Rosetta Stone (RST, Financial), the $212.6 million Virginia-based literacy educator, reported a (-)0.13% revenue decline year over year to $93.6 million in the first half of the year and narrower losses of (-)$681,000 compared with (-)$16.49 million in the year prior.
Rosetta Stone recorded lower overall operating expenses at (-)18.3% decline even after having excluded its $1.7 million impairment charge in relation to its Consumer Fit Brains business.
“The second quarter was a period of continued progress with relatively flat year-over-year revenue for the second consecutive quarter after substantial restructuring that characterized the past two years.
“Through our turnaround efforts we have focused the company on our best products in our most attractive markets and establishing a more efficient infrastructure, which we believe has put us on the path to profitable future growth.
“To help accelerate our progress, I am excited to announce the hiring of Matt Hulett as president of Language.
“Matt is an innovative business and product development executive with wide-ranging and relevant SaaS experience in both consumer and enterprise businesses. Matt will oversee all areas of our language businesses working closely with our leadership team to continue to drive Rosetta Stone forward.” –Â John Hass, chairman, president and CEO
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Valuations
Rosetta Stone has not delivered any profits in the past 10 quarters resulting in no trailing price-earnings (P/E) ratio while its liabilities matched its assets in the recent filing therefore resulting in no price-book (P/B) ratio either.
Meanwhile, the company had a price-sales (P/S) ratio of 1.09 times vs. the industry median of 2.47 times (GuruFocus data).
Total returns
Rosetta Stone underperformed the broader Standard & Poor's 500 index so far this year with 7.07% total returns vs. the index’s 10.4%.
Rosetta Stone
According to filings, Rosetta Stone was founded in 1992, and its 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, was founded more than 30 years ago and is a leader in the literacy education space. Lexia helps students build fundamental reading skills through its rigorously researched, independently evaluated and widely respected instruction and assessment programs. Rosetta Stone was incorporated in 2005.
As Rosetta Stone has evolved, the company believes that its Enterprise & Education Language and Literacy segments are its largest opportunities for long-term value creation. According to the company, the customers in these markets have needs that recur each year, creating a more predictable sales opportunity. The company also believes the demand is growing for learning-based literacy solutions in the U.S. and English language-learning around the globe.
The company also emphasizes its development of products and solutions for corporate and K-12 learners who need to speak and read English.
Rosetta Stone’s business is organized into three operating segments: Enterprise & Education Language, Literacy and Consumer.
Enterprise & Education Language
The Enterprise & Education Language segment derives language-learning revenues from sales to educational institutions, corporations and government agencies worldwide under a Software-as-a-Service model.
In the first half, revenue in this segment fell (-)5.8% year over year to $33.76 million (36% of total sales) with segment margin of 42.9% compared with 36.8% the year prior.
Literacy
The Literacy segment derives revenue under a SaaS model from the sales of literacy solutions to educational institutions serving grades K through 12.
In the first half, Literacy revenue grew 32% year over year to $20.54 million (22% of sales) and registered 12.4% margin vs. 3.2% in the year prior period.
According to filings, Rosetta’s Literacy segment experienced this huge jump in revenue reflecting the impact of purchase accounting.
The company expects that it will continue to experience the purchase accounting impacts for the Literacy segment through 2017 due to the typical subscription length. As a result, it expects year-over-year revenues to become more comparable as it moves beyond the purchase accounting impact, which it expects to result in lower growth rates than it expects to experience during 2017. Rosetta anticipates additional investments in the Literacy business to grow this segment.
Consumer
The Consumer segment derives revenue from sales to individuals and retail partners worldwide.
In the first half, revenue in this segment fell (-)7.3% year over year to $93.6 million (42% of sales) and registered margins of 36.7% compared to 21.2% in the year prior.
Sales and profits
In the past three years, Rosetta had revenue decline average of (-)9.8%.
Cash, debt and book value
As of June, Rosetta Stone had $26.4 million in cash and cash equivalents and $2.4 million in obligations under capital lease while having a negative equity of (-)$59 million. Overall equity declined by (-)$6.63 million and capital lease fell by (-)$477,000.
Of its $178.9 million 39%Ă‚ was identified as goodwill and intangibles while book value declined by (-)$6.63 million to (-)$59 million.
Cash flow
In the first half, Rosetta Stone’s cash outflow from operations improved by $7.8 million year over year to (-)$4.63 million brought by lower losses in the period. Capital expenditures were $5.4 million leaving the company with (-)$10 million in free cash outflow compared to (-)$18.4 million the year prior.
Despite the outflows, Rosetta allocated $974 million in payments to capital lease obligations and financing costs.
The cash flow summary
In the past three years, Rosetta allocated $32 million in capital expenditures and $3 million in debt repayments (capital leases) and generated (-)$29 million in free cash outflows.
Conclusion
It does not appear that Rosetta sees an ongoing struggle in its overall operations as its business is susceptible to cyclicality. For example, the company expects all of its segments (literacy, enterprise & education and consumer) to experience stronger operations in the second half of the year brought by reasons from school to holiday shopping season.
Nonetheless, the company remains liquid as its cash position far exceeds its lease obligations while having a good amount of goodwill and intangibles at 40%. In addition, the company has struggled to generate steady positive free cash flow generation in recent years.
Analysts have an average buy recommendation on Rosetta with a $14.5 per share target price vs. $9.62 per share at the time of writing.
Brought by cyclicality and poor profit generation (if any) including unsteady free cash flow generation, Rosetta is a pass.
Disclosure: I do not have shares in the company mentioned.
