Online education platform, 2U (NASDAQ:TWOU) fell short of analysts' expectations in Q2 FY2023, with revenue down 8.02% year on year to $222.1 million. 2U made a GAAP loss of $173.7 million, down from its loss of $62.9 million in the same quarter last year.
2U (TWOU) Q2 FY2023 Highlights:
- Revenue: $222.1 million vs analyst estimates of $234.2 million (5.15% miss)
- EPS (non-GAAP): -$0.18 vs analyst estimates of -$0.07
- The company reconfirmed revenue guidance for the full year of $990 million at the midpoint
- Free Cash Flow was -$27.2 million, down from $26.3 million in the previous quarter
- Gross Margin (GAAP): 65%, down from 71.3% in the same quarter last year
Originally named 2tor after the founder's dog Tor, 2U (NASDAQ:TWOU) provides software for universities and colleges to deliver online degree programs and courses.
There is a growing demand for online courses; however, the poor completion rate of online classes shows that creating a successful online course is hard and requires more effort than just uploading a recording of the lecture online.
While universities are experts in teaching, they struggle to create engaging online courses. As the COVID pandemic makes it difficult for students to learn on-campus, there is a need for platforms that make it possible to replicate the offline learning experience.
2U provides schools with software as a service that helps them create online courses that are engaging and successful with students. The cloud-based software works as an operating system that the whole course runs on and includes all the user-facing technology for students to engage with their courses and behind the scenes infrastructure to host and administer engaging video content.
Using the software, schools can create instructor-led live classes, track student engagement and learning outcomes, and also provide a social network to connect students and other faculty. 2U also offers expert services to train universities on how to create engaging classes and insights on courses that are most likely to perform well.
Courses are available on the web and mobile platforms, which means they can be accessed from any location at all times. 2U generates revenue by taking a cut from tuition paid by students to schools. While it started by enabling some of the world’s top universities such as UC Berkeley and Yale to offer degree programs, it has since expanded into delivering boot camps, short courses, and professional programs to people trying to advance their careers.
The overwhelming trend of moving work, life and consumption of content online is starting to catch up with the education sector that has until recently stuck to providing courses and degrees in the same way as they did decades ago - in person. The COVID pandemic massively accelerated adoption of online education and has forced institutions to invest in creating digital courses, which drives demand for the software that enables it.
Competitors in the online learning space include Stride (NYSE:LRN), Adtalem Global Education (NYSE:ATGE), Arco Platform (NASDAQ:ARCE), Strategic Education (NASDAQ:STRA), and schools that develop their online courses in-house.
This quarter, 2U's revenue was down 8.02% year on year to $222.1 , which might disappointment some shareholders.
Ahead of the earnings results announcement, the analysts covering the company were expecting sales to grow 10.9% over the next 12 months.
What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. 2U's gross profit margin, an important metric measuring how much money there's left after paying for servers, licenses, technical support, and other necessary running expenses, was 65% in Q2.
That means that for every $1 in revenue the company had $0.65 left to spend on developing new products, sales and marketing, and general administrative overhead. 2U's gross margin is poor for a SaaS business and it's deteriorated even further over the last year. This is probably the opposite direction that shareholders would like to see it go.
Cash Is King
If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills. 2U burned through $27.2 million of cash in Q2 despite being cash flow positive last year.
2U has burned through $25.2 million of cash over the last 12 months, resulting in a negative 2.93% free cash flow margin. This below-average FCF margin stems from 2U's poor unit economics or a continuous need to reinvest in its business to penetrate the market.
Key Takeaways from 2U's Q2 Results
With a market capitalization of $355.5 million, 2U is among smaller companies, but its more than $53.3 million in cash on hand and near break-even free cash flow margins puts it in a stable financial position.
We struggled to find many strong positives in these results. It was unfortunate that 2U's revenue missed analysts' expectations, free cash flow turned negative and gross margin declined. Overall, this was a mediocre quarter for 2U. The company is down 11.5% on the results and currently trades at $3.78 per share.
Is Now The Time?
When considering an investment in 2U, investors should take into account its valuation and business qualities as well as what's happened in the latest quarter. We cheer for everyone who's making the lives of others easier through technology but in case of 2U, we'll be cheering from the sidelines. Its revenue growth has been very weak, and analysts expect growth rates to deteriorate from there. On top of that, unfortunately its customer acquisition is less efficient than many comparable companies and gross margins aren't as good as other tech businesses we look at.
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