2U Inc (TWOU) 2016 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen. And welcome to the first-quarter 2016 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. (Operator instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Mr. Ed Goodwin, Senior Director of Investor Relations. Please go ahead.

Thank you, operator. Good afternoon, everyone. And welcome to 2U's first-quarter 2016 earnings conference call. By now, you should have received a copy of the earnings release for the Company's first-quarter 2016 results. If you have not, a copy is available on our website, investor. 2u.com.

The recorded webcast of this call will be available in the Investor Relations section of our website. Also, we routinely post announcements and information on our website, which we encourage you to access and make use of.

Today's speakers are Chip Paucek, CEO and Co-Founder; Cathy Graham, CFO; and Susan Cates, COO, who will be joining for Q&A.

During today's call, we may make forward-looking statements including statements regarding the Company's future financial and operating results, future market conditions, and the plans and objectives of management for future operations. These forward-looking statements are not historical facts, but rather are based on our current expectations and beliefs and are based on information currently available to us.

The outcome of the events described in these forward-looking statements is subject to known and unknown risks and uncertainties that could cause actual results to differ materially from the results anticipated by these forward-looking statements. This includes but is not limited to those risks contained in the risks factors section of the Company's annual report on Form 10-K for the year ended December 31st, 2015, and other reports filed with the SEC.

All information provided in this call is as of today. Except as required by law, we undertake no obligation to update publicly any forward-looking statements made on this call to conform to statements or actual results or changes in our expectations. It is also 2U's policy not to update our financial guidance other than in public communications.

Non-GAAP financial measures discussed during this call are reconciled to the most directly comparable GAAP measures in the table attached to our press release. I would now like to turn the call over to Chip.

Thanks, Ed. Our business is delivering. For the ninth consecutive quarter, 2U exceeded its previously stated guidance for all financial measures. Revenue for Q1 increased 37% year over year. Adjusted EBITDA was positive for the second quarter in a row, and at $2.2 million, showed an improvement of approximately 900 basis points in margin over the first quarter of last year.

And there's more. With these results, we're increasing our expectations for full-year 2016. We've reached a pivotal moment on our path to profitability, and are now guiding to adjusted EBITDA profitability for full-year 2016.

As a reminder, at the time of IPO in March 2014, we expected to hit adjusted EBITDA profitability at some point in 2017 to 2019. In 2015, we updated that guidance to adjusted EBITDA profitability for full-year 2017. Today, I'm telling you that we now expect to be adjusted EBITDA profitable for full-year 2016. That's this year, a full year ahead of our latest forecast. It's a pretty big watershed moment for my team.

Before we go any further, I want to address changes to the team that were announced yesterday. By now you all know that Jim Shelton has resigned to become the head of education for the Chan Zuckerberg Initiative. This is a unique position to say the last, a natural fit for Jim, and everyone here wishes him well. Treating people with the respect they deserve on the way out is critical to a successful culture. I truly wish him the best.

But that does mean I expected it or love the change. It wasn't part of the plan. Yes, I'm aware it's our third executive-level departure since the beginning of the year. As analysts and investors, you wouldn't be doing your jobs if you didn't ask me if there was something in the water here at 2U given these changes. I can assure you, the answer to that is a resounding no.

Rob Cohen's retirement was something he had been considering for a long time. Jeff Rinehart had personal issues he needed to make a priority. He's now teaching at American University. And Jim has made a career choice that we must respect. The reality is, in our entire history, we've had low turnover at the exec level. These three are clustered close together. You know what? That stinks. But they're unrelated. I have to play the hand I'm dealt. It is what it is.

Most importantly, that hand is solid. Susan Cates made it stronger as our new COO. We have such a strong bench of capable, tenured executives with deep experience in our business: Cathy, Harsha, James, Ian, Todd, Megan, [Gav], Brad, JZ, Andrew -- an incredibly deep bench with them.

We've made the decision to divide up Jim's responsibilities, and two of our seasoned executives have been promoted to take some of those over. First, let's talk about program management. Jason Zocks has been promoted to EVP of Program Management and will now oversee all of our launch programs. JZ joined 2U in 2008. And as GM of Nursing at Georgetown, he developed our first healthcare program into a world-class standard, opening the doors to multiple verticals.

JZ was also responsible for creating our first multiple program vertical, or MPV program, and drove much of that strategy. More recently, he's been a regional EVP and GM overseeing a group of programs and helping to develop the talent pool within program management. Our partners are well served with JZ at the helm. There's no on-the-job training required.

Now let's talk about pipeline. Andrew Hermalyn will now head new university partnership development for 2U as EVP of Business Development. Andrew has been with the Company since inception, and is currently the regional EVP overseeing our Syracuse programs.

Way back in the day when we were a small Company, Andrew was our VP of University Relations. So he's done some of this before. Frankly, while it was on a smaller scale, he did it at a time with much more uncertainty where every deal was extremely unlikely. He closed many of the early deals with me. With Andrew as the GM for our Syracuse University programs, he's proven that he can build large partner relationships.

We move ahead and continue delivering on our promises. How? A team. An awesome team. A team of talented, diverse, passionate people who will drive this opportunity.

So let's talk about program pipeline a bit. It continues to be strong. We've signed and announced all six programs for our 2016 launch schedule. We've also announced eight of at least 21 new programs for 2017 and 2018. The three program announcements over the past few weeks all follow our strategy of finding a great partner who wants to lead in the 21st century, who is a brand and region match and expand with them.

Our first partner, the USC Rossier School of Education, announced a program in school counseling pending school, university, and state approvals. This would be our second in that vertical. We're thrilled to have another program with Rossier, and particularly like have MPV programs in school counseling at USC on the West Coast and NYU on the East Coast.

Additionally, we've announce two new programs at Syracuse, which now has a program of seven. Why seven? The leadership there is excellent, and our program selection algorithm recommends most degrees at Syracuse. Our hope is that these two are not our last new programs at Syracuse University.

The first new program was Executive MPA at Syracuse, which will be offered by the Maxwell School of Citizenship and Public Affairs, the nation's top school of public affairs. This is our second program in the public administration vertical, bringing our MPV count to nine verticals.

Second, the Syracuse University College of Law announced a groundbreaking Juris Doctor program. The JD is clearly one of the largest verticals by enrollments, but very few universities currently offer an online hybrid JD. Should the program be approved, it could become a very large opportunity for us from a financial standpoint.

We love this, but let's give you some disclaimers. This program must go through ABA approval. We will support Syracuse as it goes through their process. Until it is fully approved, investors should basically ignore the potential impact of a JD program. We have no timetable for launch yet.

So why am I telling you about it? The contract's done, and there'll be many people working on it externally so you would hear about it anyway. We just want to get ahead of it. We'll obviously keep you posted.

One final comment on an important milestone for 2U before I turn it over to Cathy. Last month, we announced that our very first partner, the USC Rossier School of Education extended its contract with 2U for an additional 12 years. The agreement, which now runs through 2030, also significantly reduces exclusivity in the education vertical. We've now unlocked exclusivity across the portfolio, and were able to pursue our MPV strategy in every vertical.

Those of you who have followed us for a while know the journey of exclusivity. When we started the Company, we believed the programs should be exclusive. We would offer each degree with a single partner. But we were wrong about the assumption that you could scale a program infinitely. Over time, we learned the value of powering a particular degree with multiple universities, now known as our MPV strategy. And that value's not just for the second program, but for all programs in that vertical.

A huge amount of my personal time was spent going back to our original partners, who were sold exclusivity by me, and explaining how the MPV strategy benefited their programs. This has been a complicated process that's taken a substantial amount of time and energy.

With Rossier done, all of our original partners have extended their contracts and allow for MPV. This is a big relief to me personally. I am thrilled to have this school and its pioneer Dean, Karen Gallagher, with is for the long haul. We're unbelievably proud of that relationship. Karen is changing the world with us.

Our first five programs have now each signed extensions ranging from 2028 to 2032. This means we do not have a contract up for renewal until the end of 2021, which is nearly six years from now. Our client base is stable and committed to growing with us for a long time. We're ready for it.

Now I want to turn it over to my great CFO, Cathy Graham.

Thank you, Chip. 2016 kicked off with a great first quarter from the financial results perspective. Revenue came in nicely ahead of our guidance. And that performance, along with shifting of some expected Q1 costs to the second half of the year, produced higher-than-anticipated adjusted EBITDA.

At least as importantly, these results combined with our increasing visibility into the rest of the year, now lead us to expect that we will be adjusted EBITDA profitable for full-year 2016. More about that in a moment.

But first, let's review the first quarter. At $47.4 million, first-quarter revenue exceeded the comparable 2015 period by 37%. Revenue growth was once again driven primarily by an increase in full course equivalents. Compared to the prior first-year period, first-quarter FCEs increased by 35%, and average revenue per FCE increased by 1%.

FCE increases were generated across our program base. But as our business model projects, the largest increases were from programs in their first three to four years of operations. As we expand our program portfolio with additional launches at new and existing university partners, our revenue base continues to rapidly diversity.

At $2.2 million, first quarter adjusted EBITDA showed significant improvement over the $1.6 million loss reported in the prior-year period. Said most clearly, our adjusted EBITDA margin improved by more than 900 basis points year over year from a 4.6% loss in the first quarter of 2015 to a 4.6% profit in this past quarter.

Though we expected first-quarter adjusted EBITDA to be positive, the results we achieved were clearly well above our expectations and guidance. While revenue overperformance was a contributor, a deferral of certain costs to later in the year was a bigger factor.

As we told you at year end, we're doing a major ERP installation, and have planned for significant implementation costs in the first quarter. We have now extended the design phase of that project, pushing more of our implementation costs into the second half of the year.

Also, though we expected and did see continuing improvement in our marketing efficiency, because of timing issues, we did not recognize as much in direct marketing expense during the quarter as anticipated. We also expect this timing difference to reverse, shifting marketing costs to the third and perhaps fourth quarters.

From a balance sheet perspective, we ended first quarter with $186.7 million in cash and no outstanding debt.

So with this quarter's results and our updated full-year earnings guidance, we continue to track towards sustainable adjusted EBITDA profitability. We will continue to use cash for technology, content, and other infrastructure investments in support of program and corporate growth.

Given our current cash position, we continue to believe that we are fully funded to increase our expected program launch schedule from six programs in 2016 to nine in 2017 and 12 or more in 2018 while maintaining progress towards steady-state margins.

Now looking forward. We've provided guidance for the second quarter, and as our business continues to perform, are raising our guidance for full-year 2016. On the topline, we're now expecting revenue of between $48.2 million and $48.7 million for the second quarter, and the $199.7 million and $201.5 million for the full year. At their midpoints, these ranges imply year-over-year revenue growth of 37% for the second quarter and 34% for the full year. We continue to expect revenue to step up sequentially for the remainder of the year.

To help you with your quarterly models, we now believe that of the revenue we recognize in the second half of 2016, approximately 48% will be recognized in the third quarter. We now expect an adjusted EBITDA loss of between $3.3 million and $2.9 million for the second quarter. At the midpoint of the range, this would represent an approximately 21% improvement and an approximately 500 basis point margin improvement over the same quarter of the prior year.

As is typical, second quarter is expected to be our lowest earnings quarter as it has the highest amount of annual and periodic costs, including for graduations, on-campus, and other physical program activities.

We're very excited that our performance to date along with our view of the coming quarters has allowed us to accelerate our expectations for adjusted EBITDA profitability to 2016. Until recently, we believed that this would not occur until 2017. And being able to move our expectations forward is a meaningful indicator that we remain on the path to our adjusted EBITDA profitability goals.

For full-year 2016, we now expect adjusted EBITDA of between $0 and $1.5 million. At the midpoint of this range, guidance implies an almost 500 basis point margin improvement compared to 2015 results.

For those of you maintaining models, I want to remind you of something I said earlier. We have shifted certain implementation and marketing costs from the first quarter into the second half of the year. While the had the effect of increasing adjusted first-quarter EBITDA, and we increased our full-year expectations by even more when looking at the third and fourth quarter specifically, those costs will now offset some of the efficiency gains we might have otherwise expected to see.

And in the longer term, I want to reiterate that we do not expect to see adjusted EBITDA margins improve at the same rate post-breakeven as they did pre-breakeven. We have always said that once we reached adjusted EBITDA breakeven, we would begin accelerating our launch schedule. And we've already announced new program launch targets through 2018 [which] show exactly that.

While we still expect to move towards steady-state margins, the additional investments associated with having more programs in their early years of operation will lower the trajectory towards those targets. We expect the corresponding benefit will be an extended period of continued high growth. And as we've consistently said, we believe that balancing sustained growth with past or long-term profitability targets is a smart and prudent way to run this business.

But in such a great quarter with such great guidance, it would be a shame to end on a cautionary note. So while it's my job to caution you not to get ahead of us, it's also my great pleasure to remind you that the first quarter results were a terrific way to kick off what we expect to be another year of high-revenue growth and improving profitability measures. I'm personally thrilled at how far we've come since our public debut, and that we now have the annual adjusted EBITDA profitability milestone insight. What CFO wouldn't be proud?

With that, let me turn things back over to Chip for closing remarks.

Thanks, Cathy. I typically close with a story about impact. Outcomes drive our business, and we will never forget that. It's also important to note that impact can only come with sustainability. Ultimately, sustainability isn't optional. Ed tech hasn't had many big wins. It's tough to make businesses work in this space. Adoption cycles are long. Penetration is difficult. Institutional forces and inertia make business models really tough.

We started in 2008 with a dream of building a company that could make an impact, one that could change higher education, one that could end the segregation of the online student, one that can make them real and equal. 1,100 employees, almost 900 active faculty, and 14 universities have built a company that is making a difference and is now built to last.

So on a day of some management changes, let's not forget the past nor the promise of the future. This Company is changing higher education. It's the opportunity of a lifetime for me, and I don't take that lightly. I'm incredibly proud of what my team has accomplished despite the odds. We didn't let the skeptic win.

2U is poised for profitability and continued growth and ready to deliver on the promise of a future in which all universities need to make this transformation. No back row indeed.

And with that, I'm now open to receiving your questions.

(Operator instructions)

Michael Nemeroff, Credit Suisse.

Hi, guys. Thanks for taking my questions. Congratulations on a good quarter. And thanks, Chip, for explaining some of these departures. I was definitely getting a bunch of questions over the last couple of days on that.

Just a question on the enrollment trends and the marketing efficiency. I'm curious how you're seeing the 2016 cohort on the enrollment trends and marketing efficiency as it compares to the 2015 cohort which we know was a very strong cohort thus far?

Thanks, Michael. So we are definitely seeing real marketing efficiency. The one different between 2015 and 2016, if we talk about the 2015 cohort specifically, you do have some MPV programs that have scaled really nicely. So if you look at our last quarter, we did disclose that Syracuse MBA is already the sixth highest on annual enrollment.

2015 to 2016, the one big difference in the years -- as you know, we can't always control timing -- and the 2016 cohort itself is substantially more back half just based on when approvals came in, versus the 2015 cohort where they're sort of nicely spaced throughout the year. So it's really not a comparison we can make simply because of the timing. We had a good number of programs in 2015 that launched early in the year, and therefore, by the end of the year, scaled nicely.

Now, pretty excited to see things like Speech Pathology with NYU, a brand new vertical, start hot. We like that. That's a new vertical. And for me -- I know investors get excited about MPV, and they should -- but we love seeing new verticals launch because you can't have a second without a first. And ultimately, when a new vertical like speech that has really very little competition starts off strong, that's a really good indicator. So we like what we see.

That's helpful, Chip. Thanks. And then, Cathy, if I may, one for you. We're never satisfied as analysts. You've given us EBITDA profitability much sooner than expected. But how should we think about that profitability as we move forward? Are you planning on running the Company close to breakeven? Or should we think about big improvements in the margins, (inaudible) several hundred basis points per year going forward? Just give us a sense of how we should think about that margin going forward over the next, let's say, one to three years?

Sure. So we've talked -- what you've seen us do is to drive towards adjusted EBITDA breakeven at a pretty rapid pace. You've seen 600, 700, 800, 900 basis point improvements year over year. And we don't expect that coming out of adjusted EBITDA breakeven and headed towards steady-state margins.

However, we do expect to continue a trajectory towards steady-state margins, just at a lower rate. Our intention is not to run the Company at breakeven. It's to continue to drive towards steady-state margins, but at a lower trajectory that will allow us to increase the number of launches that we do every year so that we can maintain significantly higher growth rates than we would otherwise do if we move towards steady-state profitability at a faster rate.

Right, okay. Thank you.

Andre Benjamin, Goldman Sachs.

Thanks, and good evening. So our first question is, you have put this target of positive EBITDA in 2016 out. We [sit] at the end of the first quarter. We know it takes a while for new programs to come on board, so that's less likely in 2016 to be a surprise.

But what's the chance that something else could come up that you'd want to spend money on this year that makes sense for the long-term of the Company that would take you back down to negative EBITDA in 2016? Would you be more likely to defer that so you can make sure you hit the milestone? Or should we say you're just going to do whatever's right for the Company long term?

Well, I mean, I think I don't consider -- doing what's right for the Company is what we're doing here. And in doing that, we're going to hit that milestone. In other words, we do believe -- we wouldn't put this out there if we weren't extraordinarily confident we were going to hit it. I mean, that's the whole point.

We do believe long term it is super important for us to hit these milestones, not because you guys like it, but because we think it's important for us to control our own destiny and run this business the right way. So -- you look like you want to add here, Cathy.

I just want to add that, Andre, given the business model that we have and the long lead times that we have that it takes us to get programs in place and get to the point where we are marketing and running those and building content, at this point in the year -- well, I suppose there's always something that could come up. It is extremely unlikely, and we don't have anything on the horizon. It's just not the way our business model works.

Yes, I mean, we're actively planning 2017, 2018, and even a little bit of 2019. I mean, that's -- this is long-term business, so it's a long-term play. And we're not -- acquisitions, if that's what you're going for, is not -- that's not a core part of our growth strategy at all.

All right, that's fair. And then, well, I know you take great pride in the quality of innovation of your technology stack. Our discussion with some of your customers indicates that they view the quality of the services you provide from marketing to 24/7 customer support to placement services, those are some of the critical factors that really drive stickiness, which they don't think they'll be able to replace versus the technology.

So in light of that, are you looking to make any more significant investments in expanding your range of services that help drive stickiness? Or should we expect most of the investment to remain in technology?

Well, what's interesting is, fundamentally, the services are all so heavily tech-enabled that a tremendous amount of the tech stack, and therefore some of the genius of our CTO, James Kenigsberg, is to build high-quality services that allow great use of technology to drive them. So you can't make placements this quarter -- 28,589 placements without -- that's inception to date -- without great technology helping to power it.

So we continue to build this notion of the Platform with a capital P, this idea that it is a combination of tech and service that makes these schools great in the 21st century. It's not either or. We're actively rolling our right now a brand new online campus.

And at the same time, there's a tremendous amount of work going into -- and that's the online campus is the front end that the students see -- and then a tremendous amount of work is going into deploying everything from our MPV strategy to better retention techniques through data analysis to improved compliance, frankly. This is not a -- to make them great in this transition, it's kind of about building a bigger digital university.

So what you might have heard a little bit, Andre, is that clearly there are other pieces of technology universities can use. But when you start looking at the moat around the business, truly placement is really very difficult for a university that might have done placement at one hospital near their campus to do it literally all over the world.

Marketing -- another piece that the MPV strategy itself is becoming a reason that people actually sign up. We never expected that. That's an evolution in the business because, ultimately, the efficiency we can gain is substantially stronger than anything you could do as a single program, whether it was the university or us back when we were a single program.

And then, I also don't want to make light of the fabulous technology itself. There is quite a bit of proprietary tech that we continue to build and will continue to invest in. So it's a bit of -- it's that Platform with a capital P.

Thank you.

Corey Greendale, First Analysis.

Hey, good afternoon. First, I just want to hear publicly that no one on the call is in serious discussions about joining Gates or Lumina. (Laughter)

No. Let me make that clear: no one on the call is in serious discussions about doing anything but running this awesome Company.

Great. Excellent. So as long as we're talking about management, is Susan there?

I am here.

Hey, Susan. It was good to see you a couple weeks ago. Sorry we couldn't talk longer.

It was great to see you as well.

But just since you're the newest great addition there, I would just love to hear your perspective on the opportunity. What particularly attracted you to this opportunity? I'm sure there were a number of things you could have done. And just how the experience has been since you joined?

Sure, absolutely. It's been really great for me to see that the fantastic experience that I've had and that UNC has had as a partner to 2U for the last six years isn't limited to UNC. We have just a tremendous level of talent and passion across the Company that's really focused on supporting our university partners and supporting their students to change their lives and to change the way that higher education is delivered in this country and beyond.

So I'm really excited to be here. I feel like I've been kind of a second cousin twice removed of the family for a long time. And so to be part of sort of the immediate family is a lot of fun. I'm really excited about it. And thinking about the opportunity and thinking about the things that I'm focused on in my first month here and thinking forward for the next year and beyond, one of the things that I'm focused on relates back to what I said about the level of talent that we have.

We have been incredibly successful as a Company over the last eight years at attracting fantastic people to the Company to do what we do. And we've grown from a great idea to over 1,000 people delivering for our universities and delivering for their students. We're going to double that over the next three years and go from 1,000 to 2,000.

So as we do that, we have to really invest in making sure that our talent strategy is strong enough to support the success that I know we're going to have on the business strategy. Everywhere from recruitment to onboarding to developing our managers to thinking really methodically from a talent review standpoint about how we are thinking about how we are building the talent for those 2018 programs that we're already working towards.

The second big thing that I'm focused on that has been eyeopening coming over from the partner side in the last month is to get greater insight into just our tremendous strength on the way we're using data to drive our business and shape our business in some areas, and particularly in marketing.

Chip talked a lot about our MPV strategy and how -- and what we've built in terms of the competency on data analytics in areas of our business that has really completely reshaped the way we approach it and made us so valuable to our partners is a competency that I want to make sure that we're thinking aggressively about how do we apply to all areas of our business from thinking about the learning experience to thinking about how do we use data analytics to tie back into our talent strategy.

So I'm excited about that. I'm excited to think about how we're putting all that together. And it's definitely -- I'm a month in, and definitely drinking from a fire hose and loving it. So really looking forward to being here for a very long time.

Great. That's good to hear. Thank you for that. And then I just had a few quicker numbers questions. What is -- is the LTR to TCA still at [3.2]?

This quarter it's a [3.1]. So small, tiny fluctuations quarter to quarter. So it's -- sorry?

Seasonal.

Yes, seasonal.

Okay, that's fine. And then, I just want to be clear. Cathy, you're coming across loud and clear about don't expect the EBITDA margin to continue improving at the same rate. But it sounds like there are a couple of timing things going on with this spend. So I just want to be clear. Do you expect that EBITDA will be more positive in 2017 than it is in 2016?

Yes, we've said that we will continue, if you think sort of full year over full year, that we will continue to make progress in our margins, just not as high a rate. Law of large numbers being what it is, we want to move our revenue forward and we have the capacity to do so.

So it makes sense for us to continue to accelerate that sort of launch schedule. But we don't see that that will result in either managing at zero growth on earnings. There will be improvement in our profitability. And we will continue to march towards steady-state margins.

Okay. And then just one last one for Chip. Can you -- I know you don't like to get too much into individual programs. But since the Enterprise program did launch and it's your first one, can you just talk a little about how that's going relative to your expectations?

Yes, it's just so early. We just don't know enough to really comment about it. It's a perfectly appropriate question to ask because it is a slightly different version of what we do. And we told everybody that we wouldn't do more of them until we had a better read, and we've honored that. So every program that we've announced since we announced that program has been a full program. So TBD, Corey. And that's not code for we don't like what we see. It's literally just too early.

Okay. No, fair enough. Thank you.

Michael Tarkan, Compass Point.

Thanks for taking my questions. Just competitively, and I know I ask you this one a fair amount, but have you noticed any changes in the past few months in terms of new entrants into the space or faster growth from some of your existing players?

I mean, not really. It really is right now still the same players that we've talked about in the past. I think everyone's pretty aware of who those are. I won't go through them. But we haven't seen any substantial change.

Right now, we do believe we're in an excellent position and at the top of the space. There's no doubt for, if you're a great school in the world -- and I say that specifically, in the world -- and you're thinking about going online, I think you're thinking about us or doing it yourself. And we like that. We're not resting on our laurels. We're certainly not taking it for granted. We're going to keep making it better. But we do have a lead, and I don't intend to give it up.

Okay, thanks. And then one on the marketing side. So I know Google has recently made some changes to its search layout on desktop and mobile, so [another] paid ad on top and removing the ads on the right rail. Just wondering, I know get a fair amount of traffic from both paid and organic. Just wondering if you're seeing any impact from that change?

No, I would say we are constantly -- SEO and organic is a huge part of our business. And guys like [Colen Snay] constantly working on it behind the scenes, working for Harsha to drive extraordinarily high-quality results.

And the good news for 2U is, while clearly we have to constantly monitor it -- as a good example, Mobilegeddon we were nicely ahead of because of a pretty massive deployment of mobile across our business by Marcus Cohn and a bunch of smart people here. So effectively, we feel like the overall efficiency being generated by MPV dwarfs everything else.

Thanks.

Jeff Silber, BMO Capital.

Thanks so much. I'm going to continue on an earlier theme about analysts never being happy. As you continue the process towards maturity, so to speak, is there a timeframe when you think the Company will be free cash flow positive?

Yes. So when we were launching sort of in the five program a year kind of launch schedule, we had said that free cash flow generally would tag behind adjusted EBITDA breakeven by about a year. As we step up the number of programs that we're doing every year and new launches, that timeframe extends out. But it actually will depend on what the mix of new programs are, and what the timing of those launches are.

So while we now anticipate that the trail for cash flow breakeven is longer than a year, we're not yet ready to put a stake in the sand as to how much longer because we just don't have an idea in terms of what the future holds in terms of new launches.

Although, Jeff, I would say I'm actually happy that you're asking that question because that shows that we've evolved to a new state.

That's good to hear. So just continuing on this theme, just bringing it a little bit more into the present, I think at the beginning of the year, you had guided for $40 million to $45 million, including about $18 million to $20 million in content development. Is that something we should still be thinking on? And I know we're not talking about 2017, but from a framework perspective, how should we be thinking about those costs next year? Thanks.

So we have no change in our view from capital expenditures from what we talked about on our year-end call. We still think that that sort of mid 40s number is a good number with the high teens, $20 million or so being in the sort of tech and content side, and everything else being related to our facilities and the build-outs that we're doing.

I'll also remind you that of that build-out amount, somewhere in the neighborhood of $10 million of it will not be cash for us. That will be reimbursed to us by landlord TI. So just keep that little bit of a gap in mind.

As we roll into 2017, we would expect that, as is typical, the content and technology would step up a bit, given the fact that we'll be deploying even more programs. But the part related to facilities should drop off significantly. Won't drop off entirely, and particularly in the first portion of the year because we will probably still be in facilities construction in the first quarter of 2017. But on a full-year basis, we'd expect that portion of it to go down significantly.

All right. That's really helpful. Thank you so much.

Ben McFadden, Pacific Crest Securities.

Hey, everyone. Thanks for taking my questions. Chip, I wanted to start with a pipeline question here. Just on this JD opportunity with Syracuse University, it doesn't really seem like there's much in the way of competition in the JD space. So maybe you could kind of talk about the opportunity there and what gets you confident and excited that that vertical specifically can take off. And maybe as a side note to that, what have you learned from the Wash-U LLM that makes you think that you're ready for that vertical?

Thank you, Ben. So first I would say that legal education, there's no doubt in our mind from delivering an extraordinarily high-quality top 20 school with Wash-U, Wash University in St. Louis, for now, since 2013, that legal education can be delivered this way. The reality is, we're really starting to believe that no form of graduate education won't be delivered this way. Long term, we do thing there'll be an MD, no doubt.

But we have to prove quality. And in the case of the JD, we just have the be very careful that everybody understands there's a reason that there aren't a lot of these. And the fact that the Syracuse University school College of Law is willing to work with us on it is a great indication of what they think of quality not just in our previous legal programs, but equally important, in the programs we're delivering for them at their top communications school, Syracuse, and at their top business school, Whitman School of Management.

So as you probably understand, Ben, I can't get into the weeds on the JD specifically. It is a done deal with 2U, of course. That is a signed contract. And as we said, we felt like just sort of learning from some of the past, just putting it out there and understanding that every program we have is going to have to go through what is not our accreditation, literally every program. This goes on behind the scenes. It's not our process.

And we do have -- things happen that are positive all the time on that side. It's just that if I talk about them, I'm immediately losing. So the notion of (inaudible) giving Northwestern Counseling eight-year accreditation, which is the maximum they could give for that program. That happened. No one knew about it. You know what? That's fine because the reality, it's not my process.

So we have pretty high confidence in this opportunity. We wouldn't be doing it. We wouldn't be spending the time and the resources if we didn't think it was a big opportunity. And we also do think that's a particular discipline where not only can we drive high-quality instruction through things like our our BLT, bidirectional learning tool, but great live classes with high-quality faculty at a low class size where people probably have a significantly more intimate experience than they might have in a campus program.

And then go to a clinical -- in this case, not clinical -- a physical placement. Or go to campus and actually perform on-campus like they would in a traditional JD. But all of that has to come in due time, and we can't put the cart before the horse. So we are excited about it. But the reason that, in the short term, I'd like you to ignore it is we're not relying on that program to meet the overall commitments we've made to you of 6, 9, and 12-plus. So in our mind, it's done, and you're going to hear about, so we better tell you. But ultimately, we've got more opportunities going that get us to that long-term commitment, and we have high confidence in that.

Great. And then a question for Cathy. I just had a question around seasonality. I guess it's two questions. First is, how should we think about start dates of classes, how that might have affected the growth rate that you saw in full course equivalents in Q1?

And then as a follow-up to that, as we look at the Q3 guide for 48% of revenue, I think it was 46% of revenue in 2015, how much of that has to do with timing around when classes start, or potentially when you're launching these new programs?

Yes, so the biggest thing actually is that as our portfolio increases, it starts to wash out the variation. And this is what we're seeing. So as we get more and more programs, we're starting to see a smoother increase in revenue patterns, which has got the underlying factor of a smoother pattern in FCE increases.

There will certainly be periods in which you see larger step-ups. So January always has a very large number of classes starting. That sort of end of August, September, early October timeframe always has a very large number of classes starting. But that's getting to be pretty consistent from a portfolio standpoint.

If you'll remember two years ago, and everything prior to that for any periods that we reported, you remember that we used to see second-quarter revenue actually go down because in our early programs, there were a very small number of class days relatively speaking in the second quarter.

The fact that we're now getting to sort of a critical mass of programs is really washing all of that out. That said, there'll sort of be that early first quarter, early fall kind of concentration that's pretty consistent across our programs.

Great, thank you.

Jeff Meuler, Baird.

Yes, thank you. Can you comment on the new logo pipeline? And obviously you teased out with the emphasis on the specific in the world comment. But also a lot of your announcements recently have been follow-ons at existing partners. I don't know if that's just what we should think about as the evolution of the business that will continue to overweight existing programs or additional programs at existing partners? Or any comment just on the new logo pipeline broadly?

Sure. Thank you, Jeff. So number one, they're coming. We're not stopping new logo development. And we have a good number of them that we think are in really good shape that will fill out some of our schedule. At the same time, just remember the program selection algorithm is real. And when we do find a university that has the right combination of everything and is excited about working with us, that's a great opportunity.

So with the continued evolution of the business, you're correct. That is what it is. Back in the day at the IPO, when we were on the roadshow, we obviously heard a ton about customer concentration risk. We don't hear that as much these days, which is great. But let's keep in mind, last year Syracuse was something like 4% of revenue. So it was small, and we want it to be bigger. So it is a bit of a balance.

New logos are real. They're coming. We happen to be in a run here of really great stuff happening in the portfolio. And I understand as you guys have said, you always want more. No one's ever happy. I understand that's our life. But for a long time, people were wondering, would anybody ever renew these contracts? Well, yes. The answer to that was yes. People a long time were wondering, would anybody do more programs? And guess what? The answer to that's yes. So there's good stuff there.

And Jeff, just a final comment on the world, there's no doubt that we are -- as I've said for a long time, you will see us launch non-US grad before we launch US undergrad. And we're getting close.

Got it. And then just from a management perspective with the turnover that you've had and with the accelerated launches coming up over the next two years, who bears responsibility for the launch process? Does that fall under program management? Or is it a separate team?

So it's really under the pipeline development. We have a Head of Implementation named Nate Greeno who's done a great job there. And it is a bridge between operating the program and closing the program. And we've learned over the years -- we've actually gotten quite good at this -- that something -- we didn't even have that function for a long time.

And ultimately, that function helps us craft the right opportunity with the school. Because you have to remember, while these are partnerships, we're definitively the subservient partner. It's not our program. It's not our degree. It's not our product. It's not our decision. And how all of that rolls out is, often there's 100 people involved on their side. Which I don't want to terrify you; that's been our business from day one. But that is what our business is.

So having a group of people that are helping craft the opportunity. Many of our operating execs are involved at various stages. There's a moment where Harsha shows up to talk marketing. There's a moment where James shows up to talk technology, or one of their great team members. So it is a bit of a bridge.

That implementation strategy has actually pretty solid from the standpoint of, even down to the fact that we now have a grade for every program going in. We're being surgical and targeted on what we're going after. But it's got to work both ways. So it's got to fulfill both the mission and ultimately the business objective of that particular institution.

So today, that's not a major pain point. Obviously as we go from 6 to 9 to 12-plus, Susan will have a lot to say as to how exactly that builds and grows. I don't know if you'd like to comment on that at all. But I mean, that's pretty much the story. We feel -- right now pipeline, we're liking it. We like where we are.

I'm obviously heavily involved. That hasn't changed. It is nice, Jeff, to have me -- part of the reason we talked about that whole notion of unlocking the programs is just very simply that that was just -- I can't overstate, for me personally, how when I say a relief, it's great for the business, but it also has really freed me up to help with other activities that are critical to the business.

Got it. Thanks, Chip.

Brian Schwartz, Oppenheimer.

My question this afternoon, Chip, wanted to ask you a question here about your future technology roadmap. Kind of detour you a little bit away from the quarter here and the current trends. Because we're starting to see here in software step-up in M&A activity among private technology companies. We're starting to even see it among public SaaS companies. And it's something we haven't seen in the market for quite a long time.

Now, you guys have avoided M&A. But you also have a very strong balance sheet. So I was wondering whether you think adding a technology company is maybe a successful way for you guys to go in building out the platform capabilities or even entering adjacent markets? Thanks.

Thank you, Brian. So the adjacent market is the easy place to start. The answer to that is no. We're solidly focused on higher education, believe that it's critical to stay focused. And by the way, you're talking about -- I mean, it's such a massive market, and we're so early in our TAM that the 60 and 3 was a step up from 30 and 2. For those that don't know that, the 60 verticals and three programs per vertical. We're probably being conservative in that three programs per vertical. It's just a really big opportunity.

So we're not going to steer away from higher ed anytime soon. We're really good at it. We understand the importance of these sensitive relationships and being a brand steward. And I think a lot of things when I talk about investors tend to drone out, but it's really true. So that's easy.

I'm clearly not going to rule out that we wouldn't go out and acquire an external technology. But right now, it is all about the student experience, the faculty experience, and the university experience. And you know what? We will buy if we need to. We will license if we need to. We will build if we need to. It's all about creating a great digital version of that university.

So I do think that there will come a time where there is something that we see, whether it's because -- venture capital, obviously a lot of money's gone into ed tech, and there might be opportunities for something for us that we could bring in. But it'll all be based on what we really think it does for either our product, our business, or our funnel.

Thank you.

Kerry Rice, Needham.

Hey, thanks for squeezing me in. And apologize (multiple speakers). Thanks, Chip. You may have talked about this -- I've been juggling earnings calls tonight -- but your renewal with USC, excluding the inclusion of the School Counseling program, do you get any ability to increase contribution margin from a renewal like this and leverage tech even more broadly as you kind of fan out to the other programs within USC? Or does the curriculum change enough to where you have to continue to invest and contribution either stays the same or maybe dips again as you renew and then builds back up? Thanks.

No, I mean, I think it's more philosophical than that. We are built -- as I say, it's a partnership. The fact that Karen was willing to commit to us again for 12 more years is pretty amazing. I mean, I don't want to sit here and toot our horn, but this is certainly something that consumed our public life in 2014. I mean, this is all we heard was about the long term and the fact that when these deals were coming close to an end that there would be some crisis. And the fact that we're getting these kind of commitments, I think, does say a lot about quality.

And I guess what I would say is, in terms of the long-term perspective we take on this -- my people here are going to laugh because when we're on the road, when I do tell this, I screw up the analogy of whether it's pigs or hogs.

Pigs get fed.

Pigs get fed. Pigs get fed and hogs get slaughtered. And the notion of making sure that we are really happy with what we can generate financially from these programs, and we also want our partners to be equally happy. We want them to have a really positive financial experience, not just an outcome for their students.

And so we're not spending a tremendous amount of time trying to optimize contracts as they come up for renewal. We have good deals. We're very happy with them. And our partners are obviously reciprocating because we're getting these long extensions. And I think that that is a truly more elegant way to think about this business really long term. Like, you got to deliver for these people. they're putting their careers, their schools on the line. And the fact is, I've been around since 2008. Chapel Hill and Georgetown have been around since 1789. They win.

I appreciate the insight there. Thank you.

There are no further questions at this time. I'll turn the call back over to Chip Paucek, CEO.

Well, thank you for joining us on this call. Just one call out to all of you at one of the firms is that we found that there's been a real interest from your employee base in our quality degree programs. So if you have an associate there or an analyst that's looking for a Master of Data Science or a Master in Business from a great school like Berkeley or Chapel Hill of Syracuse, please send them our way. You know how to reach us.

With that, we'll talk to you out on the road. Take care, everybody.

This concludes today's conference call. You may now disconnect.