Rosetta Stone Inc
Annual Report 2016

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, 2016Commission 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.)1621 North Kent Street, Suite 1200Arlington, 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 $159.3 million as of June 30, 2016 (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, 2017, there were 22,161,289 shares of common stock outstanding.Documents incorporated by reference: Portions of the definitive Proxy Statement to be delivered to stockholders in connection with the 2017 AnnualMeeting of Stockholders to be held on May 19, 2017 are incorporated by reference into Part III.TABLE OF CONTENTS PagePART IItem 1.Business4Item 1A.Risk Factors8Item 1B.Unresolved Staff Comments24Item 2.Properties24Item 3.Legal Proceedings24Item 4.Mine Safety Disclosures24PART IIItem 5.Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities25Item 6.Selected Financial Data26Item 7.Management's Discussion and Analysis of Financial Condition and Results of Operations27Item 7A.Quantitative and Qualitative Disclosures About Market Risk51Item 8.Financial Statements and Supplementary Data51Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure51Item 9A.Controls and Procedures51Item 9B.Other Information52PART IIIItem 10.Directors, Executive Officers and Corporate Governance53Item 11.Executive Compensation53Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters53Item 13.Certain Relationships and Related Transactions, and Director Independence53Item 14.Principal Accounting Fees and Services53PART IVItem 15.Exhibits and Financial Statement Schedules54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 can be identified by non-historical statements and often include words suchas "outlook," "potential," "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. These statements mayinclude, but are not limited to, statements relating to: our business strategy; guidance or projections related to revenue, Adjusted EBITDA, bookings, andother measures of future economic performance; the contributions and performance of our businesses, including acquired businesses and internationaloperations; projections for future capital expenditures; and other guidance, projections, plans, objectives, and related estimates and assumptions. Aforward-looking statement is neither a prediction nor a guarantee of future events or circumstances. In addition, forward-looking statements are based onthe Company’s current assumptions, expectations and beliefs and are subject to certain risks and uncertainties that could cause actual results to differmaterially from our present expectations or projections. Some important factors that could cause actual results, performance or achievement to differmaterially from those expressed or implied by these forward-looking statements include, but are not limited to: the risk that we are unable to execute ourbusiness strategy; declining demand for our language learning solutions; the risk that we are not able to manage and grow our business; the impact of anyrevisions to our pricing strategy; the risk that we might not succeed in introducing and producing new products and services; the impact of foreignexchange fluctuations; the adequacy of internally generated funds and existing sources of liquidity, such as bank financing, as well as our ability to raiseadditional funds; the risk that we cannot effectively adapt to and manage complex and numerous technologies; the risk that businesses acquired by us mightnot perform as expected; and the risk that we are not able to successfully expand internationally. We expressly disclaim any obligation to update or reviseany forward-looking statements, whether as a result of new information, future developments or otherwise, except as required by law. These factors shouldnot be construed as exhaustive and should be read in conjunction with the other cautionary statements risks and uncertainties that are more fully describedin the Company's filings with the U.S. Securities and Exchange Commission (SEC), including those described below in this Annual Report on Form 10-K inPart I, Item 1A: "Risk Factors" and Part II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations,” thosedescribed elsewhere in this Annual Report on Form 10-K, and those described from time to time in our future reports filed with the Securities and ExchangeCommission. 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 digital solutions drive positive learning outcomes for the inspired learner at home or in schools and workplaces around the world.Founded in 1992, Rosetta Stone's language division uses cloud-based solutions to help all types of learners read, write, and speak more than 30languages. Lexia Learning, Rosetta Stone's literacy education division, was founded more than 30 years ago and is a leader in the literacy education space.Today, Lexia helps students build fundamental reading skills through its rigorously researched, independently evaluated, and widely respected instructionand assessment programs. Rosetta Stone Inc. was incorporated in Delaware in 2005.As our Company has evolved, we believe that our Enterprise & Education Language and Literacy segments are our largest opportunities for long-termvalue creation. The customers in these markets have needs that recur each year, creating a more predictable sales opportunity. This need profile also fits wellwith our suite of language and literacy products, and the well-known Rosetta Stone brand. We also believe the demand is growing for e-learning basedliteracy solutions in the U.S. and English language-learning around the globe.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, our focus is on the following priorities:1.Grow literacy sales and market share by providing fully aligned digital instruction and assessment tools for K-12, building a direct distribution salesforce to augment our historical reseller model, and continuing to develop our implementation services business;2.Position our Enterprise & Education Language segment for profitable growth by focusing our direct sales on our best geographies and customersegments, partnering with resellers in other geographies and successfully delivering our CatalystTM product to Corporate customers. Catalystintegrates our Foundations, Advantage, and Advanced English for Business products with enhanced reporting, assessment and administrator toolsthat offers a simple, more modern, metrics-driven suite of tools that are 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;4.Seek opportunities to leverage our language assets including our content, tools and pedagogy, as well as our well-known Rosetta Stone brand,through partnerships with leading players in key markets around the world; and5.Continue to identify opportunities to become more efficient.In pursuing these priorities, we will (i) allocate capital to the areas of our business that we believe have the greatest value creation potential, includingour Lexia literacy business, (ii) focus our businesses on their best customers, including K-12 learners primarily in North America, Corporate learners primarilyin North America and Northern Europe in our Enterprise & Education Language segment, and passionate learners in the U.S. and select non-U.S. geographiesin our Consumer language business, and (iii) optimize the sales and marketing costs for these businesses and the costs of our business overall.Business SegmentsOur business is organized into three operating segments: Enterprise & Education Language, Literacy, and Consumer. The Enterprise & EducationLanguage segment derives language-learning revenues from sales to educational institutions, corporations, and government agencies worldwide under aSoftware-as-a-Service ("SaaS") model. The Literacy segment derives revenue under a SaaS model from the sales of literacy solutions to educationalinstitutions serving grades K through 12. The Consumer segment derives revenue from sales to individuals and retail partners worldwide. For additionalinformation regarding our segments, see Note 17 of Item 8, Financial Statements and Supplementary Data. Prior periods are presented consistently with ourcurrent operating segments and definition of segment contribution.4Table of ContentsProducts and ServicesEnterprise & Education Language:Enterprise & Education Language-Learning Solutions: Rosetta Stone provides a series of web-based subscriptions to interactive language-learningsolutions for schools, business and other organizations that are primarily available online. Our core language-learning suite offers courses and practiceapplications in multiple languages, each leveraging our proprietary context-based immersion methodology, speech recognition engine and innovativetechnology features. Available in 24 languages and designed for beginner to intermediate language learners, Rosetta Stone Foundations builds fundamentallanguage skills. Rosetta Stone Advantage is available for all proficiency levels in 9 of the 24 languages and focuses on improving everyday and businesslanguage skills. Our Advanced English for Business solution serves multinational companies seeking to build their employees’ English language proficiencyso they are able to communicate and operate in a global business environment. In 2016, we completed the development of Catalyst, which consolidates andaligns our Foundations, Advantage and Advanced English for Business products into a single solution for our enterprise customers. Catalyst providesstreamlined access and simplified pricing for the full suite of English and world language learning content, along with assessment, placement, ongoingreporting and demonstration of results, all of which address important customer needs to focus and demonstrate payback. Specifically designed for use withour language-learning solutions, our Enterprise & Education Language customers may also purchase our audio practice products and live tutoring sessions toenhance the learning experience.Literacy: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. This research-proven technology based approach accelerates reading skillsdevelopment, predicts students' year-end performance and provides teachers with data-driven action plans to help differentiate instruction. Lexia ReadingCore5 is available for all abilities from pre-K through grade 5. Our reading intervention program, Lexia Strategies, is designed for struggling readers in grades6 and above. Lexia RAPID Assessment is a computer-adaptive screener and diagnostic tool for grades K-12 that identifies and monitors reading and languageskills to provide actionable data for instructional planning. Lexia's solutions deliver norm-referenced performance data and analysis to enable teachers tomonitor and modify their instruction to address specific student needs. These literacy solutions are provided under web-based subscriptions.Our Enterprise & Education Language and Literacy customers can maximize their learning solutions with administrative tools, professional services andcustom solutions.Administrative Tools: Our Enterprise & Education Language and Literacy learning programs come with a set of administrative tools for performancemonitoring, and to measure and track learner progress. Administrators can use these tools to access real-time dynamic reports and identify each learner'sstrengths and weaknesses.Professional Services: Professional services provide our customers with access to experienced training, implementation and support resources. Our teamworks directly with customers to plan, deploy, and promote the program for each organization, incorporate learning goals into implementation models,prepare and motivate learners, and integrate the Enterprise & Education Language and Literacy solutions 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. Our interactive portfolio oflanguage-learning solutions is powered by our widely recognized brand, and building on our 24-year heritage in language-learning.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, and Amazon App Store for Android.Rosetta Stone Language-Learning Solutions: Rosetta Stone provides intuitive, easy-to-use language-learning programs that can be purchased assoftware subscription or in perpetual formats including digital download, CD, or in-app purchase.5Table of ContentsOur language-learning suite offers courses and practice applications in multiple languages, each leveraging our proprietary immersion methodology,speech recognition engine and innovative technology features. Beginner to intermediate language-learning products are available in 30 languages to buildfundamental language skills. More advanced language-learning products are available in 9 of the 30 languages. We also offer online services to enhance andaugment our learners' capabilities. Our Online Tutoring is an online service that provides conversational coaching sessions with native speakers to practiceskills and experience direct interactive dialogue. Our Online Games and Activities are online services that provide a world-wide community for users aroundthe world with games, online chat, read-along stories, and other features to improve language skills. Our current suite of mobile language-learning appsincludes companions to our computer-based language-learning apps which enables learners to access their language program anytime anywhere.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. We continue to evaluate changes to our solutions to strengthen our brand and improvethe relevance of our offering portfolio.Our research and development expenses were $26.3 million, $29.9 million, and $33.2 million for the years ended December 31, 2016, 2015 and 2014,respectively.Customers and Distribution ChannelsNo customer accounted for more than 10% of the Company's revenue during the years ended December 31, 2016, 2015 or 2014. Our practice is to shipour products promptly upon receipt of purchase orders from customers; consequently, backlog is not significant.Enterprise & Education Language:Our Enterprise & Education Language distribution channel is focused on targeted sales activity primarily through a direct sales force in five markets:K-12 schools, colleges and universities, government agencies, not-for-profit organizations, and corporations. Our Enterprise & Education language-learningcustomers include the following:Educational Institutions. These customers include primary and secondary schools and colleges and universities.Government Agencies and Not-for-Profit Organizations. These customers include government agencies and organizations developing workforcesthat 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.Third-party Resellers and Partners. We utilize third-party resellers and partners to provide our language-learning solutions to businesses, schools, andpublic-sector organizations in markets predominantly outside the U.S.Literacy:Our Literacy distribution channel utilizes a direct sales force as well as relationships with third-party resellers focused on the sale of Lexia solutions toK-12 schools.Consumer:Our Consumer distribution channel comprises a mix of our call centers, websites, third party e-commerce websites, app-stores, consignment distributors,select retail resellers, and daily deal partners. We believe these channels complement each other, as consumers who have seen our direct-to-consumeradvertising may purchase at our retailers, and vice versa.Direct to consumer. Sales generated through either our call centers, our e-commerce website at www.rosettastone.com, and app stores.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 relationships6Table of Contentsinclude 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 withdaily deal resellers.Home School. We promote interest in the language-learning market through advertising in publications focused on home schooling and attendinglocal trade shows.Sourcing and FulfillmentConsistent with the SaaS model in our Enterprise & Education Language and Literacy segments, 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, and literacy.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. In the enterprise and education-focused language market, we compete with EF English Live (formerly EF Englishtown), Global English, Wall StreetEnglish (Pearson), inlingua, Imagine Learning, Transparent Language, Duolingo, Middlebury Interactive Languages, Speexx as well as many privatelanguage schools and other classroom-based courses. Within consumer-focused language learning, our competitors include Berlitz (Benesse Holdings),Pimsleur (Simon & Schuster, part of CBS Corporation), Living Language (Penguin Random House, a joint venture of Pearson and Bertelsmann), McGraw-HillEducation, Duolingo, Inc., Fluenz, Busuu Ltd., Babbel (operated by Lesson Nine GmbH) and many other small and regionally-focused participants. Inaddition there are several competitors that are primarily focused on teaching English including Open English (Open English LLC), EF English Live andInglés Sin Barreras.In the literacy category, we compete primarily in the K-12 digital reading space in the U.S. with Imagine Learning, Scientific Learning, Odyssey(Compass Learning), Renaissance, Houghton Mifflin Harcourt, Curriculum Associates, and iStation.SeasonalityOur business is affected by variations in seasonal trends. Within our Enterprise & Education Language segment, sales in our education, government, andcorporate sales channels are seasonally stronger in the second half of the calendar year due to purchasing and budgeting cycles. Literacy segment sales areseasonally stronger in the second and third quarters of the calendar year corresponding to the end and beginning of school district budget years. Consumersales are affected by seasonal trends associated with the holiday shopping season. In particular, we generate a significant portion of our Consumer sales in thefourth quarter during the period beginning on Black Friday through the end of the calendar year.Our operating segments are affected by different sales-to-cash patterns. Consumer sales typically turn to cash more quickly than Enterprise & EducationLanguage and Literacy 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 thesecond half of the year we have been a net generator of cash.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. In certain circumstances, we may sub-license ourintellectual property including our trademarks and software for use in certain markets.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.7Table of ContentsWe have registered a variety of trademarks, including our primary or house marks, Rosetta Stone, The Blue Stone Logo, Lexia Learning, Lexia, FitBrains, and Catalyst. 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, 2016, we had 1,012 total employees, consisting of 717 full-time and 295 part-time employees. We have employees in France andSpain who are represented by a collective bargaining agreement. We believe that we have good relations with our employees.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.Available 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 information contained in, or that can be accessed through, our website is not part of, and is not incorporatedinto, this Annual Report on Form 10-K.The SEC maintains a website that contains reports, proxy statements and other information regarding issuers that file electronically with the SEC. Thesematerials 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 7, 2016 with the SEC for the period ended September 30, 2016. 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.8Table of ContentsWe might not be successful in executing our strategy of focusing on the Enterprise & Education Language and Literacy segments and on more passionatelanguage learners in the Consumer 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 & EducationLanguage segment by serving the needs of corporate and K-12 language learners, and prioritizing those who wish to speak and read English. In addition, weare now focusing on the needs of more passionate language learners in our Consumer segment, rather than addressing the needs of the mass marketplace. If wedo not successfully execute our strategy, our revenue and profitability could decline. Our recent strategy changes include actions to reduce headcount, exitunprofitable geographies, and other savings initiatives. 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 business, economic, and competitive uncertainties and contingencies,some of which are beyond our control. If these estimates and assumptions are incorrect, or if other unforeseen events occur, our business and financial resultscould be adversely affected.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 or outside party confirms or examines the projections and, accordingly, no such person expresses any opinion or any other formof assurance with respect thereto.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 as 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. We expressly disclaim any obligations to update or revise anyguidance, whether as a result of new information, future events or otherwise, except as required by law. In light of the foregoing, investors are urged not torely 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,9Table of Contentsmobile applications, audio courses and lessons, videos, games, stories, news, digital textbooks, and through other means. We estimate that there arethousands of free mobile applications on language-learning; free products are provided in at least 50 languages by private companies, universities, andgovernment agencies. Low barriers to entry allow start-up companies with lower costs and less pressure for profitability to compete with us. Competitors thatare focused more on user acquisition rather than profitability and funded by venture capital may be able to offer products at significantly lower prices or forfree. As free online translation services improve and become more widely available and used, people may generally become less interested in languagelearning. Although we also offer free products such as mobile apps, if we cannot successfully attract users of these free products and convert a sufficientportion of these free users into paying customers, our business could be adversely affected. If free products become more engaging and competitive or gainwidespread acceptance by the public, demand for our products could decline or we may have to lower our prices, which could adversely impact our revenueand 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 software products and related services is subject to rapidly changing consumer demand and trendsin 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;•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 marketplaces. Furthermore, consumers may defer purchases of our solutions in anticipation of new products or new versions from us or ourcompetitors. A decline in consumer demand for our solutions, or any failure on our part to satisfy such changing consumer preferences, could harm ourbusiness and profitability.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 Language business could be impaired.10Table of ContentsWe 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, which could adversely affect 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 reduce 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.We have no control over the quantity 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 of our products. The fact that we also sell our products directly could cause retailers ordistributors to reduce their efforts to promote our products or stop selling our 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 Language customers. Any increase in the taxation of onlinesales could 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 uncertainwhether we will need to lower prices to effectively compete and what other short-term or 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 adversely affect our reportedfinancial 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;11Table of Contents•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 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 our marketing budget it cannot be assured that we can increase the amount of remnant advertising at the discounted priceswe have obtained in the past. If any of these events occur, we may purchase time slots and publication dates at higher prices, which would 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. In March 2016, as part of the 2016Restructuring Plan, we initiated actions to withdraw our direct sales presence in almost all of our non-U.S. and non-northern European geographies related tothe distribution of the Enterprise & Education Language offerings. These operations added sales, but at too high a cost and without the near-term ability tocapture scale efficiencies. We continuously review and optimize certain of our website sales channels in Europe, Asia and Latin America. In addition, wecontinue to optimize our indirect sales channels in Europe, Asia and Latin America through reseller and other arrangements with third parties. If we areunable to stabilize and reduce losses in our international operations successfully and in a timely manner, our business, revenue and financial results could beharmed. Such stabilization and reduction may be more difficult or take longer than we anticipate, and we may not be able to successfully market, sell, deliverand support our products and services internationally to the extent we 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 accurately12Table of Contentscould significantly harm our ability to attract and retain customers and our results of operations. For example, the number of individuals who access theInternet through devices other than a personal computer, such as tablet computers, mobile devices, televisions and set-top box devices, has increaseddramatically and this trend is likely to continue. Our products and services may not work or be viewable on these devices because each manufacturer ordistributor may establish unique technical standards for such devices. Accordingly, we may need to devote significant resources to the creation, support andmaintenance of such versions. If we fail to develop or sell products and services on a cost-effective basis that respond to these or other technologicaldevelopments and changing customer needs, we may be harmed in our ability to attract and retain customers, and our revenue and business could suffer.Furthermore, our customers who view our advertising via mobile devices might not buy our products to the same extent that they do when viewing ouradvertising via personal computers or laptops. Accordingly, if we cannot convince customers to purchase our products via mobile devices, our business andresults 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 traditional desktop computers has been declining, while the demand for mobile devices such as notebook computers, smartphones and tablets has beenincreasing, which means that we must be able to market to potential customers and to provide customers with access to and use of our products and serviceson many platforms and operating systems, as they may be changed from time to time. To the extent new releases of operating systems, including for mobileand non-PC devices, or other third-party products, platforms or devices make it more difficult for our products to perform, and our customers use alternativetechnologies, 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 Language and Literacy customers. As a result, we must continually ensure that our products interoperateproperly with these varied and customized systems. Changes in operating systems, the technologies we incorporate into our products or the computer systemsour customers use may damage our business.Our products and internal systems rely on software that is highly technical and maintained by third parties and if such third-party software containsundetected errors or vulnerabilities or if it not supported or updated to keep pace with current computer hardware, our business could be adverselyaffected.Our products and internal systems rely on software, including software developed or maintained internally and/or by third parties, that is highlytechnical and complex. In addition, our products and internal systems depend on the ability of such software to store, retrieve, process, and manage immenseamounts of data. Such software has contained, and may now or in the future contain, undetected errors, bugs, or vulnerabilities. Some errors may only bediscovered after the code has been released for external or internal use. Errors, vulnerabilities, or other design defects within the software on which we relymay result in a negative experience for users and marketers who use our products, delay product introductions or enhancements, result in measurement orbilling errors, compromise our ability to protect the data of our users and/or our intellectual property or lead to reductions in our ability to provide some or allof our services.For example, we rely on Adobe Flash as a platform for our software. Adobe Flash is one of the most versatile programming systems available and isunique in its ability to allow the integration of many forms of electronic formatted media into an interactive and user friendly system. However, in July 2015,certain vulnerabilities discovered in Adobe Flash led to temporary interruption of support for Adobe Flash by popular web browsers. As a result, somesoftware makers are opting to exclude Adobe Flash from their web browsers. If similar interruptions occur in the future and disrupt our ability to provide ourproducts to some or all of our users, our ability to generate revenue would be harmed. Additionally, if Adobe Flash were to become deleted from Adobe’sproduct line or become not supported or updated to keep pace with current computer hardware, then our software products would become obsolete veryquickly. Any errors, bugs, vulnerabilities, or defects discovered in the software on which we rely, and any associated degradations or interruptions of service,could result in damage to our reputation, loss of users, loss of revenue, or liability for damages, any of which could adversely affect our business and financialresults.If 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 Language or Literacy customers are colleges, universities, primary and secondary schools and school districts,other education providers, armed forces and government agencies that depend substantially on government funding. Accordingly, any general decrease,delay or change in federal, state or local funding for colleges, universities, primary and secondary schools and school districts, or other education providers orgovernment agencies that use13Table of Contentsour products and services could cause our current and potential customers to reduce their purchases of our products and services, to exercise their right toterminate licenses, or to decide not to renew licenses, any of which could cause us to lose revenue. In addition, a specific reduction in governmental fundingsupport for products such as ours would also cause us to lose revenue and could adversely affect our overall gross margins.Some of our Enterprise & Education Language and Literacy business is characterized by a lengthy and unpredictable sales cycle, which could delay newsales.We face a lengthy sales cycle between our initial contact with some potential Enterprise & Education Language and Literacy customers and the signingof license agreements with these customers. As a result of this lengthy sales cycle, we have only a limited ability to forecast the timing of such Enterprise &Education Language and Literacy sales. A delay in or failure to complete license transactions could cause us to lose revenue, and could cause our financialresults to vary significantly from quarter to quarter. Our sales cycle varies widely, reflecting differences in our potential Enterprise & Education Languageand Literacy customers' decision-making processes, procurement requirements and budget cycles, and is subject to significant risks over which we have littleor 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 a 100% SaaS-based model for our Consumer business and sell our solutions as subscriptions, rather than packaged software, 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 recognized 65-90% ofthe revenue at the time of sale. Certain of our online products are sold under different subscription terms, from short-term (less than one year) to long-term(typically 36-months) subscriptions with a corresponding license term. Typically, long-term subscriptions include substantially higher discounts, resulting inless cash and revenue from the initial sale to the customer and selling a higher proportion of long-term subscriptions could have a substantially negativeimpact on our revenue, results of operations and cash flow in any quarterly reporting period. Furthermore, to the extent that customers use our products andservices for only a short time after purchase, online subscription customers could be less likely to renew their subscriptions beyond the initial term with theeffect 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, especially during the holidayselling season, as well as higher sales to governmental, educational institutions, and corporations in the second half of the calendar year. We sell to asignificant number of our retailers, distributors and Enterprise & Education Language customers on a purchase order basis and we receive orders when thesecustomers need products and services. As a result, their orders are typically not evenly distributed throughout the year. Our quarterly results of operations alsomay fluctuate significantly as a result of a variety of other factors, including the timing of holidays and advertising initiatives, changes in our products,services and advertising initiatives and changes in those of our competitors. Budgetary constraints of our Enterprise & Education Language and Literacycustomers may also cause our quarterly results to fluctuate.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.Acquisitions, 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 experience14Table of Contentsdifficulty integrating new technology, employees, and business systems, that we divert management's attention from our other businesses or that we acquireundiscovered liabilities such as patent infringement claims or violations of the U.S. Foreign Corrupt Practices Act and similar worldwide anti-bribery laws. Itmay take longer than expected to realize the full benefits, such as increased revenue, enhanced efficiencies, or more customers, or those benefits mayultimately be smaller than anticipated, or may not be realized. These events and circumstances could harm our operating results or financial condition.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.Despite our precautions and significant ongoing investments to protect against security risks, data protection breaches, cyber-attacks and otherintentional disruptions of our products and offerings, we may be a target of attacks specifically designed to impede the performance of our products andofferings and harm our reputation as a company. If our systems are harmed or fail to function properly or if third parties improperly obtain and use thepersonal information of our customers or employees, we may be required to expend significant resources to repair or replace systems or to otherwise protectagainst security breaches or to address problems caused by the breaches. A major breach of our network security and systems could have serious negativeconsequences for our businesses, including possible fines, penalties and damages, reduced customer demand for our products and services, harm to ourreputation and brand, and loss of our ability to accept and process customer credit card orders. Any such access, disclosure or other loss of information couldresult in legal claims or proceedings and regulatory penalties, disrupt our operations and result in a loss of confidence in our products and services, whichcould lead to a material and adverse effect on our business, reputation or financial results.We may incur significant costs related to maintaining data security and in the event of any data security breaches that could compromise our informationtechnology network security, trade secrets and customer data. The secure processing, maintenance and transmission of personal, financial or other information that is entrusted to us by our customers is critical to ouroperations and business strategy, and we devote significant resources to protecting such information. The expenses associated with protecting suchinformation could reduce our operating margins. Additionally, threats to our information technology network security can take a variety of forms. Individualhackers and groups of hackers, and sophisticated organizations or individuals may threaten our information technology network security. Cyber attackersmay develop and deploy malicious software to attack our services and gain access to our networks or data centers, hold access to critical systems orinformation for ransom, or act in a coordinated manner to launch distributed denial of service or other coordinated attacks. Cyber threats and attacks areconstantly evolving, thereby increasing the difficulty of detecting and successfully implementing measures to defend against them. We may be unable toanticipate potential techniques or implement adequate preventative measures in time. Cyber threats and attacks can have cascading impacts that unfold withincreasing speed across internal networks and systems. Breaches of our network, credit card processing information, or data security could disrupt the securityof our internal systems and business applications, impair our ability to provide services to our customers and protect the privacy of their data, cause productdevelopment delays, compromise confidential or technical business information harming our competitive position, result in theft or misuse of our intellectualproperty or other assets, expose us to contractual or regulatory audit or investigation, require us to allocate additional resources to alternative and potentiallymore costly technologies more frequently than anticipated, or otherwise adversely affect our business. We maintain cyber risk insurance, but our policycoverage limits may not be sufficient to cover all of our losses caused by any future information security-related breaches or events.15Table of ContentsOur business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy and data protection. Changes in regulations orcustomer concerns regarding privacy and protection of customer data, or any failure to comply with such laws, could adversely affect 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 advertising networks is a topic of active interest among federal, state, andinternational regulatory bodies, and the regulatory environment is unsettled and rapidly evolving. Many states have passed new laws impacting requirednotifications to customers and/or state agencies where there is a security breach involving personal data, such as California’s Information Practices Act.We also face similar risks in international markets where our products, services and apps are offered. Foreign data protection, privacy, competition, andother laws and regulations can impose different obligations or be more restrictive than those in the United States. We are subject to international laws andregulations that dictate whether, how, and under what circumstances we can transfer, process and/or receive transnational data that is critical to our operationsand ability to provision our products and perform services for our customers, including data relating to users, customers, or partners outside the United States,and those laws and regulations are uncertain and subject to change.Recent legal developments in Europe have created complexity and compliance uncertainty regarding certain transfers of information from Europe tothe U.S. For example, in October 2015, the European Court of Justice invalidated the 2000 US-EU Safe Harbor program as a legitimate and legally authorizedbasis on which U.S. companies, including Rosetta Stone, could rely for the transfer of personal data from the European Union to the United States. TheEuropean Union and United States recently agreed to an alternative transfer framework for data transferred from the European Union to the United States,called the Privacy Shield Framework. Rosetta Stone participates and has certified to its compliance to the Privacy Shield Framework. However, this newframework also faces a number of legal challenges, is subject to an annual review that could result in changes to our obligations, and also may be challengedby national regulators or private parties. In addition, other available bases on which to rely for the transfer of EU personal data outside of the EuropeanEconomic Area, such as standard Model Contractual Clauses (MCCs), have also been subjected to regulatory or judicial scrutiny. This has resulted in someuncertainty, and compliance obligations could cause us to incur costs or require us to change our business practices in a manner adverse to our business.If one or more of the legal bases for transferring personal data from Europe to the United States is invalidated, or if we are unable to transfer personaldata between and among countries and regions in which Rosetta Stone operates, it could affect the manner in which we provide our services or adverselyaffect our financial results. Any failure, or perceived failure, by us to comply with or make effective modifications to our policies, or to comply with anyfederal, state, or international privacy, data-retention or data-protection-related laws, regulations, orders or industry self-regulatory principles could result inproceedings or actions against us by governmental entities or others, a loss of customer confidence, damage to the Rosetta Stone brands, and a loss ofcustomers, which could potentially have an adverse effect on our business. In addition, various federal, state and foreign legislative or regulatory bodies mayenact new or additional laws and regulations concerning privacy, data-retention and data-protection issues, including laws or regulations mandatingdisclosure to domestic or international law enforcement bodies, which could adversely impact our business, our brand or our reputation with customers. Forexample, some countries are considering laws mandating that personal data regarding customers in their country be maintained solely in their country.Having to maintain local data centers and redesign product, service and business operations to limit personal data processing to within individual countriescould increase our operating costs significantly. In addition, the European Commission has approved a data protection regulation, known as the General DataProtection Regulation (GDPR), which has been finalized and is due to come into force in or around May 2018. The GDPR will include additional operationaland other requirements for companies that receive or process personal data of residents of the European Union that are different than those currently in placein the European Union, and that will include significant penalties for non-compliance. The interpretation and application of privacy, data protection and data retention laws and regulations are often uncertain and in flux in the U.S. andinternationally. Complying with these varying international requirements could cause us to incur substantial costs or require us to change our businesspractices in a manner adverse to our business and operating results. In addition, these laws may be interpreted and applied inconsistently from country tocountry and inconsistently with our current policies and practices, complicating long-range business planning decisions. If privacy, data protection or dataretention laws are interpreted and applied in a manner that is inconsistent with our current policies and practices we may be deemed non-compliant, subjectto legal or regulatory process, fined or ordered to change our business practices in a manner that could cause use to incur substantial costs, or that adverselyimpacts our business or operating results.16Table of ContentsWe 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.We 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.The uncertainty surrounding the terms of the United Kingdom's withdrawal from the European Union and its consequences could cause disruptions andcreate uncertainty to our businesses and adversely impact consumer and investor confidence in our products and services.In June 2016, a majority of voters in the United Kingdom elected to withdraw from the European Union in a national referendum (also referred to as"Brexit"). The referendum was advisory, and by the terms of the Treaty on European Union, any withdrawal is subject to a negotiation period that could lastat least two years after the government of the United Kingdom formally initiates the withdrawal process. The ultimate effects of Brexit on us are difficult topredict, but because we currently conduct business in the United Kingdom and in Europe, the results of the referendum and any eventual withdrawal couldcause disruptions and create uncertainty to our businesses, including affecting the business of and/or our relationships with our customers and suppliers, aswell as altering the relationship among tariffs and currencies, including the value of the British pound and the Euro relative to the U.S. dollar. Suchdisruptions and uncertainties could adversely affect our financial condition, operating results, and cash flows. Additionally, Brexit could result in legaluncertainty and potentially divergent national laws and regulations as new legal relationships between the United Kingdom and the European Union areestablished. The ultimate17Table of Contentseffects of Brexit on us will also depend on the terms of any agreements the United Kingdom and the European Union make to retain access to each other'srespective markets either during a transitional period or more permanently. Any of these effects, among others, could materially adversely affect our business,business opportunities, results of operations, and financial condition.Uncertainty in the global geopolitical landscape from recent events may impede the implementation of our strategy outside the United States.There may be uncertainty as to the position the United States will take with respect to world affairs and events following the 2016U.S. presidential election and related change in political agenda, coupled with the transition of administrations. This uncertainty may include such issues asU.S. support for existing treaty and trade relationships with other countries. This uncertainty, together with other key global events during 2016 (such as thecontinuing uncertainty arising from the Brexit referendum in the United Kingdom as well as ongoing terrorist activity), may adversely impact (i) the abilityor willingness of non-U.S. companies to transact business in the United States, including with the Company (ii) regulation and trade agreements affectingU.S. companies, (iii) global stock markets (including the New York Stock Exchange on which our common stock is traded), and (iv) general global economicconditions. All of these factors are outside of our control, but may nonetheless cause us to adjust our strategy in order to compete effectively in globalmarkets.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 may 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, Literacy and Enterprise & Education Language 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 will18Table of Contentsrequire modification and refinement as our business needs change, which could prolong difficulties we experience with systems transitions, and we may notalways employ the most effective systems for our purposes. If we experience difficulties in implementing new or upgraded information systems or experiencesignificant system failures, or if we are unable to successfully modify our management information systems or respond to changes in our business needs, wemay not be able to effectively manage our business and we may fail to meet our reporting obligations. In addition, as a result of the automation of thesemanual processes, the data produced may cause us to question the accuracy of previously reported financial results.Failure 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 other restrictive covenants and the failure to maintain a sufficient borrowing base or tocomply with such covenants could prevent us from borrowing funds, and could cause any outstanding debt to become immediately payable, which mightadversely impact our 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 economic difficulties continue, our revenue, profitability and cash flows could be significantly reduced. A liquidity shortfall may delaycertain development initiatives or may expose us to a need to negotiate further funding. While we anticipate that 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 atleast the next 12 months, we may need to raise additional capital to fund operations in the future or to finance acquisitions. If we seek to raise additionalcapital in order to meet various objectives, including developing future technologies and services, increasing working capital, acquiring businesses andresponding to competitive pressures, capital may not be available on favorable terms or may not be available at all. A lack of sufficient capital resourcescould significantly limit our ability to take advantage of business and strategic opportunities. Any additional capital raised through the sale of equitysecurities would dilute our stock ownership. If adequate19Table of Contentsadditional funds are not available, we may be required to delay, reduce the scope of, or eliminate material parts of our business strategy, including potentialadditional acquisitions or development of new products, services and technologies.We 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 non-cash 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. We may be required to record significant charges to earnings in ourfinancial statements during the period in which any impairment of our goodwill or indefinite lived intangible assets is determined, resulting in a negativeeffect 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. The application of indirect taxes (such as sales and use tax, value-added tax, goods and services tax, business tax and gross receipt tax) to our businesses and to our users is complex, uncertain and evolving, in part becausemany of the fundamental statutes and regulations that impose indirect taxes were established before the adoption and growth of the Internet and e-commerce. We are subject to audit by multiple tax authorities throughout the world. Although we believe our tax estimates are reasonable and accurate, the finaldetermination of tax audits and any related litigation could be materially different from our historical tax provisions and accruals. The results of an audit orlitigation could have a material adverse effect on our financial statements in the period or periods for which that determination is made. In addition, the United States government and other governments are considering and may adopt tax reform measures that could impact future effectivetax rates favorably or unfavorably affected by changes in tax rates, changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws ortheir interpretation. Such changes could have a material adverse impact on our financial results. Further, any changes to the U.S. or any foreign jurisdictions’tax laws, tax rates, or the interpretation of such tax laws, including the Base Erosion Profit Shifting project being conducted by the Organization forEconomic Co-operation and Development could significantly impact how U.S. multinational corporations are taxed. Although we cannot predict whether orin what form any legislation changes 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.We record tax valuation allowances to reflect uncertainties about whether we will be able to realize some of our deferred tax assets before they expire.Our tax valuation allowance is based on our estimates of taxable income for the jurisdictions in which we operate and the period over which our deferred taxassets will be realizable. In the future, we could be required to increase the valuation allowance to take into account additional deferred tax assets that wemay be unable to realize. An increase in the valuation allowance would have an adverse impact, which could be material, on our income tax provision andnet 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.20Table of ContentsIn 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 not provide us with proprietary protection or competitive advantages, and, as with any technology, competitors may be able todevelop similar or superior technologies now or in the future. In addition, we have not emphasized patents as a source of significant competitive advantageand have instead sought to primarily protect our proprietary rights under laws affording protection for trade secrets, copyright and trademark protection of ourproducts, brands, and other intellectual property where available and appropriate. These measures afford only limited protection and may be challenged,invalidated or circumvented by third parties. In addition, these protections may not be adequate to prevent our competitors or customers from copying orreverse-engineering our products. Third parties could copy all or portions of our products or otherwise obtain, use, distribute and sell our proprietaryinformation without authorization. Third parties may also develop similar or superior technology independently by designing around our intellectualproperty, which would decrease demand for our products. In addition, our patents may not provide us with any competitive advantages and the patents ofothers may seriously 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 drive potential online customersaway from our websites to competing and unauthorized websites, which could harm our reputation and cause us to lose sales.21Table of ContentsOur 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, Lexia Learning, Lexia, Fit Brains and Catalyst 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 possible that our competitors will adopt trademarks similar to ours, thus impeding our ability to build brand identity and possiblyleading to customer confusion. In fact, various third parties have registered trademarks that are similar to ours in the U.S. and overseas. Furthermore,notwithstanding the fact that we may have secured trademark rights for our various trademarks in the U.S. and in some countries where we do business, inother countries we may not have secured similar rights and, in those countries there may be third parties who have prior use and prior or superior rights to ourown. That prior use, prior or superior right could limit use of our trademarks and we could be challenged in our efforts to use our trademarks. We could incursubstantial costs in prosecuting or defending trademark infringement suits. If we fail to effectively enforce our trademark rights, our competitive position andbrand recognition may 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 adversely affect our business. Third parties also mayacquire country-specific domain names in the form of Country Code TLDs that include our trademarks or similar terms and which prevent us from operatingcountry-specific websites from which customers can view our products and engage in transactions with us. Moreover, the regulation of domain names in theU.S. and foreign countries is subject to change. Governing bodies could appoint additional domain name registrars, modify the requirements for holdingdomain names or release additional TLDs. As a result, we may have to incur additional costs to maintain control over potentially relevant domain names ormay not maintain exclusive rights to all potentially relevant domain names in the U.S. 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 our strong brands, and failing to maintain or enhance the Rosetta Stone brands in a cost-effective manner could harm ouroperating results.Maintaining and enhancing our brands is an important aspect of our efforts to attract new customers and expand our business. We believe thatmaintaining and enhancing our brands will depend largely on our ability to provide high-quality, innovative products, and services, which we might not dosuccessfully. Our brands may be negatively impacted by a number of factors such as service outages, product malfunctions, data protection and securityissues, and exploitation 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 development22Table of Contentsis inherently uncertain in a rapidly evolving technological environment in which there may be numerous patent applications pending, many of which areconfidential 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 to time we may be required to renegotiate with these third parties ornegotiate with new third parties to include their technology or content in our existing products, in new versions of our existing products or in wholly newproducts. We may not be able to negotiate or renegotiate licenses on commercially reasonable terms, or at all, and the third-party software may not beappropriately supported, maintained or enhanced by the licensors. If we are unable to obtain the rights necessary to use or continue to use third-partytechnology or content in our products and services, this could harm our business, by resulting in increased costs, or in delays or reductions in productshipments 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.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.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.23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. PropertiesAs of December 31, 2016, our corporate headquarters are located in Arlington, Virginia, where we occupy approximately 13,000 square feet of space onthe top floor of an office building under a lease that ends January 31, 2020. For more information about our Arlington, Virginia lease and subleases, pleasesee Note 16 of Item 8, Financial Statements and Supplementary Data. We currently own one facility in Harrisonburg, Virginia, that provides operations andcustomer support services. We lease another facility in Virginia for use as a packing and distribution center for all of our U.S. and some of our internationalfulfillment.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. We utilize international locations in or near cities including the following: London,United Kingdom; Vancouver, Canada; and Cologne, Germany. Our offices and facilities are used across multiple segments. We believe our offices andfacilities are adequate for our current needs.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.24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, 2017 when the last reported sales price of our common stock on the NYSE was $7.69 per share. The following table setsforth, for each of the periods indicated, the high and low reported sales price of our common stock on the NYSE. High LowYear ended December 31, 2016 Fourth Quarter $9.20 $6.80Third Quarter 9.22 7.44Second Quarter 8.46 6.68First Quarter 8.60 6.17Year ended December 31, 2015 Fourth Quarter $8.22 $6.31Third Quarter 8.50 6.40Second Quarter 9.19 6.39First Quarter 10.37 7.16DividendsWe 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 SecuritiesOur revolving credit facility contains financial and restrictive covenants that, among other restrictions and subject to certain limitations, limit ourability to repurchase our shares.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 31,2011 through December 31, 2016, 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, 2011 in our common stock and in each of the foregoing indices and assumes reinvestment of dividends, if any.25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, 2016, 2015, 2014, 2013 and 2012, and the selected consolidatedbalance sheet data as of December 31, 2016, 2015, 2014, 2013 and 2012 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.26Table of Contents Year Ended December 31, 2016(1) 2015(2) 2014(3) 2013(4) 2012(5) (in thousands, except per share data)Selected Statements of Operations Data: Revenue $194,089 $217,670 $261,853 $264,645 $273,241Gross profit 159,768 179,143 208,799 218,931 224,331Loss from operations (26,920) (43,813) (78,850) (18,442) (5,266)Net loss (27,550) (46,796) (73,706) (16,134) (33,985) Loss per share attributable to common stockholders: Basic $(1.25) $(2.17) $(3.47) $(0.75) $(1.61)Diluted $(1.25) $(2.17) $(3.47) $(0.75) $(1.61) Other Selected Data: Total stock-based compensation expense $4,906 $7,195 $6,762 $9,241 $8,009Total intangible amortization expense $4,351 $5,192 $6,263 $1,822 $40_______________________________________________________________________________(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 2016 to exit the direct sales presence in almost all of its non-U.S. and non-northern European geographies related to thedistribution of its Enterprise & Education Language offerings. Under this initiative, the Company made headcount reductions, office leaseterminations, and other cost reductions in France, China, Brazil, Canada, Spain, Mexico, U.S. and the U.K.(2)As discussed in Notes 1 and 13 of Item 8, Financial Statements and Supplementary Data, the Company undertook restructuring actions in the firstquarter of 2015 to focus on the Enterprise & Education business and optimize the Consumer business for profitability. Under this initiative, theCompany undertook headcount and cost reductions to areas including Consumer sales and marketing, Consumer product investment, and generaland administrative functions.(3)The Company acquired Vivity Labs, Inc. on January 2, 2014 and Tell Me More S.A. on January 9, 2014. The results of operations from these entitieshave been included from the acquisition date.(4)The Company acquired Livemocha, Inc. on April 1, 2013 and acquired Lexia Learning Systems, Inc. on August 1, 2013. The results of operationsfrom these entities have been included from the acquisition date.(5)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. As of December 31, 2016 2015 2014 2013 2012 (in thousands)Selected Consolidated Balance Sheet Data: Cash and cash equivalents $36,195 $47,782 $64,657 $98,825 $148,190Total assets 194,310 228,543 288,173 290,776 279,405Total deferred revenue 141,457 142,748 128,169 78,857 63,416Notes payable and capital lease obligation 2,559 3,143 3,748 242 5Total stockholders' (deficit) equity (1,659) 22,410 63,445 131,243 148,194Item 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 Reform 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-looking27Table of Contentsstatements as a result of a number of factors, including those discussed under ("Risk Factors") and elsewhere in this Annual Report on Form 10-K.OverviewRosetta Stone is dedicated to changing people's lives through the power of language and literacy education. Our innovative digital solutions drivepositive learning outcomes for the inspired learner at home or in schools and workplaces around the world. Founded in 1992, Rosetta Stone's languagedivision uses cloud-based solutions to help all types of learners read, write, and speak more than 30 languages. Lexia Learning, Rosetta Stone's literacyeducation division, was founded more than 30 years ago and is a leader in the literacy education space. Today, Lexia helps students build fundamentalreading skills through its rigorously researched, independently evaluated, and widely respected instruction and assessment programs. Rosetta Stone Inc. wasincorporated in Delaware in 2005.The Enterprise & Education Language segment derives revenue from sales to educational institutions, corporations, and government agenciesworldwide. The Literacy segment derives revenue from the sales of literacy solutions to educational institutions serving grades K through 12. The Consumersegment derives revenue from sales to individuals and retail partners. Our Enterprise & Education Language distribution model is focused on targeted salesactivity 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 Literacy distribution channel utilizes a direct sales force as well as relationships with third-party resellers focused on the sale ofLexia Learning solutions to K-12 schools. Our Consumer distribution channel comprises a mix of our call centers, websites, app-stores, third party e-commerce websites, select retail resellers, such as Amazon.com, Barnes & Noble, Target, Best Buy, Books-a-Million, Sam's Club, Staples, consignmentdistributors such as Wynit Distribution and Software Packaging Associates, and daily deal partners.As our Company has evolved, we believe that our Enterprise & Education Language and Literacy segments are our largest opportunities for long-termvalue creation. The customers in these markets have needs that recur each year, creating a more predictable sales opportunity. This need profile also fits wellwith our suite of language and literacy products and the well-known Rosetta Stone brand. We also believe the demand is growing for e-learning basedliteracy solutions in the U.S. and English language-learning around the globe.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, our focus is on the following priorities:1.Grow literacy sales and market share by providing fully aligned digital instruction and assessment tools for K-12, building a direct distribution salesforce to augment our historical reseller model, and continuing to develop our implementation services business;2.Position our Enterprise & Education Language business for profitable growth by focusing our direct sales on our best geographies and customersegments, partnering with resellers in other geographies and successfully delivering our Catalyst product to Corporate customers. Catalyst integratesour Foundations, Advantage, and Advanced English for Business products with enhanced reporting, assessment, and administrator tools that offers asimple, more modern, metrics-driven suite of tools that are 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;4.Seek opportunities to leverage our language assets including our content, tools and pedagogy, as well as our well-known Rosetta Stone brand,through partnerships with leading players in key markets around the world, and5.Continue to identify opportunities to become more efficient.In pursuing these priorities, we will (i) allocate capital to the areas of our business that we believe have the greatest value creation potential, includingour Lexia literacy business, (ii) focus our businesses on their best customers, including K-12 learners primarily in North America, Corporate learners primarilyin North America and Northern Europe in our Enterprise & Education Language segment, and passionate learners in the U.S. and select non-U.S. markets inour Consumer language business, and (iii) optimize the sales and marketing costs for these businesses and the costs of our business overall.28Table of ContentsIn March 2016, we announced the 2016 Restructuring Plan ("2016 Restructuring Plan"), outlining our withdrawal of the direct sales presence in almostall of our non-U.S. and non-northern European geographies related to the distribution of the Enterprise & Education Language offerings. These operationsadded sales, but at too high a cost and without the near-term ability to capture scale efficiencies. Where appropriate, we will seek to operate through partnersin the geographies being exited. We have also initiated processes to close our software development operations in France and China. These actions were inaddition to the 2015 Restructuring Plan to accelerate and prioritize our focus on satisfying the needs of the more passionate learners in the Unites States andselect non-U.S. geographies in the Consumer language segment. In March 2015, we initiated a plan (the "2015 Restructuring Plan") to make reductions toConsumer sales and marketing, Consumer product investment, and general and administrative costs. See Note 2 and Note 13 of Item 8, Financial Statementsand Supplementary Data for additional information about these strategic undertakings.In conjunction with the 2016 and 2015 Restructuring Plans, outside financial and legal advisors have been retained to assist management and theBoard of Directors with their ongoing comprehensive review to analyze potential options to improve financial performance and enhance shareholder value.In March 2016, we announced our strategy to position the organization for success and we have prioritized the growth of literacy sales and have begunto take actions to align resources to drive this growth. As a result of this shift, we reevaluated our segment structure. Prior to the strategy shift, we weremanaged in two operating segments (Enterprise & Education and Consumer). Following the shift, we are managed in three operating segments (Enterprise &Education Language, Literacy, and Consumer). We discuss the profitability of each segment in terms of segment contribution. Segment contribution is themeasure of profitability used by our Chief Operating Decision Maker. Segment contribution includes segment revenue and expenses incurred directly by thesegment, including material costs, service costs, customer care and coaching costs, sales and marketing expense and bad debt expense. Prior periods havebeen reclassified to reflect our current segment presentation and definition of segment contribution.For the year ended December 31, 2016, Enterprise & Education Language segment contribution increased to $28.3 million with a segment contributionmargin of 39%, compared to $21.3 million with a segment contribution margin of 28% for the year ended December 31, 2015. The dollar and marginincreases were primarily due to the cost reduction initiatives in early 2016 as compared to the prior year. Literacy segment contribution increased to $5.6million with segment contribution margin of 17% for the year ended December 31, 2016 as compared to a segment contribution of $0.7 million and asegment contribution margin of 3% for the year ended December 31, 2015. The dollar and margin increases were primarily due to the larger revenue base onwhich segment contribution is calculated, offset by an increase in sales and marketing expense due to the transition to a direct sales team and supportinfrastructure. The margin improvement partially related to the effect of purchase accounting that will diminish over time. Consumer segment contributiondecreased to $21.1 million with a contribution margin of 24% for the year ended December 31, 2016, from $30.0 million with a contribution margin of 25%for the year ended December 31, 2015. The dollar and margin decreases were primarily due to a decrease in Consumer revenue of $31.7 million.For the year ended December 31, 2015, Enterprise & Education Language segment contribution increased to $21.3 million with a segment contributionmargin of 28%, compared to $16.9 million with a segment contribution margin of 23% for the year ended December 31, 2014. The dollar and marginincreases were primarily due to the increase in Enterprise & Education revenue which was slightly offset by an increase in direct sales related expenses.Literacy segment contribution increased to $0.7 million with segment contribution margin of 3% for the year ended December 31, 2015, as compared to asegment contribution loss of $3.0 million and a segment contribution margin of negative 30% for the year ended December 31, 2014. The dollar and marginincreases were primarily due to the impacts of purchase accounting. Consumer segment contribution increased to $30.0 million with a contribution margin of25% for the year ended December 31, 2015, from $28.0 million with a contribution margin of 16% for the year ended December 31, 2014. The dollar andmargin increases in Consumer segment contribution was primarily due to cost reduction initiatives.Over the last few years, our Consumer strategy has been to shift more and more of our Consumer business to online subscriptions (with access across theweb and apps) and away from perpetual digital download and CD packages. We believe that these online subscription formats provide customers with anoverall better experience, flexibility to use our products on multiple platforms (tablets, smartphones and computers), and provide a more economical andrelevant way for us to deliver our products to customers. One challenge to encouraging customers to enter into or renew a subscription arrangement is thatusage of our product varies greatly, ranging from customers that purchase but do not have any usage to customers with high usage. The majority of purchaserstend 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 gymmembership. We expect the trend in Consumer subscription sales to accelerate through the end of 2017 as customer preferences continue to move towardscross-platform experiences. Our goal is to move almost entirely all of our Consumer business to subscription sales by the end of 2017.29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 and literacy solutions. Revenue is presented as subscription and service revenue or product revenuein our consolidated financial statements. Subscription and service revenue consists of sales from web-based software subscriptions, online services,professional services, and certain mobile applications. Our online services are typically sold in short-term service periods and include dedicated onlineconversational coaching services and access to online communities of language learners. Our professional services include training and implementationservices. Product revenue primarily consists of revenue from our perpetual language-learning product software, our audio practice products, and certainmobile applications. Our audio practice products are often combined with our language-learning software and sold as a solution.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 $39 in revenue per unit is derived from these short-term online services. As a result, we typically defer 10% to35% 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 software and ourweb-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 sales force as well as through our network of resellers and organizations who typically gain accessto our solutions under a web-based subscription service. We distribute our Consumer products predominantly through our direct sales channels, primarilyutilizing our websites and call centers, which we refer to as our direct-to-consumer channel. We also distribute our Consumer products through select third-party retailers and distributors. For purposes of explaining variances in our revenue, we separately discuss changes in our Enterprise & Education Language,Literacy, and our Consumer segments because the customers and revenue drivers of these channels are different.Within our Enterprise & Education Language segment, sales in our education, government, and corporate sales channels are seasonally stronger in thesecond half of the calendar year due to purchasing and budgeting cycles. Literacy segment sales are seasonally stronger in the third quarter of the calendaryear corresponding to school district budget years. Consumer sales are affected by seasonal trends associated with the holiday shopping season. We expectthese trends to continue.Cost of Subscription and Service Revenue and Cost of Product RevenueCost of subscription and service revenue primarily represents costs associated with supporting our web-based subscription services and onlinelanguage-learning services, which includes online language conversation coaching, hosting costs, and depreciation. We also include the cost of credit cardprocessing and customer technical support in both cost of subscription and service revenue and cost of product revenue. Cost of product revenue consists ofthe direct and indirect materials and labor costs to produce and distribute our products. Such costs include packaging materials, computer headsets, freight,inventory receiving, personnel costs associated with product assembly, third-party royalty fees and inventory storage, obsolescence and shrinkage.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, and30Table of Contentscommissions earned by our sales personnel. Sales commissions are generally paid at the time the customer is invoiced. However, sales commissions aredeferred and recognized as expense in proportion to when the related revenue is recognized.Research 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, as well as new paid and complementary products and services to our language-learning and literacysolutions.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 acquisitions and other corporate expenses.Impairment. Impairment expenses consist primarily of goodwill impairment, impairment of long-lived assets, and impairment expense related to theabandonment of previously capitalized internal-use software projects.Lease Abandonment and Termination. Lease abandonment and termination expenses include the recognition of costs associated with the terminationor abandonment 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 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. See Note 2 of Item 8, Financial Statementsand Supplementary Data for a complete description of our significant accounting policies.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,31Table of Contentsmobile applications, and professional services. Revenue is recognized when all of the following criteria are met: there is persuasive evidence of anarrangement; the product has been delivered or services have been rendered; the fee is fixed or determinable; and collectability is reasonably assured.Revenue is recorded net of discounts and net of taxes.We 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 portion of Consumer revenue from theCD and digital download formats of the Rosetta Stone language-learning product which are typically multiple-element arrangements that contain twodeliverables: perpetual software, delivered at the time of sale, and online service, which is considered an undelivered software-related element. The onlineservice includes access to conversational coaching services. Because we only sell the perpetual language-learning software on a stand-alone basis in ourhomeschool version, we do not have a sufficient concentration of stand-alone sales to establish VSOE for the perpetual product. Where VSOE of theundelivered online services can be established, arrangement consideration is allocated using the residual method. We determine VSOE by reference to therange of comparable stand-alone renewal sales of the online service. We review these stand-alone sales on a quarterly basis. VSOE is established if at least80% of the stand-alone sales are within a range of plus or minus 15% of a midpoint of the range of prices, consistent with generally accepted industrypractice. Where VSOE of the undelivered online services cannot be established, revenue is deferred and recognized commensurate with the delivery of theonline 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 Language and Literacy customers, and to a lesser extent to our Consumercustomers. These arrangements can include web-based subscription services, audio practice products and professional services or any combination thereof.We do not have a sufficient concentration of stand-alone sales of the various deliverables noted above to our customers, and therefore cannot establish VSOEfor each deliverable. Third party evidence of fair value does not exist for the web-based subscription, audio practice products and professional services due tothe lack of interchangeable language-learning products and services within the market. Accordingly, we determine the relative selling price of the web-basedsubscription, audio practice products and professional services deliverables included in our non-software multiple element arrangements using our bestestimate of selling price. We determine our best estimate of selling price based on our 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 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 packaged product returns at the time of sale based on historical return rates, estimated channel inventory levels, the timingof new product introductions, 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 for web-based subscriptions and online services is recognized ratably over the term of the subscription or service period, assuming all revenuerecognition criteria have been met. Our CD and digital download formats of Rosetta Stone language-learning products are typically bundled with an onlineservice where customers are allowed to begin their online services at any point during a registration window, which is typically up to six months from thedate of purchase from us or an authorized reseller. The online services that are not activated during this registration window are forfeited and revenue isrecognized upon expiry. Revenue from non-refundable upfront fees that are not related to products already delivered or services already performed is deferredand recognized ratably 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 are sold 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 passes32Table of Contentsand 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 certainother sales, we defer revenue until the customer receives the product because we legally retain a portion of the risk of loss on these sales during transit. Inother cases where packaged software products are sold to resellers on a consignment basis, revenue is recognized for these consignment transactions once theend user sale has occurred, assuming the remaining revenue recognition criteria have been met. Cash sales incentives to resellers are accounted for as areduction of revenue, unless a specific identifiable benefit is identified and the fair value is reasonably determinable. Price protection for changes in themanufacturer suggested retail value granted to resellers for the inventory that they have on hand at the date the price protection is offered is recorded as areduction 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 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 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.Stock-Based CompensationAll stock-based awards, including employee stock option grants, are recorded at fair value as of the grant date. For options granted with service and/orperformance conditions, the fair value of each grant is estimated on the date of grant using the Black-Scholes option pricing model. For options granted withmarket-based conditions, the fair value of each grant is estimated on the date of grant using the Monte-Carlo simulation model. Determining the fair value atthe grant date requires the use of estimates, including expected term, future stock price volatility, forfeiture rates, and risk-free interest rate.As we do not have sufficient historical option exercise experience that spans the full 10 year contractual term for determining the expected term ofoptions granted, we estimate the expected term of options using a combination of historical information and the simplified method. We use our ownhistorical stock price data to estimate a forfeiture rate and expected volatility over the most recent period commensurate with the estimated expected term ofthe awards. For the risk free interest rate, we use a U.S. Treasury Bond rate consistent with the estimated expected term of the option award.Stock-based compensation expense associated with service-based equity awards is recognized in the statement of operations on a straight-line basisover the requisite service period, which is the vesting period. For equity awards granted with performance-based conditions, stock compensation expense isrecognized in the statement of operations ratably for each vesting tranche based on the probability that operating performance conditions will be met and towhat extent. For equity awards granted with market-based conditions, stock compensation expense is recognized in the statement of operations ratably foreach vesting tranche regardless of meeting or not meeting the market conditions. Stock compensation expense is recognized based on the estimated portionof the awards that are expected to vest. Estimated forfeiture rates were applied in the expense calculation.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, 2016, our reporting units are: Enterprise & Education Language, Literacy, Consumer Language, and Consumer Fit Brains. Each ofthese businesses is considered a reporting unit for goodwill impairment testing purposes. Consumer Language and Consumer Fit Brains are components ofthe Consumer operating segment.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 its33Table of Contentscarrying amount. If the carrying value exceeds the fair value, we measure the amount of impairment loss in "Step 2", if any, by comparing the implied fairvalue 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.Consistent with our election in prior annual tests, we exercised our option to bypass Step 0 for all reporting units with remaining goodwill balances inconnection with the annual goodwill impairment analysis performed as of June 30, 2016. The Enterprise & Education Language and Literacy reporting unittests both resulted in fair values that substantially exceeded the carrying values, and therefore no goodwill impairment charges were recorded in connectionwith the annual analysis for these reporting units.The Consumer Fit Brains reporting unit was also evaluated, which resulted in a fair value that was significantly below the carrying value. The decreasein fair value was due to the second quarter 2016 strategy update for the Consumer Fit Brains business. The Consumer Fit Brains reporting unit was no longerconsidered central to our core strategy to focus on language and literacy learning. Due to the continued declines in operations since the $5.6 million partialimpairment in the fourth quarter of 2015, we revised the Consumer Fit Brains financial projections in the second quarter of 2016 assuming reduced mediaspend and reduced revenue in 2016 and beyond. The change in operating plans and the lack of cushion since the fourth quarter 2015 impairment resulted inan implied fair value of goodwill that was significantly below its carrying value. As a result, we recorded a second quarter impairment loss of $1.7 million,which represented a full impairment of the remaining Consumer Fit Brains reporting unit's goodwill. The impairment charge was recorded in the "Impairment"line on the statement of operations.We routinely review goodwill at the reporting unit level for potential impairment as part of our internal control framework. As of December 31, 2016,the Enterprise & Education Language and Literacy reporting units are the only reporting units with remaining goodwill balances. In the fourth quarter of2016, we evaluated these reporting units to determine if a triggering event has occurred. As of December 31, 2016, the Company concluded that there wereno indicators of impairment that would cause us to believe that it is more likely than not that the fair value of any such reporting units is less than thecarrying value. Accordingly, a detailed impairment test has not been performed and no goodwill impairment charges were recorded in connection with theinterim impairment reviews of any such reporting units.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 second quarter of 2016, we revised the business outlook and financial projections for the Consumer Fit Brains reporting unit, whichprompted a long-lived intangible asset impairment analysis of the Consumer Fit Brains tradename, developed technology, and customer relationships. Thecarrying values of the intangible assets exceeded the estimated fair values. As a result, we recorded an impairment loss of $1.2 million associated with theimpairment of the remaining carrying value of the Consumer Fit Brains long-lived intangible assets as of June 30, 2016. The impairment charge was recordedin the "Impairment" line on the statement of operations.During the fourth quarter of 2016, 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 exceeded the carrying value. There has been no impairment of intangible assetsduring the years ending December 31, 2015 and 2014.34Table of ContentsValuation 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 2016, 2015, and 2014, we recorded $1.0million, $1.1 million, and $0.2 million in impairment expense related to the abandonment of software projects that were previously capitalized.Restructuring CostsAs part of the 2016 and 2015 Restructuring Plans, we announced and initiated actions to reduce headcount and other costs in order to support ourstrategic shift in business focus. In connection with these plans, we incurred restructuring related costs, including employee severance and related benefitcosts, contract termination costs, and other related costs. These costs are included within Cost of Sales and our Sales and marketing, Research anddevelopment, and General and administrative operating expense categories in our consolidated statements of operations.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 and costs to terminate operating leases. Contract terminationcosts are recognized at fair value in the period 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. Such costs are recognizedat 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; and35Table of Contents•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, 2016, a full valuation allowance exists for the U.S., Japan, China, Hong Kong, Mexico, Spain, Brazil, Canada, and France where wehave determined 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, 2016. 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, 2016 and 2015, our net deferred tax liability was $6.2 million and $5.0 million, respectively.Going Concern AssessmentThe consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction ofliabilities in the normal course of business. Management has evaluated whether relevant conditions or events, considered in the aggregate, indicate that thereis substantial doubt about the Company's ability to continue as a going concern. Substantial doubt exists when conditions and events, considered in theaggregate, indicate it is probable that the Company will be unable to meet its obligations as they become due within one year after the financial statementissuance date. The assessment is based on the relevant conditions that are known or reasonable knowable as of March 14, 2017. The assessment of our ability to meet our future obligations is inherently judgmental, subjective and susceptible to change. The inputs that weconsidered important in a going concern analysis, include, but are not limited to, our 2017 cash flow forecast, 2017 operating budget, and long-term plan thatextends beyond 2017. These inputs consider information including, but not limited to, our financial condition, liquidity sources, obligations due within oneyear after the financial statement issuance date, funds necessary to maintain operations, and financial conditions, including negative financial trends or otherindicators of possible financial difficulty.We have considered both quantitative and qualitative factors as part of the assessment that are known or reasonably knowable as of March 14, 2017,and concluded that conditions and events considered in the aggregate, do not indicate that it is probable that we will be unable to meet obligations as theybecome due through the one year period following the financial statement issuance date.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.36Table of ContentsResults of OperationsThe following table sets forth our consolidated statement of operations for the periods indicated. Year Ended December 31, 2016 2015 2014 (in thousands, except per share data)Statements of Operations Data: Revenue: Subscription and service $154,336 $151,701 $125,602Product 39,753 65,969 136,251Total revenue 194,089 217,670 261,853Cost of revenue: Cost of subscription and service revenue 23,676 21,629 18,862Cost of product revenue 10,645 16,898 34,192Total cost of revenue 34,321 38,527 53,054Gross profit 159,768 179,143 208,799Operating expenses Sales and marketing 114,340 136,084 173,208Research and development 26,273 29,939 33,176General and administrative 40,501 50,124 57,120Impairment 3,930 6,754 20,333Lease abandonment and termination 1,644 55 3,812Total operating expenses 186,688 222,956 287,649Loss from operations (26,920) (43,813) (78,850)Other income and (expense): Interest income 46 23 17Interest expense (470) (378) (233)Other income and (expense) 2,297 (1,469) (1,129)Total other income and (expense) 1,873 (1,824) (1,345)Loss before income taxes (25,047) (45,637) (80,195)Income tax expense (benefit) 2,503 1,159 (6,489)Net loss $(27,550) $(46,796) $(73,706)Loss per share: Basic $(1.25) $(2.17) (3.47)Diluted $(1.25) $(2.17) $(3.47)Common shares and equivalents outstanding: Basic weighted average shares 21,969 21,571 21,253Diluted weighted average shares 21,969 21,571 21,253Stock-based compensation included in: Cost of revenue 48 101 108Sales and marketing 998 1,327 1,975Research and development 709 841 958General and administrative 3,151 4,926 3,721Total stock-based compensation expense $4,906 $7,195 $6,76237Table of ContentsComparison of the Year Ended December 31, 2016 and the Year Ended December 31, 2015Our total revenue decreased to $194.1 million for the year ended December 31, 2016 from $217.7 million for the year ended December 31, 2015. Thechange in total revenue was primarily due to a decrease in Consumer revenue of $31.7 million and a slight decrease in Enterprise & Education Languagerevenue of $4.0 million, which were partially offset by an increase in Literacy revenue of $12.2 million.We reported an operating loss of $26.9 million for the year ended December 31, 2016 compared to an operating loss of $43.8 million for the year endedDecember 31, 2015. Operating expense decreased $36.3 million, comprised of decreases of $21.7 million in sales and marketing expenses, $9.6 million ingeneral and administrative expenses, $3.7 million in research and development expenses, and $2.8 million in impairment expenses. The decrease in generaland administrative expenses and sales and marketing expenses reflects the continued savings as a result of the 2016 Restructuring Plan and other ongoingexpense reduction actions. The $36.3 million reduction in operating expenses were partially offset by a decrease in gross profit of $19.4 million, driven by adecrease of $4.2 million in cost of revenue, which was offset by a $23.6 million decrease in revenue, and a slight increase of $1.6 million in leaseabandonment and termination expenses associated with the space consolidation and move to our new headquarters.Revenue by Operating SegmentThe following table sets forth revenue for our three operating segments for the years ended December 31, 2016 and 2015: Year ended December 31, 2016 versus 2015 2016 2015 Change % Change (in thousands, except percentages)Enterprise & Education Language $72,083 37.1% $76,129 35.0% $(4,046) (5.3)%Literacy 34,123 17.6% 21,928 10.0% $12,195 55.6 %Consumer 87,883 45.3% 119,613 55.0% $(31,730) (26.5)%Total Revenue $194,089 100.0% $217,670 100.0% $(23,581) (10.8)%Enterprise & Education Language SegmentTotal Enterprise & Education Language revenue decreased $4.0 million, or 5%, from $76.1 million for the year ended December 31, 2015 to $72.1million for the year ended December 31, 2016. The decrease in Enterprise & Education Language revenue reflects a decrease of $5.3 million in the corporatechannel, which was partially offset by increases of $0.7 million and $0.5 million in our non-profit and education sales channels, respectively. We expectrevenue associated with the Enterprise & Education Language segment will slightly decline in the near term, due to the execution of our strategy to exit ourdirect presence in unprofitable geographies and manage this business for profitable growth. Where appropriate, we will seek to operate in the geographies weexit through partners. Our goal is to offset this decline with growth in our retained channels. We expect to continue to balance investments and adjust ourcost structure to align scale without impacting growth.Literacy SegmentLiteracy revenue increased $12.2 million, or 56%, from $21.9 million for the year ended December 31, 2015 to $34.1 million for the year endedDecember 31, 2016, partially reflecting the impact of purchase accounting. Adjusting for the impact of purchase accounting on Literacy revenue, revenuewould have been $38.4 million for the year ended December 31, 2016 compared to $29.8 million for the year ended December 31, 2015, and the Literacypro-forma growth would have been 29% year-over-year. The revenue growth was due to increased market share associated with new literacy offerings, a largerrevenue capacity associated with the move from resellers to a direct sales team, and an increase in implementation services. We will continue to experiencethe purchase accounting impacts for the Literacy segment through 2017 due to the typical subscription length. As a result, we expect year-over-year revenuesto become more comparable as we move beyond the purchase accounting impact, which we expect to result in lower growth rates than what we experiencedduring 2016. We anticipate additional investments in the Literacy business to grow this segment.Consumer SegmentConsumer revenue decreased $31.7 million, or 27%, from the year ended December 31, 2015 to the year ended December 31, 2016. This decrease waslargely due to reductions in revenue from our direct-to-consumer, retail, and homeschool sales channels of $18.1 million, $11.6 million, and $2.4 million,respectively. These declines reflect the decision to significantly curtail promotional pricing under our shift in strategy. The reduction in the retail channelwas due in part to the planned reduction in the suggested retail value in the U.S. which impacted Consumer revenue by $3.6 million. The reduction in38Table of Contentshomeschool revenue was primarily due to the sale of the Korea entity in the third quarter of 2015. In connection with our recent shift in strategy, we continueto manage the Consumer business for a targeted bottom-line result which has resulted in a decline in scale which we expect to continue. Our Consumerbusiness is seasonal and typically peaks in the fourth quarter during the holiday shopping season.Revenue by Subscription and Service Revenue and Product RevenueWe categorize and report our revenue in two categories—subscription and service revenue and product revenue. Subscription and service revenueincludes web-based software subscriptions, online services, as well as revenues from professional services. Subscription and service revenues are typicallydeferred at the time of sale and then recognized ratably over the subscription or service period. Product revenue includes revenues allocated to our perpetuallanguage-learning product software, revenues from the sale of audio practice products, and sales of certain mobile applications. We bundle our perpetualproduct software typically with online services. As a result, we typically defer 10% to 35% of the revenue of each of these bundled sales. We recognize thedeferred revenue associated with the online services over the term of the service period.The following table sets forth revenue for subscription and service revenue and product revenue for the years ended December 31, 2016 and 2015: Year ended December 31, 2016 versus 2015 2016 2015 Change % Change (in thousands, except percentages)Subscription and service revenue $154,336 79.5% $151,701 69.7% $2,635 1.7 %Product revenue 39,753 20.5% 65,969 30.3% (26,216) (39.7)%Total revenue $194,089 100.0% $217,670 100.0% $(23,581) (10.8)%Subscription and Service RevenueSubscription and service revenue increased $2.6 million, or 2%, to $154.3 million for the year ended December 31, 2016. An increase in Literacysegment revenue, which entirely falls within the subscription and service revenue category, contributed $12.2 million of the $2.6 million increase, due in partto the write-down effects of purchase accounting on the pre-acquisition deferred revenue balances associated with the Lexia acquisition. Within theEnterprise & Education Language segment, the corporate sales channel decreased by $4.3 million, which was partially offset by an increase in the educationsales channel of $0.9 million. Consumer segment subscription and service revenue declined in the direct-to-consumer, homeschool, and retail channels of$4.3 million, $1.6 million, and $1.6 million, respectively, due to the Consumer decline in revenue associated with our recent shift in strategy to focus on thepassionate learner. In the Consumer segment, we have begun shifting sales from our box-based and perpetual download products to similarly priced long-term subscription products. However, it is important to note that these subscribers generally only stay for the duration of the subscription period, which couldnegatively impact our revenue in the future. We are testing shorter duration subscriptions which if we are successful in achieving an adequate level ofrenewals, allow pricing that has the potential to open up new customer demographics. If, over time, more of our Consumer products are sold through shorter-term subscriptions it would have the effect of spreading the receipt of cash from those sales over the initial sale period and any subsequent renewals. Our goalis to be almost entirely subscription-based by the end of 2017.Product RevenueProduct revenue decreased $26.2 million, or 40%, to $39.8 million during the year ended December 31, 2016 from $66.0 million during the year endedDecember 31, 2015. Product revenue primarily decreased $13.8 million and $10.1 million in our direct-to-consumer and retail sales channels, respectively,within the Consumer segment. The decrease in retail sales is due in part to the reduction in suggested retail value in the U.S. which negatively impactedproduct revenue by $3.6 million. Product revenue also decreased due to the ongoing transition of our sales model towards subscription sales rather thanperpetual license and box product sales, with an objective to be nearly all subscription-based by the end of 2017.Cost of Subscription and Service Revenue and Product Revenue and Gross ProfitThe following table sets forth cost of subscription and service revenue and product revenue, as well as gross profit for the years ended December 31,2016 and 2015:39Table of Contents Year ended December 31, 2016 versus 2015 2016 2015 Change % Change (in thousands, except percentages)Revenue: Subscription and service $154,336 $151,701 $2,635 1.7 %Product 39,753 65,969 (26,216) (39.7)%Total revenue 194,089 217,670 (23,581) (10.8)%Cost of revenue: Cost of subscription and service revenue 23,676 21,629 2,047 9.5 %Cost of product revenue 10,645 16,898 (6,253) (37.0)%Total cost of revenue 34,321 38,527 (4,206) (10.9)%Gross profit $159,768 $179,143 $(19,375) (10.8)%Gross profit percentages 82.3% 82.3% —% Total cost of revenue decreased $4.2 million for the year ended December 31, 2016 from $38.5 million for the year ended December 31, 2015. Thedecrease in total cost of revenue was primarily due to a decline in product revenue which also reflects the ongoing shift of the Consumer segment towardssubscriptions which resulted in decreases in inventory expense, freight and payment processing fees, and professional services. Inventory expense declined$2.7 million due to the decrease in box product sales. Freight and processing fees decreased $2.1 million due to the decrease in box product sales, which wasslightly offset by an increase in amortization of capitalized internal-use software costs.Cost of Subscription and Service RevenueCost of subscription and service revenue for the year ended December 31, 2016 was $23.7 million, an increase of $2.0 million, or 9% from the yearended December 31, 2015. As a percentage of subscription and service revenue, cost of subscription and service revenue increased slightly to 15% from 14%for the year ended December 31, 2016 compared to the prior year period. The dollar increase in cost of subscription and service revenue was primarily due toincreases in amortization of capitalized internal-use software costs and other allocable costs due to the shift in sales mix to subscription service sales.Cost of Product RevenueCost of product revenue for the year ended December 31, 2016 was $10.6 million, a decrease of $6.3 million or 37% compared to $16.9 million for theyear ended December 31, 2015. As a percentage of product revenue, cost of product revenue slightly increased to 27% for the year ended December 31, 2016from 26% as compared to the prior year period. The dollar decrease in cost of product revenue is primarily due to decreases of $1.8 million, $1.4 million,$0.8 million, and $0.6 million in inventory costs, payroll and benefits, freight costs, and payment processing fees respectively, due to the shift away fromhard product sales to online subscription sales.Gross ProfitGross profit decreased $19.4 million to $159.8 million for the year ended December 31, 2016 compared to $179.1 million for the year endedDecember 31, 2015. Gross profit percentage remained flat at 82% for both the years ended December 31, 2016 and December 31, 2015. The dollar decrease ingross profit was primarily due to the decrease in revenue.Operating Expenses Year ended December 31, 2016 versus 2015 2016 2015 Change % Change (in thousands, except percentages)Sales and marketing $114,340 $136,084 $(21,744) (16.0)%Research and development 26,273 29,939 (3,666) (12.2)%General and administrative 40,501 50,124 (9,623) (19.2)%Impairment 3,930 6,754 (2,824) (41.8)%Lease abandonment and termination 1,644 55 1,589 2,889.1 %Total operating expenses $186,688 $222,956 $(36,268) (16.3)%40Table of ContentsIn the first quarter of 2016, we announced and initiated actions to exit the direct sales presence in almost all of our non-U.S. and non-northern Europeangeographies related to the distribution of our Enterprise & Education Language offerings and to close our software development operations in France andChina. 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 2016 and 2015 Restructuring Plans 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.The following table presents restructuring costs associated with the 2016 and 2015 Restructuring Plans included in the related line items of our resultsfrom operations: Year ended December 31, 2016 2015 (in thousands)Cost of revenue $573 $113Sales and marketing 2,324 4,492Research and development 913 602General and administrative 1,383 3,584Total $5,193 $8,791While there were restructuring plans initiated in each of the years ended December 31, 2016 and 2015, the severance expenses in 2015 were greater thanthe severance expenses in 2016, primarily due to a larger number of headcount reductions in senior management in 2015.Sales and Marketing ExpensesSales and marketing expenses for the year ended December 31, 2016 were $114.3 million, a decrease of $21.7 million, or 16%, from the year endedDecember 31, 2015. As a percentage of total revenue, sales and marketing expenses decreased to 59% for the year ended December 31, 2016, from 63% forthe year ended December 31, 2015. The decrease in sales and marketing expense was primarily due to decreases in media and marketing spend, payroll andbenefits, and professional services. Media expenses decreased $8.0 million, comprised of a reduction of $4.1 million in online and social media and adecrease of $3.9 million in offline media. Marketing expenses decreased $1.8 million due to overall decreased spend in advertising and retail visual displaysdue to the change in focus in the general consumer market. Payroll and benefit expense decreased $6.4 million primarily due to the reduction in headcountwhich resulted in lower salary expense, severance expense, and stock compensation expense. Professional services expenses declined $3.5 million related toa $1.1 million contract termination fee associated with the 2015 Restructuring Plan and other reductions in the consumer market. We intend to continue tooptimize our Consumer media and marketing costs and manage the Consumer business for profitability and plan to manage the sales and marketing expensesto drive these results.Research and Development ExpensesResearch and development expenses were $26.3 million for the year ended December 31, 2016, a decrease of $3.7 million, or 12%, from the year endedDecember 31, 2015. As a percentage of revenue, research and development expenses remained flat at 14% for both of the years ended December 31, 2016 and2015. The dollar decrease was primarily due to a reduction in payroll and benefits expense of $2.7 million driven by increased capitalized labor projectsprimarily associated with new Lexia product offerings and Catalyst and secondarily due to a reduction in headcount. In the near term we will focus ourproduct investment on Lexia and key Enterprise & Education Language initiatives.General and Administrative ExpensesGeneral and administrative expenses for the year ended December 31, 2016 were $40.5 million, a decrease of $9.6 million, or 19%, from the year endedDecember 31, 2015. As a percentage of revenue, general and administrative expenses decreased slightly to 21% for the year ended December 31, 2016compared to 23% for year ended December 31, 2015. The decrease in general and administrative expenses was primarily due to reductions in payroll andbenefits, bad debt, and other cost reductions. Payroll and benefits decreased $4.3 million driven by a reduction in headcount, heavier executive restructuringaccruals in the prior year related to the 2015 Restructuring Plan, and reductions in stock compensation expense related to the change in CEO in the secondquarter of 2015. Bad debt expense decreased by $1.0 million due to reduced sales in the consumer41Table of Contentsmarket and improvements in accounts receivable collections. Other costs decreased due to the ongoing cost saving measures. We expect our general andadministrative expenses to increase slightly in the near term.ImpairmentImpairment expense for the year ended December 31, 2016 was $3.9 million, a decrease of $2.8 million, from the year ended December 31, 2015. Thedecrease was due to the 2016 second quarter impairment of the Fit Brains goodwill of $1.7 million, the second quarter impairment of Fit Brains intangibleassets of $1.2 million, and the third quarter impairment of $1.0 million associated with a previously capitalized software project that no longer aligned to ourstrategic direction. These 2016 amounts were partially offset by a $5.6 million goodwill impairment charge related to our Consumer Fit Brains reporting unitand prior year impairment charges related to the abandonment of previously capitalized internal-use software projects.Lease Abandonment and TerminationLease abandonment and termination expenses for the year ended December 31, 2016 were $1.6 million, compared to $0.1 million for the year endedDecember 31, 2015. The increase was attributable to the fourth quarter 2016 lease abandonment charge associated with the planned space consolidation ofour former headquarters location in Arlington, VA.Other Income and (Expense) Year ended December 31, 2016 versus 2015 2016 2015 Change % Change (in thousands, except percentages)Interest income $46 $23 $23 100.0 %Interest expense (470) (378) (92) 24.3 %Other income and (expense) 2,297 (1,469) 3,766 (256.4)%Total other income and (expense) $1,873 $(1,824) $3,697 (202.7)%Interest income for the year ended December 31, 2016 was $46 thousand, a slight increase from the year ended December 31, 2015. Interest incomerepresents interest earned on our cash and cash equivalents.Interest expense for the year ended December 31, 2016 was $0.5 million, an increase of $0.1 million, from the year ended December 31, 2015. Thisincrease was primarily attributable to interest on our capital leases and the recognition of our financing fees associated with our undrawn credit facility.Other income and (expense) for the year ended December 31, 2016 was income of $2.3 million, an increase of $3.8 million, as compared to expense of$1.5 million for the year ended December 31, 2015. The change was primarily attributable to foreign exchange fluctuations.Income Tax Expense (Benefit) Year ended December 31, 2016 versus 2015 2016 2015 Change % Change (in thousands, except percentages)Income tax expense $2,503 $1,159 $1,344 116.0%Our Income tax expense for the year ended December 31, 2016 was $2.5 million, compared to $1.2 million for the year ended December 31, 2015. Theincrease primarily due to the inability to benefit from Canada losses, higher earnings in U.K. and Germany in 2016, and tax benefit related to Koreawithholdings in 2015.42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 increases in Literacy and Enterprise & EducationLanguage revenue of $12.0 million and $1.3 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 SegmentDuring 2016, our operating segment structure changed to three operating segments: Enterprise & Education Language, Literacy, and Consumer. Our2015 and 2014 operating segments were recast under our current operating segment structure and the following table sets forth revenue for our operatingsegments 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 Language $76,129 35.0% $74,788 28.6% $1,341 1.8 %Literacy 21,928 10.0% 9,912 3.8% $12,016 121.2 %Consumer 119,613 55.0% 177,153 67.6% $(57,540) (32.5)%Total Revenue $217,670 100.0% $261,853 100.0% $(44,183) (16.9)%Enterprise & Education Language SegmentTotal Enterprise & Education revenue increased $1.3 million, or 2%, from $74.8 million for the year ended December 31, 2014 to $76.1 million for theyear ended December 31, 2015. The increase in Enterprise & Education Language revenue was comprised primarily of increases of $3.7 million and $0.8million in our education and non-profit sales channels, respectively, which were partially offset by a decrease of $2.9 million in the corporate sales channel.Literacy SegmentLiteracy revenue increased $12.0 million, or 121%, from $9.9 million for the year ended December 31, 2014 to $21.9 million for the year endedDecember 31, 2015. Literacy revenue increased, in part, due to the revenue recognition of subscription service contracts recorded as deferred revenue in priorperiods. Due to purchase accounting, deferred revenue associated with Lexia was recorded at fair value, which is lower than the book value, and resulted inlower 2014 revenue. As a result, we expect year-over-year revenues to become more comparable as we move beyond the purchase accounting impact, whichwill result in lower revenue growth rates than what we experienced during 2015.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.Revenue by Subscription and Service Revenue and Product RevenueThe following table sets forth revenue for subscription and service revenue and product revenue for the years ended December 31, 2015 and 2014:43Table of Contents Year ended December 31, 2015 versus 2014 2015 2014 Change % Change (in thousands, except percentages)Subscription and service revenue $151,701 69.7% $125,602 48.0% $26,099 20.8 %Product revenue 65,969 30.3% 136,251 52.0% (70,282) (51.6)%Total revenue $217,670 100.0% $261,853 100.0% $(44,183) (16.9)%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.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.Cost of Subscription and Service Revenue, Product Revenue Gross ProfitThe following table sets forth cost of subscription and service revenue and cost of product revenue, as well as gross profit for the years endedDecember 31, 2015 and 2014: Year ended December 31, 2015 versus 2014 2015 2014 Change % Change (in thousands, except percentages)Revenue: Subscription and service $151,701 $125,602 $26,099 20.8 %Product 65,969 136,251 (70,282) (51.6)%Total revenue 217,670 261,853 (44,183) (16.9)%Cost of revenue: Cost of subscription and service revenue 21,629 18,862 2,767 14.7 %Cost of product revenue 16,898 34,192 (17,294) (50.6)%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, payroll and benefits expense, and freight and payment processing fees.Inventory expense declined $6.3 million primarily due to the decrease in product sales combined with higher first quarter 2014 charges to inventoryobsolescence in our Asian operations that did not recur in 2015. Payroll and benefit expenses declined $3.7 million driven by reduced headcount as a resultof the44Table of Contents2015 Restructuring Plan, the absence of higher severance payments in 2014 related to operations in France and Korea, and lower variable incentivecompensation expenses based on reduced funding expectations. Freight and processing fees decreased $3.5 million due to the decrease in 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.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.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.The 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 $—45Table of ContentsSales 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.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.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.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.46Table of ContentsOther 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)%.Liquidity and Capital ResourcesLiquidityOur principal source of liquidity at December 31, 2016 consisted of $36.2 million in cash and cash equivalents and short-term investments, a decreaseof $11.6 million, from $47.8 million as of December 31, 2015. Our primary operating cash requirements include the payment of salaries, employee benefitsand other personnel related costs, as well as direct advertising expenses, costs of office facilities, and costs of information technology systems. Historically,we have primarily funded these requirements through cash flow from our operations. For the year ended December 31, 2016, we generated $1.2 million cashflows 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 Language and Literacysegments while we optimize our Consumer segment for profitability and cash generation. Our operating segments are affected by different sales-to-cashpatterns. Within our Enterprise & Education Language and Literacy segments, revenue in our education, government, and corporate sales channels areseasonally stronger in the second half of the calendar year due to purchasing and budgeting cycles. Our Consumer revenue is affected by seasonal trendsassociated with the holiday shopping season. Consumer sales typically turn to cash more quickly than Enterprise & Education Language and Literacy 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 wehave been a net generator of cash. We expect this trend to continue.47Table of ContentsOn 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.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 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 we were eligible to borrow $20.8 million ofavailable credit less $4.0 million in letters of credit that have been issued by Silicon Valley Bank on our behalf, resulting in a net borrowing availability of$16.8 million. We are subject to certain financial and restrictive covenants under the credit facility, which have been amended to reflect the revised outlookin connection with our 2016 Restructuring Plan. We are required to maintain compliance with a minimum liquidity ratio and maintain a minimum AdjustedEBITDA. As of December 31, 2016, we were in compliance with all of the covenants under the revolving credit agreement. On March 10, 2017, we enteredinto the sixth amendment to the credit facility, which primarily extended the term to April 1, 2020.The total amount of cash that was held by foreign subsidiaries as of December 31, 2016 was $6.5 million. As of December 31, 2016, we do not intend torepatriate the cash from our foreign subsidiaries, however, if we were to repatriate this foreign cash, no tax liability would result due to the current period andcarryforward net operating losses.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.Capital ResourcesWe 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 from the date of issuance of this report. We have generated significant operating losses as reflected in our accumulateddeficit and stockholders' deficit and we may continue to incur operating losses in the future that may continue to require additional working capital toexecute strategic initiatives. Our future capital requirements will depend on many factors, including development of new products, market acceptance of ourproducts, the levels of advertising and promotion required to launch additional products and improve our competitive position in the marketplace, theexpansion of our sales, support and marketing organizations, the optimization of office space in the U.S. and worldwide, building the infrastructure necessaryto support our growth, the response of competitors to our products and services, and our relationships with suppliers. We extend payments to certain vendorsin order to minimize the amount of working capital deployed in the business. In order to maximize our cash position, we will continue to manage our existinginventory, accounts receivable, and accounts payable balances. Borrowings under our credit facility can be utilized to meet working capital requirements,anticipated capital expenditures, and other obligations.Cash Flow Analysis for the Year ended December 31, 2016 as compared to the year ended December 31, 2015 Year ended December 31, 2016 versus 2015 2016 2015 Change % Change (in thousands, except percentages)Net cash provided by (used in) operating activities $1,240 $(5,645) $6,885 (122.0)%Net cash used in investing activities $(12,476) $(9,374) $(3,102) 33.1 %Net cash used in financing activities $(658) $(727) $69 (9.5)%48Table of ContentsNet Cash Provided By Operating ActivitiesNet cash provided by operating activities was $1.2 million for the year ended December 31, 2016 compared to net cash used in operating activities of$5.6 million for the year ended December 31, 2015, a favorable change of $6.9 million. The primary factor contributing to the increase in cash provided byoperating activities is the improvement in net loss, which reflects our cost reduction initiatives to drive profitable results. For a summary of the factors thatled to the net loss for the year ended December 31, 2016 see "Results of Operations" section above. Non-cash items primarily consisted of $13.3 million indepreciation and amortization expense, $4.9 million in stock-based compensation expense, and $3.9 million in impairment loss, which was partially offset by$2.4 million in a gain on foreign currency transactions. The primary drivers of the change in operating assets and liabilities were a decrease in accountsreceivable of $14.7 million and an increase in accrued compensation of $2.7 million, partially offset by a decrease in other current liabilities of $13.3 million.The decrease in accounts receivable was primarily related to the lower sales during 2016 as compared to 2015 and faster collections which slightly improveddays sales outstanding. The increase in accrued compensation was primarily attributable to an increase in variable compensation related to a higher fundingrate in 2016 when compared to 2015. The decrease in other current liabilities reflected our shift in strategy, which resulted in lower operating expenses andfewer obligations due for marketing, advertising, and rebates which included the $4.6 million cash outflow associated with the reduction in suggested retailvalue initiated in mid-2016Net Cash Used in Investing ActivitiesNet cash used in investing activities was $12.5 million for the year ended December 31, 2016, compared to $9.4 million for the year endedDecember 31, 2015. Net cash used in investing activities increased primarily due to a larger amount of capitalized software costs in 2016 as compared to2015.Net Cash Used in Financing ActivitiesNet cash used in financing activities was flat at $0.7 million for the years ended December 31, 2016 and 2015.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.49Table of ContentsNet 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 taxbenefit of $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 increasein other current 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 were 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.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 a building in France, certain equipment, and certain software under capital lease agreements. Thefollowing table summarizes our future minimum rent payments under non-cancellable operating and capital lease agreements as of December 31, 2016 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 $2,901 $635 $963 $949 $354Operating leases 12,250 4,552 6,104 1,594 —Total $15,151 $5,187 $7,067 $2,543 $35450Table of ContentsItem 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.Item 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, 2016. 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, 2016, 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, 2016. 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).51Table of ContentsOur 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, 2016 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, 2016 that had materially affected, or is reasonably likely to materially affect,our internal control over financial reporting.Item 9B. Other InformationNone.52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 the2017 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 2017 Annual Meeting of Stockholders to be filed with the SECno later than 120 days after the fiscal year ended December 31, 2016 (the "2017 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 2017 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 2017 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 2017 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 2017 Proxy Statement.53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.54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 HassPresident, Chief Executive Officer,and Chairman of the BoardDate: March 14, 2017 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 President, Chief Executive Officer and Chairman of theBoard(Principal Executive Officer)March 14, 2017A. John Hass III /s/ THOMAS M. PIERNO Chief Financial Officer(Principal Financial Officer)March 14, 2017Thomas M. Pierno /s/ M. SEAN HARTFORD Vice President, Controller and Principal AccountingOfficer(Principal Accounting Officer)March 14, 2017M. Sean Hartford /s/ PATRICK W. GROSS DirectorMarch 14, 2017Patrick W. Gross /s/ LAURENCE FRANKLIN DirectorMarch 14, 2017Laurence Franklin /s/ DAVID P. NIERENBERG DirectorMarch 14, 2017David P. Nierenberg /s/ CAROLINE J. TSAY DirectorMarch 14, 2017Caroline J. Tsay /s/ STEVEN P. YANKOVICH DirectorMarch 14, 2017Steven P. Yankovich 55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' (Deficit) 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, 2016 and 2015,and the related consolidated statements of operations, comprehensive loss, changes in stockholders' (deficit) equity, and cash flows for each of the three yearsin the period ended December 31, 2016. These financial statements are the responsibility of the Company's management. Our responsibility is to express anopinion on 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, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, 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, 2016, 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, 2017 expressed an unqualified opinion on theCompany's internal control over financial reporting./s/ DELOITTE & TOUCHE LLPMcLean, VirginiaMarch 14, 2017 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, 2016, 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, 2016, 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, 2016 of the Company and our report dated March 14, 2017 expressed an unqualified opinion on thoseconsolidated financial statements./s/ DELOITTE & TOUCHE LLPMcLean, VirginiaMarch 14, 2017F-3Table of ContentsROSETTA STONE INC.CONSOLIDATED BALANCE SHEETS(in thousands, except per share amounts) As of December 31, 2016 2015Assets Current assets: Cash and cash equivalents $36,195 $47,782Restricted cash 402 80Accounts receivable (net of allowance for doubtful accounts of $1,072 and $1,196, at December 31, 2016 andDecember 31, 2015, respectively) 31,788 47,327Inventory 6,767 7,333Deferred sales commissions 14,085 13,526Prepaid expenses and other current assets 3,813 3,612Total current assets 93,050 119,660Deferred sales commissions 4,143 5,614Property and equipment, net 24,795 22,532Goodwill 48,251 50,280Intangible assets, net 22,753 28,244Other assets 1,318 2,213Total assets $194,310 $228,543Liabilities and stockholders' (deficit) equity Current liabilities: Accounts payable $10,684 $10,778Accrued compensation 10,777 8,201Income tax payable 785 121Obligations under capital lease 532 521Other current liabilities 22,150 35,318Deferred revenue 113,821 106,868Total current liabilities 158,749 161,807Deferred revenue 27,636 35,880Deferred income taxes 6,173 4,998Obligations under capital lease 2,027 2,622Other long-term liabilities 1,384 826Total liabilities 195,969 206,133Commitments and contingencies (Note 16) Stockholders' (deficit) equity: Preferred stock, $0.001 par value; 10,000 and 10,000 shares authorized, zero and zero shares issued and outstanding atDecember 31, 2016 and December 31, 2015, respectively — —Non-designated common stock, $0.00005 par value, 190,000 and 190,000 shares authorized, 23,451 and 23,150 sharesissued and 22,451 and 22,150 shares outstanding at December 31, 2016 and December 31, 2015, respectively 2 2Additional paid-in capital 190,827 185,863Treasury stock, at cost; 1,000 and 1,000 shares at December 31, 2016 and December 31, 2015, respectively (11,435) (11,435)Accumulated loss (177,344) (149,794)Accumulated other comprehensive loss (3,709) (2,226)Total stockholders' (deficit) equity (1,659) 22,410Total liabilities and stockholders' (deficit) equity $194,310 $228,543 See accompanying notes to consolidated financial statementsF-4Table of ContentsROSETTA STONE INC.CONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except per share amounts) Years Ended December 31, 2016 2015 2014Revenue: Subscription and service $154,336 $151,701 $125,602Product 39,753 65,969 136,251Total revenue 194,089 217,670 261,853Cost of revenue: Cost of subscription and service revenue 23,676 21,629 18,862Cost of product revenue 10,645 16,898 34,192Total cost of revenue 34,321 38,527 53,054Gross profit 159,768 179,143 208,799Operating expenses Sales and marketing 114,340 136,084 173,208Research and development 26,273 29,939 33,176General and administrative 40,501 50,124 57,120Impairment 3,930 6,754 20,333Lease abandonment and termination 1,644 55 3,812Total operating expenses 186,688 222,956 287,649Loss from operations (26,920) (43,813) (78,850)Other income and (expense): Interest income 46 23 17Interest expense (470) (378) (233)Other income and (expense) 2,297 (1,469) (1,129)Total other income and (expense) 1,873 (1,824) (1,345)Loss before income taxes (25,047) (45,637) (80,195)Income tax expense (benefit) 2,503 1,159 (6,489)Net loss $(27,550) $(46,796) $(73,706)Loss per share: Basic $(1.25) $(2.17) $(3.47)Diluted $(1.25) $(2.17) $(3.47)Common shares and equivalents outstanding: Basic weighted average shares 21,969 21,571 21,253Diluted weighted average shares 21,969 21,571 21,253 See accompanying notes to consolidated financial statementsF-5Table of ContentsROSETTA STONE INC.CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS(in thousands) Years Ended December 31, 2016 2015 2014Net loss $(27,550) $(46,796) $(73,706)Other comprehensive loss, net of tax: Foreign currency translation loss (1,483) (1,548) (1,523)Other comprehensive loss (1,483) (1,548) (1,523)Comprehensive loss $(29,033) $(48,344) $(75,229)See accompanying notes to consolidated financial statementsF-6Table of ContentsROSETTA STONE INC.CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' (DEFICIT) EQUITY(in thousands) Non-DesignatedCommon Stock AccumulatedOtherComprehensiveIncome / (Loss) TotalStockholders'(Deficit) / Equity AdditionalPaid-inCapital Treasury Stock AccumulatedLoss Shares Amount Balance—January 1, 2014 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) $22,410Stock Issued Upon the Exercise ofStock Options 13 — 58 — — — 58Restricted Stock Award Vesting 255 — — — — — —Stock-based CompensationExpense — — 4,906 — — — 4,906Net loss — — — — (27,550) — (27,550)Other comprehensive loss — — — — — (1,483) (1,483)Balance—December 31, 2016 22,074 $2 $190,827 $(11,435) $(177,344) $(3,709) $(1,659) See accompanying notes to consolidated financial statementsF-7Table of ContentsROSETTA STONE INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands) Years Ended December 31, 2016 2015 2014CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(27,550) $(46,796) $(73,706)Adjustments to reconcile net loss to cash provided by (used in) operating activities: Stock-based compensation expense 4,906 7,195 6,762(Gain) loss on foreign currency transactions (2,449) 1,471 1,171Bad debt expense 709 1,657 2,405Depreciation and amortization 13,322 13,660 13,904Deferred income tax expense (benefit) 1,162 849 (7,667)Loss (gain) on disposal of equipment 179 (15) 184Amortization of deferred financing costs 274 160 21Loss on impairment 3,930 6,754 20,333Loss from equity method investments 45 23 —Gain on divestiture of subsidiary — (660) —Net change in: Restricted cash (378) 43 (13)Accounts receivable 14,681 26,376 (16,478)Inventory 538 (1,253) 341Deferred sales commissions 919 (4,121) (7,268)Prepaid expenses and other current assets (167) 1,080 1,844Income tax receivable or payable 719 568 (147)Other assets 668 (684) 446Accounts payable (74) (8,636) 8,394Accrued compensation 2,701 (5,485) (4,494)Other current liabilities (13,261) (14,223) 11,318Other long-term liabilities 558 (486) 459Deferred revenue (192) 16,878 48,864Net cash provided by (used in) operating activities 1,240 (5,645) 6,673CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (12,514) (8,856) (9,736)Proceeds from sale of fixed assets 38 1,642 —Decrease in restricted cash for Vivity acquisition — — 12,314Acquisitions, net of cash acquired — (1,688) (41,687)Net cash outflow from divestiture of subsidiary — (186) —Other investing activities — (286) —Net cash used in investing activities (12,476) (9,374) (39,109)CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from the exercise of stock options 58 114 669Payment of deferred financing costs (183) (130) (381)Payments under capital lease obligations (533) (711) (593)Net cash used in financing activities (658) (727) (305)Decrease in cash and cash equivalents (11,894) (15,746) (32,741)Effect of exchange rate changes in cash and cash equivalents 307 (1,129) (1,427)Net decrease in cash and cash equivalents (11,587) (16,875) (34,168)Cash and cash equivalents—beginning of year 47,782 64,657 98,825Cash and cash equivalents—end of year $36,195 $47,782 $64,657SUPPLEMENTAL CASH FLOW DISCLOSURE: Cash paid during the periods for: Interest $197 $218 $211Income taxes, net of refund $604 $601 $1,722Noncash financing and investing activities: Accrued liability for purchase of property and equipment $270 $258 $561Equipment acquired under capital lease $27 $462 $—See 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 and literacysolutions consisting of perpetual software products, web-based software subscriptions, online and professional services, audio practice products and mobileapplications. The Company's offerings are sold on a direct basis and through select third party retailers and distributors. The Company provides its solutionsto customers through the sale of packaged software and web-based software subscriptions, domestically and in certain international markets.In March 2016, the Company announced the withdrawal of direct sales presence in almost all of its non-U.S. and non-northern European geographiesrelated to the distribution of the Enterprise & Education Language offerings (the "2016 Restructuring Plan"). Where appropriate, the Company seeks tooperate through partners in the geographies being exited. The Company has also initiated processes to close the software development operations in Franceand China. These actions are in addition to the plan announced in early 2015 (the "2015 Restructuring Plan") to accelerate and prioritize its focus onsatisfying the needs of the passionate learners in the U.S. and select non-U.S. geographies in the Consumer language business. See Note 2 "Summary ofSignificant Accounting Policies," Note 13 "Restructuring," Note 17 "Segment Information" and Item 7 "Management's Discussion and Analysis of FinancialCondition and Results of Operations" within Part II for additional information about these strategic undertakings and the associated impact to the Company'sfinancial 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.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 the investee's governance body, participation in policy-making decisions, andtechnological dependencies. 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 accordance with GAAP requires management to make certain estimates and assumptions. The amountsreported in the consolidated financial statements include significant estimates and assumptions that have been made, including, but not limited to, thoserelated to revenue recognition, allowance for doubtful accounts, estimated sales returns and reserves, stock-based compensation, restructuring costs, fair valueof intangibles and goodwill, disclosure of contingent assets and liabilities, disclosure of contingent litigation, allowance for valuation of deferred tax assets,and the Company's quarterly going concern assessment. The Company bases its estimates and assumptions on historical experience and on various otherjudgments that are believed to be reasonable under the circumstances. The Company continuously evaluates its estimates and assumptions. Actual resultsmay 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 and net of taxes.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”). In doing so, the Company evaluates a variety of factors includingwhether the undelivered 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 astand-alone basis.F-9Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)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"). The Company generatesa portion of its Consumer revenue from the CD and digital download formats of the Rosetta Stone language-learning product which are typically multiple-element arrangements that contain two deliverables: perpetual software, delivered at the time of sale, and online service, which is considered an undeliveredsoftware-related element. The online service includes access to conversational coaching services. Because the Company only sells the perpetual language-learning software on a stand-alone basis in its homeschool version, the Company does not have a sufficient concentration of stand-alone sales to establishVSOE for the perpetual product. Where VSOE of the undelivered online services can be established, arrangement consideration is allocated using the residualmethod. The Company determines VSOE by reference to the range of comparable stand-alone renewal sales of the online service. The Company reviews thesestand-alone sales on a quarterly basis. VSOE is established if at least 80% of the stand-alone sales are within a range of plus or minus 15% of a midpoint ofthe range of prices, consistent with generally accepted industry practice. Where VSOE of the undelivered online services cannot be established, revenue isdeferred 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 Language and Literacy customers, and to alesser extent its Consumer customers. These arrangements can include web-based subscription services, audio practice products and professional services orany combination thereof. The Company does not have a sufficient concentration of stand-alone sales of the various deliverables noted above to its customers,and therefore cannot establish VSOE for each deliverable. Third party evidence of fair value does not exist for the web-based subscription, audio practiceproducts and professional services due to the lack of interchangeable language-learning products and services within the market. Accordingly, the Companydetermines the relative selling price of the web-based subscription, audio practice products and professional services deliverables included in its non-software multiple element arrangements using the best estimated selling price. The Company determines the best estimated selling price based on itsinternally published price list which includes suggested sales prices for each deliverable based on the type of client and volume purchased. This price list isderived from past experience and from the expectation of obtaining a reasonable 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 for web-based subscriptions and online services is recognized ratably over the term of the subscription or service period, assuming allrevenue recognition criteria have been met. The CD and digital download formats of Rosetta Stone language-learning products are bundled with an onlineservice where customers are allowed to begin their online services at any point during a registration window, which is typically up to six months from thedate of purchase from us or an authorized reseller. The online services that are not activated during this registration window are forfeited and revenue isrecognized upon expiry. Revenue from non-refundable upfront fees that are not related to products already delivered or services already performed is deferredand recognized ratably 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 are sold 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. RevenueF-10Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)from sales of packaged software products and audio practice products is recognized as the products are shipped and title passes and risks of loss have beentransferred. For many product sales, these criteria are met at the time the product is shipped. For some sales to resellers and certain other sales, the Companydefers revenue until the customer receives the product because the Company legally retains a portion of the risk of loss on these sales during transit. In othercases where packaged software products are sold to resellers on a consignment basis, revenue is recognized for these consignment transactions once the enduser sale has occurred, assuming the remaining revenue recognition 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 identifiedbenefit is identified and the fair value is reasonably determinable. Price protection for changes in the manufacturer suggested retail value granted to resellersfor 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.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 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. See Note 5 "Divestitures" for disclosures on the Company's recent divestiture.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 and deposits received on subleasedproperties.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.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. See Note 3 "Inventory" for disclosures on theCompany's inventory balances.F-11Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)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 on its trade accounts receivable. In addition, the Company maintains cash and investment balances in accounts at various banks andbrokerage 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, 2016, 2015 or 2014. The four largest distributor andreseller receivable balances collectively represented 23% and 30% of accounts receivable as of December 31, 2016 and 2015, respectively, with onecustomer that accounted for 13% and 17% of accounts receivable as of December 31, 2016 and 2015, 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, building and leasehold improvements, furniture,equipment, and software is 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 lifeExpenses 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. SeeNote 4 "Property Plant and Equipment" for the Company's additional disclosures.F-12Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)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.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 Company'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. Years Ended December 31, 2016 2015 2014 Amounts capitalized as internal-use software $11,375 $7,132 $8,811 Amortization expense of internal-use software $(6,369) $(4,786) $(3,379) Impairment expense of internal-use software $(1,029) $(1,142) $(163)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 event occurs, the Company reviews its indefinite-lived intangible asset forimpairment in accordance with ASC 350. This guidance provides the option to first assess qualitative factors to determine whether it is more likely than notthat an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative test. If necessary, thequantitative test is performed by comparing the fair value of indefinite lived intangible assets to the carrying value. In the event the carrying value exceedsthe fair value of the assets, the assets are written down to their fair value. The Rosetta Stone trade name is the Company's only indefinite-lived intangibleasset.See Note 7 "Intangible Assets" for a discussion and results associated with the Company's recent intangible asset impairment tests.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.F-13Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)See Note 6 "Goodwill" for a discussion and results associated with the Company's recent goodwill impairment tests. For income tax purposes, thegoodwill balances with tax basis are amortized over a period of 15 years.GuaranteesIndemnifications are provided of varying scope and size to certain Enterprise & Education Language and Literacy customers against claims ofintellectual property infringement made by third parties arising from the use of its products. The Company has not incurred any costs or accrued anyliabilities as a result of such obligations.Cost of Subscription and Service Revenue and Cost of Product RevenueThe cost of subscription and service revenue primarily represents costs associated with supporting the web-based subscription services and onlinelanguage-learning services, which includes online language conversation coaching, hosting costs and depreciation. Also included are the costs of credit cardprocessing and customer technical support in both cost of product revenue and cost of subscription and service revenue. Cost of product revenue consists ofthe direct and indirect materials and labor costs to produce and distribute the Company's products. Such costs include packaging materials, computerheadsets, freight, inventory receiving, personnel costs associated with product assembly, third-party royalty fees and inventory storage, obsolescence andshrinkage.Research and DevelopmentResearch and development expenses include employee compensation costs, consulting fees and overhead costs associated with the development ofour solutions. The Company develops a portion of its language-learning software products for perpetual sale to external customers. The Company considerstechnological feasibility to be established when all planning, designing, coding, and testing has been completed according to design specifications. TheCompany has determined that technological feasibility for such software products is reached shortly before the products are released to manufacturing. Costsincurred after technological feasibility is established have not been material, and accordingly, the Company has expensed all research and development costswhen incurred.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 thedeferred 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 moreF-14Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)negative evidence that exists, the more positive evidence is necessary and the more difficult it is to support a conclusion that a valuation allowance is notneeded.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. See Note 15 "Income Taxes" for additionaldisclosures.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. For options granted with serviceand/or performance conditions, the fair value of each grant is estimated on the date of grant using the Black-Scholes option pricing model. For optionsgranted with market-based conditions, the fair value of each grant is estimated on the grant date using the Monte-Carlo simulation model. These methodsrequire the use of estimates, including future stock price volatility, expected term and forfeitures.As the Company does not have sufficient historical option exercise experience that spans the full 10 year contractual term for determining the expectedterm of options granted, the Company estimates the expected term of options using a combination of historical information and the simplified method forestimating the expected term. The Company uses its own historical stock price data to estimate its forfeiture rate and expected volatility over the most recentperiod commensurate with the estimated expected term of the awards. For the risk-free interest rate, the Company uses a U.S. Treasury Bond rate consistentwith the estimated expected term of the option award.The Company's restricted stock and restricted stock unit grants are accounted for as equity awards. Stock compensation expense associated withservice-based equity awards is recognized in the statement of operations on a straight-line basis over the requisite service period, which is the vesting period.For equity awards granted with performance-based conditions, stock compensation expense is recognized in the statement of operations ratably for eachvesting tranche based on the probability that operating performance conditions will be met and to what extent. For equity awards granted with market-basedconditions, stock compensation expense is recognized in the statement of operations ratably for each vesting tranche regardless of meeting or not meeting themarket conditions. See Note 10 "Stock-Based Compensation" for additional disclosures.Restructuring CostsAs part of the 2016 Restructuring Plan and the 2015 Restructuring Plan, the Company announced and initiated actions to reduce headcount and othercosts in order to support its strategic shift in business focus. In connection with these plans, the Company incurred restructuring related costs, includingemployee severance and related benefit costs, contract termination costs, and other related costs. These costs are included within Cost of Sales and the Salesand marketing, Research and development, and General and administrative operating expense categories in 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 existed, 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 and costs to terminate operating leases. Contract terminationcosts are recognized at fair value in the period 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. Such costs are recognizedat fair value in the period in which the costs are incurred. See Note 13 "Restructuring" for additional disclosures.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, 2016 2015 2014 (dollars in thousands, except per share amounts)Numerator: Net loss $(27,550) $(46,796) $(73,706)Denominator: Common shares and equivalents outstanding: Basic weighted average shares 21,969 21,571 21,253Diluted weighted average shares 21,969 21,571 21,253Loss per share: Basic $(1.25) $(2.17) $(3.47)Diluted $(1.25) $(2.17) $(3.47)For the years ended December 31, 2016, 2015 and 2014, 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, 2016 2015 2014 (in thousands)Stock options 16 35 67Restricted stock units 174 39 103Restricted stocks 129 82 89Total common stock equivalent shares 319 156 259Comprehensive LossComprehensive loss consists of net loss and other comprehensive loss. Other comprehensive loss refers to revenues, expenses, gains, and losses that arenot included in net loss, but rather are recorded directly in stockholders' (deficit) equity. For the years ended December 31, 2016, 2015 and 2014, theCompany's comprehensive loss consisted of net loss and foreign currency translation losses. The other comprehensive loss presented in the consolidatedfinancial statements and the notes are presented net of tax. There have been no tax expense or benefit associated with the components other comprehensiveloss due to the presence of a full valuation allowance for each of the years ended December 31, 2016, 2015 and 2014.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, 2016 are as follows (in thousands): Foreign Currency TotalBalance at beginning of period $(2,226) $(2,226)Other comprehensive loss before reclassifications (1,483) (1,483)Amounts reclassified from accumulated other comprehensive loss — —Net current period other comprehensive loss (1,483) (1,483)Accumulated other comprehensive loss $(3,709) $(3,709)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, 2016, there were no reclassifications out of accumulated other comprehensive loss.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' (deficit) 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, 2016, 2015, and 2014 were $37.0 million, $46.9million and $79.6 million, respectively.Going Concern AssessmentThe consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction ofliabilities in the normal course of business. Management has evaluated whether relevant conditions or events, considered in the aggregate, indicate that thereis substantial doubt about the Company's ability to continue as a going concern. Substantial doubt exists when conditions and events, considered in theaggregate, indicate it is probable that the Company will be unable to meet its obligations as they become due within one year after the financial statementissuance date. The assessment is based on the relevant conditions that are known or reasonable knowable as of March 14, 2017. The assessment of the Company's ability to meet its future obligations is inherently judgmental, subjective and susceptible to change. The inputs thatare considered important in the Company's going concern analysis, include, but are not limited to, the Company's 2017 cash flow forecast, 2017 operatingbudget, and long-term plan that extends beyond 2017. These inputs consider information including, but not limited to, the Company’s financial condition,liquidity sources, obligations due within one year after the financial statement issuance date, funds necessary to maintain operations, and financialconditions, including negative financial trends or other indicators of possible financial difficulty.The Company has considered both quantitative and qualitative factors as part of the assessment that are known or reasonably knowable as of March 14,2017, and concluded that conditions and events considered in the aggregate, do not indicate that it is probable that the Company will be unable to meetobligations as they become due through the one year period following the financial statement issuance date.Recently Issued Accounting StandardsDuring 2016, the Company adopted the following recently issued Accounting Standard Updates ("ASU"):In August 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-15, Presentation of FinancialStatements - Going Concern (Subtopic 205-40) ("ASU 2014-15"). ASU 2014-15 addressesF-17Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide relatedfootnote disclosures. Management’s evaluation should be based on relevant conditions and events that are known and reasonably knowable at the date thatthe financial statements are issued. ASU 2014-15 is effective for annual periods ending after December 15, 2016, and interim periods thereafter. Earlyadoption is permitted. The Company has adopted this guidance and as discussed above. No additional disclosures are required.The following ASUs were recently issued but have not yet been adopted by the Company:In February 2017, the FASB issued ASU No. 2017-05, Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets ("ASU 2017-05"). ASU 2017-05clarifies the scope and accounting of a financial asset that meets the definition of an “in-substance nonfinancial asset” and defines the term, “in-substancenonfinancial asset.” ASU 2017-05 also adds guidance for partial sales of nonfinancial assets. ASU 2017-05 is effective at the same time Topic 606, Revenuefrom Contracts with Customers is effective. ASU 2017-05 may be applied retrospectively for all periods presented or retrospectively with a cumulative-effectadjustment at the date of adoption. The Company is in the process of evaluating the impact of the new guidance on the Company's financial statements anddisclosures and the adoption method.In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment("ASU 2017-04"). ASU 2017-04 simplifies the subsequent measurement of goodwill and eliminates Step 2 from the goodwill impairment test. ASU 2017-04 iseffective for annual and interim goodwill tests beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairmenttests performed on testing dates on or after January 1, 2017. The Company is in the process of evaluating the guidance. Given the prospective adoptionapplication, there is no impact on the Company's historical consolidated financial statements and disclosures.In January 2017, the FASB issued ASU No. 2017-01, Business Combination (Topic 805) Clarifying the Definition of a Business ("ASU 2017-01"). Theamendments under ASU 2017-01 clarify the definition of a business and requires that an entity apply certain criteria in order to determine when a set of assetsand activities qualifies as a business. ASU 2017-01 is effective for public entities for fiscal years beginning after December 15, 2017 and interim periodswithin those fiscal years, and should be applied on a prospective basis. Early adoption is permitted. The Company is currently evaluating the timing ofadoption of this guidance.In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230) Restricted Cash a consensus of the FASB Emerging IssuesTask Force ("ASU 2016-18"). Under ASU 2016-18, amounts generally described as restricted cash should be included with cash and cash equivalents whenreconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for public entities infiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The Company is currentlyevaluating the timing of adoption of this guidance. The new guidance only impacts presentation of the Company's consolidated statement of cash flows.In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on FinancialInstruments ("ASU 2016-13"). ASU 2016-13 changes the methodology for measuring credit losses of financial instruments and the timing of when such lossesare recorded. ASU 2016-13 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019. Early adoption ispermitted for fiscal years, and interim periods within those years, beginning after December 15, 2018. The Company is in the process of evaluating the impactof the new guidance on the Company's consolidated financial statements and disclosures.In March 2016, the FASB issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-BasedPayment Accounting ("ASU 2016-09"). Under ASU 2016-09, accounting for share-based payment award transactions was simplified related to the accountingfor (a) income tax effects; (b) minimum statutory tax withholding requirements; (c) and forfeitures. ASU 2016-09 is effective for public entities in annualperiods beginning after December 15, 2016, including interim periods within those annual periods. Early adoption is permitted. The Company expects toadopt this new guidance for its 2017 interim and annual reporting periods. Due to the historical cumulative shortfall position, the adoption of ASU 2016-09will not result in a cumulative-effect adjustment to retained earnings. ASU 2016-09 allows for an entity-wide accounting policy election, which would beapplied prospectively, to either account for forfeitures when they occur or continue to estimate the number of awards that are expected to vest. The Companyis in the process of evaluating the potential forfeiture policy election and the impact this election may have on the Company's consolidated financialstatements and disclosures. Other aspects of adoption ASU 2016-09 are not anticipated to have a material impact to the Company’s consolidated financialstatements.F-18Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)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 May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which replaces the current revenue accountingguidance. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date whichdefers the effective date of the updated guidance on revenue recognition by one year. In March 2016, the FASB issued ASU No. 2016-08, Revenue fromContracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which clarifies and improves theoperability and understandability of the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, which clarifies and improves the operabilityand understanding of the implementation guidance on identifying performance obligations and licensing. Collectively these ASUs comprise the new revenuestandard ("New Revenue Standard"). The core principle of the New Revenue Standard is that an entity should recognize revenue to depict the transfer ofpromised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods orservices. To achieve that core principle, an entity should apply a five step model to 1) identify the contract(s) with a customer, 2) identify the performanceobligations in the contract, 3) determine the transaction price, 4) allocate the transaction price to the performance obligations in the contract and 5) recognizerevenue when (or as) the entity satisfies a performance obligation. The New Revenue Standard is effective for annual periods beginning after December 15,2017.The Company expects that it will adopt the New Revenue Standard beginning in the first quarter of 2018. The New Revenue Standard provides theoption between two different methods of adoption. The full retrospective method calls for the Company to present each prior reported period shown in thefinancial statements under the new guidance. The modified retrospective method requires the Company to calculate the cumulative effect of applying thenew guidance as of the date of adoption via adjustment to retained earnings. The Company is currently considering adopting the New Revenue Standardusing the full retrospective method. The Company's ability to adopt using the full retrospective method is dependent on several factors, including thesignificance of the impact of the New Revenue Standard to the Company’s financial results, system readiness and ability to accumulate and analyze theinformation necessary to assess the impact on prior period financial statements, as necessary.The Company is currently evaluating the impact the New Revenue Standard will have on its accounting policies, processes, and system requirements.Internal resources have been assigned to assist in the evaluation and the Company will continue to make investments in systems to enable timely andaccurate reporting under the New Revenue Standard. As part of its initial evaluations, the Company believes the impact of the change in the New RevenueStandard on the Enterprise & Education and Literacy segments will be minimal as the accounting outcome of the vast majority of transactions remainsunchanged. Due to the elimination of software specific accounting guidance, the Company anticipates more significant changes to the accounting for thepackaged perpetual software product line within the Consumer segment. This change is expected to be greater in the historical periods presented forcomparison in the 2018 financial statements due to the Company pursuing its strategy to transition the Consumer segment to a fully SaaS delivery model bythe end of 2017. While the Company continues to assess all potential impacts under the New Revenue Standard, including the areas described above, we donot know or cannot reasonably estimate quantitative information related to the impact of the New Revenue Standard on the Company's consolidatedfinancial statements and disclosures at this time.F-19Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)3. INVENTORYInventory consisted of the following (in thousands): As of December 31, 2016 2015Raw materials $4,384 $3,375Finished goods 2,383 3,958Total inventory $6,767 $7,3334. PROPERTY AND EQUIPMENTProperty and equipment consisted of the following (in thousands): As of December 31, 2016 2015Land $876 $893Buildings and improvements 9,503 9,573Leasehold improvements 1,645 1,477Computer equipment 15,866 16,508Software 43,688 34,478Furniture and equipment 2,393 3,115 73,971 66,044Less: accumulated depreciation (49,176) (43,512)Property and equipment, net $24,795 $22,532The Company leases certain computer equipment, software, buildings, and machinery under capital lease agreements. As of December 31, 2016 and2015, assets under capital lease included in property and equipment above were $5.4 million and $5.5 million, respectively. As of December 31, 2016 and2015, accumulated depreciation and amortization relating to property and equipment under capital lease arrangements totaled $2.1 million and $1.5 million,respectively.The Company recorded total depreciation and amortization expense for its property and equipment for the years ended December 31, 2016, 2015 and2014 in the amount of $9.0 million, $8.5 million and $7.6 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, 2016 2015, and 2014 the Company recorded $1.0 million, $1.1 million, and $0.2 million respectively, inimpairment expense related to the abandonment of previously capitalized internal-use software projects.5. DIVESTITURESAs 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 income and (expense)” 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.F-20Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)5. DIVESTITURES (Continued)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. The first installment was paid in fullaccording to schedule and no allowance was deemed necessary. As a result of this loan receivable and the level of financial support it represents, theCompany concluded that it holds a variable interest in RSK whereby the Company is not the primary beneficiary. The maximum exposure to loss as a resultof this involvement in the variable interest entity is limited to the $0.5 million amount of the loan.6. GOODWILLThe value of gross goodwill is primarily derived from the acquisition of Rosetta Stone Ltd. (formerly known as Fairfield & Sons, Ltd.) in January 2006,the acquisition of certain assets of SGLC International Co. Ltd ("SGLC") in November 2009, the acquisitions of Livemocha, Inc. ("Livemocha") in April2013, the acquisition of Lexia Learning Systems, Inc. ("Lexia") in August 2013, and the acquisitions of Vivity Labs, Inc. ("Vivity") and Tell Me More S.A.("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 topic 350, Intangibles - Goodwill and other ("ASC 350"), or more frequently, if impairment indicators arise. The Company alsoroutinely reviews goodwill at the reporting unit level for potential impairment.The Company's reporting units were Enterprise & Education Language, Enterprise & Education Literacy, Consumer Language, and Consumer FitBrains. The combined Consumer Language and Consumer Fit Brains reporting units make up the Consumer operating and reportable segment.F-21Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)6. GOODWILL (Continued)The following table shows the balance and changes in goodwill for the Company's operating segments and reporting units for the years endedDecember 31, 2016 and 2015 (in thousands): Enterprise &EducationLanguage Literacy Consumer ConsumerLanguage Consumer FitBrains TotalBalance as of January 1, 2015 Gross Goodwill $40,084 $9,962 $20,170 $8,538 $78,754Accumulated Impairment — — (20,170) — (20,170)Goodwill as of January 1, 2015 $40,084 $9,962 $— $8,538 $58,584 Partial Impairment 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 Gross Goodwill $38,700 $9,962 $20,170 $7,222 $76,054Accumulated Impairment — — (20,170) (5,604) (25,774)Goodwill as of December 31, 2015 $38,700 $9,962 $— $1,618 $50,280 Remaining Full Impairment of Consumer Fit Brains — — — (1,740) (1,740)Effect of change in foreign currency rate (411) — — 122 (289) Balance as of December 31, 2016 Gross Goodwill $38,289 $9,962 $20,170 $7,344 $75,765Accumulated Impairment — — (20,170) (7,344) (27,514)Goodwill as of December 31, 2016 $38,289 $9,962 $— $— $48,2512016 ActivityAnnual Impairment Testing of Goodwill and Consumer Fit Brains ImpairmentConsistent with elections in prior annual tests, the Company exercised its option to bypass Step 0 for all reporting units with remaining goodwillbalances in connection with the annual goodwill impairment analysis performed as of June 30, 2016. The Enterprise & Education Language and Literacyreporting units both resulted in fair values that substantially exceeded the carrying values, and therefore no goodwill impairment charges were recorded inconnection with the annual analysis for these reporting units.The Consumer Fit Brains reporting unit was also evaluated, which resulted in a fair value that was significantly below the carrying value. The decreasein fair value was due to the second quarter 2016 strategy update for the Consumer Fit Brains business. The Consumer Fit Brains reporting unit was no longerconsidered central to the core strategy for the Company's focus on language and literacy learning. Due to the continued declines in operations since the $5.6million partial impairment in the fourth quarter of 2015 which is further discussed below, management revised the Consumer Fit Brains financial projectionsin the second quarter of 2016 assuming reduced media spend and reduced revenue in 2016 and beyond. The change in operating plans and the lack ofcushion since the fourth quarter 2015 impairment resulted in an implied fair value of goodwill that was significantly below its carrying value. As a result, theCompany recorded a second quarter impairment loss of $1.7 million, which represented a full impairment of the remaining Consumer Fit Brains reportingunit's goodwill. The impairment charge was recorded in the "Impairment" line on the statement of operations.Interim Impairment ReviewThe 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 2016, the Enterprise & Education Language and LiteracyF-22Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)6. GOODWILL (Continued)reporting units (the only reporting units with remaining goodwill balances) were evaluated to determine if a triggering event has occurred. As ofDecember 31, 2016, the Company concluded that there were no indicators of impairment that would cause it to believe that it is more likely than not that thefair value of these reporting units is less than the carrying value. Accordingly, a detailed impairment test has not been performed and no impairment chargeswere recorded for these reporting units in connection with the interim impairment review.2015 ActivityConsumer Fit Brains ImpairmentDuring 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 and liabilities (primarily developedtechnology and deferred revenue) in Step 2 of the interim goodwill impairment test, resulted in an implied fair value of goodwill below its carrying value. Asa result, the Company recorded an impairment loss of $5.6 million associated with the interim impairment assessment of the Consumer Fit Brains reportingunit as of December 31, 2015.7. INTANGIBLE ASSETSIntangible assets consisted of the following items as of the dates indicated (in thousands): Trade name /trademark * Core technology Customerrelationships Patents and Other Total Gross Carrying Amount $12,442 $15,149 $26,245 $312 $54,148Accumulated Amortization (1,271) (7,817) (16,603) (213) (25,904)Balance as of December 31, 2015 $11,171 $7,332 $9,642 $99 $28,244 Gross Carrying Amount 12,431 15,092 26,149 312 53,984Accumulated Amortization (1,481) (9,859) (18,485) (251) (30,076)Accumulated Impairment (26) (1,001) (128) — (1,155)Balance as of December 31, 2016 $10,924 $4,232 $7,536 $61 $22,753* 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 19 monthsCore technology 32 monthsCustomer relationships 69 monthsPatents 27 monthsF-23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, 2016 2015 2014Included in cost of revenue: Cost of subscription and service revenue $404 $322 $209Cost of product revenue 182 264 377Total included in cost of revenue 586 586 586Included in operating expenses: Sales and marketing 2,178 2,804 3,677Research and development 1,587 1,802 2,000General and administrative — — —Total included in operating expenses 3,765 4,606 5,677Total $4,351 $5,192 $6,263The following table summarizes the estimated future amortization expense related to intangible assets as of December 31, 2016 (in thousands): As ofDecember 31, 20162017 $3,7492018 3,1552019 1,5322020 1,2822021 940Thereafter 1,488Total $12,1462016 ActivityImpairment Reviews of Intangible AssetsThe Company also routinely reviews indefinite-lived intangible assets and long-lived intangible assets for potential impairment as part of theCompany’s internal control framework.During the second quarter of 2016, the Company revised the business outlook and financial projections for the Consumer Fit Brains reporting unit,which prompted a long-lived intangible asset impairment analysis of the tradename, developed technology, and customer relationships associated with theConsumer Fit Brains reporting unit ("Consumer Fit Brains Intangible Assets"). The carrying values of the Consumer Fit Brains Intangible Assets exceeded theestimated fair values. As a result, the Company recorded an impairment loss of $1.2 million associated with the impairment of the remaining carrying value ofthe Consumer Fit Brains Intangible Assets as of June 30, 2016. The impairment charge was recorded in the "Impairment" line on the statement of operations.As an indefinite-lived intangible asset, the Rosetta Stone tradename was evaluated as of December 31, 2016 to determine if indicators of impairmentexist. The Company elected to bypass the option to first assess qualitative factors to determine whether it is more likely than not that the Rosetta Stone tradename was impaired and performed the quantitative assessment. In the quantitative assessment, the Company noted that the fair value of the Rosetta Stonetrade name exceeded the carrying value. There were no impairment charges related to the Rosetta Stone trade name for the year ended December 31, 2016.Additionally, all other long-lived intangible assets were evaluated at December 31, 2016 to determine if indicators of impairment exist and theCompany concluded that there are no additional potential indicators of impairment and no furtherF-24Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)7. INTANGIBLE ASSETS (Continued)impairment chargers were recorded during the year ended December 31, 2016. There were no impairment charges related to intangible assets for the yearsended December 31, 2015 and 2014.8. OTHER CURRENT LIABILITIESThe following table summarizes other current liabilities (in thousands): As ofDecember 31, 2016 2015Accrued marketing expenses $8,460 $20,022Accrued professional and consulting fees 2,050 1,746Sales return reserve 1,338 3,728Sales, withholding, and property taxes payable 3,772 3,879Other 6,530 5,943Total Other current liabilities $22,150 $35,3189. FINANCING ARRANGEMENTSRevolving Line of CreditSee Note 21 "Subsequent Events" regarding the March 2017 amendment of the Company’s credit facility. The following discussion pertains tothe credit facility as in effect as of December 31, 2016.On 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.F-25Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)9. FINANCING ARRANGEMENTS (Continued)The credit facility contains customary affirmative and negative covenants, including covenants that limit or restrict our ability to, among other things,incur additional indebtedness, dispose of assets, execute a material change in business, acquire or dispose of an entity, grant liens, make share repurchases,and make distributions, including payment of dividends. The Company is required to maintain compliance with a minimum liquidity amount and minimumfinancial performance requirements, as defined in the credit facility. As of December 31, 2016, the Company was in compliance with all covenants.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, 2016, there were no borrowings outstanding and the Company was eligible to borrow the entire $20.8 million of available credit,less $4.0 million in letters of credit have been issued by the Bank on the Company's behalf, resulting in a net borrowing availability of $16.8 million. Aquarterly commitment fee accrues on any unused portion of the credit 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, 2016 and 2015, the Company acquired equipment or software through the issuance of capital leases totaling$27,000 and $0.5 million, respectively. This non-cash investing activity has been excluded from the consolidated statement of cash flows. There were noequipment or software acquired through the issuance of capital leases during the year ended December 31, 2014.As of December 31, 2016, the future minimum payments under capital leases with initial terms of one year or more are as follows (in thousands):Periods Ending December 31, 2017 $6352018 4832019 4802020 4762021 473Thereafter 354Total minimum lease payments $2,901Less amount representing interest 342Present value of net minimum lease payments $2,559Less current portion 532Obligations under capital lease, long-term $2,02710. 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 authorizedF-26Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)10. STOCK-BASED COMPENSATION (Continued)available stock. All unissued stock associated with the 2006 Stock Incentive Plan expired in 2016 at the end of the ten year contractual term.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 of 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 stock incentive awards and options granted under the 2009 Plan generally expire at the earlier of a specified period aftertermination of service or the date specified by 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 2009 Plan, 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, 2016 there were1,403,424 shares available for future grant under the 2009 Plan.Valuation AssumptionsThe determination of fair value of our stock-based awards is affected by assumptions regarding subjective and complex variables. Generally, ourassumptions are based on historical information and judgment is required to determine if historical trends may be indicators of future outcomes. Inaccordance with ASC 718, the fair value of stock-based awards to employees is calculated as of the date of grant. Compensation expense is then recognizedover the requisite service period of the award. Stock-based compensation expense recognized is based on the estimated portion of the awards that areexpected to vest. Estimated forfeiture rates are applied in the expense calculation. The Company calculates the pool of additional paid-in capital associatedwith excess tax benefits in accordance with ASC 718. The Company determines the fair values of stock-based awards as follows:•Service-Based Restricted Stock Awards, Restricted Stock Units, and Performance-Based Restricted Stock Awards: Fair value is determined based onthe quoted market price of our common stock on the date of grant.•Service-Based Stock Options and Performance-Based Stock Options: Fair value is determined using the Black-Scholes pricing model, which requiresthe use of estimates, including the risk-free interest rate, expected volatility, expected dividends, and expected term.•Market-Based Restricted Stock Awards and Market-Based Stock Options: The fair value of the market-based awards is determined using a Monte-Carlo simulation model. The Monte Carlo valuation also estimates the number of market-based awards that would be awarded which is reflected inthe fair value on the grant date.For the years ended December 31, 2016, 2015, and 2014 the fair value of service-based stock options and performance-based stock options granted wascalculated using the following assumptions in the Black-Scholes model: Years Ended December 31, 2016 2015 2014Expected stock price volatility 46%-47% 49%-63% 63%-65%Expected term of options 5.5-6.5 years 6 years 6 yearsExpected dividend yield — — —Risk-free interest rate 1.24%-1.50% 1.19%-1.75% 1.46%-1.80%F-27Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)10. STOCK-BASED COMPENSATION (Continued)For the years ended December 31, 2016, 2015, and 2014 the fair value of market-based stock options and market-based restricted stock awards grantedwas calculated using the following assumptions in the Monte-Carlo simulation model: Years Ended December 31, 2016 2015 2014Expected stock price volatility 45%-49% none noneExpected term of options 1.7 years-7 years none noneExpected dividend yield — none noneRisk-free interest rate .71%-1.53% none noneStock-Based Compensation ExpenseStock compensation expense associated with service-based equity awards is recognized in the statement of operations on a straight-line basis over therequisite service period, which is the vesting period. For equity awards granted with performance-based conditions, stock compensation expense isrecognized in the statement of operations ratably for each vesting tranche based on the probability that operating performance conditions will be met and towhat extent. For equity awards granted with market-based conditions, stock compensation is recognized in the statement of operations ratably for eachvesting tranche regardless of meeting or not meeting the market conditions.The following table presents stock-based compensation expense included in the related financial statement line items (in thousands): Years Ended December 31, 2016 2015 2014Included in cost of revenue: Cost of subscription and service revenue $(4) $44 $13Cost of product revenue 52 57 95Total included in cost of revenue 48 101 108Included in operating expenses: Sales and marketing 998 1,327 1,975Research & development 709 841 958General and administrative 3,151 4,926 3,721Total included in operating expenses 4,858 7,094 6,654Total $4,906 $7,195 $6,762F-28Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)10. STOCK-BASED COMPENSATION (Continued)Service-Based Stock OptionsThe following table summarizes the Company's service-based stock option activity from January 1, 2016 to December 31, 2016: OptionsOutstanding WeightedAverageExercisePrice WeightedAverageContractualLife (years) AggregateIntrinsicValueOptions Outstanding, January 1, 2016 1,837,165 $10.58 7.70 $130,262Options granted 464,194 7.50 Options exercised (12,971) 4.42 Options cancelled (494,458) 10.65 Options Outstanding, December 31, 2016 1,793,930 9.81 7.58 1,154,498Vested and expected to vest at December 31, 2016 1,687,078 9.93 7.50 1,032,107Exercisable at December 31, 2016 1,125,493 $10.34 7.02 $576,390As of December 31, 2016 and 2015, there was approximately $3.1 million and $5.2 million of unrecognized compensation expense related to non-vested service-based stock options that is expected to be recognized over a weighted average period of 2.36 and 1.84 years, respectively.Service-based stock options are granted at the discretion of the Board of Directors or the Compensation Committee (or its authorized member(s)) andexpire 10 years from the date of the grant. Service-based stock options generally vest over a four-year period based upon required service conditions and donot have performance or market conditions.The weighted average remaining contractual term and the aggregate intrinsic value for service-based stock options outstanding at December 31, 2016was 7.58 years and $1.2 million, respectively. The weighted average remaining contractual term and the aggregate intrinsic value for service-based stockoptions exercisable at December 31, 2015 was 7.70 years and $0.1 million, respectively. As of December 31, 2016, service-based stock options that werevested and exercisable totaled 1,125,493 shares of common stock with a weighted average exercise price per share of $10.34.The weighted average grant-date fair value per share of service-based stock options granted was $3.41 and $4.77 for the years ended December 31,2016 and 2015, 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, 2016, and the exercise price, multiplied by the number of in-the-money service-based stock options) that would have beenreceived by the option holders had all option holders exercised their options on December 31, 2016. This amount is subject to change based on changes tothe fair market value of the Company's common stock.F-29Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)10. STOCK-BASED COMPENSATION (Continued)Service-Based Restricted Stock AwardsThe following table summarizes the Company's service-based restricted stock activity for the years ended December 31, 2016 and 2015, respectively: Nonvested Outstanding Weighted Average GrantDate Fair Value Aggregate IntrinsicValueNonvested Awards, January 1, 2015 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 3,624,153Awards granted 300,650 7.59 Awards vested (196,001) 9.54 Awards canceled (71,848) 9.65 Nonvested Awards, December 31, 2016 374,380 8.94 3,348,080During 2016 and 2015, 300,650 and 481,992 shares of service-based restricted stock were granted, respectively. The aggregate grant date fair value ofthe service-based restricted stock awards in 2016 and 2015 was $2.3 million and $4.4 million, respectively, which will be recognized as expense on astraight-line basis over the requisite service period of the awards, which is also the vesting period. The Company's service-based restricted stock awards areaccounted for as 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 didnot grant any restricted stock prior to April 2009.During 2016, 71,848 shares of restricted stock were forfeited. As of December 31, 2016, future compensation cost related to the nonvested portion ofthe service-based restricted stock awards not yet recognized in the statement of operations was $2.6 million and is expected to be recognized over a period of2.06 years.Service-based restricted stock awards are considered outstanding at the time of grant as the stockholders are entitled to voting rights and to receive anydividends declared subject to the loss of the right to receive accumulated dividends if the award is forfeited prior to vesting. Unvested service-based restrictedstock awards are not considered 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, 2016 to December 31, 2016: Units Outstanding WeightedAverageGrant Date Fair Value AggregateIntrinsicValueUnits Outstanding, January 1, 2016 187,942 $11.16 $1,257,332Units granted 67,663 7.70 Units released (58,719) 11.51 Units cancelled (8,829) 8.50 Units Outstanding, December 31, 2016 188,057 9.93 1,675,588Vested and expected to vest at December 31, 2016 115,263 7.70 1,026,990Vested and deferred at December 31, 2016 82,157 $12.44 $732,019During 2016 and 2015, 67,663 and 63,436 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 2016 and 2015 was $0.5 million and $0.5 million, respectively. Beginning June 2015, all restricted stock unit awards vest quarterlyover a one year period from the dateF-30Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)10. STOCK-BASED COMPENSATION (Continued)of grant, with expense recognized straight-line over the vesting period. Prior to June 2015, all restricted stock unit awards were immediately vested withexpense recognized in full on the grant date. The Company's restricted stock units 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 units prior to April 2009.Performance and Market Conditioned Restricted Stock Awards and Stock OptionsOn April 4, 2016, the Company named Mr. John Hass as President, CEO and Chairman of the Board. In conjunction with his appointment, theCompensation Committee approved a stock-based compensation package for Mr. Hass aimed to provide significant reward potential for achievingoutstanding Company operating performance results and building shareholder value. The package was comprised of performance-based restricted stockawards (PRSAs), performance-based stock options (PSOs), market-based restricted stock awards (MRSAs), and market-based stock options (MSOs). Awardsalso vest if a majority change in control of the Company occurs during the performance or vesting period.Performance Conditioned:In addition to the performance condition, the PRSAs and PSOs also have a service condition. Vesting of PRSAs and PSOs are dependent upon whetherthe Company achieves certain operating performance targets which are based on the Company's defined measures of revenue, bookings, adjusted free cashflow, and adjusted EBITDA, measured against the full-year 2016 operating results. Following the end of the performance measurement period on December31, 2016, PRSAs and PSOs issued based on the operating performance metrics will vest 50%, 25%, and 25% on April 4, 2017, 2018 and 2019, respectively.The Company records compensation expense ratably for each vesting tranche of the PRSAs and PSOs based on the probability that operatingperformance conditions will be met and to what extent. Changes in the probability estimates will be accounted for in the period of change using a cumulativecatch-up adjustment to retroactively apply the new probability estimates. In any period in which the Company determines that achievement of theperformance metrics is not probable, the Company ceases recording compensation expense and all previously recognized compensation expense for theaward is reversed.The PRSAs were granted at "target" (at 100% of target). Based upon actual attainment of the operating performance results through December 31, 2016relative to target, actual issuance of RSAs can fall anywhere between a maximum of 200% and 0% of the target number of PRSAs originally granted. As ofDecember 31, 2016, future compensation cost related to the nonvested portion of the PRSAs not yet recognized in the consolidated statement of operationswas $0.2 million and is expected to be recognized over a weighted average period of 1.69 years.The following table summarizes the Company's PRSA activity from January 1, 2016 to December 31, 2016: NonvestedPRSAs Outstanding WeightedAverageGrant DateFair Value AggregateIntrinsicValueNonvested PRSAs, January 1, 2016 — $— $—PRSAs granted 70,423 7.10 500,003PRSAs vested — — PRSAs canceled — — Performance adjustments (8,360) Nonvested PRSAs, December 31, 2016 62,063 $7.10 $440,647The PSOs were granted at "maximum" (at 200% of target). Based on actual attainment of the operating performance results through December 31, 2016relative to maximum, actual issuance of stock options can fall anywhere between 100% and 0% of the maximum number of PSOs originally granted. As ofDecember 31, 2016, future compensation cost related to the nonvested portion of the PSOs not yet recognized in the consolidated statement of operationswas $0.2 million and is expected to be recognized over a weighted average period of 1.69 years.F-31Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)10. STOCK-BASED COMPENSATION (Continued)The following table summarizes the Company's PSO activity from January 1, 2016 to December 31, 2016: PSOs Outstanding WeightedAverageGrant Date Fair Value AggregateIntrinsicValuePSOs Outstanding, January 1, 2016 — $— $—PSOs granted 314,465 3.24 1,000,242PSOs released — — PSOs cancelled — Performance adjustments (175,898) PSOs Outstanding, December 31, 2016 138,567 3.24 440,750Vested and expected to vest at December 31, 2016 — — —Exercisable at December 31, 2016 — $— $—Market Conditioned:In addition to the market condition, the MRSAs and MSOs also have a service condition. Vesting of these MRSAs and MSOs are dependent uponwhether the Company achieves predetermined growth rates of total shareholder return for the two-year measurement period beginning on January 4, 2016 andending on December 29, 2017. Following the end of the market performance measurement period on December 29, 2017, MRSAs and MSOs issued based ontotal shareholder return will vest annually on a pro-rata basis over three years beginning April 4, 2018. The Company records compensation expense ratablyfor each vesting tranche of the MRSAs and MSOs based on the Monte Carlo fair value estimated on the grant date, regardless of meeting or not meeting themarket conditions.The MRSAs were granted at "target" (at 100% of target). Based upon actual attainment of total shareholder return growth rate results through December29, 2017 relative to target, actual issuance of RSAs can fall anywhere between a maximum of 200% and 0% of the target number of MRSAs originallygranted. As of December 31, 2016, future compensation cost related to the nonvested portion of the MRSAs not yet recognized in the consolidated statementof operations was $0.3 million and is expected to be recognized over a weighted average period of 2.56 years.The following table summarizes the Company's MRSA activity from January 1, 2016 to December 31, 2016: NonvestedMRSAs Outstanding WeightedAverageGrant DateFair Value AggregateIntrinsicValueNonvested MRSAs, January 1, 2016 — $— $—MRSAs granted 70,423 6.17 434,510MRSAs vested — — MRSAs canceled — — Nonvested MRSAs, December 31, 2016 70,423 $6.17 $434,510The MSOs were granted at "maximum" (at 200% of target). Based on actual attainment of total shareholder return growth rate results through December29, 2017 relative to maximum, actual issuance of stock options can fall anywhere between 100% and 0% of the maximum number of MSOs originallygranted. As of December 31, 2016, future compensation cost related to the nonvested portion of the MSOs not yet recognized in the consolidated statementof operations was $0.2 million and is expected to be recognized over a weighted average period of 2.56 years.F-32Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)10. STOCK-BASED COMPENSATION (Continued)The following table summarizes the Company's MSO activity from January 1, 2016 to December 31, 2016: MSOs Outstanding WeightedAverageGrant Date Fair Value AggregateIntrinsicValueMSOs Outstanding, January 1, 2016 — $— $—MSOs granted 314,465 0.94 294,550MSOs released — — MSOs cancelled — — MSO Outstanding, December 31, 2016 314,465 — —Vested and expected to vest at December 31, 2016 — — —Exercisable at December 31, 2016 — $— $—11. STOCKHOLDERS' (DEFICIT) EQUITYAt December 31, 2016, 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, 2016 and 2015, the Company had shares of Common Stock issued of 23,450,864 and 23,149,634, respectively, and shares of Common Stockoutstanding of 22,450,864 and 22,149,634, respectively.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, debt facility covenants and other contractual limitations, and applicable legal requirements. For the year endedDecember 31, 2013, the Company paid $11.4 million to repurchase 1,000,000 shares at a weighted average price of $11.44 per share as part of this program.No shares were repurchased during the years ended December 31, 2014, 2015, or 2016. Shares repurchased under the program were recorded as treasury stockon the Company’s consolidated balance sheet. The shares repurchased under this program during the year ended December 31, 2013 were not the result of anaccelerated share repurchase agreement. Management has not made a decision on whether shares purchased under 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. The Company has not paid any cash dividends on its common stock and does not intend to do so inthe foreseeable future.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, $2.0 million, and $2.2 million for theyears ended December 31, 2016, 2015 and 2014, respectively.13. RESTRUCTURING AND OTHER EMPLOYEE SEVERANCE2016 Restructuring ActionsIn the first quarter of 2016, the Company announced and initiated actions to withdraw the direct sales presence in almost all of its non-U.S. and non-northern European geographies related to the distribution of Enterprise & Education Language offerings. The Company has also initiated processes to closeits software development operations in France and China.F-33Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)13. RESTRUCTURING AND OTHER EMPLOYEE SEVERANCE (Continued)Restructuring charges included in the Company’s consolidated statement of operations related to the 2016 Restructuring Plan include the following:•Employee severance and related benefits costs incurred in connection with headcount reductions involving employees primarily in France,China, Brazil, Canada, Spain, Mexico, U.S. and the U.K.;•Contract termination costs associated with operating lease terminations from office closures; and•Other related costs.The following table summarizes activity with respect to the restructuring charges for the 2016 Restructuring Plan during the year ended December 31,2016 (in thousands): Balance at January 1,2016 Cost Incurred Cash Payments Other Adjustments (1) Balance at December 31,2016Severance costs $— $4,367 $(3,867) $— $500Contract termination costs — 165 (74) (69) 22Other costs — 590 (399) (121) 70Total $— $5,122 $(4,340) $(190) $592(1) Other Adjustments includes non-cash period changes in the liability balance, which may include non-cash lease closure expense and foreigncurrency translation adjustments.2015 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. During 2016, the final payments were made against the 2015 Restructuring Plan accruals and the Company does not expect to incur anyadditional restructuring costs in connection with the 2015 Plan.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.The following table summarizes activity with respect to the restructuring charges for the 2015 Restructuring Plan during the years ended December 31,2015 and December 31, 2016 (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.F-34Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)13. RESTRUCTURING AND OTHER EMPLOYEE SEVERANCE (Continued) Balance at January 1,2016 Cost Incurred Cash Payments Balance at December 31,2016Severance costs $252 $71 $(323) $—Contract termination costs — — — —Other costs — — — —Total $252 $71 $(323) $—Restructuring CostThe following table summarizes the major types of costs associated with the 2016 and 2015 Restructuring Plans for the years ended December 31, 2016and 2015, and total costs incurred through December 31, 2016 (in thousands): Years endedDecember 31, Incurred through 2016 2015 December 31, 2016Severance costs $4,438 $7,240 $11,678Contract termination costs 165 1,134 1,299Other costs 590 417 1,007Total $5,193 $8,791 $13,984As of December 31, 2016, the entire restructuring liability of $0.6 million was classified as a current liability within accrued compensation and othercurrent liabilities on the consolidated balance sheets.The following table presents restructuring costs associated with the 2016 and 2015 Restructuring Plans included in the related line items of ourStatement of Operations (in thousands): Years endedDecember 31, 2016 2015Cost of revenue $573 $113Sales and marketing 2,324 4,492Research and development 913 602General and administrative 1,383 3,584Total $5,193 $8,791These restructuring expenses are not allocated to any reportable segment under our definition of segment contribution as defined in Note 17 "SegmentInformation."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 receivedF-35Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)13. RESTRUCTURING AND OTHER EMPLOYEE SEVERANCE (Continued)approval from the French Labour Administration and when the specific employees impacted were determined. These criteria were met in the third quarter of2014 and the Company recorded an accrual and related expense of $1.0 million. Severance payments totaling $0.5 million related to this reduction in forcewere paid during the fourth quarter of 2014 and $0.4 million was paid in 2015.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 was paid in 2016.As of December 31, 2016, the Company does not expect any further activity associated with the 2014 Employee Severance Actions and wereconsidered closed and remaining accruals were reversed.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 a further effort to reduce general and administrative expenses through a planned space consolidation, effective October 10, 2016, the Companyrelocated its headquarters location to 1621 North Kent Street, Suite 1200, Arlington, Virginia 22209. The previously leased space at the 7th floor of 1919North Lynn Street was abandoned and ceased to be used by the Company on October 10, 2016 and resulted in $1.6 million in lease abandonment expense inthe fourth quarter of 2016.A summary of the Company’s lease abandonment activity for the years ended December 31, 2016 and 2015 is as follows (in thousands): As of December 31, 2016 2015Accrued lease abandonment costs, beginning of period $1,282 $1,679Costs incurred and charged to expense 1,644 55Principal reductions (803) (452)Accrued lease abandonment costs, end of period $2,123 $1,282Accrued lease abandonment costs liability: Short-term $1,047 $455Long-term 1,076 827Total $2,123 $1,282F-36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, 2016 and 2015 (inthousands): As ofDecember 31, 2016 2015Deferred tax assets: Inventory $735 $564Net operating and capital loss carryforwards 61,174 48,334Deferred revenue 10,862 13,908Accrued liabilities 6,975 9,780Stock-based compensation 4,440 4,656Amortization and depreciation 1,056 31Bad debt reserve 389 398Foreign and other tax credits 1,881 1,517Gross deferred tax assets 87,512 79,188Valuation allowance (78,363) (70,464)Net deferred tax assets 9,149 8,724Deferred tax liabilities: Goodwill and indefinite lived intangibles (6,098) (4,782)Deferred sales commissions (7,060) (7,337)Prepaid expenses (656) (625)Foreign currency translation (1,508) (973)Other — (5)Gross deferred tax liabilities (15,322) (13,722)Net deferred tax liabilities $(6,173) $(4,998)For the year ended December 31, 2016, the Company recorded income tax expense of $2.5 million. The tax expense was primarily related to currentyear profits of operations in Germany and the U.K. Additionally, the tax expense relates to the tax impact of the amortization of U.S. indefinite-livedintangible assets and the inability to recognize tax benefits associated with current year 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 of these entities.For the year ending 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.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, respectively. Additionally, no tax benefits were provided on2012 losses incurred in foreign jurisdictions where the Company has determined a valuation allowance is required. As of December 31, 2016, a full valuationallowance was provided for domestic and certain foreign deferred tax assets in those jurisdictions where the Company has determined the deferred tax assetswill 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.F-37Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)15. INCOME TAXES (Continued)As of December 31, 2016, 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 Total2017-2021 $— $679 $— $— $— $— $6792022-2026 — 2,308 — — 11,824 — 14,1322027-2031 — 11,526 — — — 377 11,9032032-2036 86,621 76,568 — — — 3 163,1922037-2041 39,304 33,777 — — — 909 73,990Indefinite — — 4,309 8,193 — 665 13,167Totals $125,925 $124,858 $4,309 $8,193 $11,824 $1,954 $277,063As of December 31, 2016, the Company had federal and state capital loss carryforward amounts and expiration periods as follows (in thousands):Year of Tax Capital Loss Expiration U.S. Federal State2017-2021 $6,837 $4,9472022-2026 — —2027-2031 — 1282032-2036 — —2037-2041 — —Indefinite — —Totals $6,837 $5,075As of December 31, 2016, the Company had federal tax credit carryforward amounts and expiration periods as follows (in thousands):Year of Tax Credit Expiration U.S. Federal2017-2021 $—2022-2026 1,5172027-2031 1212032-2036 2182037-2041 —Indefinite 25Totals $1,881F-38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, 2016 2015 2014United States $(24,963) $(41,458) $(60,434)Foreign (84) (4,179) (19,761)Loss before income taxes $(25,047) $(45,637) $(80,195)The provision for taxes on income consists of the following (in thousands): Federal $— $(157) $29State 78 96 23Foreign 1,250 444 1,258Total current $1,328 $383 $1,310Deferred: Federal $1,147 $1,148 $(5,425)State 169 169 (797)Foreign (141) (541) (1,577)Total deferred 1,175 776 (7,799)Provision (benefit) for income taxes $2,503 $1,159 $(6,489)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, 2016 2015 2014Income tax benefit at statutory federal rate $(8,766) $(15,973) $(28,068)State income tax expense, net of federal income tax effect 219 231 (782)Acquired intangibles — — —Nondeductible goodwill impairment 604 1,961 —Other nondeductible expenses 384 88 482Tax rate differential on foreign operations (474) (1,019) 276Increase in valuation allowance 10,404 15,713 21,772Tax audit settlements — (96) —Change in prior year estimates — 225 (69)Other tax credits 129 29 (102)Other 3 — 2Income tax expense (benefit) $2,503 $1,159 $(6,489)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, 2016 and 2015, the Company had no unrecognized tax benefits or interest and penalties.F-39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, 2016 2015Balance at January 1, $— $446Increases for tax positions taken during prior years — —Settlements with tax authorities — (446)Reductions for tax positions taken during prior years — —Lapse of statute of limitations — —Balance at December 31, $— $—The 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. The Company does not expect that the amounts of unrecognized tax benefitswill change significantly within the next twelve months.The Company had an accumulated consolidated deficit related to its foreign subsidiaries of $21.6 million at December 31, 2016 and aggregate 2016losses before income tax related to its foreign subsidiaries of approximately $0.1 million. The Company has certain foreign subsidiaries with aggregateundistributed earnings of $12.0 million at December 31, 2016. The foreign subsidiaries with aggregate undistributed earnings are considered indefinitelyreinvested as of December 31, 2016. 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 $0.8 million, $1.4 million, and $1.7 million, in 2016, 2015 and 2014, 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.F-40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, 2016 and the years thereafter (in thousands): As ofDecember 31,2016Periods Ending December 31, 2017 $4,5522018 4,3632019 1,7412020 1,0042021 590Thereafter —Total future minimum operating lease payments $12,250Total expenses under operating leases were $4.0 million, $5.1 million and $5.6 million during the years ended December 31, 2016, 2015 and 2014,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 offerings. 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 $0.3 million, $0.2 million, and$31,000 for the years ended December 31 2016, 2015 and 2014, 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.LitigationFrom 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 INFORMATIONIn March 2016, the Company announced its strategy to position the organization for success. The Company has prioritized the growth of literacy salesand is taking actions to align resources to drive this growth. As a result of this shift, the Company reevaluated its segment structure. Prior to the strategy shift,the Company was managed in two operating segments - "Enterprise & Education" and "Consumer". Following the shift, the Company is managed in threeoperating segments - "Enterprise & Education Language", "Literacy", and "Consumer". The current Literacy segment was previously a component of the"Enterprise & Education" segment and is comprised solely of the Lexia business. The Literacy segment focuses on delivering subscription-based Englishliteracy-learning and assessment solutions to grades K through 12. The Company'sF-41Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)17. SEGMENT INFORMATION (Continued)current operating segments also represent the Company's reportable segments. The Company will continue to evaluate its management reporting and willupdate its operating and reportable segments as appropriate.The Company assesses profitability of each segment in terms of segment contribution. Segment contribution is the measure of profitability used by ourChief Operating Decision Maker ("CODM"). The CODM assesses profitability and performance of the Company on its current operating segments. Segmentcontribution includes segment revenue and expenses incurred directly by the segment, including material costs, service costs, customer care and coachingcosts, sales and marketing expenses, and bad debt expense. Segment contribution excludes depreciation, amortization, stock compensation, research anddevelopment, restructuring related expenses, and other non-recurring expenses. The Company does not allocate expenses beneficial to all segments, whichinclude certain general and administrative expenses such as legal fees, payroll processing fees, and accounting related expenses. These expenses are includedin the unallocated expenses section in the following table. Revenue from transactions between the Company's operating segments is not material. Priorperiods have been reclassified to reflect our current segment presentation and definition of segment contribution.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.Operating results by segment for the years ended December 31, 2016, 2015, and 2014 were as follows (in thousands, except percentages): Years Ended December 31, 2016 2015 2014Revenue: Enterprise & Education Language $72,083 $76,129 $74,788Literacy 34,123 21,928 9,912Consumer 87,883 119,613 177,153Total revenue $194,089 $217,670 $261,853Segment contribution: Enterprise & Education Language $28,304 $21,321 $16,945Literacy 5,634 729 (2,984)Consumer 21,120 30,047 28,012Total segment contribution $55,058 $52,097 $41,973Unallocated expenses, net: Unallocated cost of sales 5,624 3,023 2,775Unallocated sales and marketing 6,574 9,303 7,632Unallocated research and development 26,273 29,939 33,176Unallocated general and administrative 37,933 46,836 53,095Unallocated impairment 3,930 6,754 20,333Unallocated lease abandonment and termination 1,644 55 3,812Unallocated non-operating (income)/expense (1,873) 1,824 1,345Total unallocated expenses, net $80,105 $97,734 $122,168Loss before income taxes $(25,047) $(45,637) $(80,195) Segment contribution margin: Enterprise & Education Language 39.3% 28.0% 22.7 %Literacy 16.5% 3.3% (30.1)%Consumer 24.0% 25.1% 15.8 %F-42Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)17. SEGMENT INFORMATION (Continued)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, 2016, 2015 and 2014, respectively (in thousands): Years Ended December 31, 2016 2015 2014United States $162,815 $177,966 $212,070International 31,274 39,704 49,783Total revenue $194,089 $217,670 $261,853The information below summarizes long-lived assets by geographic area classified as held and used for the years ended December 31, 2016 and 2015,respectively (in thousands): As of December 31, 2016 2015United States $21,652 $18,704International 3,143 3,828Total property and equipment, net $24,795 $22,532Revenue 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, 2016, 2015 and 2014, respectively (in thousands): As of December 31, 2016 2015 2014Language learning $155,532 $191,568 $249,340Literacy 34,123 21,928 9,912Brain Fitness 4,434 4,174 2,601Total revenue $194,089 $217,670 $261,85318. RELATED PARTIESAs of December 31, 2016 and 2015, the Company had outstanding receivables from employees in the amount of $22,000 and $18,000, respectively.F-43Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)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, 2016 2015 2014Allowance for doubtful accounts: Beginning balance $1,196 $1,434 $1,000Charged to costs and expenses 709 1,657 2,405Deductions—accounts written off (833) (1,895) (1,971)Ending balance $1,072 $1,196 $1,434Promotional rebate and coop advertising reserves: Beginning balance $16,910 $23,437 $13,025Charged to costs and expenses 18,337 40,563 39,249Deductions - reserves utilized (29,279) (47,090) (28,837)Ending balance $5,968 $16,910 $23,437Sales return reserve: Beginning balance $3,728 $3,570 $4,834Charged against revenue 5,034 11,474 12,011Deductions—reserves utilized (7,424) (11,316) (13,275)Ending balance $1,338 $3,728 3,570Deferred income tax asset valuation allowance: Beginning balance $70,464 53,809 33,866Charged to costs and expenses 7,899 16,655 19,943Deductions — — —Ending balance $78,363 $70,464 $53,809F-44Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)20. SUPPLEMENTAL QUARTERLY FINANCIAL INFORMATION (Unaudited)Summarized quarterly supplemental consolidated financial information for 2016 and 2015 are as follows (in thousands, except per share amounts): Three Months Ended March 31, June 30, September 30, December 31,2016 Revenue $48,002 $45,716 $48,693 $51,678Gross profit $39,954 $37,752 $40,322 $41,740Net loss $(7,507) $(8,978) $(5,452) $(5,613)Basic loss per share $(0.34) $(0.41) $(0.25) $(0.25)Shares used in basic per share computation 21,867 21,948 21,993 22,065Diluted loss per share $(0.34) $(0.41) $(0.25) $(0.25)Shares used in diluted per share computation 21,867 21,948 21,993 22,0652015 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 21,80121. SUBSEQUENT EVENTSExtension of Credit FacilityOn March 10, 2017, the Company entered into the sixth amendment to its credit facility, which primarily extended the term to April 1, 2020.Definitive Agreement with SOURCENEXTOn March 13, 2017, the Company entered into a series of agreements (the “Agreement”) with SOURCENEXT Corporation, (“SOURCENEXT”), aleading software distributor and developer in Japan. Under the Agreement, the Company will provide a perpetual, exclusive license of certain brands andtrademarks, including the primary Rosetta Stone brand, and product code for exclusive development and sale of language and education-related products inJapan.In conjunction with the Agreement, the Company will receive approximately $9 million and if certain additional brand licensing and technologytransfers are successfully completed, SOURCENEXT will pay the Company an additional $4 million, net of adjustments. In addition, the Company isguaranteed to receive minimum payments totaling an additional $6 million over the next ten years. Finally, as part of the Agreement, the Company will havethe first right to license and sell any products developed by SOURCENEXT under the Rosetta Stone trademark in territories outside of Japan.F-45Table of ContentsEXHIBIT INDEX Index to exhibits3.1 Second Amended and Restated Certificate of Incorporation (incorporated herein by reference to Exhibit 3.2 to Amendment No. 3 to theCompany’s Registration Statement on Form S-1 (No. 333-153632) filed on February 23, 2009).3.2 Third Amended and Restated Bylaws (incorporated herein by reference to Exhibit 3.1 filed with the Company's Current Report on Form 8-Kfiled on November 22, 2016).4.1 Specimen certificate evidencing shares of common stock (incorporated herein by reference to Exhibit 4.1 to Amendment No. 3 to theCompany’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 Investor Shareholders and other Shareholderslisted on Exhibit A thereto (incorporated herein by reference to Exhibit 4.3 to Amendment No. 1 to the Company’s Registration Statementon Form S-1 (No. 333-153632) filed on November 5, 2008).10.1+2006 Incentive Option Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s Registration Statement on Form S-1 (No.333-153632) filed on September 23, 2008).10.2+2009 Omnibus Incentive Plan, as amended and restated and effective June 12, 2015 (incorporated herein by reference to Exhibit 99.1 filedwith the Company’s Registration Statement on Form S-8 (No. 333-204904) filed on June 12, 2015).10.3+Director Form of Option Award Agreement under the 2006 Plan (incorporated herein by reference to Exhibit 10.3 to the Company’sRegistration 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 10.6 to the Company’s AnnualReport 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 Exhibit 10.4 to the Company’sRegistration 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 to Exhibit 10.5 to the Company’sAnnual 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 byreference to Exhibit 10.25 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011).10.8+Amended Executive Form of Option Award Agreement under 2009 Plan effective for awards after February 1, 2016 (incorporated herein byreference to Exhibit 10.11 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015).10.9+Amended Executive Form of Option Award Agreement under 2009 Plan effective for awards granted May 9, 2016 (incorporated herein byreference to Exhibit 10.3 in the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2016.)10.10+Form of Restricted Stock Award Agreement under the 2009 Plan (incorporated herein by reference to Exhibit 10.13 to Amendment No. 4 tothe Company’s Registration Statement on Form S-1 (No. 333-153632), filed on March 17, 2009).10.11+Amended Executive Form of Restricted Stock Award Agreement under 2009 Plan effective for awards after October 1, 2011 (incorporatedherein by reference to Exhibit 10.26 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011).10.12+Amended Executive Form of Restricted Stock Award Agreement under 2009 Plan effective for awards after February 1, 2016 (incorporatedherein by reference to Exhibit 10.11 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015).10.13+Amended Executive Form of Restricted Stock Award Agreement under 2009 Plan effective for awards granted May 9, 2016 (incorporatedherein by reference to Exhibit 10.3 in the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2016.)10.14+Director Form of Restricted Stock Unit Award Agreement under the 2009 Plan (incorporated herein by reference to Exhibit 10.12 in theCompany’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014).10.15+Director Form of Restricted Stock Unit Award Agreement under the 2009 Plan (for awards beginning June 2015) (incorporated herein byreference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2015)10.16+2013 Rosetta Stone Inc. Long Term Incentive Program (pursuant to the Rosetta Stone Inc. 2009 Omnibus Incentive Plan) (incorporatedherein by reference to Exhibit 10.24 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014).Table of Contents Index to exhibits10.17+Form of Award Agreement under the 2013 Long Term Incentive Program (incorporated herein by reference to Exhibit 10.25 in theCompany’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014).10.18+2014 Executive Bonus Plan (incorporated herein by reference to Exhibit 10.23 in the Company’s Annual Report on Form 10-K for the fiscalyear ended December 31, 2014).10.19+Policy on Recoupment of Performance Based Compensation (Clawback Policy) (incorporated herein by reference to Exhibit 10.26 in theCompany’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014).10.20+Rosetta Stone Inc. Change in Control Severance Plan (incorporated herein by reference to Exhibit 10.18 in the Company's Annual Report onForm 10-K for the fiscal year ended December 31, 2015.)10.21 Form of Indemnification Agreement entered into with each director and executive officer (incorporated herein by reference to Exhibit 10.7 tothe Company’s Registration Statement on Form S-1 (No. 333-153632) filed on September 23, 2008).10.22 Form of Indemnification Agreement to be entered into with each director and executive officer, revised as of August 2015 (incorporatedherein by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2015).10.23+Executive Employment Agreement between Rosetta Stone Ltd. and Stephen Swad effective as of November 9, 2010 (incorporated herein byreference to Exhibit 10.1 filed with the Company’s Current Report on Form 8-K filed on October 13, 2010).10.24+Amendment to Executive Employment Agreement between Rosetta Stone Ltd. and Stephen Swad effective as of December 22, 2011(incorporated herein by reference to Exhibit 10.22 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31,2011).10.25+Second Amendment to Executive Employment Agreement between Rosetta Stone Ltd. and Stephen Swad effective as of February 22, 2012(incorporated herein by reference to Exhibit 10.23 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31,2011).10.26+Executive Employment Agreement between Rosetta Stone Ltd. and Judy Verses effective as of October 5, 2011 (incorporated herein byreference to Exhibit 10.18 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011).10.27+Executive Employment Agreement between Rosetta Stone Ltd. and Thomas Pierno effective as of May 2, 2012 (incorporated herein byreference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on May 1, 2012).10.28+Executive Employment Agreement between Rosetta Stone Ltd. and Eric Ludwig effective as of January 1, 2015 (incorporated herein byreference to Exhibit 10.30 in the Company’s Annual Report on Form 10-K for the fiscal year 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 toExhibit 10.31 in the Company’s Annual Report on Form 10-K for the fiscal year 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 byreference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2015).10.31+Executive Employment Agreement between Rosetta Stone Ltd. and A. John Hass III effective as of April 1, 2016 (incorporated herein byreference to Exhibit 10.1 in the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2016.)10.32+Executive Employment Agreement between the Company and Sonia Cudd, effective as of January 2, 2015 (incorporated herein by referenceto Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2015).10.33 Lease Agreement dated as of February 20, 2006, by and between Premier Flex Condos, LLC and Fairfield Language Technologies, Inc., asamended (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 and Rosetta Stone Ltd.(incorporated herein by reference to Exhibit 10.11 to Amendment No. 1 to the Company’s Registration 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 byreference to Exhibit 10.23 filed with the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012).10.36 Sub-Sublease Agreement dated as of April 3, 2014, by and between Rosetta Stone Ltd. and The Corporate Executive Board Company(incorporated herein by reference to Exhibit 10.27 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31,2014).10.37*Sub-Sublease Agreement dated as of July 14, 2016, by and between Rosetta Stone Ltd. and Snagajob.com, Inc.Table of Contents Index to exhibits10.38+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. 2 to the Company’s Registration Statement on Form S-1 (No.333-153632), filed on January 21, 2009).10.39 Loan and Security Agreement between Rosetta Stone Ltd. and Silicon Valley Bank, executed on October 28, 2014 (incorporated herein byreference to Exhibit 99.3 filed to the Company’s Current Report on Form 8-K filed on October 29, 2014).10.40 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 Quarterly Report on Form 10-Q for the period ended March 31, 2015).10.41 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 Report on Form 10-Q for the period ended March 31, 2015).10.42 Third Amendment to Loan and Security Agreement dated as of June 29, 2015 between Silicon Valley Bank and Rosetta Stone Ltd.(incorporated herein by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2015).10.43 Fourth Amendment to Loan and Security Agreement dated as of December 29, 2015 between Silicon Valley Bank and Rosetta Stone Ltd(incorporated herein by reference to Exhibit 10.42 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31,2015.).10.44 Fifth Amendment to Loan and Security Agreement dated as of March 14, 2016 between Silicon Valley Bank and Rosetta Stone Ltd.(incorporated herein by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2016).10.45*Sixth Amendment to Loan and Security Agreement dated as of March 10, 2017 between Silicon Valley Bank 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.Exhibit 10.37SUB-SUBLEASE AGREEMENTTHIS SUB-SUBLEASE AGREEMENT (this “Sub-Sublease”) is made and entered into as of the 14th day of July, 2016,by and between (i) ROSETTA STONE LTD., a Virginia corporation (“Sub-Sublandlord”) and (ii) Snagajob.com, Inc., aDelaware corporation, (“Sub-Subtenant”).Recitals:A. Paramount Group, Inc. (as successor in interest to Waterview, L.P.) (“Landlord”) and the Corporate Executive BoardCompany (“Tenant”) are parties to that certain Deed of Lease dated as of August 16, 2004 (“Prime Lease”), pursuant to whichTenant leases floors 4 - 24 (the “Prime Lease Premises”) in the building located at 1919 North Lynn Street, Arlington, Virginia, (the“Building”), at the rent and subject to the terms and conditions set forth in the Prime Lease; andB. Tenant (as “Sublandlord”) and Rosetta Stone Ltd. (as “Subtenant”) are parties to that certain Sublease Agreement datedas of October 6, 2008 (the “Original Sublease”), as amended by First Amendment to Sublease Agreement dated November 1, 2012(the “First Amendment to Sublease,” and, together with the Original Sublease, the “Sublease”), pursuant to which Subtenantsubleases a portion of the Prime Lease Premises consisting of the entire rentable area of the 6th and 7th floors of the Building (the“Subleased Premises”) from Sublandlord; andC. Subtenant (as “Sub-Sublandlord”) desires to sub-sublease to Sub-Subtenant, and Sub-Subtenant desires to sub-subleasefrom Sub-Sublandlord a portion of the Subleased Premises consisting of the entire rentable area of the seventh (7th) floor of theBuilding (the “Sub-Subleased Premises”), containing approximately 31,281 rentable square feet as more particularly described inExhibit D, upon the terms and conditions set forth herein.NOW THEREFORE, in consideration of the mutual covenants set forth herein, the parties hereto agree as follows:1.Recitals: Incorporation of Terms. The foregoing recitals, and, subject to Section 6 hereof, the terms and provisionsof the Sublease, are incorporated herein by reference and are made a substantive part of this Sub-Sublease. Capitalized terms notdefined herein shall have the meanings ascribed to such terms in the Sublease (and if not defined therein, then in the Prime Lease). ThisSub-Sublease is subject and subordinate to the Sublease and the Prime Lease in all respects, unless otherwise stated herein. For allpurposes under this Sub-Sublease, the rentable area of the Sub-Subleased Premises is hereby stipulated and agreed to be 31,281rentable square feet, the rentable area of the Sublease Premises is stipulated and agreed to be 62,562 rentable square feet and therentable area of the Building is hereby stipulated and agreed to be 625,062 rentable square feet,1which rentable areas shall not be subject to further calculation, except in the event of a change in the physical size of any such space.2. Sub-Subleased Premises.(a) Sub-Sublease; Condition of Sub-Subleased Premises. As of the Sub-Sublease Commencement Date (defined inSection 3 below), Sub-Sublandlord shall sub-sublease to Sub-Subtenant and Sub-Subtenant shall sub-sublease from Sub-Sublandlord,the Sub-Subleased Premises upon the terms and conditions set forth herein. Sub-Sublandlord shall tender possession of the Sub-Subleased Premises to Sub-Subtenant on the Sub-Sublease Commencement Date, vacant of occupants on the Sub-SubleaseCommencement Date, with the removal, reconfiguration, and other work described in subsections (b), (c) and (e) below completed,and otherwise in broom-clean condition. Sub-Subtenant has fully inspected the Sub-Subleased Premises and, subject to Sub-Sublandlord’s removal and reconfiguration obligations set forth in subsections (b) and (c) below, Sub-Subtenant shall accept the Sub-Subleased Premises in its “as is,” “where-is” condition as of the date hereof, including without limitation all mechanical, electrical andplumbing systems servicing the Sub-Subleased Premises. Sub-Subtenant acknowledges that, except as specifically set forth in this Sub-Sublease, no representations, statements or warranties, express or implied, have been made by or on behalf of Sub-Sublandlord withrespect to the condition of the Sub-Subleased Premises or the Building, and that Sub-Sublandlord has made no representation,statement or warranty as to the leasing of any personal property, fixtures, or equipment in the Sub-Subleased Premises other than theWalls/Partitions, Systems Furniture, Personal Property and Supplemental HVAC (as each such term is defined below).(b) Systems Furniture and Modular Walls/Partitions. The configuration of the Sub-Subleased Premises shallinclude modular walls and partitions, approximately as shown on Exhibit B-l, attached hereto, (“Walls/Partitions”) and officesystems furniture also shown on Exhibit B-l, attached hereto (“Systems Furniture”). Sub-Subtenant shall have the right to use theWalls/Partitions and Systems Furniture as part of the Sub-Subleased Premises at no additional charge, subject to the conditions hereof;provided, however, Subl-Sublandlord agrees to remove any Systems Furniture or Walls/Partitions or Personal Property (hereinafterdefined) designated by Sub-Subtenant , all at Sub-Sublandlords’ sole cost and expense. Sub-Subtenant shall be present to designatesuch items for removal on the day that Sub-Sublandlord moves out of the Subleased Premises. If not insured by the Sublandlord, Sub-Subtenant shall insure the Walls/Partitions and Systems Furniture under the special cause of loss business property insurance requiredby Section 17.A.(1) of the Prime Lease, naming Tenant as loss payee under such policy for the Walls/Partitions and Systems Furniture.Provided that Sub-Subtenant receives the prior written consent of Sublandlord and Sub-Sublandlord, Sub-Sublandlord’s consent not tobe unreasonably withheld, conditioned or delayed, Sub-Subtenant shall have the right to perform modifications to the Wall/Partitionsand/or Systems Furniture in accordance with Section 2(b) of the Sublease.2(c) Office Furniture. In consideration for the rents and other promises contained in this Sub-Sublease, Sub-Sublandlord shall sub-sublease to Sub-Subtenant (and Sub-Subtenant shall sub-sublease from Sub-Sublandlord) the furniture andequipment listed on Exhibit B-2 attached hereto (the “Personal Property”) at no extra cost or expense to Sub-Subtenant. Sub-Sublandlord shall remove any furniture and equipment located in the Sub-Sub-Subleased Premises in excess of that set forth onExhibit B-2 prior to the Sub-Sublease Commencement Date and any items designated by Sub-Subtenant for removal on the day thatSub-Sublandlord moves out of the Sub-Subleased Premises shall be removed within three (3) business days thereafter. The partieshereby agree to amend and replace Exhibit B-2 promptly following such date that Sub-Sublandord surrenders the Sub-SubleasedPremises to Sub-Subtenant. Sub-Sublandlord represents and warrants that Sublandlord is the owner of the Personal Property, except asindicated in Exhibit B-2; however Sub-Sublandlord has full authority to sub-sublease such Personal Property to Sub-Subtenant. Sub-Subtenant shall not have the right to remove all or any Personal Property from the Sub-Subleased Premises and hereby agrees to returnthe Personal Property to Sub-Sublandlord at the end of the Sub-Sublease Term in substantially the same condition as of the date hereof,normal wear and tear and damage from casualty excepted, and Sub-Subtenant shall make any necessary repairs or restoration to suchPersonal Property in the event such damage or restoration is required as a result of the negligent or willful misuse thereof by Sub-Subtenant. Unless insured by Sublandlord, Sub-Subtenant shall be responsible to insure the Personal Property under the special causeof loss business property insurance required by Section 17.A.(1) of the Prime Lease, naming Tenant as loss payee under such policyfor the Personal Property.(d) Supplemental HVAC. As of the date hereof, the Sub-Subleased Premises contains and/or is served bysupplemental HVAC equipment as set forth on Exhibit B-3 (“Supplemental HVAC”). Sub-Subtenant shall have the right to use theSupplemental HVAC under the terms and conditions hereinafter set forth. Sub-Sublandlord makes no representation or warranty as tothe capacity or output of the Supplemental HVAC or to its sufficiency to service Sub-Subtenant’s particular requirements in the Sub-Subleased Premises, and Sub-Subtenant acknowledges that the Supplemental HVAC equipment is in its "as is, where is" condition.Sub-Subtenant shall reimburse Sub-Sublandlord from time to time, within thirty (30) days after invoice therefor, all costs for use of theSupplemental HVAC actually incurred by Sub-Sublandlord pursuant to invoice from Sublandlord, including, without limitation, costsfor electricity and chilled water or condenser water (including any costs for depreciation charged by Landlord as set forth below)serving the Supplemental HVAC for use in the Sub-Sublease Premises. Sub-Sublandlord shall not be required, under anycircumstance, to replace the Supplemental HVAC servicing the Sub-Subleased Premises or to perform repairs or maintenance thereto,but shall use commercially reasonable efforts to cause Sublandlord to require the services covered under Supplement HVAC servicecontract to be performed. Sub-Subtenant shall have no responsibility to replace the Supplemental HVAC or to perform repairs ormaintenance thereto.33. Term.(a) Sub-Sublease Term. The term of this Sub-Sublease (the “Sub-Sublease Term”) shall commence on October 15,2016 (the “Sub-Sublease Commencement Date”) and shall expire at midnight on December 15, 2018 (the “Sub-SubleaseExpiration Date”), unless sooner terminated or cancelled in accordance with the terms of this Sub-sublease. If Sub-Sublandlord hasnot tendered possession of the Sub-Subleased Premises to Sub-Subtenant on or before October 15, 2016, then Sub-Subtenant, at itssole discretion, shall have the right to terminate this Sub-Sublease by delivering written notice of such termination to Sub-Sublandlordany time before October 31, 2016. There shall be no fee, payment, penalty or other sum due from Sub-Subtenant in connection withSub-Subtenant’s exercise of its termination right in this Section 3(a). Notwithstanding anything contained herein to the contrary, theOctober 15, 2016 date set forth above shall be extended one day for each day that Sub-Sublandlord is delayed in delivering the Sub-Subleased Premises to Sub-Subtenant due to actions of Sublandlord, it employees, agents, or contractors or Sub-Subtenant or due tocasualty or Unavoidable Delay.(b) Early Entry. Provided no Default by Sub-Subtenant then exists, from and after the date that is fifteen (15) daysimmediately prior to the Sub-Sublease Commencement Date (such period, the “Early Access Period”), Sub-Subtenant shall bepermitted to access the Sub-Subleased Premises (subject to the provisions of this subsection (b)) for purposes of inspecting same,surveying requirements, moving and performing any move-related tasks, including installing furniture, fixtures, equipment, voice anddata systems, telecommunications cabling and wiring in the Sub-Subleased Premises (subject to the provisions of this Sub-Sublease,including, without limitation, Section 7 of this Sub-Sublease). Such access to the Sub-Subleased Premises shall be subject tocommercially reasonable prior notice to and prompt approval by Sub-Sublandlord (each of which notice and approval may betelephonic or by email correspondence), and shall be at no charge to Sub-Subtenant, but in no event shall Sub-Subtenant be permittedto commence business operations in the Sub-Subleased Premises prior to the Sub-Sublease Commencement Date without the approvalof Sub-Sublandlord. Sub-Sublandlord shall use reasonable efforts to assist with the coordination of Sub-Subtenant’s access to theBuilding and the Sub-Subleased Premises, such assistance shall specifically include coordination with the Building’s propertymanager. Notwithstanding the foregoing, neither Sub-Subtenant nor any agent, contractor, representative, employee or invitee of Sub-Subtenant (collectively, “Invitee”) shall enter the Sub-Subleased Premises during the Early Access Period during those times that Sub-Sublandlord determines, in its reasonable discretion, that such entry will substantially interfere with activities of Sub-Sublandlord orSub-Sublandlord’s agents or employees in the Sub-Subleased Premises. Prior to each such event, Sub-Sublandlord shall notify Sub-Subtenant of specific times during which Sub-Subtenant may make such entry. During the Early Access Period, Sub-Subtenant andany of its Invitees shall use commercially reasonable efforts to neither delay nor otherwise inhibit the work being performed in the Sub-Subleased Premises by Sub-Sublandlord or Sub-Sublandlord’s agents4or employees. Sub-Sublandlord shall have no responsibility with respect to any items placed in the Sub-Subleased Premises by Sub-Subtenant or any Invitee prior to the Sub-Sublease Commencement Date, except to the extent any damage is caused to such propertydue to Sub-Sublandlord’s gross negligence or willful misconduct. Sub-Subtenant shall reimburse Sub-Sublandlord, within thirty (30)days after invoice, all costs actually incurred by Sub-Sublandlord associated with Sub-Subtenant’s access during the Early AccessPeriod, including (i) costs which are billed to Sub-Sublandlord by Sublandlord, including, without limitation, engineering charges orovertime/extra hours service charges associated with non-business hour access to the Building, if any, and (ii) reasonable costs incurredby Sub-Sublandlord in repairing or replacing any damage to the Sub-Subleased Premises required to be repaired by Sublandlord underthe Sublease or (iii) reasonable costs incurred by Sub-Sublandlord in repairing or replacing damage to any property or equipmentlocated therein and required to be repaired by Sublandlord under the Sublease, which damage, in the case of (ii) and (iii) above, wascaused by Sub-Subtenant or its Invitees. Notwithstanding anything in this Sub-Sublease to the contrary, all of the provisions of thisSub-Sublease (including, without limitation, all insurance, indemnity and utility provisions) shall apply during the Early Access Period,except that during such period Sub-Subtenant shall not be obligated to pay Rent.(c) Extension Option. Provided that Sub-Subtenant elects to enter into a direct lease with Landlord, then, at Sub-Subtenant’s election, the Sub-Sublease Extension Date shall be extended to December 31, 2018 upon the same terms and conditionsset forth herein.4. Rent.(a) Base Sub-Subrent. Beginning on the Sub-Sublease Commencement Date, and throughout the Sub-SubleaseTerm, Sub-Subtenant shall pay to Sub-Sublandlord, as base sub-subrent hereunder, an annual rental (“Annual Base Sub-Subrent”)for each Sub-Sublease Year in an amount set forth below, which Annual Base Sub-Subrent shall increase as set forth below. For allpurposes of this Sub-Sublease, the term “Sub-Sublease Year” shall mean, with respect to the first Sub-Sublease Year, the periodcommencing on the Sub-Sublease Commencement Date and ending at midnight on the day immediately before the first anniversary ofthe Sub-Sublease Commencement Date, and, with respect to future Sub-Sublease Years, the one year periods ending on theanniversary of such date thereafter. Annual Base Sub-Subrent through the Sub-Sublease Term shall be as follows:5Sub-Sublease YearAnnual BaseSub-Subrent perRentable SquareFootAnnual Base Sub-SubrentMonthly Installmentof Annual BaseSub-Subrent1(Anticipated to be October 15,2016 - October 14, 2017)*$39.00$1,219,959.00$101,663.252(Anticipated to be October 15,2017 - October 14, 2018$40.17$1,256,557.77$104,713.153(Anticipated to be October 15,2018 to December 15, 2018**)$41.38$1,294,254.50$107,854.54* Subject to abatement as set forth in Section 4(b) below.** Subject to extension pursuant to Section 3(c) above.(b) Subrent Payments. The Annual Base Sub-Subrent for each Sub-Sublease Year shall be payable by Sub-Subtenant to Sub-Sublandlord in equal monthly installments in advance; provided, however, in lieu of payment to Sub-Sublandlord,such payments shall be made directly to Sublandlord by Sub-Subtenant, following prior written notice to Sub-Subtenant signed byboth Sublandlord and Sub-Sublandlord, if and to the extent required pursuant to the Consent (defined in Section 23 hereof). Allpayments of Annual Base Sub-Subrent shall be due and payable on the first day of each and every calendar month during the Sub-Sublease Term. Sub-Subtenant’s obligation to pay Annual Base Sub-Subrent hereunder that accrues during the Sub-Sublease Termshall survive the expiration or earlier termination of this Sub-Sublease. In the event that the Sub-Sublease Term commences on a dateother than the first day of a calendar month or expires on a day other than the last day of a calendar month, Annual Base Sub-Subrentowed for less than a full month shall be prorated on the basis of a 30-day month. Notwithstanding anything herein to the contrary, thefirst three (3) full calendar months’ installments of Annual Base Sub-Subrent shall be abated (e.g. if the Sub-Sublease CommencementDate is October 15, 2016, the monthly installment of Annual Base Sub-Subrent shall be abated for November 2016, December 2016and January 2017).(c) Additional Sub-Subrent. For purposes hereof “Additional Sub-Subrent” means all other amounts (other thanAnnual Base Sub-Subrent) payable by Sub-Subtenant to Sub-Sublandlord pursuant to this Sub-Sublease, including, without limitation,costs arising from Sub-Subtenant’s use of the Supplemental HVAC for servicing the Sub-Subleased Premises or electrical usage orcosts incurred by Sub-Sublandlord under the Sublease arising or resulting from Sub-6Subtenant’s use of the Sub-Subleased Premises, including Sub-Subtenant’s payment obligations pursuant to Section 10 below. AnnualBase Sub-Subrent hereunder shall be gross rent, such that Sub-Subtenant shall not be responsible to pay any pass-through expenserental in connection with this Sub-Sublease, such as those in Sections 5 B. and C of the Prime Lease and the Pass-Through ExpenseRental (as defined in the Sublease) which includes both Operating Expenses and Real Estate Tax Expenses. Sub-Sublandlord shallcontinue to be responsible at its sole cost and expense to pay all such Pass-Through Expense Rental required under the Sublease,including Pass-Through Expense Rental for the Sub-Subleased Premises. “Rent” as used herein shall mean Annual Base Sub-Subrentand Additional Sub-Subrent.5. Permitted Use; Access. The Sub-Subleased Premises shall be used by Sub-Subtenant only for general office use and usesancillary thereto in accordance with all applicable Laws and for no other purpose, except as may be permitted by Sublandlord and thePrime Lease to the contrary. Subject to the provisions of the Prime Lease and this Sublease, Sub-Sublandlord shall not interfere withSub-Subtenant’s accessing the Sub-Subleased Premises in accordance with Section 12.A.(7) of the Prime Lease. Unless a longer timeperiod is required pursuant to the terms of the Sublease or Prime Lease, Sub-Sublandlord shall not access the Sub-Subleased Premisesunless Sub-Sublandlord has provided Sub-Subtenant at least twenty-hour (24) hours’ advance written notice (except in case ofemergency).6. Compliance with Sublease.(a) Obligations under the Sublease. Sub-Subtenant hereby acknowledges that it has read the Sublease, a true, correctand complete copy of which is attached hereto as Exhibit C and, except as set forth below, such Sublease is incorporated herein byreference as fully as if the terms and provisions thereof were set forth herein. Sub-Subtenant agrees to assume the same responsibilitiesand duties that the Sub-Sublandlord has as “Subtenant” to the Sublandlord with respect to the Sub-Subleased Premises, exceptingmatters relating to the identification of the Sub-Subleased Premises, and the amount and due dates of the rentals payable therefor, andother excluded or modified terms set forth herein provided, however, in no event shall Sub-Sublandlord be deemed to have assumedthe responsibilities of the Sublandlord under the Sublease, unless such responsibilities have been expressly assumed herein.Notwithstanding the foregoing, upon the written request of Sub-Subtenant, Sub-Sublandlord agrees to use commercially reasonableefforts to enforce its rights under the Sublease against Sublandlord with respect to the Sub-Subleased Premises. Sub-Subtenant shallhave the right, at Sub-Subtenant’s sole cost and expense, to obtain consents, approvals and waivers directly from Sublandlord, andshall have the right to contact Sublandlord directly for enforcement of obligations of Sublandlord with respect to the Sublease so longas the obligations of Sub-Sublandlord as Subtenant under the Sublease are not increased by any of the foregoing and Sub-Sublandlorddoes not incur any additional costs or expenses under the Sublease resulting therefrom (or Sub-Subtenant agrees to reimburse Sub-Sublandlord for such7costs or expenses). If both Sublandlord’s and Sub-Sublandlord’s consent, approval or waiver are required pursuant to the terms of thisSub-Sublease and there are additional costs and expenses in connection with Sublandlord’s consent, approval or waiver, Sub-Sublandlord shall not charge Sub-Subtenant any additional amount in connection with its request for consent, approval or waiver.(b) Incorporation of Sublease Provisions. In furtherance of the provisions of Section 6(a), except as otherwisespecifically provided for herein and to the extent they are not inconsistent with the terms and conditions of this Sub-Sublease, the sub-subletting effected hereby shall be upon all of the terms and conditions of the letting effected by the Sublease, except the provisions ofthe Sublease relating to “Sublandlord” shall be deemed to refer to Sub-Sublandlord, the provisions thereof relating to “Subtenant” shallbe deemed to refer to Sub-Subtenant, the provisions of the Sublease relating to the Sublet Premises (as defined in the Sublease) shall bedeemed to refer to the Sub-Subleased Premises, the provisions of the Sublease referring to the Sublease shall be deemed to refer to thisSub-Sublease, and the provisions of the Sublease relating to “Rent” shall be deemed to refer to Annual Base Sub-Subrent andAdditional Sub-Subrent (unless, in any of the foregoing cases, the context otherwise requires). The foregoing notwithstanding, thefollowing provisions of the Sublease shall not be applicable to this Sub-Sublease (except for the definitions contained therein): Section4, 5, 7, 8, 11 (except for the requirements of the Letter of Credit), 12, 13, 15, and 16. With respect to the relationship between the Sub-Sublandlord and the Sub-Subtenant, the express terms and conditions of the Sub-Sublease shall govern (and where the Sub-Sublease issilent, the Sublease shall govern). If Sublandlord shall default in the performance of any of its covenants or obligations under theSublease, Sub-Subtenant shall have the right, in the name of Sub-Sublandlord, to make any demand or institute any action orproceeding at law or in equity or otherwise against Sublandlord permitted under the Sublease for the enforcement of Sublandlord’sobligations or covenants under the Sublease.(c) Avoidance of Sublease Termination. Sub-Sublandlord and Sub-Subtenant each shall take no action or permitanything to be done which would cause a termination of the Prime Lease or the Sublease (provided that Sub-Sublandlord shall beentitled to terminate the Sublease pursuant to Section 9 of the Sublease in connection with the exercise of its rights following anycondemnation or casualty affecting the Sub-Subleased Premises). Each of Sub-Sublandlord and Sub-Subtenant shall indemnify, defendand hold the other harmless from and against any loss, cost, damage or expense (including, without limitation, court costs andreasonable attorneys’ fees) incurred as a result of a breach by Sub-Sublandlord or Sub-Subtenant, as the case may be, of the foregoingcovenant. Without limiting any other right or remedy of Sub-Subtenant, if Sublandlord seeks to terminate the Sublease in connectionwith the default or alleged default by Sub-Sublandlord (or Subtenant under the Sublease), Sub-Sublandlord shall take all actionrequired to maintain the Sublease in full force and effect for the benefit of Sub-Subtenant, and Sub-Sublandlord shall take all actionrequired to reinstate the Sublease.8(d) Actions Requiring Sublandlord Consent. Whenever Sub-Subtenant desires to take any action that would requirethe consent of Sublandlord under the Sublease, Sub-Subtenant shall only take such action if the consent of each of Sublandlord andSub-Sublandlord is obtained, which consent, in the case of Sub-Sublandlord, shall automatically be deemed obtained if consented toby Sublandlord so long as the obligations of Sub-Sublandlord as Subtenant under the Sublease are not increased by any of theforegoing and Sub-Sublandlord does not incur any additional costs or expenses under the Sublease resulting therefrom (or Sub-Subtenant agrees to reimburse Sub-Sublandlord for such costs or expenses).7. Alterations, Electrical Usage.(a) Alterations.(i) Sub-Subtenant shall not make or permit to be made any alterations, additions, improvements, ormodifications to the Sub-Subleased Premises (an “alteration”) without (i) the prior written consent of Sub-Sublandlord andSublandlord, the latter’s consent to be deemed granted in accordance with Section 6(d) above or, if Section 6(d) is not applicable, suchconsent not to be unreasonably withheld, conditioned or delayed, and (ii), to the extent required by the Prime Lease, the prior writtenconsent of Landlord. If the alteration is a Cosmetic Alteration, then Sub-Sublandlord’s consent shall not be required (but Sub-Subtenant shall notify Sub-Sublandlord of such alteration). A “Cosmetic Alteration” is an alteration that is (i) cosmetic in nature (e.g.,painting, wallcoverings, carpeting, hanging of artwork, and the like), and (ii) does not require a building permit to perform. If thealteration is other than a Cosmetic Alteration, then Sub-Sublandlord’s consent shall be required, which consent shall not beunreasonably withheld, conditioned or delayed (and which consent shall be deemed obtained if no response is made by Sub-Sublandlord to Sub-Subtenant’s request for consent within ten (10) days after Sub-Subtenant’s delivery of such written request to Sub-Sublandlord). Any alterations shall be made at Sub-Subtenant’s expense, in a good and workmanlike manner by contractors andsubcontractors approved by Sublandlord, and, if required by the Prime Lease, by Landlord, provided, however, with respect toalterations affecting the Walls/Partitions or Systems Furniture, Sub-Subtenant shall use contractors, subcontractors and vendorsdesignated by Sublandlord. All alterations shall be made only after Sub-Subtenant: (i) has obtained all necessary permits fromgovernmental authorities having jurisdiction and has furnished copies thereof to Sublandlord, and (ii) has complied with all otherrequirements reasonably imposed by Sublandlord, including without limitation any requirements due to the underwriting guidelines ofSublandlord’s insurance carriers. At Sub-Subtenant’s expense, Sub-Sublandlord shall join in submitting Sub-Subtenant’s plans for anynecessary governmental approval, if required by applicable law. Sub-Sublandlord’s consent (or deemed consent) to any alterations andapproval (or deemed approval) of any plans and specifications constitutes approval of no more than the concept of these alterations andnot a representation or warranty with respect to the quality or functioning of such alterations, plans and specifications. Sub-Subtenantshall reimburse Sub-Sublandlord any9charge actually incurred by Sub-Sublandlord by invoice from Sublandlord in connection with any alteration performed by or on behalfof Sub-Subtenant hereunder, and Sub-Sublandlord shall not charge Sub-Subtenant any amount in addition thereto. Sub-Subtenanthereby agrees to indemnify and hold Sub-Sublandlord harmless against and from any and all claims, damages, costs, and fines arisingsolely out of the alterations performed by or on behalf of Sub-Subtenant hereunder, except to the extent caused by the negligence orwillful misconduct of Sub-Sublandlord or anyone acting by or through Sub-Sublandlord.(ii) All alterations performed by or on behalf of Sub-Subtenant shall remain in place at the end of the Sub-Sublease Term unless Sublandlord requires removal of same in writing, in which event, Sub-Subtenant shall be responsible to restorethose portions of the Sub-Subleased Premises altered by Sub-Subtenant that are required to be restored by Sublandlord, at Sub-Subtenant’s sole cost and expense on or prior to the end of the Sub-Sublease Term (including any early termination thereof). UnlessSublandlord requires removal of any or all alterations performed by or on behalf of Sub-Subtenant, Sub-Subtenant shall have noobligation to remove the same. Upon written request from Sub-Subtenant to Sub-Sublandlord, as permitted under Section 8(B) of theFirst Amendment to Sublease, Sub-Sublandlord shall promptly request Sublandlord’s determination of the restoration or removal ofWalls/Partitions and Systems Furniture proposed by Sub-Sublandlord to be modified in accordance with the provisions of this Sub-Sublease, by delivering written request of such determination to Sublandlord, accompanied by a set of plans and specificationsshowing the proposed modifications (including identifying items that will be removed or altered). Sub-Sublandlord shall usecommercially reasonable efforts to enforce its right under the Sublease to cause Sublandlord to respond within ten (10) business daysfollowing receipt of Sub-Sublandlord’s written request for Sublandlord’s determination (together with the plans and specificationsregarding the proposed modification) as to whether Sublandlord will require the restoration or removal of the proposed modifications tothe Walls/Partitions and/or Systems Furniture. Sublandlord’s determination shall be promptly delivered to Sub-Subtenant after Sub-Sublandlord’s receipt thereof. Notwithstanding anything to the contrary in this Sub-Sublease, the Sublease or the Prime Lease, Sub-Subtenant shall have no obligation to make or cause improvements or alterations the Sub-Subleased Premises and shall have noliability or responsibility to remove or restore any alterations made to the Sub-Subleased Premises prior to the Commencement Date ofthis Sub-Sublease.(iii) Electrical Usage. Except to the extent caused by the negligence or willful misconduct of Sub-Sublandlord,Sub-Subtenant hereby agrees to indemnify and hold Sub-Sublandlord harmless against and from any and all claims, damages, costs,and fines arising out of or connected with Sub-Subtenant’s use of electricity in the Sub-Subleased Premises in excess of the Sub-Subleased Premises Standard Electrical Capacity, which is five (5) watts per rentable square foot of the Sub-Subleased Premises(convenience) and 1.5 watts per rentable square foot Sub-Subleased Premises (lighting).108. Liability for Damage or Injury and Indemnification.(a) Limitation of Liability; Indemnification. Sub-Sublandlord shall not be liable for any damage to the Sub-Subleased Premises or any injury to persons sustained by Sub-Subtenant or its employees, agents, invitees, guests, or other personscaused by conditions or activities on the Sub-Subleased Premises or the Building (including, without limitation, the Cafeteria, FitnessCenter, Bike Room or Shower Facilities), or activities of Sub-Subtenant in or upon the Building (including, without limitation, use ofthe Cafeteria, Fitness Center, Bike Room or Shower Facilities), except to the extent any loss, cost, damage or expense is attributable tothe gross negligence or intentional misconduct of Sub-Sublandlord or its agents or employees, and subject to the waiver of subrogationprovisions hereof and in the Sublease. Subject to the waiver of subrogation provisions set forth in subsection (b), below, except to theextent caused by the negligence or willful misconduct of Sub-Sublandlord or its agents or employees, (each of the foregoing, an“Indemnified Party”), Sub-Subtenant hereby indemnifies and saves harmless the non-negligent Indemnified Parties from any liability,loss, cost or expense (including, without limitation, reasonable attorneys’ fees) arising out of (i) Sub-Subtenant’s use or occupancy ofthe Sub-Subleased Premises, the Cafeteria, Fitness Center, Bike Room or Shower Facilities and (ii) Sub-Subtenant’s failure to keep,observe or perform any of the terms, provisions, covenants, conditions and obligations on Sub-Subtenant’s part to be kept, observed orperformed under this Sub-Sublease. Subject to the waiver of subrogation provisions set forth in subsection (b), below, except to theextent caused by the gross negligence or willful misconduct of Sub-Subtenant, Sub-Sublandlord hereby indemnifies and savesharmless Sub-Subtenant from any liability, loss, cost or expense (including, without limitation, reasonable attorneys’ fees) arising out of(x) Sub-Sublandlord’s failure to keep, observe or perform any of the terms, provisions, covenants, conditions and obligations on Sub-Sublandlord’s part to be kept, observed or performed under this Sub-Sublease and (y) the negligence or willful misconduct of Sub-Sublandlord or anyone acting by or through Sub-Sublandlord. Sub-Subtenant’s and Sub-Sublandlord’s obligation hereunder shallsurvive the termination of this Sub-Sublease. Unless carried by Sublandlord, Sub-Subtenant shall carry all insurance, in form andsubstance as required of Sub-Sublandlord under the Sublease.(b) Waiver of Subrogation. Notwithstanding anything to the contrary in this Sub-Sublease, whether the loss ordamage is due to the negligence of Sub-Sublandlord or its agents or employees, Sub-Subtenant hereby releases Sub-Sublandlord andits agents and employees from responsibility for and waives its entire claim of recovery for (i) any and all loss or damage to thepersonal property of Sub-Subtenant located in the Sub-Subleased Premises arising out of any of the perils which are covered by Sub-Subtenant’s property insurance policy or which would be covered by an all-risk property insurance policy required to be obtained bythe terms herein if such policy was obtained by Sub-Subtenant, or (ii) loss resulting from business interruption at the Sub-SubleasedPremises, arising out of any of the perils which may be covered by the business interruption insurance policy carried by Sub-Subtenantor which would be covered by a business11interruption insurance policy required to be obtained by the terms herein, with twenty-four (24) months coverage if such policy wasobtained by Sub-Subtenant. Similarly, notwithstanding anything to the contrary in this Sub-Sublease, whether the loss or damage isdue to the negligence of Sub-Subtenant or its agents or employees, Sub-Sublandlord hereby releases Sub-Subtenant and its agents andemployees from responsibility for and waives its entire claim of recovery for any and all loss or damage to personal property of Sub-Sublandlord located in the Sub-Subleased Premises, arising out of any of the perils which are covered by any such property insuranceor business interruption insurance which Sub-Sublandlord obtains or would be covered if any such policy was obtained by Sub-Sublandlord if such policy was required to be obtained by the terms herein. Sub-Sublandlord and Sub-Subtenant shall each cause itsrespective insurance carrier(s) to consent to such waiver of all rights of subrogation against the other, and to issue an endorsement to allpolicies of insurance obtained by such party confirming that the foregoing release and waiver will not invalidate such policies. Sub-Subtenant shall only be required to obtain such insurance waiver if and to the extent Sublandlord has not done so for the benefit ofSubtenant under the Sublease.9. Assignments and Subleases. (a) Sub-Subtenant shall not have the right to assign, mortgage, pledge or otherwise encumber this Sub-Sublease or anyinterest herein (including any assignment by operation of law), or sub-sublet all or any part of the Sub-Subleased Premises (any of theforegoing, a “transfer”) without the prior written consent of either Sub-Sublandlord or Sublandlord, including, without limitation,transfers to Permitted Transferees (hereinafter defined). Sub-Sublandlord’s approval shall be deemed given in accordance with Section6(d) of this Sub-Sublease and if Section 6(d) of this Sub-Sublease does not apply, such approval shall not be unreasonably withheld,conditioned or delayed. No assignment or sub-subletting shall relieve Sub-Subtenant from primary liability for all obligations of Sub-Subtenant under this Sub-Sublease, whether accruing before or after the date of such assignment or sub-subletting. For purposes of thisSub-Sublease, the term “sublet” or “sub-sublet” shall be deemed to include the granting of any rights of occupancy of any portion ofthe Sub-Subleased Premises. Any attempted transfer in violation of the requirements of this Section 9 shall be null and void and of noforce or effect. Notwithstanding anything to the contrary in the Prime Lease or Sublease, Sub-Sublandlord shall not have recapturerights.(b) Except for transfers to Permitted Transferees, if Sub-Subtenant wishes to enter into a transfer, Sub-Subtenant mustprovide not less than ten (10) days’ prior written notice thereof to Sub-Sublandlord, which notice shall include the proposed effectivedate of such assignment or sublease, and in the case of a proposed sublease, shall specify the space to be sublet.(c) The consent (or deemed consent) by Sub-Sublandlord to any transfer shall neither be construed as a waiver orrelease of Sub-Subtenant from any covenant or obligation of Sub-Subtenant under this Sub-Sublease, nor as relieving Sub-Subtenantfrom giving Sub-12Sublandlord the aforesaid ten (10) days’ notice of, or from obtaining the consent of Sub-Sublandlord as and in accordance withsubsection (a) above, to, any further transfer. The collection or acceptance of rent from any such transferee shall not constitute a waiveror release of Sub-Subtenant from any covenant or obligation of Sub-Subtenant under this Sub-Sublease, except as expressly agreed bySub-Sublandlord in writing.(d) Notwithstanding anything contained herein to the contrary, the Sub-Subleased Premises may be occupied by, orsubleased or assigned to, a Sub-Subtenant Affiliate (as hereinafter defined), and such occupancy, assignment or sublease shall bepermitted provided Sub-Subtenant delivers notice thereof to Sub-Sublandlord prior to such occupancy, assignment or sublease andsuch Sub-Subtenant Affiliate agrees in writing to assume all obligations of Sub-Subtenant under this Sub-Sublease. For purposes ofthis subparagraph, a “Sub-Subtenant Affiliate” shall mean an entity that, directly or indirectly Controls, is Controlled by, or is undercommon Control with Sub-Subtenant. For purposes of this subparagraph, “Control” shall mean ownership of sufficient stock ormembership or partnership interests of an entity to have voting control of such entity (such as ownership of 50% or more of theoutstanding voting stock of a corporation or of the outstanding membership, partnership or other similar interest if such entity is not acorporation). Notwithstanding anything contained herein to the contrary, Sub-Subtenant may assign this Sub-Sublease to an entity withwhich Sub-Subtenant merges, consolidates or which purchases all or substantially all of Sub-Subtenant’s stock or assets (a“Successor”) without Sub-Sublandlord’s prior written approval. The term “Permitted Transferee” shall mean a Sub-SubtenantAffiliate or Successor, and the term “Permitted Transfer” shall mean a transfer to Permitted Transferee in accordance with thisSection 9(d). In the event of a transfer to a Sub-Subtenant Affiliate, Sub-Subtenant shall not be released from any covenant orobligation of Sub-Subtenant under this Sub-Sublease, but shall remain jointly and severally liable with Sub-Subtenant Affiliate for theperformance of all covenants and obligations hereunder. In the event of a transfer to a Successor, such Successor shall expresslyassume all obligations of Sub-Subtenant under this Sub-Sublease in writing.10. Services and Amenities.(a) Services. Anything contained in this Sub-Sublease to the contrary notwithstanding, the only services or rights towhich Sub-Subtenant is entitled hereunder are those to which Sub-Sublandlord is entitled under the Sublease from Sublandlord. In theevent Sub-Sublandlord is entitled to any rental abatement on account of any interruption of essential services to the Sub-SubleasedPremises (and not other portions of the Subleased Premises subleased by Sub-Sublandlord pursuant to the Sublease) pursuant to theterms of the Sublease, Sub-Subtenant shall be entitled to proportionately abate its rental obligations hereunder for the same period oftime. Sub-Subtenant shall, within thirty (30) days of demand, pay or reimburse Sub-Sublandlord for all costs and expenses actuallyincurred by Sub-Sublandlord (i) payable under the Sublease arising13solely out of Sub-Subtenant’s acts or omissions with respect to this Sub-Sublease or the Sub-Subleased Premises or Sub-Subtenant’srequests for services in excess of those provided by Landlord and included in Operating Expenses under the Prime Lease in connectionwith the Sub-Subleased Premises and (ii) for services to the Sub-Subleased Premises requested in writing by Sub-Subtenant which areprovided directly by Sublandlord and billed to Sub-Sublandlord, including (a) supplemental chilled or condenser water, (b) abovebuilding standard or overtime HVAC, (c) extra cleaning, (d) overtime or dedicated freight elevator service, and (e) any maintenance,repair or other service for which a separate charge is payable to Landlord under the Prime Lease or which is provided by Sublandlord,and (f) any janitorial service in excess of those described on Exhibit E of the Prime Lease. Sublandlord currently causes the carpetingin the elevator lobby of the Sub-Subleased Premises to be cleaned approximately once per quarter, which frequency exceeds that setforth in the standard janitorial specifications set forth on Exhibit E of the Prime Lease; such excess is not subject to a separate charge..To the extent Sub-Sublandlord is billed for such costs, Sub-Subtenant shall pay the excess charge to Sub-Sublandlord that is allocableto the Sub-Subleased Premises as Additional Sub-Subrent from time to time. Sublandlord currently maintains the SupplementalHVAC, as well as the water heaters, water filters, VAV boxes, and appurtenances thereto. To the extent Sub-Sublandlord is billed bySublandlord for such costs attributable to the Sub-Subleased Premises, Sub-Subtenant shall pay its proportionate share of suchmaintenance costs to Sub-Sublandlord as Additional Sub-Subrent from time to time. Sub-Sublandlord shall charge Sub-Subtenant theactual costs of those excess services set forth in this Section 10(a) and in no event add any costs or expenses to Sub-Subtenant’sproportionate share of such costs, such as a management fee, administration fee, or other markup. Notices from Sub-Subtenantrequesting overtime HVAC services shall be delivered to the Director fo Support Services for the Corporate Executive BoardCompany (or such other contact of which Sub-Sublandlord notifies Sub-Subtenant from time to time). The current cost for overtimeHVAC services is: i) Eighty-nine dollars and 50 cents ($89.50) per hour for up to three (3) hours; and ii) One hundred and ninety-sixdollars and 50 cents ($196.50) per hour for four (4) or more hours. Sub-Sublandlord shall provide Sub-Subtenant with up to twohundred twenty-five (225) access card keys for its employees at Five and 00/100 Dollars ($5.00) per card. Sub-Subtenant may obtainadditional or replacement access card keys for its employees by written request to Sub-Sublandlord, at Sub-Sublandlord’s actual costtherefor. Security management is provided to Building by Kastle Systems.14(b) Amenities. Subject to Sublandlord’s prior written approval, Sub-Subtenant shall have access to and use of, at nocost to Sub-Subtenant, the Cafeteria and Fitness Facility (as such terms are defined in the Sublease) upon the same terms andconditions set forth in the Sublease. If Sublandlord does not provide such written, Sections 28(a), (b) and (d) of the Sublease shall notapply. Sub-Subtenant shall have access to and use of the bike room and shower facilities provided by Landlord in accordance with theterms of the Sublease. Sub-Subtenant acknowledges that Sub-Sublandlord does not have sole authority over the amenities in thisSubsection 10(b); however, Sub-Sublandlord shall not take any action or permit anything to be done which would cause Sub-Subtenant to lose its rights to the use and access of the Cafeteria, Fitness Facility, bike room and shower facilities.11. Default. In the event that Sub-Subtenant shall be in default beyond any applicable notice and cure period of anycovenant or obligation under this Sub-Sublease, or if any other default set forth in Section 19 of the Prime Lease occurs with respect toSub-Subtenant and is not cured within the applicable notice and cure periods set forth in such Section 19, then Sub-Sublandlord shallhave available to it all of the remedies available to Sublandlord under the Sublease in the event of a like default or failure on the part ofthe Subtenant thereunder. Sub-Subtenant shall have the same cure periods and notice rights in connection with a default under thisSub-Sublease as Tenant has under the Prime Lease; provided, however, if Sub-Sublandlord receives a notice of default fromSublandlord relating to a default by Sub-Subtenant, then Sub-Sublandlord shall immediately provide the notice to Sub-Subtenant andthe period of time to cure such Sub-Subtenant default set forth in such default notice shall govern. Sub-Sublandlord shall usecommercially reasonable efforts to mitigate its damages resulting from a default under this Sub-Sublease by Sub-Subtenant beyond anyapplicable notice and cure period. Notwithstanding anything contained herein to the contrary, except with respect to payments that arerequired to be made by Sub-Subtenant directly to Sub-Sublandlord hereunder which fail to be paid within the timeframes requiredhereby, Sub-Sublandlord shall not declare a default against Sub-Subtenant unless Sublandlord has delivered a notice of such default toSubtenant under the Sublease with respect to the actions or omissions of Sub-Subtenant (including failure of Sub-Subtenant to paySub-Subrent directly to Sublandlord). In no event shall Sub-Subtenant be liable for consequential or punitive damages.12. No Waiver. The failure of either party to insist at any time upon the strict performance of any covenant or agreementherein, or to exercise any option, right, power or remedy contained in this Sub-Sublease shall not be construed as a waiver or arelinquishment thereof for the future. No act or thing done by Sub-Sublandlord or its agents during the term hereof shall be deemed anacceptance or surrender of the Sub-Subleased Premises, and no agreement to accept a surrender of the Sub-Subleased Premises shallbe valid unless in writing and signed by Sub-Sublandlord.13. Surrender of Sub-Subleased Premises; Holdover. Upon the expiration or other termination of the Sub-Sublease Term,Sub-Subtenant shall quit and surrender to Sub-Sublandlord15the Sub-Subleased Premises, broom clean, in good order and condition, ordinary wear and tear and damage from casualty excepted,and Sub-Subtenant shall remove all of its property as provided in Section 10.B. of the Prime Lease. Sub-Subtenant shall only berequired to remove alterations that are required to be removed by Sublandlord in writing and are not the obligation of Sub-Sublandlordto be removed pursuant to the terms of the Sublease. In the event of holding over by Sub-Subtenant or any person or entity claimingunder Sub-Subtenant after expiration or other termination of the Sub-Sublease Term, or in the event Sub-Subtenant continues tooccupy the Sub-Subleased Premises after the termination of Sub-Subtenant’s right of possession due to a default by Sub-Subtenant,such holding over or possession shall constitute a tenancy at sufferance. In the event of any such holding over, Sub-Sublandlord shallhave the right, in accordance with applicable law, to enter upon and take possession of the Sub-Subleased Premises. Sub-Subtenantshall, throughout the entire holdover period, pay Rent at the times and in the manner required by this Sub-Sublease; provided,however, if Sub-Subtenant holds over in the Sub-Subleased Premises after the Sub-Sublease Expiration Date, and if Sub-Sublandlorddesires to repossess the Sub-Subleased Premises at any time after the Sub-Sublease Expiration Date, then Sub-Sublandlord shalldeliver written notice requiring Sub-Subtenant to vacate the Sub-Subleased Premises (the “Vacation Notice”), which vacation andsurrender shall occur not earlier than the later of (x) thirty (30) days after the Vacation Notice or (y) the Termination Date (the“Vacation Date”). If Sub-Subtenant has not vacated and surrendered the Sub-Subleased Premises to Sub-Sublandlord on or before theVacation Date, then, from and after the Vacation Date, and during the holdover period, in addition to Sub-Sublandlord’s other rightsand remedies, Sub-Subtenant shall pay Monthly Base Sub-Subrent to Sub-Sublandlord in an amount equal to 150% of the MonthlyBase Sub-Subrent in effect during the last month of the Sub-Sublease Term, prorated for the number of days of holdover past theVacation Date. No holding over by Sub-Subtenant after the expiration of the Sub-Sublease Term and no acceptance of Rent by Sub-Sublandlord during a holdover period, whether with or without the consent of Sub-Sublandlord, shall be construed to extend the Sub-Sublease Term or prevent Sub-Sublandlord from recovering immediate possession of the Sub-Subleased Premises by summaryproceedings or otherwise. In addition, in the event of any unauthorized holding over by Sub-Subtenant which results in holdover underthe Sublease by Sub-Sublandlord, Sub-Subtenant will protect, defend, indemnify and hold Sub-Sublandlord harmless from and againstany claims, demands, liability, costs, expenses or damages (including reasonable attorneys’ fees) for which Sub-Sublandlord maybecome liable to Sublandlord under the Sublease due to such holding over.14. Security Deposit.(a) Within one (1) business day after Sub-Sublandlord provides Sub-Subtenant with written notice of Landlord’s andSublandlord’s acceptance of this Sub-Sublease, Sub-Subtenant shall deliver to Sub-Sublandlord a security deposit (“SecurityDeposit”) in the amount of the then-current amount of three (3) Monthly Installments of Annual Base Sub-Subrent, which SecurityDeposit may be in the form of cash or a letter of credit that conforms to the requirements for the16form of Letter of Credit set forth in Section 11(b) of the Sublease, to secure the payment and performance by Sub-Subtenant of all ofSub-Subtenant’s obligations, covenants, conditions and agreements under this Sub-Sublease. If in the form of cash, Sub-Sublandlordshall not be required to keep the Security Deposit separate from other funds or accounts of Sub-Sublandlord and the Security Depositshall not bear interest. If Sub-Subtenant defaults in the observance or performance of any of such terms and conditions (beyond anyapplicable notice and cure period of any covenant or obligation under this Sub-Sublease), Sub-Sublandlord may use or apply all or anypart of the Security Deposit for the payment of any Rent not paid when due or for the payment of any other amounts due Sub-Sublandlord by reason of such default, including any actual and reasonable costs of Sub-Sublandlord’s observing or performing suchterms or conditions on Sub-Subtenant’s behalf and any deficiencies in reletting or damages incurred by Sub-Sublandlord. If Sub-Sublandlord shall use or apply all or any part of the Security Deposit, Sub-Subtenant shall, within five (5) business days’ after receiptof written notice of such use or application, deliver to Sub-Sublandlord additional funds so as to restore the Security Deposit to theamount specified above. If Sub-Subtenant shall faithfully observe and perform all of the terms and conditions of this Sub-Sublease orcure any default thereof, the Security Deposit, or so much thereof as shall not have been used or applied in accordance with thisSection 14, shall be returned to Sub-Subtenant within thirty (30) days after the expiration or sooner termination of this Sub-Subleaseand the vacation and surrender of the Sub-Sublet Premises in accordance with this Sub-Sublease. In the event of any assignment ofSub-Sublandlord’s interest in this Sub-Sublease, Sub-Sublandlord shall transfer the Security Deposit to such assignee, in which eventsuch assignee shall hold, use and apply the Security Deposit in accordance with the covenants, terms and conditions of this Sub-Sublease. Following receipt of written notice of transfer of the Security Deposit, Sub-Subtenant shall look solely to the assignee for thereturn of the Security Deposit and Sub-Sublandlord shall thereupon be released from all liability to Sub-Subtenant for the return of theSecurity Deposit. Sub-Subtenant shall not assign (other than to a permitted assignee of this Sub-Sublease) or encumber its interest inthe Security Deposit and no such assignment or encumbrance shall be valid or binding upon Sub-Sublandlord unless Sub-Sublandlordprovides written consent to such assignment or encumbrance. Broker. Each party represents and warrants to the other that, except forCBRE, Inc. (“Sub-Sublandlord’s Broker”) and Jones Lang LaSalle Brokerage, Inc. (“Sub-Subtenant’s Broker” and, togetherwith Sub-Sublandlord’s Broker, “Brokers”) (i) no broker brought about this transaction or dealt with either party in connectionherewith, and (ii) neither party has had any dealings with any real estate broker, finder or other person, with respect to this Sub-Sublease in any manner. Each party agrees to indemnify, defend and hold harmless the other against and from any and all losses, costs,claims, damages and expenses (including, without limitation, reasonable attorneys’ fees) which may be claimed by any broker (otherthan the Brokers) by reason of any dealings, actions or agreements with the indemnifying party. Sub-Sublandlord agrees to compensatethe Brokers pursuant to the terms of a separate agreement between Sub-Sublandlord and the Brokers.17(b) If Tenant is not currently in a monetary default beyond any applicable notice and cure periods as of April 15, 2017and October 15, 2017 respectively (a) prior to April 15, 2017, then the amount of the Security Deposit shall be reduced to two (2)Monthly Installments of Annual Base Sub-Subrent, and (b) prior to October 15, 2017, then the amount of the Security Deposit shall bereduced to one and one half (1.5) Monthly Installments of Annual Base Sub-Subrent. If the Security Deposit is held in cash, Landlordshall return to Tenant one (1) Monthly Installment of Annual Sub-Subrent within five (5) days following each applicable reductiondate (i.e. by April 20, 2017 and October 20, 2017). If the Security Deposit is held in the form of a letter of credit, Landlord and Tenantshall cooperate to cause the appropriate reduction in the letter of credit within five (5) days after each applicable reduction date.15. Notices. Sub-Sublandlord shall concurrently send to Sub-Subtenant copies of any notices to Sublandlord or Landlord andshall immediately deliver to Sub-Subtenant copies of any notices from Sublandlord or Landlord. All notices given or required to begiven pursuant to the provisions hereof shall be in writing and shall only be sent by reputable overnight delivery service or certifiedmail, postage prepaid, return receipt requested, to the following addresses, or to such other address as the party to be notified shallspecify in writing by such notice:Sub-Sublandlord:Rosetta Stone Ltd.135 West Market StreetHarrisonburg, VA 22801Attention: General CounselSub-Subtenant:SNAGAJOB.COMAt the Sub-Subleased PremisesAttn: Alisha A. RodriguesWith a copy to:Cooley LLP11951 Freedom DriveSuite 1500Reston, Virginia 20190Attn: Michelle G. SchulmanNotices shall be deemed given and effective upon the date of delivery (or refusal to accept delivery) if delivered by hand orovernight delivery service, and upon the date set forth on the return receipt therefor if delivered by certified mail.16. Parking. Sub-Subtenant shall have the ongoing right, but not the obligation, to obtain non-reserved, first-come, first-served parking contracts, by contracting directly with the Garage Operator, for the parking of up to thirty-seven (37) automobiles in theGarage upon the same rental, terms and conditions in the parking contracts that the Garage makes available to Sub-Sublandlord,18and Sub-Sublandlord hereby relinquishes and shall have no further rights with respect to such spaces under the Sublease. The currentrates paid by Sub-Sublandlord to Garage are: i) One hundred and seventy-five dollars ($175) per general parking space; and ii) Threehundred and fifty dollars ($350) per reserved parking space. All parking rights granted to Sub-Subtenant shall be at Sub-Subtenant’ssole risk. Sub-Subtenant shall obtain parking access keys directly from Sublandlord at Sub-Subtenant’s expense. Notwithstandinganything to the contrary in the Sublease, Sub-Sublandlord shall not have the right to issue permits (or to cause such issuance) orestablish other reasonable parking controls (or cause such controls to be established) in addition to those in place as of the date hereof.17. Sub-Subtenant Signage. Subject to written approval by Sublandlord, Sub-Subtenant shall have the right to install, at itsexpense, (a) signage in the Building lobby and (b) suite entry signage at the entrance to the Sub-Subleased Premises, in a location andwith dimensions as approved by Sublandlord. Sub-Subtenant shall be permitted to remove Sub-Sublandlord’s signage in order toinstall its signage. Sub-Subtenant acknowledges and agrees that the Building does not have a lobby directory. Sub-Sublandlord shallcooperate in good faith to obtain any required approvals to lobby and suite entry signage; provided, however, if Sublandlord andLandlord (if required under the Prime Lease) do not approve the signage, the Sub-Sublandlord and Sub-Subtenant shall work togetherin good faith to redesign the signage package and resubmit to the necessary parties.18. Waiver of Jury Trial. THE PARTIES HERETO EACH HEREBY WAIVES ALL RIGHT TO TRIAL BY JURY INANY CLAIM, ACTION, PROCEEDING OR COUNTERCLAIM BY EITHER PARTY AGAINST THE OTHER ON ANYMATTERS ARISING OUT OF OR IN ANY WAY CONNECTED WITH THIS SUB-SUBLEASE, THE RELATIONSHIP OFTHE PARTIES HERETO OR SUB-SUBTENANT’S USE OR OCCUPANCY OF THE SUB-SUBLEASED PREMISES.19. Reciprocal Litigation Costs. In the event of any litigation between Sub-Sublandlord and Sub-Subtenant, theunsuccessful party as determined by a court of competent jurisdiction shall reimburse the successful party for all reasonable legal fees,court costs and out-of-pocket expenses incurred by the successful party in prosecuting or defending any such action. For the purposesof this Section 20, “litigation” shall include any legal proceeding or retention of an attorney to enforce any right or obligation under thisSub-Sublease.20. Estoppel Certificates. Each party shall, from time to time, within ten (10) business days following request by the otherparty, execute and deliver to such persons as requested by such party, a statement certifying that this Sub-Sublease is unmodified andin full force and effect (or if there have been modifications, that the same is in full force and effect as so modified), stating the dates towhich Annual Base Sub-Subrent and other charges payable under this Sub-Sublease have19been paid, and stating that, to the certifying party’s knowledge, the requesting party is not in default hereunder (or if a default is allegedto exist, stating the nature of such alleged default).21. Representations. Sub-Sublandlord represents and warrants that, as of the date hereof: (a) to the best of Sub-Sublandlord’sknowledge, as of the Sub-Sublease Commencement Date the Sub-Subleased Premises are in compliance with all applicable Laws andall systems servicing the Sub-Subleased Premises, including mechanical, electrical and plumbing systems and the SupplementalHVAC, are in good working order and repair, (b) Sub-Sublandlord has not caused the presence of Hazardous Materials in, on or underthe Sub-Subleased Premises, (c) Sub-Sublandlord has not received any notice from the Sublandlord asserting that Sub-Sublandlord isin Default under the Sublease and, to its knowledge, it is not aware of any default on its part under the Sublease, (d) the Sublease isunmodified and in full force and effect; and (e) Sub-Sublandlord has the power and authority to enter into this Sub-Sublease. Sub-Subtenant represents and warrants that it has the power and authority to enter into this Sub-Sublease.22. Consent of Sublandlord. The parties shall enter into the Consent of Sublandlord letter agreement substantially in theform attached hereto as Exhibit A on or about the date hereof the (“Consent”). If Sublandlord fails to execute the Consent withinthirty (30) days after written request therefor, following full execution and delivery by both parties of this Sub-Sublease, then eitherparty shall have the right to terminate this Sub-Sublease by written notice thereof to the other party and Sublandlord, which must bedelivered within five (5) business days after expiration of such thirty (30) day period (time being of the essence), else such right toterminate is automatically waived and of no further force or effect.23. Miscellaneous.(a) Time of the Essence. Time is of the essence in the performance by both parties with respect to their obligationshereunder.(b) Severability. In the event any part of this Sub-Sublease is held to be unenforceable or invalid for any reason, thebalance of this Sub-Sublease shall not be affected and shall remain in full force and effect during the term of this Sub-Sublease.(c) Binding Effect. The covenants, conditions, agreements, terms and provisions of this Sub-Sublease shall be bindingupon and shall inure to the benefit of the parties hereof and each of their respective successors and assigns, subject to the restrictionsand limitations set forth herein.(d) Governing Law. It is the intention of the parties hereto that this Sub-Sublease (and the terms and provisionshereof) shall be construed and enforced in accordance with the laws of the Commonwealth of Virginia.20(e) Entirety. It is understood and agreed by and between the parties hereto that this Sub-Sublease and the Consentcontain the final and entire agreement between the parties relative to the subject matter hereof, and that they shall not be bound by anyterms, statements, conditions or representations relative to the subject matter hereof, oral or written, express or implied, not hereincontained. This Sub-Sublease may not be changed or terminated orally or in any manner other than by an agreement in writing andsigned by all parties hereto.(f) Submission Not an Offer. The submission of this Sub-Sublease by either party to the other shall not constitute anoffer by such party and neither party shall be bound in any way unless and until this Sub-Sublease is executed and delivered by bothparties.(g) Counterparts. This Sub-Sublease may be executed in two (2) or more counterparts, each of which shall bedeemed an original, but all of which together shall constitute one and the same instrument.(h) Exhibits. The exhibits attached hereto are made a substantive part of this Sub-Sublease.(i) Appointment of Resident Agent. For purposes of § 55-218.1 of the Code of Virginia, Sub-Sublandlord appointsas its resident agent:_____________________.(j) No Recordation. Neither party shall have the right to record this Sub-Sublease or the Sublease.(k) Intentionally omitted.(l) Quiet Enjoyment. Sub-Sublandlord covenants and agrees with Sub-Subtenant that so long as no default by Sub-Subtenant exists under this Sub-Sublease after notice and applicable cure periods have passed, Sub-Subtenant shall have quiet andundisturbed and continuous possession of the premises, free from any claims against the Sub-Sublandlord and all persons claimingunder it, by or through the Sub-Sublandlord.(m) No Merger or Imputed Obligations. The covenants, representations, warranties, and obligations of Sub-Subtenant under this Sub-Sublease shall apply only to Sub-Subtenant and shall not be conferred or imputed to Sublandlord under theSublease or to Tenant under the Prime Lease, regardless of any unity of identity among the entities comprising Sub-Subtenant,Sublandlord and Tenant. Each of the Prime Lease, Sublease, and Sub-Sublease shall be and remain separate and distinct documentsand none of the rights and obligations among them shall merge notwithstanding unity of identity among parties thereto.[Signature Page Follows]21IN WITNESS WHEREOF, the parties hereto have made and entered into this Sub-Sublease Agreement under seal as of thedate and year first set forth above.WITNESS/ATTEST: [signed as witness]SUB-SUBTENANT:SNAGAJOB.COMBy: /s/ Keith Haas Name: Keith Haas Title: CFO WITNESS/ATTEST: Vivian DinhSUB-SUBLANDLORD:ROSETTA STONE LTD.By: /s/ Thomas M. Pierno Name: Thomas M. Pierno Title: CFO Exhibits to be attached:Exhibit A: Form of Consent of SublandlordExhibit B-1: Walls/Partitions and Systems FurnitureExhibit B-2: Personal PropertyExhibit B-3: Supplemental HVACExhibit C: Prime Lease and SubleaseExhibit D: Sub-Subleased Premises22Exhibit 10.45Execution VersionSIXTH AMENDMENT TO LOAN AND SECURITY AGREEMENTThis Sixth Amendment to Loan and Security Agreement (this “Amendment”) is entered into this 10th day of March, 2017, byand between (i) SILICON VALLEY BANK, a California corporation with a loan production office located at 275 Grove Street,Suite 2-200, Newton, Massachusetts 02466 (“Bank”), and (ii) ROSETTA STONE LTD., a Virginia corporation, and LEXIALEARNING SYSTEMS LLC, a Delaware limited liability company (individually and collectively, jointly and severally, the“Borrower”).RECITALSA. Bank and Borrower have entered into that certain Loan and Security Agreement dated as of October 28, 2014, asamended by a certain First Amendment to Loan and Security Agreement dated March 31, 2015, as further amended by a certainSecond Amendment to Loan and Security Agreement dated May 1, 2015, as further amended by a certain Third Amendment to Loanand Security Agreement dated June 26, 2015, as further amended by a certain Fourth Amendment to Loan and Security Agreementdated December 29, 2015, and as further amended by a certain Joinder and Fifth Amendment to Loan and Security Agreement datedMarch 14, 2016 (as the same may from time to time be further amended, modified, supplemented or restated, the “Loan Agreement”).B. Bank has extended credit to Borrower for the purposes permitted in the Loan Agreement.C. Borrower has requested that Bank amend the Loan Agreement to make certain revisions to the Loan Agreement as morefully set forth herein.D. Bank has agreed to so amend certain provisions of the Loan Agreement, but only to the extent, in accordance with theterms, subject to the conditions and in reliance upon the representations and warranties set forth below.AGREEMENTNOW, THEREFORE, in consideration of the foregoing recitals and other good and valuable consideration, the receipt andadequacy of which is hereby acknowledged, and intending to be legally bound, the parties hereto agree as follows:1.Definitions. Capitalized terms used but not defined in this Amendment shall have the meanings given to them in theLoan Agreement.2. Amendments to Loan Agreement.2.1 Section 2.1.2(e) (Letters of Credit). Section 2.1.2(e) is deleted in its entirety and replaced with the following:“(e) To guard against fluctuations in currency exchange rates, upon the issuance of any Letter of Creditpayable in a Foreign Currency, Bank shall create areserve (the “Letter of Credit Reserve”) under the Revolving Line in an amount equal to a percentage (whichpercentage shall be determined by Bank in its sole discretion) of the face amount of such Letter of Credit. The amountof the Letter of Credit Reserve may be adjusted by Bank from time to time to account for fluctuations in the exchangerate. The availability of funds under the Revolving Line shall be reduced by the amount of such Letter of CreditReserve for as long as such Letter of Credit remains outstanding.”2.2 Section 2.5(c) (Fees; Termination Fee). Subsection (c) of Section 2.5 is deleted in its entirety and replaced withthe following:“(c) Termination Fee. Upon termination of this Agreement by Borrower for any reason (or upon theacceleration of the Obligations in accordance with Section 9.1 hereof) prior to the first anniversary of the SixthAmendment Effective Date, in addition to the payment of any other amounts then-owing, a termination fee in anamount equal to one percent (1.00%) of the Revolving Line; provided that no termination fee shall be charged if thecredit facility hereunder is replaced with a new facility from Bank;”2.3 Section 3.2 (Conditions Precedent to all Advances). Subsections (a) and (b) of Section 3.2 are deleted in theirentirety and replaced with the following:“(a) timely receipt of the Credit Extension request and any materials and documents required by Section 3.4;(b) the representations and warranties in this Agreement shall be true, accurate, and complete in all materialrespects on the date of the proposed Credit Extension and on the Funding Date of each Credit Extension; provided,however, that such materiality qualifier shall not be applicable to any representations and warranties that already arequalified or modified by materiality in the text thereof; and provided, further that those representations and warrantiesexpressly referring to a specific date shall be true, accurate and complete in all material respects as of such date, and noEvent of Default shall have occurred and be continuing or result from the Credit Extension. Each Credit Extension isBorrower’s representation and warranty on that date that the representations and warranties in this Agreement remaintrue, accurate, and complete in all material respects; provided, however, that such materiality qualifier shall not beapplicable to any representations and warranties that already are qualified or modified 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; and”2.4 Section 3.4 (Procedures for Borrowing). Section 3.4 is deleted in its entirety and replaced with the following:“3.4 Procedures for Borrowing. Subject to the prior satisfaction of all other applicable conditions to the making ofan Advance (other than Advances under Sections 2.1.2) set forth in this Agreement, to obtain an Advance, Borrowershall notify Bank (which notice shall be irrevocable) by electronic mail by 12:00 p.m. Eastern time on the Funding Dateof the Advance. Such notice shall be made by Borrower through Bank’s online banking program, provided, however,if Borrower is not utilizing Bank’s online banking program, then such notice shall be in a written format acceptable toBank that is executed by an Authorized Signer. Bank shall have received satisfactory evidence that the provision ofsuch notices and the requests for Advances have been approved by the Board. In connection with any such notification,Borrower must promptly deliver to Bank by electronic mail or through Bank’s online banking program such reports andinformation, including without limitation, sales journals, cash receipts journals, accounts receivable aging reports, asBank may request in its sole discretion. Bank shall credit proceeds of an Advance to the Designated Deposit Account.Bank may make Advances under this Agreement based on instructions from an Authorized Signer or withoutinstructions if the Advances are necessary to meet Obligations which have become due.”2.5 Section 6.2(h) (Financial Statements, Reports, Certificates). Subsection (h) of Section 6.2 is deleted in itsentirety and replaced with the following:“(h) a Borrowing Base Report (and any schedules related thereto and including any other informationrequested by Bank with respect to Borrower’s Accounts) (i) on the first Business Day of each month and the fifteenth(15th) day of each month when a Streamline Period is note in effect and there are Advances outstanding under theRevolving Line, (ii) within thirty (30) days after the end of each month when a Streamline Period is in effect and thereare Advances outstanding under the Revolving Line, and (iii) within forty-five (45) days after the end of each fiscalquarter if there are no Advances outstanding under the Revolving Line;”2.6 Section 6.4(c) (Accounts Receivable; Collection of Accounts). Subsection (c) of Section 6.4 is deleted in itsentirety and replaced with the following:“(c) Collection of Accounts. Each Credit Party shall direct Account Debtors to deliver or transmit all proceedsof Accounts into a lockbox account (with respect to check receipts) or such other “blocked account” as may bespecified by Bank (either such account, the “Cash Collateral Account”). Whether or not an Event of Default hasoccurred and is continuing, Borrower shall immediately deliver all payments on and proceeds of Accounts to the CashCollateral Account. Subject to Bank’s right to maintain a reserve pursuant to Section 6.3(g), all amounts received in theCash Collateral Account shall be (i) applied to immediately reduce the Obligations when a Streamline Period is not ineffect (unless Bank, in its sole discretion, at times when an Event of Default exists, elects not to so apply such amounts),or (ii) transferred on a daily basis to the Designated Deposit Account when a Streamline Period is in effect. Borrowerhereby authorizes Bank to transfer to theCash Collateral Account any amounts that Bank reasonably determines are proceeds of the Accounts (provided thatBank is under no obligation to do so and this allowance shall in no event relieve Borrower of its obligationshereunder).”2.7 Section 6.4(e) (Accounts Receivable). Subsection (e) of Section 6.4 is deleted in its entirety and replaced with thefollowing:“(e) Verifications; Confirmations; Credit Quality; Notifications. Bank may, from time to time, (i) verify andconfirm directly with the respective Account Debtors the validity, amount and other matters relating to the Accounts,either in the name of Borrower or Bank or such other name as Bank may choose, and notify any Account Debtor ofBank’s security interest in such Account and/or (ii) conduct a credit check of any Account Debtor to approve any suchAccount Debtor’s credit.”2.8 Section 6.4(g) (Accounts Receivable). The following new subsection (g) is hereby inserted in Section 6.4immediately following subsection (h) thereof:“(g) Reserves. Notwithstanding any terms in this Agreement to the contrary, at times when anEvent of Default exists, Bank may hold any proceeds of the Accounts and any amounts in the Cash Collateral Accountthat are not applied to the Obligations pursuant to Section 6.4(c) above (including amounts otherwise required to betransferred to Borrower’s operating account with Bank when a Streamline Period is in effect) as a reserve to be appliedto any Obligations regardless of whether such Obligations are then due and payable.”2.9 Section 6.11 (Access to Collateral; Books and Records). Section 6.11 is amended in its entirety and replacedwith the following:“6.11 Access to Collateral; Books and Records. At reasonable times, on three (3) Business Days’ notice (providedno notice is required if an Event of Default has occurred and is continuing), Bank, or its agents, shall have the right toinspect the Collateral and the right to audit and copy Borrower’s Books. Such inspections and audits shall be conductedno more often than once every twelve (12) months unless an Event of Default has occurred and is continuing in whichcase such inspections and audits shall occur as often as Bank shall determine is necessary. The foregoing inspectionsand audits shall be conducted at Borrower’s expense and the charge therefor shall be One Thousand Dollars ($1,000)per person per day (or such higher amount as shall represent Bank’s then-current standard charge for the same), plusreasonable out-of-pocket expenses. In the event Borrower and Bank schedule an audit more than ten (10) days inadvance, and Borrower cancels or seeks to or reschedules the audit with less than ten (10) days written notice to Bank,then (without limiting any of Bank’s rights or remedies) Borrower shall pay Bank a fee of One Thousand Dollars($1,000) plus any out-of-pocket expenses incurred by Bank to compensate Bank for the anticipated costs and expensesof the cancellation or rescheduling.”2.10 Section 6.16 (Online Banking). The following new Section 6.16 is hereby inserted immediately followingSection 6.15:“6.16 Online Banking. Utilize Bank’s online banking platform for all matters requested by Bank which shall include,without limitation (and without request by Bank for the following matters), uploading information pertaining toAccounts and Account Debtors, requesting approval for exceptions, requesting Credit Extensions, and uploadingfinancial statements and other reports required to be delivered by this Agreement (including, without limitation, thosedescribed in Section 6.2 of this Agreement).”2.11 Section 8.2(a) (Covenant Default). Section 8.2(a) is amended in its entirety and replaced with the following:“(a) Any Credit Party fails or neglects to perform any obligation in Sections 6.2 (and has failed to cure suchdefault within three (3) Business Days), 6.3 (and has failed to cure such default within three (3) Business Days), 6.4,6.5 (and has failed to cure such default within ten (10) Business Days), 6.6 (and has failed to cure such default withinten (10) Business Days), 6.7 (and has failed to cure such default within three (3) Business Days), 6.8, 6.11, 6.12 (andhas failed to cure such default within ten (10) Business Days), 6.14 or 6.16 or violates any covenant in Section 7; or”2.12 Section 9.2 (Power of Attorney). Section 9.2 is deleted in its entirety and replaced with the following:“9.2 Power of Attorney. Borrower hereby irrevocably appoints Bank as its lawful attorney-in-fact, exercisablefollowing the occurrence of an Event of Default, to: (a) endorse Borrower’s name on any checks, payment instruments,or other forms of payment or security; (b) sign Borrower’s name on any invoice or bill of lading for any Account ordrafts against Account Debtors; (c) demand, collect, sue, and give releases to any Account Debtor for monies due, settleand adjust disputes and claims about the Accounts directly with Account Debtors, and compromise, prosecute, ordefend any action, claim, case, or proceeding about any Collateral (including filing a claim or voting a claim in anybankruptcy case in Bank’s or Borrower’s name, as Bank chooses); (d) make, settle, and adjust all claims underBorrower’s insurance policies; (e) pay, contest or settle any Lien, charge, encumbrance, security interest, or other claimin or to the Collateral, or any judgment based thereon, or otherwise take any action to terminate or discharge the same;and (f) transfer the Collateral into the name of Bank or a third party as the Code permits. Borrower hereby appointsBank as its lawful attorney-in-fact to sign Borrower’s name on any documents necessary to perfect or continue theperfection of Bank’s security interest in the Collateral regardless of whether an Event of Default has occurred until allObligations have been satisfied in full and the Loan Documentshave been terminated. Bank’s foregoing appointment as Borrower’s attorney in fact, and all of Bank’s rights andpowers, coupled with an interest, are irrevocable until all Obligations have been fully repaid and performed and theLoan Documents have been terminated.”2.13 Section 13 (Definitions). The following terms and their respective definitions set forth in Section 13.1 are deletedin their entirety and replaced with the following:“Adjusted EBITDA” means (a) GAAP Net Income plus (b) Interest Expense (less interest income), (c) incometax benefit and expense, (c) depreciation, (d) amortization and (e) stock-based compensation expense, (f) other non-operating expense (less other income) (as such amount is shown on the “Other income and (expense)” line item belowthe operating income line in the Ultimate Parent's relevant income statement, determined in accordance withGAAP), (g) goodwill impairment, (h) the change in Deferred Revenue (excluding acquired Deferred Revenue), less (i)the change in deferred commissions, (j) any items related to the litigation with Google Inc., (k) restructuring and relatedwind down costs, consulting and other related costs associated with development and implementation of Borrower’srevised business strategy, severance costs and transaction and other costs associated with mergers and acquisitions, and(l) all adjustments related to recording the non-cash tax valuation allowance for deferred tax assets (with items (k) and(l) not to exceed an aggregate amount of $6,000,000 in any trailing twelve (12) month period following the SixthAmendment Effective Date).“Borrowing Base” is (a) eighty percent (80%) of Eligible Accounts, as determined by Bank from Borrower’smost recent Borrowing Base Report (and as may subsequently be updated by Bank in Bank’s sole discretion basedupon information received by Bank including, without limitation, Accounts that are paid and/or billed following thedate of the Borrowing Base Report) (provided, however, Eligible Accounts with respect to clauses (b), (c), (d) and (q)shall not include Accounts in excess of ninety (90) days of invoice date to the extent the aggregate amount of suchAccounts exceeds ten percent (10%) of Eligible Accounts), plus (b) during a Non-Formula Period, the Non-FormulaAmount; provided, however, that Bank has the right to decrease the foregoing percentage in its good faith businessjudgment upon prior consultation with Borrower to mitigate the impact of events, conditions, contingencies, or riskswhich may adversely affect the Collateral or its value; provided, further that in the event Bank exercises such right todecrease the foregoing percentage, such circumstance shall not in and of itself constitute a Material Adverse Change orcreate an inference that a Material Adverse Change has occurred.“Immaterial Subsidiary” means (a) any Foreign Subsidiary of Ultimate Parent organized or incorporatedunder the laws of The People’s Republic of China, and (b) any Subsidiary which (i) for the most recent fiscal year hadless than Two Million Dollars ($2,000,000) of revenues and (ii) as of the end of such fiscal yearwas the owner of less than Two Million Dollars ($2,000,000) of assets (or, with respect to any Subsidiary formed oracquired after the most recent fiscal year end, which has less than such amount of revenues and assets); provided that (i)at no time shall the Persons designated as Immaterial Subsidiaries have aggregate revenues for the most recent fiscalyear in excess of Twenty Million Dollars ($20,000,000), (ii) for the first year following the Effective Date, the UltimateParent’s Japanese subsidiary, Rosetta Stone Japan Inc., shall be deemed an “Immaterial Subsidiary”, and (iii)notwithstanding the foregoing, Ultimate Parent’s Brazilian subsidiary, Rosetta Stone Ensino de Linguas Ltda, shall bedeemed an “Immaterial Subsidiary” provided that such Subsidiary (a) for the most recent fiscal year had less than TwoMillion Dollars ($2,000,000) of revenues and (b) as of the end of such fiscal year was the owner of less than TwoMillion Dollars ($2,000,000) of assets.“Prime Rate” is the rate of interest per annum from time to time published in the money rates section of TheWall Street Journal or any successor publication thereto as the “prime rate” then in effect; provided that, in the eventsuch rate of interest is less than zero, such rate shall be deemed to be zero for purposes of this Agreement; and providedfurther that if such rate of interest, as set forth from time to time in the money rates section of The Wall Street Journal,becomes unavailable for any reason as determined by Bank, the “Prime Rate” shall mean the rate of interest per annumannounced by Bank as its prime rate in effect at its principal office in the State of California (such Bank announcedPrime Rate not being intended to be the lowest rate of interest charged by Bank in connection with extensions of creditto debtors); provided that, in the event such rate of interest is less than zero, such rate shall be deemed to be zero forpurposes of this Agreement.“Revolving Line Maturity Date” is April 1, 2020.“Streamline Period” is, on and after the Sixth Amendment Effective Date, provided no Event of Default hasoccurred and is continuing, the period (a) commencing on the first day of the month following the day that Borrowerprovides to Bank a written report that Borrower has maintained, for each consecutive day in the immediately precedingcalendar month, Liquidity in an amount at all times greater than (A) from April 1st through and including August 31st ofeach year, Fourteen Million Dollars ($14,000,000) and (B) from September 1st through and including March 31st ofeach year, Seventeen Million Five Hundred Thousand Dollars ($17,500,000) (either such amount, the “StreamlineBalance”); and (b) terminating on the earlier to occur of (i) the occurrence of an Event of Default, and (ii) the first daythereafter in which Borrower fails to maintain the Streamline Balance. Upon the termination of a Streamline Period,Borrower must maintain the Streamline Balance each consecutive day for one (1) calendar month prior to entering intoa subsequent Streamline Period. Borrower shall give Bank prior written notice of Borrower’s election to enter into anysuch Streamline Period, and each such Streamline Period shall commence on the first day of the monthly periodfollowing the date the Bank determines, in its reasonable discretion, that the Streamline Balancehas been achieved, subject, however, in each such case to Bank’s reasonable determination made within a reasonabletime after receipt of the relevant report that Borrower has maintained the requisite Liquidity in the relevant time periods.2.14 Section 13 (Definitions). The preamble in the definition of Eligible Accounts set forth in Section 13.1 is deletedin its entirety and replaced with the following:“Eligible Accounts” means Accounts which arise in the ordinary course of Borrower’s business that meet allBorrower’s representations and warranties in Section 5.12, that have been, at the option of Bank, confirmed inaccordance with Section 6.4(e) of this Agreement, and are due and owing from Account Debtors deemed creditworthyby Bank in its good faith business judgment. Bank reserves the right, upon prior consultation with Borrower, at anytime after the Effective Date to adjust any of the criteria set forth below and to establish new criteria in its good faithbusiness judgment. Unless Bank otherwise agrees in writing, Eligible Accounts shall not include:2.15 Section 13 (Definitions). The following new defined terms are hereby inserted alphabetically in Section 13.1:“Borrowing Base Report” is that certain report of the value of certain Collateral in the form attached hereto asExhibit B.“Credit Extension” is any Advance, any Overadvance, Letter of Credit, or any other extension of credit byBank for Borrower’s benefit.“Sixth Amendment Effective Date” is March 10, 2017.2.16 Section 13 (Definitions). The following defined terms set forth in Section 13.1 are deleted in their entirety:“Transaction Report” is that certain report of transactions and schedule of collections in the form attachedhereto as Exhibit B, with appropriate insertions.2.17 Exhibit B (Borrowing Base Report). The Transaction Report (as defined in the Loan Agreement until the dateof this Amendment) appearing as Exhibit B to the Loan Agreement is deleted in its entirety and replaced with the Borrowing BaseReport in the form of Exhibit B attached hereto.2.18 Exhibit D (Compliance Certificate). The Compliance Certificate appearing as Exhibit D to the LoanAgreement is deleted in its entirety and replaced with the Compliance Certificate in the form of Exhibit D attached hereto.2.19 Exhibit E (Financial Covenants). The financial covenants set forth in Exhibit E to the Loan Agreement aredeleted in their entirety and replaced with the financial covenants set forth on Exhibit E attached hereto.3. Conditions Precedent to Effectiveness. This Amendment shall not be effective until each of the following conditionsprecedent have been fulfilled to the satisfaction of Bank:3.1 This Amendment shall have been duly executed and delivered by the respective parties hereto. Bank shall havereceived a fully executed copy hereof.3.2 All necessary consents and approvals to this Amendment shall have been obtained by Borrower.3.3 After giving effect to this Amendment, no Default or Event of Default shall have occurred and be continuing.3.4 Bank shall have received the fees costs and expenses required to be paid pursuant to Section 5 of this Amendment(including the 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:4.1 This Amendment is, and each other Loan Document to which it is or will be a party, when executed and deliveredby Borrower, will be the legally valid and binding obligation of Borrower, enforceable against Borrower in accordance with itsrespective terms, except as enforcement may be limited by bankruptcy, insolvency, reorganization, moratorium or similar laws relatingto or limiting creditors’ rights generally and equitable principals (whether enforcement is sought by proceedings in equity or at law).4.2 Its representations and warranties set forth in this Amendment, the Loan Agreement, as amended by thisAmendment and after giving effect hereto, and the other Loan Documents to which it is a party are (i) to the extent qualified bymateriality, true and correct in all respects and (ii) to the extent not qualified by materiality, true and correct in all material respects, ineach case, on and as of the date hereof, as though made on such date (except to the extent that such representations and warrantiesrelate solely to an earlier date, in which case such representations and warranties shall have been true and correct in all material respectsas of such earlier date).4.3 The execution and delivery by Borrower of this Amendment, the performance by Borrower of its obligationshereunder and the performance of Borrower under the Loan Agreement, as amended by this Amendment, (i) have been dulyauthorized by all necessary organizational action on the part of Borrower and (ii) will not (A) violate any provisions of the certificate ofincorporation or formation or organization or by-laws or limited liability company agreement or limited partnership agreement ofBorrower 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 theirrelationships with Borrower in connection with this Amendment and in connection with the other Loan Documents. Borrowerunderstands and acknowledges that Bank is entering into this Amendment in reliance upon, and in partialconsideration for, the above representations, warranties, and acknowledgements, and agrees that such reliance is reasonable andappropriate.5. Payment of Costs and Expenses. Borrower shall pay to Bank a fully-earned, non-refundable amendment fee equal to OneHundred Twenty Five Thousand Dollars ($125,000), which fee shall be paid on the Sixth 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 and instruments relating hereto or thereto (which costsinclude, without limitation, the reasonable and documented fees and expenses of any attorneys retained by Bank).6. Choice of Law. THIS AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE PARTIESHEREUNDER SHALL BE GOVERNED BY, AND SHALL BE CONSTRUED AND ENFORCED IN ACCORDANCEWITH, THE LAWS OF THE STATE OF NEW YORK. Each party hereto submits to the exclusive jurisdiction of the State andFederal courts in the Southern District of the State of New York; provided, however, that nothing in the Loan Agreement as amendedby this Amendment shall be deemed to operate to preclude Bank from bringing suit or taking other legal action in any other jurisdictionto realize on the Collateral or any other security for the Obligations, or to enforce a judgment or other court order in favor of suchAgent. TO THE EXTENT PERMITTED BY APPLICABLE LAW, EACH PARTY HERETO WAIVES ITS RIGHT TOA JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION ARISING OUT OF OR BASED UPON THISAMENDMENT, THE OTHER LOAN DOCUMENTS OR ANY CONTEMPLATED TRANSACTION, INCLUDINGCONTRACT, TORT, BREACH OF DUTY AND ALL OTHER CLAIMS. EACH PARTY HERETO ACKNOWLEDGESTHAT THIS WAIVER IS A MATERIAL INDUCEMENT TO ENTER INTO A BUSINESS RELATIONSHIP, THATEACH HAS ALREADY RELIED ON THIS WAIVER IN ENTERING INTO THIS AMENDMENT, AND THAT EACHWILL 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 LEGALCOUNSEL AND THAT IT KNOWINGLY AND VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS FOLLOWINGCONSULTATION WITH LEGAL COUNSEL.7. Counterpart Execution. This Amendment may be executed in any number of counterparts and by different parties onseparate counterparts, each of which, when executed and delivered, shall be deemed to be an original, and all of which, when takentogether, shall constitute but one and the same Amendment. Delivery of an executed counterpart of this Amendment by telefacsimile orby e-mail transmission of an Adobe file format document (also known as a PDF file) shall be equally as effective as delivery of anoriginal executed counterpart of this Amendment. Any party delivering an executed counterpart of this Amendment by telefacsimile orby e-mail transmission of an Adobe file format document (also known as a PDF file) also shall deliver an original executed counterpartof this Amendment but the failure to deliver an original executed counterpart shall not affect the validity, enforceability, and bindingeffect of this Amendment.8. Effect on Loan Documents.8.1 The amendments set forth herein shall be limited precisely as written and shall not be deemed (a) to be aforbearance, waiver, or modification of any other term or condition of the Loan Agreement or of any Loan Documents or to prejudiceany right or remedy which Bank may now have or may have in the future under or in connection with the Loan Documents; (b) to be aconsent to any future consent or modification, forbearance, or waiver to the Loan Agreement or any other Loan Document, or to anywaiver of any of the provisions thereof; or (c) to limit or impair Bank’s right to demand strict performance of all terms and covenants asof any date. Borrower hereby ratifies and reaffirms its obligations under the Loan Agreement and the other Loan Documents to whichit is a party and agrees that none of the amendments or modifications to the Loan Agreement set forth in this Amendment shall impairBorrower’s obligations under the Loan Documents or Bank’s rights under the Loan Documents. Borrower hereby further ratifies andreaffirms the validity and enforceability of all of the Liens heretofore granted, pursuant to and in connection with the Loan Agreementor any other Loan Document, to Bank as collateral security for the obligations under the Loan Documents, in accordance with theirrespective terms, and acknowledges that all of such Liens, and all collateral heretofore pledged as security for such obligations,continues to be and remain collateral for such obligations from and after the date hereof. Borrower acknowledges and agrees that theLoan Agreement and each other Loan Document is still in full force and effect and acknowledges as of the date hereof that Borrowerhas no defenses to enforcement of the Loan Documents. Borrower waives any and all defenses to enforcement of the Loan Agreementas amended hereby and each other Loan Documents that might otherwise be available as a result of this Amendment of the LoanAgreement. To the extent any terms or provisions of this Amendment conflict with those of the Loan Agreement or other LoanDocuments, the terms and provisions of this Amendment shall control.8.2 To the extent that any terms and conditions in any of the Loan Documents shall contradict or be in conflict withany terms or conditions of the Loan Agreement, after giving effect to this Amendment, such terms and conditions are hereby deemedmodified or amended accordingly to reflect the terms and conditions of the Loan Agreement as modified or amended hereby.8.3 This Amendment is a Loan Document.9. Entire Agreement. This Amendment constitutes the entire agreement between Borrower and Bank pertaining to thesubject matter contained herein and supersedes all prior agreements, understandings, offers and negotiations, oral or written, withrespect hereto and no extrinsic evidence whatsoever may be introduced in any judicial or arbitration proceeding, if any, involving thisAmendment. All of the terms and provisions of this Amendment are hereby incorporated by reference into the Loan Agreement, asapplicable, as if such terms and provisions were set forth in full therein, as applicable. All references in the Loan Agreement to “thisAgreement”, “hereto”, “hereof”, “hereunder” or words of like import shall mean the Loan Agreement as amended hereby.10. Release. Borrower may have certain Claims against the Released Parties, as those terms are defined below, regarding orrelating to the Loan Agreement or the other Loan Documents. Bank and Borrower desire to resolve each and every one of such Claimsin conjunction with theexecution of this Amendment and thus Borrower makes the releases contained in this Section 10. In consideration of Bank enteringinto 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 their behalf (collectively, the “Released Parties”), of and from any and all claims,allegations, causes of action, costs or demands and liabilities, of whatever kind or nature, from the beginning of the world to the dateon which this Amendment is executed, whether known or unknown, liquidated or unliquidated, fixed or contingent, asserted orunasserted, foreseen or unforeseen, matured or unmatured, suspected or unsuspected, anticipated or unanticipated, which Borrowerhas, had, claims to have had or hereafter claims to have against the Released Parties by reason of any act or omission on the part of theReleased Parties, or any of them, occurring prior to the date on which this Amendment is executed, including all such loss or damageof any kind heretofore sustained or that may arise as a consequence of the dealings among the parties up to and including the date onwhich this Amendment is executed, including the administration or enforcement of the Loans, the Obligations, the Loan Agreement orany of the Loan Documents (collectively, all of the foregoing, the “Claims”). Borrower represents and warrants that it has noknowledge of any claim by it against the Released Parties or of any facts or acts of omission of the Released Parties which on the datehereof would be the basis of a claim by Borrower against the Released Parties which is not released hereby. Borrower represents andwarrants that the foregoing constitutes a full and complete release of all Claims.11. Severability. The provisions of this Amendment are severable, and if any clause or provision shall be held invalid orunenforceable in whole or in part in any jurisdiction, then such invalidity or unenforceability shall affect only such clause or provision,or part thereof, in such jurisdiction and shall not in any manner affect such clause or provision in any other jurisdiction, or any otherclause or provision in this Amendment in any jurisdiction.[Remainder of page intentionally left blank; signature page follows]IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed and delivered by their properand duly authorized officers as of the day and year first above written.BORROWER:ROSETTA STONE LTD.By____/s/ Thomas Pierno______________________ Name:__ Thomas Pierno ______________________ Title:__Chief Financial Officer__________________NEW BORROWER:LEXIA LEARNING SYSTEMS LLCBy: /s/ Sonia Galindo Name: Sonia Galindo Title: Manager BANK:SILICON VALLEY BANKBy___Will Deevy_____________________________ Name:___Will Deevy _________________________ Title:____Vice President_______________________Each Guarantor hereby acknowledges and confirms that it has reviewed and approved the terms and conditions of theAmendment. Each Guarantor hereby consents to the Amendment and agrees that the Guaranty of such Guarantor relating to theObligations of Borrower under the Loan Agreement shall continue in full force and effect, shall be valid and enforceable and shall notbe impaired or otherwise affected by the execution of the Amendment or any other document or instruction delivered in connectionherewith. Each Guarantor represents and warrants that, after giving effect to the Amendment, all representations and warrantiescontained in each Loan Document which such Guarantor is a party are true, accurate and complete as if made the date hereof, and allsuch Loan Documents are hereby ratified and confirmed and shall remain in full force and effect.GUARANTORS:ROSETTA STONE INC.By: /s/ Thomas Pierno Name: Thomas Pierno Title: Chief Financial Officer ROSETTA STONE HOLDINGS INC.By: /s/ Thomas Pierno Name: Thomas Pierno Title: Chief Financial Officer ROSETTA STONE INTERNATIONAL INC.By: /s/ Thomas Pierno Name: Thomas Pierno Title: Chief Financial Officer LIVEMOCHA LLCBy: /s/ Sonia Galindo Name: Sonia Galindo Title: Manager EXHIBIT BBorrowing Base Report[To be provided by Bank]EXHIBIT DCOMPLIANCE CERTIFICATETO: SILICON VALLEY BANK Date: FROM: ROSETTA STONE LTD. and LEXIA LEARNING SYSTEMS LLCThe undersigned authorized officer of Rosetta Stone Ltd. and Lexia Learning Systems LLC (each and together, jointly and severally, “Borrower”)certifies that under the terms and conditions of the Loan and Security Agreement between Borrower and Bank (the “Agreement”): (1) Each Credit party is incomplete compliance for the period ending _______________ with all required covenants except as noted below; (2) there are no Events of Default; (3) allrepresentations and warranties in the Agreement are true and correct in all material respects on this date except as noted below; provided, however, that suchmateriality qualifier shall not be applicable to any representations and warranties that already are qualified or modified by materiality in the text thereof; andprovided, further that those representations and warranties expressly referring to a specific date shall be true, accurate and complete in all material respects asof such date; (4) each Credit Party and each of its Subsidiaries, has timely filed all required tax returns and reports, and each Credit Party and each of itsSubsidiaries has timely paid all foreign, federal, state and local taxes, assessments, deposits and contributions owed by such Credit Party or Subsidiary exceptas otherwise permitted pursuant to the terms of Section 5.8 of the Agreement; and (5) no Liens have been levied or claims made against any Credit Party orany of its Subsidiaries relating to unpaid employee payroll or benefits of which Borrower has not previously 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 meaningsgiven them in the Agreement.Please indicate compliance status by circling Yes/No under “Complies” column. Reporting CovenantsRequiredComplies Monthly or Quarterly financial statements with Compliance CertificateMonthly within 30 dayswhen there are Advances outstanding;quarterly within 45 days when there areno Advances outstandingYes NoAnnual financial statement (CPA Audited) withCompliance CertificateFYE within 90 daysYes No10‑Q, 10‑K and 8-KWithin 5 days after filing with SECYes NoProjectionsFYE within 90 daysYes NoA/R Agings & A/P ReportBi-weekly when a Streamline Period isnot in effect and there are Advancesoutstanding; monthly within 30 dayswhen a Streamline Period is in effectand there are Advances outstanding;quarterly within 45 days when there areno Advances outstandingYes NoBorrowing Base ReportsBi-weekly when a Streamline Period isnot in effect and there are Advancesoutstanding; monthly within 30 dayswhen a Streamline Period is in effectand there are Advances outstanding;quarterly within 45 days when there areno Advances outstandingYes No The following Intellectual Property was registered (or a registration application submitted) after the Effective Date (if no registrations, state “None”)___________________________________________________________________________________________Financial CovenantsRequiredActualComplies Achieve on a Quarterly Basis: Minimum Liquidity$12,500,000$Yes NoMinimum Adjusted EBITDA*$Yes No*See Exhibit EStreamline PeriodAppliesLiquidity > $14,000,000 (4/1 – 8/31)Yes NoLiquidity > $17,500,000 (9/1 – 3/31)Yes NoNon-Formula PeriodApplies Liquidity > $25,000,000Yes 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 theOperating Documents of any Credit Party or any of its Subsidiaries since the date of the most recently deliveredCompliance Certificate? If yes, provide copies of any such amendments or changes with this Compliance Certificateto the extent not previously delivered to Bank.YesNoThe following are the exceptions with respect to the certification above: (If no exceptions exist, state “No exceptions to note.”)-------------------------------------------------------------------------------------------------------------------------------ROSETTA STONE LTD.LEXIA LEARNING SYSTEMS LLCBy: 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.I. Liquidity (Section 6.8(a))Required: $12,500,000Actual:A.Aggregate value of the unrestricted cash maintained in Deposit Accounts or Securities Accounts at Bank or its Affiliates$B.Availability Amount (excluding the Non-Formula Amount from the Borrowing Base)$C.Liquidity (line A plus line B)$Is line C equal to or greater than $12,500,000? No, not in compliance Yes, in complianceII. ADJUSTED EBITDA (Section 6.8(b))Required:Adjusted EBITDA, measured on a trailing twelve (12) month basis as of the end of each fiscal quarter during the periods specified below, ofat least (loss not worse than) the following:Quarterly PeriodAdjusted EBITDAMarch 31, 2017($7,500,000)June 30, 2017 and each fiscal quarter thereafter($5,000,000)Actual (for the cumulative period referenced):A.Net Income$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)”" line itembelow the operating income line in the Ultimate Parent's relevant income statement, determined in accordance with GAAP)$ 7. Goodwill impairment$ 8. Change in Deferred Revenue$ 9. Change in deferred commissions$ 10. items related to the litigation with Google Inc. 11. 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 with mergersand acquisitions (not to exceed an aggregate amount, when added to the adjustments listed in line 12, of $6,000,000 in anytrailing twelve (12) month period following the Sixth Amendment Effective Date)$ 12. adjustments related to recording the non-cash tax valuation allowance for deferred tax assets (not to exceed an aggregateamount, when added to the costs listed in line 11, of $6,000,000 in any trailing twelve (12) month period following the SixthAmendment Effective Date)$ 13. Total Line B: The sum of lines 1 through 8 minus lines 9 through 12$C.ADJUSTED EBITDA (line A plus line B)$Is line C at least (loss not worse than) $______________? No, not in compliance Yes, in complianceEXHIBIT EFINANCIAL COVENANTSAchieve on a consolidated basis with respect to Ultimate Parent and its Subsidiaries:(a) Liquidity. Maintain at all times, to be certified to Bank as of the last day of each month, Liquidity equal to or greater than TwelveMillion Five Hundred Thousand Dollars ($12,500,000).(b) Adjusted EBITDA. Adjusted EBITDA, measured on a trailing twelve (12) month basis as of the end of each fiscal quarter during theperiods specified below, of at least (loss not worse than) the following:Quarterly PeriodAdjusted EBITDAMarch 31, 2017($7,500,000)June 30, 2017 and each fiscal quarter thereafter($5,000,000)2102364.6Exhibit 21.1ROSETTA STONE INC. SUBSIDIARIESAs of March 14, 2017 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, 2017, 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, 2016./s/ DELOITTE & TOUCHE LLPMcLean, VirginiaMarch 14, 2017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 Galindo, 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, 2017Signature Title /s/ A. JOHN HASS III President, Chief Executive Officer and Chairman of the Board(Principal Executive Officer)A. John Hass III /s/ THOMAS M. PIERNO Chief Financial Officer(Principal Financial Officer)Thomas M. Pierno /s/ Patrick W. Gross DirectorPatrick W. Gross /s/ LAURENCE FRANKLIN DirectorLaurence Franklin /s/ DAVID P. NIERENBERG DirectorDavid P. Nierenberg /s/ CAROLINE J. TSAY DirectorCaroline J. Tsay /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, 2017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, 2017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, 2016, as filed with the Securities and ExchangeCommission on the date hereof (the "Report"), I, A. John Hass, President, Chief Executive Officer, and Chairman of the Board of Rosetta Stone Inc. (the"Company"), hereby certify, to my knowledge, 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, 2017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, 2016, 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, 2017

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