Rosetta Stone Management Discusses Q2 2013 Results - Earnings Call Transcript

| About: Rosetta Stone (RST)

Rosetta Stone (NYSE:RST)

Q2 2013 Earnings Call

August 07, 2013 4:30 pm ET

Executives

Steve Somers - Vice President of Corporate Development, Investor Relations & Treasury

Stephen M. Swad - Chief Executive Officer, President and Director

Thomas M. Pierno - Chief Financial Officer and Principal Accounting Officer

Analysts

Jeffrey P. Meuler - Robert W. Baird & Co. Incorporated, Research Division

Peter P. Appert - Piper Jaffray Companies, Research Division

Matthew J. Kempler - Sidoti & Company, LLC

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

John H. Lewis - Osmium Partners, LLC

Operator

Greetings, and welcome to the Rosetta Stone Incorporated Second Quarter 2013 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Steve Somers. Thank you. Mr. Somers, you may begin.

Steve Somers

Thanks very much. Good afternoon, and let me welcome you to Rosetta Stone's Second Quarter 2013 Earnings Call. I'm Steve Somers, Vice President of Corporate Development and Investor Relations, and I'm joined today by Steve Swad, Rosetta Stone's President and CEO; and Tom Pierno, our CFO, to discuss the operations and financial results for the second quarter and our outlook.

In addition to our commentary, we have made our 2Q '13 earnings results press release and the slide deck supporting this webcast available on our IR website at investors.rosettastone.com. Please review them to find important additional information.

There are or will be forward-looking statements in our press release, slides and conversation today. We offer these statements under the Safe Harbor provided by U.S. law, of course, risks and uncertainties attached to any forward-looking statement. A detailed discussion of such risks and uncertainties is contained in our Form 10-K for the fiscal year-ended December 31, 2012, filed with the SEC in March 2013, which is available in the Investor Relations section of our website. We ask that you review those risk factors before making any investment decision. Please note these forward-looking statements reflect our opinions only as of the date of this presentation, and we undertake no obligation to revise or publicly release the results of any revision to the forward-looking statements in light of new information or future events.

We also use non-GAAP numbers in our presentation. The definitions of those numbers and their reconciliation to GAAP numbers are available in today's press release, on our website and as filed with the SEC today on Form 8-K. Now here's Steve.

Stephen M. Swad

Thanks, Steve, and welcome, everyone. I would characterize the second quarter as another solid quarter where we showed steady progress against our strategy, and we took meaningful actions to improve future results and move us closer to our 2015 targets.

Before elaborating on the quarter, let me just highlight where Rosetta Stone is today and what the main areas of focus are moving forward. As you know, we are currently in the midst of transforming Rosetta Stone. For over a year now, we've talked regularly about 3 strategic areas of focus: leveraging the brand, innovating the platform and expanding distribution. As each quarter has passed, we've been putting more definition around these focus areas and executing against them. Specifically, we're accelerating our shift to the cloud. We are investing in a platform to power the delivery of learning content. We are investing to deliver innovative products with an emphasis on mobility by leveraging the iOS and Android ecosystems. We are putting more resources into our Institutional segment, which we recently renamed Enterprise & Education or E&E for short. And we are focused on improving our financial profile. Furthermore, we are taking advantage of our strong balance sheet to make strategic acquisitions to enhance our opportunities. These efforts are all geared to deliver on our 2015 goals of $400 million plus of revenue with low double-digit operating margins. With that backdrop, let me talk about the second quarter.

Overall, top line core bookings were up high single digits, as we grew our consumer DTC business and retail business by leveraging our online marketing and deepening our distribution through partners such as Groupon, Facebook, Amazon and now Brookstone, which has joined as a distribution partner in Q2. Our core E&E business was up only modestly, but we believe the investments that we are making in people, products and systems has positioned us for more growth in the back half of the year.

On the international consumer side, the top line declined again, but there are improvements being made and some bright spots. The rate of revenue decline has slowed to less than half of what it was in Q1, and we are seeing positive results out of Germany, as well as small but directionally positive gains in the Korean proctor channel. And finally, Japan is starting to show modest improvements but still slower than we would like. Overall, I see pockets of positive activity, but international consumer needs more time before turning positive in the aggregate.

We made a number of operational decisions this quarter that reflect the transformation that we are carrying out. We closed our remaining U.S. kiosks and shifted those resources to more productive channels. We again made adjustments to our product development team, and we continue to make progress on new products that we expect to launch in the second half of this year. Specifically, we will have a product for intermediate learners of business English that will be sold through our corporate E&E vertical, and we will be introducing a few new kids apps.

The second quarter also saw us push further into more mobile applications with downloads of our recently launched travel apps and a taste of TOTALe now exceeding 300,000 in just 3 months. These apps are proving to be a new way to find customers interested in spending money to learn a language.

We also acquired Livemocha on the first day of the quarter, accelerating our push into the cloud with its robust platform and 16 million member base. With respect to Livemocha, I'm pleased with the progress being made. We fully integrated the technology team into our product development group. We've moved some of the G&A functions into Rosetta Stone's infrastructure, and we've had some earlier-than-expected success selling TOTALe to Livemocha's community, particularly in the U.S. Importantly, we've already begun to leverage the Livemocha platform, which will power our new business English product.

While Livemocha represented a nice first step to accelerate our technology platform, the recent acquisition of Lexia Learning is our first extension beyond language learning and a natural move into the adjacent reading space. Lexia is one of the leading reading technology companies and will help take Rosetta Stone deeper into the K-12 market. I've talked to you in the past about wanting to develop a robust kid's business and bolster our E&E business. Lexia checks both of those boxes and grows our E&E business to over $80 million annually.

In addition to those reasons, I'm excited about this acquisition because we have acquired the right product at the right time. Lexia's new Core5 reading program was just launched on July 1 and was developed to specifically address the common core of state standards. It goes beyond remedial solutions and is a true learn-to-read product that is suitable not only for struggling readers but also for the general student population. With Lexia's expertise, we plan to extend into the consumer market with a suite of best-in-class reading products and take both the school and consumer solutions to other international markets.

The digital reading market represents a large and growing opportunity, and we've got the right team to take advantage of that opportunity. Longer term, I expect the booking from Lexia's products to grow to over $40 million or 2x the 2013 projected bookings and that we could see margins for that business rise to low- to mid-teen percentages. We anticipate that the growth will come from a growing market for digital reading products, increased student penetration, higher sales productivity and higher recurring revenues from a shift to a subscription model. Although financial results in 2013 will only be neutral on a cash flow basis for Lexia, I am very optimistic about the value that Lexia brings to Rosetta Stone.

Even with the addition of Lexia, we're still planning on introducing additional kid solutions for the consumer market this quarter. These products will introduce kids to the world of Rosetta Stone through apps and taken together with Lexia, create the beginning of a strong kid-focused franchise.

So overall, I continue to be pleased with the progress we're making. We believe that with a market-leading brand and experienced management team and a modern technology platform, we earn a position to further penetrate the large global market for language and learning in general and that we have the products and the multiple outlets to realize the growth opportunity.

Before turning it over to Tom, let me say that I remain comfortable with our 2015 objectives of $400 million plus of pro forma revenue and 10% to 13% pro forma adjusted EBITDA margins and that the company remains focused on executing toward that end.

Now let me turn the call over to Tom.

Thomas M. Pierno

Thanks, Steve, and good afternoon, everyone. Financial results in the second quarter reflected the continuation and progress of trends that we have seen over the last several quarters with mid-single-digit consolidated bookings and revenue growth in our core business, improved margins and growing adjusted EBITDA. With the many actions we have taken over the 1.5 years to transform the company, comparisons to historical results have gotten more complicated. With that in mind, we will be discussing our results to reflect the underlying dynamics of the current state of the business, and as Steve Somers mentioned at the outset, we have provided a slide deck, which depicts some of those trends.

That being said, let me start by discussing core bookings. Total core bookings, which we define as bookings before discontinued North America Consumer kiosks and E&E network sales increased 7% to $62.3 million in the quarter with growth in North America Consumer and our Enterprise & Education segment. Within our North America Consumer segment, core bookings, which exclude the kiosk channel, were up 15% to $38.7 million year-over-year driven by 10% growth in DTC and over 30% growth in retail. Growth in DTC benefited from cross selling to our recently acquired Livemocha member base and sales through Facebook, while the sharp growth in retail was driven by sales to Groupon, reflecting our continued emphasis on digital channels.

Reported North America Consumer bookings were $39.3 million, up 5% from a year ago. On the revenue side, reported revenue increased 8% to $39.9 million, while core revenue, which again excludes the kiosk channel, increased by 18%.

Within our Rest of World Consumer segment, bookings declined by 15% or $1.2 million to $6.9 million. The positive note here is that the rate of bookings decline slowed to half the rate experienced in the last 6 months. This was due to over 60% growth in Germany, as 2Q was the first quarter since 2011 that was not impacted by the absence of hard product sales in Germany from a comp perspective and smaller declines in each of the U.K., Japan and Korea operations. While we have yet to turn the corner internationally, we are managing the business better and are encouraged by the improvement in the quarter.

Turning to volume and pricing. Consumer product units sold increased 15% to 149,000 units in the second quarter, while average revenue per unit or ARPU decreased 14% to $275 from $319. The increase in units reflects introductory sales from cross selling to our Livemocha member base, as well as sales from online partners like Groupon, while the decrease in pricing reflects the impact of promotional pricing in the quarter, as well as channel mix shift with more sales coming from online offers through daily deal partners like Groupon and Amazon and the absence of sales through the higher ARPU U.S. kiosk channel, which we closed down in April.

Our product unit metrics include sales of digital downloads, which in the second quarter were almost 15% of the total. Paid online learners grew 75% over last year to over 85,000 at the end of the quarter and had monthly ARPU of $25 per month, which is in line with monthly ARPU for the last 4 quarters and reflects lifetime revenue of approximately $300 consistent with that for our product units.

Taken together with digital downloads, revenue from paid online learners and downloads made up approximately 25% of the $47.4 million of consumer revenue in the quarter. This is up from 20% in the first quarter and compares to just 9% a year ago, reflecting our strategy to offer expanded purchasing and delivery options to meet the shift in buying preferences and behaviors of our customers.

In the Enterprise & Education segment of our business, reported bookings were down 4% in the quarter to $16.9 million, but core bookings, which excludes $1.6 million of network product in 2Q 2012 that we have deemphasized, grew 4%. Subscription bookings were up slightly year-over-year, while the renewal rate on our larger managed accounts remain better than 80%.

We experienced growth in our North America corporate vertical and continued to see gains in our small but growing international E&E business. Reported E&E revenue in the quarter decreased 7% to $14.7 million, but core E&E revenue was up 2%. In addition to the reported 2% top line revenue growth that we reported in the quarter, we again grew adjusted EBITDA meaningfully, making further progress towards our 2015 goal of double-digit adjusted EBITDA margins. Adjusted EBITDA increased by 148% to $2.8 million from $1.1 million, a year ago. While margins increased approximately 265 basis points to 4.5% from 1.8%, a year ago. The expansion of margins was driven by a combination of improvement in gross profit and lower sales and marketing expenses, partially offset by higher R&D and G&A expenses. Gross profit benefited from the continued shift to online offerings, further cost management of hard-product box costs and lower studio coaching costs, all of which helped to lift gross profit margin 200 basis points to 84%.

R&D increased by $2.6 million year-over-year, reflecting the continuing emphasis on new product and platform development, which we have said is a primary focus for us this year.

Sales and marketing expenses decreased by $2 million, reflecting marketing efficiencies and lower expenses from the kiosk channel compared with a year ago. As a reminder, we closed the remaining 56 kiosks in the U.S. in April and ended this quarter with just 20 kiosks all located in Asia compared to 99 kiosks at the end of 2Q 2012.

General and administrative expenses increased by $700,000 due largely to the addition of Livemocha in the quarter. So even as we increased our investment in product and added additional expenses related to Livemocha in the quarter, we were able to still grow margins significantly. Adjusted EBITDA includes $2.5 million of add-backs, mainly related to severance and lease termination costs associated with the shuttering of our U.S. kiosks and costs associated with the Livemocha acquisition.

We ended the second quarter with $132.1 million of cash on the balance sheet or approximately $6 of cash per share compared to $139.4 million at March 31, 2013. The decrease in cash was due to our acquisition of Livemocha, offset by a modest increase in working capital. Deferred revenue increased by $11.6 million to $61.6 million in the quarter compared to last year and by $1.7 million sequentially. CapEx in the quarter was $1.7 million, and free cash flow was $800,000 compared with $2.4 million, a year ago.

As Steve mentioned at the outset, we completed our acquisition of Lexia on August 1 for $22.5 million in cash. At the time that we announced our agreement to acquire Lexia, we provided updated guidance to reflect the addition of Lexia to our results for the remaining 5 months of 2013. Because the acquisition is subject to material purchase accounting adjustments, we are going to discuss guidance in future results on a pro forma basis, excluding the impact of Lexia's purchase accounting on those results.

With that being said, the guidance for Rosetta Stone's business before Lexia remains unchanged from what we issued at the beginning of the year, which called for revenues of $280 million to $290 million and adjusted EBITDA of $16 million to $18 million. With the addition of Lexia, we expect pro forma revenue to be between $287 million to $298 million and pro forma adjusted EBITDA to be between $14 million and $17 million. This guidance reflects the contribution from Lexia of $7 million to $8 million to pro forma revenue and negative $1 million to negative $2 million to pro forma adjusted EBITDA.

While we don't guide to cash flow as a metric, I would reiterate Steve's earlier comment that while 5-month pro forma adjusted EBITDA contribution from Lexia is negative, on a cash basis, we expect Lexia to be flat to positive to Rosetta Stone for the balance of 2013 and cash flow positive in 2014, reflecting our enthusiasm for this business.

For the second half of 2013, we are expecting an acceleration of growth in our E&E business, combined with continued single-digit growth in our core North America Consumer business. We also expect our third quarter pro forma adjusted EBITDA, before the addition of Lexia, will be flat to slightly up year-over-year due primarily to increased product development investment and lower expected daily deal activity. Including Lexia, third quarter pro forma adjusted EBITDA will be down year-over-year.

With that, operator, we are ready [Audio Gap]

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Jeff Meuler with Baird.

Jeffrey P. Meuler - Robert W. Baird & Co. Incorporated, Research Division

With core -- can we think about, once we get through 3 more quarters of things the way that they are and fully anniversary the closing of the kiosks and the discontinuation of the license sales for the Institutional or, I guess, E&E channel, that the current core will then be kind of the headline reported results or are there still some things that you guys are doing in terms of pruning the low-calorie spend and it'll take a little bit longer to kind of have an apples-for-apples core versus reported number?

Stephen M. Swad

Jeff, this is Steve. No, I think you've got it. And in fact, that's why we're presenting it the way we are, so you could see what we think of as the core part of the business. And as time passes, that will be our base going forward.

Jeffrey P. Meuler - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then how do you guys think about the cost of customer acquisition for the paid online subscription users? And I ask that because it sounds like the expected lifetime revenue for them is actually higher than the average ARPU for the box product at this point, and I would think the gross margins on that are higher. So how do you think about cost of customer acquisition there?

Stephen M. Swad

Yes. Good question, Jeff. I agree with your statements that we're seeing some decent trends in lifetime value, and I also agree that delivery costs are lower, and so the margins on that business are better and more robust, like what you would expect as the company transformed to digital. We don't have great data on separating like entries into our website in the box sales and into online subscription sales. And so it's hard for me to answer.

Thomas M. Pierno

We actually -- we pretty much cast the net wide right now and then give the customer choice. And so we spend money to basically drive people to the website, and then they're presented with choice. And so it's very little right now that we're doing standalone for just our subscription product, and that's one of the things that we've been trying to consciously do now as we test our way into this, is kind of let the customer at this point kind of need our transformation, and so far, we've been pleased with the take rate.

Stephen M. Swad

We do -- just one little footnote to that. We do -- we sniff on how you come to our website and then we're always testing how to optimize that. And if you come to us on a tablet, you should see our TOSUB [ph]offering, our online offering first. And of course, our tablet traffic is increasing. But Tom's point still holds. I just wanted to know that we do have some sophistication in the way we deliver message based on how you come see us.

Jeffrey P. Meuler - Robert W. Baird & Co. Incorporated, Research Division

I think last quarter you said that you'd be disappointed if you didn't get another one done. But for the 2015 financial targets that you reiterated at the time of the Lexia transaction, do they incorporate additional M&A? Or could you get there without additional M&A?

Stephen M. Swad

Jeff, we set those targets and then we execute operationally with the assets we have against those targets. And then we look at M&A to be opportunistic to accelerate growth. I would expect M&A to continue in some form, and I've been pretty clear on that because I think it's helping us create value. And so I -- in this business, there are puts and takes. I think the international business is slower than I thought it would be when I set those goals. I think the U.S. business is stronger than I thought it would be. I don't -- I think you should assume some M&A in that number but also recognize that there are puts and takes and a lot of drivers in the core business as well.

Operator

Our next question comes from Peter Appert from Piper Jaffray.

Peter P. Appert - Piper Jaffray Companies, Research Division

So Steve, you got a lot of stuff in the works here and making it a little more challenging to think about the performance of the company. So is it possible for you to highlight the products or applications that you'd really call out to us that we should focus on where you think the revenue opportunities is most interesting or dramatic and maybe the scale of the opportunity in some of these things? And I'm thinking about, for example, the children's applications for example.

Stephen M. Swad

Yes. Let me hit a few of them. Let's start with the E&E business. And we're investing in that in -- we started investing in systems over a year ago, and then we invested in the renewal side of that business with some people, and we're actually investing more behind systems there. And then I mentioned that we're -- we started the hunter/farmer model, so again, a different way to focus on new business, so investment around systems and people. And now what we're doing is adding product to that core platform, and that's coming in 2 ways. It's coming through this business English that is intermediate, and we're going to push that initially through the corporate channel. And then, I think it'll go into the education channel through ELL and then -- or through higher ed. And then it'll go international, and then it'll come into the consumer markets around Hispanic. And so -- but -- so E&E, we're investing a lot in. I said that -- and then we also just bought a company called Lexia. So I see that business, that $80 million, and I see the annual run rate, that's actually $80 million plus. And I see the dynamics of that business getting more online. So it's 95% digital, and we're getting better at the renewals. And so I see the dynamics of that business changing, and I see us continuing to invest. On the consumer side in the U.S., a couple of things. We're moving to digital, and the earlier question that Jeff had kind of highlights that, which does nice things to the way you can deliver that business. And you can -- you should be able to get efficiencies around that. And it's also -- it moves the business into -- it moves the product into something that's going to be around for a long, long time. And so I see that as a key initiative. And as you point out, we are investing behind kids. This -- I think of it as a suite of kids products, and we are in the beginning stages of this kids franchise. I'm really pleased with the Lexia acquisition that, that should provide us both depth and breadth. We're going to have a market-leading product in the K-5 space. We're going to bring that product into the consumer space with time, and that'll become part of this kids franchise that I'm messaging. We're also going to bring that product internationally to kids. We've got a growing proctor business in Korea, and we see that reading product fitting nicely into Korea. And I mentioned that I see the Lexia business doubling over -- I didn't give a time, over the medium term. And I think kids though starting out slow, Peter, but then growing. And we're going to -- these first couple apps were in test mode, we're going to get feels for what engages younger children, and then we're going to build around that. And so I expect you to hear from me around kids even as we go into 2014. We certainly -- certainly, in our next call, I'll have more specificity about what we've released, and I'll be able to give you a progress report.

Peter P. Appert - Piper Jaffray Companies, Research Division

What specifically, in the corporate English market, I would think that would be, by itself, a fairly significant end-user market. Is it possible to put any specific numbers around how big you think the revenue opportunity for you could be from that?

Stephen M. Swad

No. I don't feel so comfortable on that. I think near term, we're -- think single-digits millions, but then I see that growing at a rapid pace to double-digit millions. And then as we go global with it, I think it even gets bigger. And Peter, to me what this does is it allows us to play in a space that we're not playing right now. As you know, our products are beginner products. And so, I see this as, as all brand-new where we should be able to take existing customers and upsell them, and then get into new customers because we've got products that fit their needs. So I like what I see.

Peter P. Appert - Piper Jaffray Companies, Research Division

How about on Lexia, that's a certainly very interesting product, but the concern might be that it's subscale relative to the market. Did you have the marketing clout to sell it? Do you need to do more -- I mean this is sort of a follow-on to the prior question I guess. Do you need to do more from an M&A standpoint to really get the scale in that market?

Stephen M. Swad

I love Lexia. To me, it's a bulls-eye strategically. I've been telling The Street that I was looking for assets that could use a little help. And this asset is beautiful, it's well designed. It's got tremendous research supporting its efficacy, and it is well-known in the K-12 space. And so, we're going to help in the K-12 space, but they're well on their way, and we're going to help with some selling infrastructure and things. But we're going to just invest behind them and let that product make its way through K-12. Interestingly though, I see it coming to us through our Korean channel, as I mentioned, and also our home school channel, and then just regular old consumer channel. This is a tight adjacency to language. You could think of this as a way to learn English. It happens to be just through reading. So I find it to be a beautiful adjacency in one, where with our brand and our marketing muscle and the amount of traffic that comes to our website right now, I feel like we could bring things of this company that it couldn't have done on its own. And importantly, they're bringing to us, Rosetta Stone, things that we couldn't do on our own. In the short time we've owned them, the discussion we've had about how children learn has been extremely robust. And I'm just pleased to have that talent join the Rosetta Stone family. I think it's going to be good things to the company, its shareholders and its customers.

Peter P. Appert - Piper Jaffray Companies, Research Division

One last thing and then I will get off. The ARPU for the box product, do you think we're at a relatively stable level here or should we anticipate any further deterioration and further in out quarters?

Stephen M. Swad

Peter, I continue to believe that we have a great value proposition. We're convenient. We're effective. We're available on demand. But the trends have been down sequentially and year-on-year. And we're working with some -- we've got some new marketing ideas, some new bundling ideas, some new product offering ideas to try to change that direction. But for right now, I think you should just think the trends that you've seen over the last 6 or 7 quarters are going to continue at least for a quarter or 2, notwithstanding our attempts to stabilize. I'm going to try to flatten that thing out and grow it, but it's hard for me to sit here right now and tell you. You should know I'm trying, but I have been trying and I haven't had much luck.

Thomas M. Pierno

We've talked about the difficulties that the single product has in the market place, which is the only lever to play with this price. We can make it bigger. We can make it smaller. And so, forcing that one product to go up and down the demand curve has been kind of our issue. Now there is science behind the pricing. And so while -- Steve is actually right and we do expect those trends to continue, but we're also -- we use research and modeling to guide us as to the optimum price point, and we're pleased that we continue to see lower price drive higher volume and, therefore, higher overall revenue. And so, that's the good output that we're looking for.

Stephen M. Swad

Just a few things behind what we're trying to do on that front. Package our product with a tablet is an example where it's a beautiful fit. There's no better way to learn a language with Rosetta Stone than on a tablet. And so, we're in the beginning stages of working out some deals with tablet makers. And that would, we think, helps stabilize and maybe even lift ARPU.

Thomas M. Pierno

We're not getting into the tablet business.

Stephen M. Swad

No, we're not -- we're not going to be a principal. Thank you, Tom. We also have some higher-end offerings with one-on-one coaching, and we're testing that. And we've had a small amount of success, and I think we got more work to do around targeting. Interestingly, this advanced business English, I could see with time -- and I'm thinking 2014 now, with just advanced English and advanced Spanish and doing some more bundling around deeper languages as another way to change that ARPU. And so, those are the kinds of things we're working on to change the trajectory, but it's going to take a little time.

Operator

Our next question comes from Matthew Kempler with Sidoti & Company.

Matthew J. Kempler - Sidoti & Company, LLC

So on Livemocha, I'm just wondering, are there any measures you can provide for that business to help us benchmark what that segment means to Rosetta Stone and watch the progress over time?

Stephen M. Swad

Matt, that's a tough one. The business in that company is pretty well integrated into our business. And so, I don't have much. I mentioned in the comments that we were pleasantly surprised that we were able to execute a few introductory offers like "Welcome to the Rosetta Stone family" type offer to their community, and those performed well. We're working on the Livemocha Facebook site with the teams, and we're seeing some decent results there. But I can't -- it's kind of blended now. People are blended. Efforts are blended. And so, I can't do much. I'm thinking of it -- yes, I think -- I think you should think -- the other thing that's important is we're using that platform in this product that we're launching, this business English product, which to me is key. That if you call one of the core tenets of the acquisition was that platform, and we thought it was state-of-the-art, we thought it was ubiquitous, we thought it was modular. And so, the fact that we're building our first product on that platform is I think a very strong sign that the rationale for the acquisition is coming through. And then the second data point is the community. We love that community. We think it's the largest language learning community in the world. We want to nurture it. And we also said we thought we'd be better at up-selling, down-selling, cross-selling than the company was alone. And certainly, less than a quarter in, I think that's true. As we release these apps and other light-touch things, that's a beautiful community to get feedback from and distribute our product in a pretty big way.

Thomas M. Pierno

And Matt, this is Tom, so just following on what Steve said, which I 100% agree with, the focus of the -- where we are in the first 90 days now into, it kind of follows the priorities of the acquisition. First, was the technology platform, which is fully integrated, as Steve said, and we're actively using that. The second was hopefully some monetization from cross-sell, upsell, which we started testing and had some earlier-than-expected success with. And the third is we don't want to harm the community. And so we've tried to tread lightly kind of in that area right now while we're really focusing on those first 2 things. But I would expect later in the year as we move into 2014, we'll be doing different things in terms of working with that community. But again, looking at it as something special that we want to kind of maintain and nurture, as Steve said.

Matthew J. Kempler - Sidoti & Company, LLC

Okay. But has there been any change in direction with Livemocha's business model or product offering at this point?

Stephen M. Swad

No. Not much. They were focused -- on the consumer side, the product -- they were finishing their platform and product, and we've let that happen. And it's in the midst of being rolled out to their consumer base right now, unchanged and according to original plan. They had some energy spent on sales of Livemocha product to the B&B world, and we've redirected that energy. It wasn't terribly profitable. We didn't see a big market demand. And so, we've redirected that energy pretty meaningfully.

Matthew J. Kempler - Sidoti & Company, LLC

Okay. All right. And just from a high level in terms of the bookings, you talked about 7% core bookings for the quarter. How did that -- did that match up with what you were looking for in the second quarter and were there areas that may outperformed or underperformed?

Stephen M. Swad

Yes. The quarter was better than we thought. If you recall, we guided flat to down, I think. And some of the Livemocha's stuff kind of came in a quarter earlier than we thought. The retail channel in the U.S. was stronger than we thought it would be. International kind of came in on target. We had a -- while I'm happy with the progress in E&E, we had a few large deals slip, and that may have been -- that was on the low end of where I thought it'd come in, but still within a range of what I thought. So but net-net, it was a better quarter than we thought.

Matthew J. Kempler - Sidoti & Company, LLC

Okay. And then I just wanted to ask on Japan, only 1 quarter into the new plan. But getting any feedback for that, that we're on the right track with the changes made, anything that gives you confidence that several months from now, several quarters from now we'll be seeing a different response in Japan?

Stephen M. Swad

Confidence is an overstatement, but we feel like there are little green arrows popping up that, May kind of came in exactly the way we thought. June came in exactly the way we thought. July came in the way we thought. And so, to the extent that's progress, which it is, I bet you it's been more than 1 year since I've been able to say that. I feel like we're getting our arms around it. The team is innovating and executing. I suspect we're going to have a twist or turn just because that's the way life is. But I'm pleased.

Thomas M. Pierno

They're testing into the new messaging, the new targeting and, as Steve said, seeing some small green arrows. So response rates are higher on the test than versus the control that we've been running, kind of things like that.

Matthew J. Kempler - Sidoti & Company, LLC

Retail seems to be taking hold a little bit.

Stephen M. Swad

Yes, better, Matt. But not out of the woods.

Thomas M. Pierno

Not out of the woods yet, right.

Stephen M. Swad

But better.

Operator

Our next Western comes from Brandon Dobell with William Blair.

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

A couple of quick ones, I guess, and then a couple of long ones. A quick ones, expectations that you guys have I guess kind of built into year guidance for what the different ARPUs look like? So for the product and the online side of it, should we expect a continuation or progress up, especially on the product side? How do we think about what you guys are expecting?

Stephen M. Swad

I mean in 2013, I think the trends that you've seen are reasonable proxies for how we think the rest of the year is going to be. I mentioned to Peter that we're trying to move the needle on the ARPU. And in fact, we have a little bit, but not enough. And so I'd say those are reasonable. As we move out longer term, our product offering is going to expand. And so, I expect to have products that are priced above $300, well above $300, and those will help lift ARPU. I expect to have products at the $300 level. And I expect to have product below the $300 level to meet the various demands along the price curve. And so, it's harder for me to give specific guidance. I continue to believe and I've said this before, that if you can use technology to change somebody's life, that value proposition resonates with a customer, resonates today, I think it's going to resonate tomorrow. And I think that should support a $300 price point. That's the way we operate internally on average.

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

Okay. And kind of as a segue to that, given all the different, as you mentioned, kind of puts and takes and all the different things going on with different product launches and product efforts. How do we -- or what should we expect those, all those initiatives or efforts do to the metrics that you guys are going to give us? Or are they going to be so different in terms of how you look at them relative to the North American Consumer business? There's going to be different categories and metrics that we should be tracking, we should be following? Like I said, I'm just trying to boil all the stuff you got going down to kind of a little easier framework for us to try and start building a model, which seems to be getting a little more complicated than it was before.

Stephen M. Swad

Yes. As you expand your product portfolio, it gets more complicated. But I think the core is about the same. And we'll give you more color as needed. We certainly want transparency.

Thomas M. Pierno

We're going to test our way into these things as we develop them and then ultimately release them. And so the -- any kind of change in metrics that we're looking at and making will inevitably be reflected in our disclosure and how we talk about the business.

Stephen M. Swad

We're trying. We're trying. I mean, we're trying along the way. The core growth is one way to do that so that you can see the business, excluding the puts and takes, that come with a transformation. We also -- this -- I think it was about a year ago this at time, we've started disclosing the online subs. And then since then, we've got digital downloads. And so now you're getting percent digital. And so, you're getting more color as we move through this transition with that in mind. And I see the general framework holding.

Thomas M. Pierno

No, that's it. I think Steve's right.

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

Okay. Steve, in your opening remarks, you talked a little bit about some of the download activity that you're pretty happy it. I guess 2 questions related to that. Is that -- are those numbers continuing to grow month-on-month? And has that activity, that action being able to track it as it translated into subscriptions or kind of follow-on stuff from those people who are downloading the apps or those kind of things?

Stephen M. Swad

Yes. I mean, yes, let me talk at a bigger picture. If you recall, one of the strategic initiatives is to reduce the marketing spend relative to revenue. And you're seeing those declines happening. And we're investing in products so that our suite of products becomes bigger and more attractive and plays at multiple places around the demand curve. And you're going to start to see that happen, certainly, by the time we end this year. And as it relates to these downloads and taste, those are new ways to get the customers that replace a 30-second ad or 60-second ad. Not replace, that's too strong. But that didn't exist 5 years ago, didn't exist 3 quarters ago at this company. And so I find it to be a nice perpetual way to invest in our product, have customers use our product as a taste and then engage with our brand and our product, and then move to the purchase. And so, I see that as something that's going to continue where product becomes part of the tools that we use to generate sales, taste the product, and entering into the iOS and Android ecosystems, are key to that. That's the way I see it. And then to your exclusive question of, "hey, are these customers -- do they buy?" The answer is yes. We find them to be top-tier leads that are performing at the moment, extremely well.

Thomas M. Pierno

Better than our best list.

Stephen M. Swad

Yes, and so -- it is good to hear. And so I find it kind of strategically as a validation of the path we're on to reduce our need for like media. Just raw media, not replace it, reduce it, and invest some of that back into the product and have the product be the way to engage the customer engages with us.

Brandon Burke Dobell - William Blair & Company L.L.C., Research Division

Right. Okay. And then final one for me, within the new E&E segments, how do you feel about where the sales force is? What kind of your, I guess, people-driven, go-to-market strategy as opposed to the kind of web advertising go-to-market strategy -- do have the right people in the right place? Do you need to hire some more guys for the enterprise side of it or even, I guess, for the education side of it now that you've got a couple more assets to go to market with?

Stephen M. Swad

We're testing. Great question, Brandon. The Lexia sales force is largely indirect, and there's a handful, a small handful of folks that are doing a great job, and we extend -- we expect to continue that partnership with them. There are areas where there's no coverage, and we've got tests that are being launched where Rosetta Stone will pick up some extra products and take those to market, and we're investing behind a direct sales force with Lexia, and we're going to test that as well. And then we're going to read those tests and invest behind the best-performing test. We also have equipped some of our national sales teams with the product offering. And so we have work to do. I'm comfortable with our position right now. We have work to do on what we're going to do to optimize it. The leadership of the group, I'm pleased, with, Judy Verses leads that group. She came to us from Blackboard. She's solid. She's a very solid executive and has a lot more capacity. This is an $80 million business and she came from hundreds of millions of dollars. And then, the Lexia President is also strong. His name is Nick Gaehde. He's strong in the K-12 space. And so I feel like the leadership in that group is in very good shape.

Operator

Our next question comes from John Lewis with Osmium Partners.

John H. Lewis - Osmium Partners, LLC

Just a couple of quick questions. I guess first up, on your February call, you -- I think you were asked the question, do you feel that operating cash flow will be higher in 2013 than it was in 2012. And I think you said you believe it will be net of the tax refund. Given the changes and where Lexia is going from being a contributor to operating cash flow and given you've reiterated guidance, do you still feel that operating cash flow will be what you said it was?

Stephen M. Swad

I don't know. Yes, I think the answer is yes. John, it's funny -- let me say it differently that I think that we are expecting growth, full year growth with adjusted EBITDA. And we are expecting our deferred revenue to grow. And those things translate to cash. Those 2 things translate to cash, more cash.

John H. Lewis - Osmium Partners, LLC

So it will be pretty heavily loaded obviously to Q4?

Stephen M. Swad

Yes.

Thomas M. Pierno

Back-half loaded, right.

John H. Lewis - Osmium Partners, LLC

Got it. A couple of other questions I had was, well, it's super helpful that you give the 2015 objective. I think one of the interesting parts of the Rosetta story, the transformation is going from potentially shorter-term relationships with the customer to long-term relationships. I think in your E&E business, you have 85% annual renewals and it's 95% SaaS-based. So I guess the question is, what would you -- do you have a number that you would feel comfortable with in terms of what percent of that $400 million will be recurring revenue, long-term-oriented relationships with customers in 2015, just a ballpark?

Stephen M. Swad

No, John, I don't -- but here's what I do have. I believe that the E&E business will grow at above average rate. So its share of the pie should grow in '14 and in '15. That's all I can do. And you're right, you're absolutely right on your point. We're in the midst of some -- refreshing our planning the way you do this time of the year. And so, with time, we'll give you more color around that. I just think it's a bit early right now.

John H. Lewis - Osmium Partners, LLC

I do appreciate that, but maybe could you give more color on -- excluding E&E, because that's obviously recurring. It's sticky. On your direct-to-consumer, how do you see your model changing to be more sticky over the next 2 years? Or are we going to see -- just any color there would be great.

Stephen M. Swad

Okay. I got it. Remember, there are 2 things. We're offering choice to our customers so that subscription is a choice, and we're seeing that grow. And then, we're also going to offer our customers other products. And so, I also think it's multiple sales to a customer will be a key metric in the future. So your point, which I think is a valid one, which is you will get recurring sales from a customer, I agree with that. I'm also expecting more than 1 product from customers with time as the product suite expands.

John H. Lewis - Osmium Partners, LLC

Got it. Okay. So it's just the big picture of leveraging the customer cost across a menu of items. So it's obviously keeping a longer term with a single item or multiple items on the menu. So great, I look forward to hearing more.

Operator

We have a follow-up question from Jeff Meuler with Baird.

Jeffrey P. Meuler - Robert W. Baird & Co. Incorporated, Research Division

On the core U.S. consumer growth that, to me, was one of the key points this quarter, I was wondering, would you be willing to help us quantify some of the different growth drivers behind the U.S. consumer core growth between -- how much of this is being driven by daily deals, how much of this is the Livemocha cross-sales, et cetera? Just to try to help us figure out how sustainable it is.

Stephen M. Swad

Yes. It's -- we haven't provided that much detail. I will say that you've named them, that Livemocha was a contributor to our DTC growth and Groupon was a contributor to our retail growth.

Thomas M. Pierno

Actually, the -- one of the big drivers was on the subscription and service side of the business with the revenue, and growth in that was our paid online order growth year-over-year. And then, the unit growth on the product side was, as Steve indicated, and you've said as well in DTC and retail. And so our benefit there was the Livemocha cross-sell, which again, was a little earlier than we expected in the year, as well as Groupon.

Jeffrey P. Meuler - Robert W. Baird & Co. Incorporated, Research Division

Is the Livemocha cross-sell though just order being to like a couple hundred thousand dollars, or are we talking like $1 million-plus in terms of the cross-sell component?

Stephen M. Swad

It was more than a couple hundred thousand.

Jeffrey P. Meuler - Robert W. Baird & Co. Incorporated, Research Division

Okay. So it's a relatively small contributor. On the daily deals, when did you start doing the daily deals in a meaningful way? Was it within the last year or...

Thomas M. Pierno

Back half of last year. We tested into it, and then we leaned into Groupon in the back half. We've added Amazon in the first half of this year. So yes.

Stephen M. Swad

And Jeff, just, kind of to me, a couple of points on that. What we look at is whether or not that activity is cannibalizing our other channels. And while you never know one for one, we can -- we got pretty good daily and even hourly information. And we find that to be additive to the Rosetta Stone pool. And so, if you recall, one of the initiatives is extend distribution, and we believe this meets it, and it's an official way to distribute. And also, if you go back to the question that John Lewis was asking about recurring revenue, as this customer base grows, the capability of the company to sell, that base more stuff. Either a language product or other product, goes way up. And so, I am interested in getting that base as strong as I can and as healthy as I can and then exposing that base to a suite of products that are relevant and important to it. And so, I also look at these relationships as a way to deepen my base, particularly when it's not cannibalistic.

Jeffrey P. Meuler - Robert W. Baird & Co. Incorporated, Research Division

Right, and then just finally, just -- I this is the case. I just want to verify. The E&E channel it is exactly the same, just a new name. You didn't move any revenue around?

Thomas M. Pierno

That's correct. Re-branding only. New no new elements in it.

Operator

There are no further questions at this time. I'd like to turn the floor back over to management for closing comments.

Stephen M. Swad

All right. Thank you. Thank you, shareholders. My takeaway is we're on a path to execute against our strategy. I'm pleased with the progress we're making. I expect us to continue. And I expect value to be created along the way. I'm pleased with the value that's been created and I expect more value to be created and the management team is focused and there's more to come. That's all I have, and I'll speak to you in another quarter.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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