ROSETTA STONE INC. This Quarterly Report on Form 10-Q (this "Report") and other statements or presentations made from time to time by the Company, including the documents incorporated by reference, contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by non-historical statements and often include words such as "outlook," "potential," "believes," "expects," "anticipates," "estimates," "intends," "plans," "seeks" or words of similar meaning, or future-looking or conditional verbs, such as "will," "should," "could," "may," "might," "aims," "intends," "projects," or similar words or phrases. These statements may include, but are not limited to, statements related to: our business strategy; guidance or projections related to revenue, Adjusted EBITDA, sales and bookings (which is an operational metric that represents executed contracts received by the Company that are either recorded immediately as revenue or deferred revenue and in any one period is equal to revenue plus the change in deferred revenue), and other measures of future economic performance; the contributions and performance of our businesses including acquired businesses and international operations; projections for future capital expenditures; and other guidance, projections, plans, objectives, and related estimates and assumptions. A forward-looking statement is neither a prediction nor a guarantee of future events or circumstances. In addition, forward-looking statements are based on the Company's current assumptions, expectations and beliefs and are subject to certain risks and uncertainties that could cause actual results to differ materially from our present expectations or projections. Some important factors that could cause actual results, performance or achievement to differ materially from those expressed or implied by these forward-looking statements include, but are not limited to: the impact of the COVID-19 pandemic on the global economy; the risk that we are unable to execute our business strategy; declining demand for our language learning and literacy solutions; the risk that we are not able to manage and grow our business; the impact of any revisions to our pricing strategy; the risk that we might not succeed in introducing and producing new products and services; the impact of foreign exchange fluctuations; the adequacy of internally generated funds and existing sources of liquidity, such as bank financing, as well as our ability to raise additional funds; the risk that we cannot effectively adapt to and manage complex and numerous technologies; the risk that businesses acquired by us might not perform as expected; and the risk that we are not able to successfully expand internationally. 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. These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements risks and uncertainties that are more fully described in the Company's filings with theU.S. Securities andExchange Committee (SEC), including those described below, those discussed in the sections titled "Risk Factors" in Part II, Item 1A of this Report and those updated from time to time in our future reports filed with theSecurities and Exchange Commission . This section should be read together with our unaudited consolidated financial statements and related notes set forth elsewhere in this Report, "Management's Discussion and Analysis of Financial Condition and Results of Operations", and our Annual Report on Form 10-K filed with theSecurities and Exchange Commission onMarch 11, 2020 . OverviewRosetta Stone Inc. ("Rosetta Stone," the "Company," "we" or "us") is dedicated to changing people's lives through the power of language and literacy education. Our innovative digital solutions drive positive learning outcomes for the inspired learner at home or in schools and workplaces around the world. Founded in 1992, Rosetta Stone's language division uses advanced digital technology to help all types of learners read, write, and speak world languages.Lexia Learning , Rosetta Stone's literacy education division, was founded more than 30 years ago and is a leader in the literacy education space. Today, Lexia helps students build foundational reading skills through its rigorously researched, independently evaluated, and widely respected instruction and assessment programs.Rosetta Stone Inc. was incorporated inDelaware in 2005. The Literacy segment derives the majority of its revenue from sales of literacy solutions to educational institutions serving grades K through 12. The Enterprise & Education ("E&E") Language segment derives revenue from sales of language-learning solutions to educational institutions, corporations, and government agencies worldwide. The Consumer Language segment derives the majority of revenue from sales of language-learning solutions to individuals and retail partners. Our Literacy distribution channel utilizes a direct sales force as well as relationships with third-party resellers focused on the sale ofLexia Learning solutions to K-12 schools. Our E&E Language distribution model is focused on targeted sales activity primarily through a direct sales force in five markets: K-12 schools; higher education; federal government agencies; corporations; and not-for-profit organizations. Our Consumer Language distribution channel comprises a mix of our call centers, websites, app-stores, third party e-commerce websites, select retail resellers, such as Amazon.com, Barnes & Noble, Target, and Best Buy, consignment distributors such asSoftware Packaging Associates , and daily deal partners and home shopping resellers.
As our Company has evolved, we believe that our current portfolio of language
and literacy products and our SaaS-based delivery model provides multiple
opportunities for long-term value creation. We also believe the demand is
growing for e-learning based literacy solutions in the
We continue to emphasize the development of products and solutions for learners
who need to speak and read English. This focus extends to the Consumer Language
segment, where we continue to make product investments serving the needs of
passionate language learners who are mobile, results focused and value a quality
language-learning experience.
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To position the organization for success, our focus is on the following priorities:
1. Continued growth of our K-12 business; 2. Leveraging our iconic Rosetta Stone brand; 3. Position ourselves as a leader in adaptive blended learning; and 4. Accelerate growth and increase intrinsic value. As ofJune 30, 2020 , we currently have three operating segments, Literacy, E&E Language, and Consumer Language. We discuss the profitability of each segment in terms of segment contribution. Segment contribution is the measure of profitability used by our Chief Operating Decision Maker ("CODM"). See Note 16 "Segment Information" of Part 1 - Item 1, Financial Statements for information about recent changes in the definition and presentation of segment contribution.
COVID-19 Update
In late 2019, a novel strain of coronavirus that causes the disease COVID-19 surfaced and quickly spread, causing a global pandemic. To combat the spread of COVID-19, authorities have taken a variety of steps to protect their citizens, including closing schools and workplaces and requiring people to stay at home and practice social distancing. These actions have had significant negative impacts on the global economy. OnMarch 16, 2020 , our global employee base began to work from home. We have a distributed workforce that has historically operated out of multiple offices. As a result, we already had in place the appropriate technology and tools to facilitate operating in a remote work environment and under restricted travel. As such, to date, we have not identified any significant issues with travel restrictions and in the transition to a remote work environment. We have established a plan, in compliance with applicable guidance, to return to our offices. We have also given our employees the option to continue to work remotely for the remainder of the year. We have not had any COVID-19 related employment terminations, however we have taken the following employee-related actions to decrease costs and preserve our cash flows to provide cushion for future uncertainty:
• the furlough of 14 employees effective
an additional 4 employees effective
indirect support of the Enterprise business;
• adoption of the deferral on the payment of social security under the
CARES Act through the remainder of 2020;
• discontinuation of the 4% company match on 401(k) contributions beginning
• a pause on salary increases that have not already been communicated; and
• restriction on personnel hiring to only areas that are critical to thebusiness or that create or support bookings, especially in our K-12 and
Consumer Language businesses.
We recognize that COVID-19 has changed the way our employees work with each other and our customers, and we are committed to ensuring these changes cause the least disruption to our learners. All of our solutions can be used by learners remotely and we are capable of providing our services to our customers while following social distancing protocols. In response to extensive business and school closures around the world and the growing need to adopt distance-learning solutions, we implemented the following initiatives:
• expanded access to our products for all of our existing K-12 customers
through the end of the 2019/2020 school year, with no additional charge,
to help them move to remote learning (the "Learn From Home" program);
• provided Lexia Academy , which provides online implementation and training
support for teachers, to help teachers implement our products with their
students;
• communicated to districts and schools regarding best practices for remote
learning;
• left expired licenses on for a period of time for customers who were
dealing with very disruptive changes to the way they worked, and delayed
aggressive collection actions;
• made available three months of a free language learning subscription to
any elementary, middle or high school student through June 30, 2020 ;
• provided free unlimited group language tutoring for all paying consumer
subscribers through
• upgraded our "bronze" access level Enterprise customers to a "silver"
access level at no charge to provide access to online group tutoring
through
During the second quarter of 2020, we experienced the following as a direct result of COVID-19:
• in Lexia, there was a 12% increase in active school licenses and a
tripling of the number of unlimited school site licenses, attributable to
expansions in existing districts that were driven by the Learn From Home
initiative. While we recognize that not all of these new learners will
convert to paying licenses, we are focused on continuing these
relationships, with as many of these schools as we can as paying
customers;
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• an increase in Consumer Language subscriptions and users as people sought
language learning enrichment opportunities during stay-at-home orders.
Given the proximity of the
onset of the pandemic, it is not possible to precisely determine how much
of the 92% second quarter year-over-year bookings growth was directly
attributable to the pandemic, but we believe a significant portion is
attributable to the pandemic. We do not expect Consumer bookings growth
to continue at this rate in future periods;
• we did not make any short term borrowings under our credit facility
during our typical mid-year seasonal cash low point driven primarily by
the increase in Consumer language bookings. These Consumer sales turn to
cash quickly because they are paid up front via credit card transactions
and had a positive impact on our liquidity during the first half of 2020;
• reduction of future pipeline sales opportunities in our Enterprise
business where new and existing customers that are experiencing financial
hardship may decide to postpone purchase or renewal;
• direct and indirect cost cutting measures in the E&E Language business,
including furloughs, to reduce related operating expenses by
approximately $4 million on an annual basis; and
• a year over year reduction in second quarter travel related expenses of
While we continue to be confident of our ability to support learners during this period, there remains uncertainty surrounding:
• unprecedented levels of disruption that may distract our customers and
delay purchasing decisions;
• customers, particularly in our Enterprise business and with our custom
content deals that support language preservation for Native American
tribes, that may be facing financial difficulties that may lead to
delayed purchase decisions slower cash collection or non-renewal due to
lack of funds;
• the length of the economic downturn and the impact on local K-12 school
budgets and consumer discretionary spending; and
• productivity disruptions caused by the distraction of our workforce in a
remote work environment.
We continue to monitor these risks. Alternatively, the COVID-19 pandemic may continue to create opportunities for us to expand our relationships with existing customers who appreciate the value of remote learning. We believe that over time that this period will serve to highlight the affordability and convenience of online training and coaching.
Components of Our Statements of Operations
Revenue
We derive revenue from sales of language-learning and literacy solutions. Our
revenue consists of fees associated with web-based software subscriptions,
online services, professional services, and mobile applications. Subscription
revenue is generated from contracts with customers that provide access to hosted
software over a contract term without the customer taking possession of the
software. Subscription revenue is recognized ratably over the contract period as
the performance obligation is satisfied. Subscription revenue is generated by
all three reportable segments and range from short-term to multi-year contracts.
Online services are typically sold in short-term service periods and include
dedicated online conversational coaching services and access to online
communities of language learners. Professional services include training and
implementation services. Online services revenue and professional services
revenue are recognized as the services are provided. Expired services are
forfeited and revenue is recognized upon expiry.
We sell our solutions directly and indirectly to individuals, educational
institutions, corporations, and governmental agencies. We sell to enterprise and
education organizations primarily through our direct sales force as well as
through our network of resellers and organizations who typically gain access to
our solutions under a web-based subscription service. We distribute our Consumer
Language products predominantly through our direct sales channels, primarily
utilizing our websites, mobile applications and call centers, which we refer to
as our direct-to-consumer ("DTC") channel. We also distribute our Consumer
Language products through select third-party retailers and distributors. For
purposes of explaining variances in our revenue, we separately discuss changes
in our E&E Language, Literacy, and our Consumer Language segments because the
customers and revenue drivers of these channels are different.
Literacy segment sales are seasonally strongest in the second and third quarter
of the calendar year corresponding to the end and beginning of school district
budget years. Within our E&E Language segment, sales in our education,
government, and corporate sales channels are seasonally stronger in the second
half of the calendar year due to purchasing and budgeting cycles. Consumer
Language sales are affected by seasonal trends associated with the holiday
shopping season. We expect these trends to continue, but may be impacted by the
COVID-19 pandemic.
Cost of Revenue
Cost of revenue primarily represents costs associated with supporting our
web-based subscription services and online language-learning services, which
includes online language conversation coaching, hosting costs and depreciation.
We also include the cost of credit card processing and customer technical
support in cost of revenue. Cost of revenue also includes third-party royalty
fees, and inventory storage, obsolescence and shrinkage.
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Table of Contents Operating Expenses We classify our operating expenses into the following categories: sales and marketing, research and development, and general and administrative. Our operating expenses primarily consist of personnel costs, direct advertising and marketing expenses, and professional fees associated with contract product development, legal, accounting and consulting. Personnel costs for each category of operating expenses include salaries, bonuses, stock-based compensation and employee benefit costs. Sales and Marketing. Our sales and marketing expenses consist primarily of direct advertising expenses related to television, print, radio, online and other direct marketing activities, personnel costs for our sales and marketing staff, and commissions earned by our sales personnel and app stores. Sales commissions are generally paid when a customer contract is either recorded as revenue or deferred revenue. However, sales commissions are deferred and recognized as expense in proportion to when the related revenue is recognized. Research and Development. Research and development expenses consist primarily of employee compensation costs, consulting fees, and overhead costs associated with development of our solutions. Our development efforts are primarily based in theU.S. and are devoted to modifying and expanding our offering portfolio through the addition of new content, as well as new paid and complementary products and services to our language-learning and literacy solutions. General and Administrative. General and administrative expenses consist primarily of shared services, such as personnel costs of our executive, finance, legal, human resources and other administrative personnel, as well as accounting and legal professional services fees including professional service fees related to other corporate expenses.
Interest and Other Income (Expense)
Interest and other income (expense) primarily consist of interest income, interest expense, and foreign exchange gains and losses. Interest income represents interest received on our cash and cash equivalents. Interest expense is primarily related to interest on our finance leases, interest on borrowings associated with our credit facility, and amortization of deferred financing fees associated with our credit facility. Fluctuations in foreign currency exchange rates in our foreign subsidiaries cause foreign exchange gains and losses. Other income (expense) can also include the gains and losses associated with non-customer transactions.
Income Tax Expense
Income tax expense consists of federal, state and foreign income taxes.
Critical Accounting Policies and Estimates
In presenting our financial statements in conformity withU.S. generally accepted accounting principles ("GAAP"), we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses, and related disclosures. Some of the estimates and assumptions we are required to make relate to matters that are inherently uncertain as they pertain to future events. We base these estimates and assumptions on historical experience or on various other factors that we believe to be reasonable and appropriate under the circumstances. On an ongoing basis, we reconsider and evaluate our estimates and assumptions. Our future estimates may change if the underlying assumptions change. Actual results may differ significantly from these estimates. We believe that the following critical accounting policies involve our more significant judgments, assumptions and estimates and, therefore, could have the greatest potential impact on our consolidated financial statements. In addition, we believe that a discussion of these policies is necessary for readers to understand and evaluate our consolidated financial statements contained in this quarterly report on Form 10-Q: • Revenue Recognition • Stock-based Compensation •Goodwill • Going Concern Assessment
For further information on our critical and other significant accounting
policies, see our Annual Report on Form 10-K filed with the
Goodwill We test goodwill for impairment annually onJune 30 of each year at the reporting unit level in accordance with the provisions of Accounting Standards Codification topic 350, Intangibles-Goodwill and Other ("ASC 350") or more frequently, if impairment indicators arise. This guidance provides the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. The factors that we consider important, and which could trigger a quantitative test, include, but are not limited to: a significant decline in the market value of our common stock for a sustained period; a 34
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material adverse change in economic, financial market, industry or sector trends; a material failure to achieve operating results relative to historical levels or projected future levels; and significant changes in operations or business strategy. If, based on a review of qualitative factors, it is more likely than not that the fair value of a reporting unit is less than its carrying value we perform a quantitative goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. If the carrying value exceeds the fair value, we measure the amount of impairment loss, if any, by comparing the implied fair value of the reporting unit goodwill to its carrying amount. For our annual goodwill test performed atJune 30 , we exercised our option to bypass the qualitative assessment and began our annual test with the quantitative test using a fair value approach. In estimating the fair value of our reporting units, we use a variety of techniques including the income approach (i.e., the discounted cash flow method) and the market approach (i.e., the guideline public company method). Our projections are estimates that can significantly affect the outcome of the analysis, both in terms of our ability to accurately project future results and in the allocation of fair value between reporting units. As ofJune 30, 2020 , we determined that the fair values of our reporting units with remaining goodwill balances exceeded their carrying values. Accordingly, no goodwill impairment charges were recorded in connection with the annual impairment test. For additional risk factors which could affect the assumptions used in our valuation of our reporting units, see the section titled "Risk Factors" in Part II, Item 1A of this Report. Accordingly, we cannot provide assurance that the assumptions, estimates and values used in our assessment will be realized and actual results could vary materially.
Results of Operations
The following table sets forth our consolidated statements of operations for the periods indicated (in thousands, except per share amounts):
Three months ended June 30, Six months ended June 30,
2020 2019 2020 2019
Revenue $ 49,195 $ 45,942 $ 96,374 $ 90,553
Cost of revenue 11,436 8,861 22,537 17,287
Gross profit 37,759 37,081 73,837 73,266
Operating expenses
Sales and marketing 25,974 25,800 51,408 49,038
Research and development 6,177 5,776 13,094 11,514
General and administrative 8,945 8,566 18,507 17,258
Total operating expenses 41,096 40,142 83,009 77,810
Loss from operations (3,337 ) (3,061 ) (9,172 ) (4,544 )
Other income and (expense):
Interest income 10 9 26 42
Interest expense (54 ) (99 ) (107 ) (159 )
Other income and (expense) 18 519 89 1,315
Total other income and (expense) (26 ) 429 8 1,198
Loss before income taxes (3,363 ) (2,632 ) (9,164 ) (3,346 )
Income tax expense 223 175 603 5
Net loss $ (3,586 ) $ (2,807 ) $ (9,767 ) $ (3,351 )
Loss per share:
Basic $ (0.15 ) $ (0.12 ) $ (0.41 ) $ (0.14 )
Diluted $ (0.15 ) $ (0.12 ) $ (0.41 ) $ (0.14 )
Common shares and equivalents outstanding:
Basic weighted average shares 24,103 23,455 23,953 23,247
Diluted weighted average shares 24,103 23,455 23,953 23,247
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Comparison of the three months ended
The following table sets forth revenue for our three operating segments for the three months endedJune 30, 2020 and 2019 (in thousands, except percentages): Three months ended June 30, 2020 versus 2019 2020 2019 Change % Change (in thousands, except percentages) Revenue and Revenue as a Percent of Total Revenue Literacy$ 17,814 36.2 %$ 15,101 32.9 %$ 2,713 18.0 % Enterprise & Education Language 13,640 27.7 % 14,502 31.6 % (862 ) (5.9 )% Consumer Language 17,741 36.1 % 16,339 35.5 % 1,402 8.6 % Total Revenue$ 49,195 100.0 %$ 45,942 100.0 %$ 3,253 7.1 % Segment Contribution and Segment Contribution Margin Literacy$ 3,048 17.1 %$ 2,371 15.7 %$ 677 28.6 % Enterprise & Education Language 5,486 40.2 % 5,848 40.3 % (362 ) (6.2 )% Consumer Language 4,512 25.4 % 3,649 22.3 % 863 23.7 % Language Shared Services (2,662 ) (3,387 ) 725 21.4 % Total Segment Contribution$ 10,384 $ 8,481 $ 1,903 22.4 % Literacy Segment The increase in Literacy segment revenue was a result of continued demand for its product portfolio and the concentrated efforts of a direct sales team. As an impact of the COVID-19 disruptions, our Literacy customers could renew their sales contracts later, which could result in lower revenue recognized in period. In the second quarter, we built deferred revenue partially through the sale of multi-year new sales in a US state that only recently became available to purchase our Literacy services, as well as the conversion of free licenses that had been provided to our Literacy customers as part of our Learn From Home initiative. Our Literacy business is seasonal with sales consolidating into the second and third calendar quarters that correspond to the end and beginning of the school district operating budget years. This typical seasonality may be impacted by slower than expected renewal and payment as a result of COVID-19 disruptions. The COVID-19 pandemic has created uncertainty surrounding the pressure on school budgets given the economic downturn. The Literacy segment contribution dollar and margin increases were primarily due to higher revenues, partially offset by higher direct expenses related to sales and marketing, research and development, and cost of sales. Direct sales and marketing and cost of sales expenses increased due to the increase in the direct sales team, investments made to improve the Literacy product portfolio and infrastructure and higher implementation and training services costs in support of Literacy sales growth. Lower amounts were capitalized as internal-use software during 2020 due to the completion and release of several large projects in the prior year. E&E Language Segment E&E Language segment revenue was down year over year. The North America K-12 business was down$0.6 million and the Enterprise business was down$0.3 million . Before shared Language research and development expense, the E&E Language segment contribution dollar and margin slightly decreased on lower revenue and higher cost of sales associated with increases in headount. We believe the enterprise portion of E&E Language is the most economically sensitive to the COVID-19 crisis and has been negatively affected by the impact of the pandemic on businesses and the international response to the pandemic. In connection with this, we also no longer expect new custom content bookings in 2020 as Native American tribes, which have historically been our largest customers for these bookings, have been especially affected by the pandemic. We expect to continue to balance investments and adjust our cost structure to align scale. Consumer Language Segment Consumer Language segment revenue increased compared to the prior year period. Revenue growth naturally lags bookings growth and that was the case in the second quarter of 2020 as we built deferred revenue through the sale of products such as ourLifetime Unlimited offering in what has seasonally been our slowest quarter. A large portion of sales in the second quarter of 2020 were attributable to our Lifetime offering, which is recognized as revenue over 24 months, resulting in only a small amount of revenue recognized within the second quarter. We expect Lifetime sales, which are collected in cash up front, will continue to be a significant portion of Consumer Language bookings this year. The COVID-19 pandemic has created demand for our consumer offerings as learners use their time at home to invest in a new language, however, a prolonged economic downturn may create uncertainty for future sales. 36
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Typically, our Consumer business is seasonal with consumer sales peaking in the fourth quarter during the holiday shopping season. This typical seasonality has been impacted by the recentLifetime Unlimited offering launch, as well as the demand for our consumer offerings as a result of the COVID-19 pandemic. As a result, we expect our first and second quarter Consumer Language bookings to be higher than the fourth quarter holiday shopping season. Before shared Language research and development expense, the Consumer Language segment contribution dollar and margin increases were primarily driven by higher revenues. In the event of a prolonged economic downturn, we will be able to manage our customer acquisition costs.
Revenue by Geographic Area
The following table sets forth revenue by geographic area and the corresponding percent of total revenue for the three months endedJune 30, 2020 and 2019 (in thousands, except percentages): Three months ended June 30, 2020 versus 2019 2020 2019 Change % Change (in thousands, except percentages) United States$ 44,415 90.3 %$ 41,179 89.6 %$ 3,236 7.9 % International 4,780 9.7 % 4,763 10.4 % 17 0.4 % Total revenue$ 49,195 100.0 %$ 45,942 100.0 %$ 3,253 7.1 % United States RevenueUnited States revenue increased primarily due to the increase in Literacy revenue from our Lexia business, which is predominately recorded as domestic revenue. Additionally, app store revenue in the US increased$0.6 million as compared to prior year. International Revenue
International revenue was nearly flat year over year.
Cost of Revenue and Gross Profit
The following table sets forth cost of revenue and gross profit for the three
months ended
Three months ended June 30, 2020 versus 2019
2020 2019 Change % Change
(in thousands, except percentages)
Revenue $ 49,195 100.0 % $ 45,942 100.0 % $ 3,253 7.1 %
Cost of revenue 11,436 23.2 % 8,861 19.3 % 2,575 29.1 %
Gross profit $ 37,759 76.8 % $ 37,081 80.7 % $ 678 1.8 %
Cost of Revenue
The increase in cost of revenue was primarily due to an increase of $1.2 million
in payroll and benefits primarily resulting from headcount changes in the
customer support and operations teams as well as higher variable compensation
expense on higher funding levels as compared to 2019. Additionally, amortization
of previously capitalized software costs increased $0.9 million related to
projects that were recently placed into service.
Gross Profit
Gross profit was nearly flat year over year while gross margin declined on the higher cost of revenue discussed above.
Operating Expenses
The following table sets forth operating expenses and the corresponding
percentage of total revenue for the three months ended
Three months ended June 30, 2020 versus 2019
2020 2019 Change % Change
(in thousands, except percentages, which reflect expense as a percentage of total revenue)
Sales and marketing $ 25,974 52.8 % $ 25,800 56.2 % $ 174 0.7 %
Research and development 6,177 12.6 % 5,776 12.6 % 401 6.9 %
General and administrative 8,945 18.2 % 8,566 18.6 % 379 4.4 %
Total operating expenses $ 41,096 $ 40,142 $ 954 2.4 %
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Table of Contents Sales and Marketing Expenses Sales and marketing expense was essentially flat as a$0.9 million increase in payroll and benefits due to higher variable compensation expense on higher funding levels as compared to 2019 and a$0.6 million increase in commission expense was partially offset by a decrease in travel related expenses of$1.0 million .
Research and Development Expenses
Research and development expenses increased as we continued to invest in the growth of the business. The increase was primarily due to higher payroll and benefits expense of$0.9 million driven by lower capitalized labor costs during 2020 due to the completion and release of several large projects in the prior year as well as higher variable compensation expense on higher funding levels as compared to 2019, offset by lower travel related expenses of$0.2 million and lower professional fees of$0.1 million .
General and Administrative Expenses
General and administrative expenses were slightly up due to a
Interest and Other Income (Expense)
Three months ended June 30, 2020 versus 2019
2020 2019 Change % Change
(in thousands, except percentages)
Interest income $ 10 $ 9 $ 1 11.1 %
Interest expense (54 ) (99 ) 45 45.5 %
Other income and (expense) 18 519 (501 ) (96.5 )%
Total other income and (expense) $ (26 ) $
429
Interest income represents interest earned on our cash and cash equivalents.
Interest expense primarily represents interest on our financing leases, interest
on our short term borrowing associated with our credit facility, and the
recognition of our deferred financing fees associated with our credit facility.
The change in other income and (expense) was primarily attributable to foreign
exchange fluctuations.
Income Tax Expense
Three months ended June 30, 2020 versus 2019
2020 2019 Change % Change
(in thousands, except percentages)
Income tax expense $ 223 $ 175 $ 48 27.4 %
Income tax expense was flat year over year. Income tax expense in the second
quarter of 2020 was related to profits of operations for foreign jurisdictions
in the U.K. , Germany , Canada , France and China and deferred tax expense related
to the impact of amortization of indefinite lived intangible assets. For the
three months ended June 30, 2020 , our worldwide effective tax rate was (6.6)%.
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Comparison of the six months ended
The following table sets forth revenue for our three operating segments for the
six months ended
Six months ended June 30, 2020 versus 2019
2020 2019 Change % Change
(in thousands, except percentages)
Revenue and Revenue as a
Percent of Total Revenue
Literacy $ 35,300 36.6 % $ 29,907 33.0 % $ 5,393 18.0 %
Enterprise & Education
Language 27,192 28.2 % 28,945 32.0 % (1,753 ) (6.1 )%
Consumer Language 33,882 35.2 % 31,701 35.0 % 2,181 6.9 %
Total Revenue 96,374 100.0 % 90,553 100.0 % 5,821 6.4 %
Segment Contribution and
Segment Contribution Margin
Literacy $ 5,865 16.6 % $ 5,384 18.0 % $ 481 8.9 %
Enterprise & Education
Language 10,984 40.4 % 11,955 41.3 % (971 ) (8.1 )%
Consumer Language 7,422 21.9 % 8,197 25.9 % (775 ) (9.5 )%
Language Shared Services (5,847 ) (7,067 ) 1,220 17.3 %
Total Segment Contribution $ 18,424 $ 18,469 $ (45 ) (0.2 )%
Literacy Segment
The increase in Literacy segment revenue reflects continued demand for its
product portfolio and the concentrated efforts of a direct sales team and strong
renewal and retention rates. As an impact of the COVID-19 disruptions, our
Literacy customers could renew their sales contracts later, which could result
in lower revenue recognized in period. In the second quarter, we built deferred
revenue partially through the sale of multi-year new sales in a US state that
only recently became available to purchase our Literacy services, as well as the
conversion of free licenses that had been provided to our Literacy customers as
part of our Learn From Home initiative. Our Literacy business is seasonal with
sales consolidating into the second and third calendar quarters that correspond
to the end and beginning of the school district operating budget years. This
typical seasonality may be impacted by slower than expected renewal and payment
as a result of the COVID-19 disruptions. The COVID-19 pandemic has created
uncertainty surrounding the pressure on school budgets given the economic
downturn.
The Literacy segment contribution dollar increase was primarily due to higher
revenues, partially offset by higher direct expenses related to sales and
marketing, research and development, and cost of sales. Direct sales and
marketing and cost of sales expenses increased due to the increase in the direct
sales team, investments made to improve the Literacy product portfolio and
infrastructure and higher implementation and training services costs in support
of Literacy sales growth. Lower amounts were capitalized as internal-use
software during 2020 due to the completion and release of several large projects
in the prior year which contributed to the decrease in segment contribution
margin.
E&E Language Segment
E&E Language segment revenue was down year over year across the reseller, North America K-12 and affiliate channels. Before shared Language research and development expense, the E&E Language segment contribution dollar and margin decreased on lower revenue. We believe the enterprise portion of E&E Language is the most economically sensitive to the COVID-19 crisis and has been negatively affected by the impact of the pandemic on businesses and the international response to the pandemic. In connection with this, we also no longer expect new custom content bookings in 2020 as Native American tribes, which have historically been our largest customers for these bookings, have been especially affected by the pandemic. We expect to continue to balance investments and adjust our cost structure to align scale.
Consumer Language Segment
Consumer Language segment revenue increased as global app store revenue was higher by$1.5 million as compared to the prior year period. Revenue growth naturally lags bookings growth and that was the case in the second quarter of 2020 as we built deferred revenue through the sale of products such as ourLifetime Unlimited offering in what has seasonally been our slowest quarter. A large portion of sales in the first half of 2020 were attributable to our Lifetime offering, which is recognized as revenue over 24 months. We expect Lifetime sales, which are collected in cash up front, will continue to be a significant portion of Consumer Language bookings this year. The COVID-19 pandemic has created demand for our consumer offerings as learners use their time at home to invest in a new language, however, a prolonged economic downturn may create uncertainty for future sales. Typically, our Consumer business is 39
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seasonal with consumer sales peaking in the fourth quarter during the holiday shopping season. This typical seasonality has been impacted by the recentLifetime Unlimited offering launch as well as the demand for our consumer offerings as a result of the COVID-19 pandemic. As a result, we expect our first and second quarter Consumer Language bookings to be higher than the fourth quarter holiday shopping season. Before shared Language research and development expense, the Consumer Language segment contribution dollar and margin declines were primarily driven by$1.5 million in higher direct first quarter sales and marketing expenses related to increased media expenses related to targeted streaming television and native content campaigns to drive sales. Any resulting increase in bookings may be recognized as revenue over periods up to 24 months, while the sales and marketing expense will be recognized as incurred, which may cause the segment contribution to decline. In the event of a prolonged economic downturn, we will be able to manage our customer acquisition costs.
Revenue by Geographic Area
The following table sets forth revenue by geographic area and the corresponding percent of total revenue for the six months endedJune 30, 2020 and 2019 (in thousands, except percentages): Six months ended June 30, 2020 versus 2019 2020 2019 Change % Change (in thousands, except percentages) United States$ 86,944 90.2 %$ 81,009 89.5 %$ 5,935 7.3 % International 9,430 9.8 % 9,544 10.5 % (114 ) (1.2 )% Total revenue$ 96,374 100.0 %$ 90,553 100.0 %$ 5,821 6.4 % United States RevenueUnited States revenue increased primarily due to the increase in Literacy revenue from our Lexia business, which is predominately recorded as domestic revenue. Additionally, app store revenue in the US increased$0.9 million as compared to prior year. International Revenue
International revenue was nearly flat year over year.
Cost of Revenue and Gross Profit
The following table sets forth cost of revenue and gross profit for the six
months ended
Six months ended June 30, 2020 versus 2019
2020 2019 Change % Change
(in thousands, except percentages)
Revenue $ 96,374 100.0 % $ 90,553 100.0 % $ 5,821 6.4 %
Cost of revenue 22,537 23.4 % 17,287 19.1 % 5,250 30.4 %
Gross profit $ 73,837 76.6 % $ 73,266 80.9 % $ 571 0.8 %
Cost of Revenue
The increase in cost of revenue was primarily due to an increase of $2.9 million
in payroll and benefits primarily resulting from headcount changes in the
customer support and operations teams as well as higher variable compensation
expense on higher funding levels as compared to 2019. Additionally, amortization
of previously capitalized software costs increased $1.8 million related to
projects that were recently placed into service.
Gross Profit
Gross profit was flat year over year while gross margin declined on the higher cost of revenue discussed above.
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The following table sets forth operating expenses and the corresponding
percentage of total revenue for the six months ended
Six months ended June 30, 2020 versus 2019
2020 2019 Change % Change
(in thousands, except percentages, which reflect expense as a percentage of total revenue)
Sales and marketing $ 51,408 53.3 % $ 49,038 54.2 % $ 2,370 4.8 %
Research and development 13,094 13.6 % 11,514 12.7 % 1,580 13.7 %
General and administrative 18,507 19.2 % 17,258 19.1 % 1,249 7.2 %
Total operating expenses $ 83,009 $ 77,810 $ 5,199 6.7 %
Sales and Marketing Expenses
The increase in sales and marketing expense was primarily due to $1.5 million in
higher first quarter sales and marketing expenses related to increased media
expenses related to targeted streaming television and native content campaigns
to drive Consumer Language sales, $1.2 million in higher payroll and benefits
due to higher variable compensation expense on higher funding levels as compared
to 2019, and a $0.7 million increase in commission expense, partially offset by
a decrease in travel related expenses of $1.0 million .
Research and Development Expenses
Research and development expenses increased primarily due to increased payroll and benefits expense of$2.1 million driven by lower capitalized labor costs during 2020 due to the completion and release of several large projects in the prior year as well as higher variable compensation expense on higher funding levels as compared to 2019, partially offset by lower travel related expenses of$0.2 million .
General and Administrative Expenses
General and administrative expenses were up due to a$1.2 million increase in payroll and benefits due to higher variable compensation expense on higher funding levels as compared to 2019, an increase of$0.2 million in bad debt expense due to the increase in bookings and the accounts receivable balance year over year, partially offset by lower travel related expenses of$0.1 million .
Interest and Other Income (Expense)
Six months ended June 30, 2020 versus 2019
2020 2019 Change % Change
(in thousands, except percentages)
Interest income $ 26 $ 42 $ (16 ) (38.1 )%
Interest expense (107 ) (159 ) 52 32.7 %
Other income and (expense) 89 1,315 (1,226 ) (93.2 )%
Total other income and (expense) $ 8 $ 1,198 Interest income represents interest earned on our cash and cash equivalents. Interest expense primarily represents interest on our financing leases, interest on our short term borrowing associated with our credit facility, and the recognition of our deferred financing fees associated with our credit facility. The change in other income and (expense) was primarily attributable to the first quarter 2019$1.4 million gain on the sale of certain idle assets that did not recur in 2020 and foreign exchange fluctuations. Income Tax Expense Six months ended June 30, 2020 versus 2019 2020 2019 Change % Change (in thousands, except percentages) Income tax expense $ 603$ 5 598 11960.0 % The increase in income tax expense was related to theVirginia state adoption of an indefinite carry forward of net operating losses that resulted in a release of our state valuation allowance and recognition of$0.6 million in state tax benefit in the first quarter of 2019 which did not recur in 2020. Income tax expense in the year to date period of 2020 was related to profits of operations for foreign jurisdictions in theU.K. ,Germany ,Canada ,France andChina and deferred tax expense related to the impact of amortization of indefinite lived intangible assets. For the six months endedJune 30, 2020 , our worldwide effective tax rate was (6.6)%. 41
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Liquidity and Capital Resources
Liquidity
Our principal source of liquidity atJune 30, 2020 , consisted of$31.3 million in cash and cash equivalents and short-term investments. Our primary operating cash requirements include the payment of salaries, employee benefits and other personnel related costs, as well as direct advertising expenses, costs of office facilities, and costs of information technology systems. Historically, we have primarily funded these requirements through cash flows from our operating activities. Our operating segments are affected by different sales-to-cash patterns. Within our E&E Language and Literacy segments, revenue in our education, government, and corporate sales channels are seasonally stronger in the second half of the calendar year due to purchasing and budgeting cycles. Our Consumer Language revenue is affected by seasonal trends associated with the holiday shopping season. Consumer Language sales typically turn to cash more quickly than E&E Language and Literacy sales, which tend to have longer collection cycles. Historically, in the first half of the year we have been a net user of cash and in the second half of the year we have been a net generator of cash. We expect the trend to use cash in the first half of the year and generate cash in the second half of the year to continue. OnOctober 28, 2014 , we executed a Loan and Security Agreement withSilicon Valley Bank ("Bank") to obtain a credit facility. Since the original date of execution, we have executed several amendments to the credit facility to reflect updates to our financial outlook, expand availability, and extend the credit facility. Under the eighth amendment executed onMarch 10, 2020 , we may borrow up to$25.0 million . The credit facility has a term that expires onApril 1, 2023 , during which time we may borrow and re-pay loan amounts and re-borrow the loan amounts subject to customary borrowing conditions. However, we must have less than$5.0 million in outstanding borrowings for 30 consecutive days during each twelve month period beginning as of the date of execution. Interest will accrue at the greater of Prime Rate or 1.5% and must be paid quarterly. As ofJune 30, 2020 , there were no borrowings outstanding under the credit facility. We are subject to certain financial and restrictive covenants as defined in the credit facility As ofJune 30, 2020 , we were in compliance with all of the covenants under the credit facility and we expect to be in compliance with these covenants in the future. We did not make any short term borrowings under our credit facility during our typical mid-year seasonal cash low point due to an increase in Consumer language bookings which turn to cash quickly because they are paid up front via credit card transactions and had a positive impact on our liquidity during the first half of 2020. We do not expect to make any short term borrowings under the credit facility for the remainder of 2020. The credit facility is available to provide additional liquidity if necessary. See the section at the beginning of this Item 2 titled "COVID-19 Update" for a discussion of the COVID-19 impact to liquidity.
The total amount of cash that was held by foreign subsidiaries as of
During the last three years, inflation has not had a material effect on our business and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future.
Capital Resources
We believe our current cash and cash equivalents, short-term investments, borrowings under our credit facility, and funds generated from our sales will be sufficient to meet our cash needs for at least the next twelve months from the date of issuance of this report. We have generated significant operating losses as reflected in our accumulated loss and we may continue to incur operating losses in the future that may continue to require additional working capital to execute strategic initiatives. Our future capital requirements will depend on many factors, including development of new products, market acceptance of our products, the levels of advertising and promotion required to launch additional products and improve our competitive position in the marketplace, the expansion of our sales, support and marketing organizations, the optimization of office space in theU.S. and worldwide, building the infrastructure necessary to support our growth, the response of competitors to our products and services, and our relationships with suppliers. We extend payments to certain vendors in order to minimize the amount of working capital deployed in the business. In order to maximize our cash position, we will continue to manage our existing inventory, accounts receivable, and accounts payable balances. Borrowings under our credit facility can be utilized to meet working capital requirements, anticipated capital expenditures, and other obligations. We expect the trends experienced with revenue and expenses during 2019 will continue for 2020. Cash Flow Analysis Six months ended June 30, 2020 versus 2019 2020 2019 Change % Change (in thousands,
except percentages)
Net cash used in operating activities
82.2 %
Net cash used in investing activities
8.7 %
Net cash provided by financing activities
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Net cash used in operating activities improved in the first half of 2020 as compared to the same period in 2019. Operating cash flow was impacted by the overall increase in year-over-year bookings of$16.8 million , which resulted in an increase in deferred revenue. Partially offsetting the increase in bookings were higher selling-related cash outflows.
Net cash used in investing activities slightly improved in the first half of 2020 as compared to the same period of 2019. Lower amounts were capitalized as internal-use software during 2020 due to the completion and release of several large projects in the prior year. Additionally, there was a$1.4 million cash inflow in 2019 related to the sale of non-current idle assets that did not recur in 2020.
Net Cash Provided by Financing Activities
Net cash provided by financing activities decreased in the first half of 2020 as compared to the same period of 2019. A net$9.9 million of borrowings were made under the credit facility in 2019 in order to provide additional cash during the seasonal cash low point. No borrowings were made in 2020 as an unseasonal increase in cash sales in Consumer offset the seasonal low point of cash. A$2.5 million decrease in proceeds from stock option exercises also contributed to the decline in financing cash flow.
Off-Balance Sheet Arrangements
We do not engage in any off-balance sheet financing arrangements. We do not have any material interest in entities referred to as variable interest entities, which include special purpose entities and other structured finance entities.
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