Rosetta Stone's Struggles Internationally Translate Into a Weak Quarter

Shares of Rosetta Stone plunged 18% following third-quarter results that fell well below analyst estimates and forced the company to reduce revenue guidance for the full year. While there were multiple disappointments within the company's third-quarter earnings release, a particular area of concern is the ongoing decline in the company's international consumer business.

Struggles internationally are nothing new
Over a year ago, I wrote about the turnaround at Rosetta Stone led by new CEO Steve Swad. At the time, the primary area of concern was an ongoing decline in international consumer revenue led primarily by sharp reductions in Japan and Korea. In mid-2012, management was realigning to focus on this once-promising growth opportunity and experimenting with pricing and product mix. Fast-forward to third-quarter 2013, and there are still no answers to solve the rapidly declining international revenue; in fact, international consumer revenue dropped 28% year over year in Q3 2013 compared to already weak prior-year results.

The trend in Rosetta Stone's international consumer revenue tells a troubling story:

Quarter Revenue 

YOY % Change 

Q1 2010 $10.0 275% 
Q2 2010  $8.2  155% 
Q3 2010  $9.9  119% 
Q4 2010  $17.2  102% 
Q1 2011  $15.0  50% 
Q2 2011  $12.9  58% 
Q3 2011  $11.0  12% 
Q4 2011  $12.8  (25%) 
Q1 2012  $12.2  (19%) 
Q2 2012  $8.1  (38%) 
Q3 2012  $9.9  (10%) 
Q4 2012  $10.1  (21%) 
Q1 2013  $8.6  (30%) 
Q2 2013  $7.5  (7%) 
Q3 2013 $7.2  (28%) 

Revenue in millions.  Source: Rosetta Stone earnings releases. 

As this table illustrates, international consumer revenue has not just declined year over year, but has dropped to levels not seen since Rosetta Stone first went public in 2009. This is hardly the pillar of growth that many investors (myself included) thought would be a basis for a solid investment.

So what went wrong?
As the story has been for over a year, struggles in Japan and Korea have led the rapid decline in international consumer revenue. Management has taken steps each quarter to make the international consumer a strategic priority, relocating dedicated management to Asia to focus on stabilizing the business in that region, and providing new pricing, product, and messaging combinations to the consumer. Thus far, Rosetta Stone has not seen the benefits. Swad acknowledged this on the most recent earnings call, stating, "while we have taken steps to change management and alter our go-to-market strategy in Japan, we have not yet seen significant positive impact from these actions. But we are seeing small signs of progress."

Small signs of good news, such as a new one-month subscription SKU in Japan and the doubling of revenue from the proctor channel in Korea are nice anecdotes. However, the fact remains that the company has not come close to offsetting the huge declines in its primary sales channels such as home shopping.

International is a challenge for other software companies
While Rosetta Stone's struggles internationally are certainly a concern, the company is not alone. Activision Blizzard recently reported a 46% drop in revenues from its Asia-Pacific geographic region and a 13% decline in Europe. With Asia-Pacific and Europe representing half of Activision Blizzard's revenue, this appears to be an even bigger red flag than Rosetta Stone's results. However, it is important to note that Activision Blizzard is a larger, consistently profitable company that is poised to succeed thanks to its newly earned independence from Vivendi and the arrival of next-generation gaming consoles.

This international pressure extends beyond discretionary software purchases like Rosetta Stone's language learning and Activision Blizzard's gaming titles. For example, security software giant Symantec , which derives more than half of its revenue internationally, recently reported a 3% decline in international revenue. In the company's Asia-Pacific & Japan region, revenue declined 14%. Given the established nature of Symantec's core business and the fact that the company's security and protection software is considered to be far less discretionary than personal education and entertainment software, this decline demonstrates that the pressures facing Rosetta Stone's international consumer business are at least partially external. 

Looking ahead
With the recent trend of eight consecutive quarters of year-over-year declines in international consumer revenue, Rosetta Stone has mounting pressure to deliver improved results in the fourth quarter and early 2014. To help turn the international business around, Rosetta Stone expects to release a new English-language software suite that the management has described as "the most significant product that this company has released in probably 2 years, 2.5 years."  This is expected to provide a boost to the company's efforts to stabilize the international consumer business.

At this point, it is difficult to conclude whether the third quarter is a bump in the road toward recovery or a sign of weakness in Rosetta Stone's business model. Investors should carefully monitor upcoming press releases, investor presentations, and fourth-quarter results to make an informed decision on whether to buy, sell, or hold Rosetta Stone.

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The article Rosetta Stone's Struggles Internationally Translate Into a Weak Quarter originally appeared on Fool.com.

Fool contributor Brian Shaw owns shares of Activision Blizzard and Rosetta Stone. The Motley Fool recommends Activision Blizzard and Rosetta Stone. The Motley Fool owns shares of Activision Blizzard and 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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