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Rosetta Stone Inc. Reports Second Quarter 2018 Results

Literacy segment increases to record $12.7 million in revenue, 29% of total revenue

With the conversion of Consumer Language to SaaS model complete, Rosetta Stone is now fully subscription-based

ARLINGTON, Va., Aug. 02, 2018 (GLOBE NEWSWIRE) -- Rosetta Stone Inc. (NYSE: RST), a world leader in technology-based learning solutions, today announced financial results for the second quarter ended June 30, 2018.

Second Quarter 2018 Highlights

  • Revenue at Lexia, the Company’s Literacy segment, grew 22% year-over-year to a record high of $12.7 million.
      
  • Revenue within the Consumer Language segment declined 15% year-over-year to $15.4 million. The expected revenue decline reflects the transition to a full subscription model in which revenue is recognized ratably over the subscription period, which was completed in the first quarter 2018.
      
  • Total operating expenses increased 1% year-over-year, to $39.2 million.
      
  • At June 30, 2018, the Company had zero debt outstanding and cash and cash equivalents totaled $20.9 million.

“Our second quarter performance highlights the growing power of our Literacy business Lexia, and continued traction creating value within our Consumer Language segment following the transition to a full subscription model,” said John Hass, Chairman, President and Chief Executive Officer. “Lexia’s momentum headed into the critical "back to school" selling season is strong, driven by our expanded literacy product portfolio, and we’re on track to deliver against our sales goal for 2018.  Within our Language business, we’re pleased with our continued progress in important areas of our direct to consumer offering, including mobile apps, and the progress in our Enterprise and Education business, particularly our global corporate business.”

Second Quarter 2018 Financial Review

Revenue:  Total revenue decreased $2.4 million, or 5% year-over-year, to $43.5 million in the second quarter 2018, reflecting declines in the Company's Language segments driven largely by the transition in the Consumer Language segment from 52% perpetual product sales in the second quarter 2017, to 97% subscription-based sales in the second quarter 2018.

Revenue at Lexia grew 22% year-over-year to a record high of $12.7 million in the second quarter 2018.  Literacy sales grew 20% over the prior year period, despite a continuing and expected shift in business activity to Lexia's seasonally strongest "back to school" selling season, which begins late in the second quarter and peaks in the third quarter.

Enterprise & Education ("E&E") Language segment revenue decreased $1.9 million, or 11% year-over-year, to $15.4 million in the second quarter 2018. The decline reflected the Company's strategic decision to exit certain geographies and customer lines on a direct sales basis and reduce overall selling expense, which was part of the E&E Language restructuring announced in March 2016. E&E Language revenue from continuing geographies declined $1.5 million or 10% year-over-year. E&E Language sales decreased 4% year-over-year, primarily reflecting lower sales through the Company’s affiliate and education channels.

Consumer Language segment revenue decreased $2.8 million, or 15% year-over-year, to $15.4 million in the second quarter 2018. The decline was due to a $2.9 million reduction in product revenue, reflecting both the shift to SaaS-based revenue in the DTC channel and lower unit sales in the retail channel following the conversion of various retail partners to sell the Company's subscriptions. Subscription and service revenue increased $0.1 million, or 1% year-over-year, benefiting from an 11% year-over-year increase in subscribers to 417,000 at June 30, 2018.  Subscriber growth was largely driven by the inclusion of lower priced, shorter initial duration subscriptions in the Company’s portfolio. Subscriptions with a duration of one year or less totaled 41% of the subscription unit mix sold in the second quarter 2018, up from 29% in the same quarter last year.

US$ thousands, except for percentages

    Three Months Ended June 30,    
    2018   Mix %   2017   Mix %   % change
Revenue from:                    
Literacy   $ 12,695     29 %   $ 10,370     22 %   22 %
E&E Language   15,356     35 %   17,260     38 %   (11 )%
Consumer Language   15,451     36 %   18,275     40 %   (15 )%
Total   $ 43,502     100 %   $ 45,905     100 %   (5 )%

Net Loss:  In the second quarter of 2018 the Company reported a net loss of $4.2 million or $(0.18) per diluted share. In the comparable period a year ago, the Company had a net loss of $1.1 million or $(0.05) per diluted share.

Total operating expenses increased $0.2 million, or 1% year-over-year, to $39.2 million in the second quarter 2018 as increased investment in sales and marketing were partially offset by declines in research and development expense and general and administrative expense.

Balance Sheet:  As of June 30, 2018, the Company had zero debt and a cash and cash equivalents balance of $20.9 million.

Deferred revenue at June 30, 2018 totaled $139.7 million and includes $16.6 million from the SOURCENEXT transaction, of which $15.7 million is long-term. Short-term deferred revenue of $93.5 million at June 30, 2018, or approximately 67% of the total balance, will be recognized as revenue over the next 12 months. Before SOURCENEXT deferred revenue, approximately 75% of the total was current at June 30, 2018.

Free Cash Flow and Adjusted EBITDA:  Free cash flow, a non-GAAP financial measure, was an $18.5 million outflow in the second quarter 2018, compared to an outflow of $13.8 million in the second quarter 2017. The year-over-year change in free cash flow primarily reflects the Company's net loss, along with an increase of $1.1 million in capital expenditures.  The Company's capital expenditures primarily relate to capitalized labor on product and IT projects. Free cash flow in the second quarter of 2017 also benefited from the receipt of $2.5 million of SOURCENEXT cash. Adjusted EBITDA, a non-GAAP financial measure, was $1.4 million in the second quarter 2018, compared to $3.9 million in the year ago period. The year-over-year change in Adjusted EBITDA primarily reflects the Company's higher net loss this quarter, compared to the same quarter last year. The Company's cash flow has historically been seasonal, with a net use of cash during the first half of the year and positive cash generation during the second half of the year. With the continued growth at Lexia and the increasing mix of sales from the education marketplace, which is seasonally strongest in the third quarter, it is expected that the majority of the Company's second half positive cash flow will be generated in the third quarter.

Earnings Conference Call

In conjunction with this announcement, Rosetta Stone will host a conference call today at 5:00 p.m. ET during which time there will be a discussion of the results and the Company's 2018 outlook. Investors may dial into the live conference call using 1-201-689-8470 (toll / international) or 1-877-407-9039 (toll-free). A live webcast will also be available on the Investor Relations page of the Company's website at http://investors.rosettastone.com. A replay will be made available soon after the live conference call is completed and will remain available until midnight on August 9. Investors may dial into the replay using 1-412-317-6671 and passcode 13681500.

Caution on Forward-Looking Statements

This press release contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by non-historical statements and often include words such as "outlook," "potential," "believes," "expects," "anticipates," "estimates," "intends," "plans," "seeks" or words of similar meaning, or future-looking or conditional verbs, such as "will," "should," "could," "may," "might," "aims," "intends," "projects," or similar words or phrases. These statements may include, but are not limited to, statements relating to: our business strategy; guidance or projections related to revenue, Adjusted EBITDA, sales, and other measures of future economic performance; the contributions and performance of our businesses including acquired businesses and international operations; projections for future capital expenditures; and other guidance, projections, plans, objectives, and related estimates and assumptions. A forward-looking statement is neither a prediction nor a guarantee of future events or circumstances. In addition, forward-looking statements are based on the Company’s current assumptions, expectations and beliefs and are subject to certain risks and uncertainties that could cause actual results to differ materially from our present expectations or projections. Some important factors that could cause actual results, performance or achievement to differ materially from those expressed or implied by these forward-looking statements include, but are not limited to: the risk that we are unable to execute our business strategy; declining demand for our language learning solutions; the risk that we are not able to manage and grow our business; the impact of any revisions to our pricing strategy; the risk that we might not succeed in introducing and producing new products and services; the impact of foreign exchange fluctuations; the adequacy of internally generated funds and existing sources of liquidity, such as bank financing, as well as our ability to raise additional funds; the risk that we cannot effectively adapt to and manage complex and numerous technologies; the risk that businesses acquired by us might not perform as expected; and the risk that we are not able to successfully expand internationally. We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future developments or otherwise, except as required by law. These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements, risks and uncertainties that are more fully described in the Company's filings with the U.S. Securities and Exchange Commission (SEC), including those described under the section entitled “Risk Factors” in the Company’s most recent quarterly Form 10-Q filings and Annual Report on Form 10-K for the year ended December 31, 2017, and those updated from time to time in our future reports filed with the Securities and Exchange Commission.

Non-GAAP Financial Measures

To supplement the condensed consolidated financial statements, which are prepared and presented in accordance with accounting principles generally accepted in the United States ("GAAP"), the Company uses, and this press release contains references to, the non-GAAP financial measures of financial performance listed below.

  • Sales represents executed contracts received by the Company that are either recorded immediately as revenue or deferred revenue. Therefore, sales is an operational metric and in any one period is equal to revenue plus the change in deferred revenue.
      
  • Adjusted EBITDA is GAAP net income/loss plus interest income and expense, other income/expense, income tax benefit/expense, impairment, lease abandonment and termination, depreciation, amortization, stock-based compensation, restructuring, and strategy and cost-reduction related consulting expenses. In addition, Adjusted EBITDA excludes "Other" items related to non-restructuring wind down and severance costs, and transaction and other costs associated with mergers and acquisitions, as well as all adjustments related to recording the non-cash tax valuation allowance for deferred tax assets. Adjusted EBITDA for prior periods has been revised to conform to current definition.
      
  • Free cash flow is cash flow from operating activities minus cash used in purchases of property and equipment.
      
  • Segment contribution is calculated as segment revenue less expenses directly incurred by or allocated to the segment. Direct segment expenses include costs and expenses that are directly incurred by or allocated to the segment and include materials costs, service costs, customer care and coaching costs, sales and marketing expenses, and bad debt expense. In addition to the previously referenced expenses, the Literacy segment includes direct research and development expenses and Combined Language includes shared research and development expenses, cost of revenue, and sales and marketing expenses applicable to the Consumer Language and E&E Language segments. Prior periods have been reclassified to reflect our current segment presentation and definition of segment contribution.

The definitions, GAAP comparisons, and reconciliation of those measures with the most directly comparable GAAP financial measures are available in this press release or in the corresponding earnings presentation, which are posted on our website at www.rosettastone.com.

Management believes that these non-GAAP measures of financial results provide useful information to management and investors regarding certain financial and business trends relating to the Company’s financial condition and results of operations, enabling a better understanding of the long-term performance of the Company’s business. Management uses these non-GAAP measures to compare the Company’s performance to that of prior periods for trend analysis, and for budgeting and planning purposes. Management believes that the use of these non-GAAP financial measures provides an additional tool for investors to use in evaluating ongoing operating results and trends and in comparing the Company’s financial measures with other software and education-technology companies, many of which present similar non-GAAP financial measures to investors.

The presentation of this additional financial information is not intended to be considered in isolation from, as a substitute for, or superior to, the financial information prepared and presented in accordance with GAAP. The Company urges investors to review the reconciliation of its non-GAAP financial measures to the comparable GAAP financial measures, which it includes in press releases announcing earnings information, including this press release, or in corresponding earnings presentations, and not to rely on any single financial measure to evaluate the Company’s business. The Company’s non-GAAP measures may not be comparable to those used by other companies, and we encourage you to review and understand all our financial reporting before making any investment decision.

About Rosetta Stone Inc.

Rosetta Stone Inc. (NYSE: RST) is dedicated to changing people's lives through the power of language and literacy education. The company's innovative digital solutions drive positive learning outcomes for the inspired learner at home or in schools and workplaces around the world.

Founded in 1992, Rosetta Stone's language division uses cloud-based solutions to help all types of learners read, write and speak more than 30 languages. Lexia Learning, Rosetta Stone's literacy education division, was founded more than 30 years ago and is a leader in the literacy education space. Today, Lexia helps students build fundamental reading skills through its rigorously researched, independently evaluated, and widely respected instruction and assessment programs.

For more information, visit www.rosettastone.com. "Rosetta Stone" is a registered trademark or trademark of Rosetta Stone Ltd. in the United States and other countries.

Investors:
Laura Bainbridge / Jason Terry
Addo Investor Relations
1-310-829-5400
IR@rosettastone.com


ROSETTA STONE INC.

CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
(unaudited)

       June 30, 
 2018
  December 31,
 2017
Assets        
Current assets:        
Cash and cash equivalents   $ 20,925     $ 42,964  
Restricted cash   73     72  
Accounts receivable (net of allowance for doubtful accounts of $342 and $375, at June 30, 2018 and December 31, 2017, respectively)   23,253     24,517  
Inventory   2,114     3,536  
Deferred sales commissions   9,495     14,466  
Prepaid expenses and other current assets   4,357     4,543  
Total current assets   60,217     90,098  
Deferred sales commissions   6,614     3,306  
Property and equipment, net   33,550     30,649  
Goodwill   49,471     49,857  
Intangible assets, net   17,369     19,184  
Other assets   2,027     1,661  
Total assets   $ 169,248     $ 194,755  
Liabilities and stockholders' (deficit) equity        
Current liabilities:        
Accounts payable   $ 10,557     $ 8,984  
Accrued compensation   6,336     10,948  
Income tax payable   48     384  
Obligations under capital lease   452     450  
Other current liabilities   12,628     16,454  
Deferred revenue   93,530     110,670  
Total current liabilities   123,551     147,890  
Deferred revenue   46,187     40,593  
Deferred income taxes   2,084     1,968  
Obligations under capital lease   1,589     1,850  
Other long-term liabilities   32     31  
Total liabilities   173,443     192,332  
Commitments and contingencies        
Stockholders' (deficit) equity:        
Preferred stock, $0.001 par value; 10,000 and 10,000 shares authorized, zero and zero shares issued and outstanding at June 30, 2018 and December 31, 2017, respectively        
Non-designated common stock, $0.00005 par value, 190,000 and 190,000 shares authorized, 24,262 and 23,783 shares issued and 23,262 and 22,783 shares outstanding at June 30, 2018 and December 31, 2017, respectively   2     2  
Additional paid-in capital   198,896     195,644  
Accumulated loss   (188,679)     (178,890)  
Accumulated other comprehensive loss   (2,979)     (2,898)  
Treasury stock, at cost, 1,000 and 1,000 shares at June 30, 2018 and December 31, 2017, respectively   (11,435)     (11,435)  
Total stockholders' (deficit) equity   (4,195)     2,423  
Total liabilities and stockholders' (deficit) equity   $ 169,248     $ 194,755  
 

 

ROSETTA STONE INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited) 


    Three Months Ended June 30,   Six Months Ended June 30,
    2018   2017   2018   2017
Revenue:                
Subscription and service   $ 42,678     $ 41,985     $ 84,176     $ 83,435  
Product   824     3,920     2,134     10,163  
Total revenue   43,502     45,905     86,310     93,598  
Cost of revenue:                
Cost of subscription and service revenue   7,258     6,058     14,632     12,592  
Cost of product revenue   672     1,533     2,732     3,140  
Total cost of revenue   7,930     7,591     17,364     15,732  
Gross profit   35,572     38,314     68,946     77,866  
Operating expenses:                
Sales and marketing   24,874     24,037     49,065     48,205  
Research and development   6,019     6,348     12,325     12,762  
General and administrative   8,324     8,594     16,856     16,619  
Total operating expenses   39,217     38,979     78,246     77,586  
(Loss) income from operations   (3,645)     (665)     (9,300)     280  
Other income and (expense):                
Interest income   23     17     48     30  
Interest expense   (81)     (130)     (164)     (245)  
Other income and (expense)   (1)     425     (229)     736  
Total other income and (expense)   (59)     312     (345)     521  
(Loss) income before income taxes   (3,704)     (353)     (9,645)     801  
Income tax expense   454     782     915     1,482  
Net loss   $ (4,158)     $ (1,135)     $ (10,560)     $ (681)  
Loss per share:                
Basic   $ (0.18)     $ (0.05)     $ (0.47)     $ (0.03)  
Diluted   $ (0.18)     $ (0.05)     $ (0.47)     $ (0.03)  
Common shares and equivalents outstanding:                
Basic weighted average shares   22,663     22,248     22,561     22,187  
Diluted weighted average shares   22,663     22,248     22,561     22,187  
 

 

ROSETTA STONE INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)(unaudited) 

    Three Months Ended June 30,   Six Months Ended June 30,
    2018   2017   2018   2017
CASH FLOWS FROM OPERATING ACTIVITIES:                
Net loss   $ (4,158)     $ (1,135)     $ (10,560)     $ (681)  
Adjustments to reconcile net loss to cash used in operating activities:                
Stock-based compensation expense   1,353     1,359     1,936     1,506  
Loss (gain) on foreign currency transactions   (125)     (175)     120     (452)  
Bad debt expense (recovery)   136     64     61     (300)  
Depreciation and amortization   3,479     2,987     7,089     6,062  
Deferred income tax expense   81     330     117     630  
(Gain) loss on disposal of equipment   (17)     1     (17)      
Amortization of deferred financing fees   34     85     68     156  
Loss from equity method investments       105         100  
Gain on sale of subsidiary       (506)         (506)  
Net change in:                
Accounts receivable   (9,907)     (6,993)     1,131     4,195  
Inventory   (44)     571     1,423     932  
Deferred sales commissions   (7)     539     1,648     2,127  
Prepaid expenses and other current assets   729     136     90     (671)  
Income tax receivable or payable   (256)     292     (347)     (245)  
Other assets   (235)     190     (401)     192  
Accounts payable   1,667     426     1,609     (1,254)  
Accrued compensation   (6,185)     (5,128)     (4,588)     (3,397)  
Other current liabilities   (1,135)     (2,663)     (3,548)     (5,652)  
Other long-term liabilities       (9,247)         (485)  
Deferred revenue   274     8,006     (10,565)     (7,257)  
Net cash used in operating activities   (14,316)     (10,756)     (14,734)     (5,000)  
CASH FLOWS FROM INVESTING ACTIVITIES:                
Purchases of property and equipment   (4,188)     (3,080)     (8,136)     (5,393)  
Proceeds from sale of fixed assets   17         17     2  
Proceeds from the sale of subsidiary       110         110  
Net cash used in investing activities   (4,171)     (2,970)     (8,119)     (5,281)  
CASH FLOWS FROM FINANCING ACTIVITIES:                
Proceeds from the exercise of stock options   849     367     1,316     441  
Payment of deferred financing costs       (143)         (143)  
Payments under capital lease obligations   (110)     (102)     (225)     (344)  
Net cash provided by (used in) financing activities   739     122     1,091     (46)  
Decrease in cash and cash equivalents   (17,748)     (13,604)     (21,762)     (10,327)  
Effect of exchange rate changes in cash, cash equivalents, and restricted cash   (469)     (95)     (276)     138  
Net decrease in cash and cash equivalents   (18,217)     (13,699)     (22,038)     (10,189)  
Cash, cash equivalents, and restricted cash - beginning of period   39,215     40,107     43,036     36,597  
Cash, cash equivalents, and restricted cash - end of period   $ 20,998     $ 26,408     $ 20,998     $ 26,408  
 

 


 ROSETTA STONE INC.

Reconciliation of GAAP Net Loss to Adjusted EBITDA
(in thousands)
(unaudited)

    Three Months Ended June 30,   Six Months Ended June 30,
    2018   2017   2018   2017
GAAP net loss   $ (4,158)     $ (1,135)     $ (10,560)     $ (681)  
                         
Total other non-operating expense (income), net   59     (312)     345     (521)  
Income tax expense   454     782     915     1,482  
Depreciation and amortization   3,479     2,987     7,089     6,062  
Stock-based compensation   1,353     1,359     1,936     1,506  
Restructuring expenses   (23)     205     8     985  
Strategy consulting expense               169  
Other EBITDA adjustments   261     16     402     55  
Adjusted EBITDA*   $ 1,425     $ 3,902     $ 135     $ 9,057  
 

* Adjusted EBITDA is GAAP net income/loss plus interest income and expense, other income/expense, income tax benefit/expense, impairment, lease abandonment and termination, depreciation, amortization, stock-based compensation, restructuring, and strategy and cost-reduction related consulting expenses. In addition, Adjusted EBITDA excludes “Other” items related to non-restructuring wind down and severance costs, and transaction and other costs associated with mergers and acquisitions, as well as all adjustments related to recording the non-cash tax valuation allowance for deferred tax assets. Adjusted EBITDA for prior periods has been revised to conform to current definition.

 

ROSETTA STONE INC.
Reconciliation of Cash Used in Operating Activities to Free Cash Flow
(in thousands)
(unaudited)

    Three Months Ended
 June 30,
  Six Months Ended
 June 30,
    2018   2017   2018   2017
Net cash used in operating activities   $ (14,316)     $ (10,756)     $ (14,734)     $ (5,000)  
Purchases of property and equipment   (4,188)     (3,080)     (8,136)     (5,393)  
Free cash flow*   $ (18,504)     $ (13,836)     $ (22,870)     $ (10,393)  
 

 * Free cash flow is cash flow from operations minus cash used in purchases of property and equipment.

 

Rosetta Stone Inc.
Supplemental Information
(unaudited)

  Quarter-Ended   Year
Ended
  Quarter-Ended
  Mar 31
2017
  Jun 30
2017
  Sep 30
2017
  Dec 31
2017
  Dec 31
2017
  Mar 31
2018
  Jun 30
2018
 
Revenue by Segment (in thousands, except percentages) 
                           
Literacy 10,170   10,370   11,028   12,040   43,608   12,384     12,695
E&E Language 16,500   17,260   16,529   14,978   65,267   15,436   15,356
Consumer Language 21,023   18,275   18,649   17,771   75,718   14,988   15,451
Total 47,693   45,905   46,206   44,789   184,593   42,808   43,502
                           
YoY Growth (%)                          
Literacy 34%   30%   26%   23%   28%   22%   22%
E&E Language (10)%   (1)%   (10)%   (16)%   (9)%   (6)%   (11)%
Consumer Language (5)%   (10)%   (14)%   (26)%   (14)%   (29)%   (15)%
Total (1)%   —%   (5)%   (13)%   (5)%   (10)%   (5)%
                           
% of Total Revenue                          
Literacy 21%   22%   24%   27%   24%   29%   29%
E&E Language 35%   38%   36%   33%   35%   36%   35%
Consumer Language 44%   40%   40%   40%   41%   35%   36%
Total 100%   100%   100%   100%   100%   100%   100%
                           
Revenues by Geography                          
                           
United States 41,241   39,384   39,661   38,539   158,825   36,965   37,759
International 6,452   6,521   6,545   6,250   25,768   5,843   5,743
Total 47,693   45,905   46,206   44,789   184,593   42,808   43,502
                           
Revenues by Geography (as a %)                          
United States 86%   86%   86%   86%   86%   86%   87%
International 14%   14%   14%   14%   14%   14%   13%
Total 100%   100%   100%   100%   100%   100%   100%
 


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"Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995: Statements in this press release regarding Rosetta Stone PR's business which are not historical facts are "forward-looking statements" that involve risks and uncertainties. For a discussion of such risks and uncertainties, which could cause actual results to differ from those contained in the forward-looking statements, see "Risk Factors" in the Company's Annual Report or Form 10-K for the most recently ended fiscal year.
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