2U [TWOU] Conference call transcript for 2022 q2
2022-07-28 20:56:17
Fiscal: 2022 q2
Operator: Good afternoon. My name is Julianne, and I will be your conference operator today. At this time, I would like to welcome everyone to 2U Inc.'s Second Quarter 2022 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakerâs remarks, there will be a question-and-answer session. I would now like to turn the call over to Lillian Brownstein, Deputy General Counsel. Please go ahead, Ms. Brownstein.
Lillian Brownstein: Thank you, Operator. Good afternoon, everyone, and welcome to 2U's Second Quarter 2022 Earnings Conference Call. On the call this afternoon are Chip Paucek, our Co-Founder and CEO; and Paul Lalljie, our CFO. Following Chip and Paul's prepared remarks, we will take questions. Our Investor Relations website investor.2u.com has our earnings press release and slide presentation, as well as a simultaneous webcast of this call. A webcast replay of this call will be made available for the next 90 days. Statements made on this call may include forward-looking statements regarding our financial and operating results, the continued impact of COVID-19, plans and objectives of management for future operations, including the realignment plan, the integration of IDEX; 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 as of today and we have no plans or duty to update them. Please refer to the earnings press release and to the risk factors described in the documents, we filed with the Securities and Exchange Commission, including our annual report on Form 10-K for the year ended December 31, 2021 and other SEC filings for information on risks, uncertainties and assumptions that may cause our 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 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 the call over to Chip.
Chip Paucek: Thanks, Lillian. Over the last six months, we've become increasingly confident in our platform strategy, which puts edX at the center, as a unifying platform to drive high-quality learning outcomes. We're bringing together our universities learners and enterprise partners into one platform driving network effects to deliver our mission, deepen our strategic mode, drive sustainability and power long-term growth. During what was clearly a complicated quarter, our confidence in our platform strategy increased due to meaningful progress on various tactics we discussed on last quarter's call, including organic demand generation and the publishing platform of edX. As the quarter elapsed and the work progressed, we also realized that in order to really unlock this overall strategy, we need to fully reorganize our company around the edX platform. We do it to service to ourselves, our partners, our learners, and our shareholders, if we didn't go all the way into this platform transformation. Simultaneously, while that was going on during the current quarter, the macroeconomic environment that we talked about on the Q1 call deteriorated further. This put additional pressure on our normal way of doing business, and also on organic demand, within all of online education, with some particular challenges in higher education. The combination of these three things, one, increasing confidence in our strategy; two, a realization of the need to fully reorganized to unlock; and three, a deteriorating macro environment drove us to make more immediate transition to the platform strategy. We believe that accelerating our transition to a platform company will strengthen our foundation and long-term sustainability by driving long-term profitability and cash flow. Now, before I address the reorganization, it's important to note that, despite the macro challenges, the long-term outlook for higher education and digital education remains positive. We fully believe that higher education is particularly countercyclical, which will improve our business as conditions evolve. Our changes this quarter will make us much stronger as demand improves. One positive to the post-COVID world is that online education is pervasive and is here to stay, and more importantly, higher education is still the single best path of social mobility and economic prosperity in the world. Nonetheless, we are radically changing to you now. It was time for decisive action. So what does that mean? We're realigning our business and organization around the edX brand and platform, including one unified product and marketing strategy. The immediate changes include: number one, a new marketing framework. This should significantly reduce our overall marketing spend as a percentage of revenue and increased efficiency and profitability; two, a simplified organizational structure and employee reductions. We believe this will eliminate redundancies and increase agility along with other cost-cutting initiatives; and three a new model for partners. This includes bold and important steps to support our partners and expanding access and bringing down the cost of higher education. I'll now touch on each of these. First marketing. Marketing investment decisions will be made at the platform level, aggregated across business lines with the goal of increasing the lifetime value of each learner. This does not mean that there'll be no more product level marketing, but we now have a world-class platform that allows us to do so more efficiently and as part of a unified strategy. Under our new leadership, which I'll cover in a minute. We've already begun enforcing a new higher bar for all marketing spend decisions, while at the same time leveraging our ability to drive and benefit from organic volume from the edX platform. As a result, we plan to exit the calendar year, at a run rate equivalent to the long-term target we set out at our 2020 Investor Day of marketing spend at 37% of revenue. We believe this will be transformative to our business. This isn't the moment to push the efficient frontier of marketing. We have a flexible and variable cost basis, which allows us to implement a new marketing framework and let more profit flow through the bottom line. This impacts the full year guidance, we shared last quarter. Our full year EBITDA expectations increased by 30%, while our revenue expectations come down by 10%. The Executive Education business will be particularly impacted by this new marketing framework. We expect to see a significant drop on the top line, but contribution to margin by year-end. We come to the conclusion, that you simply can't run that part of the business of paid spend alone and we believe this is a universal issue not a 2U issue. We believe there are opportunities for selective attention here, but will not be expanding this business for now. Instead we plan to make it as profitable as possible, and simply build programs off of our growing marketplace and organic presence. We do see opportunities for the expansion of our boot camp business, where the built-in value has been overshadowed by the larger losses in exec ed and the edX integration. To be clear, we still have work to do in Alt Cred, but our goal is to have this segment drive towards positive EBITDA for 2023. Moving on to our second point, the organizational changes. We're moving to a more streamlined leadership and operational structure. As part of these changes, all marketing spend and revenue decisions for 2U will now be aggregated under our newly appointed Chief Revenue Officer, Harsha Mokkarala, who's been with the company for over nine years. Harsha and his team including our newly appointed Chief Marketing Officer, Michael Kurbjeweit who's also been with 2U nine years, will focus on optimizing marketing spend at a platform level while continuing to drive growth. In addition edX Founder Anant Agarwal, will take on a new role as our first ever Chief Platform Officer, responsible for our unified product and technology strategy. As we consolidate individual businesses under the edX umbrella, significant headcount reductions representing 20% of total budgeted personnel spend will take place in Q3, with a focus on creating greater alignment and efficiency across the organization, as well as removing silos and redundancies that have developed over the years. While this is the right call, it certainly isn't an easy one. The colleagues who will be leaving us have done great work and helped us build this company over the last 15 years. I'm very grateful for that. We'll do everything, we can to treat them well and assist them in their transitions. They've earned our care and respect and we will honor that.I do want to note that these changes will have no impact on the quality of our offerings. In fact, we expect the reorganization will deliver greater value to learners and improve student outcomes. Finally, moving on to our position in the market. Our commitment to edX's founding mission is stronger than ever. As we embrace our future at edX, we're taking bold and important steps to help our partners expand access and bring down the cost of higher education. These steps include embracing edX's flexible approach to degree support, and evolving our revenue share structure to give universities more options and flexibility, to leverage our industry-leading technology and services for their online degree programs. In this model, revenue share for degree programs will begin at a base of 35% and go up from there allowing universities to stack additional bundles, of tech-enabled services depending on their needs. This model offers options that lower our upfront investment, speed up the time line to positive cash flow and open the door for conversations, with universities looking for greater flexibility. We have a new flexible edX degree to announce today. We just signed a new university partner, University of Wisconsin Madison, the school of business to power a disruptively priced $24,000 master of business analytics. This deal also includes the MicroMasters on the fundamentals of business. The combination of a low-price degree and a MicroMasters attached to it should allow us to unlock the full potential of the edX platform. We'll also be announcing a new initiative to help our existing partners bring down the cost of higher education. Trading greater affordability for revenue share to support and encourage our partners to bring down tuition for students in the 180-plus online graduate degree programs we power at edX 2U lower its share for partners who choose to lower their tuition price. As we've said many times before, lower tuition is not only good for the world it's better for our business. Lower prices increase student demand, which decreased our marketing costs. We've been focused on helping our partners drive greater affordability for many years, but we're super proud to deliver this clear action. You'll see more about these initiatives in the coming days. As we make all of these changes, I'm proud to say that by year's end we'll have answered the question from our IPO eight years ago. Yes you can build a sustainable education business in higher ed at scale. Now I'll turn it over to Paul to talk about the financials in more detail.
Paul Lalljie: Thanks, Chip and good afternoon, everyone. As Chip discussed, in a macroeconomic environment that remained challenging in the second quarter, we are radically changing to you by accelerating our transition to a platform company. These changes we are discussing today had a significant impact on our second quarter results and full year guidance. So I'll ask you to keep them in mind as we discuss the numbers. Taking a closer look at our results for the quarter. Revenue for the quarter totaled $241.5 million, up 2% from a year ago including $10 million from edX. Full course equivalents or FCEs, totaled $84000 for the quarter roughly flat on a year-over-year basis and on a sequential basis decreased 2%. In the degree program segment, revenue in the second quarter totaled $143.1 million, a decline of roughly 2% from the second quarter of 2021. This decrease was largely driven by higher leaves of absence in certain of our degree programs and a 2% decrease in average revenue per FCE. Revenue from the Alternative Credential segment totaled $98.4 million, growth of 8% from the second quarter of 2021, primarily due to $7.1 million from edX and a 1% increase in average revenue per FCE. The performance in alternative credentials included a 12% decline in exact ad revenue, primarily due to our decisions to reduce planned marketing. Now let's take a look at cost and expenses. Operating expense for the quarter totaled $289.4 million, up from $274.3 million in the second quarter of 2021. This $15.1 million increase includes $17.1 million of operating expense from edX and a $15.1 million restructuring charge in connection with the planned reduction of 20% of our personnel and personnel-related expenses. Personnel and personnel-related expense, our largest expense line item decreased $6.2 million. Importantly, note that this includes the addition of $5.9 million of expense associated with edX. Marketing and sales as a percent of revenue came in at 44% for the quarter, driven by a $3.5 million decrease in marketing spend on prospect generation. Important to point out here, we spent $11 million less than we projected to spend in the second quarter as part of our new marketing framework. Moving on to profitability for the quarter. Net loss for the quarter totaled $62.9 million compared to a net loss of $21.9 million in the second quarter of last year reflecting the higher operating expense I just discussed and a $5.7 million higher interest expense. In addition, in the second quarter of 2021, we benefited from a $27.9 million non-operating gain on the sale of an investment in Keypath Education. Adjusted EBITDA, totaled $21.9 million, a year-over-year increase of 28%. The increase was driven primarily by reduced marketing expense and lower personnel and personnel-related expense. Adjusted EBITDA margin in the degree segment was 28% for the quarter, an 850 basis point improvement over the second quarter of 2021, showing the inherent profitability of the degree segment business model. Adjusted EBITDA in the Alternative Credential segment was a negative 18%, a 600 basis point decline from the second quarter of 2021, primarily due to increased losses in the exec ed business related to macroeconomic conditions and the inclusion of edX's operating expense. Now for a discussion of the balance sheet and cash flow statement. We ended the quarter with cash and cash equivalents of $237.8 million, an increase of $4.2 million from the end of the first quarter. Our accounts receivable balance totaled $9.8 million, down $8.1 million from the end of the first quarter. Fluctuations in our accounts receivable balance reflects the timing of payments from university partners. Unlevered free cash flow on a trailing 12-month basis was $11.5 million, compared to a net use of $34.1 million at the end of the first quarter. This improvement in unlevered free cash flow was driven by lower marketing spend, lower personnel and personnel-related expenses and improved net working capital. I will now discuss how we expect the remainder of the year to play out. We expect the current realignment plan to be completed during the fourth quarter and believe it will generate approximately $70 million in annualized cost savings once completed, which includes a 20% reduction in overall personnel and personnel-related expenses. We incurred a restructuring charge of $15.8 million in the second quarter and expect to incur an aggregate restructuring charge of between $35 million and $40 million by the time the plan is completed. Let me say that Chip and I believe there is further opportunity to improve our operating efficiency, through process reengineering, workflow automation and a rationalization of our real estate footprint. It is too early to size these initiatives, but nonetheless, critical to understand that we are firmly focused on driving simplification and cost reduction throughout the organization. Given all the initiatives I've discussed, we are revising our 2022 full year outlook. We now expect revenue to exceed $960 million representing growth of 2%, while at the same time increasing our adjusted EBITDA guidance, which we now expect to range from $105 million to $115 million for the full year, representing 65% growth at the midpoint. To give a bit more color on our updated full year revenue expectations. The primary driver of the change is our revamped framework for marketing, spend which impacted revenue in the second quarter and will impact revenue for the full year. While the macroeconomic environment remained challenging during the second quarter and may remain challenging in the near-term we believe, that our new marketing framework, when the environment improves. We also expect capital expenditures to be approximately $70 million and weighted average shares outstanding to be approximately 77.4 million shares. And while we are not providing 2023 guidance at this time, in part based on the initiatives we have discussed on this call we expect to generate at least $150 million in adjusted EBITDA next year. We also expect to achieve our long-term target for marketing and sales as a percent of revenue of 37%. To conclude, we were already powering high-quality digital education offerings at an unmatched scale. This quarter we have taken important steps to align the business behind a single platform under the edX brand and create a sustainable engine to drive profitable growth and cash flow in the near and long-term. We look forward to sharing our progress with you in the coming quarters. With that, let me hand the call back to Chip.
Chip Paucek: Thanks Paul. Before we move to Q&A, I want to take a moment to acknowledge and thank our outgoing Chief Operating Officer, Mark Chernis. As you saw in our release and filings, Mark decided to step down from his current role to pursue other opportunities and transition to a consulting capacity in October. He's been part of 2U's history for 14 years, first as a director and then as our COO. Mark's leadership and contributions have been invaluable to me, and in making 2U the company it is today. I'm beyond grateful for his contributions to 2U and for our friendship. I wish him nothing, but the best in his future endeavors. And now we'll open it up to questions.
Operator: Our first question comes from Stephen Sheldon from William Blair. Please go ahead. Your line is open.
Stephen Sheldon: Hey thanks. And before asking questions, I just wanted to quickly applaud this move to focus on profit and free cash flow. Great to see, I think it makes a lot of sense just to ensure that investors can see the sustainability of the model. But the first question here, what are you targeting here on the profit and free cash flow side over the next few years? And specifically, are there certain targets you have in place that maybe once you'd hit, you'd shift focus or have a little bit more flexibility to focus more on top line growth again? I guess how are you thinking about those trade-offs over the next -- over the medium term?
Chip Paucek: Well the first thing I would say before I turn it to Paul. What I would say -- first of all Stephen thank you for your comment is that, the -- we do believe that the company has a number of growth levers and we didn't fill the script with lots of commentary on it because we thought at this time the important thing was for us to drive home the transformation of the company, the focus on cash flow, the focus on profitability because of the platform that we are able to transition to. And so -- but we do think that there are a number of profitable growth categories for the company, not just enterprise which I know we talked about last time and continues to be strong, but our boot camp business is totally underappreciated. The fact that we're now able to work directly with either governments or foundations to offer technology training at scale in a way that other people can't. The new flexible model on degrees, we do think will be responded to very favorably by the market. So, there's a variety of interesting options. And as we transition to a platform company, we do think that the edX platform itself has a lot of innovation ahead of it to offer more creative solutions for people to sort of unlock their potential. So there's a bunch there, but I want to pass it to you to talk about I believe in Slide five in the investor deck. Worth highlighting Stephen.
Paul Lalljie: So Stephen, Slide five of the investor presentation has some margin progression and also target margins as we go forward. But there are a couple of things here. I think we've always talked about a variable cost basis particularly around marketing spend. But I'd like to go back and highlight a couple of things at Chip's script, right? Chip talked about the confidence that we've gained over the last six months as we begin to integrate and operate edX as part of the combined entity. We now have an organic marketing platform that gives us the confidence to modulate and to change the marketing framework that we have around marketing spend. So the first target that we have is, around marketing and sales as a percentage of revenue. That number for 2023, we're expecting that to be 37% and if that number is 37% you can see from our historical trends, the other cost categories have been pretty consistent overtime and that allows us to achieve a margin of 15% on the EBITDA level and -- the EBITDA line next year. And importantly based on the numbers we are providing for this year, it's around 12%. And most importantly if you translate all of this to what really matters, free cash flow. It's a free cash flow positive business exiting December 31, 2022 and positive for the calendar year in 2023. And at these margin levels, it gives us the flexibility to reinvest growth opportunities, reengineer the balance sheet do all the things that we need to do as a company to be sustainable both in the top line and the bottom line.
Chip Paucek: What I would add is, $150 million minimum of EBITDA in 2023 and I do think it's worth pointing out the reason I turn your attention to Slide five is, the percent of sales and marketing for 2U has been part of the discussion around the company for a long time. And 2019, 56%, 2021 46% exiting this year at 37% which was the high end of the range that we gave at Investor Day in 2020. So, we feel like our transition to a platform strategy is really going to allow us to not just drive profitable growth in the future, but to really have a great foundation from here to grow. And I give my CFO a tremendous amount of credit for driving us in that direction over the last couple of years.
Stephen Sheldon: Got it. That's really helpful. I appreciate that. And then, just a follow-up on the planned changes to the revenue share structure in degrees, can you dig into that a little bit more, especially for the university partners that are lowering the tuition they charge. Have you started having discussions around that with partners? And if so, I guess what feedback have you gotten from them as you've discussed this with them?
Chip Paucek: Yes. We have and we'll announce that more fully here in the next day or so. We've said for some time that lower prices are actually good for the business because they are, and we do have unmatched scale that allows us to drive it down. And to be clear from an organic perspective the greater the affordability, the more organic volume that we're going to see for those offerings. And that's the benefit of transitioning to edX is that organic about volume. So, the goal here is to maintain quality while we increase access for people. Now in existing program, we've definitely seen improvements in enrollment based on tuition coming down. And we're excited to drive that conversation and incentivize our partners to have that conversation with us, because we thought it was time.
Stephen Sheldon: Great, thank you.
Operator: Our next question comes from Jeff Meuler from Baird. Please go ahead. Your line is open.
Jeff Meuler: Yes. Thank you. So just as investors look to have confidence in the 2023 EBITDA and free cash flow projections, just help us with that agreed trends, because it looks like that's your primary profit pool and degree took a pretty big step down in revenue this quarter. So just, what are you assuming or just help us with the profit pool sustainability to kind of underpin the $150 million in 2023?
Chip Paucek: Jeff, first, I would want to be careful with the notion of a pretty big step down. Granted, it did go down 2% but not how I would define pretty big and it's a pretty tough comp. So -- but regardless of that, what you are dealing with right now in the entire world of higher ed is, this is a very tricky time. We're probably at a nature of overall in a post-COVID world where you've got some reopening happening everywhere. You have people sort of getting out into their lives. We saw for the first time, and Paul mentioned this in his prepared comments, we did see a different retention now. Our retention is still extremely high if you look at it across -- if you compare it to other types of programs in the market. But that actually did drive some of the change in the current period, no question, retention coming down a little bit by having an increase in people taking leave of absences. And we've got a good history of being able to bring those people back into the system to complete their degrees. But nonetheless that actually hit -- that hit the current period. And we believe that as the economy does soften, it is countercyclical. We found that, it hasn't quite hit the job market yet, but we do believe that will happen over time. And as it does, we do think that the Degree business will improve. We operate in so many different disciplines right now that have a significant shortage of people, whether itâd be the helping hands disciplines, the health disciplines like nursing or speech and our STEM programs. So, we like the odds of the sustainability of that business. I would also say I feel like we are doing the Degree business at a scale that others are not. And it's significantly more profitable than most other folks. So, we're big believers in driving new degree opportunities. And we think that our pipeline will start to show that. I was pretty excited to be able to have one announcement today that is meaningful disruptively priced. So, this is kind of what we said at Investor Day 2020.
Paul Lalljie: Yes. And Jeff, this is Paul here. So, $70 million reduction on an annualized basis into 2023 that is to some extent rises -- increases the margin on both sides of the business. I would say more pointedly on the alternative prudential side of the house while it is negative today, and our goal and objective is to make that business positive in 2023 or at least flat, zero in 2023. And with the Degree side of the business, it has the predictability and it has a larger organic component when it comes to marketing. An organic component is, of course, a cheaper portion of marketing. So at the end of the day, it is -- 2023 is more near-term and specifically has the benefit of the $70 million run rate reduction in expenses that contributes to about $150 million EBITDA in 2023.
Jeff Meuler: Okay. Thanks. And then help me with the partner, the university partner conversation. I understand how this plays well into mission of expanding reach around high quality education at an affordable price point all super important things. But from, I guess, two fronts. One, what's the impact on surplus for university partners with the new strategy? And what do you tell the university partners that may have staffed to a certain enrollment expectation, or just help us with the university partner conversation?
Chip Paucek: Well, the staffing to enrollment level is -- the lower prices definitely drive your enrollment higher. So that's not the issue. We think you can drive a meaningful surplus. The reason that we're willing to put revenue share behind it is simply to help that conversation and incentivize what is a long-term partner to help us drive greater affordability. In general, we have found partners to be responsive to the conversation. Part of the reason that we're doing this is to put the full force of the company behind it because at our scale we can. We think it will be good for everybody longer term. Now to be clear Jeff there are -- the different degrees and different university brands and different prices means there's a variety of different outcomes related to the size of the revenue difference and the size of the price difference. So it's not easy to put into a formula. And we're keen on folks getting as affordable as they can, because we think it really does benefit not just the world but the company. So far response is -- it's positive. We've got good discussions happening and we should have some schools that we're able to talk about in the short-term.
Jeff Meuler: Thank you. And I, obviously, personally love the wind today. So, I miss Wisconsin. Thanks.
Operator: Our next question comes from Ryan MacDonald from Needham. Please go ahead. YOUR line is open.
Ryan MacDonald: Hi, Chip and Paul, thanks for taking my questions. And, yeah, I love the new focus here on profitability. Chip, I wanted to double-click on the selective marketing spend and the shift in strategy towards more of a portfolio basis rather than the individual product. Can you talk about how that works again, I guess in those conversations with your university partners in terms of being able to balance out marketing spend appropriately to make sure that your partners are getting the appropriate amount of marketing to drive those enrollments. How does this new strategy change that shift and focus at all?
CHip Paucek: Ryan, I would say, I think the story here is just making sure that we are all in it together. It is an appropriate partnership. And if something is going to require marketing spend to be unprofitable then it's not sustainable for anybody. And so whether the story is that we need to try to drive the price down, organic with edX is a huge factor. Organic -- the story of marketing these programs more and more, we do think that the platform is a necessity. It's really not an option -- it's not optional like you need to have this kind of platform. And one of the reasons we were so excited to team up with edX is just the scarcity value of this type of opportunity is real. So to be clear, we will continue to drive university individual program marketing but as we aggregate the activity under edX, all the boats will rise because we'll have greater opportunities to offer new types of offerings to people that have come in. One of the things that's notable is like at 2U we've got learner growth. And at the same time we've got this other very large bucket of activity that is effectively prospect flow or lead flow. Those over time come together into something that gets much more compelling for everybody that's part of our partnerships. They can't be distinctly separate long-term. They really need to come together. So building both pre-enrollment and post-enrollment opportunities on the edX platform is a meaningful part of the long-term strategy, and it does start today because now we've reorganized the company entirely under one platform.
Ryan MacDonald: That's very helpful. And then maybe just one quick clarifying question. As you talk about the -- I guess, the macro impacts -- you talked about within degrees that you saw an increase in people taking leave of absences. But you chat about what you're seeing on sort of, top of the funnel for new enrollments with programs as you look out into not just, I guess, beyond this fall but building sort of a pipeline for next spring as well?
Chip Paucek: So I would say it's interesting that like the first thing I would say is overall -- like overall demand across, sort of, traffic organically related to education is down. And so some of that you see in actually not just degree, but across our full business. So that's sort of a place to start is I said we're operating right now in maybe the, sort of, last couple of quarters like this nature of where demand is. And the reason I say that is, the economy is softening, but you haven't yet seen that hit the job market and we think it will. And over time we think that that will benefit programs that -- where people are looking to get into new types of jobs and new types of careers. The retention difference was small in terms of quality retention, but meaningful enough to drive the current period the change in the business. So Paul, go ahead.
Paul Lalljie: Yes. So that was roughly around $6 million of sequential decline on retention. That was the largest driver in the degree business. So overall while we're seeing overall softness from a marketing perspective and a new enrollment perspective, we also had the retention challenge on a sequential basis Q1 to Q2 in the degree business in particular.
Chip Paucek: That's a big part of the reason we felt like -- throughout the quarter I mean I said at the beginning, but it's worth reiterating like we got more confident in the platform, yes. We got more -- it was more obvious to us that we really had to rework to unlock it fine. The other thing that happened is the macro did get worse during the quarter. And for that reason we decided that we needed to take decisive action. Like we thought this kind of action was prudent, and we think it positions us well. And we do think that it will get better. When it gets better we've just got a really profitable base to grow from.
Ryan MacDonald: Helpful color. Thanks a lot.
Operator: Our next question comes from Tom Singlehurst from Citi. Please go ahead. Your line is open.
Tom Singlehurst: Good evening. It's Tom here from Citi. A lot of what you said make a lot of sense, I think will be welcome to many shareholders. I wanted to ask one question about the way that you go to market though. I mean, I get the impression that 2U's position historically has been, sort of, perceived as and has actually been quite premium sort of white glove service if you will. If you're moving to a model where you're marketing more as a platform and you're reducing headcount do you just make -- how do you make sure that you don't compromise the sort of quality of the sort of service to in particular your university partners?
Chip Paucek: Yes. So by the way it's late over there so we appreciate you being on. I would say, we made it purposely clear in the prepared remarks to emphasize the fact that -- we're doing this in a way that we believe will not decrease quality and that is of most concern to the company and to the management team. Quality has been our hallmark. And I believe we've got good odds. I mean part of what is going on here is the company has done M&A over the years. And what you're seeing now is the company bringing those together in a more fundamental way and eliminating some redundancy and that's difficult because we care very much about the people, but it is necessary. And we do not believe that this will impact the quality of the programs. So ultimately quite proud of the high-quality outcomes across the business including this was not the quarter to have the prepared remarks with a whole bunch of strong statements about how great some particular thing is we were really proud of the Gallup survey related to our boot camp programs, which didn't get that much attention and we think should have that proved that the year one ROI was effectively equal to the cost of the boot camps. So like quality matters. And we do think our universities a big part of the reason that they are with 2U is that we've proven that over the years. And under the edX banner being able to have a broader platform strategy that folks can participate in has been responded too well. I mean it's notable that the Wisconsin program is both a master's degree and a micro masters day one and that should open up access and drive greater affordability to an already affordable degree. But the key is it all has to be done at our quality level. I do think 2U and edX coming together makes it really interesting. Like we didn't have the platform, but I will tell you that the tech-enabled services that power these things across the board are exceptional. And our partners know that which is why today still today many years later we haven't lost a degree partner.
Tom Singlehurst: That's very clear. And then one quick follow-up for Paul. FX can't be helping. I mean the strength of the US dollar especially for your international programs, how much of a drag is that in the sort of guidance reset?
Paul Lalljie: Yes. That was a significant contributor to the exec ed performance. I lumped it under the bucket of the macro environment in my plus explanation in the script in the prepared remarks. It is factored in. It is not expected to get better in the guidance that we've provided. But it is a main contributor in our exec ed business.
Tom Singlehurst: Thatâs very clear. Thanks so much.
Operator: Our next question comes from Josh Baer from Morgan Stanley. Please go ahead, your line is open.
Josh Baer: Great. Thanks for the question. I wanted to dig in on the change in the flexibility of degree offerings. I was hoping you could repeat or review how the economics will work one more time? And then I have a couple of follow-ups.
Chris Paucek: So, we have a piece coming out on this tomorrow that will give greater detail. But the flexible model starts with the core service bundle at 35% and then adds -- you stack on it depending on the needs of the university partner. And this came out of the innovation group here based on conversations with both current and potential partners as to what they may want to see. So, an example of that Josh is like not everyone needs course production or course build and we find that to be very positive because that's a large CapEx load and some universities have built groups on their campus to drive -- to build online courses. And I happen to think our learning design is excellent but not everyone needs it. And so having that priced into the original bundle makes it challenging for some schools. So, that's one example. Other examples are paid marketing will not be part of the core bundle because it's not necessary for every single university program either because the university isn't trying to make it that large or because it's not appropriate for that particular program. And so effectively the core bundle offers a set of core services that we believe when combined with the edX platform because it includes nurturing -- lead nurturing, we think it will drive quality profitable programs 2U with a significantly smaller like very little J curve so much lower investment upfront. And if it's a program that the school is interested in scaling up at a level that is more like a historical program and we have some of those in play right now at what looks like very similar 2U historical rev share levels. People tend to over-focus on the rev share percentage and not focus on what you're doing for the rev share in order to help the university partner, which is one of the reasons the surplus provided to the school is typically very positive. So, it's like a comprehensive set of options for school and we think it's going to have a strong market response. Now, to be clear Josh, there still will be programs that look much more like what you've seen historically from us. We just want to be more flexible for the university partner.
Josh Baer: Got it. Thanks. Two follow-ups there. So, the core service bundle is that basically just the technology?
Chris Paucek: No, it's not. And we can get you some more on this, but it includes -- the core service includes the technology. It includes the organic coming off of our platform. It includes lead nurturing. It includes a basic level of student support, but not things like clinical placement. If someone is going to be placed into a local doctor's office or a school or some -- that's a large part of our operation here and has a real expense load to it. So no, it's not just technology. We actually think it will be super competitive with anything else that is out in the market today and that's only because of our scale.
Josh Baer: Great. That makes a lot of sense. And then last question on this is, I could see how this is a competitive and interesting development around flexibility for new conversations. My question is how -- what are the implications for existing customers, existing partners, existing contracts, or do they have a chance to like existing partner that might be able to do parts of the OPM services themselves like do they have a chance to opt into this flexible pricing model to revisit contracts? Like what's the approach for the existing customers?
Chip Paucek: We've got very good conversations happening across the board with regard to the way the original contract was laid out and the length of the contract. And I think you know Josh that as I said, we haven't lost a degree partner. And all of those conversations as you get into the renewal period as people start needing to think about what the contract is going to look like after the first let's say eight or 10 years, whenever that happens. We're engaged in a whole variety of conversations. And certainly this is part of it. But the original construct 2U invested in that sort of beginning part of the J curve over those original programs. And therefore -- and the school understands that. So just a reminder that those contracts are not only strong and valid, but we're having really good conversations with partners about what the future of those looks like. Now in all of our extensions or renewals, whether it was because we were going back to the client because we needed to change something about the contract like exclusivity or because the contract is starting to come to the end of the contract, we've never really gotten extremely close to the end of the contract to be clear. We always approach it as a positive friendly conversation that happens long before we get to the end. But all of those conversations have included revenue share adjustments over time and that's perfectly appropriate because the company at that stage is now into the cash flow and that program has generated the IRR that we expected and so it's like what is the go-forward look. Now I will tell you during the time period of 2U starting to today, there are basically no online programs. Now there's a whole bunch of online programs. And so you have to be thinking about it more as a platform strategy. And I will tell you it's getting harder and harder for university partners to do this on their own without that because candidly the only people that win by more and more people coming on without a platform partner are the social media networks like that's it. That's a win in that case. So having the platform, we think is a competitive advantage long-term to each of our individual partners because if you're only the platform and you don't do per program marketing, life gets hard in doing degrees. It's tough. Well, if you have the platform and you have per program marketing, as long as you're setting the bar at a reasonable level like for the company, we think that's a good place to land. And so we like our odds of more new programs at existing partners because of this flexible service. And I will tell you just based on conversations that have been had so far, there'll be a wide variety of these. It's not -- as you'll see when we announce it tomorrow, there's like a stack to it. And there'll be some that want the core with just clinical placement or some that want the core with course production or some that want paid marketing because they want to scale the program. So we're just trying to create greater flexibility for people.
Josh Baer: Great. Thank you. I appreciate it.
Operator: Our next question comes from George Tong from Goldman Sachs. Please go ahead. Your line is open.
George Tong: Hi. Thanks. Good afternoon. I'd like to dive deeper into yourâ¦
Chip Paucek: Hey, George.
George Tong: Hi. Into your platform strategy. Can you elaborate on the details of what your marketing framework involves the mechanics of it? And we understand it should result in cost savings, but how will it drive improved revenue performance?
Chip Paucek: Well, I mean George, I think today we're going to be careful to not go too into the weeds, but I would say how much marketing spend come down in the current period?
Paul Lalljie: Current period we did not spend $11 million in paid that we were originally planning to spend. And for the year it's going to be about $40 million.
Chip Paucek: It's significant George. Like the platform does allow you to aggregate organic demand. We mentioned on our last call that we were at roughly 10% of our lead flow coming in a run rate of 10%. That is clearly going up based on the platform itself and based on us reducing paid options that aren't as good from a conversion standpoint. Now as you get into platform innovation, there's all kinds of things we think we can do to drive opportunities across all of our products, including degrees. So we do think that you'll see a wide variety of different innovations on the platform side, butâ¦
Paul Lalljie: Yes. So, George, if you think of the platform the platform allows us to leverage the six pillars that we talked about in the last call, whether it's traffic, whether it's SEO and content publishing, or portfolio marketing versus the single product marketing that we talked about, it allows us to do things that are very different. And keep in mind, organic marketing is our cheapest form of marketing.. So at the end of the day if we're going to cut paid marketing it, therefore means that we're cutting the less productive marketing. And if we cut the less productive marketing, we therefore improve profitability almost immediately, the point that we have the backdrop of an organic marketing platform that can help us to grow at the same time.
Chip Paucek: So George just a couple of helpful comments from last call I outlined a series of strategies related to the edX marketplace. And one is building traffic, the other is SEO and driving greater SEO. The third is portfolio marketing versus single product marketing evolving the product evolution to create stackables that's pretty critical. And then obviously international and enterprise opportunities. But like we'll dig into these in greater detail and show you the progress of them at the Investor Day we'll announce, because we think it's a bit overdue for us to get with this community. So, one thing that you can do on your own to see the power of it right now is just go to Google and type online master's degrees. And once you get past the paid ads, you'll see that there's a pretty substantial ranking of edX that wasn't there six months ago.
George Tong : Got it. That's helpful. And then as a follow-up, you're reducing your guidance for revenue by 10% due to macro headwinds. How do you square that with the view that higher education is countercyclical?
Paul Lalljie : So a couple of things. On the guidance, guidance is coming down from $1.70 billion at the midpoint to $960 million. And at the same time EBITDA is going up from a midpoint of $85 million to a midpoint of $110 million.
Chip Paucek: So, I'd like to just correct that that is not because of macro headwinds. That is us leaning into the platform strategy realigning and changing the marketing sort of framework and doing it to drive greater profitability to the bottom line. I just want to clear that up.
George Tong : Right. But to follow-up though you mentioned that you are experiencing macro headwinds and that's accounting for some of the revenue shortfall in the quarter and reflected in the full year guide. So just how do you square that with the view of that higher education is countercyclical if you're being impacted by macro headwinds today?
Chip Paucek: Well, I mean, we obviously go across the business not just degrees. And the job market has not been substantially impacted as of yet. We do believe that winter is in the process of coming. So, we think that you'll see that happen. But the macro that we were seeing in the quarter caused us to just believe that we needed to be decisive and make this change now, because we thought it was smart to do so.
Paul Lalljie: Yes. And George, if we look back at how we got to the numbers we just talked about, whether it's on the revenue coming down or the EBITDA increasing. It comes from basically three buckets. It comes from a reduction in marketing spend which has a flow-through effect on the bottom line. It comes from a reduction in personnel-related expense, which flows through to the bottom line also. And then the other side of the equation has operational efficiencies across the business that we will reduce over time. Now, where does the macro come into all of this? From a macro perspective, it somewhat gave us the opportunity or allowed us to accelerate our platform strategy, knowing that we have confidence and what the organic platform in edX can do for us. And putting all of those together got us to the endpoint. It is not the macro that caused the decrease, but it is -- the macro is a contributor in that environment and that trifecta if you will.
George Tong: Got it. Helpful. Thank you.
Operator: Our next question comes from Jeff Silber from BMO Capital Markets. Please go ahead. Your line is open.
Jeff Silber: Thank you so much. I know restructuring is painful. I don't want to get into the details. But at a high level, what type of positions, are being eliminated? And do you think that could have an adverse impact on your business?
Chris Paucek: So Jeff, it's across the company, it's across the board at different levels, different departments, so difficult for me to comment further. But we did bring -- we brought three companies together over the last five years and haven't done this. And it was time particularly given not just the macro, but unlocking the platform strategy. This entire conversation around the reorg started unrelated to what was going on in the macro. We've been working on it for a while. And just the macro certainly drove in our opinion the need for us to be more urgent on the matter.
Jeff Silber: Okay. Fair enough. If I can move on to another potential uncomfortable topic. There's been a lot of speculation in the media about another company coming to your Board with a buyout offer. If you're willing to comment on that great, if not, more importantly, are you finding any of your partners or potential partners asking about this? Do you think schools might be more reluctant to sign on if they think there might be an ownership change?
Chris Paucek: So Jeff over what is now eight years as a public company, the number of times that I've been asked about something related to this is not small. As a public company, you're effectively always for sale. And you're of course going to do what's right for shareholders. We don't comment on rumors and our partners have been perfectly fine about this discussion. And our partners are in general pretty used to us having discussions related to what it means to be a public company and have benefited from a strong long-term public business that we think right now just got a lot stronger.
Jeff Silber: Okay. Thatâs really helpful. Thanks so much.
Operator: Ladies and gentlemen, this concludes today's call. You may now disconnect.
