2U Inc (TWOU) 2017 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the 2U, Inc. 2017 Third Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this call may be recorded.

I would now like to introduce your host for today's conference, Mr. Ed Goodwin, Vice President of Investor Relations. Sir, your line is open.

Thank you, operator. Good afternoon, everyone, and welcome to 2U Third Quarter 2017 Earnings Conference Call. By now, you should have received a copy of the earnings release for the company's third quarter 2017 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 Christopher "Chip" Paucek, CEO and Co-Founder; and Cathy Graham, CFO.

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 Risk Factors section of the company's annual report on Form 10-K for the year ended December 31, 2016, 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. Also, it is 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 tables attached to our press release.

I would now like to turn the call over to Chip.

Thanks, Eddie. We've now delivered our 15th quarter of excellent financial results as a public company. In the third quarter, we again performed well against all of our expectations. We are at or above the high end of our guidance ranges for revenue and each of our earnings measures. Revenue was $70.3 million, a 35% improvement year-over-year, with 27% of this increase coming from our graduate program segment. Adjusted EBITDA loss was $3.7 million, and while this was a greater loss year-over-year, it was at the top end of our guidance and primarily related to the GetSmarter acquisition. More importantly, we successfully closed our acquisition of GetSmarter on July 1, and both teams have hit the ground running.

Strategically, we are a stronger, more complete company. Our 2 product lines, Graduate Programs and Short Courses, each have attributes you find in the world's best digital education, extremely high retention, people-mediated technology platforms and even in-person experiences. Both products offer the type of overall value you'd see in high-quality campus programs. And as we've said in the past, this is a story of and, rather than or. Newer credentials are clearly part of the present and future but the power of the degree continues to be strong and in high demand.

We love the strategic rationale but the power is are already showing up in our guidance. Our expectations in our core business have not changed, with the DGP business showing revenue growth at or slightly above 30% for 2018 and accelerating into 2019. But GetSmarter adds an enviable new growth engine to this strong base. Our preliminary 2018 consolidated view is 38% to 39% revenue growth over 2017.

We believe our financial success is driven by a very simple formula. When students win, universities win. And when universities win, 2U wins. We're winning because we're executing for our clients and it makes me incredibly proud to hear them saying it. Take this headline from a November 1 article in the Vanderbilt News quote "Success of Peabody programs inspires exploration of future online opportunities". The Vanderbilt DGP just started classes with an initial cohort of 43 students, and the school said it expects enrollment to grow significantly next year.

Dean Camilla Benbow commented "Peabody has rolled out its online programs rapidly since they were announced, and we've been very pleased by the number, quality and diversity of the students who applied and enrolled". Now Vanderbilt is already discussing expanding its online offerings. In the article, Associate Provost for Digital Learning John Sloop says "We've truly just begun to scratch the surface of the opportunities that lie within the online classroom. The success of the 2 degree programs at Peabody represents a strong return on Vanderbilt's practice of exploratory investigation of educational technology". So Vanderbilt students are winning, Vanderbilt's winning and that's how 2U wins. While the formula is simple, it's not at all easy or easy to replicate. It takes a deep investment and a commitment to quality across the end-to-end product and the many parts of 2U. But together the end-to-end model offers a strength of outcomes and financial strength that the simple fee-for-service models or low-cost models can't deliver. Whether it be in person experiences, clinical placements at scale, accessibility for those in need, data-driven marketing scale or even machine learning deployed throughout the business, our competitors simply can't compete.

Over the years, we've gotten plenty of questions about what the 2U end-to-end model means financially to our universities. So at our Investor Day on October 5, we took the time to show you a model of what we believe the financial impact of partnering with 2U should have on the university side. For an average 2U program, at steady state the surplus delivered to the university should be larger on a dollar-for-dollar basis than the adjusted EBITDA generated by 2U. After we shared that model, Kent Syverud, the 13th Chancellor of Syracuse University joined me on stage for a fireside chat. I'm so thankful Kent took the time to fly down from Syracuse to join us at our Investor Day. During our fireside, Kent not only concurred with the model we presented, but said that the overall value to the university is actually much greater than the university surplus. Now as reminder, Syracuse has 6 2U powered DGPs.

So let me quote Kent for a second "I know you're interested in the financials and I thought this was actually a pretty transparent presentation you just saw about the financials. It's accurate in terms of Syracuse's experience. We get not just the 40% in revenue, we get the investment of a large fraction of the 60% in the things we can't, and probably shouldn't be doing, because it's not our area of special expertise. So we get the marketing, the IT support, the sophisticated curriculum development, the working with our faculty that we get through this plan." So yes, we are delivering real financial impact for our partners, but why does this matter? Well, Kent addressed that also. He finished the fireside chat with an emotional story from his childhood that truly hit home to everyone in the room. He grew up in Rochester, New York, which was home of the Eastman Kodak company. Now let me quote Kent again here. "So when I look at the hundreds of beautiful college campuses around this country and the world, I see some Kodak parks. Kodak Park today, by the way, is a field of ruble. If you haven't been to my hometown, you should go visit it. So as a steward of what is a great University, when I look out over what looks like Kodak Park, I have to ask myself, are we so invested in chemistry that we're going to ignore where education is going or could go and be disrupted? Without Syracuse University, there isn't much left in Syracuse so I feel this obligation to have an entity that changes enough to scale up and be bigger in the impact. And so far, 2U has really been helping us do that. We're approaching 2,000 full-time students through 2U related programs, which is a very significant part of our enrollment."

The 2U end-to-end model is driving real value for our partners. This is why new universities choose to partner with us. This is why existing partners continue to add new programs. This is why we're taking over programs that were previously do-it-yourself or even some that were powered by competitors. This is why we continue to step up our launch targets.

2U is no longer a missionary sale. Pipeline has simply never looked this good. Let's look at where we stand for the next 2 years. We originally targeted launching 12 new programs in 2018. Last year we raised that target to 13 programs. At Investor Day, we announced that all 13 slots had been filled. We discussed 12 of the 13 on our last call. At an Investor Day, we announced that the Yale PA Program has been approved by its accrediting body and will be the 13th DGP, with classes beginning quite quickly, January 2018.

So just give me a moment to talk about Yale. I think most of you thought this would never happen. It has been a heck of a journey, but we believed in the importance of the discipline. Physician assistant jobs are projected to grow from 37 -- 37.4% from 2016 to 2026 according to the U.S. Bureau of Labor Statistics. And we believe that Yale was the partner to show the accrediting body that it's possible to deliver a high-quality program that blends the physical and the digital. So we invested heavily upfront to show the quality of the program that didn't exist yet. We built courses. I've even seen the cadaver photo shoots to prove it. GoPros on the cadaver and the person dissecting the cadaver, you can ask me about that later. We had to prove upfront that we could deliver clinical placements. We were asked to deliver 480, we delivered 2,276. All at the risk, all without a guarantee. Now I want to give a quick shout-out to our placement specialist, Allie, who led this effort, and by the way, she just got married. Congrats, Allie. But I believe this will have a profound impact on medical education and I give credit to Yale's leadership for persevering. Jim Van Rhee, Richard Belitsky, Lucas Swineford, Linda Lorimer, Dean Bob Alpern. Those are the names of some of the folks that resisted the temptation to give up, and instead, did the hard work of leading change. They even had the confidence to add time to the contract, giving the upfront investment required. We have 13 years from program launch in January.

So Yale took us up to 13 DGPs for 2018, but due to university demand, we've now increased the 2018 launch cohort to 14 programs. We expect to announce the final program before the end of the year. Now think about that timing folks, we're well ahead. And we're not stopping there. We're now actively filling the 2019 cohort, which has targeted 16 programs. I'm very happy to tell you that we think we can name them all today and they're all being fully negotiated as we speak. We've already announced the first program for this cohort, slotted for January of 2019. We will partner with our fifth school at USC, the Sol Price School of Public Policy for our record seventh DGP with USC, a suite of degrees in the public administration vertical. The 2 degrees in this DGP are a Master of Urban Planning and a Master of Public Policy. So 2019 is going really well, expect to hear announcements soon.

Between now and the end of 2017, we expect to announce some new DGPs and some new short course partners. It's all coming faster than in the past and we're ready for it. From 16 programs in 2019, we then step up to at least 19 programs in 2020. Let me put this ramp into perspective.

At the end of 2016, we have launched a total of 24 DGPs. By the end of 2020, we're targeting to more than triple that number. We believe that this step up in our annual program launch targets will help deliver 30-plus% revenue growth in the core business for the foreseeable future. As Cathy discussed at Investor Day, we believe that revenue growth will stay at, or just slightly above 30% in 2018 due to the back-end nature of the recent cohort launches, coupled with inherent early program scaling dynamics. But once we get through 2018, we expect that the program launch increases and a shift in mix to MPV programs will lead to an acceleration of DGP revenue growth in 2019 and then an additional acceleration in 2020. The domestic graduate opportunity is huge, but it's a big world out there. We're the leader in digital education and we have no intention of giving that up. As we discussed extensively at Investor Day, we think the growth opportunity in the short course market is significant. GetSmarter gives to 2U an additional growth engine with a faster flywheel. GetSmarter's growth formula is straightforward: continue to add global legends, add current 2U partners and expand the course portfolio at existing partners. Now Cathy will discuss our financial results in more detail, give guidance for Q4 and full year 2017 and give a detailed preliminary look into 2018, which by the way, you're going to like. She's dressed in purple, her favorite color, and ready to go.

Take it away, Ms. Graham.

Thank you, Chip. Once again, 2U delivered against its financial expectations for the third quarter, reporting revenue that came in strongly ahead of guidance. At $70.3 million, third quarter revenue exceeded the comparable 2016 period by 35%. In our graduate programs business, revenue grew 27% year-over-year, with the remainder of the quarter's revenue growth coming from the addition of short course revenue from our newly acquired subsidiary, GetSmarter.

With respect to the short course revenue, I want to remind you of two things we told you on our last call. First, we expected short course revenue in the third quarter to be relatively low, about half of our expectation for fourth quarter short course revenue. This is because a significantly majority of the expected second half short course revenue is related to new courses being launched in the late third and fourth quarters.

And second, a portion of GetSmarter's deferred revenue balance at June 30 was eliminated in purchase accounting and was not run through the P&L. As a standalone company, GetSmarter would have recognized approximately $700,000 of additional revenue in the third quarter. Please keep these points in mind when thinking about the size or the short course business and the trajectory of that revenue moving into 2018.

In our graduate program business, revenue growth continued to be driven primarily by an increase in full course equivalents. For the third quarter, we had over 24,000 graduate program FCEs at an average revenue per FCE of $2,740. Compared to the prior year period, third quarter FCEs for this business line increased by 26%, while average revenue per FCE increased by 1%.

We've also provided FCEs and average revenue per FCE for our new short course business. For the third quarter, we had almost 4,100 short course FCEs at an average revenue per FCE of $1,232. Third quarter course offerings were largely with South African universities, which carry a lower per course price than those from the U.S. and U.K. universities. You should expect to see average revenue per short course FCE increase in the fourth quarter, as higher priced U.S. and U.K. university courses start launching.

Note that for the third quarter, we calculated average revenue per FCE for the short course business as though the approximately $700,000 in revenue eliminated in purchase accounting had been recognized. We believe that this provides a truer picture of the volume-price relationship for this business segment as well as providing the proper basis for comparison and trend analysis moving forward.

Before we move to our loss results for the quarter, I want to remind you that we've added a new cost line in our P&L called curriculum and teaching. This line captures short course costs that arise from differences between our graduate program and Short Course business models.

In our short course business, students enroll with and pay tuition directly to us and we recognize the full amount of tuition as revenue. We then pay the university clients their share upon course completion, and that expense is reflected in curriculum and teaching. Additionally, we compensate the university approved course tutors who interact directly with students during these short courses. These costs are also reflected in the curriculum and teaching cost category.

At $3.7 million, $7.4 million and $14.7 million, respectively, third quarter adjusted EBITDA loss, adjusted net loss and net loss, all came in at or above the high end of our guidance ranges, but all expanded year-over-year. Adjusted EBITDA loss expanded by $3.5 million compared to the same quarter of 2016, due to the inclusion of our new short course business.

The low third quarter short course revenue we described above, combined with a ramp-up of marketing and other operating costs to support upcoming course launches, drove the quarter's adjusted EBITDA loss expansion.

Adjusted net loss expanded by $4.7 million year-over-year. In addition to the short course operating factors that drove adjusted EBITDA loss expansion, third quarter adjusted net loss also expanded because of expected and previously discussed additional depreciation expense related to the buildout of both our headquarters facility in Maryland and additional floors in our Denver office.

These expenses were offset somewhat by operating-related tax benefits generated in our Short Course business.

At $14.7 million, third quarter net loss expanded by $7.9 million over the prior year period. In addition to the factors that drove adjusted net loss expansion, third quarter net loss also expanded because of expected and previously discussed increase in stock compensation expense related to our growth and where we are in our vesting schedule. Additional stock compensation related to grants we made to GetSmarter management in conjunction with the acquisition and the amortization of acquired intangible assets resulting from the acquisition. These expenses were offset somewhat by operating-related tax benefits generated in our Short Course business and acquisition-related tax benefits generating as a result of our acquisition of GetSmarter.

From a balance sheet perspective, we ended the third quarter with $202.4 million in cash. This balance reflects third quarter activity, including both the use of $97.1 million in cash for the purchase of GetSmarter, and the addition of $189.9 million in gross proceeds from the sale of common stock in our September follow-on offering.

Our quarter-end balance sheet also reflects $42.3 million in receivables balances. This is driven by our graduate programs business, which, as you'll recall, all would have a high receivable balance at third quarter and because of the timing of fall academic term starts.

Other notable changes to our balance sheet in the third quarter include the addition of goodwill and the net deferred tax liability, all related to purchase accounting for the GetSmarter acquisition. I'll further remind you that the $3.5 million in deferred government grant obligations represent the state and county incentives we received earlier this year in conjunction with occupying our new headquarters building. These obligations, along with any accrued interest on them will be forgiven if we hit certain job growth targets over multiple years and otherwise, comply with the terms of the respective agreements.

Now looking forward, we've provided guidance for the fourth quarter and increased guidance for full year 2017. We now expect revenue to be between $84.6 million and $85.6 million for the fourth quarter and are increasing our full year guidance to between $284.7 million and $285.7 million. At their midpoint, these ranges represent year-over-year revenue growth of 48% for the quarter and 39% for the year. Looking at earnings measures for the fourth quarter, we expect net income or loss of between a net loss of $600,000 and net income of $100,000. At the midpoint of this range, as a percentage of the midpoint of our revenue guidance, it implies margin improvement of 4 percentage points over the fourth quarter of 2016.

We're also expecting fourth quarter positive adjusted net income of between $7.3 million and $8 million. At the midpoint of this range as a percentage of the midpoint of our revenue guidance, it implies margin improvement of 5 percentage points compared to the same quarter of 2016.

Adjusted EBITDA for the fourth quarter is now expected to be positive at between $11.8 million and $12.5 million. At the midpoint of this and our first quarter revenue ranges, this implies a 14% adjusted EBITDA margin, 6 percentage points better than our margin in the same quarter of last year.

With respect to our fourth quarter earnings measures, let me remind you that in both our graduate program and Short Course businesses, we reduce our marketing activities during the year-end holiday period, so fourth quarter margins typically increase. Fourth quarter margins should not be viewed as a run rate going into the early quarters of 2018.

With respect to our overall fourth quarter expectations, you'll note that we're holding guidance in line with what was implied during our last call. Remember that in the second half of the year, we typically have significant revenue visibility into the graduate program segment, which makes up the majority of our business. Given this, we would not expect significant changes to guidance going into the fourth quarter.

Further, we already know that we have about $250,000 in unanticipated revenue downside in graduate programs during the fourth quarter from a higher level of deferrals and leave of absences by students who were impacted by Hurricanes Harvey and Irma. This largely offsets any revenue upside we might otherwise have anticipated.

Looking at full year earnings measures. We now expect net loss and adjusted net loss in the ranges of $30.6 million to $29.9 million and $4.9 million to $4.2 million, respectively. Taking the midpoints of these ranges as a percentage of the midpoint of our 2017 revenue guidance, it implies a 1 percentage point decline in net loss margin and a 1 percentage point improvement in adjusted net loss margin over full year 2016. We're now expecting a positive adjusted EBITDA of between $10.5 million and $11.2 million for the full year, which as the midpoint of this and our full year revenue range, implies a 4% adjusted EBITDA margin. This represents a 2 percentage point improvement over the adjusted EBITDA margin for 2016.

Now as we approach the end of the year, and though we have not completed our budget cycle, we'd like to give you a first look at our expectations for 2018. Before we talk specifics, I'd like to remind you of a couple of directional statements we've already made.

First, we've told you that in 2018, year-over-year revenue growth for our graduate program segment should be at, or just slightly above 30% before accelerating in 2019. This implies that revenue growth above this 30% or so marked for 2018 is the result of the addition of short course revenue. And second, we told you to expect that 2018 adjusted EBITDA margins in our graduate programs business will remain relatively flat to 2017's margin for that segment.

For full year 2018, we're currently expecting revenue growth of between 38% and 39% over full year 2017. We expect that a greater-than-typical percentage of this revenue will be recognized in the second half of the year because of both the ramp-up of 2018 graduate programs that launch early in the year and the addition of short course revenue that we expect to accelerate later in the year. The back-end weighting of short course revenue is largely driven by 2 factors: first, agreements with several university clients require that their short courses launched in late 2017, undergo a standard review procedure process after the first presentation. This delays additional presentations of these courses until late first or second quarter 2018.

And second, there are quite a few additional new course launches anticipated during 2018, but given scheduling and lead times, a number of them are targeted for midyear or beyond. We're now expecting that for full year 2018, we will generate a net loss margin of between 11.6% and 11% and adjusted net loss margin of between 1.9% and 1.4%, and a positive adjusted EBITDA margin of between 3.8% and 4.3%. Note that in the second quarter, we typically incur a disproportionate amount of annual costs that reduce our earnings measures related to meetings, trainings, graduations and other periodic events in our graduate program business. Conversely, we typically reduce our marketing costs during the year-end holiday period in both our business lines, which increases earnings measures in the fourth quarter.

However, because of the investments we're making in both launching and scaling graduate programs earlier in the year, and because we anticipate launching a meaningful number of new short courses in the mid- to late year, we're anticipating significant differences in our margins between the first and second halves of 2018. Given that our margin patterns are expected to vary significantly from prior years, we have given you a fair amount of detail about how we expect our loss and earnings measures to be distributed across the year. I encourage you to read this section of our earnings release carefully in order to understand how we believe 2018 will unfold. And finally, as a last word on our forward-looking expectations, I want to remind you that we're in the early stages of integrating the GetSmarter acquisition and scaling what is still a relatively early stage short course business.

For the remainder of 2017 and for 2018, our short course financial results will remain highly sensitive to the performance of new courses in their first or second presentations. By definition, early presentations of new courses have the least certainty around student enrollment, and therefore, revenue and margins. Please give us some time to see how these early course presentations will perform and don't immediately assume that revenue and margin results will come in at the top end of their ranges.

But despite that cautionary note, we remain very excited about both our graduate program and Short Course businesses. The synergies we now see, both in cross-selling opportunities and potential operating efficiencies, reinforce our belief that the GetSmarter acquisition can create real value for the combined company. We look forward to having you on this journey with us as we finish out this year and move through 2018. Chip?

Thanks, Cathy. I'd like to close this call discussing my recent trip to Cape Town. Last week, I visited GetSmarter with a few of the 2U functional heads to work on the integration efforts we discussed with you at Investor Day. The trip went extremely well and I came away even more confident in our joint success. But more important than the integration meetings was the time I spent with the over 300 incredible people at GetSmarter. During my time with the team, one of the GetSmarter values was on full display. Play to win. My belief is we acquired a company that's transformative to the higher education space. GetSmarter is indeed playing to win on a global basis. Congrats to Sam, Rob, [Dyesco] and the over 300 incredible South Africans in Cape Town changing the face of higher education. There's a South African term called "gees". It means bringing the good spirit, good vibes and the energy. I love this integration and the opportunity it presents. By the way, that's spelled G-E-E-S for the transcript. Play to win indeed.

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

(Operator Instructions) And our first question comes from Michael Nemeroff with Crédit Suisse.

Just curious, how much of the increase in the guidance in 2018 is actually coming from GetSmarter? Is it all GetSmarter, that increase? And then also related to GetSmarter. Last quarter, you weren't 100% confident in guiding on the sustainability of that revenue and the contributions. Can you give us an update 3 months later about how you feel guiding to it now? And then one on the full-time course equivalent metric. Looks like we're seeing a little bit of a decel there. Can you tell us why we shouldn't be concerned about that longer term?

So first, I would say given that we've spent a fair amount of time talking about our DGP business being at or above 30 -- at or right above 30 for 2018, it's reasonable to presume that the increase comes from GetSmarter. We feel very confident in their growth trajectory. We do think that we were already a very good growth story, and it is clear that GetSmarter really does substantially increase the TAM of the company and the sort of growth opportunity worldwide. And I think that's represented in the 38% to 39% revenue guide for next year, so we're pretty psyched about that. In terms of the other attributes of GetSmarter, I just want to remind everybody, it's still very early. We're in heavy integration and we're not at a point yet where we're -- where we can talk about sort of unit economics or the long-term margin profile. What I will tell you is we do believe that there's real margin in that business and we really like what we think that means for us long term, as the companies come together and we do start to get more of the benefit from things like a very large shared marketing funnel. Just one example of something that we think could be pretty profound to the margin impact long term. And then I'll pass it over to Cathy for the FCE question.

Yes. So on FCEs, when we talk about the fact that FCEs in the graduate program business are -- or that revenue growth in the graduate program business is going to be at or just slightly above 30%, and we've told you that, that sort of will ramp up further in the back of the year. Almost by definition, some quarters are going to have to be lower and some quarters will have to be higher. And that, frankly, is a pattern that we've seen related to revenue over the past couple of years as well. So we don't have any concerns around that. It is -- there's timing of FCEs versus revenue growth, and we're confident that those 2 will track, if you look at it over the period of a number of quarters.

And our next question comes from the line of Brian Schwartz with Oppenheimer.

Chip, I wanted to ask you a question just about kind of the future of the investment strategy, really the enablement of combining the short course -- the value proposition of the short courses with the DGP offerings. And I'm just wondering if that has even started today in your conversations with your pipeline and the future opportunities. Or if you could maybe bring us up to speed on maybe the duration, or how long you think the enablement will take to combine the sales motions, where 2U as a business will be able to go in and really offer these 2 value propositions that we think are unique in the market today.

So I'd say, Brian, is that one of the things I'm most pleased about, not surprised by, but pleased by is how well the teams are working together. So there are definitely similar cultures, even though we're sort of an ocean away -- not sort of, we're an ocean away from each other. They're a long way from us. But the teams are working really well together and one of the places where that's now evident is on the pipeline. It is very clear that the pipeline will go both directions, without a doubt. I mean that's very obvious at this point. We feel that the 2U clients will have some announcement soon about 2U clients taking up short courses and vice versa. So I would argue that we -- it's early days. But there's no question that when we talk about being a more comprehensive solution for our clients, having a stronger product assortment where why would somebody go to somebody else if we've got both degrees in short courses. We really didn't have an answer for the short course piece, so we think that's very real. And at this point, now our marketing teams are working very closely. So you might have seen at Investor Day, the somewhat love fest between Harsha and Ryan, the 2 various -- the 2 CMOs between the 2 companies. We feel very strongly that that's like real, that's showing up now in how we're actually -- like what we're actually executing on a daily basis that investors wouldn't be able to see. So -- and then I would just close by -- it's exciting for me to see GetSmarter increase our guidance for next year and show that kind of 39% revenue growth guide, that's great, but this is really a story for the future. We didn't do this to make you guys happy. We did it because it's all about 2U being the world's leader in digital education. And ultimately, that's what this is about that. So we are a more complete company that serves students and universities better, whether it be long-term degree attainment with something like the LPA or it be as short course in Fintech. They're both pretty important.

Chip, that's a great lead into my second and final question. I just wanted to ask you again, here about the future and about the business. So you've got a unique business here in terms of the predictability that -- you've got very high revenue predictability here for the next couple of years. And where you have set the guidance, you have the business accelerate in the top line next year, whether that's with the GetSmarter. But if we think about the year after in '19, there's good odds that the business is going to continue to reaccelerate. So the question I wanted to ask you about that is I'm a software analyst and a technology analyst, and usually when we see businesses accelerating in a category, we want them to increase the investment profile to really capitalize on what's happening in the business. So can you talk about how you think about that and think about the investment profile and the opportunity? And just imagine accelerating growth while also showing improving profitability. Thanks Chip.

I love the use of the presumptive close there. So I would say that you are correct that we have continued to accelerate the business. We've done it because of demand and because we're having a huge impact on many people's lives. What we're looking for is institutional will from these global legends meeting the market opportunity, where there's a great program that has the potential to be transformative online and to build a great business for both sides of the equation, which is one of the reasons why we were pretty happy about the Investor Day section on the university side as something that, certainly, we've about from the bears. And we just hadn't ever really explained it fully, and that's why we did it in this call. So is it possible that we see additional acceleration long term? Sure, it is, but we're just not willing to do that yet. I think 2U has built a business that has good bones. And one of the reasons it has good bones is we don't sort of -- we try to make sure that we're doing the right thing along the way, which includes investment. So as an example, when we told you all at Investor Day that margins were not going to continue to expand year-on-year, the reason for that is that we had to continue to invest in whether it be our academic product, which is -- when we say academic product, you can think about it with a capital p. It's not just a tech. It's a really broad assortment of both technology and services we provide to our clients, or things like our team. So whether it be the addition of Rani Hammond, our Chief People Officer, or David Sutphen our Chief Communications Officer. Like all of these additional pieces continue to add bandwidth, and that won't stop. We have to continue to do that as we scale. So for now, we're very comfortable with where we are, which is 14 programs for 2018 and 16 for 2019. If you look at the transcript, I did say "at least", so that's maybe a little bit of a hint.

And our next question comes from the line of Jeff Meuler with Baird.

So you give us most of the pieces, but not all to get pretty good estimates for the short course quarterly revenue and it looks to imply some pretty big numbers in the back half. I guess the question is any callouts in terms of seasonality to be considering or anything anomalous implied for the second half? Because the way I'm hearing you describe it, it sounds like the anomaly is more in the first half and those big back-half quarterly numbers are more true run rate type numbers.

What I would say, Jeff, is like the number -- just think about -- like look at University Cape Town, now that we understand this business more fully. Out of the 70-plus courses that GetSmarter runs today, 50 are with UCT. So you're talking about the one school that they've had a really long history with and there's a lot of courses. So there is a very large number of courses that are possible. Like within the world of possible, if you look at our program selection algorithm, from our data science team, that's really important in selecting programs. The same thing applies to courses, there's a large number of courses that we could run over time, and when you run them, #1, you have to get them up and running, which means Amy Johnson and the team at GetSmarter that builds the courses have to do them. People actually have to do stuff. It's not just me waving a magic wand and saying, "Hey we're going to have a bunch of courses." People have to build them, and that takes if you do it right. So they have to build them over time, and then as they build them, once they run them for the first time, they have to pause and review them to make sure that everything is going really well, because the secret of both GetSmarter and 2U is really, really high course completion, or in our case, degree completion. So that's only going to get there if they have quality. So ultimately, I think it's really important that you remember that they're just in a very early sort of stage of their life cycle. And now I will tell you that year-on-year, from Q1 to Q1, it's still pretty impressive. It's just that they're scaling, so it's just going to take time for it to show up in the numbers. And if you want to add anything...

Yes. Let me just add a few things, which is I think that, while I wouldn't use the word seasonality, because I think it is too early to kind of attribute a seasonal pattern to the GetSmarter and short course revenue, I think you're correct in saying that as you move towards the back half of the year, they start to pick up a more normalized rhythm and we hope that, that then will, as we keep going forward, we'll move into -- we'll sort of even further refine itself. We know we gave a lot of detail around the 2018 numbers but we -- when we looked at this, what we said was the patterns that we are going to see here next year that we expect are really so different from what we've showed you in the past, and they're different between the first half and the second half, and even in some cases, between the quarters in the first half and the second half, that we wanted to give you more directionality to try and help you get those things right. And we'll be able to refine them as we go on. But our hope is as we get back towards the end of the year, that we're getting the company into a bit more of a rhythm.

And then just I guess, given the continued expansion of the USC partnership throughout the data point about the breath of Qs on the calls, the commodore's looking at expanding, there's lots of other examples, are you thinking any differently about -- as you look to sign a new partner program, just how important is the breadth of the opportunity at the university when you're signing one particular -- your program as you think about the program selection algorithm and what program at what university you want to target?

So there's no uniformity of opinion at all of these schools. They're all very complex organizations. I thought Kent -- another thing Kent said is being the Chancellor of Syracuse was sort of like being the President of the European Union. It's a very complicated environment. I do think the notion of one sort of offering of any kind across the entire university is tricky. With that said, when we are identifying programs, without question, we're looking at great brands that have great leaders that are willing to do the hard work that will be required to sort of lean in and do this the hard way, which is really what working with 2U is. It's not easy to lead change this way. Well, we also think there's a big market opportunity. So as you know, Jeff, the regional bias is real, and without question finding great schools like a sort of Denver or a Vanderbilt, or all of these different universities that you've now seen us launch, the geography is also part of the story.

And our next question comes from the line of Corey Greendale with First Analysis.

So I appreciate all the detail on the longer term. I just want to go back to the question about the short course programs. I have a shorter-term question about those. In Q3, in the quarter you just reported, did the DGP and short course segments both perform as expected within the broader results?

Did the DGP -- say that again for me, Corey?

So I know the -- it was a good quarter overall, I'm just wondering if you look at each segment, if each segment performed according to your expectations?

So Corey, in the third quarter, yes, they largely performed relative to what we expected. We are, if you look at the second half overall, we are still in the process of making some resource allocation decisions around where we put some money in the fourth quarter. But you'll note that for the fourth quarter -- for the second half of the year and our full year expectations overall, we have kept them largely where we anticipated that they would be, and expect that they'll be there, regardless of some of these resource allocations things that we may switch around.

And in Q4, we should still expect the revenue per FCE in the short course business to increase as you get more U.S. or non-South Africa exposure?

You should. The fourth -- you'll remember that we said that the fourth quarter should be sort of more than double third quarter results from a revenue standpoint, and the largest reason behind that is actually launches of U.K. and U.S. programs, which are priced more highly.

So it's not a big hockey stick in the FCEs from Q3 to Q4. It's more mix?

It's a combination. There will be an increase in FCEs, but there will also be a combination -- increase in average revenue per FCE. So the price is mix, but it will still drive an increase in FCE.

They might worse, given comps on the price per FCE for their domestic clients versus the...

Sure so you'll remember that when we talked about -- early on, we gave you information that said that the South African courses generally run around the $1,000 per course, whereas the U.K. and U.S. courses are somewhere in the $2,500 to $3,000 per course. So I think as you can imagine, as they launch more of the non-South African business, that's going to drive up that average revenue per course.

Got it. I have a very big picture question, and I realize that you were preparing for earnings, you probably haven't had a chance to read through the whole proposed tax legislation. But there's a bunch of things in there that it would impact education, whether it's deductibility of the student interest, or the lifetime learning credit, or your University partners. Any early thoughts on what the impact could be on students or your partners, and therefore, on you from any of the changes proposed?

I mean it's really tough Corey. You know from following us with regards to some of the more direct sort of potential regulations out there that affect us directly, even with those what is discussed versus what turns into law, we could talk about this for hours. There's no clarity as to what's going to happen. 2U has existed now today in multiple administrations, multiple parts -- different parties and different economies where you've got -- we started the company at the worst possible economy in the history of the United States and now we're in a better economy. So I feel like we are a bit acyclical, and if there is some impact in tax code that affect us, there's probably a put somewhere else that helps us. It's -- it's too early to say.

And our next question comes from the line of Alex Paris of Barrington Research.

Most of my questions have been asked and answered, but I have a couple of clarifying questions, if I may. So GetSmarter was a little over $5 million in gross revenue. If you didn't have that accounting anomaly, $4.3 million, if I did the math right, recognized revenue, and then Cathy, I think you said that the expectation for GetSmarter in your guidance for fourth quarter is twice that. And I just wanted to make sure that I have the right base, $4.3 million or a little over $5 million?

You do. What we had said previously in the last quarter about the distribution of revenue, and are reinforcing here, is that our that expectation is that it will be more than twice the reported revenue.

I got you. Okay. And then Chip, I think you mentioned that we should expect more GetSmarter partners announced before year-end. Should we expect -- is this from the pipeline at GetSmarter that existed before acquisition or should we expect maybe a 2U university partner in there?

Certainly, either are possible. There's a lot out there. The pipeline team is super active. So one of the things we've said historically, now that -- by the way, public almost 4 years, right? So we've been doing this for a while and of the public scrutiny -- the scrutiny of the public markets and we've definitely said that one of the tricky things for us is the slotting, which is one of the reasons I'm so proud of what's happened with the launch schedules. Slotting them -- not so much identifying them or even doing the contract, but getting them actually up and running, there are many different factors, whether it be approvals, accreditations, state approvals in some cases, faculty, bandwidth. There's a bunch of different reasons why something may or may not choose to go at a particular time. So a little tricky for me to tell you which exactly ones they will be, but we have so many coming that I have no doubt there will be more between now and the end of the year.

Okay, good. Thanks. And then if I have my numbers right, I think GetSmarter in 2016 had roughly $18 million in revenue and it looks like we have $12 million in the second half of this year, $12 million for the period of time that 2U owned it through the end of the year. And I guess, I could do the math, you gave it in percentages. But are you presuming growth in GetSmarter on a pro forma basis if you had had it for the full year 2017 and 2018?

Yes. So if you were to -- while we're not giving guidance specifically on those 2 different segments, certainly, given what we have told you, you can back into it and there is an expectation which we implied last time, and will do so again, that there is year-over-year growth in GetSmarter -- in the GetSmarter segment for 2017 over '16, though as we've told you, it is not significant growth because of the back ending of their entry -- back ending of the revenue related to their entry into sort of more of the international space. So you'll see much more acceleration in 2018.

Great thanks. And then I guess, last question, I think last quarter, you gave a backlog number, Cathy. Would you care to update that this quarter?

Well I can do it for you there, Alex. How about that? I'm going to answer the financial question. It's $341 million.

$341 million?

Yes, $341 million.

And our next question comes from the line of Kerry Rice with Needham.

Maybe just one philosophical question or thoughts about the business. If you already targeted 16 DGPs for 2019, Chip, is there anything -- any obstacles to say you get to 17, 18 more, do you have to add a lot more people, do you need to add some infrastructure, is there any capacity, I guess, constraints above -- to get above 16, is the first question. And then a couple of housekeeping questions for Cathy. The lifetime value the total cost ratio, if you don't mind giving that out. And I think that's it since the backlog question was asked.

So what I would say is obviously, if we do substantially above 16, of course, we would have to add. The people that are in the room may kill me if I didn't actually answer that right away. So of course, we would have to. As a matter -- the different levels would require different levels of investment. But I can't really give you a blanket answer until we would know how many. Now I will tell you the fact that we're holding margin flat year-on-year is indicative of the scaling and our need to continue to invest in scale. This is a story of growth and we're growing. So we're putting our foot on the gas with regard to the growth engine we have. But going above that 16 we just -- we're just not there yet.

And as far as the LTR to TCA number, or ratio, it was 3 for the third quarter. You know our target is sort of at that 3.2 and we sort of run in the high 2s to 3.2, depending on where we are in investing for growth of new programs. But that is a little bit higher than it's been in the last quarter or so.

It's gone up in the last couple of quarters.

Our next question comes from the line of Jeff Silber from BMO Capital Markets.

It's Henry Chien calling for Jeff. Just a question on sort of a follow-up to the prior one on your expenses and scaling them. It seems like your margin expectations for 2018 are a little bit better than what you had signaled earlier. Just curious of where you're getting additional leverage on your expenses and just any thoughts around that point?

Yes. So really in some ways, our margin improvement is coming out of -- any improvement in margin expectations is really coming out of the fact that I think we've upped our revenue expectations a little bit. But largely, we are still expecting to be relatively flat in margins in the graduate programs business and not adding significant margin out of the short course business as we want to continue to invest in that, particularly as we drive these new course offerings throughout the year. While it is a shorter cycle, we'd really like to get a lot of new courses up and running during 2018. And even though it's a shorter investment to return cycle in that short course business, when you start overlapping them, it still does require a period of investment.

Got it. Okay. And for the short courses that are expected to be launches, will you be announcing it similarly to how you do the graduate programs with the press release and just...

No. We will not be announcing courses. There's just too many of them. So we will likely announce something that we believe is important to you and material and we'll determine what those are at that time. But most likely, the partners.

And the last question is from Michael Tarkin with Compass Point.

This is actually Andrew on for Mike. The first question, just sort of on the competitive front. Have you guys seen any change there? I know that there was some turnover at Coursera. I'm just wondering what you're seeing there in terms of competitive environment?

I would say we continue to feel very strongly about our leadership position in the space. We feel like our recent announcements are indicative of that whether it's Rice or Vanderbilt or Harvard, or now our seventh DGP at USC. We like where we are. I mean, we're certainly not taking it for granted. So we are aware of what everybody else is doing in the space. And from a competitive landscape standpoint, we just acquired the only company that I was worried about, so that says something.

Okay, just on the J.D. vertical, has there been any update there? I know you had the initial partner pull out after a pushback from the ABA. And I think you said you had somebody else in the works. Any update there?

No update for you yet. We're working on it, as matter of fact, literally right now next to me. Our General -- one of our General Counsels is sitting next to me working on it. So it's coming along.

Ladies and gentlemen, I would now like to turn the call back to Chip Paucek for further remarks.

Okay, thank you, operator. I'd like to give a quick shout-out to the moms of the earnings crew. We did the dads last time. We can't leave out the moms. Jeanette Goodwin, Ellie Paucek, Jackie Norden, Barb Loninstal, Betsey Goss, Sandra Moore, Gail Papa, Vicki Nash, Faith Dugan, Barb Shulman, Golderan Nursal, Christine Mizander, Maurine Klan and the late Anne Graham and Judy Susten. Thanks, everybody. I'll talk to you out on the road.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.