Rosetta Stone (NYSE:RST) has been an incredibly frustrating company to invest in for a lot of people. The potential seems so big, with the world growing, yet becoming so much more connected every day, and millions of people learn a new language every year, whether for business or personal benefit. This trend is only likely to grow in coming decades. Can Rosetta Stone leverage that opportunity? So far, it hasn't, and honestly, that might not be the source of growth going forward.
The company reports earnings after the market closes on Oct. 29, and there are a handful of things that really matter the most. Let's take a look at the three things that I'm going to pay the most attention to in the earnings release.
1. E&E most important right now
For all the potential in the consumer market, the only source of growth in the business right now is the Enterprise and Education segment. Last quarter, E&E grew 73%, largely because of the acquisition of Lexia. However, "pro forma" -- or organic growth that excludes acquisitions -- still increased 8%, while the company saw continued declines in both of its consumer segments.
While the consumer business still drives the majority of revenue, E&E business offers enormous benefits for the long-term business. These deals are often long-term and provide a predictable source of revenue to the company. The typical E&E customer is a multinational business that will have regular demand for language training, or an educational institution that features foreign language classes as part of its curriculum. The upshot for this market is the predictability, versus a consumer market that's much less a product of need.
Furthermore, much of the company's growth going forward isn't necessarily foreign language. The Lexia acquisition, especially, will be a key driver of growth in E&E for literacy and reading comprehension, not foreign language.
Even after the latest acquisitions, the company operates in a fragmented market. Rosetta Stone leadership has stated that further acquisitions are likely to take place, though the focus right now is on integration and execution. CEO Stephen Swad, from the Q2 earnings call:
So our heads are collectively down right now; we're just executing against the strategy. We'll kind of assess, pull our heads up in a quarter or two and see how we're doing on the integration of what we have. We'll have some proof points on the strategy, and then we'll figure out how to accelerate that. And acquisition is always a lever that we can use.
2. Stabilization of consumer business in North America and abroad
Rosetta Stone has easily the most recognized brand in foreign language learning in North America, yet it has never really executed on its potential to dominate the market. Furthermore, the international consumer market has been in a state of near-freefall over the past couple of years. After falling another 27% last quarter, it now represents less than 10% of total sales. The North American consumer business fell 17% in sales last quarter, though at $32.4 million in revenue is still more than 57% of total revenues and an important part of the business.
The company has fully exited the kiosk business, which may have helped create brand awareness, wasn't generating sales. The company's entire retail business continues to struggle as well, which makes sense considering that the way consumers think about and buy software today has very little to do with going to a retailer. This has led to a revamping of its product lineup to include apps for mobile devices, as well as offering the software as a service, available for periods of time from a few months, up to three years. The company still offers its PC software for consumers as well.
However, the biggest struggle seems to be finding the right price point. Over the first half of the year, the average price for online subscriptions declined 27%, and the price of the PC software has been decreased several times over the past few years. Considering that sales continue to fall even as prices come down, the company has a lot of work to do here.
On the international front, it could be acquisitions that help turn things around. Tell Me More was the top brand in Europe -- a market where Rosetta Stone has continually struggled -- and if it can leverage the acquisition similar to its success with Lexia in the U.S., we could see improvement in coming quarters.
3. New areas
Foreign language learning is the foundation, but it might not be the best place for future growth. Over the past several years, very little has worked for Rosetta Stone with growing its foreign language business. However, as the second quarter showed, Lexia -- a reading skills system -- has big potential and is actually growing.
Additionally, Fit Brains -- a competitor to the popular Lumosity -- is another source of potential growth. While there is competing evidence as to the real benefit of so-called "brain training," the category is growing in popularity.
The reality is, Rosetta Stone's core consumer language business -- both in the U.S and abroad -- will probably continue to decline over the next few quarters, before stabilizing. If the economies of Europe and Asia continue to slow, the international business could remain muted for a long time.
However, the company has wisely diversified its offerings beyond foreign language training, leveraging its long-term relationships with literally thousands of schools and businesses to integrate other language and reading related products that are in demand. Instead of getting too caught up in the decline of the core business, look for stabilization at some point, and pay close attention to the company's ability to leverage and grow these new businesses. That's probably the future for the company, even as foreign language will remain the foundation.