When language and educational software expert Rosetta Stone Inc (NYSE:RST) last reported earnings, I noted that the company looked to be shifting its business focus and that the investing thesis was likely to shift along with it. Well, the company just released financial results for its fourth quarter and full 2014, also announcing that yes, indeed, the company best known for its foreign language software is shifting priorities. This looks like great news for investors who've bought in the past few years:
Let's take a closer look at the results and see what management had to say about its new focus on its global Enterprise and Education -- or E&E -- business.
North American consumer business revenue declines, but bookings climb
Even with the new focus on E&E, Rosetta Stone's core language software business will remain an important part of the business. Here's the company's revenue breakout by segment:
Sales fell at both consumer segments, but that's partly a product of the company's shift in direction some time ago, away from the yellow boxes of software at kiosks and toward Web- and app-based access, for which users pay for access over a period of time. This approach results in less upfront revenue, since a booked sale can't be recognized until the service has been provided, which can be several months or more. For example, let's say someone went to Rosetta Stone's website and signed up for a six-month subscription to learn German. That customer may have paid the full amount upfront, or he or she could have signed up for monthly billing. Either way, Rosetta Stone can't recognize the full six-month sale until it's complete and paid for. Hence the importance of bookings, to help better understand how the business is performing at signing up new customers.
The reality is, though, that while bookings are up in the North America Consumer segment, revenue is down for another quarter. That takes us to our next topic.
E&E: It's where the growth is
E&E revenue and bookings both grew last quarter, a continuation of growth in Q3 as well. The thing is, the consumer segment faces stiff competition from much cheaper offerings, and more casual consumers interested in learning a language haven't shown that they're likely to spend hundreds of dollars on language software with so many cheaper options available.
Enterprise and educational customers, however, put a higher emphasis on quality, as it has a measurable and tangible impact on their ability to educate or train their students or employees, which in turn affects Rosetta Stone's ability to retain business. In short, professionals are willing to pay up for a quality product, while casual learners haven't. The company is serious about this new focus. From the earnings release:
The Company is refocusing its corporate strategy and realigning resources around its Global E&E segment in order to pursue the most attractive opportunities for enhancing shareholder value. To accomplish this, the Company is prioritizing the needs of educators and corporations, where the most profitable growth potential is anticipated. This decision follows several months of close collaboration between management and a leading education consulting firm hired to perform a thorough review of Rosetta Stone's strategy, with active oversight from the board. The Company will carry this focus over to the Consumer business as well, where it will focus on the more serious learner to complement the Global E&E segment and fully leverage the brand.
How it's getting there
The company also announced a major realignment to fund this growth. To start, Rosetta Stone is reducing headcount in its non-Global E&E segments by 15%, largely in sales, marketing, and consumer product development, as well as some general and administrative areas. Management expects the staff cuts and cost-cutting measures to give the company about $50 million per year, which it will then reinvest in Global E&E growth.
The company is also expanding the roles of several executives, in what looks like an effort to better leverage its foreign-language software in the E&E business segment.
Final thoughts: Probably more changes ahead
Rosetta Stone took an $18 million non-cash charge to the value of its consumer business in the fourth quarter, another indication that the company is truly moving beyond the consumer market and focusing heavily on E&E. The release said it will also take an approximately $7 million charge in the first quarter -- mostly in cash severance payments -- because of the actions to realign the business.
This is probably just the first step, and there could be further changes as management figures out what works, and where its resources will be best used. Will these big changes finally lead to a winning investment? It's early to say, but E&E sales are growing strongly. Based on that alone, it's easy to see why management wants to focus on this business.