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Edited Transcript of RST earnings conference call or presentation 6-Nov-19 10:00pm GMT

Q3 2019 Rosetta Stone Inc Earnings Call

Arlington Nov 14, 2019 (Thomson StreetEvents) -- Edited Transcript of Rosetta Stone Inc earnings conference call or presentation Wednesday, November 6, 2019 at 10:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* A. John Hass

Rosetta Stone Inc. - Chairman & CEO

* Matthew N. Hulett

Rosetta Stone Inc. - Co-President & President of Language

* Nicholas C. Gaehde

Rosetta Stone Inc. - Co-President & President of Literacy

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Conference Call Participants

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* Alexander Peter Paris

Barrington Research Associates, Inc., Research Division - Director of Research and Education & Business Services Analyst

* Eric Martinuzzi

Lake Street Capital Markets, LLC, Research Division - Head of Research & Senior Research Analyst

* Steven Bruce Frankel

Dougherty & Company LLC, Research Division - Senior VP & Director of Research

* Jason Terry

ADDO Investor Relations - VP

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Presentation

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Operator [1]

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Greetings, ladies and gentlemen, and welcome to the Rosetta Stone Third Quarter 2019 Earnings Conference Call. (Operator Instructions) It is now my pleasure to introduce your host, Mr. Jason Terry. Thank you, you may begin.

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Jason Terry, ADDO Investor Relations - VP [2]

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Thank you. Good afternoon, everyone, and welcome to Rosetta Stone's Third Quarter 2019 Earnings Conference Call. Speaking on today's call will be John Hass, Chairman and CEO, along with Nick Gaehde and Matt Hulett, Co-Presidents of Rosetta Stone. Additionally, Tom Pierno, the company's Chief Financial Officer, will also be available during the Q&A portion of today's call.

We've posted to the Investor Relations section of our Website at www.rosettastone.com both the earnings release and a slide presentation which accompanies today's call. We've also posted supplemental information and analysis on our Website.

I want to remind everyone that as always, there will be elements in today's presentation which are forward looking and are based on our best view of the world and our business as we see them today. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially. A description of these risks and uncertainties and other factors that could affect our financial results are included in our most recent annual report on Form 10-K and quarterly report on Form 10-Q. We expressly disclaim any obligation to update or revise any forward-looking statements except as required by law. Today's presentation and discussion also contains references to non-GAAP financial measures. The full definition, GAAP comparison and a reconciliation of those measures are available in the aforementioned presentation and press release.

I'll now turn the call over to John.

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

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Thank you and welcome everyone. We have a lot to cover so please turn to Slide 2. We have shared this slide with you a few times in the past. Let me clear as to why this background is critical to our future. We have the experience and expertise to be the leader in helping people build the communication skills necessary to improve their lives. Whether it is a child learning to read in the classroom or an adult learning a second language in retirement, we build equity and deliver positive societal change. Please turn to Slide 3 for a review of our consolidated results.

Consolidated bookings in the third quarter grew 21% to $81.5 million with contributions from every segment in the business. This is the largest year-over-year increase in organic bookings in the history of the company and is indicative of what we are capable of doing during the seasonally important third quarter. It is not all we are capable of. We expected more and we'll talk today about what it will take to deliver that.

Consolidated revenues grew 6% in the quarter to $45.5 million, our largest quarter-over-quarter dollar increase in 2019. Importantly, with over $80 million in bookings and $45 million in revenues, we added $36 million to deferred revenue in the quarter. Net income in Q3 was a loss of $2.9 million, an improvement in $3.6 million over the same period in 2018. This was driven by higher revenues and lower variable incentive compensation expense partially offset by increased sales and marketing expense during our peak selling season.

Adjusted EBITDA in the quarter improved to $2.5 million which is a loss of $700,000 in 2018. We ended the quarter with $36.2 million of cash can no debt. The $25 million increase in our net cash position since the end of Q2, and $29 million of operating cash flow and $4 million of CapEx. When we utilized our seasonal [borrowed] facility, we said it would be repaid by the end of the year. We are pleased that we repaid the line fully in Q3 and will not use it again this year.

Let's move to performance of our business units beginning with literacy on Slide 4 and I will turn the call over to Nick.

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Nicholas C. Gaehde, Rosetta Stone Inc. - Co-President & President of Literacy [4]

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Thank you, John, and good afternoon everyone.

Literacy bookings in the third quarter were a record $41 million, an increase of 21% versus the third quarter of 2018. To put this in context, this represents more than 85% of the total bookings we recorded in all of 2017 and more than double the full year myLexia joined the Rosetta Stone family. But as John said, we expected more in Q3. Revenue in Q3 in the literacy segment was a record $15.6 million, an increase of 18% over Q3 2018.

Literacy segment contribution more than doubled from $1 million to $2.1 million, relative to Q3 last year. The key to bookings and revenue growth in Q3 with continued improvement in the new sales performance for our core distribution channels along the strong dollar-based renewal rates. I will unpack each of these in a moment but first let me talk about the timing of bookings this year as it continues to evolve.

The third quarter is the season in which school budgets are released and it's critical to our growth. This year, however, we expect full year bookings growth to be positively impacted by bookings in both Q3 and Q4. In fact, based on business to-date in our current pipeline, we expect bookings in Q4 to be approximately 30% higher than in Q4 last year.

Why are we seeing more bookings growth in Q4 this year than in past years? First, we heard from many districts that the federal funding that supports schools of large low-income populations was released later this year than last, causing many schools to delay both new and renewal purchases. Secondly, as our business has grown, the volume of open deals at the end of the third quarter has grown as well. Many of these spilled into Q4 and are closing now.

Overall, I am pleased with the growth in our core markets and distribution channels. We've continued to penetrate our existing districts as well as the 60% of the market where we currently don't have a presence. Over the past 12 to 18 months, we invested in staff and marketing initiatives along with product and services to open up these targeted locations. We've been selective and focused on our approach, aware that while success can yield 6 or 7 figure contracts, the time to gain acceptance and win programs as well as overcome a [entrenched] competition is significant.

That said, we have made solid progress in places like New York City, Arizona and Virginia. Texas has proven to be more challenging, and although we have had district wins in that market and have grown new business in that state by over 40% this year, overall closed business has been less than we had hoped. Many districts in Texas have focused their initial adoption on filling traditional core print-based literacy curriculum needs and have deferred the selection of providers for digital blended learning solution like ours.

We're committed to the Texas opportunity and expect to see more success next year and the years following at districts address their supplemental curriculum needs. In all cases, we're confident that we can -- when we consistently demonstrate significant impact on student performance, these relationships will expand over time. Please turn to the next slide.

We have made progress growing our presence both in districts where we did not have customers and in districts where we have been able to expand based on the strength of our partnerships and the performance gains of the students we serve. In the third quarter, we saw an increase of over 35% in the number of new districts compared to the number of new districts in the third quarter of 2018. And even when we start with small initial purchase, it represents a toehold to expand in future years. There's more opportunity here. Please turn to the next slide.

The investments in our product portfolio enable us to expand our district penetration and also the lifetime value of our customers. This growth is achieved through multibuilding and multiproduct sales with the launch of PowerUp 2 years ago, we began to build our presence in middle and high schools. In 2 years, we have brought this solution for nonproficient readers to over 4000 schools. Please turn to Slide 7.

The growth in bookings in Q3 drove a 16% increase in ARR to $55.5 million. This growth was driven by an increasingly productive sales force with more solutions to offer and is shown through continued strong renewal performance in the third quarter. Retention rates are 88% while renewal rates were 102%. We are achieving rates in K-12 which are very strong even as our business has undergone significant growth and structural change. This speaks to the excellent value we deliver to our customers.

We conduct extensive analysis to understand the factors behind customers who don't renew their contracts. We see fewer larger accounts that do not renew with the majority of nonrenewals occurring among smaller accounts. That said, we are not satisfied if we lose any customers. We're confident that as we mature as an organization, we can do a better job of providing our customer success teams with the data they need to identify accounts that are showing early signs that they might not renew and then reestablish customer commitment and minimize the risk of cancellation.

Please turn to Slide 8. As we look to the end of 2019 and beyond, it's important to remember what we are building. The continued penetration of Core5 in elementary schools, the introduction of new products like PowerUp and the building of a national direct sales and service team have driven bookings growth, growth that has been compounding since 2014 at an average of 25% has almost doubled our business in 3 years. Now we need to do that again, please turn to Slide 9, and we can, because even as we grow, we remain underpenetrated in the markets we already serve.

We can triple the number of schools we're in just by fully penetrating all schools in those districts where we already have a presence. To make a difference in even more lives, we are going to make a large targeted investment in K-12 sales, marketing and service teams that support our customers. Please turn to Slide 10. Over the past 2 years, the size of our sales force has grown slowly, even as we grew bookings by almost 50%. While rec productivity has gone up, it will be approximately $1.2 million this year in hindsight as it's come at the expense of opportunities to grow our business more quickly with existing and new customers. This became clear to us as we were closing the largest Q3 in Lexia's history.

We have a capacity and structure issue, not a business opportunity issue. To rectify this and set the business up for strong sustainable and profitable growth, we'll take a number of steps. First, we're expanding the size of our field sales team. As importantly, to structurally build efficient capacity we'll be focusing field reps on bigger accounts and new business opportunities while investing in our inside sales teams with the capacity and skill to grow our large volume, smaller customers. This will be a high ROI investment getting the right people at the right level focused on the right accounts.

This is a step change investment that we will not need to repeat in the near future but is warranted given the scale of the opportunity in front of us. Please turn to Slide 11. We are confident in this investment because we have the solutions fundamental to the success from K-12. Portfolio world-class literacy products, and soon, a new product to serve the needs of English language learners, no other company has the deep experience and expertise to serve the needs of all students and to be the leader in literacy and language education. Next slide, please?

And these products address a big market with great societal needs; a need that is unfortunately highlighted in the recent release of the Federal government's NAEP scores, also called the Nation's Report Card. The 2019 scores for reading show an alarming decline of student proficiency where the average 8th grade reading score declined in more than half of the states compared with the average score in fourth grade declining in 17 states. The good news that this crisis is getting national attention.

Most importantly, we know from our 36 years' experience and deep portfolio research that we can be a powerful force to change these trends and provide students with the opportunity to succeed not only in school but in life.

For an update on the performance of our language business, let me turn the call over to Matt.

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Matthew N. Hulett, Rosetta Stone Inc. - Co-President & President of Language [5]

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Thanks, Nick. Bookings in our language segments totaled $40.5 million in Q3 with enterprise and education bookings growing $6.7 million, with 38% over Q3 last year driven by the $7.4 million long-term custom content deal we announced in early August, while consumer segment bookings were flat on a year-over-year basis.

Total revenues for the language segments were $29.9 million in Q3, an increase of 1% over the same period last year. Within this, consumer revenues were $15.8 million, an increase of 9% from Q3 2018 while E&E revenues, as opposed to bookings were $14.1 million, a decrease of 6% from Q3 2018. Consumer language revenues were negatively impacted in the quarter by a higher mix of long-term subscriptions than in the same period last year. These sales are attractive from an LTV perspective but have the effect of lowering in-period revenues as the bookings are deferred over a longer period of time.

In our E&E segment I would call out the improve performance of our enterprise business outside of [cuts done globally]. These bookings grew 5% in Q3 versus the same quarter last year, even as we transitioned existing customers to our new solution. Next slide please.

We formally announced the introduction of our new product to serve business customers, Rosetta Stone Enterprises earlier in Q3. This is the successor the catalyst made possible by the consolidation of our technology stacks that we discussed on the last call. It introduced notable functionality like proprietary standards aligned assessment test, unlimited access to live online tutoring sessions from highly trained tutors who are native speakers and our 7000 hours of beginning to advanced content. Corporate customers now have the most robust cross-platform learning product in the market. Lastly, it is important to note that we have completed the majority of our migration and deflashing work across our language platforms. We are excited to unburden the R&D team to build on what is already the best in class consumer enterprise language learning solution. Please turn to the next slide and I will walk you through consumer language performance.

As expected, consumer in Q3 returned to more traditional metrics and more profitable unit economics as results were not impacted by the brand marketing test expenses that affected second quarter results. Average initial sales price per unit increased to 102 on the strength of a greater proportion of long-term unit sales. LTV to CAC was 1.7. To be clear, this means our margin per unit after all incurred and expected future marketing costs was over 40%.

Couple this with the fact that the payback period is very short in media in the case of our long-term subs and you can see why this business is attractive. While the consumer business has stabilized on a bookings and revenue basis year-over-year, increased competition in our traditional performing marketing channels has increased the cost for paid media. You can see the compression of our customer acquisition efficiency in our per unit economics.

We have the best product in the market as evidenced by our high NPS and app-store rating. Our unrivaled 97% brand awareness is a rare competitive advantage that we have not yet built on as we transform product and pricing. We are evaluating our spend which has largely been focused on shorter payback cycles to include more longer term payback marketing cycles in 2020. Please turn to Slide 16.

What gives us confidence that this is the right strategy? We have the assets necessary for success. We have consumer and enterprise products that are the best in the marketplace. That was not true in either case just a few years ago and we have the tools to do more. As we lease platform consolidation behind us, we will accelerate innovation and take advantage of everything from our software to a decade of experience delivering virtual online tutoring on a global basis and supporting all of this is the best brand in the United States and one of only a few that could begin to extend globally.

I will now turn the call back to John.

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A. John Hass, Rosetta Stone Inc. - Chairman & CEO [6]

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Thanks, Matt. Let me now turn to guidance for this year and an initial look at 2020. Please turn to Slide 17. We began 2019 with goals of running bookings and revenues, improving adjusted EBITDA and becoming cash flow positive, all while investing in the future. We will accomplish each of these but our bookings growth has not been as strong as we expected for the reasons we discussed. We now expect bookings of approximately $71 million in literacy, or 21% growth over 2018. This is strong growth but leaves us short of our expectations. We expect total bookings of $126 million in language and consolidated bookings of $197 million; 9% higher than in 2018.

Because of lower expected bookings, we are lowering our year-end revenue guidance to $182 million. This is $1 million lower for literacy and $2 million for each of the language segments. Consolidated revenue is expected to grow 5% this year. We see upside to our prior guidance for net income and adjusted EBITDA and we continue to manage expenses but we are maintaining our estimate of a loss of $15 million, and adjusted EBITDA of $6 million. Both adjusted EBITDA and net income would be higher but for the fact that more of our R&D costs than expected are being expensed rather than capitalized. Capex is now expected to be $18 million, down from our prior guidance of $20 million.

Finally, we continue to expect to end the year with $42 million in cash and no debt. All of this is the start to the improved longer-term performance we expect and we want to make sure that performance is sustainable and backed by the plans and investments required to build intrinsic value. I also don't want guidance to be an impediment to our decision making or your confidence.

Please turn to Slide 18. Given the lower starting point and more competitive operating environment in U.S. consumer, we are revising our prior outlook for next year. We are providing this preliminary outlook today, give finalized guidance as part of our year-end [goal] in March. Our outlook for 2020 is the following features; accelerating growth in literacy and relatively flat expenses across most of the company with the upfront investment in K-12 sales and marketing and implementation services Nick outlined being the major exception.

Let me start with a walkthrough of our preliminary view of bookings and revenue. We expect literacy bookings to grow 25% to 30%; grew 21% this year. Because almost all K-12 bookings growth occurs in the second half, revenue growth will grow more slowly. We expect literacy revenue in 2020 in the range of $75 million to $78 million with 21% to 26% higher than this year; which is lower than our prior outlook in part because of lower starting point but our confidence in delivering these goals is high.

Growth will be driven by continued penetration of Core5 with increasing contribution from PowerUp. Our K-5 EL solution will add to growth in 2020 but we'll want to be conservative about its launch and may do things to enable its long-term penetration and maximize its intrinsic value such as using unpaid or partially paid pilots. In consumer language, given the current competitive unit cost dynamic, we want to be more conservative in forecasting our U.S. business.

At the same time we intend to thoughtfully invest in our brand and building top-of-funnel traffic and recognition of the new Rosetta Stone. Outside of the U.S., we have referred to our work in Korea has having higher risk. We remain excited about the opportunity for blended language learning there and Asia broadly but to derisk the outlook, have eliminated these revenues in our 2020 outlook. We expect slightly higher consumer language revenue in $64 million to $66 million in 2020.

In E&E language, we expect revenues to be down slightly as growth from enterprise is more than offset by a decline in education language as part of this business moves to the literacy segment. Total language revenues are expected to be approximately $117 million to $121 million in 2020. This is the largest change to the top-line relative to our prior 2020 outlook. On a consolidated basis, this produces revenues in 2020 of approximately $192 million to $199 million or 9% growth in the high end and total bookings of $210 million to $218 million.

Moving to investments and profitability, we expect to, again, hold G&A relatively flat in 2020. Total R&D including CapEx is also expected to be flat next year with the benefits of completing our platform consolidation language offsetting a small increase of Lexia. Sales and marketing as a percentage of revenues will grow in 2020 as we invest in our K-12 infrastructure to a sustained growth for the next few years. Since joining Rosetta Stone 6 years ago, the Lexia team has had an almost unblemished record in meeting its goals, compounding growth at 25% a year.

This year we had consistently high expectations and found that as we expanded, our ability to grow new business while serving the needs of thousands of existing customers exceeded capacity of our current structure. To address this, we are adding capacity by accelerating changes to make greater use of inside sales teams who efficiently target existing customers with smaller renewals in order to expand the capacity of our field team to target larger customers and new opportunities. We will make these investments while modestly improving EBITDA and cash flow by holding other expenses across the company largely flat.

In total we expect 2020 adjusted EBITDA of approximately $10 million in operating cash flow of approximately $20 million to $24 million with capital expenditures of approximately $18 million to $20 million. Because of the more conservative bookings outlook, this is lower than originally expected. Putting this in context, adjusting for bookings that we received from SOURCENEXT and custom content deals, operating cash flow in 2018 was $4 million. 2020 is expected to be an almost $20 million improvement in operating cash flow in 2 years. This is indicative of what we can do as our business scales.

As we look beyond 2020, we believe Lexia will grow bookings at a rate of 25% for at least the next few years. Remember, we are adding a new product to the portfolio. This would produce revenue growth in the low 20% range on an ongoing basis. Consumer E&E language should grow bookings and revenue in the mid to high single-digit rate before they offset from the movement of K-5 EL sales to Lexia. This outlook serves no meaningful contribution to the opportunities we expect to have to grow in new markets in both K-12 and consumer. We will leverage G&A in the investments we are making today in R&D and realize the scale benefit of the sales and marketing investment in Lexia. This will produce EBITDA and operating cash flow margins of 8% to 12% and 14% to 16% respectively. These are not peak margins. Operating cash flow margins should reach 18% to 20% then the business scales further.

Next, the filing of our shelf registration statement raised questions about how we think about managing capital and building value that I would like to address. Please turn to the next slide. So how do we think about capital management, building value for shareholders? Our goal is to maximize the intrinsic value of our business; something we have worked hard to do over the last 5 years through the restructuring of our language business and our investments in K-12.

We measure intrinsic value through the cash flow we expect to generate between now and a future period appropriate for each business or major investment. To do this, we look at investment opportunities independently to draw judgments and to the appropriate period over which value should be considered. In K-12, our ability to address large and difficult problems and grow customer accounts one-to-one has led us to consider investments over a longer period. Big market opportunities and the compounding returns available in K-12 are the drivers of the large multiyear investments we have made in products like PowerUp.

Why is this important in the context and shelf filing? First, internal investment has, and will continue to be, prioritized over acquisitions. We have the people and expertise necessary to build world-class literacy in language products and we prefer to build products in our platforms like myLexia and with our own technologies, many of which are patented or proprietary. Finally, we are aware of the price of our shares in the market. Ultimately, we manage intrinsic value on a per share basis; issuing shares for any purpose is considered in this context, especially when we are trading at a discount to the intrinsic value of the business we are building.

Consider our K-12 portfolio. Core5 is one of the most valuable solutions in education technology. It serves the largest slice of the education budget; teaching young kids to read, and achieves scale and is continuing to grow at a fast rate. Add PowerUp, which is new and only beginning to penetrate its total addressable opportunity, and then there's our forthcoming EL product. Today it is a very large investment, one of the largest in our history with no associated bookings but we look at the transformative product we were building, we consider that the fastest growing part of the school population consists of students learning English as a second language and we could not be more excited.

Investing in these products, while extensive, we're building the long-term sustainable intrinsic value. Does this close the door to acquisitions? It does not. We consider small [tuck-in] acquisitions as Lexia was in 2013 where we can leverage assets like our data platform, distribution and brand and could consider something more transformational but the bar is very high because the internal possibilities are great. Finally, in the future, there will be the opportunity to increase per share intrinsic value through the repurchase of our own stock at a discount to the value we see in our business.

As we have gone through the process of rebuilding our language business and investing into K-12, we have not had the balance sheet capacity to repurchase shares even if the price has been attractive. As our cash flow after internal investment grows and the seasonal low point of our cash balance increases, this capacity will increase and repurchase would become a consideration.

Next slide, please? Let me end with an invitation. In March we will hold our next Investor Day. What should you expect to learn? You will hear how we are changing lives and providing profound societal [good]. You will see demonstrations of exciting new products including our English language learning product, and predict it will blow you away. You will hear how we intend to build on our foundation as the literacy expert in K-12, to be the expert in literacy and language and you will hear how we will take greater advantage of the equity in the Rosetta Stone brand in new and exciting ways. We're excited to share our plans and look forward to seeing you in March.

With that, operator, could you please open the call to questions?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Alex Paris with Barrington Research.

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Alexander Peter Paris, Barrington Research Associates, Inc., Research Division - Director of Research and Education & Business Services Analyst [2]

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Chris Howe sitting in for Alex Paris. Lots of questions here, but in no particular order, your upfront investment that you're making in sales and marketing, can you talk more about this in regard to how are you balancing growth for new customers while not moving your eye off the ball when it comes to growth within existing accounts?

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Nicholas C. Gaehde, Rosetta Stone Inc. - Co-President & President of Literacy [3]

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Sure, Chris. I think that's a question for me. This is Nick. You know, obviously our customer base has grown substantially over the past few years and is made up both of large customer accounts and smaller customer accounts. One of the investments we are making in sales and marketing is to ensure that we are aligning the right cost structure with the right customer segment. We believe we can be more efficient serving those smaller renewals with one set of team members and then focusing other teams on those larger higher value accounts and so it's an expansion of our inside sales team to focus on those high-volume, low-value customers and expansion of our field sales teams to continue to drive those larger customers and new business forward.

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Alexander Peter Paris, Barrington Research Associates, Inc., Research Division - Director of Research and Education & Business Services Analyst [4]

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That's great. And next moving to margins, in the past you have mentioned the 40% of incremental revenue that will fall to adjusted EBITDA. Can you talk about this and if there's room for potential expansion opportunities whether that be through expense rationalization or future price increases?

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

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Yes. I think it's the biggest near-term opportunities in business mix. The highest incremental margin parts of our business are the B2B businesses, the school-based business and the enterprise business. As those businesses grow more quickly than the overall business, that will improve margin in and of itself. I think we've been very disciplined in terms of cost. We took $120 million out of costs a few years ago and have essentially kept most of those costs flat.

G&A has been flat now for a number of years and we expect it to be again. R&D has been relatively flat although there's been a shift in mix from language to literacy which we expect to -- the way we expect to see that continue next year now that Matt and the language team have completed their platform consolidation on the language side; we think we have opportunity to reduce costs there and innovate more but we believe that, especially with the launch of the new EL product next year that there is room for very high intrinsic value investment on the R&D side.

We are making a one-time investment in sales and marketing but frankly we're doing that in the context of still improving margins in the literacy segment. You know, we think we will grow bookings faster and we do believe we're setting ourselves up for longer-term growth with more efficient investment by, as Nick said, focusing the right people on the right accounts, higher value people in the field focused on the biggest opportunities.

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Alexander Peter Paris, Barrington Research Associates, Inc., Research Division - Director of Research and Education & Business Services Analyst [6]

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That's very helpful, John. And my last question relates to the challenges that you mentioned in Texas; their shift more towards the traditional Core print agenda. Just moving on this topic, can you talk about other states, other than Texas, that represent similar potential prior to the change in expectation in Texas on a relative basis that you see as open field opportunity for the company?

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Nicholas C. Gaehde, Rosetta Stone Inc. - Co-President & President of Literacy [7]

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Sure. So first of all, I think as we've spoken about in previous calls, we continue to work in Utah to expand that opportunity and we're thrilled with expansion of our Utah business which is a state-funded initiative this year where we continue to really drive significant performance gains and work with more and more schools and students. There are other opportunities that we have targeted this year based upon funding and based upon sort of opportunities that we see in specific markets like New York City and Virginia and Arizona where we were able to allocate sales and marketing dollars to those specific opportunities and saw, as a result, really significant growth there.

We believe that there are -- in the future to continue to target those higher-level opportunities as we've said before, you know, we've built a capacity at a higher level now where we're working at the state level identifying not only legislative changes but funding sources that previously we really were not participating in, and we believe that's an important part of our future growth strategy.

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Operator [8]

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Our next question comes from the line of Steven Frankel with Dougherty.

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Steven Bruce Frankel, Dougherty & Company LLC, Research Division - Senior VP & Director of Research [9]

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Nick, can we start with the bookings miss and maybe help me understand how much of that was not enough feet on the street, how much of that was Texas and how much of that was deals that slipped into Q4, just to help us kind of understand the phenomenon?

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Nicholas C. Gaehde, Rosetta Stone Inc. - Co-President & President of Literacy [10]

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Sure, Steven, yep, absolutely. So I'll start with Texas where obviously as we've spoken before, there was a lot of funding in play because of the reading adoption. That is an 8-year funding cycle so there is still a lot of opportunity in Texas. We had higher expectations, even though we did grow 40% in that market this year. We had higher expectations and part of that, I think, is due to the fact that some of the big publishers really did grab a lot of the adoption dollars for Core curriculum up front and now we are focused on continuing to execute in Texas because we see it as a, continue to see it, as an opportunity but that's going to come a little slower and we're seeing a strong pipeline for 2020.

So that was part of it. The other part is, as you know, we've invested in some of our higher-level sales activities working at the state and large district level. We have high expectations there and continue to have high expectations but they're taking a little longer to materialize than we had thought. And then the third part was not necessarily feet on the street out in the marketplace but more having, as I said before, the right teams focused on the right segment of the market. It's just as we've grown, the volume of deals has expanded considerably and we have a structural issue that we're now focused on solving and I think have a good clear strategy on how to solve to make sure that we can do a better job of managing that high volume, low-value business in the future. So hopefully that answers your question?

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Steven Bruce Frankel, Dougherty & Company LLC, Research Division - Senior VP & Director of Research [11]

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All except for one piece which is, help me understand the dynamic of delays in Federal funding leading to deals getting pushed to Q4 because normally you -- I wouldn't expect Q4 bookings to be up 30% plus. I would have expected them to be up less.

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Nicholas C. Gaehde, Rosetta Stone Inc. - Co-President & President of Literacy [12]

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Yes. Great question. So the Federal funding we're talking about is specific to Title 1 which is focused on low-income populations and it did drop later this year, not necessarily to states but from states to districts and so we heard from a lot of the schools that we were working with that they didn't have the funding allocated at the district level yet and we're starting to see some of those deals closed now which is a lot of what's driving the higher growth in Q4 along with the overflow from Q3 in terms of the volume of activity that we're now closing.

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Steven Bruce Frankel, Dougherty & Company LLC, Research Division - Senior VP & Director of Research [13]

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Okay. And then the notion of let's take ESL out of the guidance for 2020, how much of that is driven by your de-risking, how much of that is, well, we're trying to sell a new product with a new sales force and it's a new category and maybe it starts slower than you thought 3 months ago?

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Nicholas C. Gaehde, Rosetta Stone Inc. - Co-President & President of Literacy [14]

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Yes. So we are being conservative about the new EL product. It doesn't launch until back to school season and so we are missing, as we knew we would, the first half of the year from a selling cycle standpoint. But we're really excited about the future of the product; so much so that we're being aggressive about some of the things we need to do to pave the way for acceleration in future years like unpaid pilots and partial pilots, really focused on seeding the market because there is such a huge opportunity and this is such a unique and innovative product.

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Steven Bruce Frankel, Dougherty & Company LLC, Research Division - Senior VP & Director of Research [15]

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Okay. And switching to Matt's side of the business, this is the first time I heard you really talk about competition. So maybe talk about what changed there and what prevented the LTV to CAC ratio from -- while it improved sequentially, it didn't get back to 2x which is what's been more than typical for you.

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Matthew N. Hulett, Rosetta Stone Inc. - Co-President & President of Language [16]

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Yes, just broadly I'll talk about the competitive situation and then get to the economics. The competitive situation is something we haven't talked about before and, you know, at a macro level, variable marketing year-over-year is actually slightly declined while we've had more increased pricing competition on things like cost for install, CBC and traditional performance marketing metrics. And this has been the more pronounced Q3. We've seen a lot of seasonality and a lot of spend but it's been more aggressive than what we've seen in the past and so we're calling that out because, as you know, the majority of our variable marketing spend has been performance-based meaning bottom of the funnel, people who specifically want to learn a language and happen to know the Rosetta Stone brand.

We have pretty much maximized our efficiency in that channel and we've learned a lot from our brand test and we have a lot more competition in that space and so we wanted to [flag] our outlook in the future for that headwind but also state the fact that we're very confident we have a well-known brand and we haven't flexed those brand variable marketing muscles before. So in short, it's gotten more competitive but we're very confident we have a brand that, A, customers really enjoy the products from and, B, understand the value from that product.

And then specific on unit economics, there was a decline year-over-year on the LTV side primarily due to pricing within trying different pricing and testing concepts in terms of trial which lowered LTV year-over-year. We kept unit economics the same for CAC but didn't generate net incremental LTV due to the pricing competition. So on a sequential basis, you'll see LTV generally flat and year-over-year you did see a decline.

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Steven Bruce Frankel, Dougherty & Company LLC, Research Division - Senior VP & Director of Research [17]

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Okay. And the decision to take worldwide English out of the forecast for next year, what have you learned in the last 3 months about that product and does it make you see it as more of a risk and less of a product that you think will work?

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Matthew N. Hulett, Rosetta Stone Inc. - Co-President & President of Language [18]

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Yes. We've said in previous calls that that investment is very speculative and we flagged that in the past. We thought we'd be conservative in our outlook to take that out of our outlook. We're very excited about Asia, we've learned a lot from that product. We're very bullish on what we call adaptive blended learning; marrying software with tutoring in our software. But we thought at this point it would be best and more prudent to take that out of the outlook to reset expectations.

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Steven Bruce Frankel, Dougherty & Company LLC, Research Division - Senior VP & Director of Research [19]

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Okay. And then John, one more question on this notion of resetting expectations. You know, going from the prior $20 million in EBITDA for 2020 to $10 million, pretty severe cutback, kind of -- maybe walk us through what the deltas are there?

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A. John Hass, Rosetta Stone Inc. - Chairman & CEO [20]

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Sure. It's about a third lower starting point. So over the course of the last of -- a little bit last quarter and then certainly in this quarter, we have reduced our bookings outlook for this year and we've gone through that in detail so we have a lower starting point and those bookings turn into revenues, you know, certainly a little bit this year but mostly next year. I think we've been reflective of that in looking at our guidance for next year; particularly on the language side. I think we've -- when we've brought the literacy guidance down, it's still 25% to 30% bookings growth which, we think, is very healthy; also very achievable especially with the launch of a new product and, as we talked about, the overall momentum that we're seeing in the business.

But, you know, look, I really don't like having the phone call where we have to lower guidance and I'm not suggesting that we've added cushioned to next year in any significant way but we want to reflect the reality that we're seeing which is the wanting to be a little more conservative on the K-12 side in the increased competitive dynamic that we're seeing in U.S. consumer, specifically; and I think we feel really good about it. The outlook for the enterprise business we feel really good about.

Lexia -- but, U.S. consumer until we can change the dynamic in that business, we are going to be disciplined allocators of capital. We think that is the right thing to do. We're not going to -- we aren't going to spend our way into revenue growth in that business, we're going to [run] that business to be as profitable as we can. We believe there will be opportunities to change the dynamic but we're not imagining those in future forecast; we're going to prove it first and then deliver those numbers.

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Operator [21]

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(Operator Instructions) Our next question comes from the line of Eric Martinuzzi with Lake Street Capital Markets.

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Eric Martinuzzi, Lake Street Capital Markets, LLC, Research Division - Head of Research & Senior Research Analyst [22]

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I wanted to follow-up on the literacy bookings; the shortfall in Q3. I think I've got it here that you've kind of boiled it down to 2 major items and I can follow the slightly slower release of the Federal dollars at the state -- from the states to the district. But I was -- I'm still struggling with the deal process -- you know, I'm writing fast here but, I was trying to capture it in the deal -- under deal processing volume. Is that to say that you had the pipeline there but didn't have the ability to process it by quarter end or is it something else?

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Nicholas C. Gaehde, Rosetta Stone Inc. - Co-President & President of Literacy [23]

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Yes, no the pipe -- that's a great question Eric. The pipeline was there, it was just a matter of a lot of smaller deals and the ability of our salespeople to be on top of that kind of volume. Ultimately, as we said, it's a structure issue that will be solved by segmenting our sales teams a little more carefully and aligning the right teams with the right cost structures to the right market segments but it really was a spillover of high volume into the fourth quarter which, as we said, is driving some of the growth in the fourth quarter that we typically don't see.

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Eric Martinuzzi, Lake Street Capital Markets, LLC, Research Division - Head of Research & Senior Research Analyst [24]

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Okay. And then as a follow-up to that, how can we -- what metrics can we observe or are you guys looking to capture to show that your -- you've improved there? In other words, hey, we're going to hire ten inside sales reps and we currently have 3 or we're going to process X number of deals per week and advance at quarter end so we don't have a log jam. What are you doing, what have you changed, as far as the operational aspects of that pipeline…

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Nicholas C. Gaehde, Rosetta Stone Inc. - Co-President & President of Literacy [25]

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Yes. So we will be adding capacity both to our field sales teams to make sure that we're continuing to drive that new business and those larger accounts with the right people and then I think, more importantly almost, we're building a stronger inside sales presence. And so making sure that we can take the high volume renewals less strategic business off of our account executives place and putting it on the plates of the inside sales teams that I think are better positioned, better capable of driving that high volume, low value, business.

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Eric Martinuzzi, Lake Street Capital Markets, LLC, Research Division - Head of Research & Senior Research Analyst [26]

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Yes, that's what I was looking for. Are you comfortable sharing metrics with us, the numbers of what you had on September 30 and what you hoped to have December 31 or March -- how will we be able to measure your progress and executing that plan?

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Nicholas C. Gaehde, Rosetta Stone Inc. - Co-President & President of Literacy [27]

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Yes. I think we're not sharing those details yet. I think Investor Day is going to be the right place for us to share an update on our channel strategy and some of the changes we're making and investments we're making at that level of detail.

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Eric Martinuzzi, Lake Street Capital Markets, LLC, Research Division - Head of Research & Senior Research Analyst [28]

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Okay. And then as I look at the -- Slide 7 is the slide that you have that covers the retention rates that you see there on the literacy side and it's been in a bit of a downtrend, could you remind me, you mentioned a couple of items but what's the key driver there aside from what we just covered? If that's all it is then I guess I've answered my own question but, is it simply the processing here because it doesn't seem like it's just a Q3 issue, it seems like it's been an issue that's perpetuated for a few quarters now on the retention rates?

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Nicholas C. Gaehde, Rosetta Stone Inc. - Co-President & President of Literacy [29]

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Yes. I think it goes hand-in-hand with the volume of the business. So we talked about one thing which is the structure of the sales channel. The other thing that we are doing is taking the incredibly rich data we have about our customers and equipping our customer success team with better health data about those accounts and so our ability to identify accounts that look like they are tailing off in terms of engagement early and to reestablish that engagement I think is going to be improved by giving those teams that health data and so we have already started to do that and we're excited about how that's going to impact the business and retention rates in the future. But I'll also say that these are still really strong retention rates and very strong renewal rates which we are excited about and speaks to the value we're delivering and the satisfaction of our customers.

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Eric Martinuzzi, Lake Street Capital Markets, LLC, Research Division - Head of Research & Senior Research Analyst [30]

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Okay. And then switching, shifting, over to the language side, just the -- if I can get a layer deeper there, where are you finding the greatest challenges coming from in the U.S.A. consumer side, if you could name those competitors or to the extent that you've got insight there would be helpful?

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Matthew N. Hulett, Rosetta Stone Inc. - Co-President & President of Language [31]

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Yes. There's a number of paid competitors that had entered the market rather aggressively and I think they're the usual suspects. Most of the competition that we see is in the traditional paid performance channels you'd normally see. One aspect, as John mentioned, I wanted to reinforce in his previous statements, was that we're going to be very measured and disciplined in terms of how we deploy variable marketing dollars in our variable marketing playbook and I would say that, you know, the traditional competitors in the performance marketing space have had us think about headwinds in terms of our spend.

But in particular, the folks that are venture capital based and are private have certainly entered the space and deployed a lot of capital both in offline market and online marketing and I think you could point to some of the more obvious ones like Babble who's been very aggressive in their paid subscription variable marketing campaigns.

So you know, we're going to, again, be very balanced in how we view the world. Year-over-year our marketing spend has been down from a variable marketing perspective and we're going to look to reallocate capital to flex some of our brand muscle in a very measured way.

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Eric Martinuzzi, Lake Street Capital Markets, LLC, Research Division - Head of Research & Senior Research Analyst [32]

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Okay. I'll leave it there. Just an editorial comment, you do have -- I think you've taken difficult medicine this quarter as a team that it is very much an expectations game in the stock market and hopefully we've reset ourselves here to a point for 2020 where we can meet or exceed because there are so many attractive aspects to the business. So I'll leave it there.

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A. John Hass, Rosetta Stone Inc. - Chairman & CEO [33]

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Thank you, Eric, and frankly I think that's a very good way to close. I think those comments are appropriate and we look forward to meeting and exceeding your expectations in the future; maybe in exceeding our own. Obviously, this is critically important to all of us as managers of your capital and your trust. So thank you for joining us tonight and we look forward to speaking with many of you going forward.

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Operator [34]

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Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.