How do Rosetta Stone's Sales Translate?

By Simon Erickson - August 14, 2012 | Tickers: EA, GE, NTDOY.PK, RST | 0 Comments

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Rosetta Stone (NYSE: RST) got stoned by investors last Thursday.

After a nice pop from their 1Q earnings report in late May, Rosetta has apparently received a change-of-heart from shareholders.  The company reported 2Q earnings on Wednesday afternoon and was greeted on Thursday morning with a 25% haircut off of its stock price.  Though it recovered a bit in the afternoon, Rosetta still finished the day down 15%.  It is down an additional 5% from Thursday until now.

Reading between the lines, I’d say that current investor sentiment is 'no bueno' (translation = not good!)

Segment Reporting

A deeper look into the company's financial statements can give us some insight as to what is driving the company's results.  Segment reporting is a practice not required by the SEC.  However, some companies obtain revenues in different forms or locations and voluntarily choose to break out their financials based on how or where they are obtained.  This gives investors a better sense of what is going on within the business.  Segment reporting is common for larger corporations and conglomerates.  As an example, General Electric (NYSE: GE) has six operating businesses that each reports as a segment:  Energy Infrastructure, Aviation, Healthcare, Transportation, Home & Business Solutions and GE Capital. 

Rosetta Stone is far from being as large or complex as GE, but they do choose to do segment reporting.  Rosetta reports their top-line revenues in two different ways:  1) by Consumer and Institutional segments; and 2) by Domestic and International segments.  The Consumer segment is representative of the software packages that are sold in kiosks of the mall (you know the ones...right next to the guys trying to sell you scalp massagers or cheap flying helicopter toys).  The Institutional segment includes clients such as the US military and educational institutions.  Domestic sales are those that fall within US borders, while International represents sales from all other countries of the world.

To get a feel for how these segments have performed over the past few years, we can look to the company's 2011 Annual Report that was released in March.  The company reported the following information for their Consumer and Institutional segments:

(All revenues are in thousands)

Digging in, we find that Consumer sales made up 77% of Rosetta’s Total Revenues in 2011.  They increased only 2% in 2011, after previously falling 2% in 2010.  Institutional sales increased much more quickly:  11% in 2011 after a 26% increase in 2010.

An even more pronounced trend appears when looking at the historical Domestic vs International segments:

(All revenues are in thousands)

Domestic sales made up 79% of 2011 Total Revenues.  They were flat (0% increase) in 2011 after falling 9% in 2010.  International Revenue accounted for 21% of 2011 total Revenue.  They increased 22% in 2011 after increasing 138% in 2010.

Rosetta has been seeing phenomenal historic growth in their International segment.  Not surprisingly, they focused quite a bit on this segment during 2010 and 2011 and allocated resources to support it.

How 2012 is Shaping Up

Since the 2011 Annual Report was released, we have received two more quarterly reports from Rosetta.  Their 2Q report from last week broke out the results of each of the segments during the first six months of 2012 as compared to 2011.  You might notice at first glance that the numbers look a little bit different, but I assure you that your eyes are not fooling you.

For Consumer and Institutional:

And for Domestic and International:

(All revenues are in thousands)

In a bizarre change of pace, Rosetta’s segments have switched roles.  Consumer is outpacing Institutional this year, and Domestic is eclipsing International.

What the Heck Does that Mean?

There are a few keys that we can take away from this analysis.

• Rosetta’s management has either shifted their priorities, gotten lucky, or has no idea what is going on as an explanation to the change in segment growth.
• Consumer sales still comprise ¾ of Rosetta’s total revenues and have significantly improved this year.  CEO Steven Swad explained some of the reasons for this, when he stated in 1Q that “Improved Web visits and conversion in the direct-to-consumer channel drove U.S. consumer results, while retail sell-through and same-store kiosk sales recorded double-digit gains in the quarter.”  This is a breath of fresh air in the discretionary consumer software environment, as it has been reported that video game sales in Q2 2012 were down 20% year over year.  Though Rosetta's software is more for education than gaming, the weak discretionary consumer software industry has been eating the lunch of companies such as Nintendo (NASDAQOTH: NTDOY.PK) and Electronic Arts (NASDAQ: EA) this year.  Nintendo's stock is down 20% YTD, and EA's down 38%.
• Conversely, Institutional sales growth has flatlined.  Federal stimulus in 2011 was partially a reason for inflated sales last year that didn’t translate to 2012.  More concerning is that Institutional customers tend to be more recurring than those of Consumer, so weakness in this segment could have more lasting impacts on future revenues. 
• Domestic sales have turned the corner.  After tough years in 2010 and 2011, they have increased 12% thus far in 2012.  The question is, how saturated is the US market already with Rosetta Stone’s products, and is this growth rate sustainable?
• International sales have been a train wreck.  Once the darling of all of the company’s segments, they actually declined in year over year comparison.  The international market is the largest opportunity for Rosetta, so falling sales in this segment is the most worrisome to me.

One final consolidated chart tells the Rosetta story, from a segment reporting perspective:

Foolish Bottom Line

Have you noticed if any of your American friends are suddenly becoming fluent in another language?  Domestic Consumer revenue has been Rosetta’s lifeline this year.  However, with falling International and Institutional sales, there’s still plenty of uncertainty in this company that is keeping the stock price in check for the time being.

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