Rosetta Stone's Change in Strategy Might Just Be Paying Off

Rosetta Stone continues to move away from its legacy consumer foreign-language business, instead focusing on what it views as a much better opportunity to grow with businesses and educators. Those steps have been slow to reach the bottom line, and the company continues to report losses, but costs are falling after major cuts last quarter, and revenues are growing quickly in the company's new target market. Some highlights:

  • Total sales fell 11%, but the Education and Enterprise segment grew 20%.
  • A net loss of $8.2 million was a $7.3 million improvement from last year.
  • Cash and equivalents declined $16 million to $29.8 million.

Let's take a closer look at the key metrics and try to put a little context on the company's efforts to date. Losses continue, but the company has cut costs significantly as it looks to get profitable.

The major transition is moving aheadWhile Rosetta Stone is still best known for its foreign-language software, the company is in the midst of a major shift in focus. As strong as its brand recognition is, the company has never been able to successfully grow a sustainable, profitable business selling software to consumers. So the company has been investing in growing its Enterprise and Education segment, which focuses on businesses and schools, which have proved to be much better customers.

Over the past six quarters, the E&E segment has grown sales at least 20% every quarter, while the consumer business has declined by double digits in every quarter but one. This trend has resulted in a big shift in sales mix. In the first quarter of 2014, the consumer segment was 71% of sales. By the end of this past quarter, that had fallen to 55%. Based on that trend, there's a real chance that the E&E business will be the majority of sales within a few quarters.

Losses improving, but capital position bears watchingRosetta Stone reported a loss of $8.2 million last quarter, a big improvement from the $15.8 million loss last year, and the $20 million loss reported in the first quarter of 2015.

According to the earnings release, the improvement is largely due to significant cost cuts the company made last quarter, including cutting headcount 15% outside the E&E segment, which the company says will result in a $50 million annual savings. In all, the company reduced costs by $10 million from last year.

The company also announced that it had identified an additional $12 million in cost savings, meaning so far this year the company has identified $62 million in annual cost savings. It's critically important that the company realize these cost savings soon, as the company's cash position declined $16 million last quarter to $29.8 million. Accounts receivable also declined $7 million sequentially.

The company has no long-term debt, so it has options for liquidity, but the bottom line is the company's restructuring has weakened its capital position, and to date it remains cash-flow negative.

What's the lesson?It looks like the company's efforts to invest in growing the part of its business with consistent demand from paying customers is paying off in sales growth, but the consumer segment continues to weigh on results. However, at some point it appears that the growth in Enterprise and Education will be worth more than the decline in the consumer business.

However, what's not clear is whether the company's cost-cutting efforts, combined with the growth, will combine to get to profitability before the company runs out of cash. The company has options to come up with extra capital -- and looks likely to have to do so -- so it's not a "death race," but it's something investors need to be acutely aware of. Whether it becomes necessary or not, Rosetta Stone has found a business that it can consistently grow. It may not be the one investors signed up for a few years ago, but it looks like it's going to be the company's future.

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Jason Hall has no position in any stocks mentioned. The Motley Fool recommends Rosetta Stone. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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