2U's (NASDAQ:TWOU) Posts Q1 Sales In Line With Estimates But Gross Margin Drops

Online education platform, 2U (NASDAQ:TWOU) reported results in line with analyst expectations in Q1 FY2023 quarter, with revenue down 5.85% year on year to $238.5 million. Guidance for the full year was also close to analyst expectations with revenues guided to $990 million at the midpoint. 2U made a GAAP loss of $54.1 million, improving on its loss of $125.8 million, 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.

Sales Growth

As you can see below, 2U's revenue growth has been unimpressive over the last two years, growing from quarterly revenue of $232.5 million in Q1 FY2021, to $238.5 million.

But this quarter 2U's revenue was down 5.85% year on year, which might be a disappointment to some shareholders.

Ahead of the earnings results the analysts covering the company were estimating sales to grow 6.02% 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 65.8% in Q1.

That means that for every $1 in revenue the company had $0.66 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 have followed 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's free cash flow came in at $26.3 million in Q1, turning positive year on year.

2U has generated $27.3 million in free cash flow over the last twelve months, 2.88% of revenues. This FCF margin is a result of 2U asset lite business model, and provides it with at least some cash to invest in the business without depending on capital markets.

Key Takeaways from 2U's Q1 Results

With a market capitalization of $396.5 million 2U is among smaller companies, but its more than $94.2 million in cash and positive free cash flow over the last twelve months put it in a very strong position to invest in growth.

This was mainly an inline quarter for 2U, although we struggled to find many strong positives in these results. The company is flat on the results and currently trades at $5.1 per share.

Is Now The Time?

2U may have had a bad quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. 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 very weak, and analysts believe that rate will remain roughly steady. And on top of that, unfortunately its gross margins aren't as good as other tech businesses we look at.

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