Rosetta Stone Inc. (NYSE:RST), a leading provider of technology-based language-learning solutions, today announced financial results for the third quarter 2012, as summarized below:

¹Definitions and reconciliations for all non-GAAP measures are provided in this press release.
² Excludes impact of legal expenses related to the lawsuit against Google, Inc. and all adjustments related to recording a non-cash tax valuation allowance for deferred tax assets.

Steve Swad, President and Chief Executive Officer of Rosetta Stone, said, “We had a good third quarter with bookings up 9% year-over-year with double-digit growth in our consumer business and single-digit growth in our institutional business. We also did a better job managing our expenses and we made progress shifting the business online with over 57,000 consumer Online Learners and over 80% of our institutional business online.” Swad added, “We grew consumer Online Learners by 115% since the beginning of the year and by 167% versus this time last year. We operated more efficiently and lowered expenses, including reducing our kiosk expenses and lowering our international media spend which allowed us to deliver Adjusted EBITDA of $1.8 million, more than double the $1.8 million loss a year ago.”

Third Quarter 2012 Operational and Financial Highlights

• Bookings grew 9%: Total bookings increased 9% year-over-year to $72.1 million from $66.1 million. The increase reflected an 11% increase in Consumer bookings as well as 4% growth in Institutional bookings related to signing new and renewal deals that will be recognized over time. Growth in Consumer bookings was due entirely to an 18% increase in the US, offset by a 10% decrease in International compared with last year.
• Revenue up slightly: Consolidated revenue of $64.3 million increased slightly from $64.2 million a year ago. US Consumer revenue increased 5% reflecting double-digit growth in the company’s direct-to-consumer (DTC) channel, offset by lower contribution from the kiosk channel as the company operated 60 fewer kiosks on average. International Consumer revenue declined 8% primarily due to a decrease in revenues from Japan, in part the result of operating fewer kiosks, and lower sales in Germany, reflecting the shift to an online-only model, partially offset by an increase in Korea from increased sales in the home shopping TV channel. The Institutional business decreased 6% mainly due to the non-renewal of the Army and Marines contracts last year, partially offset by increases in Corporate and International.

• Adjusted EBITDA: Adjusted EBITDA for the third quarter was $1.8 million, an increase of $3.6 million from ($1.8) million in the third quarter of 2011. The improvement in Adjusted EBITDA was mainly due to the small increase in revenues combined with a 7% or $2.7 million reduction in sales and marketing, partially offset by a $0.4 million increase in general and administrative (G&A) expenses and an increase in research and development costs.
• Valuation Allowance for Deferred Tax Assets: The Company recorded a non-cash charge of $25.6 million in the third quarter of 2012 to establish a valuation allowance against its deferred tax assets (“DTAs”) primarily in the United States. In accordance with US GAAP, Rosetta Stone evaluates its DTAs quarterly to determine if valuation allowances are required. This determination was based on several factors, including whether the company had a three-year historical cumulative pre-tax loss, which the Company crossed in the third quarter, and as a result, the Company recorded a non-cash charge to income tax expense. Establishment of this valuation allowance does not preclude the company from utilizing the DTAs in the future to reduce cash tax payments.
• Net Income: Rosetta Stone recorded a net loss of $33.4 million in the third quarter 2012, compared to a net loss of $1.2 million in the third quarter of 2011. Net loss per share was $1.58 compared to a net loss of $0.06 per share in the prior year period. Net loss for the quarter included the impact of the valuation allowance established against its deferred tax assets. Excluding the impact of this valuation allowance and Google-related legal costs of $1.0 million, Adjusted net loss was $1.7 million compared to a loss of $1.2 million a year ago while Adjusted net loss per share was $0.08 compared with $0.06 net loss per share a year ago.
• Balance Sheet and Cash Flow: Cash, cash equivalents and short-term investments were $126.1 million at September 30, 2012, an increase of $9.8 million compared with $116.3 million at December 31, 2011 and an increase of $14.8 million from the prior year period. The company has no debt. Net cash provided by operating activities in the quarter was $5.4 million compared with ($2.0) million a year ago. Capital expenditures were $0.9 million. Free cash flow for the quarter was $4.5 million, compared with ($4.5) million in the third quarter of 2011.

Financial Outlook

The company is providing the following update to its guidance for the full year 2012:

• Increasing the range of Adjusted EBITDA* by $2 million to $8 million to $10 million from $6 million to $8 million.
• Maintaining the range of Adjusted net loss** at $6 million to $4 million, but improving Adjusted net loss per share** to a range of $0.20 to $0.30. These figures exclude the Google legal expenses and all adjustments related to recording the valuation allowance so that they are comparable to our previous guidance of a net loss of $4 million to $6 million and net loss per share of $0.20 to $0.33.
• Lowering the range for capital expenditures to $5 million to $8 million compared with previous guidance of $8 million to $11 million.

*Adjusted EBITDA excludes legal expenses related to the lawsuit against Google Inc. and any restructuring costs.

**Adjusted net loss and Adjusted net loss per share exclude the impact of legal expenses related to the lawsuit against Google, Inc. and all adjustments related to recording the non-cash tax valuation allowance for deferred tax assets.

Non-GAAP Financial Measures

This press release contains several non-GAAP financial measures. Adjusted EBITDA is GAAP net income or loss plus interest income and expense, income tax benefit and expense, depreciation, amortization and stock-based compensation expenses. Adjusted EBITDA excludes any expenses related to the lawsuit against Google Inc., and any restructuring costs. Adjusted EBITDA for prior periods has been revised to conform to current definition. Adjusted net loss and adjusted net loss per share exclude the impact of legal expenses related to its lawsuit against Google, Inc. and all adjustments related to recording the non-cash tax valuation allowance for deferred tax assets. Free cash flow is cash flow from operations less cash used in purchases of property and equipment. Bookings represent executed sales contracts received by the Company that are either recorded immediately as revenue or as deferred revenue. Management believes that these non-GAAP measures of financial results provide useful information to investors regarding certain financial and business trends relating to the Company’s financial condition and results of operations. Management uses these non-GAAP measures to compare the Company's performance to that of prior periods for trend analyses, for purposes of determining executive incentive compensation, and for budgeting and planning purposes. These measures are used in monthly financial reports prepared for management and in quarterly financial reports presented to the Company's board of directors. Management believes that the use of these non-GAAP financial measures provides an additional tool for investors to use in evaluating ongoing operating results and trends and in comparing the Company's financial measures with other software companies, many of which present similar non-GAAP financial measures to investors.

Management typically excludes the amounts described above when evaluating the Company’s operating performance and believes that the resulting non-GAAP measures are useful to investors and financial analysts in assessing the Company’s operating performance due to the following factors:

• Amortization of Acquired Intangibles. Amortization costs and the related tax effects are fixed at the time of an acquisition, and then amortized over a period of several years after the acquisition and generally cannot be changed or influenced by management after the acquisition.
• Stock-based Compensation. Although stock-based compensation is an important aspect of compensation of the Company’s employees and executives, stock-based compensation expense is generally fixed at the time of grant, then amortized over a period of several years after the grant of the stock-based instrument, and generally cannot be changed or influenced by management after the grant. In addition, the impact of shares granted under these plans is considered in the Company’s EPS calculation to the extent the shares are dilutive.
• Bookings. Although revenue is an important aspect of measuring Company performance, the Company believes total sales bookings can be a valuable indicator of the Company's performance. The Company is transitioning to a greater amount of subscription sales, which results in an increasing portion of sales being recorded as deferred revenue.

Management does not consider these non-GAAP measures in isolation or as an alternative to financial measures determined in accordance with GAAP. The principal limitation of these non-GAAP financial measures is that they exclude significant expenses and income that are required by GAAP to be recorded in the Company's financial statements. In addition, they are subject to inherent limitations, because they reflect the exercise of judgments by management about which expenses and items of income are excluded from these non-GAAP financial measures and may not be calculated in the same manner as other companies’ similarly titled non-GAAP measures.

In order to compensate for these limitations, management presents its non-GAAP financial measures in connection with its GAAP results. The company urges investors to review the reconciliation of its non-GAAP financial measures to the comparable GAAP financial measures, which it includes in press releases announcing earnings information, including this press release, and not to rely on any single financial measure to evaluate the company's business.

Reconciliation tables of the most comparable GAAP financial measures to the non-GAAP measures used in this press release are included at the end of this release.

Investor Webcast

This news release and the accompanying tables should be read in conjunction with the additional content that is available on the company’s website.

In conjunction with this announcement, Rosetta Stone will host a webcast today at 4:30 p.m. eastern time (ET) to discuss the results and the company’s business outlook. The webcast will be available live on the Investor Relations page of the company’s website at http://investors.rosettastone.com.

Investors may also dial in to the conference line using one of the following numbers:

1-877-407-4018 (toll-free) or

1-201-689-8471 (toll/international)

A recorded replay of the webcast will be available on the “Investor Relations” page of the company’s web site http://investors.rosettastone.com after the live discussion. The replay will also be available beginning at 7:30PM ET until November 21, 2012 via telephone at the following numbers:

1-877-870-5176 (toll-free) or

1-858-384-5517 (toll/international)

Pass Code: 403092

About Rosetta Stone

Rosetta Stone Inc. provides cutting-edge interactive technology that is changing the way the world learns languages. The company’s proprietary learning techniques—acclaimed for their power to unlock the natural language-learning ability in everyone—are used by schools, businesses, government organizations and millions of individuals around the world. Rosetta Stone offers courses in 30 languages, from the most commonly spoken (like English, Spanish and Mandarin) to the less prominent (including Swahili, Swedish and Tagalog). The company was founded in 1992 on the core beliefs that learning to speak a language should be a natural and instinctive process, and that interactive technology can activate the language immersion method powerfully for learners of any age. Rosetta Stone is based in Arlington, VA., and has offices in Harrisonburg, VA, Boulder, CO, Tokyo, Seoul, London, and Sao Paulo.

“Rosetta Stone” is a registered trademark or trademark of Rosetta Stone Ltd. in the United States and other countries.

Cautionary Statement Regarding Forward-Looking Statements

Certain statements in this press release are forward-looking statements, including our guidance for future financial performance and operating targets, and our long-term growth prospects. In this context, forward-looking statements often address our expected future business and financial performance, and often contain words such as “project,” “believe,” “plan,” “expect,” “anticipate,” “estimate,” “intend,” “should,” “would,” “could,” “potentially,” “seek,” “may,” “likely,” “will,” “financial outlook,” “strategy,” or “continue.” These forward-looking statements reflect the company's current views with respect to future events and are subject to certain risks, uncertainties, and assumptions. A number of important factors could cause actual results or events to differ materially from those indicated by such forward-looking statements, including demand for language learning software; the advantages of our products, services, technology, brand and business model as compared to others; our strategic focus; our ability to maintain effective internal controls or to remediate material weaknesses; our cash needs and expectations regarding cash flow from operations; our product development plans; the appeal and efficacy of our products; our expectations regarding capturing lifetime value and a broader range of market segments through such offerings; our plans regarding expansion of our marketing initiatives and sales force; our international expansion and growth plans; our plans regarding our kiosks and retail relationships; our plans regarding our Institutional business; the impact of any revisions to our pricing strategy; our ability to manage and grow our business and execute our business strategy; our financial performance; our actions to stabilize our business in the U.S. consumer market including realigning our cost structure and revitalizing our go-to-market strategy; our plans to transition our distribution to more online in the consumer space; adverse trends in general economic conditions and the other factors described more fully in the company's filings with the U.S. Securities and Exchange Commission (SEC), including the company’s annual report on Form 10-K for the fiscal year ended December 31, 2011, which is on file with the SEC. The company assumes no obligation to update the information in this communication, except as otherwise required by law. Readers are cautioned not to place undue reliance on these forward-looking statements that speak only as of the date hereof.

*Adjusted EBITDA equals GAAP net income or loss plus interest income and expense, income tax benefit and expense, depreciation, amortization, stock-based compensation expenses, restructuring costs and any expenses related to the previously disclosed lawsuit against Google, Inc.
Prior period Adjusted EBITDA has been conformed to current definition.

*Adjusted Net Loss equals GAAP net loss adjusted for expenses related to the lawsuit against Google, Inc. and all impacts related to recording the valuation allowance.