U.S. Markets closed

Edited Transcript of RST earnings conference call or presentation 9-May-18 9:00pm GMT

Q1 2018 Rosetta Stone Inc Earnings Call

Arlington Jul 17, 2018 (Thomson StreetEvents) -- Edited Transcript of Rosetta Stone Inc earnings conference call or presentation Wednesday, May 9, 2018 at 9:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* A. John Hass

Rosetta Stone Inc. - Chairman, President & CEO

* Frank Milano

================================================================================

Conference Call Participants

================================================================================

* Bruce Goldfarb

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Welcome to the Rosetta Stone First Quarter Results Conference Call. As a reminder, (Operator Instructions) the conference is being recorded. (Operator Instructions)

I would now like to turn the conference over to Frank Milano, Investor Relations. Please go ahead.

--------------------------------------------------------------------------------

Frank Milano, [2]

--------------------------------------------------------------------------------

Good afternoon, and welcome to the Rosetta Stone First Quarter 2018 Earnings Conference Call. We have posted to the Investor Relations section of our website at www.rosettastone.com the earnings release that went out after the market closed and the slide presentation that accompanies today's call. We have also posted supplemental information and analysis on our website. This supplemental information will not be read on today's call.

In keeping with Slide 2, today's presentation contains forward-looking statements within the meaning of the applicable securities laws. These statements may include, but are not limited to, statements related to our business strategy, financial guidance or projections related to our business and other plans, objectives and related estimates and assumptions. 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.

We expressly disclaim any obligation to update or revise any forward-looking statements except as required by law. You are encouraged to read our cautionary statements, risks and uncertainties more fully described in the company's filings with the SEC, including those described under the section entitled Risk Factors in the company's most recent periodic filings.

Today's presentation and discussion also contain references to non-GAAP financial measures. The full definition, GAAP comparisons and a reconciliation of those measures are available in the presentation or in our press release, which is posted on our website at www.rosettastone.com. Our non-GAAP measures may not be comparable to those used by other companies, and we encourage you to review and understand all of our financial reporting before making any investment decision.

I will now turn the call over to John.

--------------------------------------------------------------------------------

A. John Hass, Rosetta Stone Inc. - Chairman, President & CEO [3]

--------------------------------------------------------------------------------

Thank you, Frank, and welcome, everyone. I am pleased to say that we are on track for the goals we discussed in our March call, returning Rosetta Stone to growth and positive cash flow in 2018. If accomplished, 2018 would be the first year of sales growth and positive organic cash flow since 2013.

Turning to Slide 3, in the first quarter I would highlight 2 milestones that are indicative of our focus and our progress. Demonstrating its increasing importance to the K-12 marketplace and to us, our Literacy business represented almost 30% of revenues in Q1, a testament to the decision we made 3 years ago to accelerate our investment in this business and the opportunity we see before us in K-12.

Next, we have now officially stopped selling CDs. As a result, essentially the entire product line across the company is now sold as Software as a Service. This provides customers more frequent access to improved features and functionality and provides us the benefits of recurring sales and revenue.

To understand how much progress we have made, I would remind everyone that in the first quarter last year, 58% of our Consumer Language sales were still of perpetual products. And to demonstrate how that progress is flowing through the business, we grew short-term subscribers in Q1 by 17% on a sequential basis and total subscribers to a record 395,000.

I am proud of what the team has done across the business and even more excited to show you what we can do going forward. As for the quarter, the first quarter is seasonally by far the smallest across all of our businesses, totaling only about 15% of expected sales for the year. That said, our top line results were in line with our expectations, while earnings exceeded guidance due to lower-than-planned expenses, largely due to timing within the year.

I will walk through the results in a few minutes, but let me start by highlighting a few of the key developments from the quarter.

Turning to Slide 4. In our Literacy business, we launched PowerUp, an adaptive personalized literacy program for non-proficient readers in sixth grade and above. PowerUp takes advantage of the best of what we have learned about independent student-driven learning, providing ongoing data to monitor progress and leveraging independent and teacher-led materials to bring a unique approach to an important market.

On Slide 5, PowerUp focuses on 3 instructional strands: word study, grammar and reading comprehension, and promotes student autonomy to drive progress. The program was developed using contemporary game design features to engage, motivate and build confidence in adolescents who have typically experienced years of reading difficulties. While gaining acceptance for new products in schools and districts takes time, we are pleased with the demand for meetings about and demonstrations of PowerUp, where we are able to leverage Lexia's strength in K-5.

There is clear recognition in schools that the literacy needs of older struggling readers are not being adequately addressed by other vendors' current offerings and approaches. We believe PowerUp can play a key role in meeting these needs and helping students be successful, improving their chances of graduating and better preparing them for college or work. And it's not just us that believes this. In a recent review by Tech and Learning Magazine, PowerUp received a very strong rating as an excellent comprehensive program for helping non-proficient readers in grades 6 and up to develop literacy fundamentals and higher order thinking skills.

Moving to Slide 6, PowerUp, along with Core5, our curriculum program for kindergarten through fifth grade; RAPID, our universal screener assessment for kindergarten through 12th grade; and the myLexia platform that supports these products, completes our core literacy portfolio. This portfolio, along with our service and training offerings, represents the best of adaptive personalized learning for K-12 classrooms and is expected to drive the continued growth of our Literacy business.

Moving to Slide 7. We were excited that Core5 was one of only 11 apps and the only literacy product selected by Apple to be part of the initial launch of their new Schoolwork app for the iPad this summer. Core5 was featured in March during Apple's going on a Field Trip event, where they unveiled Schoolwork. This was Apple's first major education-focused media event in 6 years. I am very proud that Core5 was one of the very few selected out of thousands of education apps by arguably the most discerning technology company in the world.

The primary reason a company like Apple or our thousands of school partners select Lexia is because our products demonstrably improve student outcomes.

On Slide 8, in March, LEAP Innovations, a nationally renowned nonprofit and leader in implementing education technology and personalized learning programs, released a report that found Lexia Reading Core5 had driven significant gains in reading proficiency. Specifically, the LEAP research team reported an 11-percentile point gain in the second report for Lexia Core5 users on their standard reading assessment, up from an already significant 5-percentile point gain in the first report.

The 11-point gain represents an extremely large increase in performance, but it's particularly significant given that the schools in the study are populated by students from low socioeconomic status families and many are English language learners.

As shown on Slide 9, successes like these have driven the Literacy segment's annual recurring revenue, or ARR, to approximately $44 million at the end of Q1, a small increase from Q4 in a seasonally light sales quarter.

But with retention rates that have been nicely above 90% for over 1.5 years now, we are set up for strong growth during the peak selling quarters this year and in the years that follow.

Turning to Slide 10, as Nick Gaehde, the President of our Literacy business, discussed on our last call, our objective is to be the K-12 literacy expert. It is the biggest and most important curriculum area in K-12 and one where we have proven repeatedly that we can make a difference in learners' lives.

We have a world-class portfolio of products and services to meet the needs of this marketplace. We have successfully made the difficult jump to a direct sales force and implementation team to reach more customers and help them succeed, all of which we believe will drive sales momentum and improve profitability.

Our outlook is especially positive as we see companies being rewarded in both the public and private sectors for success in K-12 education technology. Investors are beginning to realize that the performance overhang from the historical providers of educational content in the United States, coupled with the increasing digitization of classrooms, is an opportunity for companies like ours.

Including Language, our K-12 businesses constituted approximately 44% of total company revenues in Q1 and we look forward to their increasing recognition as a driving force within Rosetta Stone.

In Language, our objective, as shown on Slide 11, is to be the global leader in digital language sales. After a number of years of transition and change, we have the best product value proposition in our history. We have completed the transition to a 100% SaaS business model across our Language businesses. We expect sales to accelerate and are already seeing improved customer acquisition economics. Throughout, we will continue to leverage the iconic Rosetta Stone brand name.

On Slide 12, our Enterprise & Education segment had a good start to the year under new leadership. With sequential growth in customer accounts and ARR and improved renewal rates, the indicators are looking better. Now we have to begin to compound sales growth after 3 years of focusing in right-sizing the business.

We are especially pleased to see improved momentum in Catalyst sales within our Enterprise business. We will look to accelerate this growth by focusing on larger clients with more critical and sustainable language needs. While we still have work to do, I believe we are in the right places with the right distribution strategy and a strong enterprise product in Catalyst. Now it is up to us to execute and drive growth again.

Q1 was very dynamic in our Consumer Language segment. We made strong progress in a number of areas, most notably in mobile sales, which we expect to be one of the primary drivers of our future growth.

On Slide 13, during the first quarter, we introduced for the first time ever subscription pricing in the Apple App Store, and more recently in the Google Play store. Our language learners have moved decidedly to mobile platforms for both purchasing and learning. In fact, in Q1, half of our learners used Rosetta Stone only on a mobile device and now, we are well positioned with more compelling pricing plans and an almost 5 star-rated iOS app to help them succeed. Mobile was a strong area for us in Q1.

Turning to Slide 14. During Q1, total consumer language subscribers grew from approximately 370,000 to a new high of 395,000 despite runoff from high levels of 2 and 3-year subscriptions originally sold in 2015 and 2016. This runoff will continue to impact us throughout 2018, but we still expect modest growth in long-term subscribers throughout the year.

The newest part of our business, short-term subscription sales, reached a new high of 148,000 subscribers at the end of Q1, an increase of 21,000 subscribers or 17% in a single quarter. We expect growth in short-term subscribers and subsequently total subscribers to remain strong throughout 2018.

The substantial increase in short-term subscribers, driven by mobile, did have the anticipated effect of lowering our forecasted LTV per unit. As we expect, mobile customers will have generally lower overall LTVs. This is driven in part by their tendency to purchase shorter initial subscription terms, which have somewhat lower LTVs.

You can see the big increase in the relative amount of short-term subscribers in Q1 versus all of 2017 on the right-hand side of the slide, with short-term subscriptions constituting 52% of unit sales in Q1 relative to only 31% in all of 2017. With the spike in shorter-term subscriptions behind us, we currently expect LTV per unit to be relatively stable over the rest of the year.

More subscription sales relative to our prior dependence on higher initial priced perpetual products did produce lower dollar sales and revenue within Q1. Sales were lower because the initial unit price was lower as we sell more short-term subscriptions. This is offset over time as we realize renewals from these subscribers. This temporary impact is compounded in revenue recognition, where not only is a portion of expected revenue pushed out to future renewal sales, the recognition of in-period sales is also deferred over the subscription life. This is relative to our prior focus on the sale of perpetual products where revenue is recognized at the time of sale.

To give you a sense of how dramatic this was in Q1, only 6% of our initial unit sales were for perpetual products versus 58% in Q1 last year. This effect will dissipate and then reverse as we build the book of renewable subscriptions and as a growing Consumer Language deferred revenue balance is recognized.

Moving to Slide 15, subscription growth with attractive LTVs and acquisition economics led to an estimated $7.1 million of net long-term value being added in the quarter. Net LTV added is the amount of total value we estimate was added in the quarter from initial sales and expected future renewals, less the cost to acquire that value, most of which is in-period sales and marketing, plus the cost of App Store commissions on initial and assumed future renewal sales.

Looked at another way, we added almost as much value through the Consumer Language business in Q1 as we did in Q4 of 2017, historically our biggest quarter.

Net LTV added has become a critical metric as we have moved our consumer business to a subscription from perpetual products and within subscription to shorter initial term subscriptions, as it captures value created regardless of the type of product sold.

One consumer channel that has lagged for us, and which somewhat masked the strong performance of our direct-to-consumer business for the past several quarters, is Retail, where the transition to subscription has not gone as well to date as we would have liked. Retail was the last channel to move from selling physical products to selling subscriptions and it is the channel we have the least direct control over. Retail, which is expected to be 10% of total consumer sales this year, will continue to require attention as we optimize and improve sales through our partners.

You should also know that we recently reached an agreement with Univision to terminate our marketing partnership. While disappointing, our partnership constituted negligible sales in Q1 and our outlook for the Consumer segment is not dependent on sales through this partnership

Finally, turning to Slide 16, we were pleased that once again, Rosetta Stone was recognized by the Tabby Awards, the only global competition for the best tablet-optimized apps and games, for representing the best mobile apps for consumers worldwide. Rosetta Stone received 2 awards in the education category, one for the best iOS phone app and one for the best Android phone app.

Moving to our first quarter financial results on Slide 17, we generally met or exceeded guidance in all areas for the quarter. Revenues, net income and adjusted EBITDA all exceeded guidance in Q1 as each of our business lines performed in line with our expectations. Cash also exceeded guidance by approximately $2 million because we received the entire $4.5 million expected from SOURCENEXT for the year in Q1, which was approximately $2 million more than we had expected to receive in the first quarter.

The SOURCENEXT payment was in return for additional services we provided to our partner and constituted a pull forward from future years of certain guaranteed revenue-sharing payments. I would also remind you that our cash flow is highly seasonal, with the low point generally around the end of Q2 and then growing through the end of the year, largely driven by collections from K-12 sales, which peak in the June through September period.

Our low will also be exacerbated this year by the move in 2018 to shorter-term subscription sales in Consumer Language as more of these sales are collected over time rather than upfront, as they are with perpetual or long-term subscription sales. As our subscriber base grows, it will serve to dampen sales and cash seasonality, but during the transition, they are somewhat heightened.

As shown on Slide 18, our guidance for the year is largely unchanged and constitutes organic sales growth in the business for the first time since 2014. This is best represented by the second row entitled revenue plus change in deferred revenue, which is expected to grow from $182 million in 2017 to $194 million to $198 million this year. This growth will primarily be driven by strong expected growth in Lexia, which should approach $60 million in sales in 2018.

Remember, however, the GAAP revenue, GAAP net income and adjusted EBITDA, as discussed at length in our March call, will be significantly negatively affected this year by the move to subscription in our consumer business. We saw this in the first quarter driven primarily by the large year-over-year shift from selling perpetual products to the sale of subscriptions I mentioned earlier.

We finished the quarter well positioned to deliver on our commitments for 2018. In Literacy, as we continue to demonstrate improved outcomes for learners and have this impact be recognized by companies like Apple. In Language, I am pleased with the progress we are beginning to see in E&E, where I expect 2018 to be a year of growth. In Consumer Language, it is showing strength in mobile sales and overall subscriber growth with significant net LTV value added in Q1, much of which will be recognized in quarters to come.

So what does all of this mean for creating shareholder value? Turning to Slide 19, we are building value in 4 key ways.

First, we have a powerful Literacy franchise with leading products that make a real difference for learners like those in LEAP schools. And importantly, investors are starting to understand that K-12 companies that clearly demonstrate improved outcomes for learners have staying power and value in the marketplace.

In Language, we have a high-margin, predictable business that is once again an opportunity for growth as we show progress in E&E and build consumer mobile sales, subscribers and net LTV. With the final transition of Consumer Language, all of our products are now sold as subscriptions. It took us a while to get ready, but when the change to 100% subscription happened, it happened quickly and is showing good results.

And most importantly, we expect all of this to result in predictable growth for the company as a whole, which through operating leverage will drive cash flow. One final word. Many of you have asked if we plan on holding an Investor Day this year. We do, and are planning an event in November following the peak K-12 selling season. More details will follow.

With that, operator, we would be happy to take any questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) The first question comes from Bruce Goldfarb of Lake Street Capital Markets.

--------------------------------------------------------------------------------

Bruce Goldfarb, [2]

--------------------------------------------------------------------------------

Just a couple questions. In regard to the Literacy business, how are the deals shaping up for new deals and then also for renewals?

--------------------------------------------------------------------------------

A. John Hass, Rosetta Stone Inc. - Chairman, President & CEO [3]

--------------------------------------------------------------------------------

Bruce, it's John. Thank you for the question. Before I address that, let me just note, which some of you guys probably noticed, the going on a Field Trip slide was corrupted it seems like at our provider. We'll make sure we get that reposted. It's actually pretty cool to see the Core5 app on the stage at an Apple event. And so I want to make sure you see that. Bruce, we are in the middle of the peak selling season right now. As we move through the end of this school year and the beginning of next school year, we feel really good, actually, right now about the outlook for the business. The reception we're seeing for PowerUp has been very good. It's leading to a lot of conversations, not just for PowerUp, but for Core5 and the portfolio as a whole.

We were with you as recently as a couple of months ago when we had the year-end call. We have 2 months more information than we did then and I feel just as good, if not better, today than I did just a couple of months ago.

--------------------------------------------------------------------------------

Bruce Goldfarb, [4]

--------------------------------------------------------------------------------

Great. And then how was the international sales pipeline? How do you feel about that?

--------------------------------------------------------------------------------

A. John Hass, Rosetta Stone Inc. - Chairman, President & CEO [5]

--------------------------------------------------------------------------------

So the primary -- so about 10% of our Literacy business is sold outside the U.S. We're seeing pretty strong and consistent demand in that business. It's primarily to date in English-speaking countries, principally in the U.K. The other part of our business that has a large international component is our E&E Language business and we've seen really good strength in Europe over the course of the year so far. Feeling very good about that. And of course, we continue to look for opportunities to deepen relationships with resellers in reseller territories and to look for partnerships in territories that we're not in, or where we think we could be much bigger than we are today. I'd like to believe over time our Consumer Language business could also grow pretty significantly outside the U.S. That is a real to-do for us, but I think one of the biggest opportunities we have in this company.

--------------------------------------------------------------------------------

Operator [6]

--------------------------------------------------------------------------------

(Operator Instructions) There are no more questions in the queue. This concludes the question-and-answer session. I would like to turn the conference back over to management for any closing remarks.

--------------------------------------------------------------------------------

A. John Hass, Rosetta Stone Inc. - Chairman, President & CEO [7]

--------------------------------------------------------------------------------

Thank you, operator. We were with you, as I said, just a couple of months ago in March. We had a pretty good feel for how the quarter was going to shape up then. We outperformed our own expectations at that time and I think it really sets us up for a very good year. I feel good about the start we're off to. I feel good about the momentum that's building across the business and we look forward to sharing more of our progress with all of you on future calls.

With that, I'd like to thank you all for joining and we will speak again soon.

--------------------------------------------------------------------------------

Operator [8]

--------------------------------------------------------------------------------

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.