may now disconnect. Have a great day.