Rosetta Stone Inc
Annual Report 2015

Plain-text annual report

Table of ContentsUNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549Form 10-KANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2015Commission file number: 1-34283Rosetta Stone Inc.(Exact name of registrant as specified in its charter)Delaware(State of incorporation) 043837082(I.R.S. EmployerIdentification No.)1919 North Lynn St., 7th Fl.Arlington, Virginia(Address of principal executive offices) 22209(Zip Code)Registrant's telephone number, including area code:703-387-5800Securities Registered Pursuant to Section 12(b) of the Act:Title of Each Class Name of Each Exchange on Which RegisteredCommon Stock, par value $0.00005 per share New York Stock ExchangeSecurities Registered Pursuant to Section 12(g) of the Act:NoneIndicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No ýIndicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o No ýIndicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filingrequirements for the past 90 days. Yes ý No oIndicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data Filerequired to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorterperiod that the registrant was required to submit and post such files). Yes ý No oIndicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, tothe best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendmentto this Form 10-K. oIndicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):Large accelerated filer o Accelerated filer ý Non-accelerated filer o Smaller reporting company o (Do not check if a smaller reporting company) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No ýThe aggregate market value of the common stock held by non-affiliates of the registrant was approximately $136.5 million as of June 30, 2015 (basedon the last sale price of such stock as quoted on the New York Stock Exchange). All executive officers and directors of the registrant and all persons filing aSchedule 13D with the Securities and Exchange Commission in respect of registrant's common stock have been deemed, solely for the purpose of theforegoing calculation, to be "affiliates" of the registrant.As of March 8, 2016, there were 21,882,727 shares of common stock outstanding.Documents incorporated by reference: Portions of the definitive Proxy Statement to be delivered to stockholders in connection with the 2016 AnnualMeeting of Stockholders to be held on May 19, 2016 are incorporated by reference into Part III.TABLE OF CONTENTS PagePART IItem 1.Business4Item 1A.Risk Factors9Item 1B.Unresolved Staff Comments23Item 2.Properties23Item 3.Legal Proceedings23Item 4.Mine Safety Disclosures23PART IIItem 5.Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of EquitySecurities24Item 6.Selected Financial Data25Item 7.Management's Discussion and Analysis of Financial Condition and Results of Operations46Item 7A.Quantitative and Qualitative Disclosures About Market Risk49Item 8.Financial Statements and Supplementary Data49Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure50Item 9A.Controls and Procedures50Item 9B.Other Information51PART IIIItem 10.Directors, Executive Officers and Corporate Governance52Item 11.Executive Compensation52Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters52Item 13.Certain Relationships and Related Transactions, and Director Independence52Item 14.Principal Accounting Fees and Services52PART IVItem 15.Exhibits and Financial Statement Schedules53Table of ContentsPART IFORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K, including the documents incorporated by reference, contains forward-looking statements within the meaning of thePrivate Securities Litigation Reform Act of 1995. Forward-looking statements involve risks and uncertainties and provide current expectations of futureevents based on certain assumptions. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current factsand often include words such as "believes," "expects," "anticipates," "estimates," "intends," "plans," "seeks" or words of similar meaning, or future-looking orconditional verbs, such as "will," "should," "could," "may," "might," "aims," "intends," or "projects” or similar words and phrases. The absence of these wordsor similar expressions does not mean that a statement is not forward-looking. These statements may relate to: our revised business strategy; guidance orprojections related to bookings, Adjusted EBITDA, and other measures of future economic performance; the contributions and performance of ourbusinesses including acquired businesses and international operations; projections for future capital expenditures; and other guidance, projections, plans,objectives, and related estimates and assumptions. A forward-looking statement is neither a prediction nor a guarantee of future events or circumstances,and the Company's actual results may differ significantly from the events or circumstances discussed in the forward-looking statement. Managementbelieves that these forward-looking statements are reasonable as and when made. However, caution should be taken not to place undue reliance on anysuch forward-looking statements because such statements are based on beliefs and assumptions made by, and information currently available to,management and speak only as of the date when made. We expressly disclaim any obligation to update or revise any forward-looking statements, whetheras a result of new information, future events or otherwise. In addition, forward-looking statements are subject to certain risks and uncertainties that couldcause actual results to differ materially from our present guidance, expectations or projections. These risks and uncertainties include, but are not limitedto, those described below in this Annual Report on Form 10-K in Part I, Item 1A: "Risk Factors" and Part II, Item 7. "Management's Discussion and Analysisof Financial Condition and Results of Operations,” those described elsewhere in this Annual Report on Form 10-K, and those described from time to time inour future reports filed with the Securities and Exchange Commission. Table of ContentsItem 1. BusinessOverviewRosetta Stone Inc. (“Rosetta Stone,” “the Company,” “we” or “us”) is dedicated to changing people's lives through the power of language and literacyeducation. Our innovative, personalized language and reading programs drive positive learning outcomes in thousands of schools, businesses, governmentorganizations and for millions of individuals around the world. Our cloud-based programs allow users to learn online or on-the-go via tablet or smartphone,whether in a classroom, corporate setting, or personal learning environment. Rosetta Stone is also a leader in the literacy education space, helping millions ofstudents build fundamental reading skills. Additionally, our Fit Brains business offers personalized brain training programs that are both exciting andchallenging.Rosetta Stone Inc. was incorporated in Delaware in 2005. Founded in 1992, Rosetta Stone pioneered the use of interactive software to acceleratelanguage learning and is widely recognized today as the industry leader in providing effective language programs. Today we offer courses in 30 languagesacross a broad range of formats, including web-based software subscriptions, digital downloads, mobile applications, and perpetual CD packages. RosettaStone has continued to invest in language learning and expanded beyond language learning and deeper into education-technology with its acquisitions ofLivemocha Inc. ("Livemocha") and Lexia Learning Systems Inc, ("Lexia") in 2013 and Vivity Labs, Inc. ("Vivity") and Tell Me More S.A. ("Tell Me More") inJanuary 2014. These acquisitions have enabled us to meet the changing needs of learners around the world.As our Company has evolved, we believe that our language and literacy Enterprise & Education segment is our largest opportunity for long-term valuecreation. The customers in these marketplaces have demands that recur each year, creating a more predictable revenue opportunity. This demand profile alsofits well with our suite of products, the well-known Rosetta Stone brand and the demonstrated efficacy of our literacy tools. We also believe the demand for e-learning based literacy solutions in the US and English language-learning around the globe is growing.As a result, we are emphasizing the development of products and solutions for Corporate and K-12 learners who need to speak and read English. Thisfocus extends to the Consumer segment, where we continue to make product investments serving the needs of passionate language learners who aremotivated, results focused and willing to pay for a quality language-learning experience.To position the organization for success, we are focused on the following four priorities:1.Grow literacy sales by providing fully aligned digital instruction and assessment tools for K-12, building a direct distribution sales force to replaceour historical reseller model, and continuing to develop our implementation services business;2.Position our Enterprise & Education language business for profitable growth by focusing on our best geographies and customer segments andsuccessfully delivering a new language-learning suite for Corporate customers that offers a simple, more modern, metrics-driven suite of tools thatare results-oriented and easily integrated with leading corporate language-learning systems;3.Maximize the profitability of our Consumer language business by providing an attractive value proposition and a streamlined, mobile-orientedproduct portfolio focused on consumers' demand, while optimizing our marketing spend appropriately; and4.Right-size the entire cost base of the Company, including◦optimizing our media spend and other marketing costs in Consumer sales and marketing;◦right-sizing our Enterprise & Education segment to target those geographies and customer segments where we have the greatestopportunity; and◦reducing our general and administrative costs.In pursuing these priorities, we will (i) allocate capital to the areas of our business that we believe have the greatest growth potential, including ourliteracy-learning business, (ii) focus our businesses on their best customers, including Corporate and K-12 learners primarily in North America and NorthernEurope in our Enterprise & Education language business and passionate learners in the United States and select non-US geographies in our Consumerlanguage business, and (iii) optimize the sales and marketing costs for these businesses and the costs of our business overall.4Table of ContentsBusiness SegmentsOur business is organized into two operating segments: Enterprise & Education and Consumer. The Enterprise & Education segment derives revenuesfrom sales to educational institutions, corporations, and government agencies worldwide. The Consumer segment derives revenue from sales to individualsand retail partners worldwide. For additional information regarding our segments, see Note 17 of Item 8, Financial Statements and Supplementary Data. Priorperiods are presented consistently with our current operating segments and definition of segment contribution.Products and ServicesEnterprise & Education:Rosetta Stone offers a series of technology-based interactive language-learning solutions for schools, businesses and other organizations and readingand literacy solutions for schools. Rosetta Stone also offers administrator tools for performance monitoring and custom solutions to ensure that organizationsachieve desired outcomes. Through our professional services, we provide expert implementation and training services to drive critical business solutions.Language-Learning Solutions: Rosetta Stone provides web-based language-learning solutions that are primarily available online. Our core language-learning suite offers courses and practice applications in multiple languages, each leveraging our proprietary immersion methodology and innovativetechnology features. Available in 24 languages and designed for beginner to intermediate language learners, Rosetta Stone Foundations builds fundamentallanguage skills using our proprietary context-based, immersion methodology and innovative technology features. Rosetta Stone Advantage is available forall proficiency levels in 9 of the 24 languages and focuses on improving everyday and business language skills. Our Advanced English for Business solutionserves multinational companies seeking to build their employees’ English language proficiency so they are able to communicate and operate in a globalbusiness environment. Specifically designed for use with our language-learning solutions, our Global Enterprise & Education customers may also purchaseour audio practice products and live tutoring sessions to enhance the learning experience.Literacy Solutions: Our Lexia Learning suite of subscription-based English literacy-learning and assessment solutions provide explicit, systematic,personalized fundamental reading instruction for students of all abilities. These literacy solutions deliver norm-referenced performance data and analysiswithout interrupting the flow of instruction to administer a test, providing personalized learning experiences that integrate well with teachers in classrooms.This research-proven technology based approach accelerates reading skills development, predicts students' year-end performance and provides teachers data-driven action plans to help differentiate instruction. Lexia Reading Core5 is available for all abilities from pre-K through grade 5. Our reading interventionprogram, Lexia Strategies, is designed for remedial students in grades 6 and above. Lexia RAPID Assessment is a computer-adaptive screener and diagnostictool for grades K-12 that identifies and monitors reading and language skills to provide actionable data for instructional planning. Lexia's solutions delivernorm-referenced performance data and analysis to enable teachers to monitor and modify their instruction to address specific student needs. These literacysolutions are provided under web-based subscriptions.Administrator Tools: Our Enterprise & Education learning programs come with a set of administrator tools to measure and track learner progress.Administrators can use these tools to access real-time dynamic reports and identify each learner's strengths and weaknesses.Professional Services: Professional services provide our customers with access to experienced training, implementation and support resources. Our teampartners work directly with customers to plan, deploy, and promote the program for each organization, incorporate learning goals into implementationmodels, prepare and motivate learners, and integrate the Rosetta Stone products into technical infrastructure.Custom Solutions: Rosetta Stone offers tailored solutions to help organizations maximize the success of their learning programs. Our current customsolutions include curriculum development, global collaboration programs that combine language education with business culture training, and languagecourses for mission-critical government programs.Consumer:Rosetta Stone also offers a broad portfolio of technology-based learning products for personal use to the global consumer. Powered by our widelyrecognized brand, and building on our 23-year heritage in language-learning, our interactive learning solutions include a portfolio of language-learning,brain fitness, and kids' literacy and learning solutions.Many of our Rosetta Stone consumer products and services are available in flexible and convenient formats for tablets and smartphones. Our mobileapps enable learners to continue their lessons on the go and extend the learning experience away from a computer. Progress automatically syncs to meet ourcustomers' lifestyles. These apps may be available for download through the Apple App Store, Google Play, Amazon Appstore for Android, and the WindowsStore.5Table of ContentsRosetta Stone Language-Learning Solutions: Rosetta Stone provides intuitive, easy-to-use learning programs that are available under a web-basedsoftware subscription and in perpetual formats including digital download and CD. Our language-learning suite offers courses and practice applications inmultiple languages, each leveraging our proprietary immersion methodology and innovative technology features. Beginner to intermediate language-learning products are available in 30 languages to build fundamental language skills. Advanced language-learning products are available in 9 of the 30languages and focus on improving everyday and business language skills. We also offer online services to enhance and augment our learners' capabilities.Our Online Tutoring is an online service that provides conversational coaching sessions with native speakers to practice skills and experience directinteractive dialogue. Our Online Games and Activities are online services that provide a world-wide community for users around the world with games,online chat, and other features to improve language skills. Many of our perpetual language-learning offerings include access to Online Tutoring. Almost allof our language-learning offerings for consumers include access to Online Games and Activities. Our current suite of mobile language-learning apps includescompanions to our computer-based language-learning solutions.Rosetta Stone Fit Brains: Rosetta Stone Fit Brains solutions are designed to enhance memory, mood, concentration, thinking and problem-solving skillsusing brain training exercises that are exciting and challenging. Our Fit Brains system targets all six major brain areas including memory, concentration,speed, visual, language, and problem solving. Our brain fitness solutions include a web-based subscription and several brain training apps that feature morethan 40 scientifically designed brain training games. Included in a Rosetta Stone Fit Brains subscription are performance tracking tools to view trainingprogress and compare performance with others of the same age and gender.Rosetta Stone Kids: Rosetta Stone Kids mobile apps provide technology-based learning solutions for children that focus on early childhood languageand literacy. Rosetta Stone Kids Reading app was launched in 2014 aimed to teach children aged 3-7 how to read using engaging self-paced interactivegames and activities that introduce and reinforce core reading skills. Rosetta Stone Kids Reading uses award-winning, research-proven technology focusedon phonological awareness, phonics, vocabulary, fluency, and comprehension. Rosetta Stone Kids Reading includes dozens of games and stories, plushundreds of fun activities. Fit Brains for Kids Sparky's Adventures offers a first-of-its-kind cognitive approach to child learning and brain development thatprovides a fun and healthy collection of brain games for children aged 2-8. In 2013 we launched Rosetta Stone Kids Lingo Letter Sounds and Rosetta StoneKids Lingo Word Builder apps for children aged 3-6 that provide blended learning solutions to introduce kids to both basic literacy skills and a foreignlanguage.Software Developments:Our offering portfolio is a result of significant investment in software development. Our software development efforts include the design and build ofsoftware solutions across a variety of devices, pedagogy and curriculum development, and the creation of learning content. Our development team buildsnew solutions and enhances or maintains existing solutions. We have specific expertise in speech recognition technology, iterative and customer-focusedsoftware development, instructional design, and language acquisition.Our research and development expenses were $29.9 million, $33.2 million, and $34.0 million for the years ended December 31, 2015, 2014 and 2013,respectively.We continue to evaluate changes to our solutions to strengthen our brand and improve the relevance of our offering portfolio. We are focused oncompleting the alignment of our three language platforms and moving towards the consolidation of our legacy platforms to offer our customers a singlesolution that provides streamlined access and simplified pricing for the full suite of English and world language learning content, along with assessment,placement, ongoing reporting and demonstration of results, all of which address important customer needs to focus and demonstrate payback.Distribution ChannelsEnterprise & Education:Our Enterprise & Education language-learning distribution channel is focused on targeted sales activity primarily through a direct sales force in fivemarkets: K-12 schools, colleges and universities, federal government agencies, not-for-profit organizations, and corporations. Our Enterprise & Educationlanguage-learning customers include the following:Educational Institutions. These customers include primary and secondary schools and colleges and universities.U.S. Federal Government Agencies and Not-for-Profit Organizations. These customers include government agencies and organizations developingworkforces that serve non-native speaking populations, offering literacy programs, and preparing members for overseas missions.Corporations. We promote interest in this market with onsite visits, trade show and seminar attendance, speaking engagements, and direct mailings.6Table of ContentsThird-party Resellers. We utilize third-party resellers to provide our language-learning solutions to businesses, schools, and public-sector organizationsin emerging markets predominantly outside the U.S.Our Enterprise & Education literacy distribution channel utilizes a direct sales force as well as relationships with third-party resellers focused on thesale of Lexia solutions to K-12 schools.Consumer:Our Consumer distribution channel comprises a mix of our call centers, websites, third party e-commerce websites, consignment distributors, selectretail resellers, and daily deal partners. We believe these channels complement each other, as consumers who have seen our direct-to-consumer advertisingmay purchase at our retailers, and vice versa.Direct to consumer. Sales generated through either our call centers and on our e-commerce website at www.rosettastone.com.Indirect to consumer. Sales generated through arrangements with third-party e-commerce websites such as the Apple App Store, and consignmentdistributors such as Wynit Distribution and Software Packaging Associates.Retailers. Our retailers enable us to provide additional points of contact to educate consumers about our solutions, expand our presence beyond ourown websites, and further strengthen and enhance our brand image. Our retail relationships include Amazon.com, Barnes & Noble, Target, Best Buy, Books-a-Million, Sam's Club, Staples, and others in and outside of the U.S. We also partner with daily deal resellers.Home School. We promote interest in the language-learning market through advertising in publications focused on home schooling, attending localtrade shows, seminars and direct mailings.Sourcing and FulfillmentConsistent with the Software-as-a-Service ("SaaS") model in our Enterprise & Education segment, our strategy in the Consumer segment is to shift thesales mix away from CD-based product sales toward a cloud-based software subscription in order to reduce costs associated with physical packaging anddistribution.Our physical inventory utilizes a flexible, diversified and low-cost manufacturing base. We use third-party contract manufacturers and suppliers toobtain substantially all of our product and packaging components and to manufacture finished products. We believe that we have good relationships withour manufacturers and suppliers and that there are alternative sources in the event that one or more of these manufacturers or suppliers is not available. Wecontinually review our manufacturing and supply needs against the capacity of our contract manufacturers and suppliers with a view to ensuring that we areable to meet our production goals, reduce costs and operate more efficiently.CompetitionRosetta Stone competes in several categories within the technology-based learning industry, including consumer, enterprise and educational languagelearning, literacy, and brain fitness.The language-learning market is highly fragmented globally and consists of a variety of instructional and learning modes: classroom instructionutilizing the traditional approach of memorization, grammar and translation; immersion-based classroom instruction; self-study books, audio recordings andsoftware that rely primarily on grammar and translation; and free online and mobile offerings that provide content and opportunities to practice writing andspeaking. Within consumer-focused language learning, our competitors include Berlitz (Benesse Holdings), Pimsleur (Simon & Schuster, part of CBSCorporation), Living Language (Penguin Random House, a joint venture of Pearson and Bertelsmann), McGraw-Hill Education, Duolingo, Inc., Fluenz,Busuu Ltd., Babbel (operated by Lesson Nine GmbH) and many other small and regionally-focused participants. In the enterprise and education-focusedlanguage market, we compete with EF Englishtown, Global English (Pearson), Wall Street English (Pearson), inlingua, Imagine Learning, TransparentLanguage, as well as many private language schools and other classroom-based courses.In the literacy category, we compete primarily in the K-12 digital reading space in the U.S. with Scholastic, Inc., Imagine Learning, Achieve3000,Scientific Learning, Odyssey (Compass Learning), Waterford Early Reading (Pearson), Renaissance, and Istation.In the brain fitness category, the category is new and highly fragmented. We compete with Lumosity, Elevate and Posit Science as well as many onlineand digital app providers.7Table of ContentsSeasonalityOur business is affected by variations in seasonal trends. Within our Enterprise & Education segment, revenue in our education, government, andcorporate sales channels are seasonally stronger in the second half of the calendar year due to purchasing and budgeting cycles. Our Consumer revenue isaffected by seasonal trends associated with the holiday shopping season. In particular, we generate a significant portion of our Consumer sales in the fourthquarter during the period beginning on Black Friday through the end of the calendar year. We sell to a significant number of our Consumer retailers anddistributors and Enterprise & Education customers on a purchase order basis and we receive orders when these customers need products and services. As aresult, their orders are typically not evenly distributed throughout the year and generally are highest in the third and fourth quarters. Our Enterprise &Education segment and our Consumer segment are affected by different sales-to-cash patterns. Historically, in the first half of the year we have been a net userof cash and in the second half of the year we have been a net generator of cash since Consumer sales typically turn to cash more quickly than Enterprise &Education sales, which have longer collection cycles.Intellectual PropertyOur intellectual property is critical to our success. We rely on a combination of measures to protect our intellectual property, including patents, tradesecrets, trademarks, trade dress, copyrights and non-disclosure and other contractual arrangements.We have ten U.S. patents, fourteen foreign patents and several U.S. and foreign patent applications pending that cover various aspects of our language-learning and literacy technologies.We have registered a variety of trademarks, including our primary or house marks, Rosetta Stone, The Blue Stone Logo, Livemocha, Lexia Learning,Lexia and Fit Brains. These trademarks are the subject of either registrations or pending applications in the U.S., as well as numerous countries worldwidewhere we do business. We have been issued trademark registrations for our yellow color from the U.S. Patent and Trademark Office. We intend to continue tostrategically register, both domestically and internationally, trademarks we use today and those we develop in the future. We believe that the distinctivemarks that we use in connection with our solutions are important in building our brand image and distinguishing our offerings from those of our competitors.These marks are among our most valuable assets.In addition to our distinctive marks, we own numerous registered and unregistered copyrights, and trade dress rights, to our products and packaging. Weintend to continue to strategically register copyrights in our various products. We also place significant value on our trade dress, which is the overall imageand appearance of our products, as we believe that our trade dress helps to distinguish our products in the marketplace from our competitors.Since 2006, we have held a perpetual, irrevocable and worldwide license from the University of Colorado allowing us to use speech recognitiontechnology for language-learning solutions. Since 2014, we have also held a commercial license from the Florida State University Research Foundationallowing us to use certain computer software and technology in our literacy offerings. These types of arrangements are often subject to royalty or license fees.We diligently protect our intellectual property through the use of patents, trademarks and copyrights and through enforcement efforts in litigation. Weroutinely monitor for potential infringement in the countries where we do business. In addition, our employees, contractors and other parties with access toour confidential information are required to sign agreements that prohibit the unauthorized disclosure of our proprietary rights, information and technology.EmployeesAs of December 31, 2015, we had 1,148 total employees, consisting of 855 full-time and 293 part-time employees. We have employees in France, Spainand Italy who are represented by a collective bargaining agreement. We believe that we have good relations with our employees. In the first quarter of 2015,we implemented a program to reduce costs as part of an alignment of resources around our Enterprise & Education segment, including the reduction of non-Enterprise & Education headcount by approximately 15%. On March 14, 2016, we announced that we intend to exit our direct sales presence in almost all ofour non-U.S. and non-northern European geographies related to the distribution of our Enterprise & Education language offerings. If our intentions arerealized, these actions will reduce headcount by approximately 17% of our full-time workforce. For more information about these employee reductions, seeNotes 13 and 21 of Item 8, Financial Statements and Supplementary Data contained in this Annual Report on Form 10-K.Financial Information by Segment and Geographic AreaFor a discussion of financial information by segment and geographic area, see Note 17 of Item 8, Financial Statements and Supplementary Datacontained in this Annual Report on Form 10-K.8Table of ContentsAvailable InformationThis Annual Report on Form 10-K, along with our Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filedor furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act"), are available free of charge through our websiteas soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission ("SEC"). Ourwebsite address is www.rosettastone.com. The SEC maintains a website that contains reports, proxy statements and other information regarding issuers thatfile electronically with the SEC. These materials may be obtained electronically by accessing the SEC's website at www.sec.gov.Item 1A. Risk FactorsThe following description of risk factors includes any material changes to, and supersedes the description of, risk factors associated with our businesspreviously disclosed in our Quarterly Report on Form 10-Q filed on November 4, 2015 with the SEC for the period ended September 30, 2015. An investmentin our common stock involves a substantial risk of loss. Investors should carefully consider these risk factors, together with all of the other informationincluded herewith, before deciding to purchase shares of our common stock. If any of the following risks actually occur, our business, financial condition, orresults of operations could be materially adversely affected. In such case, the market price of our common stock could decline and all or part of an investmentmay be lost.The risks described below are not the only ones facing us. Our business is also subject to the risks that affect many other companies, such as generaleconomic conditions and geopolitical events. Further, additional risks not currently known to us or that we currently believe are immaterial could have amaterial adverse effect on our business, financial condition, cash flows and results of operations. In addition to the other information set forth in this annualreport on Form 10-K, you should carefully consider the risk factors discussed below and in other documents we file with the SEC that could materially affectour business, financial condition, cash flows or future results.Our business could be impacted as a result of actions by activist shareholders or others.We may be subject, from time to time, to legal and business challenges in the operation of our company due to proxy contests, shareholder proposals,media campaigns and other such actions instituted by activist shareholders or others. Responding to such actions could be costly and time-consuming,disrupt our operations, may not align with our business strategies and could divert the attention of our Board of Directors and senior management from thepursuit of current business strategies. Perceived uncertainties as to our future direction as a result of shareholder activism or potential changes to thecomposition of the Board of Directors may lead to the perception of a change in the direction of the business or other instability that may make it moredifficult to attract and retain qualified personnel and business partners, and could have a materially adverse effect on the Company’s stock price.We might not be successful in executing our strategy of focusing on the Enterprise & Education segment and on more passionate language learners in theConsumer segment, and our company reorganization and realignment might not produce the desired results.We are continuing to undertake a strategic reorganization and realignment of our business to maximize profitable growth in our Enterprise & Educationsegment by serving the needs of corporate and K-12 language learners, and prioritizing those who wish to speak and read English. In addition, we are nowfocusing on the needs of more passionate language learners in our Consumer segment, rather than addressing the needs of the mass marketplace. If we do notsuccessfully execute our strategy, our revenue and profitability could decline. Our recent strategy changes include actions to reduce headcount, exitunprofitable geographies, and other cost reductions. These cost reduction efforts could harm our business and results of operations by distractingmanagement and employees, causing difficulty in hiring, motivating, and retaining talented and skilled personnel, and creating uncertainty among ourcustomers and vendors that could lead to delays or unexpected costs. Also, our ability to achieve anticipated cost savings and other benefits from theseefforts is subject to many estimates and assumptions, which are subject to significant economic, competitive and other uncertainties, some of which arebeyond our control. If these estimates and assumptions are incorrect, or if other unforeseen events occur, our business and financial results could be adverselyaffected.Our actual operating results may differ significantly from our guidance.Historically, our practice has been to release guidance regarding our future performance that represents management's estimates as of the date of release.This guidance, which includes forward-looking statements, is based on projections prepared by management. These projections are not prepared with a viewtoward compliance with published guidelines of the American Institute of Certified Public Accountants, and neither our registered public accountants norany other independent expert or9Table of Contentsoutside party confirms or examines the projections and, accordingly, no such person expresses any opinion or any other form of assurance with respectthereto.Projections are based upon a number of assumptions and estimates that, while presented with numerical specificity, are inherently subject to significantbusiness, economic and competitive uncertainties and contingencies, many of which are beyond our control and are based upon specific assumptions withrespect to future business decisions, some of which will change. We generally state possible outcomes as high and low ranges or a single point estimates, butactual results could differ materially. The principal reason that we release guidance is to provide a basis for management to discuss our business outlook withanalysts and investors. We do not accept any responsibility for any projections or reports published by any such persons.Guidance is necessarily speculative in nature, and it can be expected that some or all of the assumptions in the guidance furnished by us will notmaterialize or will vary significantly from actual results. Accordingly, our guidance is only an estimate of what management believes is realizable as of thedate of release. Actual results may vary from our guidance and the variations may be material. In light of the foregoing, investors are urged not to rely upon,or otherwise consider, our guidance in making an investment decision in respect of our common stock.Any failure to successfully implement our strategy or the occurrence of any of the events or circumstances set forth in these "Risk Factors" andelsewhere in this annual report on Form 10-K could result in the actual operating results being different from our guidance, and such differences may beadverse and material.Intense competition in our industry may hinder our ability to attract and retain customers and generate revenue, and may diminish our margins.The business environment in which we operate is rapidly evolving, highly fragmented and intensely competitive, and we expect competition to persistand intensify. Increased competition could adversely affect operating results by causing lower demand for our products and services, reduced revenue, moreproduct returns, price reductions or concessions, reduced gross margins, and loss of customers.Many of our current and potential domestic and international competitors have substantially greater financial, technical, sales, marketing and otherresources than we do, as well as greater name recognition in some locations, as well as in some cases, lower costs. Some competitors offer more differentiatedproducts (for example, online learning as well as physical classrooms and textbooks) that may allow them to more flexibly meet changing customerpreferences. The resources of our competitors also may enable them to respond more rapidly to new or emerging technologies and changes in customerrequirements and preferences and to offer lower prices than ours or to offer free language-learning software or online services. We may not be able to competesuccessfully against current or future competitors.There are a number of free online language-learning opportunities to learn grammar, pronunciation, vocabulary (including specialties in areas such asmedicine and business), reading, and conversation by means of podcasts and MP3s, mobile applications, audio courses and lessons, videos, games, stories,news, digital textbooks, and through other means. We estimate that there are thousands of free mobile applications on language-learning; free products areprovided in at least 50 languages by private companies, universities, and government agencies. Low barriers to entry allow start-up companies with lowercosts and less pressure for profitability to compete with us. Competitors funded by venture capital, that may be focused more on user acquisition rather thanprofitability, enable our competitors to offer products at significantly lower prices or for free. As free online translation services improve and become morewidely available and used, people may generally become less interested in language-learning. Although we also offer free products such as mobile apps, if wecannot successfully attract users of these free products and convert a sufficient portion of these free users into paying customers, our business could beadversely affected. If free products become more engaging and competitive or gain widespread acceptance by the public, demand for our products coulddecline or we may have to lower our prices, which could adversely impact our revenue and other results.Historically a substantial portion of our revenue has been generated from our Consumer business. If we fail to accurately anticipate consumer demand andtrends in consumer preferences, our brands, sales and customer relationships may be harmed.Demand for our consumer focused language-learning, literacy and brain fitness software products and related services is subject to rapidly changingconsumer demand and trends in consumer preferences. Therefore, our success depends upon our ability to:•identify, anticipate, understand and respond to these trends in a timely manner;•introduce appealing new products and performance features on a timely basis;•provide appealing solutions that engage our customers;10Table of Contents•adapt and offer our products and services using rapidly evolving, widely varying and complex technologies;•anticipate and meet consumer demand for additional languages, learning levels and new platforms for delivery;•effectively position and market our products and services;•identify and secure cost-effective means of marketing our products to reach the appropriate consumers;•identify cost-effective sales distribution channels and other sales outlets where interested consumers will buy our products;•anticipate and respond to consumer price sensitivity and pricing changes of competitive products; and•identify and successfully implement ways of building brand loyalty and reputation.We anticipate having to make investments in new products in the future and we may incur significant expenses without achieving the anticipatedbenefits of our investment or preserving our brand and reputation. Investments in new products and technology are speculative, the development cycle forproducts may exceed planned estimates and commercial success depends on many factors, including innovativeness, developer support, and effectivedistribution and marketing. Customers might not perceive our latest offerings as providing significant new value and may reduce their purchases of ourofferings, unfavorably impacting revenue. We might not achieve significant revenue from new product and service investments for a number of years, if at all.We also might not be able to develop new solutions or enhancements in time to capture business opportunities or achieve sustainable acceptance in new orexisting places. Furthermore, consumers may defer purchases of our solutions in anticipation of new products or new versions from us or our competitors. Adecline in consumer demand for our solutions, or any failure on our part to satisfy such changing consumer preferences, could harm our business andprofitability.If the recognition by schools and other organizations of the value of technology-based education does not continue to grow, our ability to generate revenuefrom organizations could be impaired.Our success depends in part upon the continued adoption by organizations and potential customers of technology-based education initiatives. Someacademics and educators oppose online education in principle and have expressed concerns regarding the perceived loss of control over the educationprocess that could result from offering courses online. If the acceptance of technology-based education does not continue to grow, our ability to continue togrow our Enterprise & Education business could be impaired.We depend on discretionary consumer spending in the Consumer segment of our business. Adverse trends in general economic conditions, including retailand online shopping patterns or consumer confidence, as well as other external consumer dynamics may compromise our ability to generate revenue.The success of our business depends to a significant extent upon discretionary consumer spending, which is subject to a number of factors, includinggeneral economic conditions, consumer confidence, employment levels, business conditions, interest rates, availability of credit, inflation, and taxation.Adverse trends in any of these economic indicators may cause consumer spending to decline further, which could hurt our sales and profitability.Because a significant portion of our Consumer sales are made to or through retailers and distributors, none of which has any obligation to sell ourproducts, the failure or inability of these parties to sell our products effectively could hurt our revenue and profitability.We rely on retailers and distributors, together with our direct sales force, to sell our products. Our sales to retailers and distributors are concentrated on akey group that is comprised of a mix of websites, such as Amazon.com and the Apple App Store; select retail resellers such as Barnes & Noble, Best Buy,Target, Books-a-Million, Staples, and Sam's Club; and consignment distributors such as Wynit Distribution and Software Packaging Associates. Sales to orthrough our retailers and distributors accounted for approximately 10% of our revenue for the year ended December 31, 2015, compared to 13% for the yearended December 31, 2014.We have no control over the amount of products that these retailers and distributors purchase from us or sell on our behalf, we do not have long-termcontracts with any of them, and they have no obligation to offer or sell our products or to give us any particular shelf space or product placement within theirstores. Thus, there is no guarantee that this source of revenue will continue at the same level as it has in the past or that these retailers and distributors will notpromote competitors' products over our products or enter into exclusive relationships with our competitors. Any material adverse change in the principalcommercial terms, material decrease in the volume of sales generated by our larger retailers or distributors or major disruption or termination of a relationshipwith these retailers and distributors could result in a significant decline in our revenue and profitability. Furthermore, product display locations andpromotional activities that retailers undertake can affect the sales of11Table of Contentsour products. The fact that we also sell our products directly could cause retailers or distributors to reduce their efforts to promote our products or stop sellingour products altogether.Many traditional physical retailers are experiencing diminished foot traffic and sales. For our retail business, even though online sales have increasedin popularity and are growing in importance, we continue to depend on sales that take place in physical stores and shopping malls. Reduced customer foottraffic in these stores and malls is likely to reduce their sales of our products. In addition, if one or more of these retailers or distributors are unable to meettheir obligations with respect to accounts payable to us, we could be forced to write off accounts receivable with such accounts. Any bankruptcy, liquidation,insolvency or other failure of any of these retailers or distributors could result in significant financial loss and cause us to lose revenue in future periods.Price changes and other concessions could reduce our revenue.We continue to test and offer changes to the pricing of our products. If we reduce our prices in an effort to increase our sales, this could have an adverseimpact on our revenue to the extent that unit sales do not increase in a sufficient amount to compensate for the lower pricing. Reducing our pricing toindividual consumers could also cause us to have to lower pricing to our Enterprise & Education customers. Any increase in the taxation of online salescould have the effect of a price increase to consumers and could cause us to have to lower our prices or could cause sales to decline. It is uncertain whether wewill need to continue to lower prices to effectively compete and what the other short-term and long-term impacts could be.We also may provide our retailers and distributors with price protection on existing inventories, which would entitle these retailers and distributors tocredit against amounts owed with respect to unsold packaged product under certain conditions. These price protection reserves could be material in futureperiods.In the U.S. and Canada, we offer consumers who purchase our packaged software and audio practice products directly from us a 30-day, unconditional,full money-back refund. We also permit some of our retailers and distributors to return packaged products, subject to certain limitations. We establish revenuereserves for packaged product returns based on historical experience, estimated channel inventory levels, the timing of new product introductions and otherfactors. If packaged product returns exceed our reserve estimates, the excess would offset reported revenue, which could hurt our reported financial results.Our future growth and profitability will depend in large part upon the effectiveness and efficiency of our marketing.Our future growth and profitability will depend in large part upon the effectiveness and efficiency of our marketing, including our ability to:•appropriately and efficiently allocate our marketing for multiple products;•accurately identify, target and reach our audience of potential customers with our marketing messages;•select the right marketplace, media and specific media vehicle in which to advertise;•identify the most effective and efficient level of spending in each marketplace, media and specific media vehicle;•determine the appropriate creative message and media mix for advertising, marketing and promotional expenditures;•effectively manage marketing costs, including creative and media expenses, in order to maintain acceptable customer acquisition costs;•differentiate our products as compared to other products;•create greater awareness of our new products like kids' literacy and brain fitness, and of our brands and learning solutions;•drive traffic to our e-commerce website, call centers, distribution channels and retail partners; and•convert customer inquiries into actual orders.Our planned marketing may not result in increased revenue or generate sufficient levels of product and brand name awareness, and we may not be ableto increase our net sales at the same rate as we increase our advertising expenditures.Some of our radio, television, print, and online advertising has been through the purchase of "remnant" advertising segments. These segments arerandom time slots and publication dates that have remained unsold and are offered at discounts to advertisers who are willing to be flexible with respect totime slots. There is a limited supply of this type of advertising and the availability of such advertising may decline or the cost of such advertising mayincrease. In addition, if we increase our12Table of Contentsmarketing budget it cannot be assured that we can increase the amount of remnant advertising at the discounted prices we have obtained in the past. If any ofthese events occur, we may be forced to purchase time slots and publication dates at higher prices, which will increase our costs.We engage in an active public relations program, including through social media sites such as Facebook and Twitter. We also seek new customersthrough our online marketing efforts, including paid search listings, banner ads, text links and permission-based e-mails, as well as our affiliate and resellerprograms. If one or more of the search engines or other online sources on which we rely for website traffic were to modify their general methodology for howthey display our websites, resulting in fewer consumers clicking through to our websites, our sales could suffer. If any free search engine on which we relybegins charging fees for listing or placement, or if one or more of the search engines or other online sources on which we rely for purchased listings, modifiesor terminates its relationship with us, our expenses could rise, we could lose customers and traffic to our websites could decrease.We dynamically adjust our mix of marketing programs to acquire new customers at a reasonable cost with the intention of achieving overall financialgoals. If we are unable to maintain or replace our sources of customers with similarly effective sources, or if the cost of our existing sources increases, ourcustomer levels and marketing expenses may be adversely affected.Our international businesses may not succeed and impose additional and unique risks.Our business strategy contemplates stabilizing and reducing the losses we have experienced internationally. We continuously review and optimizecertain of our website sales channels in Europe, Asia and Latin America. In addition, we continue to optimize our indirect sales channels in Europe, Asia andLatin America through reseller and other arrangements with third parties. If we are unable to stabilize and reduce losses in our international operationssuccessfully and in a timely manner, our business, revenue, and financial results could be harmed. Such stabilization and reduction may be more difficult ortake longer than we anticipate, and we may not be able to successfully market, sell, deliver and support our products and services internationally to the extentwe expect.If we are unable to continually adapt our products and services to mobile devices and technologies other than personal computers and laptops, and toadapt to other technological changes and customer needs generally, we may be unable to attract and retain customers, and our revenue and business couldsuffer.We need to anticipate, develop and introduce new products, services and applications on a timely and cost-effective basis that keeps pace withtechnological developments and changing customer needs. The process of developing new high technology products, services and applications andenhancing existing products, services and applications is complex, costly and uncertain, and any failure by us to anticipate customers' changing needs andemerging technological trends accurately could significantly harm our ability to attract and retain customers and our results of operations. For example, thenumber of individuals who access the Internet through devices other than a personal computer, such as tablet computers, mobile devices, televisions and set-top box devices, has increased dramatically and this trend is likely to continue. Our products and services may not work or be viewable on these devicesbecause each manufacturer or distributor may establish unique technical standards for such devices. Accordingly, we may need to devote significantresources to the creation, support and maintenance of such versions. If we fail to develop or sell products and services on a cost-effective basis that respond tothese or other technological developments and changing customer needs, we may be harmed in our ability to attract and retain customers, and our revenueand business could suffer. Furthermore, our customers who view our advertising via mobile devices might not buy our products to the same extent that theydo when viewing our advertising via personal computers or laptops. Accordingly, if we cannot convince customers to purchase our products via mobiledevices, our business and results of operations could be harmed to the extent that the trend to mobile devices continues.We offer our software products on operating systems and platforms including Windows, Macintosh, Apple OS, Android, and Amazon apps. The demandfor personal computers has been declining, which means that we must be able to market to potential customers and to provide customers with access to anduse of our products and services on many platforms and operating systems, as they may be changed from time to time. To the extent new releases of operatingsystems, including for mobile and non-PC devices, or other third-party products, platforms or devices make it more difficult for our products to perform, andour customers use alternative technologies, our business could be harmed.Our software products must interoperate with computer operating systems of our customers. If we are unable to ensure that our products interoperateproperly with customer systems, our business could be harmed.Our products must interoperate with our customers' computer systems, including the network, security devices and settings, and student learningmanagement systems of our Enterprise & Education customers. As a result, we must continually ensure that our products interoperate properly with thesevaried and customized systems. Changes in operating systems, the technologies we incorporate into our products or the computer systems our customers usemay damage our business.13Table of ContentsIf there are changes in the spending policies or budget priorities for government funding of colleges, universities, schools, other education providers, orgovernment agencies, we could lose revenue.Many of our Enterprise & Education customers are colleges, universities, primary and secondary schools and school districts, other educationproviders, armed forces and government agencies that depend substantially on government funding. Accordingly, any general decrease, delay or change infederal, state or local funding for colleges, universities, primary and secondary schools and school districts, or other education providers or governmentagencies that use our products and services could cause our current and potential customers to reduce their purchases of our products and services, to exercisetheir right to terminate licenses, or to decide not to renew licenses, any of which could cause us to lose revenue. In addition, a specific reduction ingovernmental funding support for products such as ours would also cause us to lose revenue and could hurt our overall gross margins.Some of our Enterprise & Education business is characterized by a lengthy and unpredictable sales cycle, which could delay new sales.We face a lengthy sales cycle between our initial contact with some potential Enterprise & Education customers and the signing of license agreementswith these customers. As a result of this lengthy sales cycle, we have only a limited ability to forecast the timing of such Enterprise & Education sales. Adelay in or failure to complete license transactions could cause us to lose revenue, and could cause our financial results to vary significantly from quarter toquarter. Our sales cycle varies widely, reflecting differences in our potential Enterprise & Education customers' decision-making processes, procurementrequirements and budget cycles, and is subject to significant risks over which we have little or no control, including:•customers' budgetary constraints and priorities;•the timing of our customers' budget cycles;•the need by some customers for lengthy evaluations that often include administrators and faculties; and•the length and timing of customers' approval processes.As we pursue our SaaS model and move more of our Consumer business online and increasingly sell our solutions as subscriptions, rather than packagedsoftware for an upfront fee, our revenue, results of operations and cash flow could be negatively impacted.Historically, we have predominantly sold our packaged software programs under a perpetual license for a single upfront fee and recorded 65-90% of therevenue at the time of sale. Certain of our online products are sold under different subscription terms, from short-term (less than one year) to 36-monthsubscriptions with a corresponding license term. Selling more long-term subscriptions could result in substantially less cash and revenue from the initial saleto the customer and could have a substantially negative impact on our revenue, results of operations and cash flow in any quarterly reporting period.Furthermore, to the extent that customers use our products and services for only a short time after purchase, online subscription customers could be less likelyto renew their subscriptions beyond the initial term with the effect that we could earn less revenue over time from each customer than historically.Our revenue is subject to seasonal and quarterly variations, which could cause our financial results to fluctuate significantly.We have experienced, and we believe we will continue to experience, substantial seasonal and quarterly variations in our revenue, cash flows and netincome. These variations are primarily related to increased sales of our Consumer products and services in the fourth quarter during the holiday selling seasonas well as higher sales to governmental, educational institutions, and corporations in the second half of the calendar year. We sell to a significant number ofour retailers, distributors and Enterprise & Education customers on a purchase order basis and we receive orders when these customers need products andservices. As a result, their orders are typically not evenly distributed throughout the year. Our quarterly results of operations also may fluctuate significantlyas a result of a variety of other factors, including the timing of holidays and advertising initiatives, changes in our products, services and advertisinginitiatives and changes in those of our competitors. Budgetary constraints of our Enterprise & Education customers may also cause our quarterly results tofluctuate.As a result of these seasonal and quarterly fluctuations, we believe that comparisons of our results of operations between different quarters are notnecessarily meaningful and that these comparisons are not reliable as indicators of our future performance. In addition, these fluctuations could result involatility and adversely affect our cash flows. Any seasonal or quarterly fluctuations that we report in the future may differ from the expectations of marketanalysts and investors, which could cause the price of our common stock to fluctuate significantly.14Table of ContentsAcquisitions, joint ventures and strategic alliances may have an adverse effect on our business.We have made and may continue to make acquisitions or enter into joint ventures and strategic alliances as part of our long-term business strategy.Such transactions may result in use of our cash resources, dilutive issuances of our equity securities, or incurrence of debt. Such transactions also involvesignificant challenges and risks including that the transaction does not advance our business strategy, that we do not realize a satisfactory return on ourinvestment, that we experience difficulty integrating new technology, employees, and business systems, that we divert management's attention from our otherbusinesses or that we acquire undiscovered liabilities such as patent infringement claims or violations of the U.S. Foreign Corrupt Practices Act and similarworldwide anti-bribery laws. It may take longer than expected to realize the full benefits, such as increased revenue, enhanced efficiencies, or more customers,or those benefits may ultimately be smaller than anticipated, or may not be realized. These events and circumstances could harm our operating results orfinancial condition.We may incur significant costs related to data security breaches that could compromise our information technology network security, trade secrets andcustomer data. Threats to our information technology network security can take a variety of forms. Individual hackers and groups of hackers, and sophisticatedorganizations or individuals may threaten our information technology network security. Cyber attackers may develop and deploy malicious software toattack our services and gain access to our networks, data centers, or act in a coordinated manner to launch distributed denial of service or other coordinatedattacks. Cyber threats and attacks are constantly evolving, thereby increasing the difficulty of detecting and successfully defending against them. We may beunable to anticipate these techniques or to implement adequate preventative measures in time. Cyber threats and attacks can have cascading impacts thatunfold with increasing speed across internal networks and systems. Breaches of our network, credit card processing information, or data security could disruptthe security of our internal systems and business applications, impair our ability to provide services to our customers and protect the privacy of their data,resulting in product development delays, could compromise confidential or technical business information harming our competitive position, result in theftor misuse of our intellectual property or other assets, require us to allocate more resources to improved technologies, or otherwise adversely affect ourbusiness.Our possession and use of personal information presents risks and expenses that could harm our business. If we are unable to protect our informationtechnology network against service interruption or failure, misappropriation or unauthorized disclosure or manipulation of data, whether through breachof our network security or otherwise, we could be subject to costly government enforcement actions and litigation and our reputation may be damaged.Our business involves the collection, storage and transmission of personal, financial or other information that is entrusted to us by our customers andemployees. Our information systems also contain the Company's proprietary and other confidential information related to our business. Our efforts to protectsuch information may be unsuccessful due to the actions of third parties, computer viruses, physical or electronic break-ins, catastrophic events, employeeerror or malfeasance or other attempts to harm our systems. Possession and use of personal information in conducting our business subjects us to legislativeand regulatory obligations that could require notification of data breaches, restrict our use of personal information and hinder our ability to acquire newcustomers or market to existing customers. Some of our commercial partners may receive or store information provided by us or our users through ourwebsites. If these third parties fail to adopt or adhere to adequate information security practices, or fail to comply with our online policies, or in the event of abreach of their networks, our customers' data may be improperly accessed, used or disclosed. As our business and the regulatory environment evolve in theU.S. and internationally, we may become subject to additional and even more stringent legal obligations concerning our treatment of customer information.We have incurred, and will continue to incur, expenses to comply with privacy and security standards and protocols imposed by law, regulation, industrystandards or contractual obligations.If our systems are harmed or fail to function properly or if third parties improperly obtain and use the personal information of our customers oremployees, we may be required to expend significant resources to repair or replace systems or to otherwise protect against security breaches or to addressproblems caused by breaches. A major breach of our network security and systems could have serious negative consequences for our businesses, includingpossible fines, penalties and damages, reduced customer demand for our products and services, harm to our reputation and brand and loss of our ability toaccept and process customer credit card orders. Any such events could have a material and adverse effect on our business, reputation or financial results. Ourinsurance policies carry coverage limits, which may not be adequate to reimburse us for losses caused by security breaches.Changes in regulations or customer concerns regarding privacy and protection of customer data, or any failure to comply with such laws, could adverselyaffect our business.Federal, state, and international laws and regulations govern the collection, use, retention, disclosure, sharing and security of data that we receive fromand about our customers. The use of consumer data by online service providers and advertising15Table of Contentsnetworks is a topic of active interest among federal, state, and international regulatory bodies, and the regulatory environment is unsettled. Many states havepassed laws requiring notification to customers where there is a security breach for personal data, such as California’s Information Practices Act. We facesimilar risks in international markets where our products, services and apps are offered. Any failure, or perceived failure, by us to comply with or makeeffective modifications to our policies, or to comply with any federal, state, or international privacy, data-retention or data-protection-related laws,regulations, orders or industry self-regulatory principles could result in proceedings or actions against us by governmental entities or others, a loss ofcustomer confidence, damage to the Rosetta Stone brands, and a loss of customers, which could potentially have an adverse effect on our business.In addition, various federal, state and foreign legislative or regulatory bodies may enact new or additional laws and regulations concerning privacy,data-retention and data-protection issues, including laws or regulations mandating disclosure to domestic or international law enforcement bodies, whichcould adversely impact our business, our brand or our reputation with customers. For example, some countries are considering laws mandating that customerdata regarding customers in their country be maintained in their country. Having to maintain local data centers in individual countries could increase ouroperating costs significantly. The interpretation and application of privacy, data protection and data retention laws and regulations are often uncertain and influx in the U.S. and internationally. These laws may be interpreted and applied inconsistently from country to country and inconsistently with our currentpolicies and practices, complicating long-range business planning decisions. If privacy, data protection or data retention laws are interpreted and applied in amanner that is inconsistent with our current policies and practices we may be fined or ordered to change our business practices in a manner that adverselyimpacts our operating results. Complying with these varying international requirements could cause us to incur substantial costs or require us to change ourbusiness practices in a manner adverse to our business and operating results.We are subject to U.S. and foreign government regulation of online services which could subject us to claims, judgments, and remedies, including monetaryliabilities and limitations on our business practices.We are subject to regulations and laws directly applicable to providers of online services. The application of existing domestic and international lawsand regulations to us relating to issues such as user privacy and data protection, data security, defamation, promotions, billing, consumer protection,accessibility, content regulation, quality of services, and intellectual property ownership and infringement in many instances is unclear or unsettled. Also, thecollection and protection of information from children under the age of 13 is subject to the provisions of the Children's Online Privacy ProtectionAct (COPPA), which is particularly relevant to our learning solutions focused on children. In addition, we will also be subject to any new laws andregulations directly applicable to our domestic and international activities. Internationally, we may also be subject to laws regulating our activities in foreigncountries and to foreign laws and regulations that are inconsistent from country to country. We may incur substantial liabilities for expenses necessary todefend litigation in connection with such regulations and laws or to comply with these laws and regulations, as well as potential substantial penalties for anyfailure to comply.Changes in how network operators handle and charge for access to data that travel across their networks could adversely impact our business.We rely upon the ability of customers to access many of our products through the Internet. To the extent that network operators implement usage basedpricing, including meaningful bandwidth caps, or otherwise try to monetize access to their networks by data providers, we could incur greater operatingexpenses and our customer acquisition and retention could be negatively impacted. Furthermore, to the extent network operators were to create tiers ofInternet access service and either charge us for or prohibit us from being available through these tiers, our business could be negatively impacted.We are exposed to risks associated with credit card and payment fraud, and with our obligations under rules on credit card processing and alternativepayment methods, which could cause us to lose revenue or incur costs. We depend upon our credit card processors and payment card associations.As an e-commerce provider that accepts debit and credit cards for payment, we are subject to the Payment Card Industry Data Security Standard ("PCIDSS"), issued by the PCI Council. PCI DSS contains compliance guidelines and standards with regard to our network security surrounding the physical andelectronic storage, processing and transmission of individual cardholder data. Despite our compliance with these standards and other information securitymeasures, we cannot guarantee that all our information technology systems are able to prevent, contain or detect any cyber attacks, cyber terrorism, orsecurity breaches from currently known viruses or malware, or viruses or malware that may be developed in the future. To the extent any disruption results inthe loss, damage or misappropriation of information, we may be adversely affected by claims from customers, financial institutions, regulatory authorities,payment card associations and others. In addition, the cost of complying with stricter privacy and information security laws and standards could besignificant.16Table of ContentsWe are subject to rules, regulations and practices governing our accepted payment methods which could change or be reinterpreted to make it difficultor impossible for us to comply. A failure to comply with these rules or requirements could make us subject to fines and higher transaction fees and we couldlose our ability to accept these payment methods. We depend upon our credit card processors to carry out our sales transactions and remit the proceeds to us.At any time, credit card processors have the right to withhold funds otherwise payable to us to establish or increase a reserve based on their assessment of theinherent risks of credit card processing and their assessment of the risks of processing our customers’ credit cards. If our credit card processors exercise theirright to establish or increase a reserve, it may adversely impact our liquidity. Our business and results of operations could be adversely affected if thesechanges were to occur.Any significant interruptions in the operations of our website, call center or third-party call centers, especially during the holiday shopping season, couldcause us to lose sales and disrupt our ability to process orders and deliver our solutions in a timely manner.We rely on our website, an in-house call center and third-party call centers, over which we have little or no control, to sell our solutions, respond tocustomer service and technical support requests and process orders. These activities are especially important during the holiday season and in particular theperiod beginning on Black Friday through the end of the calendar year. Any significant interruption in the operation of these facilities, including aninterruption caused by our failure to successfully expand or upgrade our systems or to manage these expansions or upgrades, or a failure of third-party callcenters to handle higher volumes of use, could reduce our ability to receive and process orders and provide products and services, which could result incancelled sales and loss of revenue and damage to our brand and reputation. These risks are more important during the holiday season, when many sales ofour products and services take place.We structure our marketing and advertising to drive potential customers to our website and call centers to purchase our solutions. If we experiencetechnical difficulties with our website or if our call center operators do not convert inquiries into sales at expected rates, our ability to generate revenue couldbe impaired. Training and retaining qualified call center operators is challenging due to the expansion of our product and service offerings and theseasonality of our business. If we do not adequately train our call center operators, they will not convert inquiries into sales at an acceptable rate.If any of our products or services contain defects or errors or if new product releases or services are delayed, our reputation could be harmed, resulting insignificant costs to us and impairing our ability to sell our solutions.If our products or services contain defects, errors or security vulnerabilities, our reputation could be harmed, which could result in significant costs to usand impair our ability to sell our products in the future. In the past, we have encountered product development delays due to errors or defects. We wouldexpect that, despite our testing, errors could be found in new products and product enhancements in the future. Significant errors in our products or servicescould lead to, among other things:•delays in or loss of marketplace acceptance of our products and services;•diversion of our resources;•a lower rate of license renewals or upgrades for Consumer and Enterprise & Education customers;•injury to our reputation;•increased service expenses or payment of damages; or•costly litigation.If we fail to effectively upgrade our information technology systems, we may not be able to accurately report our financial results or prevent fraud.As part of our efforts to continue improving our internal control over financial reporting, we plan to continue to upgrade our existing financialinformation technology systems in order to automate several controls that are currently performed manually. We may experience difficulties in transitioningto these upgraded systems, including loss of data and decreases in productivity, as personnel become familiar with these new systems. In addition, ourmanagement information systems will require modification and refinement as our business needs change, which could prolong difficulties we experiencewith systems transitions, and we may not always employ the most effective systems for our purposes. If we experience difficulties in implementing new orupgraded information systems or experience significant system failures, or if we are unable to successfully modify our management information systems orrespond to changes in our business needs, we may not be able to effectively manage our business and we may fail to meet our reporting obligations. Inaddition, as a result of the automation of these manual processes, the data produced may cause us to question the accuracy of previously reported financialresults.17Table of ContentsFailure to maintain the availability of the systems, networks, databases and software required to operate and deliver our Internet-based products andservices could damage our reputation and cause us to lose revenue.We rely on internal and external systems, networks and databases maintained by us and third-party providers to process customer orders, handlecustomer service requests, and host and deliver our Internet-based learning solutions. Any damage, interruption or failure of our systems, networks anddatabases could prevent us from processing customer orders and result in degradation or interruptions in delivery of our products and services.Notwithstanding our efforts to protect against interruptions in the availability of our e-commerce websites and Internet-based products and services, we dooccasionally experience unplanned outages or technical difficulties. In addition, we do not have complete redundancy for all of our systems. In the event ofan interruption or system event we may be unable to meet contract service level requirements, or we could experience an unrecoverable loss of data whichcould cause us to lose customers and could harm our reputation and cause us to face unexpected liabilities and expenses. If we continue to expand ourbusiness, we will put additional strains on these systems. As we continue to move additional product features to online systems or place more of our businessonline, all of these considerations will become more significant.We may also need to grow, reconfigure or relocate our data centers in response to changing business needs, which may be costly and lead to unplanneddisruptions of service.We may incur losses associated with currency fluctuations and may not be able to effectively hedge our exposure, which could impair our financialperformance.Our operating results are subject to fluctuations in foreign currency exchange rates. We currently do not attempt to mitigate a portion of these risksthrough foreign currency hedging, based on our judgment of the appropriate trade-offs among risk, opportunity and expense. In the future, we might chooseto engage in foreign currency hedging transactions, which would involve different risks and uncertainties.Our revolving credit facility contains borrowing limitations and covenants and the failure to maintain a sufficient borrowing base or to comply with suchcovenants could prevent us from borrowing funds, and could cause any outstanding debt to become immediately payable, which might adversely impactour business. Our revolving credit facility contains borrowing limitations based on a combination of our cash balance and eligible accounts receivable balances andfinancial covenants currently applicable to us, as well as a number of restrictive covenants, including restrictions on incurring additional debt, makinginvestments and other restricted payments, selling assets, paying dividends and redeeming or repurchasing capital stock and debt, subject to certainexceptions. Collectively, these borrowing limitations and covenants could constrain our ability to grow our business through acquisition or engage in othertransactions. During the term of our $25.0 million revolving credit facility, we are also subject to certain financial covenants that require us to maintain aminimum liquidity amount and minimum financial performance requirements, as defined in the credit agreement. If we are not able to comply with all ofthese covenants, for any reason, we would not be able to borrow funds under the facility, and some or all of any outstanding debt could become immediatelydue and payable which could have a material adverse effect on our liquidity and ability to conduct our business.A significant deterioration in our profitability and/or cash flow caused by prolonged economic instability could reduce our liquidity and/or impair ourfinancial ratios, and trigger a need to raise additional funds from the capital markets and/or renegotiate our banking covenants.To the extent the economic difficulties continue, or worldwide economic conditions materially deteriorate, our revenue, profitability and cash flowscould be significantly reduced as customers would be unable to purchase products and services in the expected quantities and/or pay for them within normalagreed terms. A liquidity shortfall may delay certain development initiatives or may expose us to a need to negotiate further funding. While we anticipatethat our existing cash and cash equivalents, together with availability under our existing revolving credit facility, cash balances and cash from operations,will be sufficient to fund our operations for at least the next 12 months, we may need to raise additional capital to fund operations in the future or to financeacquisitions. If we seek to raise additional capital in order to meet various objectives, including developing future technologies and services, increasingworking capital, acquiring businesses and responding to competitive pressures, capital may not be available on favorable terms or may not be available at all.Lack of sufficient capital resources could significantly limit our ability to take advantage of business and strategic opportunities. Any additional capitalraised through the sale of equity securities would dilute our stock ownership. If adequate additional funds are not available, we may be required to delay,reduce the scope of, or eliminate material parts of our business strategy, including potential additional acquisitions or development of new products, servicesand technologies.18Table of ContentsWe might require additional funds from what we internally generate to support our business which might not be available on acceptable terms or at all.We might need to further reduce costs or raise additional funds through public or private financings or borrowings in order to maintain our operations attheir current level, develop or enhance products, fund expansion, respond to competitive pressures or to acquire complementary products, businesses ortechnologies. If required, additional financing might not be available on terms that are favorable to us, if at all. If we raise additional funds through theissuance of debt, equity or convertible debt securities, these securities might have rights, preferences and privileges senior to those of our currentstockholders.If our goodwill or indefinite-lived intangible assets become impaired, we may be required to record a significant charge to earnings.Under accounting principles generally accepted in the U.S. ("GAAP"), we review our goodwill and indefinite lived intangible assets for impairment atleast annually and when there are changes in circumstances. Factors that may be considered a change in circumstances include a decline in stock price andmarket capitalization, expected future cash flows and slower growth rates in our industry. In the fourth quarter of 2015, we recorded a goodwill impairmentloss of $5.6 million related to the impairment of the Consumer Fit Brains reporting unit's goodwill. We may be required to record additional significantcharges to earnings in our financial statements during the period in which any impairment of our goodwill or indefinite lived intangible assets is determined,resulting in a negative effect on our results of operations.We may have exposure to greater than anticipated tax liabilities.We are subject to income and indirect tax in the U.S. and many foreign jurisdictions. Significant judgment is required in determining our worldwideprovision for income and indirect taxes. In the ordinary course of our business, there are many transactions and calculations where the ultimate taxdetermination is uncertain. The application of indirect taxes (such as sales and use tax, value-added tax, goods and services tax, business tax and grossreceipt tax) to our businesses and to our users is complex, uncertain and evolving, in part because many of the fundamental statutes and regulations thatimpose indirect taxes were established before the adoption and growth of the Internet and e-commerce. We are subject to audit by multiple tax authoritiesthroughout the world. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could bematerially different from our historical tax provisions and accruals. The results of an audit or litigation could have a material effect on our financialstatements in the period or periods for which that determination is made. Further, any changes to the U.S. or any foreign jurisdictions’ tax laws, tax rates, orthe interpretation of such tax laws, including the Base Erosion Profit Shifting project being conducted by the Organization for Economic Co-operation andDevelopment could significantly impact how U.S. multinational corporations are taxed. Although we cannot predict whether or in what form any legislationchanges may pass, if enacted it could have a material adverse impact on our tax expense, deferred tax assets and cash flows.Our deferred tax assets may not be fully realizable.At December 31, 2015, we had gross deferred tax assets of $79.2 million which was offset by a valuation allowance of $70.5 million for certainjurisdictions. We recorded that tax valuation allowance to reflect uncertainties about whether we will be able to realize some of our deferred tax assets beforethey expire. The valuation allowance is based on our estimates of taxable income for the jurisdictions in which we operate and the period over which ourdeferred tax assets will be realizable. In the future, we could be required to increase the valuation allowance to take into account additional deferred tax assetsthat we may be unable to realize. An increase in the valuation allowance would have an adverse impact, which could be material, on our income taxprovision and net income in the period in which we record the increase.Protection of our intellectual property is limited, and any misuse of our intellectual property by others, including software piracy, could harm our business,reputation and competitive position.Our intellectual property is important to our success. We believe our trademarks, copyrights, trade secrets, patents, pending patent applications, tradedress and designs are valuable and integral to our success and competitive position. To protect our proprietary rights, we rely on a combination of patents,copyrights, trademarks, trade dress, trade secret laws, confidentiality procedures, contractual provisions and technical measures. However, even if we are ableto secure such rights in the United States, the laws of other countries in which our products are sold may not protect our intellectual property rights to thesame extent as the laws of the United States.In addition to issued patents, we have several patent applications on file in the U.S. and other countries. However, we do not know whether any of ourpending patent applications will result in the issuance of patents or whether the examination process will require us to narrow our claims. Even if patents areissued from our patent applications, which are not certain, they may be challenged, circumvented or invalidated in the future. Moreover, the rights grantedunder any issued patents may not19Table of Contentsprovide us with proprietary protection or competitive advantages, and, as with any technology, competitors may be able to develop similar or superiortechnologies now or in the future. In addition, we have not emphasized patents as a source of significant competitive advantage and have instead sought toprimarily protect our proprietary rights under laws affording protection for trade secrets, copyright and trademark protection of our products, brands, andother intellectual property where available and appropriate. These measures afford only limited protection and may be challenged, invalidated orcircumvented by third parties. In addition, these protections may not be adequate to prevent our competitors or customers from copying or reverse-engineering our products. Third parties could copy all or portions of our products or otherwise obtain, use, distribute and sell our proprietary informationwithout authorization. Third parties may also develop similar or superior technology independently by designing around our intellectual property, whichwould decrease demand for our products. In addition, our patents may not provide us with any competitive advantages and the patents of others mayseriously impede our ability to conduct our business.We protect our products, trade secrets and proprietary information, in part, by requiring all of our employees to enter into agreements providing for themaintenance of confidentiality and the assignment of rights to inventions made by them while employed by us. We also enter into non-disclosure agreementswith our technical consultants, customers, vendors and resellers to protect our confidential and proprietary information. We cannot guarantee that ourconfidentiality agreements with our employees, consultants and other third parties will not be breached, that we will be able to effectively enforce theseagreements, that we will have adequate remedies for any breach, or that our trade secrets and other proprietary information will not be disclosed or willotherwise be protected.We rely on contractual and license agreements with third parties in connection with their use of our products and technology. There is no guaranteethat such parties will abide by the terms of such agreements or that we will be able to adequately enforce our rights, in part because we rely, in manyinstances, on "click-wrap" and "shrink-wrap" licenses, which are not negotiated or signed by individual licensees. Accordingly, some provisions of ourlicenses, including provisions protecting against unauthorized use, copying, transfer, resale and disclosure of the licensed software program, could beunenforceable under the laws of several jurisdictions.Protection of trade secret and other intellectual property rights in the places in which we operate and compete is highly uncertain and may involvecomplex legal questions. The laws of countries in which we operate may afford little or no protection to our trade secrets and other intellectual propertyrights. Although we defend our intellectual property rights and combat unlicensed copying and use of software and intellectual property rights through avariety of techniques, preventing unauthorized use or infringement of our intellectual property rights is inherently difficult. Despite our enforcement effortsagainst software piracy, we could lose significant revenue due to illegal use of our software and from counterfeit copies of our software. If piracy activitiesincrease, it could further harm our business.We also suspect that competitors might try to illegally use our proprietary information and develop products that are similar to ours, which mayinfringe on our proprietary rights. In addition, we could potentially lose trade secret protection for our source code if any unauthorized disclosure of suchcode occurs. The loss of trade secret protection could make it easier for third parties to compete with our products by copying functionality. In addition, anychanges in, or unexpected interpretations of, the trade secret and other intellectual property laws in any country in which we operate may compromise ourability to enforce our trade secret and intellectual property rights. Costly and time-consuming litigation could be necessary to enforce and determine thescope of our confidential information and trade secret protection. If we are unable to protect our proprietary rights or if third parties independently develop orgain access to our or similar technologies, our business, revenue, reputation and competitive position could be harmed.Third-party use of our trademarks as keywords in Internet search engine advertising programs may direct potential customers to competitors' websites,which could harm our reputation and cause us to lose sales.Competitors and other third parties, including counterfeiters, purchase our trademarks and confusingly similar terms as keywords in Internet searchengine advertising programs in order to divert potential customers to their websites. Preventing such unauthorized use is inherently difficult. If we are unableto protect our trademarks and confusingly similar terms from such unauthorized use, competitors and other third parties may continue to drive potentialonline customers away from our websites to competing and unauthorized websites, which could harm our reputation and cause us to lose sales.Our trademarks are limited in scope and geographic coverage and might not significantly distinguish us from our competition.We own several U.S. trademark registrations, including registrations of the Rosetta Stone, Tell Me More, Livemocha, Lexia and Fit Brains trademarks, aswell as U.S. registrations of the color yellow as a trademark. In addition, we hold common law trademark rights and have trademark applications pending inthe U.S. and abroad for additional trademarks. Even if federal registrations and registrations in other countries are granted to us, our trademark rights may bechallenged. It is also possible20Table of Contentsthat our competitors will adopt trademarks similar to ours, thus impeding our ability to build brand identity and possibly leading to customer confusion. Infact, various third parties have registered trademarks that are similar to ours in the U.S. and overseas. Furthermore, notwithstanding the fact that we may havesecured trademark rights for our various trademarks in the United States and in some countries where we do business, in other countries we may not havesecured similar rights and, in those countries there may be third parties who have prior use and prior or superior rights to our own. That prior use, prior orsuperior right could limit use of our trademarks and we could be challenged in our efforts to use our trademarks. We could incur substantial costs inprosecuting or defending trademark infringement suits. If we fail to effectively enforce our trademark rights, our competitive position and brand recognitionmay be diminished.We must monitor and protect our Internet domain names to preserve their value. We may be unable to prevent third parties from acquiring domain namesthat are similar to, infringe on or otherwise decrease the value of our trademarks.We own several domain names related to our business. Third parties may acquire substantially similar domain names or Top Level Domains ("TLDs")that decrease the value of our domain names and trademarks and other proprietary rights which may hurt our business. Third parties also may acquire countryspecific domain names in the form of Country Code TLDs that include our trademarks or similar terms and which prevent us from operating country specificwebsites from which customers can view our products and engage in transactions with us. Moreover, the regulation of domain names in the United States andforeign countries is subject to change. Governing bodies could appoint additional domain name registrars, modify the requirements for holding domainnames or release additional TLDs. As a result, we may have to incur additional costs to maintain control over potentially relevant domain names or may notmaintain exclusive rights to all potentially relevant domain names in the United States or in other countries in which we conduct business, which could harmour business or reputation. Moreover, attempts may be made to register our trademarks as new TLDs or as domain names within new TLDs and we will have tomake efforts to enforce our rights against such registration attempts.Our business depends on a strong brand, and failing to maintain or enhance the Rosetta Stone brands in a cost-effective manner could harm our operatingresults.Maintaining and enhancing our brands is an important aspect of our efforts to attract and expand our business. We believe that maintaining andenhancing our brands will depend largely on our ability to provide high-quality, innovative products, and services, which we might not do successfully. Ourbrands may be negatively impacted by a number of factors such as service outages, product malfunctions, data protection and security issues, andexploitation of our trademarks by others without permission.Further, while we attempt to ensure that the quality of our brands is maintained by our licensees, our licensees might take actions that could impair thevalue of our brands, our proprietary rights, or the reputation of our products. If we are unable to maintain or enhance our brands in a cost-effective manner, orif we incur excessive expenses in these efforts, our business, operating results and financial condition could be harmed.Claims that we misuse the intellectual property of others could subject us to significant liability and disrupt our business.As we expand our business and develop new technologies, products and services, we may become subject to material claims of infringement bycompetitors and other third parties with respect to current or future products, e-commerce and other web-related technologies, online business methods,trademarks or other proprietary rights. Our competitors, some of which may have made significant investments in competing products and technologies, andmay have, or seek to apply for and obtain, patents, copyrights or trademarks that will prevent, limit or interfere with our ability to make, use and sell ourcurrent and future products and technologies, and we may not be successful in defending allegations of infringement of these patents, copyrights ortrademarks. Further, we may not be aware of all of the patents and other intellectual property rights owned by third parties that may be potentially adverse toour interests. We may need to resort to litigation to enforce our proprietary rights or to determine the scope and validity of a third-party's patents or otherproprietary rights, including whether any of our products, technologies or processes infringe the patents or other proprietary rights of third parties. We mayincur substantial expenses in defending against third-party infringement claims regardless of the merit of such claims. The outcome of any such proceedingsis uncertain and, if unfavorable, could force us to discontinue advertising and sale of the affected products or impose significant penalties, limitations orrestrictions on our business. We do not conduct comprehensive patent searches to determine whether the technologies used in our products infringe uponpatents held by others. In addition, product development is inherently uncertain in a rapidly evolving technological environment in which there may benumerous patent applications pending, many of which are confidential when filed, with regard to similar technologies.We do not own all of the software, other technologies and content used in our products and services, and the failure to obtain rights to use such software,other technologies and content could harm our business.Some of our products and services contain intellectual property owned by third parties, including software that is integrated with internally developedsoftware and voice recognition software, which we license from third parties. From time to21Table of Contentstime we may be required to renegotiate with these third parties or negotiate with new third parties to include their technology or content in our existingproducts, in new versions of our existing products or in wholly new products. We may not be able to negotiate or renegotiate licenses on commerciallyreasonable terms, or at all, and the third-party software may not be appropriately supported, maintained or enhanced by the licensors. If we are unable toobtain the rights necessary to use or continue to use third-party technology or content in our products and services, this could harm our business, by resultingin increased costs, or in delays or reductions in product shipments until equivalent software could be developed, identified, licensed and integrated.Our use of open source software could impose limitations on our ability to commercialize our products.We incorporate open source software into our products and may use more open source software in the future. The use of open source software isgoverned by license agreements. The terms of many open source licenses have not been interpreted by U.S. courts, and there is a risk that these licenses couldbe construed in a manner that could impose unanticipated conditions or restrictions on our ability to commercialize our products. Therefore, we could berequired to seek licenses from third parties in order to continue offering our products, make generally available, in source code form, proprietary code thatlinks to certain open source modules, re-engineer our products, discontinue the sale of our products if re-engineering could not be accomplished on a cost-effective and timely basis, or become subject to other consequences. In addition, open source licenses generally do not provide warranties or othercontractual protections regarding infringement claims or the quality of the code. Thus, we may have little or no recourse if we become subject to infringementclaims relating to the open source software or if the open source software is defective in any manner.As our product and service offerings become more complex, our reported revenue may become less predictable.We continue to transition our Consumer distribution more towards online. The accounting policies that apply to these sources of revenue may be morecomplex than those that apply to our traditional products and services. In addition, we may change the manner in which we sell our software licenses, andsuch change could cause delays in revenue recognition in accordance with accounting standards. Under these accounting standards, even if we deliverproducts and services to, and collect cash from, a customer in a given fiscal period, we may be required to defer recognizing revenue from the sale of suchproduct or service until a future period when all the conditions necessary for revenue recognition have been satisfied. As we move more of our Consumerbusiness online we will continue to collect less cash from our initial transactions with consumers which could substantially decrease our revenue in the shortterm. Conditions that can cause delays in revenue recognition include software arrangements that have undelivered elements for which we have not yetestablished vendor specific objective evidence of fair value, requirements that we deliver services for significant enhancements or modifications to customizeour software for a particular customer or material customer acceptance criteria.We offer Consumer language-learning packages that include perpetual software and online services that have increased our costs as a percentage ofrevenue, and these and future product introductions may not succeed and may harm our business, financial results and reputation.Our Consumer language-learning packages integrate our language-learning software solutions with online services, which provide opportunities forpractice with dedicated language conversation coaches and other language learners to increase language socialization. The costs associated with the onlineservices included with these software packages decrease margins. Customers may choose to not engage with conversation coaches or be willing to pay higherprices to do so. In addition, we are required to defer recognition of all or a portion of each sale of this packaged software over the duration of our onlineservice periods. We cannot assure you that our future software package offerings will be successful or profitable, or if they are profitable, that they willprovide an adequate return on invested capital. If our software package offerings are not successful, our business, financial results and reputation may beharmed.Substantially all of our inventory is located in one warehouse facility. Any damage or disruption at this facility could cause significant financial loss,including loss of revenue and harm to our reputation.Substantially all of our inventory is located in one warehouse facility. We could experience significant interruption in the operation of this facility ordamage or destruction of our inventory due to natural disasters, accidents, failures of the inventory locator or automated packing and shipping systems orother events. If a material portion of our inventory were to be damaged or destroyed, we might be unable to meet our contractual obligations which couldcause us significant financial loss, including loss of revenue and harm to our reputation. As our business continues to move online, we expect that this riskwill diminish over time.22Table of ContentsProvisions in our organizational documents and in the Delaware General Corporation Law may prevent takeover attempts that could be beneficial to ourstockholders.Provisions in our second amended and restated certificate of incorporation and second amended and restated bylaws, and in the Delaware GeneralCorporation Law, may make it difficult and expensive for a third party to pursue a takeover attempt we oppose even if a change in control of our companywould be beneficial to the interests of our stockholders. Any provision of our second amended and restated certificate of incorporation or second amendedand restated bylaws or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receivea premium for their shares of our common stock, and could also affect the price that some investors are willing to pay for our common stock. Our Board ofDirectors has the authority to issue up to 10,000,000 shares of preferred stock in one or more series and to fix the powers, preferences and rights of each serieswithout stockholder approval. The ability to issue preferred stock could discourage unsolicited acquisition proposals or make it more difficult for a thirdparty to gain control of our company, or otherwise could adversely affect the market price of our common stock. Further, as a Delaware corporation, we aresubject to Section 203 of the Delaware General Corporation Law. This section generally prohibits us from engaging in mergers and other businesscombinations with stockholders that beneficially own 15% or more of our voting stock, or with their affiliates, unless our directors or stockholders approvethe business combination in the prescribed manner.Item 1B. Unresolved Staff CommentsNone.Item 2. PropertiesOur corporate headquarters are located in Arlington, Virginia, where we occupy space on one floor of an office building under a lease that endsDecember 31, 2018. For more information about our Arlington, Virginia lease and subleases, please see Note 16 of Item 8, Financial Statements andSupplementary Data. We currently own one facility in Harrisonburg, Virginia, that provide operations and customer support services. We lease anotherfacility in Virginia for use as a packing and distribution center for all of our U.S. and some of our international fulfillment.In addition, the Company leases property in various locations in the U.S. and around the world as sales offices, for research and development activities,operations, product distribution, data centers, and market research. Our international locations are in or near cities including the following: Versailles, France;London, United Kingdom; Beijing and Shanghai, China; Vancouver, Canada; São Paulo, Brazil; Cologne, Germany; and, Madrid, Spain. Item 3. Legal ProceedingsInformation with respect to this item may be found in Note 16 of Item 8, Financial Statements and Supplementary Data, which is incorporated hereinby reference.Item 4. Mine Safety DisclosuresNot applicable.23Table of ContentsPART IIItem 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesMarket for Common StockOur common stock is listed on the New York Stock Exchange, or NYSE, under the symbol "RST." There were approximately 88 stockholders of recordof our common stock as of March 8, 2016. The following table sets forth, for each of the periods indicated, the high and low reported sales price of ourcommon stock on the NYSE. High LowYear ended December 31, 2015 Fourth Quarter $8.22 $6.31Third Quarter 8.50 6.40Second Quarter 9.19 6.39First Quarter 10.37 7.16Year ended December 31, 2014 Fourth Quarter $11.23 $7.42Third Quarter 10.22 8.00Second Quarter 12.32 9.20First Quarter 12.50 10.53On March 8, 2016, the last reported sales price of our common stock on the NYSE was $7.36 per share.DividendsWe have not paid any cash dividends on our common stock and do not intend to do so in the foreseeable future. We currently intend to retain allavailable funds and any future earnings to support the operation of and to finance the growth and development of our business. Further, our revolving creditfacility contains financial and restrictive covenants that, among other restrictions and subject to certain exceptions, limit our ability to pay dividends.Securities Authorized For Issuance Under Equity Compensation PlansFor information regarding securities authorized for issuance under equity compensation plans, see Part III "Item 12—Security Ownership of CertainBeneficial Owners and Management and Related Stockholder Matters."Purchases of Equity SecuritiesOn August 22, 2013, our Board of Directors approved a share repurchase program under which we are authorized to repurchase up to $25 million of ouroutstanding common stock from time to time in the open market or in privately negotiated transactions depending on market conditions, other corporateconsiderations, and applicable legal requirements. Our revolving credit facility contains financial and restrictive covenants that, among other restrictions andsubject to certain limitations, limits our ability to repurchase our shares. No shares were purchased during 2015 or 2014.Stockholder Return Performance PresentationThe following graph compares the change in the cumulative total stockholder return on our common stock during the 5-year period from December 31,2010 through December 31, 2015, with the cumulative total return on the NYSE Composite Index and the SIC Code Index that includes all U.S. publiccompanies in the Standard Industrial Classification (SIC) Code 7372-Prepackaged Software. The comparison assumes that $100 was invested on December31, 2010 in our common stock and in each of the foregoing indices and assumes reinvestment of dividends, if any.24Table of ContentsThe foregoing graph shall not be deemed to be filed as part of this Annual Report on Form 10-K and does not constitute soliciting material and shouldnot be deemed filed or incorporated by reference into any other filing of the Company under the Securities Act, or the Exchange Act, except to the extent wespecifically incorporate the graph by reference.Item 6. Selected Consolidated Financial DataThe following tables set forth selected consolidated statement of operations data, balance sheet data, and other data for the periods indicated. Theselected consolidated statement of operations data for the years ended December 31, 2015, 2014, 2013, 2012 and 2011, and the selected consolidatedbalance sheet data as of December 31, 2015, 2014, 2013, 2012 and 2011 have been derived from our audited consolidated financial statements. The selectedconsolidated financial data should be read in conjunction with the information under “Item 7. Management’s Discussion and Analysis of FinancialCondition and Results of Operations,” our consolidated financial statements, the related notes and the accompanying independent registered publicaccounting firm’s report, which are included in “Item 8. Financial Statements and Supplementary Data.” Our historical results for any prior period are notnecessarily indicative of results to be expected in any future period.25Table of Contents Year Ended December 31, 2015(1) 2014(2) 2013(3) 2012(4) 2011(5) (in thousands, except per share data)Selected Statements of Operations Data: Revenue $217,670 $261,853 $264,645 $273,241 $268,449Gross profit 179,143 208,799 218,931 224,331 219,333Loss from operations (43,813) (78,850) (18,442) (5,266) (27,858)Net loss (46,796) (73,706) (16,134) (33,985) (19,650) Loss per share attributable to common stockholders: Basic $(2.17) $(3.47) $(0.75) $(1.61) $(0.95)Diluted $(2.17) $(3.47) $(0.75) $(1.61) $(0.95) Other Selected Data: Total stock-based compensation expense $7,195 $6,762 $9,241 $8,009 $12,353Total intangible amortization expense $5,192 $6,263 $1,822 $40 $85_______________________________________________________________________________(1)As discussed in Notes 1 and 13 of Item 8, Financial Statements and Supplementary Data, the Company announced and initiated restructuringactions in the first quarter of 2015 to focus on the Enterprise & Education business and optimize the Consumer business for profitability. Under thisinitiative, the Company began headcount and cost reductions to areas including Consumer sales and marketing, Consumer product investment, andgeneral and administrative functions.(2)As discussed in Note 5 of Item 8, Financial Statements and Supplementary Data, the Company acquired Vivity Labs, Inc. on January 2, 2014 andTell Me More S.A. on January 9, 2014. The results of operations from these entities have been included from the acquisition date.(3)As discussed in Note 5 of Item 8, Financial Statements and Supplementary Data, the Company acquired Livemocha, Inc. on April 1, 2013 andacquired Lexia Learning Systems, Inc. on August 1, 2013. The results of operations from these entities have been included from the acquisition date.(4)The Company established a full valuation allowance to reduce the deferred tax assets of the Korea, Brazil, Japan and U.S. subsidiaries. Theestablishment of the valuation allowance resulted in a non-cash charge of $29.7 million during the year ended December 31, 2012.(5)On January 4, 2011 the Company's Board of Directors approved the Rosetta Stone Inc. Long Term Incentive Program ("LTIP") and thensubsequently cancelled the LTIP on November 30, 2011, resulting in $4.9 million additional operating expense. As of December 31, 2015 2014 2013 2012 2011 (in thousands)Selected Consolidated Balance Sheet Data: Cash and cash equivalents $47,782 $64,657 $98,825 $148,190 $106,516Total assets (6) 228,543 288,173 290,776 279,405 280,090Total deferred revenue 142,748 128,169 78,857 63,416 51,895Notes payable and capital lease obligation 3,143 3,748 242 5 12Total stockholders' equity $22,410 $63,445 $131,243 $148,194 $172,951(6)As discussed in Note 2 to Item 8, Financial Statements and Supplementary Data, the Company early adopted Accounting Standards Update No.2015-17 in the fourth quarter of 2015, which included the retrospective reclassification of all deferred tax assets and liabilities as non-current on theCompany's consolidated balance sheets.26Table of ContentsItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") contains forward-looking statements withinthe meaning of the Private Securities Litigation Reforms Act of 1995. The MD&A should be read in conjunction with our consolidated financial statementsand notes thereto which appear elsewhere in this Annual Report on Form 10-K. Our actual results may differ materially from those currently anticipatedand expressed in such forward-looking statements as a result of a number of factors, including those discussed under ("Risk Factors") and elsewhere in thisAnnual Report on Form 10-K.OverviewRosetta Stone is dedicated to changing people's lives through the power of language and literacy education. Our innovative, technology-drivenlanguage, reading, and brain fitness programs drive positive learning outcomes in thousands of schools, businesses, government organizations, and formillions of individuals around the world. Rosetta Stone was incorporated in Delaware in 2005. Founded in 1992, Rosetta Stone pioneered the use ofinteractive software to accelerate language learning and is widely recognized today as the industry leader in providing effective language programs. Todaywe offer courses in 30 languages across a broad range of formats, including web-based software subscriptions, digital downloads, mobile applications, andperpetual CD packages. Rosetta Stone has continued to invest in language learning and expanded beyond language learning and deeper into education-technology with its acquisitions of Livemocha and Lexia in 2013 and Vivity and Tell Me More in January 2014. These acquisitions have enabled us to meetthe changing needs of learners around the world.The Enterprise & Education segment derives revenue from sales to educational institutions, corporations, and government agencies worldwide. TheConsumer segment derives revenue from sales to individuals and retail partners. Our Enterprise & Education language distribution model is focused ontargeted sales activity primarily through a direct sales force in five markets: K-12 schools; colleges and universities; federal government agencies;corporations; and not-for-profit organizations. Our Enterprise & Education literacy distribution channel utilizes a direct sales force as well as relationshipswith third-party resellers focused on the sale of Lexia Learning solutions to K-12 schools. Our Consumer distribution channel comprises a mix of our callcenters, websites, third party e-commerce websites such as the Apple App Store, select retail resellers, such as Amazon.com, Barnes & Noble, Target, BestBuy, Books-a-Million, Sam's Club, Staples, consignment distributors such as Wynit Distribution and Software Packaging Associates, and daily deal partners.As our Company has evolved, we believe that our language and literacy Enterprise & Education segment is our largest opportunity for long-term valuecreation. The customers in these marketplaces have demands that recur each year, creating a more predictable revenue opportunity. This demand profile alsofits well with our suite of products, the well-known Rosetta Stone brand and the demonstrated efficacy of our literacy tools. We also believe the demand for e-learning based literacy solutions in the US and English language-learning around the globe is growing.As a result, we are emphasizing the development of products and solutions for Corporate and K-12 learners who need to speak and read English. Thisfocus extends to the Consumer segment where we continue to make product investments serving the needs of passionate language learners who aremotivated, results focused and willing to pay for a quality language-learning experience.To position the organization for success, we are focused on the following four priorities:1.Grow literacy sales by providing fully aligned digital instruction and assessment tools for K-12, building a direct distribution sales force to replaceour historical reseller model, and continuing to develop our implementation services business;2.Position our Enterprise & Education language business for profitable growth by focusing on our best geographies and customer segments andsuccessfully delivering a new language-learning suite for Corporate customers that offers a simple, more modern, metrics-driven suite of tools thatare results-oriented and easily integrated with leading corporate language-learning systems;3.Maximize the profitability of our Consumer language business by providing an attractive value proposition and a streamlined, mobile-orientedproduct portfolio focused on customers' demand, while optimizing our marketing spend appropriately; and4.Right-size the entire cost base of the Company, including◦optimizing our media spend and other marketing costs in Consumer sales and marketing;27Table of Contents◦right sizing our Enterprise & Education segment to target those geographies and customer segments where we have the greatest opportunity;and◦reducing our general and administrative costs.In pursuing these priorities, we will (i) allocate capital to the areas of our business that we believe have the greatest growth potential, including ourliteracy-learning business, (ii) focus our businesses on their best customers, including Corporate and K-12 learners primarily in North America and NorthernEurope in our Enterprise & Education language business and passionate learners in the United States and select non-US markets in our Consumer languagebusiness, and (iii) optimize the sales and marketing costs for these businesses and the costs of our business overall.In March 2015, we initiated a plan (the "2015 Restructuring Plan") to make reductions to Consumer sales and marketing, Consumer productinvestment, and general and administrative costs. We expect to realize annualized cost savings of approximately $65 million as a result of these actions. Ourresults of operations reflect the impact of these cost reductions as well as additional cost savings and employee reductions that have occurred outside of the2015 Restructuring Plan. We expect overall profitability within the Consumer segment to mitigate as we expect these costs savings to offset expectedrevenue declines in the Consumer segment. See Note 2 and Note 13 of Item 8, Financial Statements and Supplementary Data for additional informationabout these strategic undertakings. In addition, Stephen M. Swad, who served as our President and Chief Executive Officer throughout 2014, resigned fromthis position effective April 1, 2015. The Board of Directors appointed A. John Hass III to serve as Interim President and Chief Executive Officer, alsoeffective April 1, 2015, while the Company engaged in a search for a chief executive officer. In March 2016, the Board of Director's concluded the search andappointed A. John Hass III as President, Chief Executive Officer, and Chairman of the Board effective April 1, 2016. In conjunction with the 2015Restructuring Plan, outside financial and legal advisors were retained to assist management and the Board of Directors with their ongoing comprehensivereview to analyze potential options to improve financial performance and enhance shareholder value.We currently have two operating segments: Enterprise & Education and Consumer, rather than the three operating segments (Global Enterprise &Education, North America Consumer, and Rest of World Consumer) we had as of December 31, 2014 and 2013. We discuss the profitability of each segmentin terms of segment contribution. Segment contribution is the measure of profitability used by our Chief Operating Decision Maker. Segment contributionincludes segment revenue and expenses incurred directly by the segment, including material costs, service costs, customer care and coaching costs, sales andmarketing expense and bad debt expense.For the year ended December 31, 2015, Enterprise & Education segment contribution increased to $30.4 million with a segment contribution margin of31%, compared to $22.9 million with a segment contribution margin of 27% for the year ended December 31, 2014. The dollar and margin increases wereprimarily due to the increase in Enterprise & Education revenue which was slightly offset by an increase in direct sales related expenses. Consumer segmentcontribution decreased to $34.5 million with a contribution margin of 29% for the year ended December 31, 2015 from $35.3 million with a contributionmargin of 20% for the year ended December 31, 2014. The dollar decrease in Consumer segment contribution was primarily due to a decrease in Consumerrevenue of $57.5 million, almost entirely offset by cost reductions. The Consumer segment contribution margin increased due to our cost reductioninitiatives.For the year ended December 31, 2014, Enterprise & Education segment contribution increased slightly to $22.9 million with a segment contributionmargin of 27%, compared to $21.0 million with a segment contribution margin of 35% for the year ended December 31, 2013. The dollar increase wasprimarily due to the increase in Enterprise & Education revenue while the decrease in margin was due to the lower margin on our acquired service offerings.Consumer segment contribution decreased to $35.3 million with a contribution margin of 20% for the year ended December 31, 2014 from $70.9 millionwith a contribution margin of 35% for the year ended December 31, 2013. The dollar and margin decrease in Consumer segment contribution was primarilydue to a decrease in retail and direct-to-consumer revenues and the reduction of international operations.Over the last few years, our Consumer strategy has been to shift more and more of our Consumer business to web-based software subscriptions, digitaldownloads and mobile applications and away from perpetual CD packages. We believe that these formats provide customers with an overall improvedexperience and the flexibility to use our products on multiple platforms (i.e., tablets and mobile phones). We believe these platforms also serve moreeconomical and relevant ways for us to deliver our products to customers. One challenge to encouraging customers to enter into or renew a subscriptionarrangement is that usage of our product varies greatly, ranging from customers that purchase but do not have any usage to customers with high usage. Themajority of purchasers tend towards the lower end of that spectrum, with most usage coming in the first few months after purchase and declining over time -similar to a gym membership.28Table of ContentsFor additional information regarding our segments, see Note 17 of Item 8, Financial Statements and Supplementary Data. For additional informationregarding fluctuations in segment revenue, see Results of Operations, below. Prior periods have been reclassified to reflect our current operating segmentspresentation and definition of segment contribution.Components of Our Statement of OperationsRevenueWe derive revenue from sales of language-learning, literacy, and brain fitness solutions. Revenue is presented as product revenue or subscription andservice revenue in our consolidated financial statements. Product revenue primarily consists of revenue from our perpetual language-learning productsoftware, our audio practice products, and certain mobile applications. Our audio practice products are often combined with our language-learning softwareand sold as a solution. Subscription and service revenue consists of sales from web-based software subscriptions, online services, professional services, andcertain mobile applications. Our online services are typically sold in short-term service periods and include dedicated online conversational coachingservices and access to online communities of language learners. Our professional services include training and implementation services.In the Consumer market, our perpetual product software is often bundled with our short-term online conversational coaching and online communityservices and sold as a package. Approximately $25 to $39 in revenue per unit is derived from these short-term online services. As a result, we typically defer10% to 35% of the revenue of each of these bundled sales to be recognized over the term of the service period. The content of our perpetual product softwareand our web-based language-learning subscription offerings are the same. We offer our customers the ability to choose which format they prefer withoutdifferentiating the learning experience.We sell our solutions directly and indirectly to individuals, educational institutions, corporations, and governmental agencies. We sell to enterpriseand education organizations primarily through our direct Enterprise & Education sales force as well as through our network of resellers and organizationswho typically gain access to our solutions under a web-based subscription service. We distribute our Consumer products predominantly through our directsales channels, primarily our websites and call centers, which we refer to as our direct-to-consumer channel. We also distribute our Consumer productsthrough select third-party retailers and distributors. For purposes of explaining variances in our revenue, we separately discuss changes in our Enterprise &Education and our Consumer sales channels because the customers and revenue drivers of these channels are different.Within our Enterprise & Education segment, revenue in our education, government, and corporate sales channels are seasonally stronger in the secondhalf of the calendar year due to purchasing and budgeting cycles. Our Consumer revenue is affected by seasonal trends associated with the holiday shoppingseason. We expect these trends to continue.Cost of Product and Subscription and Service RevenueCost of product revenue consists of the direct and indirect materials and labor costs to produce and distribute our products. Such costs includepackaging materials, computer headsets, freight, inventory receiving, personnel costs associated with product assembly, third-party royalty fees andinventory storage, obsolescence and shrinkage. The cost of subscription and service revenue primarily represents costs associated with supporting our web-based subscription services and online language-learning services, which includes online language conversation coaching, hosting costs, and depreciation.We also include the cost of credit card processing and customer technical support in both cost of product revenue and cost of subscription and servicerevenue.Operating ExpensesWe classify our operating expenses into the following categories: sales and marketing, research and development, and general and administrative.When certain events occur, we also recognize operating expenses related to asset impairment and operating lease terminations.Our operating expenses primarily consist of personnel costs, direct advertising and marketing expenses, and professional fees associated with contractproduct development, legal, accounting and consulting. Personnel costs for each category of operating expenses include salaries, bonuses, stock-basedcompensation and employee benefit costs. Included within our operating expenses are restructuring costs that consist primarily of employee severance andrelated benefit costs, contract termination costs, and other related costs associated with our restructuring activities.Sales and Marketing. Our sales and marketing expenses consist primarily of direct advertising expenses related to television, print, radio, online andother direct marketing activities, personnel costs for our sales and marketing staff, and commissions earned by our sales personnel. Sales commissions aregenerally paid at the time the customer is invoiced. However, sales commissions are deferred and recognized as expense in proportion to when the relatedrevenue is recognized.29Table of ContentsResearch and Development. Research and development expenses consist primarily of employee compensation costs, consulting fees, and overheadcosts associated with development of our solutions. Our development efforts are primarily based in the U.S. and are devoted to modifying and expanding ouroffering portfolio through the addition of new content and new paid and complementary products and services to our language-learning, literacy, and brainfitness solutions.General and Administrative. General and administrative expenses consist primarily of shared services, such as personnel costs of our executive,finance, legal, human resources and other administrative personnel, as well as accounting and legal professional services fees including professional servicefees related to acquisition and other corporate expenses.Impairment. Impairment expenses consist primarily of goodwill impairment and impairment expense related to the abandonment of previouslycapitalized internal-use software projects.Lease Abandonment and Termination. Lease abandonment and termination expenses include the recognition of costs associated with the terminationor abandonment of certain of our office operating leases, such as early termination fees and expected lease termination costs.Interest and Other Income (Expense)Interest and other income (expense) primarily consist of interest income, interest expense, foreign exchange gains and losses, income from litigationsettlements, and income or loss from equity method investments. Interest income represents interest received on our cash and cash equivalents. Interestexpense is primarily related to interest on our capital leases and the amortization of deferred financing fees associated with our revolving credit facility.Fluctuations in foreign currency exchange rates in our foreign subsidiaries cause foreign exchange gains and losses. Legal settlements are related to agreedupon settlement payments from various anti-piracy enforcement efforts. Income or loss from equity method investments represents our proportionate share ofthe net income or loss of our investment in entities accounted for under the equity method.Income Tax Expense (Benefit)Income tax expense (benefit) consists of federal, state and foreign income taxes.We regularly evaluate the recoverability of our deferred tax assets and establish a valuation allowance, if necessary, to reduce the deferred tax assets toan amount that is more likely than not to be realized (a likelihood of more than 50 percent). Significant judgment is required to determine whether avaluation allowance is necessary and the amount of such valuation allowance, if appropriate.The establishment of a valuation allowance has no effect on the ability to use the deferred tax assets in the future to reduce cash tax payments. Weassess the likelihood that the deferred tax assets will be realizable at each reporting period, and the valuation allowance will be adjusted accordingly, whichcould materially affect our financial position and results of operations.Critical Accounting Policies and EstimatesIn presenting our financial statements in conformity with GAAP, we are required to make estimates and assumptions that affect the reported amounts ofassets, liabilities, revenues, costs and expenses, and related disclosures.Some of the estimates and assumptions we are required to make relate to matters that are inherently uncertain as they pertain to future events. We basethese estimates and assumptions on historical experience or on various other factors that we believe to be reasonable and appropriate under thecircumstances. On an ongoing basis, we reconsider and evaluate our estimates and assumptions. Our future estimates may change if the underlyingassumptions change. Actual results may differ significantly from these estimates.We believe that the following critical accounting policies involve our more significant judgments, assumptions and estimates and, therefore, couldhave the greatest potential impact on our consolidated financial statements. In addition, we believe that a discussion of these policies is necessary for readersto understand and evaluate our consolidated financial statements contained in this annual report on Form 10-K.Revenue RecognitionOur primary sources of revenue are web-based software subscriptions, online services, perpetual product software, and bundles of perpetual productsoftware and online services. We also generate revenue from the sale of audio practice products, mobile applications, and professional services. Revenue isrecognized when all of the following criteria are met: there is persuasive evidence of an arrangement; the product has been delivered or services have beenrendered; the fee is fixed or determinable; and collectability is reasonably assured. Revenues are recorded net of discounts.30Table of ContentsWe identify the units of accounting contained within our sales arrangements and in doing so, we evaluate a variety of factors including whether theundelivered element(s) have value to the customer on a stand-alone basis or if the undelivered element(s) could be sold by another vendor on a stand-alonebasis.For multiple element arrangements that contain perpetual software products and related online services, we allocate the total arrangement considerationto the deliverables based on the existence of vendor-specific objective evidence of fair value ("VSOE"). We generate a substantial portion of consumerrevenue from the CD and digital download formats of the Rosetta Stone language-learning packaged software product which is a multiple-elementarrangement that contains two deliverables: perpetual software, which is delivered at the time of sale, and online services, which is considered an undeliveredsoftware-related element. The online service includes access to conversational coaching services. Because we only sell the perpetual language-learningsoftware on a stand-alone basis in our homeschool version, we do not have a sufficient concentration of stand-alone sales to establish VSOE for the perpetualproduct. Where VSOE of the undelivered online services can be established, arrangement consideration is allocated using the residual method. We determineVSOE by reference to the range of comparable stand-alone renewal sales of the online service. We review these stand-alone sales on a quarterly basis. VSOE isestablished if at least 80% of the stand-alone sales are within a range of plus or minus 15% of a midpoint of the range of prices, consistent with generallyaccepted industry practice. Where VSOE of the undelivered online services cannot be established, revenue is deferred and recognized commensurate with thedelivery of the online services.For non-software multiple element arrangements we allocate revenue to all deliverables based on their relative selling prices. Our non-software multipleelement arrangements primarily occur as sales to our Enterprise & Education customers and also to our Consumer customers. These arrangements can includea web-based subscription, audio practice tools and professional services or any combination thereof. We do not have a sufficient concentration of stand-alonesales of the various deliverables noted above to our Enterprise & Education customers, and therefore cannot establish VSOE for each deliverable. Third partyevidence of fair value does not exist for the web-based software subscription services, audio practice products and professional services due to the lack ofinterchangeable language-learning products and services within the market. Accordingly, we determine the relative selling price of the web-basedsubscription, audio practice tools and professional services deliverables included in our non-software multiple element arrangements using our best estimateof selling price. We determine our best estimate of selling price based on our internally published price list which includes suggested sales prices for eachdeliverable based on the type of client and volume purchased. This price list is derived from past experience and from the expectation of obtaining areasonable margin based on our cost of each deliverable.In the U.S. and Canada, we offer consumers who purchase our packaged software and audio practice products directly from us a 30-day, unconditional,full money-back refund. We also permit some of our retailers and distributors to return unsold packaged products, subject to certain limitations. We estimateand establish revenue reserves for returns at the time of sale based on historical return rates, estimated channel inventory levels, the timing of new productintroductions, and other factors.We distribute products and services both directly to the end customer and indirectly through resellers. Our resellers earn commissions generallycalculated as a fixed percentage of the gross sale to the end customer. We evaluate each of our reseller relationships to determine whether the revenuerecognized from indirect sales should be the gross amount of the contract with the end customer or reduced for the reseller commission. In making thisdetermination we evaluate a variety of factors including whether we are the primary obligor to the end customer. Revenue is recorded net of taxes.Revenue for online services and web-based subscriptions is recognized ratably over the term of the service or subscription period, assuming all revenuerecognition criteria have been met. Our CD and digital download formats of Rosetta Stone language-learning products are typically bundled with a short-term online service where customers are allowed to begin their short-term online services at any point during a registration window, which is up to six monthsfrom the date of purchase from us or an authorized reseller. Short-term online services that are not activated during this registration window are forfeited andrevenue is recognized upon expiry. Revenue from non-refundable upfront fees that are not related to products already delivered or services already performedis deferred and recognized over the term of the related arrangement because the period over which a customer is expected to benefit from the service that isincluded within our subscription arrangements does not extend beyond the contractual period. Accounts receivable and deferred revenue are recorded at thetime a customer enters into a binding subscription agreement.Software products include sales to end user customers and resellers. In many cases, revenue from sales to resellers is not contingent upon resale of thesoftware to the end user and is recorded in the same manner as all other product sales. Revenue from the sales of packaged software is recognized as theproducts are shipped and title passes and risks of loss have been transferred. For many product sales, these criteria are met at the time the product is shipped.For some sales to resellers and certain other sales, we defer revenue until the customer receives the product because we legally retain a portion of the risk ofloss on these sales during transit. In other cases where packaged software products are sold to resellers on a consignment basis, revenue is recognized for theseconsignment transactions once the end user sale has occurred, assuming the remaining revenue recognition criteria have been met. Cash sales incentives toresellers are accounted for as a reduction of revenue, unless a31Table of Contentsspecific identifiable benefit is identified and the fair value is reasonably determinable. Price protection for changes in the manufacturer suggested retail valuegranted to resellers for the inventory that they have on hand at the date the price protection is offered is recorded as a reduction to revenue at the time of sale.We offer our U.S. and Canada consumers the ability to make payments for packaged software purchases in installments over a period of time, whichtypically ranges between three and five months. Given that these installment payment plans are for periods less than 12 months, a successful collectionhistory has been established and these fees are fixed and determinable, revenue is recognized at the time of sale, assuming the remaining revenue recognitioncriteria have been met.In connection with packaged software product sales and web-based software subscriptions, technical support is provided to customers, includingcustomers of resellers, via telephone support at no additional cost for up to six months from the time of purchase. As the fee for technical support is includedin the initial licensing fees, the technical support and services are generally provided within one year, the estimated cost of providing such support is deemedinsignificant and no unspecified upgrades/enhancements are offered, technical support revenues are recognized together with the software product and web-based software subscription revenue. Costs associated with the technical support service are accrued at the time of sale.Sales commissions from non-cancellable web-based software subscription contracts are deferred and amortized in proportion to the revenue recognizedfrom the related contract.Stock-Based CompensationAll stock-based awards, including employee stock option grants, are recorded at fair value as of the grant date and recognized as expense in thestatement of operations on a straight-line basis over the requisite service period, which is the vesting period.We use the Black-Scholes pricing model to value our stock options, which requires the use of estimates, including future stock price volatility,expected term, and forfeitures. Stock-based compensation expense recognized is based on the estimated portion of the awards that are expected to vest.Estimated forfeiture rates were applied in the expense calculation. The fair value of each option grant is estimated on the date of grant using the BlackScholes option pricing model as follows: Year ended December 31, 2015 2014 2013Expected stock price volatility 49%-63% 63%-65% 64%-67%Expected term of options 6 years 6 years 6 yearsExpected dividend yield — — —Risk-free interest rate 1.19%-1.75% 1.46%-1.80% 0.75%-1.65%Prior to the completion of our initial public offering in April 2009, our stock was not publicly quoted and we had a limited history of stock optionactivity, so we reviewed a group of comparable industry-related companies to estimate our expected volatility over the most recent period commensuratewith the estimated expected term of the awards. In addition to analyzing data from the peer group, we also considered the contractual option term and vestingperiod when determining the expected option life and forfeiture rate. Subsequent to the initial public offering and through April 2015, we continued toreview a group of comparable industry-related companies to estimate volatility, but also considered the volatility of our own stock since the initial publicoffering. After April 2015, we had a sufficient period of stock price data to estimate volatility based upon the historical volatility experienced with our ownstock price. For the risk-free interest rate, we use a U.S. Treasury Bond rate consistent with the estimated expected term of the option award.Given the nature of our granted stock options, we derive the estimated term of all stock options using a combination of peer company information andthe simplified method. Prior to the completion of our initial public offering in April 2009, our stock was not publicly quoted and we had a limited history ofstock option activity. We believe the limited historical exercise data related to our stock options does not provide a reasonable basis on which to estimate theexpected term.GoodwillThe value of goodwill is primarily derived from the acquisition of Rosetta Stone Ltd. (formerly known as Fairfield & Sons, Ltd.) in January 2006, theacquisition of certain assets of SGLC International Co. Ltd ("SGLC") in November 2009, the acquisitions of Livemocha and Lexia in 2013 and theacquisitions of Vivity and Tell Me More in 2014.As of December 31, 2015, our reporting units are: Enterprise & Education Language, Enterprise & Education Literacy, Consumer Language, andConsumer Fit Brains. Each of these businesses is considered a reporting unit for goodwill impairment testing purposes. The combined Enterprise & EducationLanguage and Enterprise & Education Literacy reporting units make32Table of Contentsup the Enterprise & Education operating segment. Consumer Language and Consumer Fit Brains are components of the Consumer operating segment. Priorto 2013, the reporting units were the same as our operating segments.We test goodwill for impairment annually on June 30 of each year at the reporting unit level using a fair value approach or more frequently, ifimpairment indicators arise. We have the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of areporting unit is less than its carrying value, a "Step 0" analysis. If, based on a review of qualitative factors, it is more likely than not that the fair value of areporting unit is less than its carrying value, we perform "Step 1" of the traditional two-step goodwill impairment test by comparing the fair value of areporting unit with its carrying amount. If the carrying value exceeds the fair value, we measure the amount of impairment loss in "Step 2", if any, bycomparing the implied fair value of the reporting unit goodwill to its carrying amount.The factors that we consider important in a qualitative analysis, and which could trigger an interim impairment review, include, but are not limited to: asignificant decline in the market value of our common stock for a sustained period; a material adverse change in economic, financial market, industry orsector trends; a material failure to achieve operating results relative to historical levels or projected future levels; and significant changes in operations orbusiness strategy. We evaluate our reporting units with remaining goodwill balances on a quarterly basis to determine if a triggering event has occurred. Wewill continue to review for impairment indicators.In estimating the fair value of our reporting units in Step 1, we use a variety of techniques including the income approach (i.e., the discounted cash flowmethod) and the market approach (i.e., the guideline public company method). Our projections are estimates that can significantly affect the outcome of theanalysis, both in terms of our ability to accurately project future results and in the allocation of fair value between reporting units.In connection with the annual goodwill impairment analysis performed as of June 30, 2015, we exercised our option to bypass Step 0 and began ourannual test with Step 1. We determined that the fair value of our Enterprise & Education literacy and Enterprise & Education language reporting unitssubstantially exceeded their carrying values. The fair value of our Consumer Fit Brains reporting unit exceeded its carrying value, although to a lesser extent,primarily due to the recent purchase and business combination in 2014. As a result of the 2015 annual test, no goodwill impairment charges were recorded.During the fourth quarter of 2015, we determined that sufficient indication existed to require performance of an interim goodwill impairment analysisfor the Consumer Fit Brains reporting unit. This indicator was due to a decline in the operations of the Consumer Fit Brains reporting unit, with decreases inrevenue and bookings within this reporting unit driving lower than expected operating results for the quarter and impacting the forecast going forward. Inthis interim goodwill impairment test, the Consumer Fit Brains reporting unit failed Step 1. The combination of lower reporting unit fair value calculated inStep 1 and the identification of unrecognized fair value adjustments to the carrying values of other assets and liabilities (primarily developed technology anddeferred revenue) in Step 2 of the interim goodwill impairment test, resulted in an implied fair value of goodwill below its carrying value. As a result, werecorded an impairment loss of $5.6 million associated with the interim impairment assessment of the Consumer Fit Brains reporting unit as of December 31,2015.During the fourth quarter of 2015, we determined that sufficient indication existed to require performance of an interim goodwill impairment analysisfor the Enterprise & Education language reporting unit. This indicator was due to declines in the operations of the Enterprise & Education reporting unit,with decreases in revenue and bookings within this reporting unit driving lower than expected operating results for the quarter and impacting the forecastgoing forward. As a result of the operating results in the fourth quarter of 2015, we have further refined our strategy of focusing on the Enterprise & Educationsegment and in March 2016 we announced a plan to exit the direct distribution of Enterprise & Education language offerings in a number of non-US marketsand right-size the overall business. In particular, we initiated a process to exit direct presence and close offices in China, Brazil and France. This plan isexpected to result in significantly lower projected revenues, bookings, and short-term profitability of the Enterprise & Education Language reporting unit. Asa result, we determined that sufficient indication existed to require the performance of an interim goodwill impairment analysis for the Enterprise &Education Language reporting unit. While this analysis did indicate that the fair value of the Enterprise & Education Language reporting unit declined, thefair value is still greater than the carrying value of this reporting unit. Since the Enterprise & Education Language reporting unit passed the Step 1 test, nofurther analysis or testing under Step 2 was necessary and no impairment charges were recorded in connection with this interim impairment assessment of thisreporting unit.We also routinely review goodwill at the reporting unit level for potential impairment as part of our internal control framework. In the fourth quarter of2015, we evaluated any reporting unit with remaining goodwill that was not tested for impairment to determine if a triggering event has occurred. Asof December 31, 2015, the Company concluded that there were no indicators of impairment that would cause us to believe that it is more likely than not thatthe fair value of any such reporting units is less than the carrying value. Accordingly, a detailed impairment test has not been performed and no goodwillimpairment charges were recorded in connection with the interim impairment reviews of any such reporting units.33Table of ContentsDuring 2014, we determined sufficient indicators existed to require the performance of interim goodwill impairment analysis for our then existent NorthAmerica Consumer and Rest of World Consumer reporting units due to unexpected declines in the Consumer language-learning business. As a result, werecorded a total goodwill impairment loss of $20.2 million during the year ending December 31, 2014, which represents a full impairment of the goodwillassociated with the language-learning Consumer business. There were no goodwill impairments in 2013.Intangible AssetsIntangible assets consist of acquired technology, including developed and core technology, customer related assets, trade name and trademark, andother intangible assets. Those intangible assets with finite lives are recorded at cost and amortized on a straight line basis over their expected lives. Intangibleassets with finite lives are reviewed routinely for potential impairment as part of our internal control framework. Annually, as of December 31, and morefrequently if a triggering event occurs, we review the Rosetta Stone trade name, our only indefinite-lived intangible asset, to determine if indicators ofimpairment exist. We have the option to first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible assetis impaired as a basis for determining whether it is necessary to perform the quantitative test. If necessary, the quantitative test is performed by comparing thefair value of indefinite-lived intangible assets to the carrying value. In the event the carrying value exceeds the fair value of the assets, the assets are writtendown to their fair value.During the fourth quarter of 2015, we elected to bypass the qualitative assessment and performed the quantitative assessment. In the quantitativeassessment, we noted that the fair value of the Rosetta Stone trade name has declined due to the reduction in forecasted revenue and bookings from both theEnterprise & Education Language and the Consumer Language reporting units, however, the fair value exceeded the carrying value. There has been noimpairment of intangible assets during the years ending December 31, 2015, 2014 and 2013.Valuation of Long-Lived AssetsAs part of our internal control framework we evaluate the recoverability of our long-lived assets. An impairment of long-lived assets is recognized inthe event that the net book value of such assets exceeds the future undiscounted net cash flows attributable to such assets. Impairment, if any, is recognized inthe period of identification to the extent the carrying amount of an asset exceeds the fair value of such asset. During 2015 and 2014, we recorded $1.1 millionand $0.2 million in impairment expense related to the abandonment of software projects that were previously capitalized. There were no impairment chargesfor the years ended December 31, 2013.Restructuring CostsIn the first quarter of 2015, as part of the 2015 Restructuring Plan, we announced and initiated actions to reduce headcount and other costs in order tosupport our strategic shift in business focus and address periods of loss. In connection with this plan, we incurred restructuring related costs, includingemployee severance and related benefit costs, contract termination costs, and other related costs. These costs are included in our operating expense line itemson the Statement of Operations.On March 14, 2016, we announced that we intend to exit the direct sales presence in almost all of our non-U.S. and non-northern European geographiesrelated to the distribution of our Enterprise & Education language offerings, the "2016 Restructuring Plan". Where appropriate, we will seek to operatethrough partners in those geographies being exited. We will also look to initiate processes to close our software development operations in France andChina. In total, if our intentions are realized, these actions will reduce headcount by approximately 17% of our full-time workforce and is expected to resultin annual expense reductions of approximately $19 million. If fully realized, these actions will result in an estimated restructuring charge ranging between$5.0 million and $6.0 million, with approximately 50% accrued in the first quarter 2016, largely reflecting separation payments. These actions are additive tothe 2015 Restructuring Plan and further support our strategic shift in business focus to help address periods of losses.Employee severance and related benefit costs primarily include cash payments, outplacement services, continuing health insurance coverage, and otherbenefits. Where no substantive involuntary termination plan previously exists, these severance costs are generally considered “one-time” benefits andrecognized at fair value in the period in which a detailed plan has been approved by management and communicated to the terminated employees. Severancecosts pursuant to ongoing benefit arrangements, including termination benefits provided for in existing employment contracts, are recognized when probableand reasonably estimable.Contract termination costs include penalties to cancel certain service and license contracts. Contract termination costs are recognized at fair value in theperiod in which the contract is terminated in accordance with the contract terms.34Table of ContentsOther related costs generally include external consulting and legal costs associated with the strategic shift in business focus of our Consumer business.Such costs are recognized at fair value in the period in which the costs are incurred.Income TaxesWe believe that the accounting estimate for the realization of deferred tax assets is a critical accounting estimate because judgment is required inassessing the likely future tax consequences of events that have been recognized in our financial statements or tax returns. Although it is possible there willbe changes that are not anticipated in our current estimates, we believe it is unlikely such changes would have a material period-to-period impact on ourfinancial position or results of operations.We use the asset and liability approach to accounting for income taxes. Deferred tax assets and liabilities represent the future tax consequences of thedifferences between the financial statement carrying amounts of assets and liabilities versus the tax bases of assets and liabilities. Under this method, deferredtax assets are recognized for deductible temporary differences, and operating loss and tax credit carryforwards. Deferred tax liabilities are recognized fortaxable temporary differences.We reduce the carrying amounts of deferred tax assets by a valuation allowance if, based on available evidence, it is more likely than not that suchassets will not be realized. Accordingly, the need to establish valuation allowances for deferred tax assets is assessed quarterly based on the more-likely-than-not realization threshold criterion. In the assessment, appropriate consideration is given to all positive and negative evidence related to the realization of thedeferred tax assets. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of futureprofitability, the duration of statutory carryforward periods, our experience with operating loss and tax credit carryforwards not expiring unused, and taxplanning alternatives. Significant judgment is required to determine whether a valuation allowance is necessary and the amount of such valuation allowance,if appropriate. The valuation allowance is reviewed quarterly and is maintained until sufficient positive evidence exists to support a reversal.In assessing the recoverability of our deferred tax assets, we consider all available evidence, including:•the nature, frequency, and severity of cumulative financial reporting losses in recent years;•the carryforward periods for the net operating loss, capital loss, and foreign tax credit carryforwards;•predictability of future operating profitability of the character necessary to realize the asset;•prudent and feasible tax planning strategies that would be implemented, if necessary, to protect against the loss of the deferred tax assets; and•the effect of reversing taxable temporary differences.The evaluation of the recoverability of the deferred tax assets requires that we weigh all positive and negative evidence to reach a conclusion that it ismore likely than not that all or some portion of the deferred tax assets will not be realized. The weight given to the evidence is commensurate with the extentto which it can be objectively verified. The more negative evidence that exists, the more positive evidence is necessary and the more difficult it is to supporta conclusion that a valuation allowance is not needed. Our valuation allowance analysis considers a number of factors, including our cumulative losses inrecent years, our expectation of future taxable income and the time frame over which our net operating losses expire.As of December 31, 2015, a full valuation allowance exists for the U.S., Japan, China, Hong Kong, Mexico, Spain, Brazil, and France where we havedetermined the deferred tax assets will not more likely than not be realized.All of the jurisdictions mentioned above, with the exception of China, have cumulative losses and pre-tax losses for the most recent year endedDecember 31, 2015. The establishment of a valuation allowance has no effect on the ability to use the deferred tax assets in the future to reduce cash taxpayments. We will continue to assess the likelihood that the deferred tax assets will be realizable at each reporting period and the valuation allowance will beadjusted accordingly, which could materially affect our financial position and results of operations.As of December 31, 2015 and 2014, our net deferred tax liability was $5.0 million and $4.2 million, respectively.Recently Issued Accounting StandardsFor a summary of recent accounting pronouncements applicable to our consolidated financial statements see Note 2 of Item 8, Financial Statementsand Supplementary Data, which is incorporated herein by reference.35Table of ContentsResults of OperationsThe following table sets forth our consolidated statement of operations for the periods indicated. Year Ended December 31, 2015 2014 2013 (in thousands, except per share data)Statements of Operations Data: Revenue: Product $65,969 $136,251 $156,792Subscription and service 151,701 125,602 107,853Total revenue 217,670 261,853 264,645Cost of revenue: Cost of product revenue 16,898 34,192 32,191Cost of subscription and service revenue 21,629 18,862 13,523Total cost of revenue 38,527 53,054 45,714Gross profit 179,143 208,799 218,931Operating expenses Sales and marketing 136,084 173,208 146,104Research and development 29,939 33,176 33,995General and administrative 50,124 57,120 56,432Impairment 6,754 20,333 —Lease abandonment and termination 55 3,812 842Total operating expenses 222,956 287,649 237,373Loss from operations (43,813) (78,850) (18,442)Other income and (expense): Interest income 23 17 117Interest expense (378) (233) (61)Other (expense) income (1,469) (1,129) 368Total other income and (expense) (1,824) (1,345) 424Loss before income taxes (45,637) (80,195) (18,018)Income tax expense (benefit) 1,159 (6,489) (1,884)Net loss $(46,796) $(73,706) $(16,134)Loss per share: Basic $(2.17) $(3.47) (0.75)Diluted $(2.17) $(3.47) $(0.75)Common shares and equivalents outstanding: Basic weighted average shares 21,571 21,253 21,528Diluted weighted average shares 21,571 21,253 21,528Stock-based compensation included in: Cost of revenue 101 108 175Sales and marketing 1,327 1,975 1,840Research and development 841 958 1,460General and administrative 4,926 3,721 5,766Total stock-based compensation expense $7,195 $6,762 $9,24136Table of ContentsComparison of the Year Ended December 31, 2015 and the Year Ended December 31, 2014Our total revenue decreased to $217.7 million for the year ended December 31, 2015 from $261.9 million for the year ended December 31, 2014. Thechange in total revenue was due to a decrease in Consumer revenues of $57.5 million, which was offset by an increase in Enterprise & Education revenue of$13.4 million.We reported an operating loss of $43.8 million for the year ended December 31, 2015 compared to an operating loss of $78.9 million for the year endedDecember 31, 2014. The decrease in operating loss was due to a decrease in operating expenses of $64.7 million, a decrease of $14.5 million in cost ofrevenue, which was offset by a $44.2 million decrease in revenue.Revenue by Operating SegmentThe following table sets forth revenue for our two operating segments for the years ended December 31, 2015 and 2014: Year ended December 31, 2015 versus 2014 2015 2014 Change % Change (in thousands, except percentages)Enterprise & Education $98,057 45.0% $84,700 32.3% $13,357 15.8 %Consumer 119,613 55.0% 177,153 67.7% $(57,540) (32.5)%Total Revenue $217,670 100.0% $261,853 100.0% $(44,183) (16.9)%Enterprise & Education SegmentTotal Enterprise & Education revenue increased $13.4 million, or 16%, from $84.7 million for the year ended December 31, 2014 to $98.1 million forthe year ended December 31, 2015. Enterprise & Education literacy revenue increased $12.0 million. Enterprise & Education language revenue increased$1.3 million, comprised primarily of increases of $3.7 million and $0.8 million in our education and non-profit sales channels, respectively, which werepartially offset by a decrease of $2.9 million in the corporate sales channel. Enterprise & Education revenue increased, in part, due to the revenue recognitionof subscription service contracts recorded as deferred revenue in prior periods. Due to purchase accounting, deferred revenue associated with Lexia and TellMe More was recorded at fair value, which is lower than the book value, and resulted in lower 2014 revenue. As a result, we expect year-over-year revenues tobecome more comparable as we move beyond the purchase accounting impact, which will result in lower revenue growth rates than what we experiencedduring 2015. As a result of the process we have initiated in March 2016 to exit our direct distribution presence and close offices in a number of non-U.S.markets where we have not yet achieved scale and right-size the Enterprise & Education Language business overall, we expect Enterprise & Educationlanguage revenue and bookings to decrease in the near-term.Consumer SegmentConsumer revenue decreased $57.5 million, or 32%, from the year ended December 31, 2014 to the year ended December 31, 2015. This decrease waslargely due to reductions in revenue from our direct-to-consumer, retail, and homeschool sales channels of $48.2 million, $10.4 million, and $1.0 million,respectively, slightly offset by an increase of $1.6 million in revenue related to our Fit Brains offerings. These declines reflect the decision to significantlycurtail promotional pricing under our 2015 strategic transformation. In 2014, we focused on driving customers to purchase our direct-to-consumer channel,particularly through our website, by implementing more aggressive discounting and promotional activity to combat the introduction of lower pricedcompetitor products. During 2015, we were more disciplined with discounting and focused on stabilizing prices. We expect Consumer revenues to decreasedue to a longer revenue recognition period associated with the continued transition from CDs and downloads to subscriptions with terms ranging up to threeyears and an anticipated reduction in our suggested retail value.Revenue by Product Revenue and Subscription and Service RevenueWe categorize and report our revenue in two categories—product revenue and subscription and service revenue. Product revenue includes revenuesallocated to our perpetual language-learning product software, revenues from the sale of audio practice products, and sales of certain mobile applications.Subscription and service revenue includes web-based software subscriptions, online services for our conversational coaching and language-learningcommunity access, as well as revenues from professional services. Subscription and service revenues are typically deferred at the time of sale and thenrecognized ratably over the subscription or service period. We bundle our perpetual product software typically with short-term online services. As a result, wetypically defer 10% to 35% of the revenue of each of these bundled sales. We recognize the deferred revenue associated with the short-term online servicesover the term of the service period.37Table of ContentsThe following table sets forth revenue for product revenue and subscription and service revenue for the years ended December 31, 2015 and 2014: Year ended December 31, 2015 versus 2014 2015 2014 Change % Change (in thousands, except percentages)Product revenue $65,969 30.3% $136,251 52.0% $(70,282) (51.6)%Subscription and service revenue 151,701 69.7% 125,602 48.0% 26,099 20.8 %Total revenue $217,670 100.0% $261,853 100.0% $(44,183) (16.9)%Product RevenueProduct revenue decreased $70.3 million, or 52%, to $66.0 million during the year ended December 31, 2015 from $136.3 million during the yearended December 31, 2014. Product revenue primarily decreased $58.6 million, $9.8 million, and $1.2 million in our direct-to-consumer, global retail, andhomeschool sales channels, respectively. Product sales volume decreased as we continue to carry out our strategy to migrate our Consumer business tosubscription-based products. Product revenue also decreased due to the year-over-year decline in product unit sales volume as a result of the strategicdecision to be more disciplined marketing and advertising expenses and curtail promotional pricing to focus on stabilizing prices.Subscription and Service RevenueSubscription and service revenue increased $26.1 million, or 21%, to $151.7 million for the year ended December 31, 2015. Within the Enterprise &Education segment, the increase in subscription and service revenue was primarily due to the $12.0 million increase in Enterprise & Education literacyrevenue combined with revenue increases within Enterprise & Education language of $3.2 million and $0.9 million in the education and non-profit servicesales channels, respectively. These increases were slightly offset by a decrease of $2.1 million in the corporate sales channel within Enterprise & Educationlanguage. The Consumer segment realized increases of $10.5 million, $1.6 million, and $0.4 million in direct-to-consumer, Fit Brains, and global retailservice sales channels, respectively. Our 2014 subscription and service revenue was lower due to the write-down effects of purchase accounting on the pre-acquisition deferred revenue balances associated with Lexia and Tell Me More. We continue to experience these purchase accounting impacts for Lexia dueto the typical subscription length. As a result, we expect the growth rates from our Enterprise & Education segment to mitigate over time. Subscription andservices sales volume increased as we continue to carry out our strategy to migrate our Consumer business to subscription-based products. However, it isimportant to note that these subscribers generally only stay for the duration of the subscription period, which could negatively impact our revenue in thefuture.Cost of Product Revenue and Subscription and Service Revenue and Gross ProfitThe following table sets forth cost of product revenue and subscription and service revenue, as well as gross profit for the years ended December 31,2015 and 2014: Year ended December 31, 2015 versus 2014 2015 2014 Change % Change (in thousands, except percentages)Revenue: Product $65,969 $136,251 $(70,282) (51.6)%Subscription and service 151,701 125,602 26,099 20.8 %Total revenue 217,670 261,853 (44,183) (16.9)%Cost of revenue: Cost of product revenue 16,898 34,192 (17,294) (50.6)%Cost of subscription and service revenue 21,629 18,862 2,767 14.7 %Total cost of revenue 38,527 53,054 (14,527) (27.4)%Gross profit $179,143 $208,799 $(29,656) (14.2)%Gross profit percentages 82.3% 79.7% 2.6% Total cost of revenue decreased $14.5 million for the year ended December 31, 2015 from $53.1 million for the year ended December 31, 2014. Thechange in total cost of revenue was primarily due to decreases in inventory expense, payroll38Table of Contentsand benefits expense, and freight and payment processing fees. Inventory expense declined $6.3 million primarily due to the decrease in product salescombined with higher first quarter 2014 charges to inventory obsolescence in our Asian operations that did not recur in 2015. Payroll and benefit expensesdeclined $3.7 million driven by reduced headcount as a result of the 2015 Restructuring Plan, the absence of higher severance payments in 2014 related tooperations in France and Korea, and lower variable incentive compensation expenses based on reduced funding expectations. Freight and processing feesdecreased $3.5 million due to the decrease in sales.Cost of Product RevenueCost of product revenue for the year ended December 31, 2015 was $16.9 million, a decrease of $17.3 million or 51% compared to $34.2 million for theyear ended December 31, 2014. As a percentage of product revenue, cost of product revenue slightly increased to 26% for the year ended December 31, 2015from 25% as compared to the prior year period. The dollar decrease in cost of product revenue is primarily due to decreases of $5.5 million, $4.7 million,$2.2 million, $1.6 million, and $1.2 million in inventory costs, payroll and benefits, freight costs, commission fees, and payment processing fees respectively,due to the shift away from hard product sales to online subscription sales.Cost of Subscription and Service RevenueCost of subscription and service revenue for the year ended December 31, 2015 was $21.6 million, an increase of $2.8 million, or 15% from the yearended December 31, 2014. As a percentage of subscription and service revenue, cost of subscription and service revenue decreased to 14% from 15% for theyear ended December 31, 2015 compared to the prior year period. The dollar increase in cost of subscription and service revenue was primarily due toincreases in hosting, amortization of capitalized internal-use software costs, and other allocable costs due to the shift in sales mix to subscription servicesales.Gross ProfitGross profit decreased $29.7 million to $179.1 million for the year ended December 31, 2015 compared to $208.8 million for the year endedDecember 31, 2014. Gross profit percentage increased to 82% from 80% for the year ended December 31, 2015 compared to the year ended December 31,2014. The dollar decrease in gross profit was primarily due to the decrease in revenue. The percentage increase in gross profit percentage was primarily due tothe decrease in inventory and freight costs associated with hard product sales as we continue to shift to a SaaS delivery model which attracts higher margins.Operating Expenses Year ended December 31, 2015 versus 2014 2015 2014 Change % Change (in thousands, except percentages)Sales and marketing $136,084 $173,208 $(37,124) (21.4)%Research and development 29,939 33,176 (3,237) (9.8)%General and administrative 50,124 57,120 (6,996) (12.2)%Impairment 6,754 20,333 (13,579) (66.8)%Lease abandonment and termination 55 3,812 (3,757) (98.6)%Total operating expenses $222,956 $287,649 $(64,693) (22.5)%In the first quarter of 2015, we announced and initiated actions to reduce headcount and other costs in order to support our 2015 strategic shift inbusiness focus. Included within our operating expenses are restructuring charges related to the 2015 Restructuring Plan which relate to employee severanceand related benefits costs incurred in connection with headcount reductions, contract termination costs, and other related costs. As a result of these actions,we realized reductions in our operating expenses, primarily associated with reduced payroll and benefits costs.39Table of ContentsThe following table presents restructuring costs associated with the 2015 Restructuring Plan included in the related line items of our results fromoperations: Year ended December 31, 2015 2014 (in thousands)Cost of revenue $113 $—Sales and marketing 4,492 —Research and development 602 —General and administrative 3,584 —Total $8,791 $—Sales and Marketing ExpensesSales and marketing expenses for the year ended December 31, 2015 were $136.1 million, a decrease of $37.1 million, or 21%, from the year endedDecember 31, 2014. As a percentage of total revenue, sales and marketing expenses decreased to 63% for the year ended December 31, 2015, from 66% forthe year ended December 31, 2014. The dollar and percentage decreases in sales and marketing expenses were primarily due to decreases in media andmarketing expenses, payroll and benefit expenses, professional services, and amortization expense, which were partially offset by an increase in commissionexpense. Media spend decreased $27.1 million due to a decrease of $17.2 million in spend from offline media like TV, radio, and print and a $9.9 milliondecrease in spend in online and social media expenses. Marketing expenses also decreased by $5.7 million due to decreased spend in creative developmentand advertising expenses as a result of the strategic shift in focus and the positioning of the Consumer business for profitability. Payroll and benefit expensedecreased $4.1 million due to salary savings from the reduced headcount as a result of the 2015 Restructuring Plan, lower variable incentive compensationexpenses based on reduced funding expectations, and the absence of Long Term Incentive Plan ("LTIP") expense as the plan ended in 2014. Professionalservices decreased $2.9 million due to reduced outsourced staffing in the call centers as a result of the strategic shift in the Consumer segment. Amortizationexpense decreased $1.2 million due to the fully depreciated Tell Me More trade name at the end of 2014. Commission expense increased $4.5 millionprimarily driven by an increase in Enterprise & Education literacy revenue. In connection with our 2016 strategy, we intend to continue to optimize ourConsumer media and marketing costs and manage the Consumer business for profitability and plan to manage the sales and marketing expenses to drivethese results.Research and Development ExpensesResearch and development expenses were $29.9 million for the year ended December 31, 2015, a decrease of $3.2 million, or 10%, from the year endedDecember 31, 2014. As a percentage of revenue, research and development expenses increased slightly to 14% from 13% for the years ended December 31,2015 and 2014, respectively. The dollar decrease was primarily due to a reduction in payroll and benefits expense of $2.3 million due to the headcountreductions from the 2015 Restructuring Plan, coupled with a $1.2 million reduction in costs associated with the Kids Reading and Kids Storytime projectsthat were released in the second half of 2014 or put on hold in the first half of 2015, respectively. In accordance with our shift in strategy, we continue tofocus our product investment on the development of the Language Learning Suite for Enterprise, a single solution that will integrate our foundations,advantage and advanced English for business products, enhance our reporting and administrator tools and extend our assessment capabilities. We expect tomaintain our current level of investment in our research and development expenses as we address these initiatives.General and Administrative ExpensesGeneral and administrative expenses for the year ended December 31, 2015 were $50.1 million, a decrease of $7.0 million, or 12%, from the year endedDecember 31, 2014. As a percentage of revenue, general and administrative expenses increased slightly to 23% for the year ended December 31, 2015compared to 22% for year ended December 31, 2014. The dollar decrease was primarily due to reductions in payroll and benefits, third party services, baddebt, communications, travel, and other expenses. Payroll and benefits decreased $2.5 million driven by the reduction in headcount related to the 2015Restructuring Plan, lower variable incentive compensation expense due to the reduction in employees, and the absence of LTIP expense as the plan ended in2014, partially offset by increases in severance and stock compensation expenses related to the change in CEO effective April 1, 2015. Third party servicesexpense decreased $1.9 million mainly driven by decreased software and hardware maintenance expenses in 2015. Bad debt expense decreased by $0.8million due to improvements in accounts receivable aging as compared to 2014. Communications expense decreased $0.5 million due to cost savingsidentified related to hosting, network, and telephone charges. Travel expenses decreased $0.5 million as a result of the international trips in support ofacquisition related activities in the first quarter of 2014. We expect our general and administrative expenses to40Table of Contentscontinue to decline as we take steps to reduce costs. Additionally, as a result of shareholder engagement and execution of our accelerated strategy, ourgeneral and administrative expenses may increase in the near term.ImpairmentImpairment expense for the year ended December 31, 2015 was $6.8 million, a decrease of $13.6 million, from the year ended December 31, 2014. Thedecrease was primarily attributable to a $20.2 million goodwill impairment charge related to our Consumer business during 2014, partially offset by a $5.6million goodwill impairment charge related to our Consumer Fit Brains reporting unit and 2015 impairment charges of $1.1 million, primarily related to theabandonment of certain previously capitalized internal-use software projects.Lease Abandonment and TerminationLease abandonment and termination expenses for the year ended December 31, 2015 were $0.1 million, compared to $3.8 million for the year endedDecember 31, 2014. The decrease was attributable to the 2014 lease abandonment of the sixth floor space in the Arlington, VA office of $3.2 million, as wellas the closure of the Japan office resulting in lease abandonment costs of $0.4 million.Other Income and (Expense) Year ended December 31, 2015 versus 2014 2015 2014 Change % Change (in thousands, except percentages)Interest income $23 $17 $6 35.3%Interest expense (378) (233) (145) 62.2%Other expense (1,469) (1,129) (340) 30.1%Total other income and (expense) $(1,824) $(1,345) $(479) 35.6%Interest income for the year ended December 31, 2015 was $23 thousand, a slight increase from the year ended December 31, 2014. Interest incomerepresents interest earned on our cash and cash equivalents.Interest expense for the year ended December 31, 2015 was $0.4 million, an increase of $0.1 million, from the year ended December 31, 2014. Thisincrease was primarily attributable to interest on our capital leases and the recognition of our financing fees associated with our undrawn credit facility.Other expense for the year ended December 31, 2015 was $1.5 million, an increase of $0.3 million, as compared to $1.1 million for the year endedDecember 31, 2014. The fluctuation was primarily attributable to foreign exchange losses, partially offset by the divestiture of our Korea entity of $0.7million.Income Tax Expense (Benefit) Year ended December 31, 2015 versus 2014 2015 2014 Change % Change (in thousands, except percentages)Income tax expense (benefit) $1,159 $(6,489) $7,648 (117.9)%Our income tax expense for the year ended December 31, 2015 was $1.2 million, compared to income tax benefit of $6.5 million for the year endedDecember 31, 2014. The tax expense was due to current year taxable income from our operations in Germany and the UK, the tax impact of the amortizationof indefinite lived intangibles, and the inability to recognize tax benefits associated with current year losses of operations in all other foreign jurisdictionsand in the U.S. due to the valuation allowance recorded against the deferred tax asset balances of these entities. These tax expenses were partially offset bytax benefits related to current year losses (excluding the Consumer Fit Brains goodwill impairment) in Canada. The goodwill that was impaired in 2015 wasnot deductible for tax. Additionally, tax benefits were recorded related to the reversal of accrued withholding taxes as a result of an intercompany transaction.For the year ended December 31, 2015, we incurred an income tax expense of $1.2 million based on losses before taxes of $45.6 million resulting in aworldwide effective tax rate of approximately (2.5)%.41Table of ContentsComparison of the Year Ended December 31, 2014 and the Year Ended December 31, 2013Our total revenue decreased to $261.9 million for the year ended December 31, 2014 from $264.6 million for the year ended December 31, 2013. Thechange in total revenue was due to decreases in Consumer revenues of $27.3 million, partially offset by an increase in Enterprise & Education revenues of$24.5 million.We reported an operating loss of $78.9 million for the year ended December 31, 2014 compared to an operating loss of $18.4 million for the year endedDecember 31, 2013. The increase in operating loss was due to a decrease in gross profit of $10.1 million, driven by a $2.8 million decrease in revenue and a$7.3 million increase in cost of revenue. Operating expenses increased $50.3 million due to increases of $27.1 million in sales and marketing, $0.7 million ingeneral and administrative, $20.3 million in impairment expenses, and $3.0 million in lease abandonment, offset slightly by a decrease of $0.8 million inresearch and development expenses.Revenue by Operating SegmentDuring 2014 and 2013, we had three operating segments: North America Consumer, Rest of World Consumer, and Global Enterprise & Education. In2015, the North America Consumer and Rest of World Consumer operating segments were combined into a single Consumer operating segment. Thefollowing table sets forth revenue under the 2015 operating segment structure for our two operating segments for the years ended December 31, 2014 and2013: Year ended December 31, 2014 versus 2013 2014 2013 Change % Change (in thousands, except percentages) Enterprise & Education $84,700 32.3% $60,209 22.8% $24,491 40.7 %Consumer 177,153 67.7% 204,436 77.2% (27,283) (13.3)%Total Revenue $261,853 100.0% $264,645 100.0% $(2,792) (1.1)%Enterprise & Education revenue increased $24.5 million, or 41%, from $60.2 million for the year ended December 31, 2013 to $84.7 million for theyear ended December 31, 2014. Enterprise & Education language revenue increased $9.9 million, $3.7 million, $1.4 million, and $1.2 million in France, theU.S., Germany, and the UK, respectively, primarily due to the sales of learning solutions acquired in 2014. Enterprise & Education literacy revenue increased$8.7 million from Lexia, which was acquired on August 1, 2013. We have seen a decline in renewal rates from existing Enterprise & Education languagecustomers while Enterprise & Education language bookings are increasing, primarily due to the sales of multi-year deals. With Enterprise & Educationlanguage bookings increasing, we expect to see an increase in bookings from new customers, which has a higher cost of acquisition when compared to therenewal of an existing customer.Consumer revenue decreased $27.3 million, or 13%, from the year ended December 31, 2013 to the year ended December 31, 2014. This decrease waslargely due to reductions in revenue from our global retail, direct-to-consumer, and kiosk sales channels of $13.8 million, $11.0 million, and $5.2 million,respectively; partially offset by an increase of approximately $2.6 million in revenue from Fit Brains. The decrease in our global retail sales channel was dueto certain of our larger retail partners significantly reducing inventory levels during 2014, resulting in fewer units ordered and lower revenue compared to theprior year. In the second quarter of 2013 we closed our entire kiosk sales channel. In recent quarters we have focused on driving customers to purchasethrough our direct-to-consumer channel, particularly through our website. Lower pricing is one tactic we used to increase sales volume in this channel. Theoverall decrease in pricing combined with the closure of our U.S. kiosks resulted in lower sales. In January 2014, we announced plans to streamline our Japanand Korea operations and use a partner model to continue to serve the Japanese market and have reorganized our Korea operations to focus more directly onfurther scaling the Proctor Assisted Learning (“PAL”) sales channel. As a result of our strategic realignment and our focus on the needs of more passionatelearners, we plan to stabilize the price of our Consumer offerings and expect that this will result in lower unit volumes and overall lower sales.42Table of ContentsRevenue by Product Revenue and Subscription and Service RevenueThe following table sets forth revenue for products and subscription and services for the years ended December 31, 2014 and 2013: Year ended December 31, 2014 versus 2013 2014 2013 Change % Change (in thousands, except percentages) Product revenue $136,251 52.0% $156,792 59.2% $(20,541) (13.1)%Subscription and service revenue 125,602 48.0% 107,853 40.8% 17,749 16.5 %Total revenue $261,853 100.0% $264,645 100.0% $(2,792) (1.1)%Product RevenueProduct revenue decreased $20.5 million, or 13%, to $136.3 million during the year ended December 31, 2014 from $156.8 million during the yearended December 31, 2013. Product revenue primarily decreased $11.6 million, $6.2 million and $3.7 million in the global retail, direct-to-consumer, andkiosk sales channels, respectively. This was partially offset by an increase of $1.8 million in the corporate sales channel. The decrease in product revenue wasdriven by lower prices on our Rosetta Stone language-learning product software bundle driven by promotional pricing in our Consumer segment, increasedlevels of daily deals, and a shift in our sales channel mix.Subscription and Service RevenueSubscription and service revenue increased $17.7 million, or 16%, to $125.6 million for the year ended December 31, 2014. The increase insubscription and service revenues was due to increases of $13.9 million in the education sales channel, $9.0 million in the corporate channel, and $2.6million related to Fit Brains. These increases were partially offset by decreases of $4.8 million, $2.6 million and $1.5 million in Consumer service revenuesfor the direct-to-consumer, global retail, and kiosk sales channels, respectively.Cost of Product Revenue and Subscription and Service Revenue and Gross ProfitThe following table sets forth cost of product revenue and subscription and service revenue, as well as gross profit for the years ended December 31,2014 and 2013: Year Ended December 31, 2014 versus 2013 2014 2013 Change % Change (in thousands, except percentages)Revenue Product $136,251 $156,792 $(20,541) (13.1)%Subscription and service 125,602 107,853 17,749 16.5 %Total revenue 261,853 264,645 (2,792) (1.1)%Cost of revenue Cost of product revenue 34,192 32,191 2,001 6.2 %Cost of subscription and service revenue 18,862 13,523 5,339 39.5 %Total cost of revenue 53,054 45,714 7,340 16.1 %Gross profit $208,799 $218,931 $(10,132) (4.6)%Gross margin percentages 79.7% 82.7% (3.0)% Cost of Product RevenueCost of product revenue for the year ended December 31, 2014 was $34.2 million, an increase of $2.0 million, or 6% from the year ended December 31,2013. As a percentage of product revenue, cost of product revenue increased to 25% from 20% for the year ended December 31, 2014 compared to the prioryear period. The increase in cost as a percentage of revenue was primarily attributable to a decline in the price per unit combined with an increase in thevolume of units sold. The dollar increase in cost of product was primarily due to increased payroll and benefits as a result of the acquisitions that occurredduring the first quarter of 2014.43Table of ContentsCost of Subscription and Service RevenueCost of subscription and service revenue for the year ended December 31, 2014 was $18.9 million, an increase of $5.3 million, or 39% from the yearended December 31, 2013. As a percentage of subscription and service revenue, cost of subscription and service revenue increased to 15% from 13% for theyear ended December 31, 2014 compared to the prior year period. The dollar increase in cost of subscription and service revenue was due to increased payrolland benefits, primarily as a result of the acquisitions that occurred during the first quarter of 2014 and second and third quarters of 2013. There was anincrease in hosting expense due to the support of additional companies and a transition to cloud-based platforms. An increase in depreciation andamortization on acquired intangible assets also contributed to the overall increase in cost of subscription and service revenue.Operating Expenses Year ended December 31, 2014 versus 2013 2014 2013 Change % Change (in thousands, except percentages)Sales and marketing $173,208 $146,104 $27,104 18.6 %Research and development 33,176 33,995 (819) (2.4)%General and administrative 57,120 56,432 688 1.2 %Impairment 20,333 — 20,333 100.0 %Lease abandonment and termination 3,812 842 2,970 352.7 %Total operating expenses $287,649 $237,373 $50,276 21.2 %Sales and Marketing ExpensesSales and marketing expenses for the year ended December 31, 2014 were $173.2 million, an increase of $27.1 million, or 19%, from the year endedDecember 31, 2013. As a percentage of total revenue, sales and marketing expenses were 66% for the year ended December 31, 2014, and 55% for the yearended December 31, 2013. The dollar and percentage increases in sales and marketing expenses were primarily attributable to a $11.0 million increase inmedia expense due to increased Internet and social media marketing campaigns, partially offset by decreased spend in television and print as onlinemarketing was determined to be more cost-effective. Increased marketing expenses of $4.9 million related to the "millennial" advertising campaign usingnewly developed creative which runs across television, videos and our website, the new 2014 online chat support services feature, and an increase in generalmedia expenses to drive visits, leads and bookings. In 2014 there was a $5.4 million increase in payroll and a $1.6 million increase in benefits expenses as aresult of our acquisitions. In addition, there was a $5.5 million increase in commission expense mainly driven from the increased sales in the Enterprise &Education segment, slightly offset by a decrease in commission expense for the Consumer segment. There was a $1.5 million increase in third party servicesdriven from new social media monitoring services, increased email messaging and related overage fees. Additionally, there was a $2.0 million increase indepreciation and amortization on acquired intangible assets. These increases were partially offset by a $2.3 million decrease in professional services drivenfrom decreased spend in call centers, $1.9 million decrease in rent and related lease termination expenses due to the closure of the remaining kiosks in thesecond quarter of 2013, and removal of kiosk staffing support that did not recur in 2014.Research and Development ExpensesResearch and development expenses were $33.2 million for the year ended December 31, 2014, a decrease of $0.8 million, or 2%, from the year endedDecember 31, 2013. As a percentage of revenue, research and development expenses remained flat at 13% for the years ended December 31, 2014 and 2013.The dollar decrease was primarily attributable to a $2.9 million decrease in payroll expense due to the increased level of capitalized labor costs associatedwith the development of new service offerings and a decrease in severance compensation expenses driven from the software development team re-organization during the year ended December 31, 2013. An additional $0.5 million decrease of research and development expenses was driven from thereduction of relocation expense related to the hiring of a new software development team in 2013. These decreases were partially offset by a $0.7 millionincrease in benefits due to the additional employee costs as a result of the acquisitions, a $1.5 million increase in amortization expense related to acquiredintangible assets, and a $0.5 million increase in rent expense due to the opening of new offices in Austin, TX and San Francisco, CA, and taking over leasesthrough acquisitions in various locations, including Seattle, WA and Concord, MA.44Table of ContentsGeneral and Administrative ExpensesGeneral and administrative expenses for the year ended December 31, 2014 were $57.1 million, an increase of $0.7 million, or 1%, from the year endedDecember 31, 2013. As a percentage of revenue, general and administrative expenses increased to 22% for the year ended December 31, 2014 compared to21% for year ended December 31, 2013. The dollar and percentage increases were primarily attributable to a $1.3 million increase in building expensesrelated to a Japan office lease termination and higher dues and subscription fees incurred by the human resources and finance groups. The dollar increase wasalso attributable to a $1.0 million increase in bad debt expense driven from increased accounts receivable aging and additional reserves related to acquiredreceivables. In addition, general and administrative expense increased $0.5 million due to increased acquisition related software and systems maintenanceand integration work performed during the year ended December 31, 2014. These increases were partially offset by a $1.3 million decrease in payroll due to adecrease in long-term incentive plan expense and bonus expense as well as a decrease in restricted stock and stock option expenses as a result of the decreasein our stock price during the year ended December 31, 2014. Rent expense also decreased by $0.6 million due to the lease abandonment of the Arlington,Virginia sixth floor lease during early 2014.ImpairmentImpairment expense for the year ended December 31, 2014 was $20.3 million, an increase of $20.3 million, from the year ended December 31, 2013.The increase was primarily attributable to a $20.2 million goodwill impairment charge related to our Consumer Language reporting units taken in 2014. Thegoodwill impairment charges were primarily a result of the decline in demand for Consumer language-learning products and services at their current pricinglevels and a change in international go-to-market strategy. In an effort to compensate for the consumer preferences, we lowered our prices and used retailpartnerships to increase sales. Despite these actions, the results were significantly lower than the forecasted sales. As a result of the above events, weperformed an impairment analysis and determined that the Consumer Language reporting units were fully impaired and recorded goodwill impairmentcharges totaling $20.2 million. The additional $0.2 million of expense related to the abandonment of a previously capitalized internal-use software project.Lease Abandonment and TerminationLease abandonment and termination expenses for the year ended December 31, 2014 were $3.8 million, compared to $0.8 million for the year endedDecember 31, 2013. The increase was primarily attributable to the lease abandonment of the sixth floor space in the Arlington, VA office of $3.2 million, aswell as the closure of the Japan office resulting in lease abandonment costs of $0.4 million.Other Income and (Expense) Year Ended December 31, 2014 versus 2013 2014 2013 Change % Change (in thousands, except percentages)Interest income $17 $117 $(100) (85.5)%Interest expense (233) (61) (172) 282.0 %Other (expense) and income (1,129) 368 (1,497) (406.8)%Total other income and (expense) $(1,345) $424 $(1,769) (417.2)%Interest income represents interest earned on our cash and cash equivalents. Interest income for the year ended December 31, 2014 was $17 thousand, adecrease of $0.1 million, or 85%, from the year ended December 31, 2013.Interest expense for the year ended December 31, 2014 was $0.2 million, an increase of $0.2 million, from the year ended December 31, 2013. Thisincrease was primarily attributable to interest on our capital leases and the amortization of deferred financing fees associated with our revolving creditfacility, which we entered into in November 2014.Other income (expense) for the year ended December 31, 2014 was an expense of $1.1 million, an increase of $1.5 million, as compared to other incomeof $0.4 million for the year ended December 31, 2013. The increase in expense was primarily attributable to foreign exchange losses.45Table of ContentsIncome Tax Benefit Year Ended December 31, 2014 versus 2013 2014 2013 Change % Change (in thousands, except percentages)Income tax benefit $(6,489) $(1,884) $(4,605) 244.4%Our income tax benefit for the year ended December 31, 2014 was $6.5 million, compared to income tax benefit of $1.9 million for the year endedDecember 31, 2013. The change from the prior year primarily resulted from the tax benefits related to the goodwill impairments taken during 2014 related tothe Consumer Language reporting units and current year losses in Canada and France. The goodwill that was written off related to acquisitions from prioryears, a portion of which resulted in a tax benefit as a result of writing off a deferred tax liability previously recorded (i.e., goodwill had tax basis and wasamortized for tax). In the current year, these tax benefit amounts were partially offset by income tax expense related to current year profits from certain foreignoperations and foreign withholding taxes. The tax benefit was also partially offset by the tax expense related to the tax impact of the amortization ofindefinite lived intangibles, and the inability to recognize tax benefits associated with current year losses of operations in all other foreign jurisdictions andin the U.S. due to the valuation allowance recorded against the deferred tax asset balances of these entities.Liquidity and Capital ResourcesOur principal source of liquidity at December 31, 2015 consisted of $47.8 million in cash and cash equivalent and short-term investments, a decrease of$16.9 million, from $64.7 million as of December 31, 2014. Our primary operating cash requirements include the payment of salaries, incentivecompensation, employee benefits and other personnel related costs, as well as direct advertising expenses, costs of office facilities, and costs of informationtechnology systems. Historically, we have primarily funded these requirements through cash flow from our operations. For the year ended December 31,2015, we generated negative cash flows from operations as reflected in our consolidated statements of cash flows.As part of our strategic shift, we have begun and continue to reorganize our business around our Enterprise & Education segment while we optimize ourConsumer segment for profitability and cash generation. Our Enterprise & Education business and our Consumer business are affected by different sales-to-cash patterns. Within our Enterprise & Education segment, revenue in our education, government, and corporate sales channels are seasonally stronger in thesecond half of the calendar year due to purchasing and budgeting cycles. Our Consumer revenue is affected by seasonal trends associated with the holidayshopping season. Consumer sales typically turn to cash more quickly than Enterprise & Education sales, which tend to have longer collection cycles.Historically, in the first half of the year we have been a net user of cash and in the second half of the year we have been a net generator of cash. We expect thistrend to continue. In 2016, we expect our cash balance to decline in part as we execute the restructuring actions in accordance with our revised strategy andother initiatives, as well as anticipated near-term lower operating results.We believe our current cash and cash equivalents, short-term investments, and funds generated from our sales will be sufficient to meet our cash needsfor at least the next twelve months. We have generated significant operating losses as reflected in our accumulated deficit and we may continue to incuroperating losses in the future that may continue to require additional working capital to execute strategic initiatives to grow our business. Our future capitalrequirements will depend on many factors, including development of new products, market acceptance of our products, the levels of advertising andpromotion required to launch additional products and improve our competitive position in the marketplace, the expansion of our sales, support andmarketing organizations, the optimization of office space in the U.S. and worldwide, building the infrastructure necessary to support our growth, the responseof competitors to our products and services, and our relationships with suppliers. We extend payments to certain vendors in order to minimize the amount ofworking capital deployed in the business. In order to maximize our cash position, we will continue to manage our existing inventory, accounts receivable,and accounts payable balances. In addition, borrowings under our revolving credit facility can be utilized to meet working capital requirements, anticipatedcapital expenditures, and other obligations.On October 28, 2014, we entered into a $25.0 million revolving credit Loan and Security Agreement with Silicon Valley Bank, which was amendedeffective March 31, 2015, May 1, 2015, June 29, 2015, December 29, 2015 and further amended effective March 14, 2016. Under the amended agreement, wemay borrow up to $25.0 million including a sub-facility, which reduces available borrowings, for letters of credit in the aggregate availability amount of $4.0million (the "credit facility"). Borrowings by RSL under the credit facility are guaranteed by us as the ultimate parent. The credit facility has a term thatexpires on January 1, 2018, during which time RSL may borrow and re-pay loan amounts and re-borrow the loan amounts subject to customary borrowingconditions.46Table of ContentsThe total obligations under the credit facility cannot exceed the lesser of (i) the total revolving commitment of $25.0 million or (ii) the borrowing base,which is calculated as 80% of eligible accounts receivable. As a result, the borrowing base will fluctuate and we expect it will follow the general seasonalityof cash and accounts receivable (lower in the first half of the year and higher in the second half of the year). If the borrowing base less any outstandingamounts, plus the cash held at SVB ("Availability") is greater than $25.0 million, then we may borrow up to an additional $5.0 million, but in no case canborrowings exceed $25.0 million. Interest on borrowings accrue at the Prime Rate provided that we maintain a minimum cash and Availability balance of$17.5 million. If cash and Availability is below $17.5 million, interest will accrue at the Prime Rate plus 1%.As of the date of this filing, no borrowings have been made under the revolving credit agreement and $4.0 million in letters of credit have been issuedby Silicon Valley Bank on our behalf. We are subject to certain financial and restrictive covenants under the credit facility, which have been amended toreflect the revised outlook in connection with our 2016 Restructuring Plan. We are required to maintain compliance with a minimum liquidity amount andminimum financial performance requirements, as defined in the Loan and Security Agreement. As of December 31, 2015, we were in compliance with all ofthe covenants under the revolving credit agreement.The total amount of cash that was held by foreign subsidiaries as of December 31, 2015 was $15.6 million. If we were to repatriate the cash from ourforeign subsidiaries, a significant tax liability could result.During the last three years, inflation has not had a material effect on our business and we do not expect that inflation or changing prices will materiallyaffect our business in the foreseeable future.Cash Flow Analysis for the Year ended December 31, 2015 as compared to the year ended December 31, 2014 Year ended December 31, 2015 versus 2014 2015 2014 Change % Change (in thousands, except percentages)Net cash (used in) provided by operating activities $(5,645) $6,673 $(12,318) (184.6)%Net cash used in investing activities $(9,374) $(39,109) $29,735 (76.0)%Net cash used in financing activities $(727) $(305) $(422) 138.4 %Net Cash Used In Operating ActivitiesNet cash used in operating activities was $5.6 million for the year ended December 31, 2015 compared to net cash provided by operating activities of$6.7 million for the year ended December 31, 2014. The primary factor affecting our net use of cash from operating activities during the year ended December31, 2015 was our net loss of $46.8 million, which was too large to be offset by the non-cash adjustments totaling $31.1 million and the favorable overallchange in operating assets and liabilities of $10.1 million. For a summary of the factors that led to the net loss for the year ended December 31, 2015 see"Results of Operations" section above. Non-cash items primarily consisted of $13.7 million in depreciation and amortization expense, $7.2 million in stock-based compensation expense, $6.8 million in impairment loss, $1.7 million in bad debt expense, and $1.5 million of loss on foreign currency transactions.The primary drivers of the change in operating assets and liabilities were a decrease in other current liabilities of $14.2 million, a decrease of $8.6 million inaccounts payable, a decrease in accrued compensation of $5.5 million, an increase in deferred sales commissions of $4.1 million, and an increase of $1.3million in inventory, partially offset by a decrease in accounts receivable of $26.4 million and an increase of $16.9 million in deferred revenue. The decreasein other current liabilities and accounts payable reflected our shift in strategy, which resulted in fewer obligations due for marketing, advertising, and rebates.The decrease in accrued compensation was primarily attributable to the 2015 Restructuring Plan, which reduced global non-Enterprise & Educationheadcount approximately 15% and led to a reduction in payroll, benefits, and variable compensation. The increase in deferred sales commission wasprimarily attributable to the 2014 acquisitions and an increase in Lexia deferred commissions. Inventory increased due to missed forecasts on holiday seasonsales orders resulting in additional inventory on hand. The decrease in accounts receivable was primarily related to the higher sales during the fourth quarter2014 holiday season as compared to 2015. The increase in deferred revenue was primarily to a higher mix of Consumer revenue associated with web-basedsoftware subscription services and to a lesser extent the purchase accounting impacts related to the 2014 acquisitions.Net cash provided by operating activities for the year ended December 31, 2014 was $6.7 million. The primary factors affecting our operating cashflows during the year were our net loss of $73.7 million, which were offset by non-cash charges totaling $37.1 million, and a favorable overall change inoperating assets and liabilities of $43.3 million. Non-cash items primarily consisted of $20.3 million in impairment loss, $13.9 million in depreciation andamortization expense, $6.8 million in stock-based compensation expense, and $2.4 million in bad debt expense, only slightly offset by a deferred income taxbenefit47Table of Contentsof $7.7 million. The primary drivers of the change in operating assets and liabilities were an increase of $48.9 million in deferred revenue, an increase in othercurrent liabilities of $11.3 million, and an increase of $8.4 million in accounts payable, partially offset by an increase in accounts receivable of $16.5million, an increase in deferred sales commissions of $7.3 million, and a decrease in accrued compensation of $4.5 million. The increase in deferred revenuewas primarily due to the purchase accounting impacts related to the 2014 acquisitions that did not exist in 2013. The increases in other current liabilities andaccounts payable was primarily attributable to the timing of our cash payments. The increase in accounts receivable was primarily related to the higher salesduring the fourth quarter 2014 holiday season as compared to 2013. The increase in deferred sales commission was primarily attributable to the 2014acquisitions that did not exist in 2013. The decrease in accrued compensation was primarily due to the reduction of payroll, benefits, and the timing of cashpayments.Net Cash Used in Investing ActivitiesNet cash used in investing activities was $9.4 million for the year ended December 31, 2015, compared to net cash used of $39.1 million for the yearended December 31, 2014. Net cash used in investing activities decreased primarily due to the 2014 acquisition related cash outflows of $29.4million pertaining to the acquisitions of Tell Me More and Vivity during the first quarter of 2014. In the first quarter of 2015, we paid the remainingholdback of $1.7 million related to the 2013 acquisition of Lexia. Purchases of property and equipment decreased from $9.7 million for the year endedDecember 31, 2014 to $8.9 million for the year ended December 31, 2015 primarily due to the reduction of internal-use software capitalization due to thecompletion and go-live of a major software project in late 2015. Proceeds from the sale of fixed assets totaled $1.6 million during the year ended December31, 2015 associated with the fourth quarter 2015 sale of an owned office building in Harrisonburg, Virginia, with no comparable activity in 2014.Net Cash Used in Financing ActivitiesNet cash used in financing activities was $0.7 million for the year ended December 31, 2015 compared to $0.3 million for the year ended December 31,2014. The decrease in net cash related to financing activities was primarily due to the decrease in proceeds from the exercise of stock options of $0.6million due to the decrease in our stock price. Capital lease payments totaled $0.7 million and $0.6 million during the years ended December 31,2015 and 2014, respectively. Deferred financing costs were larger in 2014 due to the original execution of the revolving credit facility in the fourth quarter of2014. Deferred financing fees continued to be incurred during 2015 due to the execution of the four amendments discussed above. As mentioned earlier, noborrowings have been made under the revolving credit facility.Cash Flow Analysis for the Year ended December 31, 2014 as compared to the year ended December 31, 2013 Year Ended December 31, 2014 versus 2013 2014 2013 Change % Change (in thousands, except percentages)Net cash provided by operating activities $6,673 $8,068 $(1,395) (17.3)%Net cash used in investing activities $(39,109) $(46,930) $7,821 (16.7)%Net cash used in financing activities $(305) $(10,487) $10,182 (97.1)%Net Cash Provided by Operating ActivitiesNet cash provided by operating activities was $6.7 million for the year ended December 31, 2014 compared to $8.1 million for the year endedDecember 31, 2013, a decrease of $1.4 million. The decrease in net cash provided by operating activities was primarily due to an increase in our net loss afteradjusting for depreciation, amortization, stock compensation, loss on foreign currency transactions, bad debt expense, deferred income taxes, loss on disposalof equipment, amortization of debt issuance costs, and loss on impairment. This was partially offset by favorable fluctuations in working capital, primarilydeferred revenue of $48.9 million which is principally due to the sales of subscription services in our Global Enterprise & Education language and literacysales channels and Fit Brains.Net Cash Used in Investing ActivitiesNet cash used in investing activities was $39.1 million for the year ended December 31, 2014, compared to net cash used of $46.9 million for the yearended December 31, 2013, a decrease of $7.8 million. Net cash used by investing activities related primarily to the $41.7 million for the 2014 acquisitions(net of cash) of Vivity and Tell Me More, a decrease in restricted cash related to the Vivity acquisition of $12.3 million, and $9.7 million in purchase ofproperty and equipment primarily associated with capitalized labor for internal-use software development.48Table of ContentsNet Cash Used in Financing ActivitiesNet cash used in financing activities was $0.3 million for the year ended December 31, 2014 compared to cash used in financing activities of $10.5million for the year ended December 31, 2013. Net cash used in financing activities during the year ended December 31, 2014 was primarily due to paymentsmade under capital lease obligations of $0.6 million and payment of debt issuance costs of $0.4 million, offset by net cash provided of $0.7 million from theexercise of stock options.Off-Balance Sheet ArrangementsWe do not engage in any off-balance sheet financing arrangements. We do not have any material interest in entities referred to as variable interestentities, which include special purpose entities and other structured finance entities.Contractual ObligationsAs discussed in Notes 9 and 16 of Item 8, Financial Statements and Supplementary Data, we lease buildings, parking spaces, equipment, and officespace under operating lease agreements. We also lease certain equipment, software and a building near Versailles, France under capital lease agreements. Thefollowing table summarizes our future minimum rent payments under non-cancellable operating and capital lease agreements as of December 31, 2015 andthe effect such obligations are expected to have on our liquidity and cash flow in future periods. Total Less than1 Year 1-3 Years 3-5 Years More than5 Years (in thousands)Capitalized leases and other financing arrangements $3,621 $644 $1,138 $984 $855Operating leases 16,592 5,591 8,196 2,215 590Total $20,213 $6,235 $9,334 $3,199 $1,445Item 7A. Quantitative and Qualitative Disclosures About Market RiskForeign Currency Exchange RiskThe functional currency of our foreign subsidiaries is their local currency. Accordingly, our results of operations and cash flows are subject tofluctuations due to changes in foreign currency exchange rates. The volatility of the prices and applicable rates are dependent on many factors that we cannotforecast with reliable accuracy. In the event our foreign sales and expenses increase, our operating results may be more greatly affected by fluctuations in theexchange rates of the currencies in which we do business. At this time we do not, but we may in the future, invest in derivatives or other financial instrumentsin an attempt to hedge our foreign currency exchange risk.Interest Rate SensitivityInterest income and expense are sensitive to changes in the general level of U.S. interest rates. However, based on the nature and current level of ourmarketable securities, which are primarily short-term investment grade and government securities and our notes payable, we believe that there is no materialrisk of exposure.Credit RiskAccounts receivable and cash and cash equivalents present the highest potential concentrations of credit risk. We reserve for credit losses and do notrequire collateral on our trade accounts receivable. In addition, we maintain cash and investment balances in accounts at various banks and brokerage firms.We have not experienced any losses on cash and cash equivalent accounts to date. We sell products to retailers, resellers, government agencies, andindividual consumers and extend credit based on an evaluation of the customer's financial condition, without requiring collateral. Exposure to losses onaccounts receivable is principally dependent on each customer's financial condition. We monitor exposure for credit losses and maintain allowances foranticipated losses. We maintain trade credit insurance for certain customers to provide coverage, up to a certain limit, in the event of insolvency of somecustomers.Item 8. Financial Statements and Supplementary DataOur consolidated financial statements, together with the related notes and the report of independent registered public accounting firm, are set forth onthe pages indicated in Item 15.49Table of ContentsItem 9. Changes In and Disagreements with Accountants on Accounting and Financial DisclosureNone.Item 9A. Controls and ProceduresEvaluation of Disclosure Controls and ProceduresManagement, with the participation of our Interim Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosurecontrols and procedures as of December 31, 2015. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended (the "Exchange Act"), means controls and other procedures of a company that are designed to ensure thatinformation required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized andreported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls andprocedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act isaccumulated and communicated to the Company's management, including its principal executive and principal financial officers, as appropriate to allowtimely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, canprovide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationshipof possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of December 31, 2015, our Interim Chief ExecutiveOfficer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.Management's annual report on internal control over financial reportingManagement is responsible for establishing and maintaining adequate internal control over our financial reporting. Management has assessed theeffectiveness of internal control over financial reporting as of December 31, 2015. Management's assessment was based on criteria set forth by the Committeeof Sponsoring Organizations of the Treadway Commission, or COSO, in Internal Control—Integrated Framework (2013).Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting andthe preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financialreporting includes those policies and procedures that:(1)pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect our transactions and dispositions of our assets;(2)provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generallyaccepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of management andBoard of Directors; and(3)provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could havea material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of anyevaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degreeof compliance with the policies or procedures may deteriorate.Based on using the COSO criteria, management believes our internal control over financial reporting as of December 31, 2015 was effective.Our independent registered public accounting firm, Deloitte & Touche LLP, has audited the financial statements included in this Annual Report onForm 10-K and has issued a report on the effectiveness of our internal control over financial reporting. The attestation report of Deloitte & Touche LLP isincluded on page F-3 of this Form 10-K.Changes in Internal Control over Financial ReportingThere was no change in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) or 15d-15(d) of the Exchange Act that occurred during the quarter ended December 31, 2015 that had materially affected, or is reasonably likely to materially affect,our internal control over financial reporting.50Table of ContentsItem 9B. Other InformationNone.51Table of ContentsPART IIICertain information required by Part III is omitted from this Annual Report on Form 10-K as we intend to file our definitive Proxy Statement for the2016 Annual Meeting of Stockholders pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, not later than 120 days after the endof the fiscal year covered by this Annual Report, and certain information included in the Proxy Statement is incorporated herein by reference. Item 10. Directors, Executive Officers and Corporate GovernanceThe information required by this Item is incorporated herein by reference to the information provided under the headings "Our Board of Directors andNominees," "Security Ownership of Certain Beneficial Owners and Management—Section 16(A) Beneficial Ownership Reporting Compliance," "CorporateGovernance—Code of Ethics," "Corporate Governance—Composition of our Board of Directors; Classified Board," "Corporate Governance—Committees ofour Board of Directors," "Corporate Governance—Audit Committee," "Corporate Governance—Compensation Committee," and "Corporate Governance—Corporate Governance and Nominating Committee" in our definitive proxy statement for the 2016 Annual Meeting of Stockholders to be filed with the SECno later than 120 days after the fiscal year ended December 31, 2015 (the "2016 Proxy Statement").Code of Ethics and Business ConductWe have adopted a code of ethics and business conduct ("code of conduct") that applies to all of our employees, officers and directors, includingwithout limitation our principal executive officer, principal financial officer, and principal accounting officer. Copies of both the code of conduct, as well asany waiver of a provision of the code of conduct granted to any senior officer or director or material amendment to the code of conduct, if any, are available,without charge, under the "Corporate Governance" tab of the "Investor Relations" section on our website at www.rosettastone.com. We intend to disclose anyamendments or waivers of this code on our website.Item 11. Executive CompensationThe information required by this Item is incorporated herein by reference to the information provided under the headings "Compensation CommitteeReport," "Executive Compensation," "Director Compensation," "Compensation Committee" and "Corporate Governance—Interlocks and InsiderParticipation" in the 2016 Proxy Statement.Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersThe information required by this Item is incorporated herein by reference to the information provided under the headings "Security Ownership ofCertain Beneficial Owners and Management" and "Equity Compensation" in the 2016 Proxy Statement.Item 13. Certain Relationships and Related Transactions, and Director IndependenceThe information required by this Item is incorporated herein by reference to the information provided under the headings "Corporate Governance—Director Independence," and "Transactions with Related Persons" in the 2016 Proxy Statement.Item 14. Principal Accounting Fees and ServicesThe information required by this Item is incorporated herein by reference to the information provided under the heading "Principal Accountant Feesand Services" in the 2016 Proxy Statement.52Table of ContentsPART IVItem 15. Exhibits and Financial Statement Schedules(a)Consolidated Financial Statements1.Consolidated Financial Statements. The consolidated financial statements as listed in the accompanying "Index to ConsolidatedFinancial Information" are filed as part of this Annual Report.2.Consolidated Financial Statement Schedules. Schedules have been omitted because they are not applicable or are not required or theinformation required to be set forth in those schedules is included in the consolidated financial statements or related notes.All other schedules not listed in the accompanying index have been omitted as they are either not required or not applicable, or the requiredinformation is included in the consolidated financial statements or the notes thereto.(b)ExhibitsThe exhibits listed in the Index to Exhibits are filed as part of this Annual Report on Form 10-K.53Table of ContentsSIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.ROSETTA STONE INC.By: /s/ A. JOHN HASS III A. John Hass IIIInterim Chief Executive OfficerDate: March 14, 2016 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.Signature TitleDate /s/ A. JOHN HASS III Chief Executive Officer and Director(Principal Executive Officer)March 14, 2016A. John Hass III /s/ THOMAS M. PIERNO Chief Financial Officer(Principal Financial Officer)March 14, 2016Thomas M. Pierno /s/ M. SEAN HARTFORD Vice President, Controller and Principal AccountingOfficer(Principal Accounting Officer)March 14, 2016M. Sean Hartford /s/ PATRICK W. GROSS Chairman of the Board, DirectorMarch 14, 2016Patrick W. Gross /s/ JAMES P. BANKOFF DirectorMarch 14, 2016James P. Bankoff /s/ LAURENCE FRANKLIN DirectorMarch 14, 2016Laurence Franklin /s/ DAVID P. NIERENBERG DirectorMarch 14, 2016David P. Nierenberg /s/ CAROLINE J. TSAY DirectorMarch 14, 2016Caroline J. Tsay /s/ LAURA L. WITT DirectorMarch 14, 2016Laura L. Witt /s/ STEVEN P. YANKOVICH DirectorMarch 14, 2016Steven P. Yankovich 54Table of ContentsINDEX TO CONSOLIDATED FINANCIAL STATEMENTS PageReports of Independent Registered Public Accounting FirmF-2Consolidated Balance SheetsF-4Consolidated Statements of OperationsF-5Consolidated Statements of Comprehensive LossF-6Consolidated Statements of Changes in Stockholders' EquityF-7Consolidated Statements of Cash FlowsF-8Notes to Consolidated Financial StatementsF-9F-1Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo the Board of Directors and Stockholders ofRosetta Stone Inc.Arlington, VirginiaWe have audited the accompanying consolidated balance sheets of Rosetta Stone Inc. and subsidiaries (the "Company") as of December 31, 2015 and 2014,and the related consolidated statements of operations, comprehensive loss, changes in stockholders' equity, and cash flows for each of the three years in theperiod ended December 31, 2015. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinionon the financial statements based on our audits.We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our auditsprovide a reasonable basis for our opinion.In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Rosetta Stone Inc. and subsidiaries as ofDecember 31, 2015 and 2014, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2015, inconformity with accounting principles generally accepted in the United States of America.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal controlover financial reporting as of December 31, 2015, based on the criteria established in Internal Control - Integrated Framework (2013) issued by theCommittee of Sponsoring Organizations of the Treadway Commission and our report dated March 14, 2016 expressed an unqualified opinion on theCompany's internal control over financial reporting./s/ Deloitte & Touche LLPMcLean, VirginiaMarch 14, 2016 F-2Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo the Board of Directors and Stockholders ofRosetta Stone Inc.Arlington, VirginiaWe have audited the internal control over financial reporting of Rosetta Stone Inc. and subsidiaries (the “Company”) as of December 31, 2015, based oncriteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness ofinternal control over financial reporting, included in the accompanying Management’s annual report on internal control over financial reporting. Ourresponsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require thatwe plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all materialrespects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testingand evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considerednecessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principalfinancial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to providereasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance withgenerally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management anddirectors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition ofthe company's assets that could have a material effect on the financial statements.Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override ofcontrols, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of theeffectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because ofchanges in conditions, or that the degree of compliance with the policies or procedures may deteriorate.In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on thecriteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financialstatements as of and for the year ended December 31, 2015 of the Company and our report dated March 14, 2016 expressed an unqualified opinion on thoseconsolidated financial statements./s/ Deloitte & Touche LLPMcLean, VirginiaMarch 14, 2016F-3Table of ContentsROSETTA STONE INC.CONSOLIDATED BALANCE SHEETS(in thousands, except per share amounts) As of December 31, 2015 2014 *Assets Current assets: Cash and cash equivalents $47,782 $64,657Restricted cash 80 123Accounts receivable (net of allowance for doubtful accounts of $1,196 and $1,434, at December 31, 2015 andDecember 31, 2014, respectively) 47,327 76,757Inventory 7,333 6,500Deferred sales commissions 13,526 10,740Prepaid expenses and other current assets 3,612 4,842Income tax receivable — 464Total current assets 119,660 164,083Deferred sales commissions 5,614 4,362Property and equipment, net 22,532 25,277Goodwill 50,280 58,584Intangible assets, net 28,244 34,377Other assets 2,213 1,490Total assets $228,543 $288,173Liabilities and stockholders' equity Current liabilities: Accounts payable $10,778 $19,548Accrued compensation 8,201 14,470Income tax payable 121 —Obligations under capital lease 521 594Other current liabilities 35,318 53,258Deferred revenue 106,868 95,240Total current liabilities 161,807 183,110Deferred revenue 35,880 32,929Deferred income taxes 4,998 4,222Obligations under capital lease 2,622 3,154Other long-term liabilities 826 1,313Total liabilities 206,133 224,728Commitments and contingencies (Note 16) Stockholders' equity: Preferred stock, $0.001 par value; 10,000 and 10,000 shares authorized, zero and zero shares issued and outstanding atDecember 31, 2015 and December 31, 2014, respectively — —Non-designated common stock, $0.00005 par value, 190,000 and 190,000 shares authorized, 23,150 and 22,936 sharesissued and 22,150 and 21,936 shares outstanding at December 31, 2015 and December 31, 2014, respectively 2 2Additional paid-in capital 185,863 178,554Treasury stock (11,435) (11,435)Accumulated loss (149,794) (102,998)Accumulated other comprehensive loss (2,226) (678)Total stockholders' equity 22,410 63,445Total liabilities and stockholders' equity $228,543 $288,173 See accompanying notes to consolidated financial statements* Certain amounts have been adjusted for the retrospective adoption of Accounting Standard Update No. 2015-17 (See Note 2)F-4Table of ContentsROSETTA STONE INC.CONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except per share amounts) Years Ended December 31, 2015 2014 2013Revenue: Product $65,969 $136,251 $156,792Subscription and service 151,701 125,602 107,853Total revenue 217,670 261,853 264,645Cost of revenue: Cost of product revenue 16,898 34,192 32,191Cost of subscription and service revenue 21,629 18,862 13,523Total cost of revenue 38,527 53,054 45,714Gross profit 179,143 208,799 218,931Operating expenses Sales and marketing 136,084 173,208 146,104Research and development 29,939 33,176 33,995General and administrative 50,124 57,120 56,432Impairment 6,754 20,333 —Lease abandonment and termination 55 3,812 842Total operating expenses 222,956 287,649 237,373Loss from operations (43,813) (78,850) (18,442)Other income and (expense): Interest income 23 17 117Interest expense (378) (233) (61)Other (expense) income (1,469) (1,129) 368Total other income and (expense) (1,824) (1,345) 424Loss before income taxes (45,637) (80,195) (18,018)Income tax expense (benefit) 1,159 (6,489) (1,884)Net loss $(46,796) $(73,706) $(16,134)Loss per share: Basic $(2.17) $(3.47) $(0.75)Diluted $(2.17) $(3.47) $(0.75)Common shares and equivalents outstanding: Basic weighted average shares 21,571 21,253 21,528Diluted weighted average shares 21,571 21,253 21,528 See accompanying notes to consolidated financial statementsF-5Table of ContentsROSETTA STONE INC.CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS(in thousands) Years Ended December 31, 2015 2014 2013Net loss $(46,796) $(73,706) $(16,134)Other comprehensive loss, net of tax: Foreign currency translation (loss) gain (1,548) (1,523) 188Other comprehensive (loss) income (1,548) (1,523) 188Comprehensive loss $(48,344) $(75,229) $(15,946)See accompanying notes to consolidated financial statementsF-6Table of ContentsROSETTA STONE INC.CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY(in thousands) Non-DesignatedCommon Stock AccumulatedOtherComprehensiveIncome (Loss) TotalStockholders'Equity(Deficit) AdditionalPaid-inCapital Treasury Stock AccumulatedIncome (Loss) Shares Amount Balance—January 1, 2013 21,188 $2 $160,693 $— $(13,158) $657 $148,194Stock Issued Upon the Exercise ofStock Options 550 — 2,457 — — — 2,457Restricted Stock Award Vesting 301 — — — — — —Stock-based CompensationExpense — — 9,241 — — — 9,241Repurchase of Stock OptionExercised (123) — (1,040) — — — (1,040)Sale of Shares in SecondaryOffering 10 — 160 — — — 160Secondary Offering Costs — — (388) — — — (388)Purchase of Treasury Stock (1,000) — — (11,435) — — (11,435)Net loss — — — — (16,134) — (16,134)Other comprehensive income — — — — — 188 188Balance—December 31, 2013 20,926 $2 $171,123 $(11,435) $(29,292) $845 $131,243Stock Issued Upon the Exercise ofStock Options 116 — 669 — — — 669Restricted Stock Award Vesting 287 — — — — — —Stock-based CompensationExpense — — 6,762 — — — 6,762Net loss — — — — (73,706) — (73,706)Other comprehensive loss — — — — — (1,523) (1,523)Balance—December 31, 2014 21,329 $2 $178,554 $(11,435) $(102,998) $(678) $63,445Stock Issued Upon the Exercise ofStock Options 25 — 114 — — — 114Restricted Stock Award Vesting 452 — — — — — —Stock-based CompensationExpense — — 7,195 — — — 7,195Net loss — — — — (46,796) — (46,796)Other comprehensive loss — — — — — (1,548) (1,548)Balance—December 31, 2015 21,806 $2 $185,863 $(11,435) $(149,794) $(2,226) $22,410 See accompanying notes to consolidated financial statementsF-7Table of ContentsROSETTA STONE INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands) Years Ended December 31, 2015 2014 2013CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(46,796) $(73,706) $(16,134)Adjustments to reconcile net loss to cash (used in) provided by operating activities: Stock-based compensation expense 7,195 6,762 9,241Loss (gain) on foreign currency transactions 1,471 1,171 —Bad debt expense 1,657 2,405 1,420Depreciation and amortization 13,660 13,904 9,635Deferred income tax expense (benefit) 849 (7,667) (3,869)(Gain) loss on disposal of equipment (15) 184 278Amortization of deferred financing costs 160 21 —Loss on impairment 6,754 20,333 —Loss from equity method investments 23 — —Gain on divestiture of subsidiary (660) — —Net change in: Restricted cash 43 (13) (37)Accounts receivable 26,376 (16,478) (9,477)Inventory (1,253) 341 (108)Deferred sales commissions (4,121) (7,268) (4,245)Prepaid expenses and other current assets 1,080 1,844 (878)Income tax receivable 568 (147) 827Other assets (684) 446 (68)Accounts payable (8,636) 8,394 3,702Accrued compensation (5,485) (4,494) (897)Other current liabilities (14,223) 11,318 4,250Other long-term liabilities (486) 459 481Deferred revenue 16,878 48,864 13,947Net cash (used in) provided by operating activities (5,645) 6,673 8,068CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (8,856) (9,736) (8,941)Proceeds from sale of fixed assets 1,642 — —Decrease (increase) in restricted cash for Vivity acquisition — 12,314 (12,314)Acquisitions, net of cash acquired (1,688) (41,687) (25,675)Net cash outflow from divestiture of subsidiary (186) — —Other investing activities (286) — —Net cash used in investing activities (9,374) (39,109) (46,930)CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from the exercise of stock options 114 669 2,457Repurchase of shares from exercised stock options — — (1,040)Purchase of treasury stock — — (11,435)Proceeds from equity offering, net of issuance costs — — (228)Deferred financing costs (130) (381) —Payments under capital lease obligations (711) (593) (241)Net cash used in financing activities (727) (305) (10,487)Increase (decrease) in cash and cash equivalents (15,746) (32,741) (49,349)Effect of exchange rate changes in cash and cash equivalents (1,129) (1,427) (16)Net increase (decrease) in cash and cash equivalents (16,875) (34,168) (49,365)Cash and cash equivalents—beginning of year 64,657 98,825 148,190Cash and cash equivalents—end of year $47,782 $64,657 $98,825SUPPLEMENTAL CASH FLOW DISCLOSURE: Cash paid during the periods for: Interest $218 $211 $18Income taxes, net of refund $601 $1,722 $3,290Noncash financing and investing activities: Accrued purchase price of business acquisition $— $— $3,375Accrued liability for purchase of property and equipment $258 $561 $192Equipment acquired under capital lease $462 $— $702See accompanying notes to consolidated financial statementsF-8Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS1. NATURE OF OPERATIONSRosetta Stone Inc. and its subsidiaries ("Rosetta Stone," or the "Company") develop, market and support a suite of language-learning, literacy, andbrain fitness solutions consisting of perpetual software products, web-based software subscriptions, online and professional services, audio practice tools andmobile applications. The Company's offerings are sold on a direct basis and through select third party retailers and distributors. The Company provides itssolutions to customers through the sale of packaged software and web-based software subscriptions, domestically and in certain international markets.In early 2015, the Company announced a plan (the "2015 Restructuring Plan") to accelerate growth in and prioritize its focus on the Enterprise &Education segment, emphasizing Corporate and K-12 learners who need to speak and read English. In addition, the Company’s Consumer segment wouldfocus on serving the needs of more passionate language learners rather than addressing the entire mass marketplace. In the first quarter of 2015, the Companybegan reductions to areas including Consumer sales and marketing, Consumer product investment, and general and administrative costs. See Note 2"Summary of Significant Accounting Policies," Note 13 "Restructuring," Note 17 "Segment Information" and Item 7 "Management's Discussion and Analysisof Financial Condition and Results of Operations" within Part II for additional information about these strategic undertakings and the associated impact tothe Company's financial statements and financial results.2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESPrinciples of ConsolidationThe accompanying consolidated financial statements include the accounts of Rosetta Stone Inc. and its wholly owned subsidiaries. All intercompanyaccounts and transactions have been eliminated in consolidation. For comparative purposes, certain amounts in the 2014 consolidated balance sheet havebeen reclassified to conform to the 2015 presentation. See “Recently Issued Accounting Standards” below regarding the impact of our adoption ofAccounting Standards Update No. 2015-17 on the classification of deferred tax amounts in our consolidated balance sheets.The equity method is used to account for investments in entities if the investment provides the Company with the ability to exercise significantinfluence over operating and financial policies of the investee. The Company determines its level of influence over an equity method investment byconsidering key factors such as ownership interest, representation on a governance body, participation in policy-making decisions, and technologicaldependencies. The Company's proportionate share of the net income or loss of any equity method investments is reported in "Other income and (expense)"and included in the net loss on the consolidated statements of operations. The carrying value of any equity method investment is reported in "Other assets"on the consolidated balance sheets.Use of EstimatesThe preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requiresmanagement to make certain estimates and assumptions. The amounts reported in the consolidated financial statements include significant estimates andassumptions that have been made, including, but not limited to, those related to revenue recognition, allowance for doubtful accounts, estimated sales returnsand reserves, stock-based compensation, restructuring costs, fair value of intangibles and goodwill, disclosure of contingent assets and liabilities, disclosureof contingent litigation, and allowance for valuation of deferred tax assets. The Company bases its estimates and assumptions on historical experience and onvarious other judgments that are believed to be reasonable under the circumstances. The Company continuously evaluates its estimates and assumptions.Actual results may differ from these estimates and assumptions.Revenue RecognitionThe Company's primary sources of revenue are web-based software subscriptions, online services, perpetual product software, and bundles of perpetualproduct software and online services. The Company also generates revenue from the sale of audio practice products, mobile applications, and professionalservices. Revenue is recognized when all of the following criteria are met: there is persuasive evidence of an arrangement; the product has been delivered orservices have been rendered; the fee is fixed or determinable; and collectability is reasonably assured. Revenue is recorded net of discounts.The Company identifies the units of accounting contained within sales arrangements in accordance with Accounting Standards Codification ("ASC")subtopic 605-25 Revenue Recognition - Multiple Element Arrangements (“ASC 605-25”). InF-9Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)doing so, the Company evaluates a variety of factors including whether the undelivered element(s) have value to the customer on a stand-alone basis or if theundelivered element(s) could be sold by another vendor on a stand-alone basis.For multiple element arrangements that contain perpetual software products and related online services, the Company allocates the total arrangementconsideration to its deliverables based on the existence of vendor-specific objective evidence of fair value, or vendor-specific objective evidence("VSOE"), in accordance with ASC subtopic 985-605-25 Software: Revenue Recognition-Multiple-Element Arrangements ("ASC 985-605-25"). TheCompany generates a substantial portion of its Consumer revenue from the CD and digital download formats of the Rosetta Stone language-learning productwhich is typically a multiple-element arrangement that includes two deliverables: the perpetual software, delivered at the time of sale, and the online service,which is considered an undelivered software-related element. The online service includes access to conversational coaching services. Because the Companyonly sells the perpetual language-learning software on a stand-alone basis in its homeschool version, the Company does not have a sufficient concentrationof stand-alone sales to establish VSOE for the perpetual product. Where VSOE of the undelivered online services can be established, arrangementconsideration is allocated using the residual method. The Company determines VSOE by reference to the range of comparable stand-alone renewal sales ofthe online service. The Company reviews these stand-alone sales on a quarterly basis. VSOE is established if at least 80% of the stand-alone sales are within arange of plus or minus 15% of a midpoint of the range of prices, consistent with generally accepted industry practice. Where VSOE of the undelivered onlineservices cannot be established, revenue is deferred and recognized commensurate with the delivery of the online services.For non-software multiple element arrangements the Company allocates revenue to all deliverables based on their relative selling prices. TheCompany's non-software multiple element arrangements primarily occur as sales to its Enterprise & Education customers. These arrangements can includeweb-based subscription services, audio practice materials and professional services or any combination thereof. The Company does not have a sufficientconcentration of stand-alone sales of the various deliverables noted above to its Enterprise & Education customers, and therefore cannot establish VSOE foreach deliverable. Third party evidence of fair value does not exist for the web-based subscription, audio practice and professional services due to the lack ofinterchangeable language-learning products and services within the market. Accordingly, the Company determines the relative selling price of the web-basedsubscription, audio practice tools and professional services deliverables included in its non-software multiple element arrangements using the best estimatedselling price. The Company determines the best estimated selling price based on its internally published price list which includes suggested sales prices foreach deliverable based on the type of client and volume purchased. This price list is derived from past experience and from the expectation of obtaining areasonable margin based on what each deliverable costs the Company.In the U.S. and Canada, the Company offers consumers who purchase packaged software and audio practice products directly from the Company a 30-day, unconditional, full money-back refund. The Company also permits some of our retailers and distributors to return unsold packaged products, subject tocertain limitations. In accordance with ASC subtopic 985-605, Software: Revenue Recognition ("ASC 985-605"), the Company estimates and establishesrevenue reserves for packaged product returns at the time of sale based on historical return rates, estimated channel inventory levels, the timing of newproduct introductions and other factors.The Company distributes its products and services both directly to the end customer and indirectly through resellers. Resellers earn commissionsgenerally calculated as a fixed percentage of the gross sale to the end customer. The Company evaluates each of its reseller relationships in accordance withASC subtopic 605-45, Revenue Recognition - Principal Agent Considerations (“ASC 605-45”) to determine whether the revenue recognized from indirectsales should be the gross amount of the contract with the end customer or reduced for the reseller commission. In making this determination the Companyevaluates a variety of factors including whether it is the primary obligor to the end customer. Revenue is recorded net of taxes.Revenue for online services and web-based subscriptions is recognized ratably over the term of the service or subscription period, assuming allrevenue recognition criteria have been met. The CD and digital download formats of Rosetta Stone language-learning products are bundled with a short-termonline service where customers are allowed to begin their short-term online services at any point during a registration window, which is up to six months fromthe date of purchase from us or an authorized reseller. The short-term online services that are not activated during this registration window are forfeited andrevenue is recognized upon expiry. Revenue from non-refundable upfront fees that are not related to products already delivered or services already performedis deferred and recognized over the term of the related arrangement because the period over which a customer is expected to benefit from the service that isincluded within our subscription arrangements does not extend beyond the contractual period. Accounts receivable and deferred revenue are recorded at thetime a customer enters into a binding subscription agreement.F-10Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)Software products include sales to end user customers and resellers. In many cases, revenue from sales to resellers is not contingent upon resale of thesoftware to the end user and is recorded in the same manner as all other product sales. Revenue from sales of packaged software products and audio practiceproducts is recognized as the products are shipped and title passes and risks of loss have been transferred. For many product sales, these criteria are met at thetime the product is shipped. For some sales to resellers and certain other sales, the Company defers revenue until the customer receives the product becausethe Company legally retains a portion of the risk of loss on these sales during transit. In other cases where packaged software products are sold to resellers ona consignment basis, revenue is recognized for these consignment transactions once the end user sale has occurred, assuming the remaining revenuerecognition criteria have been met. In accordance with ASC subtopic 605-50, Revenue Recognition: Customer Payments and Incentives (“ASC 605-50”),cash sales incentives to resellers are accounted for as a reduction of revenue, unless a specific identified benefit is identified and the fair value is reasonablydeterminable. Price protection for changes in the manufacturer suggested retail value granted to resellers for the inventory that they have on hand at the datethe price protection is offered is recorded as a reduction to revenue at the time of sale.The Company offers customers the ability to make payments for packaged software purchases in installments over a period of time, which typicallyranges between three and five months. Given that these installment payment plans are for periods less than 12 months, a successful collection history hasbeen established and these fees are fixed and determinable, revenue is recognized at the time of sale, assuming the remaining revenue recognition criteriahave been met.In connection with packaged software product sales and web-based software subscriptions, technical support is provided to customers, includingcustomers of resellers, via telephone support at no additional cost for up to six months from the time of purchase. As the fee for technical support is includedin the initial licensing fee, the technical support and services are generally provided within one year, the estimated cost of providing such support is deemedinsignificant and no unspecified upgrades/enhancements are offered, technical support revenue is recognized together with the software product and web-based software subscription revenue. Costs associated with the technical support are accrued at the time of sale.Sales commissions from non-cancellable web-based software subscription contracts are deferred and amortized in proportion to the revenue recognizedfrom the related contract.DivestituresThe Company deconsolidates divested subsidiaries when there is a loss of control or when appropriate when evaluated under the variable interestentity model. The Company recognizes a gain or loss at divestiture equal to the difference between the fair value of any consideration received and thecarrying amount of the former subsidiary’s assets and liabilities. Any resulting gain or loss is reported in "Other income and (expense)" on the consolidatedstatement of operations.Business CombinationsThe Company recognizes all of the assets acquired, liabilities assumed and contractual contingencies from an acquired company as well as contingentconsideration at fair value on the acquisition date. The excess of the total purchase price over the fair value of the assets and liabilities acquired is recognizedas goodwill. Acquisition-related costs are recognized separately from the acquisition and expensed as incurred. Generally, restructuring costs incurred inperiods subsequent to the acquisition date are expensed when incurred. Subsequent changes to the purchase price (i.e., working capital adjustments) or otherfair value adjustments determined during the measurement period are recorded as adjustments to goodwill.Cash and Cash EquivalentsCash and cash equivalents consist of highly liquid investments with original maturities of three months or less and demand deposits with financialinstitutions.Restricted CashRestricted cash is generally used to reimburse funds to employees under the Company's flexible benefit plan.Accounts Receivable and Allowance for Doubtful AccountsAccounts receivable consist of amounts due to the Company from its normal business activities. The Company provides an allowance for doubtfulaccounts to reflect the expected non-collection of accounts receivable based on past collection history and specific risks identified.F-11Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)InventoriesInventories are stated at the lower of cost, determined on a first-in first-out basis, or market. The Company reviews inventory for excess quantities andobsolescence based on its best estimates of future demand, product lifecycle status and product development plans. The Company uses historical informationalong with these future estimates to establish a new cost basis for obsolete and potential obsolete inventory.Concentrations of Credit RiskAccounts receivable and cash and cash equivalents subject the Company to its highest potential concentrations of credit risk. The Company reservesfor credit losses and does not require collateral on its trade accounts receivable. In addition, the Company maintains cash and investment balances inaccounts at various banks and brokerage firms. The Company has not experienced any losses on cash and cash equivalent accounts to date.The Company sells its offerings to retailers, resellers, government agencies, and individual consumers and extends credit based on an evaluation of thecustomer's financial condition, and may require collateral, such as letters of credit, in certain circumstances. Exposure to losses on receivables is principallydependent on each customer's financial condition. The Company monitors its exposure for credit losses and maintains allowances for anticipated losses. Nocustomer accounted for more than 10% of the Company's revenue during the years ended December 31, 2015, 2014 or 2013. The four largest distributor andreseller receivable balances collectively represented 30% and 33% of accounts receivable as of December 31, 2015 and 2014, respectively, with onecustomer that accounted for 17% and 18% of accounts receivable as of December 31, 2015 and 2014, respectively. The Company maintains trade creditinsurance for certain customers to provide coverage, up to a certain limit, in the event of insolvency of some customers.Fair Value of Financial InstrumentsThe Company values its assets and liabilities using the methods of fair value as described in ASC topic 820, Fair Value Measurements andDisclosures, ("ASC 820"). ASC 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. The three levels ofthe fair value hierarchy are described below:Level 1: Quoted prices for identical instruments in active markets.Level 2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active;and model-derived valuations whose inputs are observable or whose significant value drivers are observable.Level 3: Significant inputs to the valuation model are unobservable.The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, restricted cash, accounts receivable, accounts payableand other accrued expenses approximate fair value due to relatively short periods to maturity.Property and EquipmentProperty and equipment are stated at cost, less accumulated depreciation. Depreciation on property, leasehold improvements, equipment, and softwareis computed on a straight-line basis over the estimated useful lives of the assets, as follows:Software 3 yearsComputer equipment 3-5 yearsAutomobiles 5 yearsFurniture and equipment 5-7 yearsBuilding 39 yearsBuilding improvements 15 yearsLeasehold improvements lesser of lease term or economic lifeAssets under capital leases lesser of lease term or economic lifeF-12Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)Expenses for repairs and maintenance that do not extend the life of equipment are charged to expense as incurred. Expenses for major renewals andbetterments, which significantly extend the useful lives of existing property and equipment, are capitalized and depreciated. Upon retirement or dispositionof property and equipment, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized.Valuation of Long-Lived AssetsIn accordance with ASC topic 360, Property, Plant and Equipment ("ASC 360"), the Company evaluates the recoverability of its long-lived assets.ASC 360 requires recognition of impairment of long-lived assets in the event that the net book value of such assets exceeds the future undiscounted net cashflows attributable to such assets. Impairment, if any, is recognized in the period of identification to the extent the carrying amount of an asset exceeds the fairvalue of such asset. During the years ended December 31, 2015 and 2014, the Company recorded impairment expense of $1.1 million and $0.2 million,respectively, related to the abandonment of a previously capitalized internal-use software projects. There were no impairments of its long-lived assets duringthe year ended December 31, 2013.Intangible AssetsIntangible assets consist of acquired technology, including developed and core technology, customer related assets, trade name and trademark, andother intangible assets. Those intangible assets with finite lives are recorded at cost and amortized on a straight line basis over their expected lives inaccordance with ASC topic 350, Intangibles—Goodwill and Other ("ASC 350"). Annually, as of December 31, and more frequently if a triggering eventoccurs, the Company reviews its indefinite-lived intangible asset for impairment in accordance with ASC 350. This guidance provides the option to firstassess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determiningwhether it is necessary to perform the quantitative test. If necessary, the quantitative test is performed by comparing the fair value of indefinite livedintangible assets to the carrying value. In the event the carrying value exceeds the fair value of the assets, the assets are written down to their fair value. TheRosetta Stone trade name is the Company's only indefinite-lived intangible asset.During the fourth quarter of 2015, the Company elected to bypass the qualitative assessment and performed the quantitative assessment. In thequantitative assessment, the fair value of the Rosetta Stone trade name has declined due to the reduction in forecasted revenue and bookings from both theEnterprise & Education Language and the Consumer Language reporting units, however, the fair value exceeded the carrying value. There has been noimpairment of intangible assets during any of the periods presented.GoodwillGoodwill represents purchase consideration paid in a business combination that exceeds the values assigned to the net assets of acquired businesses.The Company tests goodwill for impairment annually on June 30 of each year or more frequently if impairment indicators arise. Goodwill is tested forimpairment at the reporting unit level using a fair value approach, in accordance with the provisions of ASC 350. This guidance provides the option to firstassess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value, a "Step 0"analysis. If, based on a review of qualitative factors, it is more likely than not that the fair value of a reporting unit is less than its carrying value the Companyperforms "Step 1" of the traditional two-step goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. If the carryingvalue exceeds the fair value, the Company measures the amount of impairment loss, if any, by comparing the implied fair value of the reporting unit goodwillwith its carrying amount, the "Step 2" analysis.During the fourth quarter of 2015, the Company determined that sufficient indication existed to require performance of an interim goodwill impairmentanalysis for the Consumer Fit Brains reporting unit. As a result, the Company recorded an impairment loss of $5.6 million associated with the interimimpairment assessment of the Consumer Fit Brains reporting unit as of December 31, 2015. During the fourth quarter of 2015, the Company also determinedthat sufficient indication existed to require performance of an interim goodwill impairment analysis for the Enterprise & Education Language reporting unitbeginning with a Step1 analysis. While this analysis did indicate that the fair value of the Enterprise & Education Language reporting unit declined, the fairvalue is still greater than the carrying value of this reporting unit. Since the Enterprise & Education Language reporting unit passed the Step 1 test, no furtheranalysis or testing under Step 2 was necessary and no impairment charges were recorded in connection with this interim impairment assessment of thisreporting unit.F-13Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)In the first quarter of 2014, the Company determined sufficient indication existed to require performance of an interim goodwill impairment analysisfor the then extant Rest of World Consumer reporting unit. As a result, the Company recorded a goodwill impairment loss of $2.2 million, which representeda full impairment of Rest of World Consumer’s goodwill. In the fourth quarter of 2014, the Company determined sufficient indication existed to requireperformance of an interim goodwill impairment analysis for the then extant North America Consumer Language reporting unit. As a result of this test, theCompany recorded a goodwill impairment loss of $18.0 million, which represented a full impairment of North America Consumer Language’s goodwill.For income tax purposes, the goodwill balances with tax basis are amortized over a period of 15 years.GuaranteesIndemnifications are provided of varying scope and size to certain Enterprise & Education customers against claims of intellectual propertyinfringement made by third parties arising from the use of its products. The Company has not incurred any costs or accrued any liabilities as a result of suchobligations.Cost of Product and Subscription and Service RevenueCost of product revenue consists of the direct and indirect materials and labor costs to produce and distribute the Company's products. Such costsinclude packaging materials, computer headsets, freight, inventory receiving, personnel costs associated with product assembly, third-party royalty fees andinventory storage, obsolescence and shrinkage. The Company believes cost of subscription and service revenue primarily represents costs associated withsupporting the web-based subscription services, which includes online language conversation coaching, hosting costs and depreciation. Also included arethe costs of credit card processing and customer technical support in both cost of product revenue and cost of subscription and service revenue.Research and DevelopmentResearch and development expenses include employee compensation costs, consulting fees and overhead costs associated with the development ofour solutions. The Company develops the majority of its language-learning software products for perpetual sale to external customers. The Companyconsiders technological feasibility to be established when all planning, designing, coding, and testing has been completed according to designspecifications. The Company has determined that technological feasibility for such software products is reached shortly before the products are released tomanufacturing. Costs incurred after technological feasibility is established have not been material, and accordingly, the Company has expensed all researchand development costs when incurred.Software Developed for Internal UseThe Company capitalizes software development costs related to certain of its software platforms developed exclusively to provide its web-basedsubscription services and other general and administrative use software in accordance with ASC subtopic 350-40: Internal-Use Software. Development costsfor internal-use software are expensed as incurred until the project reaches the application development stage. Internal-use software is defined to have thefollowing characteristics: (a) the software is internally developed, or modified solely to meet the entity's internal needs, and (b) during the software'sdevelopment or modification, no substantive plan exists or is being developed to market the software externally. Internally developed software is amortizedover a three-year useful life.For the years ended December 31, 2015, 2014 and 2013, the Company capitalized $7.1 million, $8.8 million, and $4.8 million in internal-use software,respectively.For the years ended December 31, 2015, 2014 and 2013, the Company recorded amortization expense relating to internal-use software of $4.8 million,$3.4 million, and $1.8 million, respectively.Income TaxesThe Company accounts for income taxes in accordance with ASC topic 740, Income Taxes ("ASC 740"), which provides for an asset and liabilityapproach to accounting for income taxes. Deferred tax assets and liabilities represent the future tax consequences of the differences between the financialstatement carrying amounts of assets and liabilities versus the tax basis of assets and liabilities. Under this method, deferred tax assets are recognized fordeductible temporary differences, and operating loss and tax credit carryforwards. Deferred liabilities are recognized for taxable temporary differences.Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of theF-14Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)deferred tax assets will not be realized. The impact of tax rate changes on deferred tax assets and liabilities is recognized in the year that the change isenacted.Significant judgment is required to determine whether a valuation allowance is necessary and the amount of such valuation allowance, if appropriate.The valuation allowance is reviewed at each reporting period and is maintained until sufficient positive evidence exists to support a reversal.When assessing the realization of the Company's deferred tax assets, the Company considers all available evidence, including:•the nature, frequency, and severity of cumulative financial reporting losses in recent years;•the carryforward periods for the net operating loss, capital loss, and foreign tax credit carryforwards;•predictability of future operating profitability of the character necessary to realize the asset;•prudent and feasible tax planning strategies that would be implemented, if necessary, to protect against the loss of the deferred tax assets;and•the effect of reversing taxable temporary differences.The evaluation of the recoverability of the deferred tax assets requires that the Company weigh all positive and negative evidence to reach aconclusion that it is more likely than not that all or some portion of the deferred tax assets will not be realized. The weight given to the evidence iscommensurate with the extent to which it can be objectively verified. The more negative evidence that exists, the more positive evidence is necessary and themore difficult it is to support a conclusion that a valuation allowance is not needed.The establishment of a valuation allowance has no effect on the ability to use the deferred tax assets in the future to reduce cash tax payments. TheCompany will continue to assess the likelihood that the deferred tax assets will be realizable at each reporting period and the valuation allowance will beadjusted accordingly, which could materially affect the Company's financial position and results of operations.Stock-Based CompensationThe Company accounts for its stock-based compensation in accordance ASC topic 718, Compensation—Stock Compensation ("ASC 718"). UnderASC 718, all stock-based awards, including employee stock option grants, are recorded at fair value as of the grant date and recognized as expense in thestatement of operations on a straight-line basis over the requisite service period, which is the vesting period.Restructuring CostsIn the first quarter of 2015, as part of the 2015 Restructuring Plan, the Company announced and initiated actions to reduce headcount and other costs inorder to support its strategic shift in business focus and address periods of loss. In connection with this plan, the Company incurred restructuring related costs,including employee severance and related benefit costs, contract termination costs, and other related costs. These costs are included within the Sales andmarketing, Research and development, and General and administrative operating expense categories on the Company's consolidated statements ofoperations.Employee severance and related benefit costs primarily include cash payments, outplacement services, continuing health insurance coverage, and otherbenefits. Where no substantive involuntary termination plan previously exists, these severance costs are generally considered “one-time” benefits andrecognized at fair value in the period in which a detailed plan has been approved by management and communicated to the terminated employees. Severancecosts pursuant to ongoing benefit arrangements, including termination benefits provided for in existing employment contracts, are recognized when probableand reasonably estimable.Contract termination costs include penalties to cancel certain service and license contracts. Contract termination costs are recognized at fair value in theperiod in which the contract is terminated in accordance with the contract terms.Other related costs generally include external consulting and legal costs associated with the strategic shift in business focus of the Company’sConsumer business. Such costs are recognized at fair value in the period in which the costs are incurred.F-15Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)Net Loss Per ShareNet loss per share is computed under the provisions of ASC topic 260, Earnings Per Share. Basic loss per share is computed using net loss and theweighted average number of shares of common stock outstanding. Diluted loss per share reflect the weighted average number of shares of common stockoutstanding plus any potentially dilutive shares outstanding during the period. Potentially dilutive shares consist of shares issuable upon the exercise ofstock options, restricted stock awards, restricted stock units and conversion of shares of preferred stock. Common stock equivalent shares are excluded fromthe diluted computation if their effect is anti-dilutive. When there is a net loss, there is a presumption that there are no dilutive shares as these would be anti-dilutive.The following table sets forth the computation of basic and diluted net loss per common share: Years Ended December 31, 2015 2014 2013 (dollars in thousands, except per share amounts)Numerator: Net loss $(46,796) $(73,706) $(16,134)Denominator: Common shares and equivalents outstanding: Basic weighted average shares 21,571 21,253 21,528Diluted weighted average shares 21,571 21,253 21,528Loss per share: Basic $(2.17) $(3.47) $(0.75)Diluted $(2.17) $(3.47) $(0.75)For the years ended December 31, 2015, 2014 and 2013, no common stock equivalent shares were included in the calculation of the Company’sdiluted net loss per share. The following is a summary of common stock equivalents for the securities outstanding during the respective periods that havebeen excluded from the earnings per share calculations as their impact was anti-dilutive. Years Ended December 31, 2015 2014 2013 (in thousands)Stock options 35 67 279Restricted stock units 39 103 90Restricted stocks 82 89 248Total common stock equivalent shares 156 259 617Comprehensive (Loss) IncomeComprehensive (loss) income consists of net loss and other comprehensive (loss) income. Other comprehensive (loss) income refers to revenues,expenses, gains, and losses that are not included in net loss, but rather are recorded directly in stockholders' equity. For the years ended December 31, 2015,2014 and 2013, the Company's comprehensive (loss) income consisted of net loss and foreign currency translation gains (losses). The other comprehensive(loss) income presented in the consolidated financial statements and the notes are presented net of tax. There have been no tax expense or benefit associatedwith the components other comprehensive loss due to the presence of a full valuation allowance for each of the years ended December 31, 2015, 2014 and2013.F-16Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)Components of accumulated other comprehensive loss as of December 31, 2015 are as follows (in thousands): Foreign Currency TotalBalance at beginning of period $(678) $(678)Other comprehensive loss before reclassifications (2,003) (2,003)Amounts reclassified from accumulated other comprehensive loss related to divestiture of foreignsubsidiary 455 455Net current period other comprehensive loss (1,548) (1,548)Accumulated other comprehensive loss $(2,226) $(2,226)Upon divestiture of an investment in a foreign entity, the amount attributable to the accumulated translation adjustment component of that foreignentity is removed as a component of other comprehensive loss and reported as part of the gain or loss on sale or liquidation of the investment. During the yearended December 31, 2015, a transfer of $0.5 million was made from accumulated other comprehensive loss and recognized as a gain within net incomerelated to the divestiture of a foreign subsidiary.Foreign Currency Translation and TransactionsThe functional currency of the Company's foreign subsidiaries is their local currency. Accordingly, assets and liabilities of the foreign subsidiaries aretranslated into U.S. dollars at exchange rates in effect on the balance sheet date. Income and expense items are translated at average rates for the period.Translation adjustments are recorded as a component of other comprehensive loss in stockholders' equity.Cash flows of consolidated foreign subsidiaries, whose functional currency is the local currency, are translated to U.S. dollars using average exchangerates for the period. The Company reports the effect of exchange rate changes on cash balances held in foreign currencies as a separate item in thereconciliation of the changes in cash and cash equivalents during the period.Advertising CostsCosts for advertising are expensed as incurred. Advertising expense for the years ended December 31, 2015, 2014, and 2013 were $46.9 million, $79.6million and $63.6 million, respectively.Recently Issued Accounting StandardsDuring 2015, the Company adopted the following recently issued Accounting Standard Updates ("ASU"):In November 2015, the Financial Accounting Standards Board ("FASB") issued ASU No. 2015-17, Income Taxes (Topic 740) Balance SheetClassification of Deferred Taxes ("ASU 2015-17"). ASU 2015-17 simplifies the presentation of deferred income taxes and requires non-current classificationof all deferred tax assets and liabilities in a classified statement of financial position. Deferred income taxes were previously required to be classified ascurrent or non-current on the consolidated balance sheets. The standard is effective for fiscal years beginning after December 15, 2016, including interimperiods within that reporting period. Early adoption is permitted for any interim and annual financial statements that have not yet been issued. Theamendments may be applied prospectively or retrospectively. The Company early adopted ASU 2015-17 effective January 1, 2015, retrospectively. Otherthan the following reclassifications and related disclosures, the adoption of ASU 2015-17 had no other impacts on the Company's consolidated financialstatements and disclosures which resulted in the following adjustments to the December 31, 2014 consolidated balance sheet (amounts in thousands):F-17Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) As of December 31, 2014 As Previously Reported Impact of Adopting ASU2015-17 As AdjustedPrepaid expenses and other current assets $5,038 $(196) $4,842Total current assets $164,279 $(196) $164,083Other assets $1,525 $(35) $1,490Total assets $288,404 $(231) $288,173Other current liabilities $56,157 $(2,899) $53,258Total current liabilities $186,009 $(2,899) $183,110Deferred income taxes $1,554 $2,668 $4,222Total liabilities $224,959 $(231) $224,728Total liabilities and stockholders' equity $288,404 $(231) $288,173In April 2014, the FASB issued ASU No. 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360):Reporting Discontinued Operations and Disclosures of Disposals of Components of Equity ("ASU 2014-08"), which amends the definition of a discontinuedoperation and requires entities to provide additional disclosures about discontinued operations as well as disposal transactions that do not meet thediscontinued operations criteria. The new guidance changes the definition of a discontinued operation and requires discontinued operations treatment fordisposals of a component or group of components that represents a strategic shift that has or will have a major impact on an entity’s operations or financialresults. ASU 2014-08 is effective prospectively for all disposals (except disposals classified as held for sale before the adoption date) or components initiallyclassified as held for sale in periods beginning on or after December 15, 2014; earlier adoption is permitted. The Company adopted ASU 2014-08 effectiveJanuary 1, 2015 and adoption did not have a material impact on the Company's consolidated financial condition, results of operations or cash flows.The following ASUs were recently issued but have not yet been adopted by the Company:In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) ("ASU 2016-02"). Under ASU 2016-02, entities will be required to recognize alease liability and a right-of-use asset for all leases. Lessor accounting is largely unchanged. ASU 2016-02 is effective for public entities in fiscal yearsbeginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company is in the process ofevaluating the impact of the new guidance on the Company's consolidated financial statements and disclosures.In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of FinancialAssets and Financial Liabilities ("ASU 2016-01"). ASU 2016-01 changes how entities measure certain equity investments and present changes in the fairvalue of financial liabilities measured under the fair value option that are attributable to their own credit. Under the new guidance, entities will be required tomeasure equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes infair value in net income unless the investments qualify for the new practicability exception. The accounting for other financial instruments, such as loans andinvestments in debt securities is largely unchanged. ASU 2016-01 is effective for public entities in fiscal years beginning after December 15, 2017, includinginterim periods within those fiscal years. The Company does not believe that the adoption of this guidance will have a material impact on the Company'sconsolidated financial statements and disclosures.In April 2015, the Financial Accounting Standards Board ("FASB") issued ASU No. 2015-05, Intangibles - Goodwill and Other - Internal-Use Software(Subtopic 350-40): Customer's Accounting for Fees Paid in a Cloud Computing Arrangement ("ASU 2015-05"). ASU 2015-05 provides guidance regardingwhether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the entity shouldaccount for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement doesnot include a software license, the entity should account for the arrangement as a service contract. ASU 2015-05 does not change the accounting for servicecontracts. ASU 2015-05 is effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2015. Early adoption ispermitted. The Company does not expect to early adopt the guidance and does not believe that the adoption of this guidance will have a material impact onthe Company's consolidated financial statements and disclosures.F-18Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)In April 2015, the FASB issued ASU No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30) Simplifying the Presentation of Debt IssuanceCosts ("ASU 2015-03"). ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a directdeduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costsare not affected by the amendments in ASU 2015-03. ASU 2015-03 will be effective for interim and annual financial statements issued for fiscal yearsbeginning after December 15, 2015. Early adoption is permitted for financial statements that have not been previously issued. The Company does not believethat the adoption of this guidance will have a material impact on the Company's consolidated financial statements and disclosures.In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40) ("ASU 2014-15"). ASU2014-15 addresses management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and toprovide related footnote disclosures. Management’s evaluation should be based on relevant conditions and events that are known and reasonably knowableat the date that the financial statements are issued. ASU 2014-15 will be effective for the first interim period within annual reporting periods beginning afterDecember 15, 2016. Early adoption is permitted. The Company does not expect to early adopt this guidance and does not believe that the adoption of thisguidance will have a material impact on the Company's financial statements and disclosures.In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASU 2014-09"), which replaces the currentrevenue accounting guidance. ASU 2014-09 is effective for annual periods beginning after December 15, 2016. In August 2015, the FASB issued ASU No.2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date ("ASU 2015-14") which defers the effective date of the updatedguidance on revenue recognition by one year to make ASU 2014-09 effective for annual periods beginning after December 31, 2017. The core principle ofASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects theconsideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply a fivestep model to 1) identify the contract(s) with a customer, 2) identify the performance obligations in the contract, 3) determine the transaction price, 4) allocatethe transaction price to the performance obligations in the contract and 5) recognize revenue when (or as) the entity satisfies a performance obligation.Entities may choose from two adoption methods, with certain practical expedients. The Company expects that it will adopt this new guidance beginning inthe first quarter of 2018 and is currently evaluating the appropriate transition method and any impact of the new guidance on the Company's consolidatedfinancial statements and disclosures.3. INVENTORYInventory consisted of the following (in thousands): As ofDecember 31, 2015 2014Raw materials $3,375 $3,163Finished goods 3,958 3,337Total inventory $7,333 $6,500F-19Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)4. PROPERTY AND EQUIPMENTProperty and equipment consisted of the following (in thousands): As of December 31, 2015 2014Land $893 $950Buildings and improvements 9,573 12,477Leasehold improvements 1,477 1,408Computer equipment 16,508 16,400Software 34,478 31,240Furniture and equipment 3,115 3,457 66,044 65,932Less: accumulated depreciation (43,512) (40,655)Property and equipment, net $22,532 $25,277In December 2015, the Company completed the sale of one of its two office buildings and associated building improvements located in Harrisonburg,Virginia. The office building and associated building improvements had a cost and net book value of $2.5 million and $1.6 million, respectively. TheCompany recognized a gain on sale of $0.1 million based on a sales price of $1.8 million and sales expenses of $0.1 million. The gain on sale was includedin "General and administrative" operating expense line item on the consolidated statements of operations for the year ended December 31, 2015.The Company leases certain computer equipment, software, buildings, and machinery under capital lease agreements. As of December 31, 2015 and2014, assets under capital lease included in property and equipment above was $5.5 million and $5.6 million, respectively. As of December 31, 2015 and2014, accumulated depreciation and amortization relating to property and equipment under capital lease arrangements totaled $1.5 million and $1.0 million,respectively.The Company recorded total depreciation and amortization expense for its property and equipment for the years ended December 31, 2015, 2014 and2013 in the amount of $8.5 million, $7.6 million and $7.8 million, respectively. Depreciation and amortization expense related to property and equipmentincludes depreciation related to its physical assets and amortization expense related to amounts capitalized in the development of internal-use software.During the years ending December 31, 2015 and 2014, the Company recorded $1.1 million and $0.2 million, respectively, in impairment expenserelated to the abandonment of a previously capitalized internal-use software project. There were no impairment charges for the year ended December 31,2013.5. DIVESTITURES AND ACQUISITIONS2015 Divestitures:As part of the shift in strategy initiated in early 2015, the Company determined that its ownership of the consumer-oriented Rosetta Stone Korea Ltd.("RSK") entity no longer agreed with the Company’s overall strategy to focus on the Enterprise & Education business. In September 2015, the Companycompleted the divestiture of 100% of the Company's capital stock of RSK to the current President of RSK for consideration equal to the assumption of RSK'snet liabilities at the date of sale. This divestiture resulted in a pre-tax gain of $0.7 million reported in “Other (expense) income” line of the consolidatedstatements of operations. This gain was comprised of a gain of $0.2 million equal to the value of the net liabilities transferred and a $0.5 million gain on thetransfer of the foreign subsidiary's cumulative translation adjustment on the date of sale.As part of the transaction, the Company has agreed to continue to provide to RSK certain of its online product offerings for resale and distribution andRSK is committed to purchase those products, for an initial term ending December 31, 2025. In addition, the Company has loaned RSK $0.5 million as ofOctober 2, 2015, which will be repaid in five equal installments due every six months beginning December 31, 2016. As a result of this loan receivable andthe level of financial support it represents, the Company concluded that it holds a variable interest in RSK whereby the Company is not the primarybeneficiary. The maximum exposure to loss as a result of this involvement in the variable interest entity is limited to the $0.5 million amount of the loan. F-20Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)5. DIVESTITURES AND ACQUISITIONS (Continued)2014 Acquisitions:In January 2014, the Company acquired Vivity Labs, Inc. and Tell Me More S.A. Under the acquisition method of accounting, the total purchase pricewas allocated to the tangible and intangible assets acquired on the basis of their respective estimated fair values at the date of acquisition. The valuation ofthe identifiable intangible assets and their useful lives acquired reflects management's estimates.Vivity Labs Inc.On January 2, 2014, the Company completed its acquisition of Vivity Labs Inc. (the "Vivity Merger" and "Vivity"). Vivity’s principal business activityis the development of brain fitness games aimed at improving the user’s cognitive function through activity, awareness and motivation through its flagshipproduct, Fit Brains. The applications are designed for use on mobile, web and social platforms. Vivity’s emphasis on mobile solutions is especiallycompatible with Rosetta Stone’s focus on cloud-based technology to enable on-the-go learning. The aggregate amount of consideration paid by theCompany was $12.2 million in cash.The acquisition of Vivity resulted in goodwill of approximately $9.3 million, none of which is deductible for tax purposes. This amount represents theresidual amount of the total purchase price after allocation to the assets acquired and liabilities assumed.All expenditures incurred in connection with the Vivity Merger were expensed and are included in general and administrative expenses. Transactioncosts incurred in connection with the Vivity Merger were $57 thousand and $51 thousand during the years ended December 31, 2014 and 2013, respectively.The results of operations for Vivity have been included in the consolidated results of operations since January 2, 2014.The Company has allocated the purchase price based on current estimates of the fair values of assets acquired and liabilities assumed in connection withthe Vivity Merger. The table below summarizes the estimates of fair value of the Vivity assets acquired, liabilities assumed and related deferred income taxesas of the acquisition date.The Company finalized its allocation of the purchase price for Vivity as of December 31, 2014. The purchase price was allocated as follows (inthousands):Cash $14Accounts receivable 452Other current assets (3)Accounts payable and accrued expenses (307)Net deferred tax liability (919)Net tangible assets acquired (763)Goodwill 9,336Amortizable intangible assets 3,577Purchase price $12,150The acquired amortizable intangible assets and the related estimated useful lives consist of the following (in thousands): Estimated Useful Lives Estimated Value January2, 2014Tradename 3 years $188Technology platform 5 years 2,448Customer relationships 3 years 941Total assets $3,577Tell Me More S.A.On January 9, 2014, the Company completed its acquisition of Tell Me More S.A., (the "Tell Me More Merger" and "Tell Me More") a companyorganized under the laws of France. Tell Me More provides online language-learning subscriptions andF-21Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)5. DIVESTITURES AND ACQUISITIONS (Continued)learning services primarily to corporate and educational organizations. Tell Me More offers a robust suite of SaaS-based language-learning products andservices that provide intermediate, advanced and business language solutions in nine languages. The Tell Me More Merger strengthens the Company'sgrowing Enterprise & Education business and expands its global footprint. The aggregate amount of consideration paid by the Company was €22.1 million($30.2 million), including assumed net debt.The Tell Me More Merger resulted in goodwill of approximately $21.7 million, none of which is deductible for tax purposes. This amount representsthe residual amount of the total purchase price after allocation to the assets acquired and liabilities assumed.All expenditures incurred in connection with the Tell Me More Merger were expensed and are included in general and administrative expenses.Transaction costs incurred in connection with the Merger were $1.0 million and $0.5 million during the years ended December 31, 2014 and 2013,respectively. The results of operations for Tell Me More have been included in the consolidated results of operations since January 9, 2014.The Company has allocated the purchase price based on current estimates of the fair values of assets acquired and liabilities assumed in connection withthe Tell Me More Merger. The table below summarizes the estimates of fair value of the Tell Me More assets acquired, liabilities assumed and related deferredincome taxes as of the acquisition date.The Company finalized its allocation of the purchase price for Tell Me More as of December 31, 2014. The purchase price was allocated as follows (inthousands):Cash $2,323Accounts receivable 2,979Inventory 246Prepaid expenses 243Fixed assets 5,595Other non-current assets 330Accounts payable (732)Accrued compensation (2,855)Deferred revenue (2,190)Other current liabilities (1,211)Obligation under capital lease (3,958)Net deferred tax liability (1,392)Net tangible assets acquired (622)Goodwill 21,703Amortizable intangible assets 9,105Purchase price $30,186The acquired amortizable intangible assets and the related estimated useful lives consist of the following (in thousands): Estimated Useful Lives Estimated Value January9, 2014Customer relationships 5 years 4,348Technology platform 5 years 4,144Tradename 1 year 613Total assets $9,1052013 Acquisitions:The Company acquired Livemocha Inc. and Lexia Learning Systems Inc. in April and August of 2013, respectively. Under the acquisition method ofaccounting, the total purchase price was allocated to the tangible and intangible assets acquiredF-22Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)5. DIVESTITURES AND ACQUISITIONS (Continued)on the basis of their respective estimated fair values at the date of acquisition. The valuation of the identifiable intangible assets and their useful livesacquired reflects management's estimates.Livemocha, Inc.On April 1, 2013, the Company completed its acquisition of Livemocha, Inc. (the “Livemocha Merger” and "Livemocha"). Livemocha is one of theworld’s largest online language-learning communities with over 16 million registered members. The acquisition of Livemocha's technology platform hasaccelerated the Company’s transition to cloud-based learning solutions and reinforced its leadership position in the competitive language-learning industry.The aggregate amount of consideration paid by the Company was $8.4 million in cash.The acquisition of Livemocha resulted in goodwill of approximately $5.2 million, none of which is deductible for tax purposes. This amount representsthe residual amount of the total purchase price after allocation to the assets acquired and liabilities assumed.All expenditures incurred in connection with the Livemocha Merger were expensed and are included in general and administrative expenses.Transaction costs incurred in connection with the Livemocha Merger were $0.4 million during the year ended December 31, 2013. The results of operationsfor Livemocha have been included in the consolidated results of operations since April 1, 2013.The Company allocated the purchase price based on current estimates of the fair values of assets acquired and liabilities assumed in connection with theLivemocha Merger. The table below summarizes the estimates of fair value of the Livemocha assets acquired, liabilities assumed and related deferred incometaxes as of the acquisition date.The Company finalized its allocation of the purchase price for Livemocha as of March 31, 2014. The purchase price was allocated as follows (inthousands):Cash $191Accounts receivable 227Other current assets 93Fixed assets 35Accounts payable and accrued expenses (956)Deferred revenue (743)Net deferred tax liability (1,161)Net tangible assets acquired (2,314)Goodwill 5,185Amortizable intangible assets 5,500Purchase Price $8,371The acquired amortizable intangible assets and the related estimated useful lives consist of the following (in thousands): Estimated Useful Lives Estimated Value April 1,2013Online community 3 years $1,800Enterprise relationships 5 years 100Technology platform 5 years 3,400Tradename 2 years 200Total assets $5,500In connection with the Livemocha Merger, the Company recorded deferred tax liabilities related to definite-lived intangible assets that were acquired. As a result of this deferred tax liability balance, the Company reduced its deferred tax asset valuation allowance by $1.2 million. Such reduction wasrecognized as an income tax benefit in the consolidated statement of operations for the year ended December 31, 2013.F-23Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)5. DIVESTITURES AND ACQUISITIONS (Continued)Lexia Learning Systems, Inc.On August 1, 2013, the Company completed its acquisition of Lexia Learning Systems, Inc. (the “Lexia Merger” and "Lexia"). Lexia is one of the mosttrusted and established companies in the literacy technology market. The transaction marked the Company’s first extension beyond language learning andtook the Company deeper into the Education Technology industry. The aggregate amount of consideration paid by the Company was $21.1 million in cash,net of working capital and deferred revenue adjustments, including a holdback of $3.4 million with 50% of such holdback paid within 30 days of theCompany filing its Form 10-K for the year ended December 31, 2013 and 50% of such holdback to be paid on the 18 month anniversary of the acquisition.The Company paid $1.7 million of the holdback in April of 2014 and paid the remaining $1.7 million in February 2015.The acquisition of Lexia resulted in goodwill of approximately $9.9 million, none of which is deductible for tax purposes. This amount represents theresidual amount of the total purchase price after allocation to the assets acquired and liabilities assumed.All expenditures incurred in connection with the Lexia Merger were expensed and are included in general and administrative expenses. Transactioncosts incurred in connection with the Lexia Merger were $0.1 million during the year ended December 31, 2013. The results of operations for Lexia havebeen included in the consolidated results of operations for the period since August 1, 2013.The Company allocated the purchase price based on current estimates of the fair values of assets acquired and liabilities assumed in connection with theLexia Merger. The table below summarizes the estimates of fair value of the Lexia assets acquired, liabilities assumed and related deferred income taxes as ofthe acquisition date.The Company finalized its allocation of the purchase price for Lexia as of June 30, 2014. The purchase price was allocated as follows (in thousands):Cash $263Accounts receivable 2,404Other current assets 105Fixed assets 255Accounts payable and accrued expenses (899)Deferred revenue (1,223)Net deferred tax liability (4,210)Net tangible assets acquired (3,305)Goodwill 9,938Amortizable intangible assets 14,500Purchase price $21,133The acquired amortizable intangible assets and the related estimated useful lives consist of the following (in thousands): Estimated Useful Lives Estimated Value August1, 2013Enterprise relationships 10 years $9,400Technology platform 7 years 4,100Tradename 5 years 1,000Total assets $14,500In connection with the Lexia Merger, the Company recorded deferred tax liabilities related to definite-lived intangible assets that were acquired. As aresult of this deferred tax liability balance, the Company reduced its deferred tax asset valuation allowance by $4.2 million. Such reduction was recognizedas an income tax benefit in the consolidated statement of operations for the year ended December 31, 2013.F-24Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)6. GOODWILLThe value of goodwill is primarily derived from the acquisition of Rosetta Stone Ltd. (formerly known as Fairfield & Sons, Ltd.) in January 2006, theacquisition of certain assets of SGLC International Co. Ltd ("SGLC") in November 2009, the acquisitions of Livemocha and Lexia in 2013, and theacquisitions of Vivity and Tell Me More in January 2014.The Company tests goodwill for impairment annually on June 30 of each year at the reporting unit level using a fair value approach, in accordance withthe provisions of ASC 350, or more frequently, if impairment indicators arise. The Company also routinely reviews goodwill at the reporting unit level forpotential impairment.Throughout 2015, the Company's reporting units were: Enterprise & Education Language, Enterprise & Education Literacy, Consumer Language, andConsumer Fit Brains. The combined Enterprise & Education Language and Enterprise & Education Literacy reporting units make up the Enterprise &Education operating and reportable segment. The combined Consumer Language and Consumer Fit Brains reporting units make up the Consumer operatingand reportable segment.During 2014, the Company's reporting units were: Enterprise & Education Language, Enterprise & Education Literacy, North America ConsumerLanguage, Rest of World Consumer, and Consumer Fit Brains. Due to a shift in strategy in the first quarter of 2015, the Company reevaluated and restructuredits reporting units, operating, and reportable segments as described above.The following table shows the balance and changes in goodwill for the Company's reporting units for the years ended December 31, 2015 and 2014 (inthousands): Enterprise & Education Consumer Enterprise &EducationLanguage Enterprise &Education Literacy ConsumerLanguage Consumer FitBrains TotalBalance as of January 1, 2014 $19,926 $9,962 $20,171 $— $50,059 Acquisition of Vivity — — — 9,336 9,336 Acquisition of Tell Me More 21,703 — — — 21,703Impairment of Rest of World Consumer — — (2,199) — (2,199)Impairment of North America Consumer Language — — (17,971) — (17,971)Effect of change in foreign currency rate (1,545) — (1) (798) (2,344)Balance as of December 31, 2014 $40,084 $9,962 $— $8,538 $58,584Impairment of Consumer Fit Brains — — — (5,604) (5,604)Effect of change in foreign currency rate (1,384) — — (1,316) (2,700)Balance as of December 31, 2015 $38,700 $9,962 $— $1,618 $50,2802015 ActivityAnnual Impairment Testing of GoodwillIn connection with the annual goodwill impairment analysis performed as of June 30, 2015, the Company exercised its option to bypass Step 0 andbegan the annual test with Step 1. The Company determined that the fair values of the Enterprise & Education Literacy, Enterprise & Education Language,and Consumer Fit Brains reporting units exceeded their carrying values. As a result of the 2015 annual impairment test, no goodwill impairment charges wererecorded as of June 30, 2015.Interim Impairment ReviewDuring the fourth quarter of 2015, the Company determined that sufficient indication existed to require performance of an interim goodwill impairmentanalysis for the Consumer Fit Brains reporting unit. This indicator was due to a decline in the operations of the Consumer Fit Brains reporting unit, withdecreases in revenue and bookings within this reporting unit driving lower than expected operating results for the quarter and impacting the forecast goingforward. In this interim goodwill impairment test, the Consumer Fit Brains reporting unit failed Step 1. The combination of lower reporting unit fair valuecalculated in Step 1 and the identification of unrecognized fair value adjustments to the carrying values of other assets andF-25Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)6. GOODWILL (Continued)liabilities (primarily developed technology and deferred revenue) in Step 2 of the interim goodwill impairment test, resulted in an implied fair value ofgoodwill below its carrying value. As a result, the Company recorded an impairment loss of $5.6 million associated with the interim impairment assessmentof the Consumer Fit Brains reporting unit as of December 31, 2015.During the fourth quarter of 2015, the Company determined that sufficient indication existed to require performance of an interim goodwill impairmentanalysis for the Enterprise & Education Language reporting unit. This indicator was due to declines in the operations of the Enterprise & EducationLanguage reporting unit, with decreases in revenue and bookings within this reporting unit driving lower than expected operating results for the quarter andimpacting the forecast going forward. As a result of the operating results in the fourth quarter of 2015, the Company has further refined its strategy of focusingon the Enterprise & Education segment and, as discussed in Note 21, in March 2016, the Company announced a plan to exit the direct distribution ofEnterprise & Education language offerings in a number of non-US markets and right-size the overall business. In particular, the Company initiated a processto exit direct presence and close offices in China, Brazil and France. This plan is expected to result in significantly lower projected revenues, bookings, andshort-term profitability of the Enterprise & Education Language reporting unit. As a result, the Company determined that sufficient indication existed torequire the performance of an interim goodwill impairment analysis for this reporting unit. While this analysis did indicate that the fair value of the Enterprise& Education Language reporting unit declined, the fair value is still greater than the carrying value of this reporting unit. Since the Enterprise & EducationLanguage reporting unit passed the Step 1 test, no further analysis or testing under Step 2 was necessary and no impairment charges were recorded inconnection with this interim impairment assessment of this reporting unit.The Company also routinely reviews goodwill at the reporting unit level for potential impairment as part of the Company’s internal control framework.In the fourth quarter of 2015, the Company evaluated any reporting unit with remaining goodwill that was not tested for impairment to determine if atriggering event has occurred. As of December 31, 2015, the Company concluded that there were no indicators of impairment that would cause it to believethat it is more likely than not that the fair value of these reporting units is less than the carrying value. Accordingly, a detailed impairment test has not beenperformed and no impairment charges were recorded in connection with the interim impairment reviews of any such reporting units.2014 ActivityRest of World Consumer Goodwill ImpairmentDuring the first quarter of 2014, the Company determined sufficient indication existed to require performance of an interim goodwill impairmentanalysis as of March 31, 2014 for the then extant Rest of World Consumer reporting unit (“ROW Consumer”). This indicator was due to unexpected declinesin the operations of the ROW Consumer reporting unit, with further decreases in revenue and bookings within the reporting unit driving lower than expectedoperating results and impacting the forecast going forward. In this interim goodwill impairment test, the ROW Consumer reporting unit failed Step 1 of thegoodwill impairment test. The combination of the lower reporting unit fair value calculated in Step 1 and the identification of unrecognized fair valuechanges to the carrying values of other assets and liabilities (primarily tradename and deferred revenue) in Step 2 of the interim goodwill impairment test,resulted in an implied fair value of goodwill below the carrying value of goodwill for ROW Consumer. As a result, the Company recorded a goodwillimpairment loss of $2.2 million, which represents a full impairment of ROW Consumer’s goodwill.North America Consumer Language Goodwill Impairment In the fourth quarter of 2014, the then extant North America Consumer Language reporting unit experienced a decline in the demand for its productsand services at its current pricing levels. In an attempt to increase demand, the Company lowered prices in its direct-to-consumer and retail sales channels.This strategy increased the number of units sold, however, revenue recognized decreased significantly due to the lower prices in 2014. Additionally, theseresults were significantly lower than the forecasted bookings, meaning that while the Company was able to increase the number of units sold, the per unitprice was lower than expected. As a result of the reduced demand and the need to offer lower prices in the fourth quarter of 2014 to generate sales, theCompany began to evaluate whether the decline in demand at prior price levels has resulted in the need for a permanent price decline. As a result of the aboveevents, the Company considered it appropriate to perform an interim goodwill impairment test for the North America Consumer Language reporting unit. Thecombination of the lower reporting unit fair value of the North America Consumer Language reporting unit, and the identification of unrecognized fair valuechanges to the carrying values of other assets and liabilities (primarily tradename, developed technology and deferred revenue) in Step 2 of the interimgoodwill impairment test, resulted in a negative implied fair value of goodwill for the North America ConsumerF-26Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)6. GOODWILL (Continued)Language reporting unit. As a result, the Company recorded a goodwill impairment loss of $18.0 million, which represented a full impairment of the NorthAmerica Consumer Language goodwill.7. INTANGIBLE ASSETSIntangible assets consisted of the following items as of the dates indicated (in thousands): December 31, 2015 December 31, 2014 GrossCarryingAmount AccumulatedAmortization NetCarryingAmount GrossCarryingAmount AccumulatedAmortization NetCarryingAmountTrade name/ trademark $12,442 $(1,271) $11,171 $12,526 $(1,062) $11,464Core technology 15,149 (7,817) 7,332 15,890 (5,661) 10,229Customer relationships 26,245 (16,603) 9,642 26,889 (14,344) 12,545Website 12 (12) — 12 (12) —Patents 300 (201) 99 300 (161) 139Total $54,148 $(25,904) $28,244 $55,617 $(21,240) $34,377The Company recorded intangible assets of $23.8 million, associated with the acquisition of Rosetta Stone Ltd. in January 2006, including itsindefinite-lived Rosetta Stone trade name.The Company recorded intangible assets of $5.5 million with the acquisition of Livemocha in April 2013, consisting of an online community,enterprise relationships, technology platform and the Livemocha trade name. The estimated useful lives of these intangible assets range from two to fiveyears.The Company recorded intangible assets of $14.5 million with the acquisition of Lexia in August 2013, consisting of enterprise relationships,technology platform and the Lexia trade name. The estimated useful lives of these intangible assets range from five to ten years.The Company recorded intangible assets of $3.6 million with the acquisition of Vivity in January 2014, consisting of customer relationships,technology platform and the Vivity trade name. The estimated useful lives of these intangible assets range from three to five years.The Company recorded intangible assets of $9.1 million with the acquisition of Tell Me More in January 2014, consisting of customer relationships,technology platform and the Tell Me More trade name. The estimated useful lives of these intangible assets range from one to five years.Included within the Trade name/ trademark intangible asset category is the Rosetta Stone trade name with a carrying amount of $10.6 million. Thisintangible asset is considered to have an indefinite useful life and is therefore not amortized, but rather tested for impairment on at least an annual basis.The Company computes amortization of intangible assets on a straight-line basis over the estimated useful life. Below are the weighted averageremaining useful lives of the Company's amortizing intangible assets: Weighted Average LifeTrade name / trademark 29 monthsCore technology 36 monthsCustomer relationships 76 monthsPatents 33 monthsF-27Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)7. INTANGIBLE ASSETS (Continued)Amortization expense consisted of the following (in thousands): Years Ended December 31, 2015 2014 2013Included in cost of revenue: Cost of product revenue $264 $377 $—Cost of subscription and service revenue 322 209 244Total included in cost of revenue 586 586 244Included in operating expenses: Sales and marketing 2,804 3,677 1,028Research and development 1,802 2,000 550General and administrative — — —Total included in operating expenses 4,606 5,677 1,578Total $5,192 $6,263 $1,822The following table summarizes the estimated future amortization expense related to intangible assets as of December 31, 2015 (in thousands): As ofDecember 31, 20152016 $4,6302017 4,1892018 3,5762019 1,5322020 1,282Thereafter 2,428Total $17,637The Company also routinely reviews indefinite-lived intangible assets and long-lived intangible assets for potential impairment as part of theCompany’s internal control framework. As an indefinite-lived intangible asset, the Rosetta Stone tradename was evaluated as of December 31, 2015 todetermine if indicators of impairment exist. The Company elected to bypass the option to first assess qualitative factors to determine whether it is more likelythan not that the Rosetta Stone trade name was impaired and performed the quantitative assessment. In the quantitative assessment, the Company noted thatthe fair value of the Rosetta Stone trade name has declined from prior estimates of fair value due to the reduction in forecasted revenue and bookings fromboth the Enterprise & Education Language and the Consumer Language reporting units, however, the fair value exceeds the carrying value. Additionally, alllong-lived intangible assets were evaluated to determine if indicators of impairment exist and the Company concluded that there are no potential indicatorsof impairment. There were no impairment charges related to intangible assets for the years ended December 31, 2015, 2014 and 2013.F-28Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)8. OTHER CURRENT LIABILITIESThe following table summarizes other current liabilities (in thousands): As ofDecember 31, 2015 2014Accrued marketing expenses $20,022 $31,985Accrued professional and consulting fees 1,746 2,804Sales return reserve 3,728 3,570Sales, withholding, and property taxes payable 3,879 5,875Accrued purchase price of business acquisition — 1,688Other 5,943 7,336Total Other current liabilities $35,318 $53,2589. FINANCING ARRANGEMENTSRevolving Line of CreditOn October 28, 2014, Rosetta Stone Ltd (“RSL”), a wholly owned subsidiary of parent company Rosetta Stone Inc., executed a Loan and SecurityAgreement with Silicon Valley Bank (“Bank”) to obtain a $25.0 million revolving credit facility (the “credit facility”). The Company executed the FirstAmendment to the credit facility with the Bank effective March 31, 2015, the Second Amendment effective May 1, 2015, the Third Amendment effectiveJune 29, 2015, and the Fourth Amendment effective December 29, 2015. The Company is subject to certain covenants under the Loan and SecurityAgreement including financial covenants and limitations on indebtedness, encumbrances, investments and distributions and dispositions of assets, certain ofwhich covenants were amended in the First, Second, Third, and Fourth Amendments, which were primarily amended to reflect updates to the Company'sfinancial outlook. The Third Amendment also changed the definition of "change of control" to eliminate the clause referring to a change in a portion of theBoard of Directors within a twelve-month period.On March 14, 2016, the Company executed the Fifth Amendment to the credit facility. Under the amended agreement, the Company may borrow up to$25.0 million including a sub-facility, which reduces available borrowings, for letters of credit in the aggregate availability amount of $4.0 million (the"credit facility"). Borrowings by RSL under the credit facility are guaranteed by the Company as the ultimate parent. The credit facility has a term that expireson January 1, 2018, during which time RSL may borrow and re-pay loan amounts and re-borrow the loan amounts subject to customary borrowing conditions.The total obligations under the credit facility cannot exceed the lesser of (i) the total revolving commitment of $25.0 million or (ii) the borrowing base,which is calculated as 80% of eligible accounts receivable. As a result, the borrowing base will fluctuate and the Company expects it will follow the generalseasonality of cash and accounts receivable (lower in the first half of the year and higher in the second half of the year). If the borrowing base less anyoutstanding amounts, plus the cash held at SVB ("Availability") is greater than $25.0 million, then the Company may borrow up to an additional $5.0million, but in no case can borrowings exceed $25.0 million. Interest on borrowings accrue at the Prime Rate provided that the Company maintains aminimum cash and Availability balance of $17.5 million. If cash and Availability is below $17.5 million, interest will accrue at the Prime Rate plus 1%.Proceeds of loans made under the credit facility may be used as working capital or to fund general business requirements. All obligations under thecredit facility, including letters of credit, are secured by a security interest on substantially all of the Company’s assets including intellectual property rightsand by a stock pledge by the Company of 100% of its ownership interests in U.S. subsidiaries and 66% of its ownership interests in certain foreignsubsidiaries.The Company is subject to certain financial and restrictive covenants under the credit facility. The credit facility contains customary affirmative andnegative covenants, including covenants that limit or restrict our ability to, among other things, incur additional indebtedness, dispose of assets, execute amaterial change in business, acquire or dispose of an entity, grant liens, make share repurchases, and make distributions, including payment of dividends. TheCompany is required to maintain compliance with a minimum liquidity amount and minimum financial performance requirements, as defined in the creditfacility. As of December 31, 2015, the Company was in compliance with all covenants.F-29Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)9. FINANCING ARRANGEMENTS (Continued)The credit facility contains customary events of default, including among others, non-payment defaults, covenant defaults, bankruptcy and insolvencydefaults, and a change of control default, in each case, subject to customary exceptions. The occurrence of a default event could result in the Bank’sacceleration of repayment obligations of any loan amounts then outstanding.As of December 31, 2015, there were no borrowings outstanding and the Company was eligible to borrow the entire $25.0 million of available creditand $4.0 million in letters of credit have been issued by the Bank on the Company's behalf. A quarterly commitment fee accrues on any unused portion of thecredit facility at a nominal annual rate.Capital LeasesThe Company enters into capital leases under non-committed arrangements for equipment and software. In addition, as a result of the Tell Me MoreMerger, the Company assumed a capital lease for a building near Versailles, France, where Tell Me More’s headquarters are located. The fair value of thelease liability at the date of acquisition was $4.0 million.During the years ended December 31, 2015, 2014, 2013, the Company acquired equipment or software through the issuance of capital leases totaling$0.5 million, zero, $0.7 million, respectively. This non-cash investing activity has been excluded from the consolidated statement of cash flows.As of December 31, 2015, the future minimum payments under capital leases with initial terms of one year or more are as follows (in thousands):Periods Ending December 31, 2016 $6442017 6452018 4932019 4922020 492Thereafter 855Total minimum lease payments $3,621Less amount representing interest 478Present value of net minimum lease payments $3,143Less current portion 521Obligations under capital lease, long-term $2,62210. STOCK-BASED COMPENSATION2006 Stock Incentive PlanOn January 4, 2006, the Company established the Rosetta Stone Inc. 2006 Stock Incentive Plan (the "2006 Plan") under which the Company's Board ofDirectors, at its discretion, could grant stock options to employees and certain directors of the Company and affiliated entities. The 2006 Plan initiallyauthorized the grant of stock options for up to 1,942,200 shares of common stock. On May 28, 2008, the Board of Directors authorized the grant of additionalstock options for up to 195,000 shares of common stock under the plan, resulting in total stock options available for grant under the 2006 Plan of 2,137,200as of December 31, 2008. The stock options granted under the 2006 Plan generally expire at the earlier of a specified period after termination of service or thedate specified by the Board or its designated committee at the date of grant, but not more than ten years from such grant date. Stock issued as a result ofexercises of stock options will be issued from the Company's authorized available stock.2009 Omnibus Incentive PlanOn February 27, 2009, the Company's Board of Directors approved the 2009 Omnibus Incentive Plan (the "2009 Plan") that provides for the ability ofthe Company to grant up to 2,437,744 new stock incentive awards or options including Incentive and Nonqualified Stock Options, Stock AppreciationRights, Restricted Stock, Restricted Stock Units, Performance Units, Performance Shares, Performance based Restricted Stock, Share Awards, Phantom Stockand Cash Incentive Awards. The stockF-30Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)10. STOCK-BASED COMPENSATION (Continued)incentive awards and options granted under the 2009 Plan generally expire at the earlier of a specified period after termination of service or the date specifiedby the Board or its designated committee at the date of grant, but not more than ten years from such grant date. Concurrent with the approval of the 2009Plan, the 2006 Plan was terminated for purposes of future grants.On May 26, 2011 the Board of Directors authorized and the Company's shareholders' approved the allocation of an additional 1,000,000 shares ofcommon stock to the 2009 Plan. On May 23, 2012, the Board of Directors authorized and the Company's shareholders approved the allocation of 1,122,930additional shares of common stock to the 2009 Plan. On May 23, 2013, the Board of Directors authorized and the Company's shareholders approved theallocation of 2,317,000 additional shares of common stock to the 2009 Plan. On May 20, 2014, the Board of Directors authorized and the Company'sshareholders approved the allocation of 500,000 additional shares of common stock to the 2009 Plan. On June 12, 2015, the Board of Directors authorizedand the Company's shareholders approved the allocation of 1,200,000 additional shares of common stock to the 2009 Plan. At December 31, 2015 there were3,349,235 shares available for future grant under the 2009 Plan.In accordance with ASC 718, the fair value of stock-based awards to employees is calculated as of the date of grant. Compensation expense is thenrecognized on a straight-line basis over the requisite service period of the award. The Company uses the Black-Scholes pricing model to value its stockoptions, which requires the use of estimates, including future stock price volatility, expected term and forfeitures. Stock-based compensation expenserecognized is based on the estimated portion of the awards that are expected to vest. Estimated forfeiture rates were applied in the expense calculation.The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model as follows: Years Ended December 31, 2015 2014 2013Expected stock price volatility 49%-63% 63%-65% 64%-67%Expected term of options 6 years 6 years 6 yearsExpected dividend yield — — —Risk-free interest rate 1.19%-1.75% 1.46%-1.80% 0.75%-1.65%Prior to the completion of the Company's initial public offering in April 2009, the Company's stock was not publicly quoted and the Company had alimited history of stock option activity, so the Company reviewed a group of comparable industry-related companies to estimate its expected volatility overthe most recent period commensurate with the estimated expected term of the awards. In addition to analyzing data from the peer group, the Company alsoconsidered the contractual option term and vesting period when determining the expected option life and forfeiture rate. Subsequent to the initial publicoffering and through April 2015, the Company continued to review a group of comparable industry-related companies to estimate volatility, but alsoreviewed the volatility of its own stock since the initial public offering. During this period, the Company considered the volatility of the comparablecompanies to be the best estimate of future volatility. After April 2015, the Company had a sufficient period of stock price data to estimate volatility basedupon the historical volatility experienced in its own stock price. For the risk-free interest rate, the Company uses a U.S. Treasury Bond rate consistent with theestimated expected term of the option award.The expected term of options granted represents the period of time that they are expected to be outstanding and is derived using a combination of peercompany information and the simplified method as described in ASC 718-10-S99. Prior to the completion of the Company's initial public offering in April2009, the stock was not publicly quoted and there was a limited history of stock option activity. The Company believes the limited historical exercise datarelated to our stock options does not provide a reasonable basis on which to estimate the expected term.F-31Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)10. STOCK-BASED COMPENSATION (Continued)Stock OptionsThe following table summarizes the Company's stock option activity from January 1, 2015 to December 31, 2015: OptionsOutstanding WeightedAverageExercisePrice WeightedAverageContractualLife (years) AggregateIntrinsicValueOptions Outstanding, January 1, 2015 2,017,642 $13.24 7.32 $760,925Options granted 1,203,031 8.92 Options exercised (25,009) 4.55 Options cancelled (1,358,499) 13.16 Options Outstanding, December 31, 2015 1,837,165 10.58 7.70 130,262Vested and expected to vest at December 31, 2015 1,740,152 10.60 7.63 130,262Exercisable at December 31, 2015 1,033,366 $10.77 6.98 $130,262As of December 31, 2015 and 2014, there was approximately $5.2 million and $6.1 million of unrecognized stock-based compensation expense relatedto non-vested stock option awards that is expected to be recognized over a weighted average period of 1.84 and 2.38 years, respectively.Stock options are granted at the discretion of the Board of Directors or the Compensation Committee (or its authorized member(s)) and expire 10 yearsfrom the date of the grant. Options generally vest over a four-year period based upon required service conditions. No options have performance or marketconditions. The Company calculates the pool of additional paid-in capital associated with excess tax benefits using the "simplified method" in accordancewith ASC 718.The weighted average remaining contractual term and the aggregate intrinsic value for options outstanding at December 31, 2015 was 7.70 years and$0.1 million, respectively. The weighted average remaining contractual term and the aggregate intrinsic value for options exercisable at December 31, 2014was 7.32 years and $0.8 million, respectively. As of December 31, 2015, options that were vested and exercisable totaled 1,033,366 shares of common stockwith a weighted average exercise price per share of $10.77.The weighted average grant-date fair value per share of stock options granted was $4.77 and $6.73 for the years ended December 31, 2015 and 2014,respectively.The aggregate intrinsic value disclosed above represents the total intrinsic value (the difference between the fair market value of the Company'scommon stock as of December 31, 2015, and the exercise price, multiplied by the number of in-the-money options) that would have been received by theoption holders had all option holders exercised their options on December 31, 2015. This amount is subject to change based on changes to the fair marketvalue of the Company's common stock.F-32Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)10. STOCK-BASED COMPENSATION (Continued)Restricted Stock AwardsThe following table summarizes the Company's restricted stock activity for the years ended December 31, 2015 and 2014, respectively: Nonvested Outstanding Weighted Average GrantDate Fair Value Aggregate IntrinsicValueNonvested Awards, January 1, 2014 634,031 $12.28 $7,785,901Awards granted 236,338 11.69 Awards vested (253,526) 10.72 Awards canceled (134,198) 13.23 Nonvested Awards, December 31, 2014 482,645 12.59 6,074,136Awards granted 481,992 9.05 Awards vested (452,341) 10.56 Awards canceled (170,717) 11.88 Nonvested Awards, December 31, 2015 341,579 10.61 3,624,153During 2015 and 2014, 481,992 and 236,338 shares of restricted stock were granted, respectively. The aggregate grant date fair value of the awards in2015 and 2014 was $4.4 million and $2.8 million, respectively, which will be recognized as expense on a straight-line basis over the requisite service periodof the awards, which is also the vesting period. The Company's restricted stock grants are accounted for as equity awards. The grant date fair value is based onthe market price of the Company's common stock at the date of grant. The Company did not grant any restricted stock prior to April 2009.During 2015, 170,717 shares of restricted stock were forfeited. As of December 31, 2015, future compensation cost related to the nonvested portion ofthe restricted stock awards not yet recognized in the statement of operations was $3.6 million and is expected to be recognized over a period of 1.93 years.Restricted stock awards are considered outstanding at the time of grant as the stockholders are entitled to voting rights and to receive any dividendsdeclared subject to the loss of the right to receive accumulated dividends if the award is forfeited prior to vesting. Unvested restricted stock awards are notconsidered outstanding in the computation of basic earnings per share.Restricted Stock UnitsThe following table summarizes the Company's restricted stock unit activity from January 1, 2015 to December 31, 2015: Units Outstanding WeightedAverageGrant Date Fair Value AggregateIntrinsicValueUnits Outstanding, January 1, 2015 124,506 $12.52 $1,215,179Units granted 63,436 8.49 Units released — — Units cancelled — — Units Outstanding, December 31, 2015 187,942 11.16 1,257,332Vested and expected to vest at December 31, 2015 153,786 8.50 203,244Vested and deferred at December 31, 2015 123,406 $12.58 $825,586During 2015 and 2014, 63,436 and 43,842 restricted stock units were granted, respectively, to members of the Board of Directors as part of theircompensation package. Restricted stock units convert to common stock following the separation of service with the Company. The aggregate grant date fairvalue of the awards in 2015 and 2014 was $0.5 million and $0.4 million, respectively. Beginning June 2015, all restricted stock unit awards vest quarterlyover a one year period from the date of grant, with expense recognized straight-line over the vesting period. Prior to June 2015, all restricted stock unitawards were immediately vested with expense recognized in full on the grant date. The Company's restricted stock units are accounted for asF-33Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)10. STOCK-BASED COMPENSATION (Continued)equity awards. The grant date fair value is based on the market price of the Company's common stock at the date of grant. The Company did not grant anyrestricted stock units prior to April 2009.Long Term Incentive ProgramOn February 21, 2013, the Company’s Board of Directors approved the 2013 Rosetta Stone Inc. Long Term Incentive Program (“2013 LTIP”). The 2013LTIP was administered under the Rosetta Stone Inc. 2009 Omnibus Incentive Plan (the “2009 Plan”) and the shares awarded under the 2013 LTIP will betaken from the shares reserved under the 2009 Plan. The purpose of the 2013 LTIP was to: motivate senior management and other executives to achieve keyfinancial and strategic business objectives of the Company; offer eligible executives of the Company a competitive total compensation package; rewardexecutives in the success of the Company; provide ownership in the Company; and retain key talent. The 2013 LTIP was effective from January 1, 2013 untilDecember 31, 2014.Certain executives were designated for eligibility by the Board of Directors to receive performance stock awards and cash upon the Company’sachievement of specified performance goals between January 1, 2013 and December 31, 2014. In order for any performance stock award grants or any cashpayments to be made under the 2013 LTIP, the Company must have met the minimum threshold requirements for a performance goal for the 2014 fiscal yearin addition to the cumulative threshold performance goals for the two year period ended December 31, 2014. Each performance goal was mutually exclusive. Each performance goal had a range of payout levels depending on the achievement of the goal ranging from zero to 200% of the incentive target. Theperformance stock awards granted were 100% vested as of the date of grant with no subsequent holding period requirement. The Company’s stockholdersapproved the material terms of the performance goals on May 23, 2013, the grant date for the performance stock awards. The amount of share-based compensation expense recognized related to the 2013 LTIP was $1.3 million and $1.4 million for the years ended December31, 2014 and 2013, respectively. Expense of $0.3 million and $0.6 million was recognized related to the cash-based portion of the 2013 LTIP for the yearsended December 31, 2014 and 2013, respectively. In the first quarter of 2015, the Company issued 160,860 performance share awards related to theconclusion of the 2013 LTIP.Stock-Based Compensation ExpenseThe following table presents the stock-based compensation expense for stock options and restricted stock included in the related financial statementline items (in thousands): Years Ended December 31, 2015 2014 2013Included in cost of revenue: Cost of product revenue $57 $95 $109Cost of subscription and service revenue 44 13 66Total included in cost of revenue 101 108 175Included in operating expenses: Sales and marketing 1,327 1,975 1,840Research & development 841 958 1,460General and administrative 4,926 3,721 5,766Total included in operating expenses 7,094 6,654 9,066Total $7,195 $6,762 $9,24111. STOCKHOLDERS' EQUITYAt December 31, 2015, the Company's Board of Directors had the authority to issue 200,000,000 shares of stock, of which 190,000,000 were designatedas Common Stock, with a par value of $0.00005 per share, and 10,000,000 were designated as Preferred Stock, with a par value of $0.001 per share. AtDecember 31, 2015 and 2014, the Company had shares of Common Stock issued of 23,149,634 and 22,935,620, respectively, and shares of Common Stockoutstanding of 22,149,634 and 21,935,620, respectively.F-34Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)11. STOCKHOLDERS' EQUITY (Continued)On May 8, 2013, the Company filed a universal shelf registration statement which became effective on May 30, 2013. The registration statementpermitted certain holders of the Company’s stock to offer the shares of common stock held by them. On June 11, 2013 the selling shareholders, ABS CapitalPartners IV Trust and Norwest Equity Partners VIII, LP, sold a combined total of 3,490,000 shares at an offering price of $16.00 per share. During Novemberand December 2013, ABS Capital Partners IV Trust sold the remainder of its common stock holdings in the Company. The shelf also provides the Companywith the flexibility to offer an amount of equity or issue debt in the amount of $150.0 million. The Company issued and sold an additional 10,000 shares at aper share price of $16.00 in the offering.On August 22, 2013, the Company’s Board of Directors approved a share repurchase program under which the Company is authorized to repurchase upto $25.0 million of its outstanding common stock from time to time in the open market or in privately negotiated transactions depending on marketconditions, other corporate considerations, and applicable legal requirements. The Company expects to fund the repurchases through existing cash balancesand cash generated from operations. For the year ended December 31, 2013, the Company paid $11.4 million to repurchase 1,000,000 shares at a weightedaverage price of $11.44 per share as part of this program. No shares were repurchased during the year ended December 31, 2015. Shares repurchased under theprogram were recorded as treasury stock on the Company’s consolidated balance sheet. The shares repurchased under this program during the year endedDecember 31, 2013 were not the result of an accelerated share repurchase agreement. Management has not made a decision on whether shares purchasedunder this program will be retired or reissued.Holders of the Company's common stock are entitled to receive dividends when and if declared by the Board of Directors out of assets or funds legallyavailable for that purpose. Future dividends are dependent on the Company's financial condition and results of operations, the capital requirements of itsbusiness, covenants associated with financing arrangements, other contractual restrictions, legal requirements, regulatory constraints, industry practice andother factors deemed relevant by its Board of Directors.12. EMPLOYEE BENEFIT PLANThe Company maintains a defined contribution 401(k) Plan (the "Plan"). The Company matches employee contributions to the Plan up to 4% of theircompensation. The Company recorded Company contribution matching expenses for the Plan totaling $2.0 million, $2.2 million, and $1.9 million for theyears ended December 31, 2015, 2014 and 2013, respectively.13. RESTRUCTURING AND OTHER EMPLOYEE SEVERANCE2015 Restructuring ActionsIn the first quarter of 2015, the Company announced and initiated actions to reduce headcount and other costs in order to support its strategic shift inbusiness focus.Restructuring charges included in the Company’s consolidated statement of operations related to the 2015 Restructuring Plan include the following:•Employee severance and related benefits costs incurred in connection with headcount reductions involving employees primarily in the U.S. andthe U.K.;•Contract termination costs; and•Other related costs.F-35Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)13. RESTRUCTURING AND OTHER EMPLOYEE SEVERANCE (Continued)The following table summarizes activity with respect to the restructuring charges for the 2015 Restructuring Plan during the year ended December 31,2015 (in thousands): Balance at January 1,2015 Cost Incurred Cash Payments Other Adjustments (1) Balance at December 31,2015Severance costs $— $7,240 $(5,940) $(1,048) $252Contract termination costs — 1,134 (1,134) — —Other costs — 417 (417) — —Total $— $8,791 $(7,491) $(1,048) $252(1) Other Adjustments includes non-cash period changes in the liability balance, which may include non-cash stock compensation expense andforeign currency translation adjustments.As of December 31, 2015, the entire restructuring liability of $0.3 million was classified as a current liability within accrued compensation and othercurrent liabilities on the consolidated balance sheets.The following table presents restructuring costs included in the related line items of our Statement of Operations (in thousands): Years Ended December 31, 2015 2014Cost of revenue $113 $—Sales and marketing 4,492 —Research and development 602 —General and administrative 3,584 —Total $8,791 $—These restructuring expenses are not allocated to any reportable segment under our definition of segment contribution as defined in Note 17 "SegmentInformation."The Company does not expect to incur any additional restructuring costs in connection with the 2015 Restructuring Plan.At each reporting date, the Company will evaluate its accrued restructuring costs to ensure the liabilities reported are still appropriate. Any changes tothe estimated costs of executing approved restructuring plans will be reflected in the Company’s consolidated statements of operations.2014 Employee Severance ActionsOn January 9, 2014, the Company completed its acquisition of Tell Me More, a company organized under the laws of France. At acquisition, the planwas to fully integrate Tell Me More into the operations of the Company. Following the acquisition, the Company undertook financial performance review ofthe French entity and of the Company as a whole. As a result, the Company identified the need to reduce expenses. In the second quarter of 2014, theCompany began to create a plan to address the economic issues of the business through the reduction of expense. The result of this economic planning was toreduce headcount within certain business units of the French entity.Under the requirements of French Labour Law, there is an expectation on the part of both the employer and employee that if an employee is terminated,the employer is required to pay a minimum amount of severance. Accordingly, the Company concluded that the termination benefits for certain employees asthe result of the reduction in force in France were payable based upon an ongoing benefit arrangement. A severance liability became probable and estimablewhen the Company received approval from the French Labour Administration and when the specific employees impacted were determined. These criteriawere met in the third quarter of 2014 and the Company recorded an accrual and related expense of $1.0 million. Severance payments totaling $0.5million related to this reduction in force were paid during the fourth quarter of 2014, $0.4 million was paid in 2015, and the remaining amount is expected tobe paid in 2016.F-36Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)13. RESTRUCTURING AND OTHER EMPLOYEE SEVERANCE (Continued)During 2014, the Company initiated other actions across its business to reduce headcount in order to align resources to support business needs. TheCompany recorded $3.2 million in severance costs associated with these actions. As a result, $2.3 million was paid during 2014, $0.8 million was paid during2015, and the remaining $0.1 million liability will be paid in 2016.14. LEASE ABANDONMENT AND TERMINATIONAs part of the Company’s effort to reduce general and administrative expenses through a planned space consolidation at its Arlington, Virginiaheadquarters location, the Company incurred a lease abandonment charge of $3.2 million for the year ended December 31, 2014. Prior to January 31, 2014,the Company occupied the 6th and 7th floors at its Arlington, Virginia headquarters. The Company estimated the liability under the operating leaseagreements and accrued lease abandonment costs in accordance with ASC 420, Exit or Disposal Cost Obligations ("ASC 420"), as the Company has no futureeconomic benefit from the abandoned space and the lease does not terminate until December 31, 2018. All leased space related to the 6th floor wasabandoned and ceased to be used by the Company on January 31, 2014.In March 2013 Rosetta Stone Japan Inc. partially abandoned its Japan office as a result of excess office space due to reduction in staff along with overalllocal operations business performance. The Company estimated the liability under the operating lease agreement reduced for anticipated sublease income inaccordance with ASC 420 as the Company had no future economic benefit from the abandoned space and the lease did not terminate until February 28,2015. As of March 31, 2014, the Company ceased to use the remaining office space in this facility and simultaneously negotiated and paid a leasetermination fee of $0.4 million. The Company has been released from all obligations under the lease arrangement as of December 31, 2014. A summary of the Company’s lease abandonment activity for the years ended December 31, 2015 and 2014 is as follows (in thousands): As of December 31, 2015 2014Accrued lease abandonment costs, beginning of period $1,679 $413Costs incurred and charged to expense 55 3,812Principal reductions (452) (2,546)Accrued lease abandonment costs, end of period $1,282 $1,679Accrued lease abandonment costs liability: Short-term $455 $496Long-term 827 1,183Total $1,282 $1,679F-37Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)15. INCOME TAXESThe following table summarizes the significant components of the Company's deferred tax assets and liabilities as of December 31, 2015 and 2014 (inthousands): As ofDecember 31, 2015 2014Deferred tax assets: Inventory $564 $535Net operating and capital loss carryforwards 48,334 27,637Deferred revenue 13,908 12,447Accrued liabilities 9,780 12,890Stock-based compensation 4,656 5,760Amortization and depreciation 31 —Bad debt reserve 398 501Foreign and other tax credits 1,517 1,283Gross deferred tax assets 79,188 61,053Valuation allowance (70,464) (53,809)Net deferred tax assets 8,724 7,244Deferred tax liabilities: Goodwill and indefinite lived intangibles (4,782) (3,465)Deferred sales commissions (7,337) (5,714)Prepaid expenses (625) (555)Amortization and depreciation — (1,337)Foreign currency translation (973) (391)Other (5) (5)Gross deferred tax liabilities (13,722) (11,467)Net deferred tax liabilities $(4,998) $(4,223)For the year ended December 31, 2015, the Company recorded income tax expense of $1.2 million primarily related to current year operations inGermany and the UK and the tax impact of the amortization of indefinite lived intangibles, and the inability to recognize tax benefits associated with currentyear losses of operations in all other foreign jurisdictions and in the U.S. due to the valuation allowance recorded against the deferred tax asset balances ofthese entities. These tax expenses were partially offset by tax benefits related to current year losses (excluding the Consumer Fit Brains goodwill impairment)in Canada. The goodwill that was impaired is not deductible for tax. Additionally, tax benefits were recorded related to the reversal of accrued withholdingtaxes as a result of an intercompany transaction.For the year ending December 31, 2014, the Company recorded an income tax benefit of $6.5 million primarily resulting from the tax benefits relatedto the goodwill impairment taken during the first quarter of 2014 related to the ROW Consumer reporting unit, the goodwill impairment taken during thefourth quarter of 2014 related to the North America Consumer Language reporting unit, and current year losses in Canada and France. The goodwill that wasimpaired related to acquisitions from prior years, a portion of which resulted in a tax benefit as a result of writing off a deferred tax liability previouslyrecorded (i.e., goodwill had tax basis and was amortized for tax). These tax benefit amounts were partially offset by income tax expense related to profits fromcertain foreign operations and foreign withholding taxes. The tax benefits were also partially offset by the tax expense related to the tax impact ofamortization of indefinite lived intangibles, and the inability to recognize tax benefits associated with current year losses of operation in all other foreignjurisdictions and in the U.S. due to the valuation allowance recorded against the deferred tax asset balances of these entities.During the third quarter of 2012, the Company established a full valuation allowance to reduce the deferred tax assets of its operations in Brazil, Japan,and the U.S., resulting in a non-cash charge of $0.4 million, $2.1 million, and $23.1 million,F-38Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)15. INCOME TAXES (Continued)respectively. Additionally, no tax benefits were provided on 2012 losses incurred in foreign jurisdictions where the Company has determined a valuationallowance is required. As of December 31, 2015, a full valuation allowance was provided for domestic and certain foreign deferred tax assets in thosejurisdictions where the Company has determined the deferred tax assets will more likely than not be realized.If future events change the outcome of the Company's projected return to profitability, a valuation allowance may not be required to reduce thedeferred tax assets. The Company will continue to assess the need for a valuation allowance.As of December 31, 2015, the Company had federal, state and foreign tax NOL carryforward amounts and expiration periods as follows (in thousands):Year of Expiration U.S. Federal State Brazil France Japan Other Foreign Total2016-2020 $— $498 $— $— $— $— $4982021-2025 — 1,180 — — 11,872 607 13,6592026-2030 — 6,288 — — — 152 6,4402031-2035 39,437 34,008 — — — 251 73,6962036-2040 48,904 38,532 — — — 932 88,368Indefinite — — 5,511 13,158 — — 18,669Totals $88,341 $80,506 $5,511 $13,158 $11,872 $1,942 $201,330As of December 31, 2015, the Company had federal and state capital loss carryforward amounts and expiration periods as follows (in thousands):Year of Tax Credit Expiration U.S. Federal State2016-2020 $— $—2021-2025 6,837 6,0552026-2030 — —2031-2035 — 3602036-2040 — —Indefinite — —Totals $6,837 $6,415As of December 31, 2015, the Company had federal tax credit carryforward amounts and expiration periods as follows (in thousands):Year of Tax Credit Expiration U.S. Federal2016-2020 $—2021-2025 1,5162026-2030 12031-2035 —2036-2040 —Indefinite —Totals $1,517F-39Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)15. INCOME TAXES (Continued)The components of loss before income taxes and the provision for taxes on income consist of the following (in thousands): Years Ended December 31, 2015 2014 2013United States $(41,458) $(60,434) $(14,360)Foreign (4,179) (19,761) (3,658)Loss before income taxes $(45,637) $(80,195) $(18,018)The provision for taxes on income consists of the following (in thousands): Federal $(157) $29 $155State 96 23 123Foreign 444 1,258 1,709Total current $383 $1,310 $1,987Deferred: Federal $1,148 $(5,425) $(3,972)State 169 (797) (112)Foreign (541) (1,577) 213Total deferred 776 (7,799) (3,871)Provision (benefit) for income taxes $1,159 $(6,489) $(1,884)Reconciliation of income tax provision (benefit) computed at the U.S. federal statutory rate to income tax expense (benefit) is as follows (in thousands): Years Ended December 31, 2015 2014 2013Income tax benefit at statutory federal rate $(15,973) $(28,068) $(6,306)State income tax expense, net of federal income tax effect 231 (782) 7Acquired intangibles — — (859)Nondeductible goodwill impairment 1,961 — —Other nondeductible expenses 88 482 1,105Tax rate differential on foreign operations (1,019) 276 (264)Increase in valuation allowance 15,713 21,772 4,263Tax audit settlements (96) — —Change in prior year estimates 225 (69) (17)Other tax credits 29 (102) —Other — 2 187Income tax expense (benefit) $1,159 $(6,489) $(1,884)The Company accounts for uncertainty in income taxes under ASC topic 740-10-25, Income Taxes: Overall: Recognition, ("ASC 740-10-25"). ASC740-10-25 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. ASC 740-10-25 also provides guidance on derecognition, classification, interest and penalties, accounting in interimperiods, disclosure, and transition.The Company recognizes interest and penalties related to unrecognized tax benefits as a component of income tax expense (benefit). As ofDecember 31, 2015 and 2014, the Company had zero and $26,000 accrued for interest and penalties, respectively, in "Other Long Term Liabilities". Duringthe years ended December 31, 2015 and 2014, the Company accrued zero and $10,000 in interest expense, respectively.F-40Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)15. INCOME TAXES (Continued)A reconciliation of the beginning and ending amount of unrecognized tax benefits, excluding interest and penalties, is as follows (in thousands): Years Ended December 31, 2015 2014Balance at January 1, $446 $143Increases for tax positions taken during prior years — 322Settlements with tax authorities (446) —Reductions for tax positions taken during prior years — (2)Lapse of statute of limitations — (17)Balance at December 31, $— $446The Company is subject to taxation in the U.S. and various states and foreign jurisdictions. The Company's tax years 2010 and forward are subject toexamination by the tax authorities. The Company was under audit by the Internal Revenue Service for tax years 2009 to 2012. During 2015, the U.S. audit fortax years 2009 through 2012 concluded and resulted in the Company recording a $0.1 million tax benefit. The previously recorded $0.4 million ofunrecognized tax benefits were settled as a result of the concluded IRS audit. During the year ended December 31, 2015, the Company recorded a netdecrease of $0.4 million of additional unrecognized tax benefits related to tax credits claimed in a prior period. As of December 31, 2015 and 2014, theCompany had zero and $0.4 million of unrecognized tax benefits, respectively. Any liabilities for unrecognized tax benefits were netted against "Income TaxReceivable." The Company does not expect that the amounts of unrecognized tax benefits will change significantly within the next twelve months.The Company had an accumulated consolidated deficit related to its foreign subsidiaries of $34.4 million at December 31, 2015 and aggregate 2015losses before income tax related to its foreign subsidiaries of approximately $4.2 million. The Company has certain foreign subsidiaries with aggregateundistributed earnings of $11.6 million at December 31, 2015. The foreign subsidiaries with aggregate undistributed earnings are considered indefinitelyreinvested as of December 31, 2015. As a result of the multitude of scenarios in which the earnings could be repatriated, if desired, and the complexity ofassociated calculations, it is not practicable to estimate the amount of additional tax that might be payable on the undistributed foreign earnings.The Company made income tax payments of $1.4 million, $1.7 million, and $3.3 million, in 2015, 2014 and 2013, respectively.16. COMMITMENTS AND CONTINGENCIESOperating LeasesThe Company leases copiers, parking spaces, buildings, a warehouse, and office space under operating lease and site license arrangements, some ofwhich contain renewal options. Building, warehouse and office space leases range from 7 months to 74 months. Certain leases also include lease renewaloptions.F-41Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)16. COMMITMENTS AND CONTINGENCIES (Continued)The following table summarizes future minimum operating lease payments as of December 31, 2015 and the years thereafter (in thousands): As ofDecember 31,2015Periods Ending December 31, 2016 $5,5912017 4,3672018 3,8292019 1,2532020 962Thereafter 590Total future minimum operating lease payments $16,592Total expenses under operating leases were $5.1 million, $5.6 million and $7.1 million during the years ended December 31, 2015, 2014 and 2013,respectively.The Company accounts for its leases under the provisions of ASC topic 840, Accounting for Leases ("ASC 840"), which require that leases be evaluatedand classified as operating leases or capital leases for financial reporting purposes. Certain operating leases contain rent escalation clauses, which arerecorded on a straight-line basis over the initial term of the lease with the difference between the rent paid and the straight-line rent recorded as either adeferred rent asset or liability depending on the calculation. Lease incentives received from landlords are recorded as deferred rent liabilities and areamortized on a straight-line basis over the lease term as a reduction to rent expense.Royalty AgreementsThe Company has entered into agreements to license software from vendors for incorporation in the Company's products. Pursuant to some of theseagreements, the Company is required to pay minimum royalties or license fees over the term of the agreement regardless of actual license sales. In addition,such agreements typically specify that, in the event the software is incorporated into specified Company products, royalties will be due at a contractual ratebased on actual sales volumes. These agreements are subject to various royalty rates typically calculated based on the level of sales for those products. TheCompany expenses these amounts to cost of sales or research and development expense, as appropriate. Royalty expense was $0.2 million, $31,000, and $0for the years ended December 31 2015, 2014 and 2013, respectively.Employment AgreementsThe Company has agreements with certain of its executives and key employees which provide guaranteed severance payments upon termination oftheir employment without cause.LitigationIn June 2011, Rosetta Stone GmbH, a subsidiary of the Company, was served with a writ filed by Langenscheidt KG (“Langenscheidt”) in the DistrictCourt of Cologne, Germany alleging trademark infringement due to Rosetta Stone GmbH’s use of the color yellow on its packaging of its language-learningsoftware and the advertising thereof in Germany. Langenscheidt sought relief in the form of monetary damages and injunctive relief; however there has notbeen a demand for a specific amount of monetary damages and there has been no specific damage amount awarded to Langenscheidt. In January 2012, theDistrict Court of Cologne ordered an injunction against specific uses of the color yellow made by Rosetta Stone GmbH in packaging, on its website and intelevision commercials and declared Rosetta Stone GmbH liable for damages, attorneys’ fees and costs to Langenscheidt. In its decision, the District Court ofCologne also ordered the destruction of Rosetta Stone GmbH’s product and packaging which utilized the color yellow and which was deemed to haveinfringed Langenscheidt’s trademark. The Court of Appeals in Cologne and the German Federal Supreme Court have affirmed the District Court's decision. The Company has filed special complaints with the German Federal Supreme Court and the German Constitutional Court directed to constitutional issues inthe German Federal Supreme Court’s decision.F-42Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)16. COMMITMENTS AND CONTINGENCIES (Continued)In August 2011, Rosetta Stone GmbH commenced a separate proceeding for the cancellation of Langenscheidt’s German trademark registration ofyellow as an abstract color mark. In June 2012, the German Patent and Trademark Office rendered a decision in the cancellation proceeding denying ourrequest to cancel Langenscheidt’s German trademark registration. The German Federal Supreme Court has denied Rosetta Stone GmbH's further appeal buthas not yet issued its written decision denying further appeal. A constitutional complaint was filed with the German Federal Supreme Court in May 2015,which is still pending.In October 2015, the parties engaged in further settlement discussions and executed a settlement agreement pursuant to which Rosetta Stone GmbH willpay a lump sum of $0.4 million in full settlement of all financial claims resulting from the proceedings, including damages and cost reimbursement toLangenscheidt. Both parties have withdrawn the pending motions. As of December 31, 2015, the Company recorded a liability equal to the full settlementamount of $0.4 million, which was paid in January 2016.From time to time, the Company has been subject to various claims and legal actions in the ordinary course of its business. The Company is notcurrently involved in any legal proceeding the ultimate outcome of which, in its judgment based on information currently available, would have a materialimpact on its business, financial condition or results of operations.17. SEGMENT INFORMATIONThe Company is managed in two operating segments - Enterprise & Education and Consumer. These segments also represent the Company's reportablesegments. Segment contribution includes segment revenue and expenses incurred directly by the segment, including material costs, service costs, customercare and coaching costs, sales and marketing expenses, and bad debt expense. The Company does not allocate expenses beneficial to all segments, whichinclude certain general and administrative expenses, facilities and communication expenses, purchasing expenses and manufacturing support and logisticexpenses. These expenses are included in the unallocated expenses section of the table presented below. Revenue from transactions between the Company'soperating segments is not material.With the exception of goodwill, the Company does not identify or allocate its assets by operating segment. Consequently, the Company does notpresent assets or liabilities by operating segment.F-43Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)17. SEGMENT INFORMATION (Continued)Operating results by segment for the years ended December 31, 2015, 2014, and 2013 were as follows (in thousands): Years Ended December 31, 2015 2014 2013Revenue: Enterprise & Education $98,057 $84,700 $60,209Consumer 119,613 177,153 204,436Total revenue $217,670 $261,853 $264,645Segment contribution: Enterprise & Education $30,431 $22,864 $20,965Consumer 34,547 35,298 70,884Total segment contribution 64,978 58,162 91,849Unallocated expenses, net: Unallocated cost of sales 8,291 8,947 4,586Unallocated sales and marketing 15,282 16,168 16,447Unallocated research and development 29,939 33,176 33,993Unallocated general and administrative 48,470 54,576 54,423Unallocated non-operating expense/(income) 1,824 1,345 (424)Unallocated impairment 6,754 20,333 —Unallocated lease abandonment 55 3,812 842Total unallocated expenses, net 110,615 138,357 109,867Income (loss) before income taxes $(45,637) $(80,195) $(18,018)Geographic InformationRevenue by major geographic region is based primarily upon the geographic location of the customers who purchase the Company's products. Thegeographic locations of distributors and resellers who purchase and resell the Company's products may be different from the geographic locations of endcustomers.The information below summarizes revenue from customers by geographic area as of December 31, 2015, 2014 and 2013, respectively (in thousands): Years Ended December 31, 2015 2014 2013United States $177,966 $212,070 $223,404International 39,704 49,783 41,241Total Revenue $217,670 $261,853 $264,645The information below summarizes long-lived assets by geographic area for the years ended December 31, 2015 and 2014, respectively (in thousands): As of December 31, 2015 2014United States $18,704 $20,451International 3,828 4,826Total $22,532 $25,277F-44Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)17. SEGMENT INFORMATION (Continued)Revenue by Product and ServiceThe Company earns revenue from the sale of language-learning, literacy and brain fitness products and services. The information below summarizesrevenue by type for the years ended December 31, 2015, 2014 and 2013, respectively (in thousands): As of December 31, 2015 2014 2013Language learning $191,568 $249,340 $263,426Literacy 21,928 9,912 1,219Brain Fitness 4,174 2,601 —Total $217,670 $261,853 $264,64518. RELATED PARTIESAs of December 31, 2015 and 2014, the Company had outstanding receivables from employees in the amount of $18,000 and $67,000, respectively.19. VALUATION AND QUALIFYING ACCOUNTSThe following table includes the Company's valuation and qualifying accounts for the respective periods (in thousands): Years Ended December 31, 2015 2014 2013Allowance for doubtful accounts: Beginning balance $1,434 $1,000 $1,297Charged to costs and expenses 1,657 2,405 1,420Deductions—accounts written off (1,895) (1,971) (1,717)Ending balance $1,196 $1,434 $1,000Promotional rebate and coop advertising reserves: Beginning balance $23,437 $13,025 $9,127Charged to costs and expenses 40,563 39,249 22,881Deductions - reserves utilized (47,090) (28,837) (18,983)Ending balance $16,910 $23,437 $13,025Sales return reserve: Beginning balance $3,570 $4,834 $5,883Charged against revenue 11,474 12,011 14,258Deductions—reserves utilized (11,316) (13,275) (15,307)Ending balance $3,728 $3,570 4,834Deferred income tax asset valuation allowance: Beginning balance $53,809 33,866 29,671Charged to costs and expenses 16,655 19,943 9,566Deductions — — (5,371)Ending balance $70,464 $53,809 $33,866F-45Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)20. SUPPLEMENTAL QUARTERLY FINANCIAL INFORMATION (Unaudited)Summarized quarterly supplemental consolidated financial information for 2015 and 2014 are as follows (in thousands, except per share amounts): Three Months Ended March 31, June 30, September 30, December 31,2015 Revenue $58,442 $51,411 $49,802 $58,015Gross profit $47,140 $42,391 $41,136 $48,476Net loss $(19,884) $(8,175) $(7,301) $(11,436)Basic loss per share $(0.95) $(0.38) $(0.34) $(0.52)Shares used in basic per share computation 21,018 21,689 21,771 21,801Diluted loss per share $(0.95) $(0.38) $(0.34) $(0.52)Shares used in diluted per share computation 21,018 21,689 21,771 21,8012014 Revenue $60,765 $57,315 $64,515 $79,258Gross profit $48,594 $45,355 $51,528 $63,322Net loss $(20,241) $(15,750) $(16,178) $(21,537)Basic loss per share $(0.96) $(0.74) $(0.76) $(1.01)Shares used in basic per share computation 21,125 21,252 21,305 21,327Diluted loss per share $(0.96) $(0.74) $(0.76) $(1.01)Shares used in diluted per share computation 21,125 21,252 21,305 21,32721. SUBSEQUENT EVENTSOn March 14, 2016, the Company announced that it intends to exit the direct sales presence in almost all of its non-U.S. and non-northern Europeangeographies related to the distribution of Enterprise & Education language offerings. Where appropriate, the Company will seek to operate through partnersin those geographies being exited. The Company will also look to initiate processes to close its software development operations in France and China. Intotal, if the Company's intentions are realized, these actions will reduce headcount by approximately 17% of our full-time workforce and is expected to resultin annual expense reductions of approximately $19.0 million. If fully realized, these actions will result in an estimated restructuring charge ranging between$5.0 million and $6.0 million, with approximately 50% accrued in the first quarter 2016, largely reflecting cash separation payments. These actions areadditive to the plans discussed in Note 13 and further support a strategic shift in business focus to help address periods of losses.On March 14, 2016, the Company executed the Fifth Amendment to its Loan and Security Agreement with Silicon Valley Bank. See Note 9 for moredetails.In March 2016 the Board of Director's concluded the search for a chief executive officer and has appointed A. John Hass III as President, ChiefExecutive Officer, and Chairman of the Board effective April 1, 2016.F-46Table of ContentsEXHIBIT INDEX Index to exhibits2.1 Agreement and Plan of Merger among Rosetta Stone Ltd., Liberty Merger Sub Inc., LiveMocha, Inc., andShareholder Representative Services LLC., dated April 1, 2013 (incorporated herein by reference to Exhibit 2.1filed with Rosetta Stone's Current Report on Form 8-K filed on April 2, 2013).3.1 Second Amended and Restated Certificate of Incorporation (incorporated herein by reference to Exhibit 3.2 toAmendment No. 3 to the Company’s Registration Statement on Form S-1 (No. 333-153632) filed on February 23,2009).3.2 Second Amended and Restated Bylaws (incorporated herein by reference to Exhibit 3.4 to Amendment No. 3 tothe Company’s Registration Statement on Form S-1 (No. 333-153632) filed on February 23, 2009).4.1 Specimen certificate evidencing shares of common stock (incorporated herein by reference to Exhibit 4.1 toAmendment No. 3 to the Company’s Registration Statement on Form S-1 (No. 333-153632) filed on February 23,2009).4.2 Registration Rights Agreement dated as of January 4, 2006 among Rosetta Stone Inc. and the InvestorShareholders and other Shareholders listed on Exhibit A thereto (incorporated herein by reference to Exhibit 4.3to Amendment No. 1 to the Company’s Registration Statement on Form S-1 (No. 333-153632) filed onNovember 5, 2008).10.1+2006 Incentive Option Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s RegistrationStatement on Form S-1 (No. 333-153632) filed on September 23, 2008).10.2+2009 Omnibus Incentive Plan, as amended and restated effective February 13, 2014 (incorporated herein byreference to Exhibit 99.1 filed with the Company’s Registration Statement on Form S-8 (No. 333-201025) filedon December 17, 2014).10.3+Director Form of Option Award Agreement under the 2006 Plan (incorporated herein by reference to Exhibit 10.3to the Company’s Registration Statement on Form S-1 (No. 333-153632) filed on September 23, 2008).10.4+Director Form of Option Award Agreement under the 2009 Plan (incorporated herein by reference to Exhibit 10.6to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014).10.5+Executive Form of Option Award Agreement under the 2006 Plan (incorporated herein by reference to Exhibit10.4 to the Company’s Registration Statement on Form S-1 (No. 333-153632) filed on September 23, 2008).10.6+Executive Form of Option Award Agreement under the 2009 Plan (incorporated herein by reference toExhibit 10.5 to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014).10.7+Amended Executive Form of Option Award Agreement under 2009 Plan effective for awards after October 1,2011 (incorporated herein by reference to Exhibit 10.25 in the Company’s Annual Report on Form 10-K for thefiscal year ended December 31, 2011).10.8+ *Amended Executive Form of Option Award Agreement under 2009 Plan effective for awards after February 1,2016.10.9+Form of Restricted Stock Award Agreement under the 2009 Plan (incorporated herein by reference to Exhibit10.13 to Amendment No. 4 to the Company’s Registration Statement on Form S-1 (No. 333-153632), filed onMarch 17, 2009).10.10+Amended Executive Form of Restricted Stock Award Agreement under 2009 Plan effective for awards afterOctober 1, 2011 (incorporated herein by reference to Exhibit 10.26 in the Company’s Annual Report onForm 10-K for the fiscal year ended December 31, 2011).10.11+ *Amended Executive Form of Restricted Stock Award Agreement under 2009 Plan effective for awards afterFebruary 1, 2016.10.12+Director Form of Restricted Stock Unit Award Agreement under the 2009 Plan (incorporated herein by referenceto Exhibit 10.12 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014).10.13+Director Form of Restricted Stock Unit Award Agreement under the 2009 Plan (for awards beginning June 2015)(incorporated herein by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q for theperiod ended June 30, 2015)10.14+2013 Rosetta Stone Inc. Long Term Incentive Program (pursuant to the Rosetta Stone Inc. 2009 OmnibusIncentive Plan) (incorporated herein by reference to Exhibit 10.24 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014).10.15+Form of Award Agreement under the 2013 Long Term Incentive Program (incorporated herein by reference toExhibit 10.25 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014).10.16+2014 Executive Bonus Plan (incorporated herein by reference to Exhibit 10.23 in the Company’s Annual Reporton Form 10-K for the fiscal year ended December 31, 2014).Table of Contents Index to exhibits10.17+Policy on Recoupment of Performance Based Compensation (Clawback Policy) (incorporated herein byreference to Exhibit 10.26 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31,2014).10.18+ *Rosetta Stone Inc. Change in Control Severance Plan.10.19 Form of Indemnification Agreement entered into with each director and executive officer (incorporated herein byreference to Exhibit 10.7 to the Company’s Registration Statement on Form S-1 (No. 333-153632) filed onSeptember 23, 2008).10.20 Form of Indemnification Agreement to be entered into with each director and executive officer, revised as ofAugust 2015 (incorporated herein by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Qfor the period ended September 30, 2015).10.21+Executive Employment Agreement between Rosetta Stone Ltd. and Stephen Swad effective as of November 9,2010 (incorporated herein by reference to Exhibit 10.1 filed with the Company’s Current Report on Form 8-Kfiled on October 13, 2010).10.22+Amendment to Executive Employment Agreement between Rosetta Stone Ltd. and Stephen Swad effective as ofDecember 22, 2011 (incorporated herein by reference to Exhibit 10.22 in the Company’s Annual Report onForm 10-K for the fiscal year ended December 31, 2011).10.23+Second Amendment to Executive Employment Agreement between Rosetta Stone Ltd. and Stephen Swadeffective as of February 22, 2012 (incorporated herein by reference to Exhibit 10.23 in the Company’s AnnualReport on Form 10-K for the fiscal year ended December 31, 2011).10.24+Executive Employment Agreement between Rosetta Stone Ltd. and Judy Verses effective as of October 5, 2011(incorporated herein by reference to Exhibit 10.18 in the Company’s Annual Report on Form 10-K for the fiscalyear ended December 31, 2011).10.25+Executive Employment Agreement between Rosetta Stone Ltd. and Thomas Pierno effective as of May 2, 2012(incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on May 1,2012).10.26+Executive Employment Agreement between Rosetta Stone Ltd. and Christian Na effective as of June 2, 2014(incorporated herein by reference to Exhibit 10.28 in the Company’s Annual Report on Form 10-K for the fiscalyear ended December 31, 2014).10.27+Agreement and General Release between Rosetta Stone Ltd. and Christian Na effective as of December 2, 2014(incorporated herein by reference to Exhibit 10.29 in the Company’s Annual Report on Form 10-K for the fiscalyear ended December 31, 2014).10.28+Executive Employment Agreement between Rosetta Stone Ltd. and Eric Ludwig effective as of January 1, 2015(incorporated herein by reference to Exhibit 10.30 in the Company’s Annual Report on Form 10-K for the fiscalyear ended December 31, 2014).10.29+Director Agreement between Rosetta Stone Inc. and A. John Hass III effective as of November 18, 2014(incorporated herein by reference to Exhibit 10.31 in the Company’s Annual Report on Form 10-K for the fiscalyear ended December 31, 2014).10.30+Executive Employment Agreement between Rosetta Stone Ltd. and A. John Hass III effective as of April 1, 2015(incorporated herein by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q for theperiod ended September 30, 2015).10.31+Executive Employment Agreement between the Company and Sonia Cudd, effective as of January 2, 2015(incorporated herein by reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q for theperiod ended March 31, 2015).10.32 Nomination and Support Agreement between John H. Lewis, Osmium Partners, LLC, Osmium Capital, LP,Osmium Capital II, LP, Osmium Spartan, LP, Osmium Diamond, LP, Osmium Special Opportunity Fund, LP, andRosetta Stone Inc. effective as of November 18, 2014 (incorporated by reference to Exhibit 10.1 filed to theCompany’s Current Report on Form 8-K filed on November 19, 2014).10.33 Lease Agreement dated as of February 20, 2006, by and between Premier Flex Condos, LLC and FairfieldLanguage Technologies, Inc., as amended (incorporated herein by reference to Exhibit 10.10 to Amendment No.1 to the Company’s Registration Statement on Form S-1 (No. 333-153632), filed on November 5, 2008).10.34 Sublease Agreement dated as of October 6, 2008, by and between The Corporate Executive Board Company andRosetta Stone Ltd. (incorporated herein by reference to Exhibit 10.11 to Amendment No. 1 to the Company’sRegistration Statement on Form S-1 (No. 333-153632), filed on November 5, 2008).10.35 First Amendment to Sublease Agreement with The Corporate Executive Board, dated as of November 1, 2012(incorporated herein by reference to Exhibit 10.23 filed with the Company’s Annual Report on Form 10-K for thefiscal year ended December 31, 2012).10.36 Sub-Sublease Agreement dated as of April 3, 2014, by and between Rosetta Stone Ltd. and The CorporateExecutive Board Company (incorporated herein by reference to Exhibit 10.27 in the Company’s Annual Reporton Form 10-K for the fiscal year ended December 31, 2014).Table of Contents Index to exhibits10.37+Software License Agreement by and between The Regents of the University of Colorado and Fairfield &Sons Ltd. dated as of December 22, 2006 (incorporated herein by reference to Exhibit 10.12 to Amendment No. 2to the Company’s Registration Statement on Form S-1 (No. 333-153632), filed on January 21, 2009).10.38 Loan and Security Agreement between Rosetta Stone Ltd. and Silicon Valley Bank, executed on October 28,2014 (incorporated herein by reference to Exhibit 99.3 filed to the Company’s Current Report on Form 8-K filedon October 29, 2014).10.39 First Amendment to Loan and Security Agreement between Rosetta Stone Ltd. and Silicon Valley Bank,effective as of March 31, 2015 (incorporated herein by reference to Exhibit 10.1 of the Company’s QuarterlyReport on Form 10-Q for the period ended March 31, 2015).10.40 Second Amendment to Loan and Security Agreement between Rosetta Stone Ltd. and Silicon Valley Bank,effective as of May 1, 2015 (incorporated herein by reference to Exhibit 10.3 of the Company’s Quarterly Reporton Form 10-Q for the period ended March 31, 2015).10.41 Third Amendment to Loan and Security Agreement dated as of June 29, 2015 between Silicon Valley Bank andRosetta Stone Ltd. (incorporated herein by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form10-Q for the period ended June 30, 2015).10.42*Fourth Amendment to Loan and Security Agreement dated as of December 29, 2015 between Silicon ValleyBank and Rosetta Stone Ltd.21.1 Rosetta Stone Inc. Subsidiaries.23.1 Consent of Deloitte & Touche LLP, independent registered public accounting firm.24.1 Power of Attorney.31.1 Certifications of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2 Certifications of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1 Certifications of Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2 Certifications of Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.101Interactive Data Files._______________________________________________________________________________* Filed herewith.*** Portions of this exhibit have been omitted pursuant to a request for confidential treatment.+ Identifies management contracts and compensatory plans or arrangements.OPTION NO.: %%OPTION_NUMBER%-%ROSETTA STONE INC. 2009 OMNIBUS INCENTIVE PLANCOVER SHEET TO NONQUALIFIED STOCK OPTION AWARD AGREEMENT Rosetta Stone Inc., a Delaware corporation (the “Company”), hereby grants an option to purchase shares of its Class B CommonStock, $.00005 par value (the “Stock”), to the optionee named below (the “Option”). The terms and conditions of the Option are setforth in the Nonqualified Stock Option Award Agreement and in the Rosetta Stone Inc. 2009 Omnibus Incentive Plan (the “Plan”).Grant Date: %%OPTION_DATE%-%Name of Optionee: %%FIRST_NAME%-% %%LAST_NAME%-%Optionee’s Employee Identification Number: %%EMPLOYEE_IDENTIFIER%-%Number of Shares Covered by Option: %%TOTAL_SHARES_GRANTED%-%Option Price per Share: $%%OPTION_PRICE%-%Vesting Start Date: %%VEST_BASE_DATE%-%Executive understands and agrees that this Non-Qualified Stock Option Award is granted subject to and in accordance with the termsof the Rosetta Stone, Inc. %%EQUITY_PLAN%-% (the "Plan"). Executive further agrees to be bound by the terms of the Plan andthe terms of the Non-Qualified Stock Option Award as set forth in the Non-Qualified Stock Option Agreement and any Addenda tosuch Non-Qualified Stock Option Agreement. A copy of the Plan is available on www.Etrade.com.Nothing in this Notice or in the Non-Qualified Stock Option Agreement or in the Plan shall confer upon Executive any right tocontinue in service for any period of specific duration or interfere with or otherwise restrict in any way the rights of the Company (orany Affiliate employing or retaining Executive) or of Executive, which rights are hereby expressly reserved by each, to terminateExecutive's Service at any time for any reason, with or without cause.Definitions. All capitalized terms in this Cover Sheet shall have the meaning assigned to them in this Cover Sheet or in the Non-Qualified Stock Option Agreement.ROSETTA STONE INC.1ROSETTA STONE INC. 2009 OMNIBUS INCENTIVE PLAN AS AMENDED NONQUALIFIED STOCK OPTION AWARD AGREEMENTThis NONQUALIFIED STOCK OPTION AWARD AGREEMENT (this “Agreement”) and the Cover Sheet to whichthis Agreement is attached (the “Cover Sheet”) are entered into between Rosetta Stone Inc., a Delaware corporation (the “Company”),and Optionee (as that term is defined in the Cover Sheet). The Board of Directors of the Company has adopted, and the stockholdersof the Company have approved, the Rosetta Stone Inc. 2009 Omnibus Incentive Plan, as amended (the “Plan”), the terms of which areincorporated by reference herein in their entirety. Any term used in this Agreement that is not specifically defined herein shall have themeaning specified in the Plan.IT IS AGREED:1.Grant of Option. Subject to the terms of the Plan, this Agreement and the Cover Sheet, on the Grant Date set forth onthe Cover Sheet (the “Grant Date”), the Company granted to Optionee an option (the “Option”) to purchase that number of shares ofthe Company’s common stock, $.00005 par value (the “Stock”), at the Option Price per Share of Stock set forth on the Cover Sheet(the “Option Price”), subject to adjustment as provided in the Plan.2. Type of Option. The Option is a nonqualified stock option which is not intended to be governed by section 422 of theCode and will be interpreted accordingly.3. Optionee’s Agreement. In accepting the Option, Optionee accepts and agrees to be bound by all the terms and conditionsof the Plan which pertain to nonqualified stock options granted under the Plan.4. Vesting of Option. Subject to the provisions of the Plan and the provision of this Agreement (including the requirement inSection 6 that Optionee continue to be employed by the Company or a Subsidiary Corporation on the dates set forth below), theOption will vest and become exercisable in accordance with the following terms:(a) on the first anniversary of the Vesting Start Date (as set forth on the Cover Sheet), and on each succeedinganniversary date of the Vesting Start Date, the Option will vest with respect to, and may be exercised for up to, one-fourth (1/4th) of thetotal number of shares of the Stock subject to the Option as set forth on the Cover Sheet (the “Option Shares”), rounded to the nearestwhole number of shares, except that on the fourth anniversary of the Vesting Start Date the Option shall vest with respect to theremaining number of Option Shares for which the Option has not previously vested;(b) If the Optionee’s employment terminates as a result of the Optionee’s involuntary termination not-for-Cause, anyportion of the Option that is vested as of the date of such termination of employment will remain exercisable until the earlier of (i) thedate that is sixty (60) days following the date of such termination of the Optionee’s employment or (ii) the Option2General Expiration Date. In the event of such a termination of employment, the portion, if any, of the Option that is unvested as of thedate of such termination will immediately vest and become exercisable in an amount equal to (A) the product obtained by multiplying(x) the total number of Option Shares granted under this Agreement by (y) a fraction, the numerator of which is the number of days inthe period beginning on the Grant Date and ending on the date of such termination of Employment, and the denominator of which isthe number of days in the period beginning on the Grant Date and ending on the fourth anniversary of the Grant Date, minus (B) thenumber of Option Shares that have vested pursuant to the vesting schedule set forth in Section 4(a) above as of the date of termination;and the portion of the Option that becomes so vested in accordance with this sentence will thereafter remain exercisable for the periodof time set forth above in this Section 4(b). Any portion of the Option that does not vest after application of the preceding sentence willbe immediately forfeited upon the date of such termination without any payment or consideration due by the Company;(c) upon the termination of employment of the Optionee by the Company without Cause or by the Optionee for GoodReason, in either case, within one year following the occurrence of a Change in Control, any portion of the Option Shares that havenot previously vested will vest and the Option shall be exercisable in full; and(d) to the extent not exercised, installments of vested Option Shares shall be cumulative and may be exercised inwhole or in part.5. Manner of Exercise.(a) To the extent that the Option is vested and exercisable in accordance with Section 4 of this Agreement, the Optionmay be exercised by Optionee at any time, or from time to time, in whole or in part, on or prior to the termination of the Option (as setforth in Section 6 of this Agreement) upon payment of the Option Price for the Option Shares to be acquired in accordance with theterms and conditions of this Agreement and the Plan.(b) If Optionee is entitled to exercise the vested and exercisable portion of the Option, and wishes to do so, in whole orpart, Optionee shall (i) deliver to the Company a fully completed and executed notice of exercise, in such form as may be designatedby the Company in its sole discretion, specifying the exercise date and the number of Option Shares to be purchased pursuant to suchexercise and (ii) remit to the Company in a form satisfactory to the Company, in its sole discretion, the Option Price for the OptionShares to be acquired on exercise of the Option, plus an amount sufficient to satisfy any withholding tax obligations of the Companythat arise in connection with such exercise (as determined by the Company) in accordance with the provisions of the Plan.(c) The Company’s obligation to deliver shares of the Stock to Optionee under this Agreement is subject to andconditioned upon Optionee satisfying all tax obligations associated with Optionee’s receipt, holding and exercise of the Option. Unlessotherwise approved by the Committee, all such tax obligations shall be payable in accordance with the provisions of the Plan.3(d) The Company and its Affiliates and subsidiaries, as applicable, shall be entitled to deduct from any compensationotherwise due to Optionee the amount necessary to satisfy all such taxes.(e) Upon full payment of the Option Price and satisfaction of all applicable tax obligations, and subject to theapplicable terms and conditions of the Plan and the terms and conditions of this Agreement, the Company shall cause certificates forthe shares purchased hereunder to be delivered to Optionee or cause an uncertificated book-entry representing such shares to be madein the name of Optionee.6. Termination of Option. Unless the Option terminates earlier as provided in this Section 6 the Option shall terminate andbecome null and void at the close of business at the Company’s principal business office on the day before the date of the tenthanniversary of the Grant Date (the “Option General Expiration Date”). If Optionee ceases to be an employee of the Company or anySubsidiary Corporation for any reason the Option shall not continue to vest after such cessation of service as an employee of theCompany or Subsidiary Corporation.(a) If Optionee ceases to be an employee of the Company or any Subsidiary Corporation due to death or Disability,(i) the portion of the Option that was exercisable on the date of such cessation shall remain exercisable for, and shall otherwiseterminate and become null and void at the close of business at the Company’s principal business office on the day that is six (6) monthsafter the date of such death or Disability, but in no event after the Option General Expiration Date; and (ii) the portion of the Optionthat was not exercisable on the date of such cessation shall be forfeited and become null and void immediately upon such cessation.(b) If Optionee ceases to be an employee of the Company or a Subsidiary Corporation due to Cause, all of the Optionshall be forfeited and become null and void immediately upon such cessation, whether or not then exercisable.(c) If Optionee ceases to be an employee of the Company or a Subsidiary Corporation for any reason other than death,Disability, or Cause, (i) the portion of the Option that was exercisable on the date of such cessation shall remain exercisable for, andshall otherwise terminate and become null and void at the close of business at the Company’s principal business office on the later of(x) the day that is sixty (60) days after the date of such cessation, or (y) the day that is thirty (30) after any blackout period(s) under theCompany’s Insider Trading Compliance Policy (as in effect from time to time) to the extent Optionee is then subject to any suchblackout period(s), but in no event after the Option General Expiration Date, and (ii) the portion of the Option that was not exercisableon the date of such cessation shall be forfeited and become null and void immediately upon such cessation.(d) Upon the death of Optionee prior to the expiration of the Option, Optionee’s executors, administrators or anyperson or persons to whom the Option may be transferred by will or by the laws of descent and distribution, shall have the right, at anytime prior to the termination of the Option to exercise the Option with respect to the number of shares that Optionee would have beenentitled to exercise if he were still alive.47. Tax Withholding. To the extent that the receipt of the Option, this Agreement or the Cover Sheet, the vesting of the Optionor the exercise of the Option results in income to Optionee for federal, state, local or foreign income, employment or other tax purposeswith respect to which the Company or its subsidiaries or any Affiliate has a withholding obligation, Optionee shall deliver to theCompany at the time of such receipt, vesting or exercise, as the case may be, such amount of money as the Company or its subsidiariesor any Affiliate may require to meet its obligation under applicable tax laws or regulations, and, if Optionee fails to do so, theCompany or its subsidiaries or any Affiliate is authorized to withhold from the shares subject to the Option (based on the Fair MarketValue of such shares as of the date the amount of tax to be withheld is determined) or from any cash or stock remuneration then orthereafter payable to Optionee any tax required to be withheld by reason of such taxable income, sufficient to satisfy the withholdingobligation.8. Capital Adjustments and Reorganizations. The existence of the Option shall not affect in any way the right or power ofthe Company or any company the stock of which is awarded pursuant to this Agreement to make or authorize any adjustment,recapitalization, reorganization or other change in its capital structure or its business, engage in any merger or consolidation, issue anydebt or equity securities, dissolve or liquidate, or sell, lease, exchange or otherwise dispose of all or any part of its assets or business, orengage in any other corporate act or proceeding.9. Employment Relationship. For purposes of this Agreement, Optionee shall be considered to be in the employment of theCompany, any Subsidiary Corporation or any Affiliates as long as Optionee has an employment relationship with the Company, anySubsidiary Corporation or any Affiliates. The Committee shall determine any questions as to whether and when there has been atermination of such employment relationship, and the cause of such termination, under the Plan and the Committee’s determinationshall be final and binding on all persons.10. Not an Employment Agreement. This Agreement is not an employment or service agreement, and no provision of thisAgreement shall be construed or interpreted to create an employment or other service relationship between Optionee and the Company,its subsidiaries or any of its Affiliates or guarantee the right to remain employed by the Company, its subsidiaries or any of itsAffiliates, for any specified term or require the Company, its subsidiaries or any Affiliate to employ Optionee for any period of time.11. No Rights As Stockholder. Optionee shall not have any rights as a stockholder with respect to any Option Shares until thedate of the issuance of such shares following Optionee’s exercise of the Option pursuant to its terms and conditions and payment of allamounts for and with respect to the shares. No adjustment shall be made for dividends or other rights for which the record date is priorto the date a certificate or certificates are issued for such shares or an uncertificated book-entry representing such shares is made.12. Legend. Optionee consents to the placing on the certificate for any Option Shares of an appropriate legend restrictingresale or other transfer of such shares except in accordance with the Securities Act of 1933 and all applicable rules thereunder.13. Notices. Any notice, instruction, authorization, request, demand or other communications required hereunder shall be inwriting, and shall be delivered either by personal5delivery, by telegram, telex, telecopy or similar facsimile means, by certified or registered mail, return receipt requested, or by courieror delivery service, addressed to the Company at the Company’s principal business office address to the attention of the Company’sGeneral Counsel and to Optionee at Optionee’s residential address as it appears on the books and records of the Company, or at suchother address and number as a party shall have previously designated by written notice given to the other party in the mannerhereinabove set forth. Notices shall be deemed given when received, if sent by facsimile means (confirmation of such receipt byconfirmed facsimile transmission being deemed receipt of communications sent by facsimile means); and when delivered (or upon thedate of attempted delivery where delivery is refused), if hand-delivered, sent by express courier or delivery service, or sent by certifiedor registered mail, return receipt requested.14. Amendment and Waiver. Except as otherwise provided herein or in the Plan or as necessary to implement the provisionsof the Plan, this Agreement may be amended, modified or superseded only by written instrument executed by the Company andOptionee. Only a written instrument executed and delivered by the party waiving compliance hereof shall waive any of the terms orconditions of this Agreement. Any waiver granted by the Company shall be effective only if executed and delivered by a dulyauthorized director or officer of the Company other than Optionee. The failure of any party at any time or times to require performanceof any provisions hereof shall in no manner effect the right to enforce the same. No waiver by any party of any term or condition, orthe breach of any term or condition contained in this Agreement, in one or more instances, shall be construed as a continuing waiver ofany such condition or breach, a waiver of any other condition, or the breach of any other term or condition.15. Dispute Resolution. In the event of any difference of opinion concerning the meaning or effect of the Plan or thisAgreement, such difference shall be resolved by the Committee.16. Governing Law and Severability. The validity, construction and performance of this Agreement shall be governed by thelaws of the State of Delaware, excluding any conflicts or choice of law rule or principle that might otherwise refer construction orinterpretation of this Agreement to the substantive law of another jurisdiction. The invalidity of any provision of this Agreement shallnot affect any other provision of this Agreement, which shall remain in full force and effect.17. Transfer Restrictions. The Option Shares may not be sold or otherwise disposed of in any manner that would constitute aviolation of any applicable federal or state securities laws or of any applicable requirements of any stock exchange on which theCompany’s shares of Stock may be listed. Optionee also agrees (a) that the Company may refuse to cause the transfer of Option Sharesto be registered on the applicable stock transfer records if such proposed transfer would in the opinion of counsel satisfactory to theCompany constitute a violation of any applicable securities law and (b) that the Company may give related instructions to the transferagent, if any, to stop registration of the transfer of the Option Shares.18. Discretionary Nature of Plan. The Plan is discretionary and may be amended, cancelled or terminated by the Company atany time, in its discretion. The grant of the Option Shares in this Agreement does not create any contractual right or other right toreceive any Option Shares or other Awards in the future. Future Awards, if any, will be at the sole discretion of the Company.6Any amendment, modification, or termination of the Plan shall not constitute a change or impairment of the terms and conditions of theOptionee’s employment with the Company.19. Successors and Assigns. This Agreement shall, except as herein stated to the contrary, inure to the benefit of and bind thelegal representatives, successors and assigns of the parties hereto.20. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be an original for allpurposes but all of which taken together shall constitute but one and the same instrument.21. Option Transfer Prohibitions. The Option granted to Optionee under this Agreement shall not be transferable orassignable by Optionee other than by will or the laws of descent and distribution, and shall be exercisable during Optionee’s lifetimeonly by him.22. Definitions. The words and phrases defined in this Section 21 shall have the respective meanings set forth belowthroughout this Agreement, unless the context in which any such word or phrase appears reasonably requires a broader, narrower ordifferent meaning.(a) "Cause" shall mean Optionee (i) committed a felony or a crime involving moral turpitude or committed any otheract or omission involving fraud, embezzlement or any other act of dishonesty in the course of his employment by the Company or anAffiliate which conduct damaged the Company or an Affiliate; (ii) substantially and repeatedly failed to perform duties of the officeheld by him or her as reasonably directed by the Company or an Affiliate; (iii) committed gross negligence or willful misconduct withrespect to the Company or an Affiliate; (iv) committed a material breach of any employment agreement between the Optionee and theCompany or an Affiliate that is not cured within ten (10) days after receipt of written notice thereof from the Company or the Affiliate,as applicable; (v) failed, within ten (10) days after receipt by the Optionee of written notice thereof from the Company or an Affiliate,to correct, cease or otherwise alter any failure to comply with instructions or other action or omission which the Board reasonablybelieves does or may materially or adversely affect the Company’s or an Affiliate’s business or operations; (vi) committed misconductwhich is of such a serious or substantial nature that a reasonable likelihood exists that such misconduct will materially injure thereputation of the Company or an Affiliate; (vii) harassed or discriminated against the Company’s or an Affiliate’s employees,customers or vendors in violation of the Company’s policies with respect to such matters; (viii) misappropriated funds or assets of theCompany or an Affiliate for personal use or willfully violated the Company policies or standards of business conduct as determined ingood faith by the Board; (ix) failed, due to some action or inaction on the part of the Optionee, to have immigration status that permitsthe Optionee to maintain full-time employment with the Company or an Affiliate in the United States in compliance with all applicableimmigration law; or (x) disclosed trade secrets of the Company or an Affiliate.(b) “Change in Control” means (i) the liquidation, dissolution or winding-up of the Company, (ii) the sale, license orlease of all or substantially all of the assets of the Company, or (iii) a share exchange, reorganization, recapitalization, or merger orconsolidation of the Company with or into any other corporation or corporations (or other form of business entity) or of any other7corporation or corporations (or other form of business entity) with or into the Company, but excluding any merger effected exclusivelyfor the purpose of changing the domicile of the Company; provided, however, that a Change in Control shall not include any of theaforementioned transactions listed in clauses (i), (ii) and (iii) involving the Company or a Subsidiary Corporation in which the holdersof shares of the Company voting stock outstanding immediately prior to such transaction or any Affiliate of such holders continue tohold at least a majority, by voting power, of the capital stock or, by a majority, based on fair market value as determined in good faithby the Board, of the assets, in each case in substantially the same proportion, of (x) the surviving or resulting corporation (or other formof business entity), (y) if the surviving or resulting corporation (or other form of business entity) is a wholly owned subsidiary ofanother corporation (or other form of business entity) immediately following such transaction, the parent corporation (or other form ofbusiness entity) of such surviving or resulting corporation (or other form of business entity) or (z) a successor entity holding a majorityof the assets of the Company. In addition, a Change in Control shall not include a bona fide, firm commitment underwritten publicoffering of the Stock pursuant to a registration statement declared effective under the Securities Act of 1933, as amended.(c) “Disability” shall have the meaning ascribed to such term in the Plan, as it may be amended from time to time.(d) “Good Reason” shall have the meaning ascribed to such term in the Optionee’s employment agreement with theCompany, or, if none, the Optionee’s resignation from employment with the Company due to (i) a material diminution in Optionee’sannual base salary, duties, authority or responsibilities or (ii) relocation of the Optionee’s primary place of employment to a geographicarea more than fifty (50) miles from Optionee’s then-current primary place of employment, without the Optionee’s consent; providedthat the Optionee has given thirty (30) days advance written notice to the Company of the initial existence of the condition described in(i) and/or (ii) and the Company has not within such thirty (30) day period remedied the condition.23. Acceptance. Optionee agrees that by accepting this Agreement, Optionee confirms that Optionee has read andunderstands the terms and provisions thereof, and accepts the Option Shares subject to all of the terms and conditions of the Plan andthis Agreement. Optionee acknowledges that there may be adverse tax consequences upon exercise of the Option Shares or dispositionof the underlying shares and that Optionee should consult a tax advisor prior to such exercise or disposition.8ROSETTA STONE INC. 2009 OMNIBUS INCENTIVE PLAN AS AMENDED COVER SHEET TO RESTRICTED STOCK AWARD AGREEMENTRosetta Stone Inc., a Delaware corporation (the “Company”), has granted to the individual whose name is set forth below onthe “Name of Executive” line (“Executive”) the shares of the Company’s common stock, $.00005 par value, specified herein, subjectto the terms and conditions set forth in this Cover Sheet, in the attached Restricted Stock Award Agreement and in the Rosetta StoneInc. 2009 Omnibus Incentive Plan, as amended (the “Plan”).Grant Date: %%OPTION_DATE,'MM/DD/YYYY'%-%Name of Executive: %%FIRST_NAME%-% %%LAST_NAME%-%Executive’s Employee Identification Number: %%EMPLOYEE_IDENTIFIER%-%sNumber of Shares of Restricted Stock Granted: %%TOTAL_SHARES_GRANTED,'999,999,999'%-%Vesting Start Date: %%VEST_BASE_DATE%-%Executive understands and agrees that this Restricted Stock Award is granted subject to and in accordance with the terms of theRosetta Stone, Inc. %%EQUITY_PLAN%-% (the "Plan"). Executive further agrees to be bound by the terms of the Plan and theterms of the Restricted Stock Award as set forth in the Restricted Stock Award Agreement and any Addenda to such Restricted StockAward Agreement. A copy of the Plan is available on www.etrade.com.Nothing in this Cover Sheet or in the Restricted Stock Award Agreement or in the Plan shall confer upon Executive any right tocontinue in service for any period of specific duration or interfere with or otherwise restrict in any way the rights of the Company (orany Affiliate employing or retaining Executive) or of Executive, which rights are hereby expressly reserved by each, to terminateExecutive's Service at any time for any reason, with or without cause.Definitions. All capitalized terms in this Cover Sheet shall have the meaning assigned to them in this Cover Sheet or in the RestrictedStock Award Agreement. THIS AGREEMENT IS NOT A STOCK CERTIFICATE OR A NEGOTIABLE INSTRUMENT1ROSETTA STONE INC. 2009 OMNIBUS INCENTIVE PLAN AS AMENDED RESTRICTED STOCK AWARD AGREEMENTThis RESTRICTED STOCK AWARD AGREEMENT (this “Agreement”) and the Cover Sheet to which this Agreementis attached (the “Cover Sheet”) is made by and between Rosetta Stone Inc., a Delaware corporation (the “Company”), and Executive(as that term is defined in the Covered Sheet), effective as of the Grant Date set forth on the Cover Sheet (the “Grant Date”), pursuantto the Rosetta Stone Inc. 2009 Omnibus Incentive Plan, as amended (the “Plan”), a copy of which previously has been made availableto Executive and the terms and provisions of which are incorporated by reference herein.WHEREAS, the Board of Directors of the Company (the “Board”) has determined that it is in the best interest of theCompany and its shareholders to grant to Executive the shares of the Company’s common stock, $.00005 par value, set forth on the“Number of Shares of Restricted Stock Granted” line on the Cover Sheet (the “Shares”), subject to the terms and conditions of thisAgreement; andWHEREAS, Executive desires to have the opportunity to hold the Shares subject to the terms and conditions of thisAgreement;NOW, THEREFORE, in consideration of the premises, mutual covenants and agreements contained herein, and other goodand valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto, intending to be legallybound hereby, agree as follows:1.Definitions. For purposes of this Agreement, the following terms shall have the meanings indicated:(a)“Change in Control” means (i) the liquidation, dissolution or winding-up of the Company, (ii) the sale, license or lease of all orsubstantially all of the assets of the Company, or (iii) a share exchange, reorganization, recapitalization, or merger orconsolidation of the Company with or into any other corporation or corporations (or other form of business entity) or of anyother corporation or corporations (or other form of business entity) with or into the Company, but excluding any mergereffected exclusively for the purpose of changing the domicile of the Company; provided, however, that a Change in Controlshall not include any of the aforementioned transactions listed in clauses (i), (ii) and (iii) involving the Company or a SubsidiaryCorporation in which the holders of shares of the Company voting stock outstanding immediately prior to such transaction orany Affiliate of such holders continue to hold at least a majority, by voting power, of the capital stock or, by a majority, basedon fair market value as determined in good faith by the Board, of the assets, in each case in substantially the same proportion,of (x) the surviving or resulting corporation (or other form of business entity), (y) if the surviving or resulting corporation (orother form of business entity) is a wholly owned subsidiary of another corporation (or other form of business entity)immediately following such transaction, the parent corporation (or other form of business entity) of such surviving or resultingcorporation (or other form of business entity) or (z) a successor entity holding a majority of the assets of the Company. Inaddition,1a Change in Control shall not include a bona fide, firm commitment underwritten public offering of the Stock pursuant to aregistration statement declared effective under the Securities Act of 1933, as amended.(b)“Forfeiture Restrictions” shall mean the prohibitions and restrictions set forth herein with respect to the sale or other dispositionof the Shares issued to Executive hereunder and the obligation to forfeit and surrender such Shares to the Company.(c)“Period of Restriction” shall mean the period during which Restricted Shares are subject to Forfeiture Restrictions and duringwhich Restricted Shares may not be sold, assigned, transferred, pledged or otherwise encumbered.(d)“Restricted Shares” shall mean the Shares that are subject to the Forfeiture Restrictions under this Agreement.(e)“Cause” shall mean Executive (i) committed a felony or a crime involving moral turpitude or committed any other act oromission involving fraud, embezzlement or any other act of dishonesty in the course of his employment by the Company or anAffiliate which conduct damaged the Company or an Affiliate; (ii) substantially and repeatedly failed to perform duties of theoffice held by him or her as reasonably directed by the Company or an Affiliate; (iii) committed gross negligence or willfulmisconduct with respect to the Company or an Affiliate; (iv) committed a material breach of any employment agreementbetween the Executive and the Company or an Affiliate that is not cured within ten (10) days after receipt of written noticethereof from the Company or the Affiliate, as applicable; (v) failed, within ten (10) days after receipt by the Executive ofwritten notice thereof from the Company or an Affiliate, to correct, cease or otherwise alter any failure to comply withinstructions or other action or omission which the Board or CEO reasonably believes does or may materially or adversely affectthe Company’s or an Affiliate’s business or operations; (vi) committed misconduct which is of such a serious or substantialnature that a reasonable likelihood exists that such misconduct will materially injure the reputation of the Company or anAffiliate; (vii) harassed or discriminated against the Company’s or an Affiliate’s employees, customers or vendors in violationof the Company’s policies with respect to such matters; (viii) misappropriated funds or assets of the Company or an Affiliate forpersonal use or willfully violated the Company policies or standards of business conduct as determined in good faith by theBoard or the CEO; (ix) failed, due to some action or inaction on the part of the Executive, to have immigration status thatpermits the Executive to maintain full-time employment with the Company or an Affiliate in the United States in compliancewith all applicable immigration law; or (x) disclosed trade secrets of the Company or an Affiliate.(f)“Disability” shall have the meaning ascribed to such term in the Plan, as it may be amended from time to time.(g)“Good Reason” shall have the meaning ascribed to such term in the Executive’s employment agreement with the Company, or,if none, the Executive’s resignation from employment with the Company due to (i) a material diminution in Executive’s annualbase salary, duties, authority or responsibilities or (ii) relocation of the Executive’s primary place of employment to ageographic area more than fifty (50) miles from Executive’s then-current primary place2of employment, without the Executive’s consent; provided that the Executive has given thirty (30) days advance written noticeto the Company of the initial existence of the condition described in (i) and/or (ii) and the Company has not within such thirty(30) day period remedied the condition.Capitalized terms not otherwise defined in this Agreement shall have the meanings given to such terms in the Plan.2.Grant of Restricted Shares. Effective as of the Grant Date, the Company shall cause to be issued in Executive’s name theShares as Restricted Shares. The Company shall cause electronic book entries evidencing the Restricted Shares, and any sharesof the Stock or rights to acquire shares of the Stock distributed by the Company in respect of Restricted Shares during anyPeriod of Restriction (the “Retained Stock Distributions”), to be issued in Executive’s name. During the Period of Restrictionsuch electronic book entries shall contain a restrictive legend notation to the effect that ownership of such Restricted Shares(and any Retained Stock Distributions), and the enjoyment of all rights appurtenant thereto, are subject to the restrictions, terms,and conditions provided in the Plan and this Agreement. During the Period of Restriction any regular dividends paid in cash orproperty (other than Retained Stock Distributions) with respect to the Restricted Shares and Retained Stock Distributions (the“Retained Cash Distributions”) shall not be paid to Executive but instead shall be accumulated by the Company until the datethe Forfeiture Restrictions applicable to the Restricted Shares and Retained Stock Distributions with respect to which suchRetained Cash Distributions shall have been made, paid, or declared shall have become vested and then on that date suchRetained Cash Distributions shall be paid to Executive. Executive shall have the right to vote the Restricted Shares awarded toExecutive and to exercise all other rights, powers and privileges of a holder of the Shares, with respect to such RestrictedShares, with the exception that (a) Executive shall not be entitled to delivery of such Restricted Shares until the ForfeitureRestrictions applicable thereto shall have expired, (b) the Company shall retain custody of all Retained Stock Distributionsmade or declared with respect to the Restricted Shares and Retained Cash Distributions made or declared with respect to theRestricted Shares and the Retained Stock Distributions (and such Retained Stock Distributions and Retained Cash Distributionsshall be subject to the same restrictions, terms and conditions as are applicable to the Restricted Shares) until such time, if ever,as the Restricted Shares with respect to which such Retained Stock Distributions and Restricted Cash Distributions shall havebeen made, paid, or declared shall have become vested, and such Retained Stock Distributions and Retained Cash Distributionsshall not bear interest or be segregated in separate accounts and (c) Executive may not sell, assign, transfer, pledge, exchange,encumber, or dispose of the Restricted Shares or any Retained Stock Distributions or any Restricted Cash Distributions duringthe Period of Restriction. Upon issuance the book entry representing the Restricted Shares shall be delivered to such depositoryas may be designated by the Compensation Committee of the Board (the “Committee”) as a depository for safekeeping until theforfeiture of such Restricted Shares occurs or the Forfeiture Restrictions lapse, together with stock powers or other instrumentsof assignment, each endorsed in blank, which will permit transfer to the Company of all or any portion of the Restricted Sharesand any securities constituting Retained Stock Distributions which shall be forfeited in accordance with the Plan and thisAgreement. In3accepting the award of the Shares set forth in this Agreement Executive accepts and agrees to be bound by all the terms andconditions of the Plan and this Agreement.3.Transfer Restrictions. The Shares granted hereby may not be sold, assigned, pledged, exchanged, hypothecated or otherwisetransferred, encumbered or disposed of, to the extent then subject to the Forfeiture Restrictions. Any such attempted sale,assignment, pledge, exchange, hypothecation, transfer, encumbrance or disposition in violation of this Agreement shall be voidand the Company shall not be bound thereby. Further, the Shares granted hereby that are no longer subject to ForfeitureRestrictions may not be sold or otherwise disposed of in any manner that would constitute a violation of any applicablesecurities laws. Executive also agrees that the Company may (a) refuse to cause the transfer of the Shares to be registered onthe applicable stock transfer records of the Company if such proposed transfer would, in the opinion of counsel satisfactory tothe Company, constitute a violation of any applicable securities law and (b) give related instructions to the transfer agent, if any,to stop registration of the transfer of the Shares. The Shares are registered with the Securities and Exchange Commission undera Registration Statement on Form S-8. A Prospectus describing the Plan and the Shares is available from the Company.4.Vesting.(a)The Shares that are granted hereby shall be subject to the Forfeiture Restrictions. The Forfeiture Restrictions shall lapse as tothe Shares that are granted hereby in accordance with the following schedule, provided that Executive’s employment with theCompany or its direct or indirect subsidiaries has not terminated prior to the applicable lapse date. On the first anniversary ofthe Vesting Start Date (as set forth in the Cover Sheet), and on each succeeding anniversary of the Vesting Start Date (eachsuch anniversary date being referred to as a “lapse date”), the Forfeiture Restrictions shall lapse with respect to one-fourth(1/4th) of the total number of Shares granted hereby, rounded to the nearest whole number, except that on the fourthanniversary of the Vesting Start Date the Forfeiture Restrictions shall lapse with respect to the then remaining number of Sharesgranted hereby for which the Forfeiture Restrictions have not previously lapsed.(b)If the Executive’s employment terminates as a result of the Executive’s involuntary termination not-for-Cause, a number ofShares that are unvested as of the date of such termination will immediately vest in an amount equal to (i) the product obtainedby multiplying (A) the total number of Shares granted under this Agreement by (B) a fraction, the numerator of which is thenumber of days in the period beginning on the Grant Date and ending on the date of such termination of Employment, and thedenominator of which is the number of days in the period beginning on the Grant Date and ending on the fourth anniversary ofthe Grant Date, minus (ii) the number of Shares that had vested pursuant to the vesting schedule set forth in Section 4 (a) aboveas of the date of termination. Any unvested Shares that do not vest after application of the preceding sentence shall be forfeitedto the Company upon the effective date of such termination without any payment or consideration due by the Company.(c)Notwithstanding any other provision of this Agreement to the contrary, if a Change in Control occurs and Executive’semployment is terminated by the Company without Cause or by4Executive with Good Reason, in either case, within one (1) year following the occurrence of the Change in Control, then allremaining Forfeiture Restrictions shall lapse as to the Shares that are granted hereby upon the date the Executive’s employmentterminates.(d)Upon the lapse of the Forfeiture Restrictions with respect to the Shares granted hereby the Company shall cause to be deliveredto Executive such Shares in electronic book entry form, and such Shares shall be transferable by Executive (except to the extentthat any proposed transfer would, in the opinion of counsel satisfactory to the Company, constitute a violation of applicablesecurities law).(e)If Executive ceases to be employed by the Company or a Subsidiary Corporation for any reason before the applicable lapsedate, including death or disability and except as provided in Section 4(b) above, the Forfeiture Restrictions then applicable tothe Shares shall not lapse and all the Shares shall be forfeited to the Company upon termination of employment and neither theCompany nor any Affiliate shall have any further obligations to the Executive under this Agreement.5.Capital Adjustments and Reorganizations. The existence of the Restricted Shares shall not affect in any way the right orpower of the Company or any company the stock of which is awarded pursuant to this Agreement to make or authorize anyadjustment, recapitalization, reorganization or other change in its capital structure or its business, engage in any merger orconsolidation, issue any debt or equity securities, dissolve or liquidate, or sell, lease, exchange or otherwise dispose of all orany part of its assets or business, or engage in any other corporate act or proceeding.6.Tax Withholding. To the extent that the receipt of the Restricted Shares or the lapse of any Forfeiture Restrictions results inincome to Executive for federal, state, local or foreign income, employment or other tax purposes with respect to which theCompany or its Affiliates or subsidiaries have a withholding obligation, Executive shall deliver to the Company at the time ofsuch receipt or lapse, as the case may be, such amount of money as the Company or any Affiliate may require to meet suchobligation under applicable tax laws or regulations, and, if Executive fails to do so, the Company and its Affiliates andsubsidiaries are authorized to withhold from the Shares granted hereby or from any cash or stock remuneration then orthereafter payable to Executive in any capacity any tax required to be withheld by reason of such taxable income, sufficient tosatisfy the withholding obligation.7.Section 83(b) Election. Executive shall not exercise the election permitted under section 83(b) of the Internal Revenue Code of1986, as amended, with respect to the Restricted Shares without the prior written approval of the General Counsel of theCompany (if Executive is the General Counsel of the Company, Executive must seek the prior written approval of the ChiefFinancial Officer or the Chief Executive Officer). If the election is permitted as provided in the prior sentence, Executive shalltimely pay the Company the amount necessary to satisfy the Company’s attendant tax withholding obligations, if any.8.No Fractional Shares. All provisions of this Agreement concern whole Shares. If the application of any provision hereunderwould yield a fractional share, such fractional share5shall be rounded down to the next whole share if it is less than 0.5 and rounded up to the next whole share if it is 0.5 or more.9.Employment Relationship. For purposes of this Agreement, Executive shall be considered to be in the employment of theCompany and its Affiliates as long as Executive has an employment relationship with the Company and its Affiliates. TheCommittee shall determine any questions as to whether and when there has been a termination of such employmentrelationship, and the cause of such termination, under the Plan and the Committee’s determination shall be final and binding onall persons.10.Not an Employment Agreement. This Agreement is not an employment agreement, and no provision of this Agreement shallbe construed or interpreted to create an employment relationship between Executive and the Company or any Affiliate, toguarantee the right to remain employed by the Company or any Affiliate for any specified term or require the Company or anyAffiliate to employ Executive for any period of time.11.Rights As Stockholder. Executive shall be the record owner of the Shares and shall be entitled to all of the rights of astockholder of the Company upon issuance of the Shares by the Company and until the Shares are sold or otherwise disposedof, subject to the terms and conditions of this Agreement. Notwithstanding the foregoing, any dividends or other distributionsshall be subject to the same restrictions on transferability as the Shares with respect to which they were paid.12.Legend. Executive consents to the placing of an appropriate legend notation on the electronic book entry representing theShares restricting resale or other transfer of the Shares except in accordance with all applicable securities laws and rulesthereunder.13.Notices. Any notice, instruction, authorization, request, demand or other communications required hereunder shall be inwriting, and shall be delivered either by personal delivery, by telegram, telex, telecopy or similar facsimile means, by certifiedor registered mail, return receipt requested, or by courier or delivery service, addressed to the Company at the Company’sprincipal business office address to the attention of the Company’s General Counsel and to Executive at Executive’s residentialaddress as it appears on the books and records of the Company, or at such other address and number as a party shall havepreviously designated by written notice given to the other party in the manner hereinabove set forth. Notices shall be deemedgiven when received, if sent by facsimile means (confirmation of such receipt by confirmed facsimile transmission beingdeemed receipt of communications sent by facsimile means); and when delivered (or upon the date of attempted delivery wheredelivery is refused), if hand-delivered, sent by express courier or delivery service, or sent by certified or registered mail, returnreceipt requested.14.Amendment and Waiver. Except as otherwise provided herein or in the Plan or as necessary to implement the provisions of thePlan, this Agreement may be amended, modified or superseded only by written instrument executed by the Company andExecutive. Only a written instrument executed and delivered by the party waiving compliance hereof shall waive any of theterms or conditions of this Agreement. Any waiver granted by the Company shall be effective only if executed and deliveredby a duly authorized officer of the Company6other than Executive. The failure of any party at any time or times to require performance of any provisions hereof shall in nomanner effect the right to enforce the same. No waiver by any party of any term or condition, or the breach of any term orcondition contained in this Agreement, in one or more instances, shall be construed as a continuing waiver of any suchcondition or breach, a waiver of any other condition, or the breach of any other term or condition.15.Dispute Resolution. In the event of any difference of opinion concerning the meaning or effect of the Plan or this Agreement,such difference shall be resolved by the Committee.16.Governing Law and Severability. The validity, construction and performance of this Agreement shall be governed by the lawsof the State of Delaware, excluding any conflicts or choice of law rule or principle that might otherwise refer construction orinterpretation of this Agreement to the substantive law of another jurisdiction. The invalidity of any provision of this Agreementshall not affect any other provision of this Agreement, which shall remain in full force and effect.17.Successors and Assigns. Subject to the limitations which this Agreement imposes upon the transferability of the Shares grantedhereby, this Agreement shall bind, be enforceable by and inure to the benefit of the Company and its successors and assigns,and to Executive, Executive’s permitted assigns, executors, administrators, agents, legal and personal representatives.18.Discretionary Nature of Plan. The Plan is discretionary and may be amended, cancelled or terminated by the Company at anytime, in its discretion. The grant of the Shares in this Agreement does not create any contractual right or other right to receiveany Shares or other Awards in the future. Future Awards, if any, will be at the sole discretion of the Company. Anyamendment, modification, or termination of the Plan shall not constitute a change or impairment of the terms and conditions ofthe Executive’s employment with the Company.19.Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be an original for allpurposes but all of which taken together shall constitute but one and the same instrument.20.Acceptance. The Executive agrees that by accepting this Agreement, Executive confirms that Executive has read andunderstands the terms and provisions thereof, and accepts the Shares subject to all of the terms and conditions of the Plan andthis Agreement. The Executive acknowledges that there may be adverse tax consequences upon the grant or vesting of theShares or disposition of the underlying shares and that the Executive has been advised to consult a tax advisor prior to suchgrant, vesting or disposition.7Irrevocable Stock PowerKNOW ALL MEN BY THESE PRESENTS, that the undersigned, For Value Received, has bargained, sold, assigned andtransferred and by these presents does bargain, sell, assign and transfer unto Rosetta Stone Inc., a Delaware corporation (the“Company”), the Shares transferred pursuant to the Restricted Stock Award Agreement dated effective _____________________,20___, between the Company and the undersigned; and subject to and in accordance with such Restricted Stock Award Agreementthe undersigned does hereby constitute and appoint the Secretary of the Company the undersigned’s true and lawful attorney,IRREVOCABLY, to sell, assign, transfer, hypothecate, pledge and make over all or any part of such Shares and for that purpose tomake and execute all necessary acts of assignment and transfer thereof, and to substitute one or more persons with like full power,hereby ratifying and confirming all that said attorney or his substitutes shall lawfully do by virtue hereof.In Witness Whereof, the undersigned has executed this Irrevocable Stock Power effective the ______ day of_____________________, 20___. Name: _________________________________5347831.3ROSETTA STONE INC.CHANGE IN CONTROL SEVERANCE PLANEffective November 1, 2015 TABLE OF CONTENTSPageARTICLE ONE FOREWORD1Section 1.01Purpose of the Plan 1ARTICLE TWO DEFINITIONS1Section 2.01“Accounting Firm” 1Section 2.02 “Affiliate” 1Section 2.03 “Base Salary” 1Section 2.04 “Board” 1Section 2.05 “Cause” 1Section 2.06 “Change in Control” 2Section 2.07 “Chief Executive Officer” 2Section 2.08 “Code” 2Section 2.09 “Committee” 3Section 2.10 “Company” 3Section 2.11 “Director” 3Section 2.12 “Disability” 3Section 2.13 “Effective Date” 3Section 2.14 “Employer” 3Section 2.15 “Exchange Act” 3Section 2.16 “Excise Tax” 3Section 2.17 “Good Reason” 3Section 2.18 “Notice of Termination” 4Section 2.19 “Participant” 4Section 2.20 “Payment” 4Section 2.21 “Person” 4Section 2.22 “Plan” 4Section 2.23 “Qualifying Termination” 4Section 2.24 “Release” 4Section 2.25 “Release Consideration and Revocation Period” 4Section 2.26 “Release Consideration Period” 4Section 2.27 “Release Revocation Period” 4Section 2.28 “Separation from Service” 4Section 2.29 “Severance Benefits” 5Section 2.30“Stock” 5Section 2.31 “Subsidiary” 5ARTICLE THREE ELIGIBILITY ANDPARTICIPATION5Section 3.01Eligibility on the Effective Date 5Section 3.02Future Eligibility 5Section 3.03Exclusive Benefits 5Section 3.04End of Participation 5ARTICLE FOUR SEVERANCEBENEFITS6Section 4.01Qualifying Termination 6Section 4.02Section 409A 7i Section 4.03Enforcement Costs 8Section 4.04Section 280G 8ARTICLE FIVE AMENDMENT ANDTERMINATION9ARTICLE SIX MISCELLANEOUS10Section 6.01Participant Rights 10Section 6.02Committee Authority 10Section 6.03 Reliance on Tables and Reports 11Section 6.04 Expenses 11Section 6.05 Successors 11Section 6.06 Gender and Number 11Section 6.07 References to Other Plans and Programs 11Section 6.08 Notices 11Section 6.09 No Duty to Mitigate 12Section 6.10 Withholding of Taxes 12Section 6.11 Choice of Law; Jurisdiction 12Section 6.12Waiver of Jury Trial 12Section 6.13 Validity/Severability 12Section 6.14 Miscellaneous 12Section 6.15 Source of Payments 13Section 6.16 Survival of Provisions 13ii 1 Article 1 FOREWORDSection 1.01 Purpose of the PlanThe Company considers it essential to the best interests of its shareholders to foster the continued employment of key management personnel in the face of apossible change in control of the Company. As such, in accordance with the terms of this Plan, effective November 1, 2015, the Company will provideSeverance Benefits to an eligible employee in the event of the Qualifying Termination of the eligible employee’s employment in connection with a Changein Control. No benefits will be provided pursuant to this Plan for any purpose whatsoever except upon the occurrence of a Change in Control.Capitalized terms used throughout the Plan have the meanings set forth in Article Two, except as otherwise defined in the Plan or where the context clearlyrequires otherwise.ARTICLE 2 DEFINITIONSWhere the following words and phrases appear in this Plan with initial capital letters, they shall have the meaning set forth below, unless a different meaningis plainly required by the context.Section 2.01 “Accounting Firm” means a nationally recognized accounting firm that (i) is not serving as accountant or auditor for the person who acquiresownership or effective control or ownership of a substantial portion of the Company’s assets (within the meaning of Section 280G of the Code) or anyAffiliate of such person, and (ii) is agreed upon by the Company and the Participant.Section 2.02 “Affiliate” means, with respect to any particular Person, any other Person controlling, controlled by or under common control with suchParticular Person. A Subsidiary of the Company shall be an Affiliate of the Company.Section 2.03 “Base Salary” means, with respect to a Participant, the Participant’s annual base salary in effect on the date of the Participant’s Separation fromService; provided, however, that if the Participant’s Separation from Service is for Good Reason due to a reduction in the Participant’s annual base salarypursuant to Section 2.18(i), the Participant’s Base Salary will be the Participant’s annual base salary in effect immediately before such reduction.Section 2.04 “Board” means the Board of Directors of the Company.Section 2.05 “Cause” means, with respect to a Participant, the Participant’s Separation from Service for any of the following:(i) the Participant commits a felony or a crime involving moral turpitude or commits any other act or omission involving fraud,embezzlement or any other act of dishonesty in the course of Participant’s employment by the Employer which conduct damages the Employer orany of its Affiliates;(ii) the Participant substantially and repeatedly fails to perform duties of the office held by Participant as reasonably directed by theBoard and/or the Chief Executive Officer;(iii) the Participant commits gross negligence or willful misconduct with respect to the Employer or any of its Affiliates;(iv) the Participant commits a material breach of the Participant’s employment agreement, if any, with the Employer or any of itsAffiliates that is not cured within ten (10) days after receipt of written notice thereof from the Board and/or Chief Executive Officer;2 (v) the Participant fails, within ten (10) days after receipt by the Participant of written notice thereof from the Board and/or ChiefExecutive Officer, to correct, cease or otherwise alter any failure to comply with instructions or other action or omission which the Board and/orChief Executive Officer reasonably believes does or may materially or adversely affect the Employer’s or any of its Affiliate’s business or operations;(vi) the Participant commits misconduct which is of such a serious or substantial nature that a reasonable likelihood exists that suchmisconduct will materially injure the reputation of the Employer or any of its Affiliates;(vii) the Participant harasses or discriminates against the Employer’s or any of its Affiliate’s employees, customers or vendors in violationof the Company’s policies with respect to such matters;(viii) the Participant misappropriates funds or assets of the Employer or any of its Affiliates for personal use or willfully violates theEmployer’s policies or standards of business conduct as determined in good faith by the Board and/or Chief Executive Officer;(ix) the Participant fails, due to some action or inaction on the part of the Participant, to have immigration status that permits theParticipant to maintain full-time employment with the Employer in the United States in compliance with all applicable immigration law, or(x) The Participant discloses trade secrets of the Employer or any of its Affiliates.Section 2.06 “Change in Control” means the occurrence of one of the following events:(i) the liquidation, dissolution or winding-up of the Company,(ii) the sale, license or lease of all or substantially all of the assets of the Company, or(iii) a share exchange, reorganization, recapitalization, or merger or consolidation of the Company with or into any other corporation orcorporations (or other form of business entity) or of any other corporation or corporations (or other form of business entity) with or into theCompany, but excluding any merger effected exclusively for the purpose of changing the domicile of the Company;provided, however, that a Change in Control shall not include any of the aforementioned transactions listed in clauses (i), (ii) and (iii) involving theCompany or a Subsidiary Corporation (as such term is defined below) in which the holders of shares of the Company voting stock outstanding immediatelyprior to such transaction or any Affiliate of such holders continue to hold at least a majority, by voting power, of the capital stock or, by a majority, based onfair market value as determined in good faith by the Board, of the assets, in each case in substantially the same proportion, of (x) the surviving or resultingcorporation (or other form of business entity), (y) if the surviving or resulting corporation (or other form of business entity) is a wholly owned subsidiary ofanother corporation (or other form of business entity) immediately following such transaction, the parent corporation (or other form of business entity) ofsuch surviving or resulting corporation (or other form of business entity) or (z) a successor entity holding a majority of the assets of the Company. In addition,a Change in Control shall not include a bona fide, firm commitment underwritten public offering of the Stock pursuant to a registration statement declaredeffective under the Securities Act of 1933, as amended. For purposes of the definition of “Change in Control,” the term “Subsidiary Corporation” means anycorporation (other than the Company) in an unbroken chain of corporations beginning with the Company if, at the time of the action or transaction, each ofthe corporations other than the last corporation in an unbroken chain owns stock possessing 50 percent or more of the total combined voting power of allclasses of stock in one of the other corporations in the chain.Section 2.07 “Chief Executive Officer” means the Chief Executive Officer of the Company.3 Section 2.08 “Code” means the Internal Revenue Code of 1986, as amended and the proposed, temporary and final regulations promulgated thereunder.Reference to any section or subsection of the Code includes reference to any comparable or succeeding provisions of any legislation that amends,supplements or replaces such section or subsection.Section 2.09 “Committee” means the Compensation Committee of the Board.Section 2.10 “Company” means Rosetta Stone Inc., a Delaware corporation, or its successor or assignee (or both, or more than one of each or both).Section 2.11 “Director” means a member of the Board.Section 2.12 “Disability” shall mean, with respect to a Participant,(i) the Participant is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mentalimpairment that can be expected to result in death or can be expected to last for a continuous period of not less than twelve (12) months, or(ii) the Participant is, by reason of any medically determinable physical or mental impairment that can be expected to result in death orcan be expected to last for a continuous period of not less than twelve (12) months, receiving income replacement benefits for a period of not lessthan three (3) months under an accident and health plan covering employees of the Company.A determination of Disability may be made by a physician selected or approved by the Committee and, in this respect, the Participant shall submit to anexamination by such physician upon request by the Committee. Any such termination for disability shall be only as expressly permitted by the Americanswith Disabilities Act and any other applicable laws.Section 2.13 “Effective Date” means November 1, 2015.Section 2.14 “Employer” means the Company and the Subsidiaries.Section 2.15 “Exchange Act” means the Securities Exchange Act of 1934, as amended, and the regulations promulgated thereunder. Reference to anysection or subsection of the Exchange Act includes reference to any comparable or succeeding provisions of any legislation that amends, supplements orreplaces such section or subsection.Section 2.16 “Excise Tax” shall mean, collectively, (i) the tax imposed by Code Section 4999 by reason of being “contingent on a change in ownership orcontrol” of the Company, within the meaning of Code Section 280G, and (ii) any similar tax imposed by state or local law, and (iii) any interest or penaltieswith respect to any tax described in clause (i) or (ii).Section 2.17 “Good Reason” means, with respect to a Participant, the Participant’s resignation from employment with the Employer after the occurrence ofany of the following events without the Participant’s consent:(i) a material diminution in the Participant’s Base Salary, duties, authority or responsibilities from the Base Salary, duties, authority orresponsibilities as in effect on the Effective Date,(ii) the failure by the Employer or any of its Affiliates to perform any material obligation undertaken by the Employer or such Affiliateunder the Participant’s employment agreement, if any, with the Employer or such Affiliate after the Participant has provided the Employer or suchAffiliate with written notice of such failure and such failure has not thereafter been cured within ten (10) days of the delivery of such written notice,or4 (iii) a relocation of the Participant’s primary place of employment to a geographic area more than fifty (50) miles from the Company’soffice in Arlington, Virginia;provided, that the foregoing events shall not be deemed to constitute Good Reason unless the Participant has notified the Employer in writing of theoccurrence of such event(s) within sixty (60) days of such occurrence and the Employer has failed to have cure such event(s) within thirty (30) business daysof its receipt of such written notice and termination occurs within one hundred (100) days of the event.Section 2.18 “Notice of Termination” means a written notice of termination of employment for Cause or Disability given by the Employer to a Participantor a written notice of termination of employment for Good Reason given by a Participant to the Company, in either case in the manner specified in Section6.08, which states the specific termination provision in the Plan relied upon for the termination, sets forth in reasonable detail the facts and circumstancesclaimed to provide the basis for termination under the provision so indicated, and specifies the Participant’s date of termination.Section 2.19 “Participant” means each individual who has become a Participant under Section 3.01 and who has not ceased to be a Participant underSection 3.04.Section 2.20 “Payment” means any payment or benefit in the nature of compensation (within the meaning of Code Section 280G(b)(2)) received or to bereceived by a Participant or for the benefit of a Participant, whether payable under the terms of this Plan or any other plan, arrangement or agreement with theEmployer or any of its Affiliates.Section 2.21 “Person” means any “person” or “group” as those terms are used in Sections 13(d) and 14(d) of the Exchange Act.Section 2.22 “Plan” means this Rosetta Stone Inc. Change in Control Severance Plan, as it may be amended from time to time, or any successor plan,program or arrangement thereto.Section 2.23 “Qualifying Termination” means, with respect to a Participant, the Participant’s Separation from Service initiated by the Employer other thanfor Cause or initiated by the Participant for Good Reason, in either case during the time period commencing on the effective date of a Change in Control andcontinuing until the earlier of (i) the two-year anniversary of such date, or (ii) the date of the Participant’s Separation from Service by reason of Disability orthe Participant’s death. In addition, if (x) the Employer initiates the Participant’s Separation from Service without Cause during the six-month period endingon the effective date of a Change in Control at the request of a third party engaging in a transaction or series of transactions that would result in a Change inControl and in contemplation of a Change in Control, or (y) the Participant initiates the Participant’s Separation from Service for Good Reason during thesix-month period ending on the effective date of a Change in Control, then the Participant’s Separation from Service shall be deemed to have occurredimmediately following the Change in Control such that it shall be deemed a Qualifying Termination.Section 2.24 “Release” means an agreement under which a Participant provides a release of claims against the Employer and agrees to confidentiality, non-competition (with a duration of twelve (12) months), and non-solicitation (with a duration of twelve (12) months) restrictive covenants in a form provided tothe Participant by the Employer in connection with the payment of benefits under this Plan.Section 2.25 “Release Consideration and Revocation Period” means the combined total of the Release Consideration Period and the Release RevocationPeriod.Section 2.26 “Release Consideration Period” means the period of time specified by the Release, not to exceed forty-five (45) days, during which theaffected Participant is permitted to consider whether or not to sign the Release.Section 2.27 “Release Revocation Period” means the period of time specified by the Release, not to exceed seven (7) days, during which the Participant ispermitted to revoke the executed Release.Section 2.28 “Separation from Service” means “separation from service” from the affiliated companies as described under Code Section 409A(a)(2)(A)(i)and any governing Internal Revenue Service guidance and Treasury regulations. A Participant who is both an employee of the affiliated companies and aDirector will not have a Separation from Service until he or she has a Separation from Service with respect to both his or her employment and his or her Boardmembership. For this purpose, the term “affiliated companies” means the Employer and any affiliate with which any entity comprising the Employer istreated as a single employer under Code Section 414(b) or 414(c).Section 2.29 “Severance Benefits” means the severance pay and the other benefits payable to a Participant pursuant to Article Four of the Plan.Section 2.30 “Stock” means the Class B Common Stock, $.00005 par value, of the Company.Section 2.31 “Subsidiary” means any company of which the Company owns securities having a majority of the ordinary voting power in electing the boardof directors directly or through one or more subsidiaries.ARTICLE 3 ELIGIBILITY AND PARTICIPATIONSection 3.01 Eligibility on the Effective DateAs of the Effective Date, the Committee has approved via resolution certain executives for participation in the Plan and has provided notice to each suchexecutive of his or her selection for Plan participation in the manner provided by Section 6.08. Each such executive will become a Participant once he or shesigns a copy of his or her notification letter and returns such signed notification letter to the Committee. Each Participant will be notified by the Committeeas to the commencement date of his or her status as a Participant.Section 3.02 Future EligibilityThe Committee may approve via resolution additional executives as Participants subsequent to the Effective Date and will provide notice to each suchexecutive of his or her selection for Plan participation in the manner provided by Section 6.08. Each such executive will become a Participant once he or shesigns a copy of his or her notification letter and returns such signed notification letter to the Committee.Section 3.03 Exclusive Benefits. Any Severance Benefits payable to a Participant under this Plan will be paid solely in lieu of, and not in addition to, anyseverance benefits payable under any offer letter, employment agreement, severance arrangement or other program or agreement on account of theParticipant’s termination of employment with the Employer.Section 3.04 End of ParticipationAn individual shall cease to be a Participant on the date on which the individual ceases to be an employee of the Employer other than by way of a QualifyingTermination. A Participant may discontinue his or her status as a Participant at any time by a prospectively or immediately effective written document that isdelivered to the Committee in the manner specified in Section 6.08. Except as provided in the next sentence, the Committee may, by resolution, discontinuean individual’s status as a Participant; provided, however, that no such discontinuance shall become effective (i) during the one-year period following thedate on which advance written notice of such discontinuance is provided to the affected Participant in the manner specified in Section 6.08, or (ii) during theperiod beginning on the effective date of a Change in Control and ending 24 months after the effective date of such Change in Control. In the event that anindividual incurs a Qualifying Termination while still a Participant, such individual shall remain a Participant until all compensation and benefits required tobe provided to the Participant under the terms of the Plan on account of such Qualified Termination have been so provided.ARTICLE 4 SEVERANCE BENEFITSSection 4.01 Qualifying Termination(a) Eligibility. A Participant will be eligible for the Severance Benefits described in this Section 4.01 upon a Qualifying Termination, subject tothe Release requirement specified below. Within seven (7) days following the date of the Separation from Service, the Company shall provide the Participantwith a Release. As a condition of receiving the Severance Benefits described in subsections (b), (c), (d), (e), (f) and (g), the Participant must execute anddeliver the Release to the Company within the Release Consideration Period, the Release Revocation Period must expire without revocation of the Releaseby the Participant, and the Participant must comply with the restrictive covenants set out in the Release. In the event the Participant breaches one or more ofsuch restrictive covenants, the Participant will forfeit any such Severance Benefits that have not been paid or provided to the Participant and must repay tothe Company the amount (or equivalent cash value) of any such Severance Benefit that has been paid to the Participant.(b) Pro-Rata Bonus for Year of Termination. If, on account of the Participant’s termination of employment with the Employer, the Participantforfeits the Participant’s right to earn a payment under an annual cash incentive plan maintained by the Employer for the performance period containing thedate of such termination of employment, the Company shall pay to the Participant a lump sum cash payment equal to the amount of the annual cashincentive payment to which the Participant would have been entitled under such plan for such performance period but for the Participant’s termination ofemployment, determined on the basis of actual achievement of the performance goals applicable under such plan for such performance period (the “ActualBonus”), multiplied by a fraction (i) the numerator of which equals the number of days in such performance period during which the Participant wasemployed by the Employer (rounded up to the next highest number of days in the case of a partial day of employment), and (ii) the denominator of which isthe total number of days in such performance period. This amount shall be paid to the Participant in a lump sum on the later of (x) the date on which theActual Bonus would have been paid to the Participant under such plan but for the Participant’s termination of employment during such performance period,or (y) within sixty (60) days following the date of the Participant’s Separation from Service (except as provided in Section 4.02(f) and subject to therequirements of Section 4.02(e)).(c) Prior Year Bonus. If, on account of the Participant’s termination of employment with the Employer, the Participant forfeits the Participant’sright to earn a payment under an annual cash incentive plan maintained by the Employer for the performance period ending immediately prior to the date ofsuch termination of employment, the Company shall pay to the Participant a lump sum cash payment equal to the amount of the annual cash incentivepayment to which the Participant would have been entitled under such plan for such performance period but for the Participant’s termination of employment,determined on the basis of actual achievement of the performance goals applicable under such plan for such performance period (the “Prior Year Bonus”).This amount shall be paid to the Participant in a lump sum on the later of (x) the date on which the Prior Year Bonus would have been paid to the Participantunder such plan but for the Participant’s termination of employment during such performance period, or (y) within sixty (60) days following the date of theParticipant’s Separation from Service (except as provided in Section 4.02(f) and subject to the requirements of Section 4.02(e)).(d) CIC Severance Amount. The Company shall pay to the Participant an amount equal to one (1) times the Base Salary. This amount shall be paidto the Participant in a lump sum within sixty (60) days following the date of the Participant’s Separation from Service (except as provided in Section 4.02(f)and subject to the requirements of Section 4.02(e)).(e) COBRA Payments. Upon the Participant’s Separation from Service, the Participant and the Participant’s spouse and eligible dependents, asapplicable, may elect health care coverage for up to eighteen (18) months from the date of the Participant’s Separation from Service pursuant to theConsolidated Omnibus Budget Reconciliation Act of 1985, as amended (“COBRA”). Subject to Section 4.02(f) and the requirements of Section 4.02(e), theEmployer will pay for up to eighteen (18) months, on an after-tax basis, the portion of Participant’s COBRA premiums for such coverage that exceeds theamount that the Participant would have incurred in premiums for such coverage under the Employer’s health plan if then employed by the Employer;provided, however, the Employer’s obligation shall only apply to the extent COBRA coverage is elected and in effect during such period. Following theeighteen (18) months of coverage, the Participant will be responsible for the full amount of all future premium payments should he or she wish to continueCOBRA coverage. However, if the Participant or the Participant’s spouse becomes eligible for group health coverage sponsored by another employer(regardless of whether such coverage is actually elected) or for any other reason the Participant’s COBRA coverage terminates, the Employer shall not beobligated to pay any portion of the premiums provided hereunder for periods after the Participant or the Participant’s spouse becomes eligible for such othercoverage or the Participant’s COBRA coverage terminates. The Participant shall have the obligation to notify the Employer if he or she or the Participant’sspouse becomes eligible for group health coverage sponsored by another employer.(f) Equity and Long-Term Incentives. With respect to any outstanding stock options held by the Participant, any portion of the shares of Stock thatare subject to such stock options that have not previously vested shall vest and such stock options shall be exercisable in full. Any such stock options heldby the Participant shall remain exercisable until, and shall otherwise terminate and become null and void at the close of business at the Company’s principalbusiness office on the later of (i) the day that is sixty (60) days after the date of the Participant’s Separation from Service, or (ii) the day that is thirty (30) afterany blackout period(s) under the Company’s Insider Trading Compliance Policy (as in effect from time to time) to the extent the Participant is then subject toany such blackout period(s), but in no event after the close of business at the Company’s principal business office on the day before the date of the tenthanniversary of the applicable grant date for each such stock option. With respect to any other outstanding equity or long-term compensation grants or awardsheld by the Participant, such grants or awards shall vest and all remaining forfeiture restrictions applicable to such grants or awards shall lapse.(g) Outplacement. Subject to the requirement of Section 4.02(e), within sixty (60) days following the date of the Participant’s Separation fromService, the Employer shall provide professional outplacement and counseling services through an outplacement firm chosen by the Employer for twelve(12) months from the date of the Participant’s Separation from Service to assist the Participant in his or her search for other employment.Section 4.02 Section 409A(a) To the extent necessary to ensure compliance with Code Section 409A, the provisions of this Section 4.02 shall govern in all cases over anycontrary or conflicting provision in the Plan.(b) It is the intent of the Company that this Plan comply with the requirements of Code Section 409A and all guidance issued thereunder by theU.S. Internal Revenue Service with respect to any nonqualified deferred compensation subject to Code Section 409A. The Plan shall be interpreted andadministered to maximize the exemptions from Code Section 409A and, to the extent the Plan provides for deferred compensation subject to Code Section409A, to comply with Code Section 409A and to avoid the imposition of tax, interest and/or penalties upon any Participant under Code Section 409A.(c) The Company does not, however, assume any economic burdens associated with Code Section 409A. Although the Company intends toadminister the Plan to prevent taxation under Code Section 409A, it does not represent or warrant that the Plan complies with any provision of federal, state,local, or non-United States law. The Company, the Subsidiaries, and their respective directors, officers, employees and advisers will not be liable to anyParticipant (or any other individual claiming a benefit through the Participant) for any tax, interest, or penalties the Participant may owe as a result ofparticipation in the Plan. Neither the Company nor any of its Affiliates have any obligation to indemnify or otherwise protect any Participant from anyobligation to pay taxes under Code Section 409A.(d) The right to a series of payments under the Plan will be treated as a right to a series of separate payments. Each such payment that is madewithin 2-1⁄2 months following the end of the year that contains the date of the Participant’s Separation from Service is intended to be exempt from CodeSection 409A as a short-term deferral within the meaning of the final regulations under Code Section 409A. Each such payment that is made later than 2-1⁄2months following the end of the year that contains the date of the Participant’s Separation from Service is intended to be exempt under the two-timesexception of Treasury Reg. § 1.409A-1(b)(9)(iii), up to the limitation on the availability of that exception specified in the regulation. Then, each paymentthat is made after the two-times exception ceases to be available shall be subject to delay, as necessary, in accordance with Section 4.02(f) below.(e) To the extent necessary to comply with Code Section 409A, in no event may a Participant, directly or indirectly, designate the taxable year ofpayment. In particular, to the extent necessary to comply with Code Section 409A, if any payment to a Participant under this Plan is conditioned upon theParticipant’s executing and not revoking a Release and if the designated payment period for such payment begins in one taxable year and ends in the nexttaxable year, the payment will be made in the later taxable year.(f) To the extent necessary to comply with Code Section 409A, references in this Plan to “termination of employment” or “terminatesemployment” (and similar references) shall have the same meaning as Separation from Service, and no payment subject to Code Section 409A that is payableupon a termination of employment shall be paid unless and until (and not later than applicable in compliance with Code Section 409A) the Participant incursa Separation from Service. In addition, if the Participant is a “specified employee” within the meaning of Code Section 409A(a)(2)(B)(i) at the time of his orher Separation from Service, any nonqualified deferred compensation subject to Code Section 409A that would otherwise have been payable on account of,and within the first six months following, the Participant’s Separation from Service, and not by reason of another event under Code Section 409A(a)(2)(A),will become payable on the first business day after six months following the date of the Participant’s Separation from Service or, if earlier, the date of theParticipant’s death.(g) To the extent that any reimbursement by the Employer to a Participant of eligible expenses under this Plan constitutes a “deferral ofcompensation” within the meaning of Code Section 409A (a “Reimbursement”) (i) the Participant must request the Reimbursement (with substantiation ofthe expense incurred) no later than 30 days following the date on which the Participant incurs the corresponding eligible expense; (ii) subject to any shortertime period provided in any expense reimbursement policy of the Employer or specifically provided otherwise in this Plan, the Employer shall make theReimbursement to the Participant on or before the last day of the calendar year following the calendar year in which the Participant incurred the eligibleexpense; (iii) the Participant’s right to Reimbursement shall not be subject to liquidation or exchange for another benefit; (iv) the amount eligible forReimbursement in one calendar year shall not affect the amount eligible for Reimbursement in any other calendar year; and (v) except as specificallyprovided otherwise in this Plan, the period during which the Participant may incur expenses that are eligible for Reimbursement is limited to five calendaryears following the calendar year in which the Participant’s Separation from Service occurs.Section 4.03 Enforcement CostsAll expenses of a Participant incurred in enforcing the Participant’s rights and/or to recover the Participant’s benefits under this Article Four, including butnot limited to, reasonable attorneys’ fees, court costs, arbitration costs, and other reasonable expenses shall be paid by the Company if the Participant prevailson any substantive issue in such proceeding. The Company shall pay or reimburse the Participant for such fees, costs and expenses, promptly uponpresentment of appropriate documentation, subject to Section 4.02(g).Section 4.04 Section 280G(b) A Participant shall bear all expense of, and be solely responsible for, any Excise Tax; provided, however, that any payment or benefit receivedor to be received by the Participant (whether payable under the terms of this Plan or any other plan, arrangement or agreement with the Employer or any of itsAffiliates (collectively, the “Payments”) that would constitute a “parachute payment” within the meaning of Code Section 280G shall be reduced to theextent necessary so that no portion thereof shall be subject to the Excise Tax but only if, by reason of such reduction, the net after-tax benefit received by theParticipant shall exceed the net after-tax benefit that would be received by the Participant if no such reduction was made.(c) The “net after-tax benefit” shall mean (i) the Payments which the Participant receives or is then entitled to receive from the Employer thatwould constitute “parachute payments” within the meaning of Code Section 280G, less (ii) the amount of all federal, state and local income and employmenttaxes payable by the Participant with respect to the foregoing calculated at the highest marginal income tax rate for each year in which the foregoing shall bepaid to the Participant (based on the rate in effect for such year as set forth in the Code as in effect at the time of the first payment of the foregoing), less (iii)the amount of Excise Tax imposed with respect to the payments and benefits described in (b)(i) above.(d) All determinations under this Section 4.04 will be made by an Accounting Firm. The Accounting Firm shall be required, in part, to evaluate theextent to which payments are exempt from Section 280G as reasonable compensation for services rendered before or after the Change in Control. All fees andexpenses of the Accounting Firm shall be paid solely by the Company. The Company will direct the Accounting Firm to submit any determination it makesunder this Section 4.04 and detailed supporting calculations to both the Participant and the Company as soon as reasonably practicable following theChange in Control.(e) If the Accounting Firm determines that one or more reductions are required under this Section 4.04, such Payments shall be reduced in the orderthat would provide the Participant with the largest amount of after-tax proceeds (with such order, to the extent permitted by Code Sections 280G and 409Adesignated by the Participant, or otherwise determined by the Accounting Firm) to the extent necessary so that no portion thereof shall be subject to theExcise Tax, and the Company shall pay such reduced amount to the Participant. The Participant shall at any time have the unilateral right to forfeit anyequity award in whole or in part.(f) As a result of the uncertainty in the application of Code Section 280G at the time that the Accounting Firm makes its determinations under thisSection 4.04, it is possible that amounts will have been paid or distributed to the Participant that should not have been paid or distributed (collectively, the“Overpayments”), or that additional amounts should be paid or distributed to the Participant (collectively, the “Underpayments”). If the Accounting Firmdetermines, based on either the assertion of a deficiency by the Internal Revenue Service against the Employer or the Participant, which assertion theAccounting Firm believes has a high probability of success or is otherwise based on controlling precedent or substantial authority, that an Overpayment hasbeen made, the Participant must repay the Overpayment to the Company, without interest; provided, however, that no loan will be deemed to have been madeand no amount will be payable by the Participant to the Company unless, and then only to the extent that, the deemed loan and payment would either reducethe amount on which the Participant is subject to tax under Code Section 4999 or generate a refund of tax imposed under Code Section 4999. If theAccounting Firm determines, based upon controlling precedent or substantial authority, that an Underpayment has occurred, the Accounting Firm will notifythe Participant and the Company of that determination, and the Company will promptly pay the amount of that Underpayment to the Participant withoutinterest.(g) The parties will provide the Accounting Firm access to and copies of any books, records, and documents in their possession as reasonablyrequested by the Accounting Firm, and otherwise cooperate with the Accounting Firm in connection with the preparation and issuance of the determinationsand calculations contemplated by this Section 4.04. For purposes of making the calculations required by this Section 4.04, the Accounting Firm may rely onreasonable, good faith interpretations concerning the application of Code Sections 280G and 4999.ARTICLE 5 AMENDMENT AND TERMINATIONSubject to the next sentence, the Committee shall have the right at any time and from time to time, by instrument in writing, to amend, modify, alter, orterminate the Plan in whole or in part. Notwithstanding the foregoing or anything in this Plan to the contrary, the Committee may not amend, modify, alter orterminate this Plan so as to adversely affect payments or benefits then payable, or which could become payable, to a Participant under the Plan, except to theminimum extent required to comply with any applicable law, (i) during the one-year period following the date on which advance written notice of suchamendment, modification, alteration or termination is provided to the affected Participant in the manner specified in Section 6.08, or (ii) during the periodbeginning on the effective date of a Change in Control and ending 24 months after the effective date of such Change in Control.ARTICLE 6 MISCELLANEOUSSection 6.01 Participant RightsExcept to the extent required or provided for by mandatorily imposed law as in effect and applicable hereto from time to time, neither the establishment ofthe Plan, nor any modification thereof, nor the creation of any fund or account, nor the payment of any benefits, shall be construed as giving to anyParticipant or other person any legal or equitable right against the Employer, or any officer or employee thereof, or the Board or the Committee, except asherein provided; nor shall any Participant have any legal right, title or interest in the assets of the Employer, except in the event and to the extent thatbenefits may actually be payable to him hereunder. This Plan shall not constitute a contract of employment nor afford any individual any right to be retainedor continued in the employ of the Employer or in any way limit the right of the Employer to discharge any of its employees, with or without cause.Participants have no right to receive any payments or benefits that the Employer is prohibited by applicable law from making.Section 6.02 Committee Authority(h) The Committee will administer the Plan and have the full authority and discretion necessary to accomplish that purpose, including, withoutlimitation, the authority and discretion to:(i) resolve all questions relating to the eligibility of Participants;(ii) determine the amount of benefits, if any, payable to Participants under the Plan and determine the time and manner in which suchbenefits are to be paid;(iii) engage any administrative, legal, tax, actuarial, accounting, clerical, or other services it deems appropriate in administering the Plan;(iv) construe and interpret the Plan, supply omissions from, correct deficiencies in and resolve inconsistencies or ambiguities in thelanguage of the Plan, resolve inconsistencies or ambiguities between the provisions of this document, and adopt rules for the administration of thePlan which are not inconsistent with the terms of the Plan document;(v) compile and maintain all records it determines to be necessary, appropriate or convenient in connection with the administration of thePlan; and(vi) resolve all questions of fact relating to any matter for which it has administrative responsibility.(i) The Committee shall perform all of the duties and may exercise all of the powers and discretion that the Committee deems necessary orappropriate for the proper administration of the Plan, including, but not limited to, delegation of any of its duties to one or more authorized officers. Allreferences to the authority of the Committee in this Plan shall be read to include the authority of any party to which the Committee delegates such authority.(j) Any failure by the Committee to apply any provisions of this Plan to any particular situation shall not represent a waiver of the Committee’sauthority to apply such provisions thereafter. Every interpretation, choice, determination or other exercise of any power or discretion given either expresslyor by implication to the Committee shall be final, conclusive and binding upon all parties having or claiming to have an interest under the Plan or otherwisedirectly or indirectly affected by such action, without restriction, however, on the right of the Committee to reconsider and re-determine such action.(k) Any decision rendered by the Committee and any review of such decision shall be limited to determining whether the decision was so arbitraryand capricious as to be an abuse of discretion. The Committee may adopt such rules and procedures for the administration of the Plan as are consistent withthe terms hereof.Section 6.03 Reliance on Tables and ReportsIn administering the Plan, the Committee is entitled to the extent permitted by law to rely conclusively upon all tables, valuations, certificates, opinions andreports which are furnished by accountants, legal counsel or other experts employed or engaged by the Committee. The Committee will be fully protected inrespect of any action taken or suffered by the Committee in good faith reliance upon all such tables, valuations, certificates, reports, opinions or other advice.The Committee is also entitled to rely upon any data or information furnished by the Employer or by a Participant as to any information pertinent to anycalculation or determination to be made under the provisions of the Plan, and, as a condition to payment of any benefit under the Plan the Committee mayrequest a Participant to furnish such information as it deems necessary or desirable in administering the Plan.Section 6.04 ExpensesAll Plan administration expenses shall be paid by the Company.Section 6.05 Successors(a) This Plan shall bind any successor of or to the Company, its assets or its businesses (whether direct or indirect, by purchase, merger,consolidation or otherwise), in the same manner and to the same extent that the Company would be obligated under this Plan if no succession had takenplace. In the case of any transaction in which a successor would not by the foregoing provision or by operation of law be bound by this Plan, the Companyshall require such successor expressly and unconditionally to assume and agree to perform the Company’s obligations under this Plan, in the same mannerand to the same extent that the Company would be required to perform if no such succession had taken place.(b) The Plan shall inure to the benefit of and be binding upon and enforceable by the Company and the Participants and their personal and legalrepresentatives, executors, administrators, successors, assigns, heirs, distributees, devisees and legatees. If a Participant should die while any amount wouldstill be payable to the Participant hereunder had the Participant continued to live, all such amounts, unless otherwise provided herein, shall be paid inaccordance with the terms of Plan to the Participant’s estate.Section 6.06 Gender and NumberIn determining the meaning of the Plan, words imparting the masculine gender shall include the feminine and the singular shall include the plural, unless thecontext requires otherwise. Unless otherwise stated, references to Sections are references to Sections of this Plan.Section 6.07 References to Other Plans and ProgramsEach reference in the Plan to any plan, policy or program, the Plan or document of the Employer or any of its Affiliates shall include any amendments orsuccessor provisions thereto without the necessity of amending the Plan for such changes.Section 6.08 NoticesNotices and all other communications contemplated by this Plan shall be in writing and shall be deemed to have been duly given when personally deliveredor when mailed by U.S. registered or certified mail, return receipt requested and postage prepaid or when sent by express U.S. mail or overnight deliverythrough a national delivery service (or an international delivery service in the case of an address outside the U.S.) with signature required. Notice to theCompany, the Board or the Committee shall be directed to the attention of the Secretary of the Company at the address of the Company’s headquarters, andnotice to a Participant shall be directed to the Participant as the most recent personal residence on file with the Company.Section 6.09 No Duty to MitigateThe Participant shall not be required to mitigate the amount of any payment provided pursuant to this Plan, nor shall the amount of any such payment bereduced by any compensation that the Participant receives from any other source, except as provided in this Plan.Section 6.10 Withholding of TaxesThe Employer may withhold from any amount payable or benefit provided under this Plan such Federal, state, local, foreign and other taxes as are required tobe withheld pursuant to any applicable law or regulation.Section 6.11 Choice of Law; JurisdictionAll questions or disputes concerning this Plan shall be governed by and construed in accordance with the internal laws of the Commonwealth of Virginia,without giving effect to any choice of law or conflict of law provision or rule (whether of the Commonwealth of Virginia or any other jurisdiction) that wouldcause the application of the laws of any jurisdiction other than the Commonwealth of Virginia. Participants hereby: (i) submit to the non-exclusivejurisdiction of any state or federal court sitting in the Commonwealth of Virginia in any action or proceeding arising out of or relating to this Plan; and (ii)agree that all claims in respect of such action or proceeding may be heard or determined in any such court. The Employer and the Participants hereby waiveany defense of inconvenient forum to the maintenance of any action or proceeding so brought. The Employer and the Participants hereby agree that a finaljudgment in any action or proceeding so brought shall be conclusive and may be enforced by suit on the judgment or in any other manner provided by law.Section 6.12 Waiver of Jury TrialThe Employer and the Participants agree that any action, demand, claim or counterclaim relating to the terms and provisions of this Plan, or to itsbreach, may be commenced in the Commonwealth of Virginia in a court of competent jurisdiction. The Employer and the Participants further agreethat any action, demand, claim or counterclaim shall be resolved by a judge alone, and the Employer and the Participants hereby waive and foreverrenounce that right to a trial before a civil jury.Section 6.13 Validity/SeverabilityIf any provision of this Plan or the application of any provision to any person or circumstances is held invalid, unenforceable or otherwise illegal, theremainder of this Plan and the application of such provision to any other person or circumstances will not be affected, and the provision so held to be invalidor unenforceable will be reformed to the extent (and only to the extent) necessary to make it enforceable or valid. To the extent any provisions held to beinvalid or unenforceable cannot be reformed, such provisions are to be stricken here from and the remainder of this Plan will be binding on the Parties andtheir successors and assigns as if such invalid or illegal provisions were never included in this Plan from the first instance.Section 6.14 MiscellaneousNo waiver by a Participant or the Employer at any time of any breach by the other party of, or compliance with, any condition or provision of this Plan to beperformed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the time or at any prior or subsequent time. Noagreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party that are notexpressly set forth in this Plan.Section 6.15 Source of PaymentsAll payments provided under this Plan, other than payments made pursuant to any Employer employee benefit plan which provides otherwise, shall be paidin cash from the general funds of the Company, and no special or separate fund shall be required to be established, and no other segregation of assets requiredto be made, to assure payment. To the extent that any person acquires a right to receive payments from the Company under this Plan, such right shall be nogreater than the right of an unsecured creditor of the Company.Section 6.16 Survival of ProvisionsNotwithstanding any other provision of this Plan, the rights and obligations of the Company and the Participants under Article Four and Sections 6.05through 6.16 will survive any termination or expiration of this Plan or the termination of the Participant’s employment for any reason whatsoever.5 Exhibit 10.42FOURTH AMENDMENT TO LOAN AND SECURITY AGREEMENTThis Fourth Amendment to Loan and Security Agreement (this “Amendment”) dated as of December 29, 2015 (the “Fourth Amendment EffectiveDate”), is by between SILICON VALLEY BANK, a California corporation with a loan production office located at 275 Grove Street, Suite 2-200, Newton,Massachusetts 02466 (“Bank”), and ROSETTA STONE LTD., a Virginia corporation (“Borrower”).W I T N E S S E T H:WHEREAS, Borrower and Bank are party to that certain Loan and Security Agreement dated as of October 28, 2014 as amended by a FirstAmendment to Loan and Security Agreement dated March 31, 2015, a Second Amendment to Loan and Security Agreement dated May 1, 2015 and a ThirdAmendment to Loan and Security Agreement dated June 26, 2015 (as amended, modified, supplemented or restated and in effect from time to time, the “LoanAgreement”); andWHEREAS, Borrower has requested that Bank agree to modify and amend certain terms and conditions of the Loan Agreement.NOW, THEREFORE, for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree asfollows:1.Capitalized Terms. All capitalized terms used herein and not otherwise defined shall have the same meaning herein as in the Loan Agreement.2.Amendment of Exhibits D and E to the Loan Agreement. Exhibit D and Exhibit E to the Loan Agreement are hereby deleted in their entireties andreplaced by Exhibit D and Exhibit E attached to this Amendment.3.Conditions Precedent to Effectiveness. This Amendment shall not be effective until each of the following conditions precedent have been fulfilledto the satisfaction of Bank:(a)This Amendment shall have been duly executed and delivered by the respective parties hereto. Bank shall have received a fullyexecuted copy hereof.(b)All necessary consents and approvals to this Amendment shall have been obtained by Borrower.(c)After giving effect to this Amendment, no Default or Event of Default shall have occurred and be continuing.(d)Bank shall have received the fees costs and expenses required to be paid pursuant to Section 5 of this Amendment (includingthe reasonable and documented fees and disbursements of legal counsel required to be paid thereunder).4.Representations and Warranties. Borrower hereby represents and warrants to Bank as follows:(a)This Amendment is, and each other Loan Document to which it is or will be a party, when executed and delivered by Borrower,will be the legally valid and binding obligation of Borrower, enforceable against Borrower in accordance with its respective terms, except asenforcement may be limited by bankruptcy, insolvency, reorganization, moratorium or similar laws relating to or limiting creditors’ rights generallyand equitable principals (whether enforcement is sought by proceedings in equity or at law).(b)Its representations and warranties set forth in this Amendment, the Loan Agreement, as amended by this Amendment and aftergiving effect hereto, and the other Loan Documents to which it is a party are (i) to the extent qualified by materiality, true and correct in all respectsand (ii) to the extent not qualified by materiality, true and correct in all material respects, in each case, on and as of the date hereof, as though madeon such date (except to the extent that such representations and warranties relate solely to an earlier date, in which case such representations andwarranties shall have been true and correct in all material respects as of such earlier date).(c)The execution and delivery by Borrower of this Amendment, the performance by Borrower of its obligations hereunder and theperformance of Borrower under the Loan Agreement, as amended by this Amendment, (i) have been duly authorized by all necessary organizationalaction on the part of Borrower and (ii) will not (A) violate any provisions of the certificate of incorporation or formation or organization or by-lawsor limited liability companyagreement or limited partnership agreement of Borrower or (B) constitute a violation by Borrower of any applicable material Requirement of Law.Borrower acknowledges that Bank has acted in good faith and have conducted in a commercially reasonable manner their relationships withBorrower in connection with this Amendment and in connection with the other Loan Documents. Borrower understands and acknowledges thatBank is entering into this Amendment in reliance upon, and in partial consideration for, the above representations, warranties, andacknowledgements, and agrees that such reliance is reasonable and appropriate.5.Payment of Costs and Expenses Borrower shall pay to Bank an amendment fee equal to Twenty Thousand Dollars ($20,000), which fee shall befully-earned and non-refundable as of the Fourth Amendment Effective Date. In addition, Borrower shall pay to Bank all reasonable costs and out-of-pocket expenses of every kind in connection with the preparation, negotiation, execution and delivery of this Amendment and any documents andinstruments relating hereto or thereto (which costs include, without limitation, the reasonable and documented fees and expenses of any attorneysretained by Bank).6.Choice of Law. THIS AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES HEREUNDER SHALL BE GOVERNEDBY, AND SHALL BE CONSTRUED AND ENFORCED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NEW YORK. Each partyhereto submits to the exclusive jurisdiction of the State and Federal courts in the Southern District of the State of New York; provided, however, thatnothing in the Loan Agreement as amended by this Amendment shall be deemed to operate to preclude Bank from bringing suit or taking other legalaction in any other jurisdiction to realize on the Collateral or any other security for the Obligations, or to enforce a judgment or other court order infavor of such Agent. TO THE EXTENT PERMITTED BY APPLICABLE LAW, EACH PARTY HERETO WAIVES ITS RIGHT TO A JURYTRIAL OF ANY CLAIM OR CAUSE OF ACTION ARISING OUT OF OR BASED UPON THIS AMENDMENT, THE OTHER LOANDOCUMENTS OR ANY CONTEMPLATED TRANSACTION, INCLUDING CONTRACT, TORT, BREACH OF DUTY AND ALL OTHERCLAIMS. EACH PARTY HERETO ACKNOWLEDGES THAT THIS WAIVER IS A MATERIAL INDUCEMENT TO ENTER INTO ABUSINESS RELATIONSHIP, THAT EACH HAS ALREADY RELIED ON THIS WAIVER IN ENTERING INTO THIS AMENDMENT, ANDTHAT EACH WILL CONTINUE TO RELY ON THIS WAIVER IN ITS RELATED FUTURE DEALINGS. EACH PARTY HERETOFURTHER WARRANTS AND REPRESENTS THAT IT HAS REVIEWED THIS WAIVER WITH ITS LEGAL COUNSEL AND THAT ITKNOWINGLY AND VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS FOLLOWING CONSULTATION WITH LEGAL COUNSEL.7.Counterpart Execution. This Amendment may be executed in any number of counterparts and by different parties on separate counterparts, each ofwhich, when executed and delivered, shall be deemed to be an original, and all of which, when taken together, shall constitute but one and the sameAmendment. Delivery of an executed counterpart of this Amendment by telefacsimile or by e-mail transmission of an Adobe file format document(also known as a PDF file) shall be equally as effective as delivery of an original executed counterpart of this Amendment. Any party delivering anexecuted counterpart of this Amendment by telefacsimile or by e-mail transmission of an Adobe file format document (also known as a PDF file) alsoshall deliver an original executed counterpart of this Amendment but the failure to deliver an original executed counterpart shall not affect thevalidity, enforceability, and binding effect of this Amendment.8.Effect on Loan Documents.(a)The amendments set forth herein shall be limited precisely as written and shall not be deemed (a) to be a forbearance, waiver, ormodification of any other term or condition of the Loan Agreement or of any Loan Documents or to prejudice any right or remedy which Bank maynow have or may have in the future under or in connection with the Loan Documents; (b) to be a consent to any future consent or modification,forbearance, or waiver to the Loan Agreement or any other Loan Document, or to any waiver of any of the provisions thereof; or (c) to limit or impairBank’s right to demand strict performance of all terms and covenants as of any date. Borrower hereby ratifies and reaffirms its obligations under theLoan Agreement and the other Loan Documents to which it is a party and agrees that none of the amendments or modifications to the LoanAgreement set forth in this Amendment shall impair Borrower’s obligations under the Loan Documents or Bank’s rights under the Loan Documents.Borrower hereby further ratifies and reaffirms the validity and enforceability of all of the Liens heretofore granted, pursuant to and in connectionwith the Guarantee and Collateral Agreement or any other Loan Document to Bank on behalf and for the benefit of the Secured Parties, as collateralsecurity for the obligations under the Loan Documents, in accordance with their respective terms, and acknowledges that all of such Liens, and allcollateral heretofore pledged as security for such obligations, continues to be and remain collateral for such obligations from and after the datehereof. Borrower acknowledges and agrees that the Loan Agreement and each other Loan Document is still in full force and effect and acknowledgesas of the date hereof that Borrower has nodefenses to enforcement of the Loan Documents. Borrower waives any and all defenses to enforcement of the Loan Agreement as amended herebyand each other Loan Documents that might otherwise be available as a result of this Amendment of the Loan Agreement. To the extent any terms orprovisions of this Amendment conflict with those of the Loan Agreement or other Loan Documents, the terms and provisions of this Amendmentshall control.(b)To the extent that any terms and conditions in any of the Loan Documents shall contradict or be in conflict with any terms orconditions of the Loan Agreement, after giving effect to this Amendment, such terms and conditions are hereby deemed modified or amendedaccordingly to reflect the terms and conditions of the Loan Agreement as modified or amended hereby.(c)This Amendment is a Loan Document.9.Entire Agreement. This Amendment constitutes the entire agreement between Borrower and Bank pertaining to the subject matter contained hereinand supersedes all prior agreements, understandings, offers and negotiations, oral or written, with respect hereto and no extrinsic evidencewhatsoever may be introduced in any judicial or arbitration proceeding, if any, involving this Amendment. All of the terms and provisions of thisAmendment are hereby incorporated by reference into the Loan Agreement, as applicable, as if such terms and provisions were set forth in fulltherein, as applicable. All references in the Loan Agreement to “this Agreement”, “hereto”, “hereof”, “hereunder” or words of like import shall meanthe Loan Agreement as amended hereby.10.Release. Borrower may have certain Claims against the Released Parties, as those terms are defined below, regarding or relating to the LoanAgreement or the other Loan Documents. Bank and Borrower desire to resolve each and every one of such Claims in conjunction with the executionof this Amendment and thus Borrower makes the releases contained in this Section 10. In consideration of Bank entering into this Amendment,Borrower hereby fully and unconditionally releases and forever discharges Bank and its directors, officers, employees, subsidiaries, branches,affiliates, attorneys, agents, representatives, successors and assigns and all persons, firms, corporations and organizations acting on any of theirbehalf (collectively, the “Released Parties”), of and from any and all claims, allegations, causes of action, costs or demands and liabilities, ofwhatever kind or nature, from the beginning of the world to the date on which this Amendment is executed, whether known or unknown, liquidatedor unliquidated, fixed or contingent, asserted or unasserted, foreseen or unforeseen, matured or unmatured, suspected or unsuspected, anticipated orunanticipated, which Borrower has, had, claims to have had or hereafter claims to have against the Released Parties by reason of any act or omissionon the part of the Released Parties, or any of them, occurring prior to the date on which this Amendment is executed, including all such loss ordamage of any kind heretofore sustained or that may arise as a consequence of the dealings among the parties up to and including the date on whichthis Amendment is executed, including the administration or enforcement of the Loans, the Obligations, the Loan Agreement or any of the LoanDocuments (collectively, all of the foregoing, the “Claims”). Borrower represents and warrants that it has no knowledge of any claim by it againstthe Released Parties or of any facts or acts of omission of the Released Parties which on the date hereof would be the basis of a claim by Borroweragainst the Released Parties which is not released hereby. Borrower represents and warrants that the foregoing constitutes a full and complete releaseof all Claims.11.Severability. The provisions of this Amendment are severable, and if any clause or provision shall be held invalid or unenforceable in whole or inpart in any jurisdiction, then such invalidity or unenforceability shall affect only such clause or provision, or part thereof, in such jurisdiction andshall not in any manner affect such clause or provision in any other jurisdiction, or any other clause or provision in this Amendment in anyjurisdiction.[SIGNATURE PAGES FOLLOW]In Witness Whereof, the parties hereto have caused this Amendment to be duly executed and delivered by their proper and duly authorized officersas of the day and year first above written.BORROWER:ROSETTA STONE LTD.By: /s/ Thomas M. Pierno Name: Thomas M. Pierno Title: Chief Financial Officer BANK:SILICON VALLEY BANKBy: /s/ Jack Gaziano Name: Jack Gaziano Title: Managing Director Acknowledged and Agreed:GUARANTORS:ROSETTA STONE INC.By: /s/ Thomas M. Pierno Name: Thomas M. Pierno Title: Chief Financial Officer ROSETTA STONE HOLDINGS INC.By: /s/ Thomas M. Pierno Name: Thomas M. Pierno Title: Chief Financial Officer ROSETTA STONE INTERNATIONAL INC.By: /s/ Thomas M. Pierno Name: Thomas M. Pierno Title: Chief Financial Officer LIVEMOCHA LLCBy: /s/ Bruce Ghrist Name: Bruce Ghrist Title: Manager LEXIA LEARNING SYSTEMS LLCBy: /s/ Bruce Ghrist Name: Bruce Ghrist Title: Manager EXHIBIT DCOMPLIANCE CERTIFICATETO: SILICON VALLEY BANK Date: FROM: The undersigned authorized officer of Rosetta Stone Ltd. (“Borrower”) certifies that under the terms and conditions of the Loan and SecurityAgreement between Borrower and Bank (the “Agreement”):(1) Each Credit party is in complete compliance for the period ending _______________ with all required covenants except as noted below;(2) there are no Events of Default; (3) all representations and warranties in the Agreement are true and correct in all material respects on this date except asnoted below; provided, however, that such materiality qualifier shall not be applicable to any representations and warranties that already are qualified ormodified by materiality in the text thereof; and provided, further that those representations and warranties expressly referring to a specific date shall be true,accurate and complete in all material respects as of such date; (4) each Credit Party and each of its Subsidiaries, has timely filed all required tax returns andreports, and each Credit Party and each of its Subsidiaries has timely paid all foreign, federal, state and local taxes, assessments, deposits and contributionsowed by such Credit Party or Subsidiary except as otherwise permitted pursuant to the terms of Section 5.8 of the Agreement; and (5) no Liens have beenlevied or claims made against any Credit Party or any of its Subsidiaries relating to unpaid employee payroll or benefits of which Borrower has notpreviously provided written notification to Bank.Attached are the required documents supporting the certification. The undersigned certifies that these are prepared in accordance with GAAPconsistently applied from one period to the next except as explained in an accompanying letter or footnotes. The undersigned acknowledges that noborrowings may be requested at any time or date of determination that Borrower is not in compliance with any of the terms of the Agreement, and thatcompliance is determined not just at the date this certificate is delivered. Capitalized terms used but not otherwise defined herein shall have the meaningsgiven them in the Agreement.Please indicate compliance status by circling Yes/No under “Complies” column. Reporting CovenantsRequiredComplies Quarterly financial statements withCompliance CertificateQuarterly within 45 days for the first three quartersof each fiscal yearYes NoAnnual financial statement (CPA Audited) with Compliance CertificateFYE within 90 daysYes No10‑Q, 10‑K and 8-KWithin 5 days after filing with SECYes No The following Intellectual Property was registered (or a registration application submitted) after the Effective Date (if no registrations, state “None”)______________________________________________________________________________________________________________________________________________________________________________________Financial CovenantsComplies Achieve on a Quarterly Basis: Minimum Quick Ratio_____:1.0_____:1.0Yes NoMinimum EBITDA_____:1.0_____:1.0Yes NoThe following financial covenant analyses and information set forth in Schedule 1 attached hereto are true and accurate as of the date of thisCertificate.Other MattersHave there been any amendments of or other changes to the capitalization table of the Credit Parties and to the Operating Documents of any Credit Partyor any of its Subsidiaries since the date of the most recently delivered Compliance Certificate? If yes, provide copies of any such amendments or changeswith this Compliance Certificate to the extent not previously delivered to Bank.The following are the exceptions with respect to the certification above: (If no exceptions exist, state “No exceptions to note.”)--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ROSETTA STONE LTD.By:Name:Title:BANK USE ONLYReceived by: _____________________authorized signerDate: _________________________Verified: ________________________authorized signerDate: _________________________Compliance Status:Yes NoSchedule 1 to Compliance CertificateFinancial Covenants of BorrowerIn the event of a conflict between this Schedule and the Loan Agreement, the terms of the Loan Agreement shall govern.Dated: ____________________I. Quick Ratio (Section 6.8(a))Required:Fiscal Quarters EndingQuick RatioDecember 31, 20141.00 to 1.00March 31, 2015 and thereafter1.25 to 1.00Actual:A.Aggregate value of the unrestricted cash and Cash Equivalents of Ultimate Parent and its consolidated Subsidiaries$B.Aggregate value of the net billed accounts receivable of Ultimate Park and its consolidated Subsidiaries$C.Aggregate value of the investments with maturities of fewer than 12 monthsof Ultimate Parent and its consolidated Subsidiaries$D.Quick Assets (the sum of lines A through C)$E.Aggregate value of Obligations to Bank$F.Aggregate value of liabilities that should, under GAAP, be classified as liabilities on Holdings’ consolidated balancesheet, including all Indebtedness, and not otherwise reflected in line E above that matures within one (1) year$G.Deferred Revenue$H.Current Liabilities (the sum of lines E and F, minus line G)$I.Quick Ratio (line D divided by line H) Is line H equal to or greater than ___:1:00? No, not in compliance Yes, in complianceII. ADJUSTED EBITDA (Section 6.8(b))Required:Fiscal Quarters EndingAdjusted EBITDA March 31, 2015$4,000,000June 30, 2015$1,000,000September 30, 2015$7,000,000December 31, 2015$1March 31, 2016$5,000,000June 30, 2016$3,000,000September 30, 2016$7,000,000December 31, 2016 and thereafter$10,000,000Actual (for the trailing four quarters):1. Fiscal quarter most recently ended:A.Net Income$B.To the extent included in the determination of Net Income 1.Interest Expense$ 2.Income tax benefit and expense$ 3.Depreciation expense$ 4.Amortization expense$ 5.Stock-based compensation expense$ 6. Other non-operating expense (less other income) (as such amount is shown on the “Other income and (expense)”" lineitem below the operating income line in the Ultimate Parent's relevant income statement, determined in accordance withGAAP)$ 7.Goodwill impairment$ 8.Change in Deferred Revenue$ 9.Impairments other than Goodwill$ 10.Change in deferred commissions$ 11.Items related to the litigation with Google Inc.$ 12.Restructuring and related wind down costs, consulting and other related costs associated with development andimplementation of Borrower’s revised business strategy, severance costs and transaction and other costs associated withmergers and acquisitions$ 13.Adjustments related to recording the non-cash tax valuation allowance for deferred tax assets.$ 14.Interest income$ 15. FX$ 16.Total Line B: The sum of lines 1 through 9 minus lines 10 through 14 and plus or minus line 15$C.ADJUSTED EBITDA (line A plus line B)$2. 1st fiscal quarter preceding the fiscal quarter most recently ended:A.Net Income$B.To the extent included in the determination of Net Income 1.Interest Expense$ 2.Income tax benefit and expense$ 3.Depreciation expense$ 4.Amortization expense$ 5.Stock-based compensation expense$ 6. Other non-operating expense (less other income) (as such amount is shown on the “Other income and (expense)”" lineitem below the operating income line in the Ultimate Parent's relevant income statement, determined in accordance withGAAP)$ 7.Goodwill impairment$ 8.Change in Deferred Revenue$ 9.Impairments other than Goodwill$ 10.Change in deferred commissions$ 11.Items related to the litigation with Google Inc.$ 12.Restructuring and related wind down costs, consulting and other related costs associated with development andimplementation of Borrower’s revised business strategy, severance costs and transaction and other costs associated withmergers and acquisitions$ 13.Adjustments related to recording the non-cash tax valuation allowance for deferred tax assets.$ 14.Interest income$ 15. FX$ 16.Total Line B: The sum of lines 1 through 9 minus lines 10 through 14 and plus or minus line 15$C.ADJUSTED EBITDA (line A plus line B)$3. 2nd fiscal quarter prior preceding the fiscal quarter most recently ended:A.Net Income$B.To the extent included in the determination of Net Income 1.Interest Expense$ 2.Income tax benefit and expense$ 3.Depreciation expense$ 4.Amortization expense$ 5.Stock-based compensation expense$ 6. Other non-operating expense (less other income) (as such amount is shown on the “Other income and (expense)”" lineitem below the operating income line in the Ultimate Parent's relevant income statement, determined in accordance withGAAP)$ 7.Goodwill impairment$ 8.Change in Deferred Revenue$ 9.Impairments other than Goodwill$ 10.Change in deferred commissions$ 11.Items related to the litigation with Google Inc.$ 12.Restructuring and related wind down costs, consulting and other related costs associated with development andimplementation of Borrower’s revised business strategy, severance costs and transaction and other costs associated withmergers and acquisitions$ 13.Adjustments related to recording the non-cash tax valuation allowance for deferred tax assets.$ 14.Interest income$ 15. FX$ 16.Total Line B: The sum of lines 1 through 9 minus lines 10 through 14 and plus or minus line 15$C.ADJUSTED EBITDA (line A plus line B)$4. 3rd fiscal quarter prior preceding the fiscal quarter most recently ended:A.Net Income$B.To the extent included in the determination of Net Income 1.Interest Expense$ 2.Income tax benefit and expense$ 3.Depreciation expense$ 4.Amortization expense$ 5.Stock-based compensation expense$ 6. Other non-operating expense (less other income) (as such amount is shown on the “Other income and (expense)”" lineitem below the operating income line in the Ultimate Parent's relevant income statement, determined in accordance withGAAP)$ 7.Goodwill impairment$ 8.Change in Deferred Revenue$ 9.Impairments other than Goodwill$ 10.Change in deferred commissions$ 11.Items related to the litigation with Google Inc.$ 12.Restructuring and related wind down costs, consulting and other related costs associated with development andimplementation of Borrower’s revised business strategy, severance costs and transaction and other costs associated withmergers and acquisitions$ 13.Adjustments related to recording the non-cash tax valuation allowance for deferred tax assets.$ 14.Interest income$ 15. FX$ 16.Total Line B: The sum of lines 1 through 9 minus lines 10 through 14 and plus or minus line 15$C.ADJUSTED EBITDA (line A plus line B)$5.Trailing 4-quarter EBITDA (Sum of lines (1C, 2C, 3C and 4C ) $Is line 5 equal to or greater than $____? No, not in compliance Yes, in complianceEXHIBIT EFINANCIAL COVENANTSAchieve on a consolidated basis with respect to Ultimate Parent and its Subsidiaries:(a)Quick Ratio. A ratio of Quick Assets to Current Liabilities, in each case, measured as at the last day of the fiscalquarters specified below, of at least the following:Fiscal Quarters EndingQuick RatioDecember 31, 20141.00 to 1.00March 31, 2015 and thereafter1.25 to 1.00(b)Adjusted EBITDA. Adjusted EBITDA, measured as of the end of each fiscal quarter during the periods specified belowfor the trailing four quarters then ended, of at least the following:Fiscal Quarters EndingAdjusted EBITDA March 31, 2015$4,000,000June 30, 2015$1,000,000September 30, 2015$7,000,000December 31, 2015$1March 31, 2016$5,000,000June 30, 2016$3,000,000September 30, 2016$7,000,000December 31, 2016 and thereafter$10,000,000Exhibit 21.1ROSETTA STONE INC. SUBSIDIARIESAs of March 14, 2016 EntityJurisdiction ofIncorporationRosetta Stone Holdings Inc. DelawareRosetta Stone Ltd. (Formerly Fairfield & Sons Ltd. d/b/a Fairfield Language Technologies)VirginiaRosetta Stone International Inc. DelawareRosetta Stone Brazil Holding LLCDelawareRosetta Stone (UK) LimitedEngland and WalesRosetta Stone Japan Inc.JapanRosetta Stone GmbHGermanyRosetta Stone Canada Inc. CanadaRosetta Stone Hong Kong LimitedHong KongRosetta Stone International inc. Shanghai Representative OfficeShanghaiRosetta (Shanghai) Software Trading Co., Ltd.ShanghaiRosetta Stone Ensino de Linguas Ltda. BrazilRosetta Stone France SASFranceLivemocha LLC (formerly Livemocha Inc.)DelawareLexia Learning Systems LLC (formerly Lexia Learning Systems Inc.)DelawareRosetta Stone S.A. (formerly Tell Me More S.A.)FranceAuralog Studios SARLFranceAuralog SLSpainRosetta Stone Mexico SA de CV (formerly Auralog SA de CV)MexicoAuralog Software Development (Beijing) Company Ltd.ChinaExhibit 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe consent to the incorporation by reference in Registration Statement Nos. 333-204904, 333-201025, 333-190528, 333-183148, 333-180483, and 333-158828 on Form S-8 and Registration Statement No. 333-188444 on Form S-3 of our reports dated March 14, 2016, relating to the consolidated financialstatements of Rosetta Stone Inc. and subsidiaries, and the effectiveness of Rosetta Stone Inc. and subsidiaries' internal control over financial reporting,appearing in this Annual Report on Form 10-K of Rosetta Stone Inc. and subsidiaries for the year ended December 31, 2015./s/ Deloitte & Touche LLPMcLean, VirginiaMarch 14, 2016Exhibit 24.1ROSETTA STONE INC.POWER OF ATTORNEYEach person whose signature appears below hereby constitutes and appoints A. John Hass, Thomas M. Pierno and Sonia G. Cudd, or any of them, eachwith power to act without the other, a true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for each person whosesignature appears below and in his or her name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K of Rosetta Stone Inc. (the"Company") and any or all subsequent amendments and supplements to the Annual Report on Form 10-K, and to file the same, or cause to be filed the same,with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto each said attorney-in-fact and agent full power to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intentsand purposes as he might or could do in person, hereby qualifying and confirming all that said attorney-in-fact and agent or his substitute or substitutes maylawfully do or cause to be done by virtue hereof.Each person whose signature appears below may at any time revoke this power of attorney as to himself or herself only by an instrument in writingspecifying that this power of attorney is revoked as to him or her as of the date of execution of such instrument or at a subsequent specified date. This powerof attorney shall be revoked automatically with respect to any person whose signature appears below effective on the date he or she ceases to be a member ofthe Board of Directors or an officer of the Company. Any revocation hereof shall not void or otherwise affect any acts performed by any attorney-in-fact andagent named herein pursuant to this power of attorney prior to the effective date of such revocation.March 14, 2016Signature Title /s/ A. JOHN HASS III Chief Executive Officer and Director(Principal Executive Officer)A. John Hass III /s/ THOMAS M. PIERNO Chief Financial Officer(Principal Financial Officer)Thomas M. Pierno /s/ Patrick W. Gross Chairman of the Board, DirectorPatrick W. Gross /s/ JAMES P. BANKOFF DirectorJames P. Bankoff /s/ LAURENCE FRANKLIN DirectorLaurence Franklin /s/ DAVID P. NIERENBERG DirectorDavid P. Nierenberg /s/ CAROLINE J. TSAY DirectorCaroline J. Tsay /s/ LAURA L. WITT DirectorLaura L. Witt /s/ STEVEN P. YANKOVICH DirectorSteven P. Yankovich Exhibit 31.1CERTIFICATION OFPRINCIPAL EXECUTIVE OFFICEROF ROSETTA STONE INC.PURSUANT TO SECURITIES EXCHANGE ACT RULES 13a-14 AND 15d-14, AS ADOPTEDPURSUANT TO SECTION 302 OF THESARBANES-OXLEY ACT OF 2002I, A. John Hass, certify that:1. I have reviewed this Annual Report on Form 10-K of Rosetta Stone Inc. (the "Registrant");2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report;4. The Registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in ExchangeAct Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for theRegistrant and have:a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, toensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared;b. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposesin accordance with generally accepted accounting principles;c. evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; andd. disclosed in this report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recentfiscal quarter (the Registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, theRegistrant's internal control over financial reporting; and5. The Registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theRegistrant's auditors and the audit committee of the Registrant's Board of Directors (or persons performing the equivalent functions):a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the Registrant's ability to record, process, summarize and report financial information; andb. any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controlover financial reporting. By: /s/ A. JOHN HASS A. John Hass(Principal Executive Officer)Date: March 14, 2016Exhibit 31.2CERTIFICATION OFPRINCIPAL FINANCIAL OFFICEROF ROSETTA STONE INC.PURSUANT TO SECURITIES EXCHANGE ACT RULES 13a-14 AND 15d-14, AS ADOPTEDPURSUANT TO SECTION 302 OF THESARBANES-OXLEY ACT OF 2002I, Thomas M. Pierno, certify that:1. I have reviewed this Annual Report on Form 10-K of Rosetta Stone Inc. (the "Registrant");2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this report;4. The Registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in ExchangeAct Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for theRegistrant and have:a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, toensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared;b. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposesin accordance with generally accepted accounting principles;c. evaluated the effectiveness of the Registrant's disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; andd. disclosed in this report any change in the Registrant's internal control over financial reporting that occurred during the Registrant's most recentfiscal quarter (the Registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, theRegistrant's internal control over financial reporting; and5. The Registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theRegistrant's auditors and the audit committee of the Registrant's Board of Directors (or persons performing the equivalent functions):a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the Registrant's ability to record, process, summarize and report financial information; andb. any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controlover financial reporting. By: /s/ THOMAS M. PIERNO Thomas M. Pierno(Principal Financial Officer)Date: March 14, 2016Exhibit 32.1CERTIFICATION OFPRINCIPAL EXECUTIVE OFFICEROF ROSETTA STONE INC.PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTEDPURSUANT TO SECTION 906 OF THESARBANES-OXLEY ACT OF 2002In connection with the accompanying Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the Securities and ExchangeCommission on the date hereof (the "Report"), I, A. John Hass, Interim Chief Executive Officer of Rosetta Stone Inc. (the "Company"), hereby certify, to myknowledge, that:1. the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company./s/ A. JOHN HASSA. John Hass(Principal Executive Officer)Date: March 14, 2016Exhibit 32.2CERTIFICATION OFPRINCIPAL FINANCIAL OFFICEROF ROSETTA STONE INC.PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTEDPURSUANT TO SECTION 906 OF THESARBANES-OXLEY ACT OF 2002In connection with the accompanying Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the Securities and ExchangeCommission on the date hereof (the "Report"), I, Thomas M. Pierno, Chief Financial Officer of Rosetta Stone Inc. (the "Company"), hereby certify, to myknowledge, that:1. the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and2. the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company./s/ THOMAS M. PIERNO Thomas M. Pierno (Principal Financial Officer)Date: March 14, 2016

Continue reading text version or see original annual report in PDF format above