Rosetta Stone's (RST) CEO John Hass on Q2 2016 Results - Earnings Call Transcript

| About: Rosetta Stone (RST)

Rosetta Stone Inc. (NYSE:RST)

Q2 2016 Earnings Conference Call

August 03, 2016, 05:00 PM ET


Frank Milano - IR

John Hass - Chairman, President, CEO

Tom Pierno - CFO


Chris Howe - Barrington Research

John Godin - Lake Street Capital Markets

John Lewis - Osmium Partners


Greetings, and welcome to the Rosetta Stone Second Quarter 2016 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] And as a reminder, this conference is being recorded.

I'd now like to turn the conference over to your host, Mr. Frank Milano, IR for Rosetta Stone. Thank you Mr. Milano. You now have the floor.

Frank Milano

Good afternoon, and let me welcome you to the Rosetta Stone second quarter 2016 earnings conference call. I am joined today by our Chairman, President and Chief Executive Officer, John Hass; and our Chief Financial Officer, Tom Pierno. John and Tom will discuss the operations and financial results for the quarter, and we will open the call to questions after our prepared remarks.

Our second quarter earnings release went out after the market closed, and is available on our website at In addition, we have posted the slide presentation that accompanies today's call to the website, which you should find helpful, as we discuss the company's results and our outlook for 2016.

In keeping with the Safe Harbor statement on Slide 2, I will remind everyone that certain statements will be made today which are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Given the uncertainties of forward-looking statements, our actual results may differ materially from anything we say in these forward-looking statements. We can give no assurance as to their accuracy, we expressly disclaim any obligation to update or revise any forward-looking statements whether as a result of new information, future developments or otherwise except as required by law.

We also use non-GAAP numbers in our presentation. For further information on the definitions of those numbers, the GAAP comparisons and the reconciliation to the nearest comparable GAAP numbers, as well as risks and uncertainties that could cause our actual results to differ, please read our company's SEC filings, earnings release and presentation, including the paragraphs beginning with the words 'caution on forward-looking statements' and 'non-GAAP financial measures' which are available on our website under the Investor Relations tab.

I will now turn the call over to John.

John Hass

Thank you, Frank, and good afternoon.

I am very pleased with our continued progress across the company in the second quarter as demonstrated by our improved profitability even as we continue to invest to grow Lexia and build a higher margin and more predictable language business.

In particular, I would highlight the performance of our K12 literacy and language that produced a combined segment quarterly record $18.6 million in bookings. I would point out that this is roughly equal in size to our consumer business in this period. I am very happy with these businesses and the momentum we're seeing in both.

Our efforts to revamp the go-to-market strategy of each business and introduce new and innovative products, all while substantially reducing expenses is delivering tangible results as we create a more focused efficient company with capital and resources allocated to our most attractive opportunities.

Over the last year, we've taken important steps to build a more sustainable consumer business focused on profitability. We significantly reduced our marketing spend as we concentrated on the most efficient, responsive and quantifiable lead generation and conversion opportunities and as we continue to simplify our business and shift more to SaaS-based subscriptions in 2016 and 2017. We'll build a revenue model with more consistency and the opportunity toward our renewal growth.

We've also begun bringing customer facing product innovation to market. During the second quarter, we released our new native iOS app to enhance our mobile language learning capabilities. This new app not only delivers a faster, cleaner and more intuitive learning experience, but also includes functionality to improve our marketing effectiveness.

We're now able to communicate directly with the learner through the app. We can encourage usage and highlight features that drive conversion. We're encouraged by the 25% increase in the number of daily active users in the first 30 days since the app's launch.

You may have seen recently the Mac world also took notice of our new language app, noting tried and true Rosetta Stone works the best and if you're serious about learning the language, Rosetta Stone is well worth your money. We couldn’t have said it better ourselves, we're very proud it was a work, our consumer and product teams put into developing and launching this new product in Q2.

Further innovation is also well underway. We're planning to release in early 2017, the first all new Rosetta Stone consumer language product in many years to be delivered through a modern mobile-focused platform. This release will be focused on increasing our market differentiation by providing the leading solution to get passionate learners speaking confidently in their new language.

In March, we announced the refocusing of and cost reductions in enterprise and education language business, identifying those market places including new SK12 and enterprise in the U.S. and Northern Europe that are most profitable with the greatest opportunity for near-term growth and focusing our direct distribution efforts there.

This led us to withdraw resources from areas like higher education in the U.S. and our direct presence in France, China and Brazil which were adding sales with a too higher cost and without the near term ability to capture scale efficiencies.

Going forward, we will approach these attractive market places differently working with local partners that can amplify the power of our offerings. We're now in the final phase of our new enterprise language product that we call CATALYST. Work is progressing well in advance of our fall commercial launch so that we can begin actively selling during the peak fourth quarter corporate season.

We've given an early look of CATALYST to some existing customers during this beta test and we've had some really great feedback thus far. This product addresses many critical needs for our enterprise customers that will help assess a customer's workforce and provide learning solutions for their entire organization, regardless of the desired language or the level of learning.

With the refocusing of this business and its improved product portfolio, the enterprise and education language segment is becoming more predictable and more profitable business, with attractive long-term growth potential.

With Lexia with its renewal rates that have consistently well exceeded 90% and expanding product portfolio, owning the customer will be the key to broadening our reach and increasing share of students and educators we can impact in schools and districts across the country. This is why we are continuing to invest heavily in building a largely direct sales force.

This transition is already bearing fruit. With bookings from our direct him increasing to 80% year-over-year to 70% of total Lexia bookings in the second quarter up from 40% in the same period last year.

That said, the team is still very new to us, with over half the sales forces having been hired within last year. We expect our sales team to become more productive as they learn to sell the expanding portfolio of Lexia products to build trusted customer relationships.

Having recently spent time with the team at Lexia’s Summer Sales Conference I can tell you that their commitment and passion is impressive. From a product perspective, in the second quarter Lexia released upgraded versions of Lexia Reading Core5, Lexia’s flagship computer adaptive personalized literacy program for pre-K through fifth grade and My Lexia, Lexia’s learner management and data reporting dashboard for educators.

In addition, Lexia announced the introduction of the kindergarten through second grade version, of its rapid assessment product, which won the Best in Show Award for Tech & Learning to 2016 ST conference. With this launch, Lexia now has a complete rapid product suite from kindergarten to 12th grade.

As a company, we cannot be more excited about our opportunity to help millions of students improve their lives through reading as we work to reach $100 million in bookings on an annual basis of Lexia by 2020.

Finally, I thought it would be useful to summarize the ongoing transformation of Rosetta Stone with a few facts and statistics. Through the actions we have taken since early 2015 to focus and simplify our business and reduce our cost base, we've significantly decreased our operating expenses without sacrificing the necessary investment to drive future growth.

In total when our most recent changes are fully implemented, we will have cut expenses outside of Lexia by over $80 million on an annualized basis. One indication of our continuing progress is that operating expenses were down 15% for the six months year-to-date versus the same period last year.

Achieving and sustaining long-term profitable growth remains our objective and our performance indicates we're on the right path with more work to be done. Before we focus on reducing expenses we continue to thoughtfully invest resources in our best opportunities. In particular to build Lexia’s product portfolio and direct sales force to position the segment for sustainable long term growth.

Consequently, even as we streamline and focus our resources we have grown the team devoted to Lexia to 21% of our total workforce at the end of June up from 8% in June 2014. As we focus capital and people here this business is becoming a bigger and bigger part of our company with the total share of bookings produced by Lexia more than doubling from 9% in the second quarter of 2014 to 21% in the same period this year.

We're also building a more stable revenue stream having fully transition to a SaaS-based model in our literacy and E&E language businesses. And as we aim to be a fully SaaS based business in the consumer segment by the end of next year.

In fact in the second quarter over 80% of our revenues came from subscriptions and services driven by our E&E language and literacy segments and to growing extent by a consumer. For example at the end of the second quarter at Lexia, we have about 1.3 million licensed core five students and separately approximately 25,000 unlimited site licenses for our literacy products.

In the future we intent to report the number of our enterprise license customers and consumer subscription customers and related information as we are able to provide more visibility to our consolidated platform, with the current license mix across the variety of products makes reporting these numbers difficult today.

Overall though a growing SaaS user base has driven 19% annualized growth in our total deferred revenue from $93.2 million at June 30, 2014 to $132.4 million the end of June 2016. Building a more profitable, more consistent and ultimately growing company with our capital and resources devoted to the best opportunities to build intrinsic value that has been and will continue to be our goal.

With that let me turn it over to Tom to take you through the highlights of the second quarter's financial results.

Tom Pierno

Thank you, John and good afternoon, everyone.

I will begin with a review of Q2 revenue and earnings. Please turn to Slide 3. Total revenue declined $5.7 million or 11% year-over-year. Included in the second quarter 2016 revenue was the adverse revenue and earnings impact of $3.6 million accrued to recognize the change in suggested retail value to price protect the in-channel inventory of our retail partners that we have previously discussed.

The impact of this one-time charge represented approximately 700 basis points of the 11% year-over-year total revenue decline. I will also note that the cash impact of this change will be approximately $4.5 million and will be settled with our retail partners through the second half of the year.

Consumer segment revenue declined $7.8 million or 28% year-over-year, partially reflecting that $3.6 million suggested retail value change, which accounted for approximately 12,000 basis points of the 28% year-over-year total consumer segment revenue decline.

The majority of the decline in consumer was the result of our change in strategy in March 2015 whereby we continued to manage that business for a targeted bottom-line result. E&E language revenue declined 6% year-over-year due to the change in our go to market strategy announced in March 2016.

As John discussed we are focusing our direct sales and marketing activity on the K-12 education marketplace in the U.S. and the enterprise marketplace in the U.S. in Northern Europe. In addition we are looking to local partners in almost all the non-U.S and non-Northern European geographies where we have decided to exit the direct presence we had previously.

Some of those partnerships are already in place such as in Brazil and Latin America, but it will take time to ramp up that business across all those geographies. The strong bookings growth in the North America K-12 business, which was up 27% year-over-year in the second quarter enhanced by a $1.3 million multiyear renewal after delivering 21% year-over-year bookings growth in Q1 has been very positive and a great motivator for our sales team as we continue to execute the E&E restructuring that begin in March.

Lexia revenue was a record high $7.9 million in the second quarter representing growth of 68% year-over-year while bookings grew 3% to $9.4 million as the transition from resellers and the ramp up of a new direct sales force continues.

We expect Lexia’s year-over-year bookings growth to continue to reaccelerate for the remainder of the year as the sales team matures. As a reminder Lexia’s results include the impact of purchase accounting on acquired deferred revenue. Adjusting for this impact Lexia’s pro forma revenue would have been $9.2 million in Q2 2016 compared to $6.9 million in the same year ago quarter.

And Lexia’s pro forma revenue growth would have been 33% year-over-year. The net loss increased $0.8 million or 10% year-over-year to a loss of $9 million or $0.41 per diluted share. The net loss this quarter included pre-tax charges of $2.5 million for restructuring and a non-cash $2.9 million charge for impairment of the remaining goodwill and other intangible assets related to our fifth grade business based upon a reduced outlook relative to our previous expectations.

The $3.6 million pretax charge for the consumer segment, change in suggested retail value also fell through the bottom line. By comparison, the net loss in Q2 2015 totaled $8.2 million or $0.38 per diluted share, which included pretax charges of $2.4 million for restructuring and $0.2 million for impairment.

Slide 4 reflects the segment contribution margin for all three segments. The literacy segment contribution margin was $1.2 million or 16% of segment revenue in the second quarter of 2016, up from negative $0.2 million or minus 4% of segment revenue in the year ago period. This growth was primarily influenced by the impact of purchase accounting. The margin improvement related to this effect will diminish over time.

Lexia's direct expenses increased 36% year-over-year resulting from the investments we are making to expand and improve our literacy product portfolio and to increase the size of the direct sales force and associated sales support personnel at Lexia.

In addition, as we grow the mix of direct sales, we recognize more of our sales and marketing expenses at the time of sale as a period cost with only the sales person's variable commission deferred and recognize over the contract period.

By comparison, when we sold principally through resellers more of the selling cost was deferred and recognized ratably over the contract period. The E&E language segment contribution margin increased to $6.8 million or 39% of segment revenue, up from $4.6 million or 25% of segment revenue in the year ago period.

This improved performance reflects a 21% reduction year-over-year in direct sales and marketing expenses largely due to the initial benefits of the March 2016 restructuring, which we continue to expect will reduce headcount by approximately 17% of the company's full time workforce of 855 people at December 31, 2015.

These actions are expected to improve segment contribution margin in Q3 and Q4, but the benefits will narrow compared to what we achieved in the first half of this year. Overall, we continue to expect that March 2016 restructuring will result in approximately $19 million of annualized expense reductions when fully realized.

Consumer segment contribution margin was $3.9 million or 19% of segment revenue which was down year-over-year compared to $9.5 million or 34% of segment revenue in the year ago period. The decline was primarily due to the $3.6 million revenue reduction associated with the change to our suggested retail value, which represented an adverse impact of approximately 1,200 basis points than the consumer segment contribution percentage.

The chart on Slide 5 depicts sales and marketing, research and development, and general and administrative expenses, which declined $3.8 million or 8% year-over-year in the second quarter even with our increasing investments at Lexia. All three operating expense categories were lower year-over-year led by G&A expense, which was down $1.8 million or 15%, and sales and marketing expense which was also down $1.8 million or 6%.

Turning to the balance sheet on Slide 6, deferred revenue of $132.4 million was largely flat sequentially at June 30, 2016, and increased $9.2 million or 7% versus the end of Q2 last year. Out of the June 2016 total $99.2 million or approximately 75% were short-term and will be recognized as revenue over the next 12 months.

We ended the second quarter with zero debt and $29.7 million of cash and cash equivalents, which was basically flat to where we ended the second quarter last year despite registering approximately $35 million in net losses during the intervening year. Within the second quarter of 2016 we paid $1.7 million of the restructuring we announced in March 2016 bringing the first half totaled payments to $2.1 million.

The non-GAAP highlights of the business can be found in the Chart on Slide 7, and the reconciliation of the GAAP metrics to the non-GAAP financial measures can be found in the appendix on Slide 11.

Starting with the free cash flow chart on the right, net cash used by operating activities improved $9.9 million in the second quarter of 2016 compared to $13.3 million used in the same quarter last year due to lower operating expenses along with better working capital management.

I also want to remind everyone that our cash has historically been seasonal, so that we have traditionally been a net user of cash in the first half of the year with our low point being between Q2 and Q3 thereafter becoming a net generator of cash in Q4.

Capital expenditures, which primarily relate to capitalized labor on product and IT projects total $3.3 million, up from $2.8 million in the second quarter last year, primarily due to increases at Lexia.

Free cash flow was negative $13.2 million in the second quarter, a $2.9 million improvement versus negative $16.1 million in the year ago period.

Turning to the net loss and adjusted EBITDA chart on the left, second quarter 2016 net loss totaled $9 million, up 10% compared to the net loss of $8.2 million in the year ago period. Please note that the net loss in Q2 2016 included pretax restructuring and impairment charges totaling $5.4 million, combined with a $3.6 million adverse effect of the change in our suggested retail value.

Similarly Q2 2015, included pretax restructuring and impairment charges totaling $2.6 million. Adjusted EBITDA was positive $0.1 million a favorable $0.4 million improvement compared to negative $0.3 million in the year ago period. The $0.1 million of adjusted EBITDA in the second quarter of 2016 includes a full impact of the $3.6 million change in suggested retail value that I discussed earlier.

With respect to full year 2016 guidance total consolidated revenue is now expected to be approximately $190 million, up from our prior guidance of $182 million. Our outlook for Lexia revenue was now approximately $32 million and Lexia bookings approaching $40 million, both down somewhat from our prior guidance as Lexia continues to ramp its direct sales force in this year's transition from a reseller model.

We continue to expect E&E language revenue of approximately $70 million. Consumer revenue is now expected to be approximately $88 million up from our prior estimate of $79 million. The transition to subscription-based sales in our direct channel is anticipated to take a little longer than previously expected resulting in higher mix of potential sales primarily in digital downloads.

Consumer bookings are expected to be approximately $100 million down $6 million from our prior guidance of slightly lower expectations from our DTC and retail channels in the second half of the year.

The consumer revenue outlook includes the one time impact of $3.6 million to adjusted retail value of our consumer products and our current estimate of $8 million in lower revenue year-over-year due to an increase in the unit mix of SaaS-based subscriptions. We now expect consumer subscriptions will increase to approximately 35% of the unit mix this year compared to 24% of the actual unit mix in 2015.

We expect the consumer revenue impact of this mix shift to be weighted towards the fourth quarter of 2016 as we plan to emphasize subscriptions more when we enter the holiday promotional period. As a remainder Rosetta Stone is paid upfront for the subscription at the time we book the sales transaction. So there is no cash impact from the transition from product based to subscription based unit sales.

For the full year 2016 we now expect the GAAP net loss to total approximately $42 million, which is improvement of approximately $13 million versus our prior guidance driven by the higher consumer revenue just discussed and lower operating expenses.

This amount includes the full after-tax effect of the March 2016 E&E restructuring cost, which we now expect will come at the low end of our previously stated range of $5 million to $6 million, plus an estimated $8 million mix shift for consumer subscriptions the $2.9 million non-cash impairment of Fifth Brands' goodwill and other intangible assets and the $3.6 million second quarter adjustment for in-channel inventory in the consumer segment.

We now expect an adjusted EBITDA loss of approximately $10 million, which is an improvement of $17 million versus our prior guidance, again driven by higher consumer revenue just discussed and lower operating expenses.

Our full year outlook for cash has also improved and we now expect to end the year with nearly $35 million in cash. As I discussed earlier, our cash has historically been seasonal. We expect this trend to continue, but it will be mitigated this year due to the back half cash impact of the adjustment to the suggested retail value of our consumer products of $4.5 million and remaining cash impact of the E&E language restructuring of approximately $3 million. We expect both of these items to be weighted somewhat more towards Q3 than Q4.

That completes my portion of today's call. I will now pass it back to John.

John Hass

Thank you, Tom. With that operator, would you please open the line for questions?

Question-and-Answer Session


Thank you, John. [Operator Instructions] And our first question comes from the line of Alex Paris from Barrington Research. Please proceed with your question.

Chris Howe

Good afternoon, this is Chris Howe sitting in for Alex Paris.

John Hass

Hi, Chris.

Chris Howe

Hi. I had a few questions here for you. What led to the success that you saw in the quarter in regards you growing the number of active monthly students using the Lexia reading Core5 product?

John Hass

Sure. Thank you for asking. Look we continue to feel very good about Core5 and its receptivity in the marketplace. It is still a relatively new product in the marketplace. It is -- Lexia has been very, very successful in pursuing a strategy, which is truly a prototypical land and expand strategy.

Of landing a school customer, a district customer, demonstrating the efficacy of the product, which we think is market leading and using that to expand from there, thus leading not just very high retention rate, the retention of a our customer with very high renewal rates as well as we are able to expand within that school, as we're able to expand within a district.

We also remain very optimistic about the growth of the direct sales force and what that will allow us to do going forward and that business is that sales force continues to mature for us.

We have very strong reseller partners in a number of areas, but I’ll tell you as I said in my prepared remarks, having spent a day with the sales team at Lexia and with our reseller, they could not be more excited than to be in the market selling our Core5 right now.

At the end of the day it grows because it works, it helps students learn, it helps them learn at a more rapid rate then they would be able to on their own and that’s ultimately what leads to our success.

Chris Howe

Thank you for the color and just expanding on that comment, when you compare Lexia reading Core5 with some of the other channels within the suite, would you say this is the part of the suite that gets you the most excited moving forward, as you continue your acceleration of growth?

John Hass

Yeah, sure. So, as we think about the suite, there are really three products that will ultimately comprise the full Lexia literacy, learning and assessment suite. So Core5 was introduced about three years ago. The very modern product it is updated on an annual basis. We updated it again in the second quarter of this year.

We have as I said, just completed the introduction of Rapid. We’re now having kindergarten through 12th grade literacy assessment product, which we also think -- which we’re also very excited about.

And as I discussed not on this call, but on a prior call, we would intent to replace our 6th through 12th grade literacy product for struggling students next year, which will complete the full suite for us.

And while we’ll be very excited about the suite and we will look to take advantage of the fact that we will offer a complete portfolio of market-leading products at that time. Core5 will continue to be the majority -- the vast majority of our sales going forward.

It is the product which teaches students to read in their formative years of pre-k through 5th grade and that will always be certainly for the foreseeable future the leading product in terms of sales in the portfolio. That said, we're excited about the other products. We're excited about the fact that we’ll be able to offer the entire portfolio.

Chris Howe

And as we build the model out, how should we think about your ramp up of hiring within Lexia? Do you expect it to be more concentrated within a certain quarter or how should we think about that line item?

John Hass

Yes, no, that’s a good question and let me just make some comments. There obviously is -- there is some pretty significant hiring going on this year. And that’s for one principle reason which is to build out the direct sales force in replacement for a portion of our reseller sales force and to build -- and that includes not just the sales team itself but the implementation specialist that support that sales team and support sales to our customers.

And so we would expect and we've already seen as I discussed, Lexia is now more than 20% of the workforce here at Rosetta Stone. There will be a significant percentage growth this year. Some portion -- some meaningful portion of that will happen this quarter, especially as we ramp up the implementation sales team to assist in the third quarter and fourth quarter implementations of our new sales this year.

The third quarter is traditionally strongest quarter for us, in terms of Lexia sales. On a percentage basis, I would then expect growth in new heads to certainly slow as we move into next year.

Chris Howe

Okay. That’s very helpful. And I noticed your partnership with Colorado's Global Village Academies, can you shed some light on how this came about, this relationship and more specifically are there other similar sized deals out there to be head or already potentially in the pipeline?

John Hass

Yes that was -- that’s a nice program for us on the Language side for those of you who might be -- might not be familiar with that. I would say it was a very nice one-off opportunity for us. It was attractive to us to work with that charter school system. We’ll certainly look for more opportunities like that.

I wouldn’t though Chris, think about that as a model for a new growth area within our K-12 Language business. That said, I couldn’t be happier with performance of the K-12 business. On the Language this year as we noted in the call to be up more than 20% each of the first two quarters in that business is really good, especially in the second quarter which is was big quarter for them.

We feel good about the third quarter. We don’t expect it to be up 20% every quarter, but we're very pleased with that business and the traction we're seeing there right now.

Chris Howe

Okay. Thank you for all the color. That’s very helpful. And I guess just more, this would be my last one, just more broadly speaking, is this the right way to think of Lexia? Are there cross-selling opportunities based upon the successful adoption you're seeing Lexia product suite it opening the entire portfolio of Rosetta products and perhaps...

John Hass

It’s a very good question. Here until we’ve chosen to date to think about that. We made some initial efforts to more directly cross staff and if you will cross manage our K-12 business between Literacy and Language.

I think what we decided pretty quickly was that given the opportunity that we have in Lexia in the Literacy business and the focus did that deserves, what we have decided to do for the time being is really ask the team to focus entirely on building out that business and we feel that opportunity is big enough and exciting enough for them that we've chosen not to distract them.

And also there is also a bit of just that’s what the market wants to, typically speaking the purchaser in K-12 for a world Language product is someone different whether it at the school or the school district level, then somebody who might be making the decision to purchase a Literacy product or a Literacy assessment product until there's a little less overlap than people might typically expect.

We do have mechanisms in place to allow for referrals and operate the business in a smart way, but at this point, we have run those businesses very independently in terms of the sales effort.

Now the natural opportunity for us in the future, which we've not really built into any forecasts at this point would be to create a true ELL product to go after the English language space in the U.S. for students learning English as a second language both to speak and to right that to speak, read and write in that mind language.

We view that as an opportunity. We view that as an opportunity, which should be a good one for us. We're tackling what's in front of us though and when we can get to it, I suspect that's something that we'll look very hard at.

Chris Howe

Okay, I appreciate all of the color. Those are all of my questions and the CATALYST product has me excited for this fall.

John Hass

That has us excited too. Thank you.


[Operator Instructions] Our next question comes from the line of Matt Blazei from Lake Street Capital Markets. Please proceed with your question.

John Godin

Hey guys this is John Godin for Matt. Thanks taking the question. Just wondered if you could talk a little bit about the new language product that's going to be coming in 2017 and how you think that's provide a bit of a competitive differentiation with some of your main competitors?

John Hass

Sure. Hey John it's nice to speak to you. So let me talk about two things. Let me talk about how we think about investment in our consumer business and I’ll then talk a bit about the product. So we continue to be very focused on driving cash in that business, that is the principle upon which we've approached the business, it's the principle on which we continue to approach that business.

That said we have a wonderful brand in the U.S. consumer space. We continue to be very, very successful in the U.S. consumer space and selected overseas markets. We've done that with very little innovation in the consumer really in the last half decade or so.

The first step in beginning to innovate again in a smart way was the introduction of our new mobile app in the second quarter, which we're really excited about and like people to try it out and let us what they think.

The next step will be new to what we refer to is kind of a simplified product offering where we will continue to push customers towards more of a mobile SaaS-based offering and away from digital downloads and boxes. That's better for us from a cost perspective and it's a better experience for users as well because it's a mobile first experience and experience that allows updates and it an experience that allows us to interact with our customers as well.

And then to your point it also allows us to develop on a mobile oriented SAS platform as opposed to a legacy digital CD-based platform and with that, the goal is really to introduce features and functionality, which are truly differentiated in the marketplace and so things that we're looking at right now would include more tailored content in space.

So right now an immersion product, we think that the use of immersion for the beginning learner is the best way to get someone speaking, but if someone just wants to learn some language for a trip, it can be a little bit difficult as you have a lot to wait through and so we have the ability to create more tailored focused content and that's relatively easy for us to do.

We’re also looking hard at the introduction of an offline version that would be part of the product. So somebody can practice on the go. They're driving their car, if they're in the kitchen working, which is relatively easy for us to do. And we also have the ability to expose customer’s capability we have now which is to allow them to practice by reading stories within the product.

And so there will be preset stories in the product they can read it in the speech recognition engine. They’ll be corrected and it will be a wonderful way for them to practice in a way in which is beyond the typical interaction with the product through speech recognition, but short of having to work with a live coach with some people frankly, are just intimidated by.

And so we think all of those will further differentiate the product in the marketplace and we’ll do it if we believe they are the right things to do to drive relatively near-term sales.

John Godin

Awesome, very helpful. I guess then a couple of other things, looking into 2017, do you guys have a bit of a timeframe that you’re targeting to reach that 100% SaaS model?

John Hass

Yes, we’re a test and learn company. We are testing now and we’re trying to make sure that we get it right and do it really well and we’ll lean in first in our direct-to-consumer business and this is a very inexact science and that’s led to the delay in some of the strong, strong move to the SaaS model this year, which changed the average SaaS part of our subscription part of our business than we expect for this year.

That said, our strong goal is to be essentially run rating it at 100% SaaS subscription business across our channels by the end of next year. It will happen first in the direct-to-consumer business and then we’ll test into and see when it’s appropriate to do the same thing in the retail channel.

John Godin

Cool. And just to clarify I think I missed it earlier, can you just go over again what drove the extra strength in the consumer business this quarter?

John Hass

Yes, and again, I think the significant improvement in our net loss outlook for the year both in EBITDA and in a GAAP basis, a very good portion of that is just improved cost management of the company. That’s roughly 50% of the change in the EBITDA estimate from our prior estimate.

The other 50% is honestly a delay in the introduction of the full push to subscription in our direct channel on the consumer side. And so this is as you know, what that causes and as we do digital downloads or sell boxes, those sales are recorded as a current sale for GAAP purposes.

As we move to subscription, those sales, although we continue to receive the cash up front, the sale proceeds are put into deferred revenue and recognized over the subscription period.

And so we honestly just got less of a subscription negative impact in GAAP revenue than we had anticipated so far. Again, we’re fully committed to it. It will occur. It’s just taken a little bit longer than we thought.

John Godin

Cool. And then just one more for me. Can you just talk a little bit about the incentive structure for your sales force as you’re ramping in the Lexia division? Can you talk a little bit how they’re incentivized and maybe the timeframe as far as when they're going to get to 90% or 100%?

John Hass

Sure. So it’s a very traditional commission-based sales structure at Lexia. They are divided. The sales team itself is essentially divided between account executives and account managers. It’s better to not a kind of hunter/farmer model where you have farmers today working on principally renewals that really the account executives tend to go after larger opportunities.

Account managers will tend to go after smaller opportunities. As I said in our prepared remarks, 50% of that team has spend with us less than a year. So it’s very new to us. We tend to hire very experience sales people, but they are new to us. So they're still learning. Lexia, they're learning the product, they're learning there are customers in some cases.

And we couldn’t be -- I personally couldn’t be more please with the success of that team and they're supported by an implementation specialist team too, which is very important to us, because we do sell implementation and training services that is a part of the Lexia sale now and no longer control by, well, we now sell that ourselves in our existing resellers also sell it.

And it’s a very good business for us not just because it drives incremental sales, but also because it helps with the efficacy of the product, which leads to retention and high renewal rates. So I don’t know when we'll reach. The true maturation of that sales force, but I believe we’ve got a long-way to go and there is a lot of room for incremental productivity with that sales force given how new it is.

John Godin

Awesome, Very helpful guys. I appreciate it.

John Hass

Thank you, John.


[Operator Instructions] Our next question comes from the line of John Lewis from Osmium Partners. Please proceed with your questions.

John Lewis

Hey John and Tom, really nice work and it’s great to actually see increasing revenue guidance. It’s been a long time to see that come out of Rosetta Stone. I know you guys have been done hard at work. So congratulations on that front.

The other thing I was just curios, have you seen bump-up in revenue given the really positive endorsement you got out of acro recently?

Tom Pierno

Thank you for asking. I think it’s too early tell, John. We're obviously really happy to get that. They're a highly respected publication. I think as I -- and we were compared to two people that certainly we compete with and in Babbel and Duolingo and I think they did nice job of recognizing what makes us different and did that in the context of the fact that it wasn’t a -- let’s just assume everyone is free or let’s ignore the cost to as in is was within the context of the fact that we do sell our product. We do not provide it for free.

And so we think it’s a very nice acclamation to the fact that you truly get’s your money. You get your money for it with us. And obviously lot’s of work to continue to do in that business, but it was very nice to see that.

John Lewis

Great, thank you. And then the other question I had for you as company continues to, I think I don’t have number for you, but I think certain millions subscription service is 38 million, I think somewhat in that range and I think you said as you go forward, you will break out more granular details, as appropriate for a largely SaaS based business is that right in Q3 and Q4?

John Hass

It is our expectation to do that going forward. We would like to be doing that now. I would -- because we operate our consumer business off of a common platform; that creates some degree of difficulty.

But we believe -- we like to provide that level of transparency to our investors as we continue the shift to 100% SaaS based business, where we are today in both Lexia and in the E&E Language business and neither of them where when they started this businesses have moved to be 100% SaaS based businesses.

And our consumer is in that transition now and they're in the early stages but as I said in responding to one of the earlier questions, we expect to be there by the end of next year and with that, I think we owe you that type of visibility.

John Lewis

I get it, heavy lift and it's a hugely -- well it's a significantly more valuable business model and so I appreciate all the hard work that you and your team have gone through to get the company to where it is and thank you very much.

John Hass

Thanks John.

John Lewis

Bye guys.


At this time, I'll turn the call back over to Mr. John Hass.

John Hass

Thank you, everybody. It's nice to speak with you all again. I hope everybody is enjoying the summer. We have a lot of work to do here. We're certainly pleased with where we have come, but I think there is even more work to do from here and we look forward to catching up with many of you over the next few days and as we go forward. Thanks and have a good night.


Ladies and gentlemen, this does conclude our teleconference for today. We thank you for your time and participation and you may disconnect your lines at this time. Have a wonderful rest of the day.

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