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2U's (NASDAQ:TWOU) Posts Q3 Sales In Line With Estimates But Gross Margin Drops


Full Report / November 07, 2022
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Online education platform, 2U (NASDAQ:TWOU) reported results in line with analyst expectations in Q3 FY2022 quarter, with revenue flat year on year at $232.2 million. On the other hand, guidance for the full year slightly missed analyst expectations with revenues guided to $960 million at the midpoint, or 0.25% below analyst estimates. 2U made a GAAP loss of $121.6 million, down on its loss of $60.1 million, in the same quarter last year.

2U (TWOU) Q3 FY2022 Highlights:

  • Revenue: $232.2 million vs analyst estimates of $232 million (small beat)
  • EPS (non-GAAP): -$0.05 vs analyst estimates of -$0.03
  • Free cash flow was negative $33.6 million, down from positive free cash flow of $25.2 million in previous quarter
  • Gross Margin (GAAP): 65.5%, down from 72.1% 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.

Sales Growth

As you can see below, 2U's revenue growth has been mediocre over the last two years, growing from quarterly revenue of $201 million in Q3 FY2020, to $232.2 million.

2U Total Revenue

This quarter 2U's revenue was flat year on year, which might be a disappointment to some shareholders.

Before the earnings results were announced, Wall St analysts covering the company were estimating revenues to decline 0.72% over the next twelve months.

Profitability

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 is left after paying for servers, licenses, technical support and other necessary running expenses was at 65.5% in Q3.

2U Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.65 left to spend on developing new products, marketing & sales and the general administrative overhead. This would be considered a low gross margin for a SaaS company and it has been going down over the last year, which is probably the opposite direction shareholders would like to see it go.

Cash Is King

If you follow StockStory for a while, you know that we put an emphasis on cash flow. Why, you ask? We believe that in the end cash is king, as you can't use accounting profits to pay the bills. 2U burned through $33.6 million in Q3, increasing the cash burn by 765% year on year.

2U Free Cash Flow

2U has burned through $29.5 million in cash over the last twelve months, resulting in a negative 3.04% free cash flow margin. This below average FCF margin is a result of 2U's need to invest in the business to continue penetrating its market.

Key Takeaways from 2U's Q3 Results

With a market capitalization of $461 million 2U is among smaller companies, but its more than $170.1 million in cash and the fact it is operating close to free cash flow break-even put it in a robust financial position to invest in growth.

We struggled to find many strong positives in these results. On the other hand, revenue growth stalled and gross margin deteriorated. Overall, this quarter's results were not the best we've seen from 2U. The company is up 1.88% on the results and currently trades at $6.5 per share.

Is Now The Time?

When considering 2U, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We cheer for everyone who is making the lives of others easier through technology, but in case of 2U we will be cheering from the sidelines. Its revenue growth has been mediocre, and analysts expect growth rates to deteriorate from there. And while its very efficient customer acquisition hints at the potential for strong profitability, unfortunately gross margins aren't as good as other tech businesses we look at.

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