E Rosetta Stone: Love The Company Not The Stock

Rosetta Stone (RST ) is a company that we have great respect for. In fact, we use the products ourselves. However, despite a recent run up in the stock, we are cautious on the name given performance. The company is a literacy education and language teaching operation. Products are used globally. The company’s language division uses cloud-based solutions to help all types of learners read, write, and speak more than 30 languages. Lexia Learning, Rosetta Stone’s literacy education division, is the flagship operation. Hope for growing revenues in 2018 have helped drive the stock, but earnings remain a concern. In this column, we will discuss the performance of the name, honing in on segment specific performance, while offering our take here.

Sales in Q4

The company actually saw a rather weak Q4 sales wise, even if much of this weakness was anticipated.Total revenue was down 13% year-over-year to $44.8 million, reflecting a decline of $10.2 million or 84% in product revenue, which was only partially offset by an increase of $3.3 million or 8% in subscription and service revenue.

The decline in product revenue was attributable to the ongoing SaaS migration in Consumer Language.The increase in subscription and service revenue reflects continuing double-digit growth at Lexia and increases in the number of new subscribers and total subscribers in Consumer Language. 

Segment specific performance tells an interesting story

Lexia is the flagship operation for Rosetta Stone. Revenue at Lexia increased 23% year-over-year to $12.0 million in the fourth quarter 2017. Lexia’s pro forma growth rate was 17% year-over-year. Lexia’s sustained revenue growth reflects strong demand for its Core5 literacy curriculum product, high retention rates, and increased effectiveness its direct sales force initiatives.

There was weakness in the other two segments of the company. The Enterprise & Education Language segment revenue decreased 16% year-over-year to $15.0 million in the fourth quarter 2017. The decline included Rosetta’s decision to exit a direct sales and marketing presence in several countries, including China, Brazil and France, as part of the 2016 restructuring plan. In addition, a large multi-year sale in the fourth quarter 2016 was not eligible for renewal in the current quarter.