Rosetta Stone Inc. (NYSE:RST) Q4 2019 Earnings Conference Call March 11, 2020 5:00 PM ET
Jason Terry – Addo Investor Relations
John Hass – Chairman and Chief Executive Officer
Nick Gaehde – President, Lexia Learning
Matt Hulett – President, Language
Tom Pierno – Chief Financial Officer
Conference Call Participants
Alex Paris – Barrington Research
Steven Frankel – Dougherty
Ryan MacDonald – Needham & Company
Eric Martinuzzi – Lake Street Capital Markets
Hannah Rudoff – D.A. Davidson
Josh Goldberg – G2 Investment Partners
Greetings, welcome to the Rosetta Stone Incorporated Fourth Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded.
I will now turn the conference over to your host Jason Terry, Addo Investor Relations. Mr. Terry, you may begin.
Thank you. Good afternoon, everyone. Welcome to Rosetta Stone’s fourth quarter and 2019 earnings conference call. Speaking on the call today will be John Hass, Chairman and CEO; and Nick Gaehde and Matt Hulett, Co-Presidents of Rosetta Stone. Additionally, Tom Pierno, the Company’s Chief Financial Officer will be available during the Q&A portion of today’s call.
We have posted to the Investor Relations section of our website at rosettastone.com, both the earnings release and a slide presentation which accompanies today’s call. We’ve also posted supplemental information and analysis on our website. I want to remind everyone that as always, there will be elements in today’s presentation which are forward-looking and are based on our best view of the world and our business as we see them today.
These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially. A description of these risks and uncertainties and other factors that could affect our financial results are included in our most recent Annual Report on Form 10-K and quarterly reports on Form 10-Q. We expressly disclaim any obligation to update or revise any forward-looking statements except as required by law.
Today’s presentation and discussion also contains references to non-GAAP financial measures. The full definition, GAAP comparison, and a reconciliation of those measures are available in the aforementioned presentation and press release.
I will now turn the call over to John.
Good afternoon, and thank you for joining the call. We have a lot to talk about so please turn to Slide 3 and I will begin by walking you through an overview of our consolidated fourth quarter and year-end results. 2019 was a year of significant progress across all of Rosetta Stone confirming that the efforts to restructure our business are behind us. 2019 was the first year since before 2014 in which each of our segments grew producing consolidated bookings growth of 9%.
Our Literacy segment led the way, driven in particular by increasing contributions from PowerUp, but for the first time in many years both Language segments also contributed to growth. I would point in particular to the very strong fourth quarter performance of Consumer Language, which saw bookings grow by 14% over Q4 2018.
On a consolidated basis, fourth quarter and full year revenue grew by 5% over the same period in 2018. This growth helped drive improvement in both Adjusted EBITDA and net income for the full year. Net income for the quarter was a loss of $6.5 million, compared to a loss of $4.4 million in the same period in 2018, and for the full year net income was a loss of $13 million compared to a loss of $21.5 million in 2018.
Adjusted EBITDA for the quarter was negative $0.9 million compared to positive $0.7 million in the same period in 2018, and for the full year it was $6.9 million compared to $0.2 million in 2018. We ended the year with a cash balance of $43 million and no debt. 2019 was a very good and important year for us.
Please turn to Slide 4. Now with a great set of SaaS-solutions producing terrific outcomes for learners, meaningful growth opportunities in both our K-12 and Language businesses, and a strong balance sheet, we are excited to move forward and begin to realize the benefits of the investments we have been making in the business. Benefits that in products like PowerUp, and our soon to be released K6 English learning solution, are either just beginning to realize their potential or have not yet even been released. It’s this latent opportunity, as well as the opportunity we see in other assets, like the Rosetta Stone brand, that get us excited about the future.
Before we go further I would like you to know that, after seeking input from our shareholders, we have decided to recommend in this year’s proxy an amendment to our charter that will allow us to eliminate our current classified board structure. We believe that the stability afforded by a classified board served us well as a relatively new public company, but as we have matured and built a strong, shareholder focused board, we believe it is no longer necessary.
I also need to let you know that we have decided to postpone our Investor Day, previously scheduled for April 15. There is much we want to share with you and we want to do that in person. We have heard from many that that might not be possible right now so we are looking to move Investor Day to this summer. I also need the team right now focused on everything that is happening in the business and with our customers. We will get back to you with a date as soon as we can reasonably do so.
Now let’s take a closer look at the performance of each of the businesses, beginning with Lexia. And for that I will hand the microphone over to Nick.
Thanks, John. Please turn to Slide 5. In our Literacy segment, revenue in the quarter was $17.1 million, an increase of 18% over the same period in 2018. For the full year revenue increased to $62.6 million, or 19% higher than 2018. Bookings were $10.8 million in the fourth quarter, an increase of 11% over the same period in 2018, while full year bookings were $68.4 million, an increase of 17% from 2018. While new customer bookings grew on both an absolute and percentage basis in 2019, we did not achieve the expectations we originally set for ourselves. In a moment I will talk about why, and what we are doing to better realize the opportunity we have.
Please turn to Slide 6. Annual recurring revenue, or ARR 17% consistent with bookings growth. ARR is driven by our ability to maintain and grow the dollars we receive from existing customers and by new sales. As we have discussed previously, retention rates, which for us are unit based, and don’t reflect the size of the account, trended down during 2019 primarily due to churn over the last couple of years in smaller accounts, including, the large number of accounts that have been coming off of grandfathered pricing leftover from when Lexia transitioned from perpetual to subscription sales.
We want to do a better, more efficient job of managing these smaller accounts, but now that we better understand the underlying reason, this is not a trend that concerns us. In 2019, dollar-based renewals continued to be strong and consistent with prior years. That said, we expected more from our renewal pool during the year as we introduced price increases that were targeted to whole-school licenses and certain annual service and implementation plans.
While in many cases the price increases were accepted by our customers, more often than we expected, schools or districts managed their expenses by shifting to lower priced service packages that maintained their prior price point. This had the benefit of improving margin on those bookings for us, as we were delivering fewer in-person services for the same dollar amount, but it did not increase bookings as much as planned if the services had been maintained and the price increase passed through.
Please turn to Slide 7 and I will talk about our expanding portfolio of solutions that will help drive growth. The first is the clear success of PowerUp. Remember, it was just a short time ago that we had only one literacy curriculum product. In 2018, we talked to you as we introduced PowerUp about how we expected it, along with Core5 to allow us to serve critical literacy needs from kindergarten through high school, and would fundamentally broaden our dialogue with school districts and deepen our impact.
And you can see the effect of PowerUp’s introduction on this slide. Since the launch of PowerUp in January of 2018, it has driven a rapid expansion in the number of customers using more than one product. PowerUp is also driving standalone sales, and in many cases is the first product we introduce into a school system that is using one of our competitors’ solutions in their elementary school buildings.
It is an effective wedge that will allow us to move down into elementary school buildings over time, especially as we demonstrate its effectiveness. By the end of last month, PowerUp was being used in over 6,000 school buildings both on a standalone basis and in combination with Core5. This is a 70% increase over February of 2018 and indicative of the largely unmet need we saw in the marketplace to help the broad population of struggling readers, and their teachers, in middle schools and high schools. And we are now beginning to see compelling evidence that our ability to develop highly effective K-12 products that produce positive changes for students and their schools is not limited to Core5.
Please turn to Slide 8. In January, our first study looking at the effectiveness of PowerUp, received an ESSA rating of Strong, which is the highest rating under the guidelines of ESSA, the Federal Government’s “Every Student Succeeds Act” is very difficult to achieve. In fact, given the effects seen in the study, PowerUp is now listed on the website of Evidence for ESSA, the organization that provides clear and authoritative information on programs that meet the ESSA evidence standards, as ‘the most effective secondary literacy intervention’, among the programs listed.
This is a special distinction earned by a product barely two years from its launch. We always believed PowerUp would be able to help the two-thirds of older students that are struggling to read that it was built for, but to have independent validation as ‘the most effective secondary literacy intervention’ is something we are very proud of. With Core5 and PowerUp we now have two successful, validated products that are highly complementary. This puts us in a much stronger position as a company than when we were a one product company, even one product as good as Core5. And now we have a great opportunity to make it three.
Please turn to Slide 9. As the success of Core5 and PowerUp demonstrate, we are very good at identifying large areas of underserved need in K-12 and building products that meet these critical needs by delivering adaptive, personalized solutions that benefit students, while providing their teachers the data and information they require, all in a way that accelerates learning. Helping emergent bilingual learners achieve language proficiency in English is the next area we are focused on.
As a reminder, this is the fastest-growing K-12 student population in the U.S., currently around 10% of students, but expected to grow to 25% by 2025. We believe there is an opportunity to dramatically improve instruction for these English as a second language learners in the United States, and potentially around the world. Our solution for K-6 emergent bilinguals will be called Rosetta Stone English, leveraging the power of our brand to drive awareness and confidence in a language development solution.
Rosetta Stone English will break new ground in a part of the marketplace that is still largely print based and unable to adequately meet the needs of these learners. Rosetta Stone English entered its beta period in early February. This is a broad program spanning over 30 schools, across eight key states including California, Florida, Texas and North Carolina, and reaching approximately 2,000 students. So far the feedback is very promising. With this expanding portfolio of products we are also focused on ensuring the sales force is structured and supported to achieve our growth targets.
Please turn to Slide 10. New Literacy bookings, despite growing more than it did in the prior three years, in both absolute and percentage terms did not meet our expectations. While we operate in a competitive marketplace, we don’t believe this is an opportunity problem. As mentioned on our third quarter call, we booked lower than expected new sales in two areas, Texas and large, or what we refer to as National Accounts.
These continue to be important and exciting opportunity and we believe we have the right positioning to drive growth in the market as it develops further, as in the case of Texas, and as our relationships mature and expand, as in the case of National Accounts. In fact, the secondary school portion of the Texas literacy adoption, where PowerUp is a great fit, begins this year. But as shown on this slide, we expect the majority of our opportunity to continue to come from focusing on the districts we are already in and where we can demonstrate positive outcomes. The opportunity represented here is huge, but we need to adjust how we were going after it.
Please turn to Slide 11. Historically, in large part to focus on upsell opportunities with current customers, regional sales managers have managed a team that included both account executives, those field based sales reps that are working face-to-face in districts and generally focused on larger accounts, and account managers, who are more like an inside sales team and generally focused on smaller accounts.
As we have grown, the volume of lower opportunity customers has built up under our sales teams, decreasing the time available for regional sales managers and their account executives to prospect for new business and drive larger expansions. In fact, we will manage approximately 4,600 renewals in our direct business this year. To address this and realize more of our growth potential, we have accelerated the evolution of our Literacy sales and marketing organization to significantly increase its capacity for new business and high value expansions and renewals, while more efficiently managing our large volume of smaller accounts with more limited expansion potential.
Earlier this year, we moved account managers out from under our regional sales managers and placed that team under two newly created regional inside sales managers. This account manager group, which we are also growing, is now entirely focused on the large volume of smaller opportunity customers. Critically, these reassignments of smaller account responsibilities to an inside sales team is allowing our field-based, regional sales managers to work more closely with their account executives for all of them to focus more productively on larger new opportunity and strategic renewals. We are also increasing the size of our field sales teams.
And finally, to improve the efficiency of all sales professionals, we are more than doubling our Account Specialist team. This team supports the transactional elements of the process so the sales team can focus on reaching out to new customers and strengthening existing customer relationships. These steps, taken together, have significantly increased our capacity to drive the engagement and focus necessary to manage renewals while also growing new business more rapidly. This is an important investment that will reduce earnings in 2020, but with that in place, it should allow us to scale faster and efficiently.
Let’s now turn to our Language businesses and I will hand it off to Matt.
Thank you, Nick. Moving to Slide 12, we had a solid fourth quarter in both our Consumer and Enterprise and Education language businesses, concluding the first year of growth since before 2014. In the fourth quarter, excluding custom content, Enterprise bookings were $10.7 million, versus $9.3 million in the same period in 2018.
The growth in Enterprise was more than offset by the year-over-year decrease in custom content within the period and lower K-12 Language bookings, resulting in total E&E bookings of $14.9 million, down $1 million from the same prior year quarter. For the year, however, total bookings in E&E were $2.8 million higher than in the prior year, driven by the large custom content deal in Q3 and improved performance in our corporate vertical.
During the quarter, the corporate team closed another seven figure contract. This global deal for a European-based company was the third million dollar or greater enterprise contract signed in the last two years. We continue to see additional expansion opportunities in our large pool of Global-1000 accounts, who currently have a low dollar value relationship with us.
Please turn to Slide 13. Consumer had a very strong fourth quarter with bookings growth of $2.5 million, or 14% over the fourth quarter of 2018, driven by Rosetta Stone app sales. Bookings also increased due to the sale of lifetime subscriptions in the Web channel, but because those sales are recognized as revenue over 24 months, they did not have a significant impact on revenue in Q4 2019. Revenues in the quarter were $15.8 million, an increase of 2% over the same period in 2018.
For the full year, Consumer Language revenue was $63.3 million versus $60.5 million in 2018, while bookings before SourceNext in the year increased by 5% to $66.4 million. As John said before, this is the first year that Consumer bookings and revenue have grown since 2014. Total contribution from the Language businesses, after the shared costs of R&D and IT, was $3.3 million in the fourth quarter, and $23.1 million for the full year.
Turning to Slide 14, the strong fourth quarter performance in Consumer was driven in part by strong sales of longer term subscriptions, in particular, our Lifetime product. We are finding that the lifetime product is attractive to a distinct customer segment that wants to commit to learning a new language, but is put off by finite subscription offers that are at odds with the investment in time they know will be required.
We recognize that lifetime sales eliminate the opportunity for future renewals from these customers and have priced the product accordingly to capture an LTV that is as high, or higher than we would otherwise expect to realize over time from future renewals of shorter-term subscription products.
Sales of lifetime subscriptions drove an increase in the average initial sales price from $103 in both the third quarter of 2019 and the fourth quarter 2018, to $120 in the fourth quarter of 2019. And while net LTV was relatively flat year-over-year, we recognized more of that LTV upfront, maximizing its benefit to us.
Turning to Slide 15. We see a logical bifurcation of our customer base into those looking to try language learning and who are most likely to purchase a three-month initial subscription, versus committed learners, who are more likely to buy a 24-month or lifetime subscription. Consequently, we are adjusting our offerings to create more value for each type of learner to better meet their objectives.
In February, for example, we added a significant upgrade to our long-term subscription offerings. For the first time, for all subscriptions 12 months and longer, learners have access to all of the 25 languages in our catalog with a single purchase. We call this Rosetta Stone Unlimited. Now a learner who buys a lifetime subscription will have the option to learn any language now or in the future. These lifetime subscriptions carry a typical average sales price per unit of approximately $189, versus $36 for a three month subscription, reflective of the tremendous value we are offering.
And the value we offer learners will only grow in 2020. We have a number of exciting new features that will be rolling out early this year and that we will talk about on future calls and share when we get to Investor Day. It is great to accelerate the pace of innovation in Language now that our platform consolidation and deflashing work is behind us.
Please turn to Slide 16. As we begin to see vitality returning to our Consumer Language business, we made the decision earlier this year to broaden our variable marketing spend to include more top of funnel, offline marketing. I have talked in the past about the enormous power of the Rosetta Stone brand, but frankly we haven’t done much to actively leverage it.
Over the last five years, we spent almost no money on offline brand marketing that can have a good return, but longer payback. Instead, virtually all of our media spend was focused on faster payback, performance digital marketing where a dollar invested relatively quickly produced bookings of approximately $1.80 on average.
We are now excited to resume investing in profitable long-term growth in our Language business. You will recall, we did a three city brand marketing test in 2019. We are utilizing the learnings from that test to expand and sharply focus our brand spend nationally during 2020. We do not intend to be, nor given the strength of our brand, do we need to be, a prolific offline advertiser. But we want to build a presence again that will broaden our customer reach and refresh what Rosetta Stone means in the mind of a language learner.
Because top of funnel advertising builds and pays back over time, we are not expecting a positive return on media for this portion of our marketing spend in 2020. Consequently, it will lower the contribution from Consumer relative to what it would have been had we not chosen to invest in our future growth. We are taking a measured approach to this as an investment and are confident the return will build and pay off over time based on our prior experience and the recent testing we’ve done.
With that, please turn to Slide 17 and John will walk through our financial outlook and share a few closing comments.
Thank you, Matt. Given everything that has happened, including the last few days, it is critical to provide context for our outlook for this year with a few thoughts about COVID-19 and its potential influence on our business in 2020 and over time.
As it regards the impact of the virus directly, our two priorities are the health and safety of our employees, and continuing to support our customers and learners during this uncertain and difficult period. For our employees, we have restricted travel and are taking precautions to promote a safe work environment, including, if necessary, temporarily closing offices, as we have in Seattle, which as you know has been ground zero here in the U.S.
For customers, all of our solutions can be used by learners, including those in K-12 and enterprise, remotely. We are working hard to ensure that we support our school and corporate customers, if they are disrupted by closures, to ensure that learning continues. We are confident we will be a great partner during what will be a challenging period for many.
As we consider the potential financial impact of this on our business, it is important to take a balanced long-term view, especially as so much is not yet known. In the intermediate term, I firmly believe the disruption caused by the virus will raise awareness of the benefits of blended learning solutions like ours.
Consider, for example, the advantages of an online coach for a corporate customer, versus sending an executive to a language center or bringing a tutor into your office. Or the ability of a young student to continue to learn to read at home using our software purchased by their district in the event of a school closure. These are real, tangible advantages to our solutions.
That said, we need to be cautious and balanced. In the near-term, uncertainty, slowing economic growth or customer distraction could impact parts of our business by prolonging customer’s decision making or even reducing learning budgets. In our K-12 business, we are confident of our ability to retain and even expand, our relationships with existing customers given the remote learning ability we provide, but it’s possible we could find it somewhat more difficult to drive new growth for a period if potential customers are focused on managing the immediate implications of the virus.
To be clear, we have not yet seen meaningful evidence of this, but we would be remiss if we weren’t planning for it. This, and our desire to achieve guidance in this important year, led us to reexamine the preliminary guidance for 2020 that we shared in November, and include a more conservative range.
In 2020, we are now guiding to consolidated revenue growth of 3% to 7%, or approximately $189 million to $195 million, through a combination of 12% to 14% revenue growth in Literacy on expected bookings growth of 20% to 25%, 4% to 7% revenue growth in Consumer on relatively flat bookings growth and a low single-digit percentage decline in revenues for E&E on a larger expected decrease in bookings.
Our outlook for strong bookings growth in Literacy is driven by expected continued high dollar renewal rates from existing customers, a third year of PowerUp, and the investment we are making to segment and more productively focus Lexia’s sales and marketing organization that Nick talked about.
This outlook is more tempered than before, in part because while we expect there may be good opportunity for growth with existing customers in this environment, we don’t yet know what the impact, if any, from disruption and distraction related to the virus will be on new business.
Included in Literacy segment guidance is a little less than $2 million of bookings from Rosetta Stone English, all of which would come in the second half of the year after its commercial release. A good part of this in 2020 is expected to come from renewals of existing E&E segment Rosetta Stone language customers.
Literacy segment revenue expectations for 2020 are also affected by lower than originally expected bookings in 2019. And secondly, because we expect approximately 80% of total Literacy bookings and nearly all of Literacy bookings growth to occur in the second half of the year, the impact of Literacy’s bookings growth this year on consolidated revenue in 2020 is diminished.
Consumer revenue in 2020 is now expected to be slightly higher than we previously thought due to the strong performance in Q4 2019. We haven’t changed our Consumer bookings growth rate for the year, as we want to see how new products, like our Unlimited Languages offering that Matt talked about, that are off to a good start in 2020, perform over a longer period.
We continue to expect a decline in E&E bookings due to lower expected bookings from custom content projects, remember we had a custom content deal of over $7 million in 2019, and declines in our K-12 language business, in part as some of its renewal business moves to the Literacy segment with the introduction of Rosetta Stone English.
Turning to profitability, we now expect adjusted EBITDA of approximately $3 million to $5 million and operating cash flow is expected to be $14 million to $16 million. Importantly, $2 million of the reduction in both EBITDA and operating cash flow from our preliminary guidance in December is the result of moving $2 million of product development costs that were previously expected to be capitalized, to R&D where they will be expensed. We now expect capital expenditures to be approximately $17 million, down from prior guidance of $18 million to $20 million and that we will be approximately cash flow breakeven for the year.
In total, expected cash flow is a few million less than we previously anticipated, but we see an opportunity to invest behind the strong performance we are seeing in Consumer, and we want to be a little more conservative in our bookings outlook in the current environment. We have offset a portion of this with expense reduction elsewhere.
As we reflect the current uncertainty in our bookings and revenue outlook, we will also be mindful of our expenses as the year progresses. As we learn more about the environment in which we are operating, we will adjust as necessary with the goal of continuing to invest in the future while remaining approximately cash flow breakeven this year.
As we look beyond 2020 and the current disruption, we see no meaningful change to the bookings trends in our business. Continued strong growth in Lexia driven by the foundation of Core5, with growing contributions from PowerUp and the introduction of Rosetta Stone English, mid-to-high single digit growth in Consumer Language and flat bookings in E&E Language as growth in Enterprise is offset by a shrinking K-12 Language business.
Please turn to Slide 18 and I will talk about Q1. Given how close it is to the end of the quarter, we would like to share our outlook for Q1. I would remind everyone that our first quarter is very small, with approximately 15% of expected bookings for the year. This is especially the case in Literacy where bookings are expected to be relatively flat with Q1 of 2019 and represent approximately 5% of total Literacy bookings for 2020. We continue to see strong performance in Q1 in our Consumer Language, and believe this provides us a great backdrop as we begin to acquaint people with the new Rosetta Stone through incremental brand advertising.
On a consolidated basis, we expect total Q1 revenue approaching $46 million, slightly up from last year, a GAAP net loss of approximately $7 million and a little over break-even adjusted EBITDA, a decline of approximately $3 million versus the prior year. Due to our typical first half use of cash, we will again have some seasonal borrowings.
As in 2019, we expect to have positive net cash at all times and intend to end the year with no debt. As implied by our full year guidance, we expect revenue growth and operating profitability to accelerate as we move through 2020 in line with the seasonal bookings growth in our business.
To wrap up, I am proud of the progress the team has made over the last five years, but this is an important year with priorities that include refreshing the understanding of what Rosetta Stone can be for someone looking to learn a language, focusing a larger K-12 sales team on renewing and expanding existing customers and driving new business growth and, later this summer, successfully launching Rosetta Stone English.
These are challenging times for many and our thoughts are with everyone affected, but I know our team will be there to support learners and develop stronger customer relationships built on trust, commitment and delivering great outcomes.
At the same time, there is much to be excited about. The growth and newly validated efficacy of PowerUp, the coming introduction of Rosetta Stone English, the first product that will bring together all that we do best across the company, the chance to reinvigorate the great Rosetta Stone brand and begin to invest behind Consumer again, and knowing that we will support our customers through the current Corona-virus event, wherever they want or need to learn.
In the interim, we will communicate with you regularly. We will keep you updated on the progress against our priorities, and we will look forward to seeing many of you in person at Investor Day.
We would now be happy to take your questions.
At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question is from Alex Paris, Barrington Research. Please proceed with your question.
Good afternoon, everyone.
I’m sure, you’re asked this question a lot as you added some great color in your commentary on what you’re doing with regard to the business in reaction to COVID-19. As we look at COVID-19, has there been any change or how should we think about the priorities for capital allocation or preservation through this fiscal year. And following up on COVID-19 has – have you changed at all your sales team expansion and/or direction in the midst of this uncertain environments?
Yes. No, those are very good questions, Chris. Thank you for asking them. We have a lot of variable expense in the – really across the company, primarily in sales and marketing, we have that in the consumer business. And Matt can speak to that. We’ll tell you right now, we are seeing a very strong environment in the Consumer business. And so the plan is to continue to lean into that and we can watch that really on a daily basis as opposed to some of our other businesses, which have a longer pipeline where we really have to be thinking out quarters. But the Consumer business, we’re able to track very closely and we’re feeling very good about the performance of that business even now. And I’ll let Nick and Matt add to this. As it regards the K-12 investment, we are absolutely committed to that.
We are certainly mindful of the opportunity that we see in the business both this year and longer term. We absolutely believe that, this is a terrible humanitarian crisis and we will do everything we can to support our team and our customers that when we come through it. The opportunity for us will be as great or greater than it has ever been. And we want to make sure that we are there with the right products and the right customers and the right customer relationships to continue to drive that.
That said, we will of course be mindful of expenses. You’ve heard me commit to trying to keep this company at the very least cash flow breakeven during the course of the year. I think that’s important. We certainly have more than sufficient liquidity to back us up based on everything that we say. We’ve renewed our credit line and actually expanded it. That was done prior to the most recent events. And so we feel very good about it. But we will be thoughtful.
That’s great, very helpful. And shifting to opportunity, perhaps, an update on how the launch of a K-5 solution is going so far in the quarter. Any idea at this point, it’s early in the year as to how much of a contributor it could be to incremental growth. And…
Nick, would you like to talk about Rosetta Stone English for a moment in the beta.
Sure. I’d be glad to. Hi, Chris. So as John mentioned and I mentioned in the presentation, we launched Rosetta Stone English about three weeks ago now. And are seeing strong use in about 30 schools with about 2,000 students in key states across the country and they’re really happy with the response we’re seeing in the engagement both from students and from educators really highlights the fact that there just is not a good product on the digital side and support those learners. But we are being fairly conservative in terms of what we are expecting from a contribution standpoint this year, we have approximately $2 million in the back half of the year. That is tied to Rosetta Stone English and obviously introducing it this summer, really just capturing half of the year and the beginning of the next school year. So the real growth for Rosetta Stone English is going to be in 2021.
And Chris, just to make sure you understand when Nick’s launch, that was the beta launch and as Nick said the actual commercial launch is not till later in the summer.
Got it. Got it. All very helpful. And I look forward to that. And any updates on the state of Texas, I know, we talked about it on the last call that should be more of a contributor this fiscal year I assume. And I’m assuming your progress is still living well in States like Utah, New York City and Arizona.
Yes. So first of all, I’ll talk about Texas, as we talked about on our third quarter call, Texas was slower to materialize in the first year than we had expected. Last year was really the 2019 adoption year, which was focused on the elementary school market. 2020 is the secondary school adoption and we’re seeing some really strong acceptance and reaction to our power up product in the secondary school market and are really pleased with the pipeline that’s developing there.
In terms of other target states, obviously Utah is an important state and customer for us. We’re continuing to work closely both with the state Department of Education as well as individual districts who are implementing our programs, and are now in over 60% of the elementary school buildings in that state and they’re seeing great engagement and great progress for those learners. And continue to look at specific states, where there’s either legislative activity or specific funding in place, where we can target our national strategy game.
Great. Thank you for the color. I appreciate it. I’ll hop back in the queue.
Our next question is from Steven Frankel, Dougherty. Please proceed with your question.
Good afternoon. Nick, let’s go back to the bookings situation again. And Q3, there clearly were some issues and Texas being one big one, but you guys seem fairly confident that you had some business slip into Q4 that you would be able to capture and you could do something north of $70 million in bookings for the full year. And you came in, call it, $3 million short of that. You did mention some pricing issue on realized prices that would seem to be not the explanation for all of the shortfalls. So I’m wondering what else happened in Q4 and do you have the right bodies in place that exit in 2020?
Yes. Thanks, Steve. Appreciate the question. So as I said from the previous question, obviously in 2019, we had more expectations for our performance around new business and especially in Texas and our national strategy initiative than we actually delivered. That being said, and we saw things that slip into the fourth quarter, where we felt confident that they are going to come in actually slip into 2020. We were hopeful given what we saw in the pipeline that they would close by the end of the year, but I think what we’re seeing is schools now shifting their focus to 2020.
The good news is a lot of the districts that we had in the pipeline in the fourth quarter of 2019 are in the pipeline for 2020. And not only in the pipeline, but because of the secondary adoption growing in size momentum. Those still will be second and third quarter sales, but we’re really pleased with the strength that we see there.
Okay. And then in terms of the bodies you have, the talent you have and the shift of the bodies over from E&E, given all the dynamics in those market, how confident are you that you have the team that can hit the ground running in 2020. And have this not be a rerun of what we saw last year?
Yes. So the things that we’ve changed in terms of our sales channel structure. I think our direct result of some of the challenges we saw in 2019, they were changes that we knew we needed to make over time. And in this case, we’ve accelerated those channel shifts. It’s really about focusing those larger opportunities and expansion opportunities into this hands of our account executives and our regional sales managers and reducing the span of control for those regional sales managers. So they have time to work those larger opportunities and work with those account executives.
At the same time, we’ve now put in place two new regional inside sales managers with an inside sales team underneath it, that can handle that high volume, low value customer segment. Quite honestly, one of the things in the fourth quarter of 2019 that we saw was just the volume of business that continued, just wasn’t able to be managed by the team we had in place given the fact that they had too many opportunities. So the structure we have now and the additional capacity and talent that’s already in place and continuing to build, I feel is the right structure, not just for 2020, but to drive us forward into the future.
Okay. And then Matt, is this shift to the higher dollar lifetime or longer term subscriptions? Is that in part a reflection of the seasonality in the business and that’s a great gift to keep, to give to people? Or is this your conscious strategy now to focus on selling that set of customers, which differentiate from your competitors?
Yes, it’s a great question. We do lean into the fact that we’re a premium brand and that we have added more utility in Q1 to allow consumers that basically have the Netflix of language learning, so adding 25 languages to all long-term subs. And the fourth quarter is more of a mix shift as we mentioned on the lifetime SKU. This was actually better than our expectations, obviously, you saw the quarter results. We’ve been pretty pragmatic in terms of how we’re guiding into that for 2020, because it’s too early to tell. But as John implied on the call, we’re having a good Q1 as well. And so strategically, we are leaning into long-term and we are leaning into add more in utility and more value for long-term subscribers. And we’re able to see that we’re getting higher growth LTV and more value out of those customers.
Okay. And how much are you going to spend on this offline marketing. And maybe where are you spending it? Are you hitting the AVOD market, radio and what’s the strategy with these dollars?
Yes, it’s a great question. So as you know, we typically focus very specifically on quick payback within a quarter digital performance based marketing. We haven’t really flexed our muscles as a large percentage of our overall marketing budget, in terms of variable marketing towards non-performance media. We’re going to lean into offline TV and digital connected TV as a – let’s call it, low-double-digit spend against our overall durable marketing. So a little bit bigger than what we did last Q2 2019, but we’ll lean into that and test into it just like we do everything else.
And that was low-double-digit as a percent of the variable marketing.
Okay. So can you give us a ballpark of how many millions of dollars that is? I’m just trying to parse your reduction in adjusted EBITDA relative to the last time you gave guidance. You were helpful with the $2 million that came out of the R&D accounting change. And so I’d love to know what this piece is?
Yes. We’re in the $3 million to $4 million range of incremental.
Okay. And I guess I’m focused on that $2 million expectation for ESL. Are you just trying to set the bar really low or now that you’ve gotten deeper into the product, do you think that the sales process might be a little more complicated than you originally thought and it may be takes two to three years for this product to ramp meaningfully?
Yes. I don’t think so, Steve. It’s really mostly the fact that we are launching it halfway through the year. And so the fact that it’s not commercially available until back to school means that we’re not able to demonstrate it and provide proof of efficacy and everything else that schools typically want to see and that when they’re adopting a program. So we’re being careful in the first year. I do believe that we feel very confident in our ability to launch that product. The go to market plans are incredibly exciting. And our sales team is in place and I think I’m incredibly excited about the opportunity to bring that product to current customers who are using the legacy language product in that market segment, but new customers as well where they haven’t been able to make inroads. But as I said, on the last question, the big growth will come in 2021.
And for those schools that today are buying Rosetta Stone through the first E and E&E group to try to do this. Is there a discount for me to make that swap or a way to make that upgrade kind of easy? Or are you kind of going at this is a rip and replace, because it’s a superior product and no one’s going to get an easy upgrade path?
Right. It’s a much better product. It’s the first product that we built for those young EL learners. And it’s the first product we’ve built that brings together our literacy expertise and language expertise. So the percentage of customers we actually have in the elementary school market, because that product was never designed for that market segment is fairly small. So half of the business will be renewals from the legacy products and the half will be new business.
Okay, great. Thank you. I’ll jump back in the queue.
Our next question is from Ryan MacDonald, Needham & Company. Please proceed with your question.
Hi, good afternoon everyone. As we’re looking at the guidance more broadly, can you handicap a little bit, as you look at sort of the change last quarter to this quarter about what the mix in the guide down is between sort of lower expectations or underperformance. Maybe if you want to call it that in 2019 versus concerns and impact from COVID-19 in [indiscernible] thanks.
Sure. So part of the guide down is the investment in the brand spend that we’ve decided we want to lean into, given the performance that we’re seeing in consumer and the opportunity to develop that as a very valuable asset here that will benefit all of the business. Even Rosetta Stone English in the K-12 business will benefit from that brand spend at least indirectly, part of it is the reclass from CapEx to R&D.
And then the guide down on the revenue side is kind of net the language business, it comes out more or less flat. It’s principally from Lexia, a few million dollars of that is because of a slightly lower jump off point and a few million dollars of that is because we want to be more conservative. The benefit of reporting when we are, which is little bit later is we have more information than we would’ve had a week or two ago about what’s going on in the world. And we felt the obligation to take that into account.
I think there are still lots of unknowns. I think we would all tend to acknowledge that. But clearly, we sit here today in the environment that we’re in and wanted to take that into account and are comfortable with the revised guidance based on what we know now. And then we’ll see how things develop over the course of the year and with schools and everything else, but we feel very good about that.
Got it. And as we’re looking out and starting to look at what school budgets can be as we get into this for the fall 2020 school year. I mean, I would imagine they remain fairly consistent year in and year out, but is there anything that that could be impacted from either whether economic growth or any sort of follow on impact from school closures of COVID-19 that could impact school budgets going into this year?
Yes, school budgets are tend to be lagging indicators of the economy, right. So I think school budgets and the federal budgets are fairly well set for the 2020, 2021 school year. Certainly, in longer term that based on the economic – the broad economic impact of COVID-19 could drive softness in future school budgets since they’re dependent on state and local tax revenues. But we feel pretty good about the funding environment for the coming school year.
Got it. And then you talked about sort of renewals being a big aspect for 2020. And I just wanted to know, given the changes you’re making into the structure of the sales force and maybe making some additions. How much visibility do you have into those renewals and the chances of success there and do the structural changes at all create an opportunity for confusion, I guess, in the near-term. Thanks.
Yes. Actually, I think they create opportunity for a lot better focus. As I said before, the way we structured the channel and the capacity of the channel in 2019 meant that each individual sales rep had an enormous number of opportunities and accounts to manage. And everything from small accounts to much larger accounts. I think the segmentation of the channel now gives each team much better clarity and much better capacity to handle the volume of the business.
So we’ve got good visibility into the renewal pool, obviously, and the other benefit we have now is we’re bringing together data from our sales teams and data from the product. So that our customer success organization has better visibility into account health than they’ve had in the past and can be more proactive in identifying accounts that are at risk and heading that off, so that those renewals are supported and managed.
Got it. Thank you very much.
Our next question is from Eric Martinuzzi, Lake Street Capital Markets. Please proceed with your question.
I wanted to revisit the Q3 literacy issues and make sure that I understand whether or not they persisted in Q4. Because I had it boiled down in Q3, I had the literacy booking shortfall boiled down to slow federal funding issues if many districts. Then the second issue was kind of sales execution. Can you address how those two items played out in Q4 and I just want to make sure I understand, whether they were resolved, addressed or persisted and whether there’s a new reason now in Q4.
Yes. No, not a new reason at all. What we found in Q3, especially, the lag in what we anticipated from Texas and from our large account strategy did persist into the fourth quarter. As I said before, we had a number of deals that we saw slip from the third quarter into the fourth quarter. And unfortunately, those did not materialize in the fourth quarter. But as I said before, the good news is that we see them continuing to build momentum in the pipeline and believe that they will grow in size and materialize in Q2 and Q3 or managing each of those larger opportunities very closely.
The other thing that again impacted Q3 and Q4 as I said before, it was just the volume of the business and the structure of our channel. That changes we’ve made to the channel and the additional capacity both in our field and inside sales teams, I think address the issues that we saw in 2019 and it’s why we feel confident going into this year.
What about the sales and marketing just that channel, if I could boil it down to a single number, I would say, the issue was at the end of December, 2019 or at the end of September, 2019, we had the headcount for sales and marketing for K-12 was x and a year from now September of 2020, it’s going to be y. Could you – have you size that up based on this investment you’ve talked about?
Yes. You see the numbers of sales reps in the presentation. So you can see the size of the account executive team and the account management team and the management infrastructure shift so and grow, right, so two new inside sales managers and new account executives and account managers on the inside sales side. The other thing we have done is we’ve doubled the size of our sales associate team. That’s the team that really is sitting here in the Concord office, helping our sales reps with quotes, helping them manage those small transactional renewals and giving our – yes, go ahead.
You’re talking numbers in the slide deck, are you talking about Slide 11?
I am talking about, let me just get there. Yes, that’s correct. Yes.
Let’s do the math for me, 2019 one number, 2020 one number.
So I just want to check with Tom and make sure that we’re comfortable in sharing exact numbers on the sales side.
Sure. Yes, I think that’s fine, there.
Okay. So again from a sales management standpoint, we have five regional sales managers managing those account executives and account managers. So when you see the account executives and account managers have seven per region and three per region, 2019 and five regions, that math is pretty straightforward. In 2020, again we reduced the span of control for a regional sales manager. So they’re just now managing seven people instead of 10 previously and brought in two regions inside sales managers with eight account managers underneath them each.
Okay. I’m getting a brain cramp here, but I’ll take it offline. I think you’ve given me what I can get to the number. So let’s talk about the price. You talked about part of the issue in K-12 was price increases that didn’t go through. In other words, you’ve got an installed base customer, you’re coming at him with a price increase and they’re saying, you know what, I’ll take less of this cheaper product over here. What’s – what do we need to fix about the pricing packaging going forward?
So first of all, if you look – take a look at 2020 and our long-term plan, there are no additional price increases baked into that plan. It’s not to say that there isn’t potential future opportunity, but it is not in the financials. So the – and we did not increase prices across the board. They were very targeted price increases. We increased the price of our unlimited site license from $8,500 to $9,000, and we increased the price of one of our service bundles, the one that had a large percentage of face to face delivery.
And so what we saw was customer saying, what that, that price increase especially on that service package is more than I want to take on this year. And they purchased a virtual implementation package instead, which had the same price point as that face to face price package before. What that did was put some pressure on bookings, because we had modeled that that price increase would have a larger impact, but it did drive better margins because the margin on that virtual service package is better.
Okay. And then I want to revisit the 2020 outlook, and if I look back to the guidance back in November, we had a revenue outlook, I want to say $196 million or so was the midpoint. Now we’re at $193 million at the midpoint, that $3 million downward revision. I think I’ve got – we had a little bit less than we expected in the 2019 bookings on the Literacy side, but everything else was kind of on track or slightly better.
So that to me explains the revenue midpoint reset. The $6 million delta on the adjusted EBITDA, we talked about $2 million from the R&D capitalized versus expense, and then we talked about $3 million to $4 million of incremental spend on the marketing side. Those three things you would all be to the negative. So I would almost think adjusted EBITDA would be lower. What’s – is there an offset on the expense side that that keeps, because the adjusted EBITDA midpoint was $10 million and now it’s $4 million. So I was looking for kind of when everything was netted out there’d be a $6 million pressure to the EBITDA.
Yes. What I mentioned in the script was reduced expenses elsewhere. We’ve cut expenses in other parts of the business to partially fund the investments and makeup for that decrease.
Got you. Okay, that covers my questions. Thank you, and congrats on the PowerUp that’s a strong rating, that’s a terrific endorsement for your product.
Thank you, Eric.
Yes. We have nice to grown as much as we have without it now to have it, it’s terrific.
Our next question is from Hannah Rudoff, D.A. Davidson. Please proceed with your question.
Hi guys, thanks for taking my questions today. I’m kind of following on the previous question about renewal rates. Could you talk about where you expect retention rates to trend going forward over the course of this coming year?
Nick, would you like to pick that?
Sure. So as we saw on the presentation renewal – retention rates did tick down a bit and that was really because of two primary factors that we talked about. One was the end of grandfathered pricing and that grandfathered pricing was put in place when we moved from perpetual to subscription pricing. The impact of that was mostly felt in 2019. The bulk of that grandfathered price is now behind us. There still is some forward, but we factored that into our modeling now much more clearly from a segmentation standpoint.
So looking at the various customer segments, understanding how they renewed in 2019 and then modeling that going forward. We’ll still see some churn in those smaller accounts in 2019, remember retention rates are unit based. But we expect it to stabilize. We expect renewal rates to continue to improve as we sell multiple products into a single account.
Great, that’s really helpful. And then can you talk about the competitive environment, particularly as it relates to Rosetta Stone English. So for new business, you’re winning with that product who are you displacing if anyone?
Right. So again Rosetta Stone English launches this summer. Most of the competitors in that space are print based competitors, products that really aren’t doing a great job of driving student performance. There are a few competitors with digital solutions that support both EL students and sort of the general student population. But none of them have the capabilities that we built, because of the expertise we have as a language learning company, right.
When you think about what the students need, they need the opportunity to practice their oral language skills in class and they don’t have that opportunity now. They’re just aren’t products that are voice enabled that gives students the ability privately to practice their speech. And it’s probably the thing that holds most students back. And so it’s a very unique product and one we are incredibly excited about, especially given the early feedback we’re seeing from our beta sites.
Great, that makes a lot of sense. Thanks, guys.
Our next question is from Noah Steinberg, G2 Investment Partners. Please proceed with your question.
Hey John, it’s Josh Goldberg. How are you?
Great, Josh. How are you?
So I had a couple of questions. I guess I’ll start with obviously everyone is wondering how this is affecting all their businesses. I just want to know what can you do to increase your competitive moat because of this? What are you doing internally to use this dislocation or distance learning opportunity to your advantage? And then I have a follow-up.
Yes. And I’ll start, and I’ll let Nick and Matt address that actually, because I think it’s relevant to both parts of the business. One thing I would mention is that a few people had asked about it prior to the call. We’ve included in the supplemental financial information that we posted to the IR website as the last couple of pages, an email that Lexia sent out to its customers, I think earlier this week, end of last week that talks about what we can do to support our K-12 customers in the event of a school closure.
I think it’s terrific. I think it’ll give you a real sense of the quality of the offering and the quality of the support and then how they recommend that everybody look at that. And if you have any trouble finding that, let us know. We’d be happy to email you a PDF of that. With that Nick, I’d let you maybe add some thoughts.
Sure. So I think as John mentioned that our first focus is on making sure that our customers already have our product know how to use it to support remote learners and teachers who won’t be in schools. And so we’re doing everything we can to make sure that they have the tools and the knowledge to leverage what they already have. Our belief is that we can be art. We know we can be a really important part of how schools plan to manage those virtual student populations now.
So first thing we’re doing is making sure we’re supporting our customers. We’re also thinking about ways in which we can support both customers and non-customers over the next two or three months to make it as they’re planning right now and we’re hearing this daily, they’re planning their contingency plans in case students close to make sure that they are aware of our product, aware how they can fill the need as they’re putting together their instructional and curriculum plans for students if and when schools close.
So we’re – from the standpoint of our products, being able to benefit those schools, we’re trying to make sure we’re in the hands of as many of those schools that are closing as possible. Long-term, I think this is an opportunity for educational technology and distance learning to play a bigger role in schools. In the short-term, as John mentioned, we do believe there’ll be a little bit of pressure on new business, but also believe that there’s opportunity for stronger renewals and expansion the schools are struggling to figure this out.
Matt, is there anything you’d like to add on the language side?
Yes, I have an interesting perspective on this. And first I’d like to say of course, we want to take care of our learners and we’re concerned about all of our global citizens. We wouldn’t want to use this pandemic and global downturn for business purposes only. And we really think about all of our learners and concerned about them. I’ve been involved as in a leadership position across two different recessions and actually ran with a President of Travel Company during 9/11.
And you mentioned the economic moat, one thing that we do feel that is time to lean into is the economic moat around the brand. Our biggest competitor in the language business is that most of our customers don’t know that we have a digital product. They still think of us as a CD company. And we see the time with the right product market fit the right execution that we’ve been able to show in Q4 that this is the time to start leaning into the brand and we’re excited to do that.
Okay. And John, if it’s okay, we’ve been involved in the company for a while. We like what you guys have done. The stock is not responded even before the last few weeks. And I think some of the concerns from investors have been really centered around this. The guidance continues to go lower. And specifically on the booking side, I think you’ve heard that from a few investors today and you’ve given really no clarity on what the bookings guidance will be on the Lexia side in 2020.
I think at one of your Analyst Day’s you talked about a 20% to 25% growth rate. You weren’t able to do that last year. It doesn’t sound even with all the increase of carrying reps that you feel confident on the 2020, even with New York and Texas in a more mature state. So can you talk a little bit about really what’s going on in that area? I mean we understand all the other issues. Just in that area, why are you not seeing this sort of exit – escape velocity to be able to grow even faster as more and more schools line up. Thank you.
Yes, thank you for the question. So just for sake of clarity, we did guide to 20% to 25% bookings growth in the Literacy segment. This year that is down from our guidance in November, which was 25% to 30%. That is based on a belief that this could be a more difficult new business environment this year, not as Nick said because of budgets that frankly because of distraction. We don’t know that yet. We haven’t yet seen that. Schools won’t close the vast majority of their business until we move into the third and fourth quarter. But this is the time in which we’re talking to new customers. Those engagements and relationships remain ongoing, but we are concerned about the unknown.
And so we took that guidance down from 25% to 30% or midpoint of 27.5%, down to a midpoint of 22.5% for this year. There remain unknowns of course. I don’t think any of us even though if there is going to be an Olympics this year, but what we are confident of is PowerUp is growing very strongly. This is our third year of selling that – behind it that takes time, we now have that. We feel very good about Texas. Again that’s somewhat related to PowerUp. And I know that sounds like a broken record, but the secondary school literacy adoption in Texas takes place this year. We think PowerUp is a great fit there. And it’s a literacy adoption. They have to do it. Distraction will not be an excuse. In Texas even with the virus, they have to get their secondary school literacy adoption in place.
And then obviously we’ve taken very significant steps in restructuring and expanding the sales team. We believe we have the best products in the market. We believe we have the best K-5 literacy product. We believe we now have. And the third-party has said we do the best K-6 through K-12 literacy product. We’re about to introduce what we think will be the best EL product for K-6. That’s a really powerful portfolio and it’s going to – it will – it’s that portfolio with the right execution that will allow us to – I think a reasonable growth rate for this business, I think escape velocity for this business is 20% to 25% on a consistent basis for the next few years. And we’re comfortable guiding to that based on the investment that we’ve made in the products that we think we’ve built. We know we’ve done.
I guess I’m back to a more so what is it that’s not helping you kind of accelerate or get more conviction on your growth rate like usually in the year or two or three of an adoption phase, you start getting better clarity like you’re not seeing that yet and I’m just…
No, again I would say like we had guided the 25% to 30% growth back in November and then long behold, we’re sitting here in the middle of March, and schools are closing. We don’t know what that means. Again, just for focus, we know our products are well-accepted. We know they deliver terrific outcomes. Our confidence in our products, our confidence in our ability to execute with the restructuring of the sales team, none of that has shaken.
The only thing that has created an uncertainty right now is, yes, our schools, principals going to be distracted. Now that could very much help the renewal business. They will – may stick with us. They may expand with us. A little bit of uncertainty is just on the new business side, which would be temporary, right. It could just be for a few months as we come through this. We just don’t know.
Our confidence in the business is frankly never been higher, to have gone from a one product company, which is always a little bit scary. And I think most of you know going from a one product company to having two successful SaaS with Core5 and PowerUp, we’re highly confident we’re about to do that again. With Rosetta Stone English, we wish the environment was a little better and when it is and when schools are all open and people are just worried about learning, I think we’ll feel very good about the business.
And because we are going to your first question, because everyone here is first and foremost is focused on supporting their customers. We are going to come out of this with better relationships than we had going in. We’re going to come out of this with a better reputation than we had going in and it’s pretty good. And our team is – we’re absolutely dedicated to our team and our team is dedicated to those customers. And when we come through it, we will be in very good shape. So we’ve got to get to the other end of this uncertainty before we can start talking about higher than 20% to 25% growth rate.
Okay, thank you.
We have reached the end of the question-and-answer session. I will now pass the call back over to management for closing comments.
Thank you. We are actually truly excited about this year. Obviously this is a very difficult year for many people, much more so for many, many people of them for us. Our focus is our team as I said and it’s our customers. We look forward to speaking to you in the future. As I said in my prepared remarks, we want to stay in touch during all of this uncertainty. So that we are close with you and you understand what is going on in the business and we look forward to doing that. Thank you for your questions and we hope you’re all well.
This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.
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