Online education platform, 2U (NASDAQ:TWOU) fell short of analyst expectations in Q2 FY2022 quarter, with revenue up 1.79% year on year to $241.4 million. 2U made a GAAP loss of $62.8 million, down on its loss of $21.8 million, in the same quarter last year.
2U (TWOU) Q2 FY2022 Highlights:
- Revenue: $241.4 million vs analyst estimates of $254.2 million (5.03% miss)
- EPS (non-GAAP): -$0.10 vs analyst estimates of -$0.17
- The company dropped revenue guidance for the full year, from $1.07 billion to $960 million at the midpoint, a 10.2% decrease
- Free cash flow of $25.2 million, up from negative free cash flow of $1.83 million in previous quarter
- Gross Margin (GAAP): 65.7%, down from 70.6% 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.
As you can see below, 2U's revenue growth has been unremarkable over the last year, growing from quarterly revenue of $237.2 million, to $241.4 million.
2U's quarterly revenue was only up 1.79% year on year, which would likely disappoint many shareholders. But the revenue actually decreased by $11.8 million in Q2, compared to $9.7 million increase in Q1 2022.
Ahead of the earnings results the analysts covering the company were estimating sales to grow 15.2% over the next twelve 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 is left after paying for servers, licenses, technical support and other necessary running expenses was at 65.7% in Q2.
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. While it improved significantly from the previous quarter this would still be considered a low gross margin for a SaaS company and we would like to see the improvements continue.
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's free cash flow came in at $25.2 million in Q2, turning positive year on year.
2U has generated $30 million in free cash flow over the last twelve months, 3.09% 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 Q2 Results
With a market capitalization of $774.5 million 2U is among smaller companies, but its more than $220.8 million in cash and positive free cash flow over the last twelve months give us confidence that 2U has the resources it needs to pursue a high growth business strategy.
It was good to see 2U improve their gross margin this quarter. That feature of these results really stood out as a positive. On the other hand, it was unfortunate to see that 2U's revenue guidance for the full year missed analysts' expectations and its revenue this quarter also missed analysts' expectations. Overall, it seems to us that this was a complicated quarter for 2U. The company is down 3.18% on the results and currently trades at $10.02 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. Although 2U is not a bad business, it probably wouldn't be one of our picks. Its revenue growth has been very weak, but at least that growth rate is expected to increase in the short term. And while its very efficient customer acquisition hints at the potential for strong profitability, unfortunately gross margins show its business model is much less lucrative than the best software businesses.
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