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Value Line recently initiated coverage of Rosetta Stone Inc. (RST) in its flagship product, The Value Line Investment Survey. The company is a leading provider of technology-based, language-learning solutions. It develops and sells software, online services, mobile applications, and audio practice tools to help individuals learn languages under the Rosetta Stone brand. It currently offers self-study solutions in over 30 languages. The company, headquartered in Arlington, VA, has several operating locations in the United States, Asia, and Europe. It completed its initial public offering in April of 2009. As of December 31, 2012, it had 1,550 employees.

Rosetta’s teaching method, which it calls Dynamic Immersion, is designed to leverage the inborn, natural-learning ability that children use when learning their native language. The company uses its own proprietary interactive technology that uses images, text, and sounds to teach language without translation or grammar explanation. It believes that this method allows people to learn languages in a fun, convenient, and effective way.

Rosetta has three operating segments: North America Consumer (which represented 63% of 2012 total sales), Rest of World Consumer (15%), and Institutional (22%). The first two divisions derive sales from individuals and retail partners. The Institutional segment derives revenues from educational institutions, government agencies, and corporations worldwide. 

The company’s primary products include Rosetta Stone Version 4 TOTALe and Rosetta Stone TOTALe online. The former good is available as tangible packaged software (CD-ROM) or as an online download. The latter combines conversational coaching and an online software subscription in a number of time-based offers, typically for three, six, or twelve months. Each of the 30 languages offered has up to five levels with four different editions: personal, enterprise, classroom, and home school. Nearly two-thirds of 2012 sales were from CD-ROM or download, while the remainder was from online subscriptions.

Customers can choose from a variety of methods in which they want to learn. Rosetta Course is a self-study curriculum and is a core component of the company’s offering. Rosetta Studio is a series of coach-led practice sessions. Rosetta World is an interactive community of language learners that gives users the opportunity to play games with other learners in a structured environment. Audio Companion includes a series of digital audio files that can be used when they are away from their computer. TOTALe Companion HD includes the company’s speech recognition technology. Finally, TOTALe Companion includes practice lessons and speech recognition technology while users are away from their computers.

Rosetta distributes its products through its websites, select retail resellers, including Amazon.com (AMZN) , Barnes & Noble (BKS), Best Buy (BBY), Costco (COST), and Staples (SPLS), as well as a network of kiosks, call centers, and home shopping networks. 

Competition in the technology-based, language-learning sector is highly fragmented globally, and consists of traditional classroom instruction, immersion-based classroom instruction, self-study books, audio recordings, and free online offerings that provide content and opportunities to practice writing and speaking. Rosetta’s primary competitors include Berlitz International, Simon & Schuster, Random House Ventures, Disney Publishing Worldwide, and McGraw-Hill Education (MHP).

Since competition remains intense, management expects ongoing pressures on both pricing and products to persist and intensify in the coming quarters. Rosetta has also seen a rise in language-learning applications on mobile platforms that are relatively inexpensive, although they are currently limited in scope.

The company does face some seasonality, as sales tend to increase in the fourth quarter during the holiday season. It also sees higher sales in the second and third quarters due to increased demand from the government and educational institutions.

Rosetta faces certain risks inherent in its products. Since it depends on discretionary consumer spending, unfavorable economic conditions could hurt sales of its primary products. Because a significant portion of its revenues are made through retailers and distributors, none of which has an obligation to sell its products, the failure of these parties to do so, for whatever reason, could temper demand.

The company believes that the mix of products sold will shift from traditional CD-ROM to digital downloads in the coming quarters. As a result, it plans to make additional investments in its online and digital platforms in 2013. It also plans to expand its distribution channels and increase its mobile presence, and will likely expand its sales activities within both existing regions and new countries. The costs associated with these initiatives will likely limit earnings prospects in the near term.

We note that the company has a solid balance sheet with no debt and about $148 million of cash on hand, or roughly $7 a share. As a result, the company is committed to making at least one acquisition this year.

For 2013, management guided for revenues in the range of $280 million to $290 million, which would be a mild increase from last year’s tally of $273 million. The bottom line is expected to be between a loss of $0.02 a share and a profit of $0.04 per share. If Rosetta reaches the high end of this guidance, it will mark the first yearly profit since 2010. Management is focused on keeping costs down, despite the need for certain investments mentioned above.

At the time of this article’s writing, the author did not have any positions in any of the companies mentioned.