Rosetta Stone Cuts Outlook, Stock Offering

Shares Fall 27 Percent as Arlington Company Cites Higher Operating Costs

Rosetta Stone, an Arlington-based language instruction company, cut its earnings outlook and canceled a secondary offering of stock Monday, sending its shares tumbling more than 25 percent.

Citing higher operating costs, Rosetta Stone said it now expected to earn 25 to 27 cents during the third quarter, down from a forecast of 33 to 35 cents a share issued just three weeks ago. For the year, the company expects earnings of $1.14 to $1.18 per share, down from an earlier forecast of $1.22 to $1.26.

Rosetta Stone did not give a reason for putting a stop to the stock offering. It blamed marketing expenses as a major factor for the revision of its earnings forecast. Its shares closed Monday at $20.63, down $7.72, or 27.2 percent.

"In the current quarter, we experimented with a significant amount of Internet and television test marketing programs and we did not expeditiously terminate certain of those programs that were not yielding acceptable results," Brian Helman, Rosetta Stone's chief financial officer, said in a statement.

Known for the bright yellow kiosks it employs to sell products in airports across the country, Rosetta Stone went public in April and has been growing quickly. Its sales nearly doubled to $209.4 million in 2008 from the previous year, and the company has credited a refreshed product lineup for the gains.

But Rosetta Stone has hit some head winds since its IPO, as rising operating costs have cut into profitability. At the end of July, the company posted a second-quarter loss of $7.3 million compared with a profit of $3.4 million a year earlier, despite an 18 percent increase in sales. During the quarter, Rosetta's operating expenses jumped to $60.4 million, from $34.4 million in 2008.

In a jittery market, any hint that a company is not being tightly managed can punish share prices, said Edward P. Meehan, principal at Oakton-based consultancy Arcady Bay Partners.

"Missing earnings by a penny can cause big price movements these days, especially when you're talking about a company that just went public in the last year," he said. "Pulling the stock offering makes things that much worse." Meehan said he suspects the company may have decided to push the secondary offering to a later date in the hopes of selling into a more solid marketplace.

Rosetta had planned to offer an additional 4.3 million shares of common stock, according to a regulatory filing last week. Its stock traded as high as $32.97 in May.

Chief executive Tom Adams said the company still expected to deliver strong results for the current fiscal year despite the higher expenses. "We continue to make the necessary investments in our business and believe we are well positioned for long-term growth," he said.

This summer, Rosetta launched an online product called "TOTALe," which lets Web-connected students converse with native speakers while they sit at their computers.

In July, the company filed a trademark infringement lawsuit against Google, asserting that the search engine company has been allowing other companies to use Rosetta Stone's name for online advertisements.

Brandon Dobell, an analyst with William Blair & Co., said he still thinks highly of the company, though he expects investors may stay clear for the time being.

"It'll take a while for the management team to convince investors they can do a good job," he said. "They've got some work to do to rebuild their credibility . . . but that doesn't change what I think the franchise is worth."

Blair said Rosetta's recent missteps would be minor for many companies. "They didn't do a good job executing on a few small things, but this is a small company and a few small things can have a big impact on a company's performance," he said.