Rosetta Stone Inc
Annual Report 2017

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, 2017Commission 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, a smaller reporting company or anemerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth 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 oEmerging growth company o (Do not check if a smaller reportingcompany) If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with anynew or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o 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 $230.9 million as of June 30, 2017 (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 February 28, 2018, there were 22,473,537 shares of common stock outstanding.Documents incorporated by reference: Portions of the definitive Proxy Statement to be delivered to stockholders in connection with the 2018Annual Meeting of Stockholders to be held on June 18, 2018 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 Risk50Item 8.Financial Statements and Supplementary Data50Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure50Item 9A.Controls and Procedures50Item 9B.Other Information51PART IIIItem 10.Directors, Executive Officers and Corporate Governance52Item 11.Executive Compensation52Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters52Item 13.Certain Relationships and Related Transactions, and Director Independence52Item 14.Principal Accounting Fees and Services52PART IVItem 15.Exhibits and Financial Statement Schedules53Item 16.Form 10-K Summary55Table of ContentsPART IFORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K (this "Report") and other statements or presentations made from time to time by the Company, including thedocuments incorporated by reference, contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.Forward-looking statements can be identified by non-historical statements and often include words such as "outlook," "potential," "believes," "expects,""anticipates," "estimates," "intends," "plans," "seeks" or words of similar meaning, or future-looking or conditional verbs, such as "will," "should," "could,""may," "might," "aims," "intends," or "projects,” or similar words or phrases. These statements may include, but are not limited to, statements related to: ourbusiness strategy; guidance or projections related to revenue, Adjusted EBITDA, sales, and other measures of future economic performance; thecontributions and performance of our businesses, including acquired businesses and international operations; projections for future capital expenditures;and other guidance, projections, plans, objectives, and related estimates and assumptions. A forward-looking statement is neither a prediction nor aguarantee of future events or circumstances. In addition, forward-looking statements are based on the Company’s current assumptions, expectations andbeliefs and are subject to certain risks and uncertainties that could cause actual results to differ materially from our present expectations or projections.Some important factors that could cause actual results, performance or achievement to differ materially from those expressed or implied by these forward-looking statements include, but are not limited to: the risk that we are unable to execute our business strategy; declining demand for our language learningand literacy solutions; the risk that we are not able to manage and grow our business; the impact of any revisions to our pricing strategy; the risk that wemight not succeed in introducing and producing new products and services; the impact of foreign exchange fluctuations; the adequacy of internallygenerated funds and existing sources of liquidity, such as bank financing, as well as our ability to raise additional funds; the risk that we cannot effectivelyadapt to and manage complex and numerous technologies; the risk that businesses acquired by us might not perform as expected; and the risk that we arenot able to successfully expand internationally. We expressly disclaim any obligation to update or revise any forward-looking statements, whether as aresult of new information, future developments or otherwise, except as required by law. These factors should not be construed as exhaustive and should beread in conjunction with the other cautionary statements risks and uncertainties that are more fully described in 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 in Part I, Item 1A: "Risk Factors" andPart II, Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations,” those described elsewhere in this Annual Reporton Form 10-K, and those described from time to time in our future reports filed with the Securities and Exchange Commission. Table of ContentsItem 1. BusinessOverviewRosetta Stone Inc. (“Rosetta Stone,” “the Company,” “we” or “us”) is dedicated to changing people's lives through the power of language and literacyeducation. Our innovative 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 foundational 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 current portfolio of language and literacy products and transition to a SaaS-based delivery modelprovide multiple opportunities for long-term value creation. We believe the demand is growing for e-learning based literacy solutions in the U.S. and Englishlanguage-learning around the globe, and we are uniquely positioned with the power of our global brand to meet the growing needs of global learners.We continue to emphasize the development of products and solutions for Corporate and K-12 learners who need to speak and read English. This focusextends to the Consumer Language segment, where we continue to make product investments serving the needs of passionate language-learners who aremobile, results- focused and value 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 ("E&E Language") segment for profitable growth by focusing our direct sales on our bestgeographies and customer segments, partnering with resellers in other geographies and successfully delivering our CatalystTM product to Corporatecustomers. Catalyst integrates our Foundations, Advantage, and Advanced English for Business products with enhanced reporting, assessment andadministrator tools that offers a simple, more modern, metrics-driven suite of tools that are results-oriented and easily integrated with leadingcorporate language-learning systems;3.Seek to maximize the benefit of the changes we have made in our Consumer Language products and successfully transition to SaaS delivery to seekadditional growth opportunities with a greater emphasis on a streamlined, mobile-oriented product portfolio focused on consumers' demand, whileoptimizing 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.Business SegmentsOur business is organized into three operating segments: Literacy, E&E Language, and Consumer Language. The Literacy segment derives revenueunder a Software-as-a-Service ("SaaS") model from the sales of literacy solutions to educational institutions serving grades K through 12. The E&E Languagesegment derives language-learning revenues from sales to educational institutions, corporations, and government agencies worldwide under a SaaS model.The Consumer Language segment derives revenue from sales to individuals and retail partners worldwide and is nearing the completion of a SaaS migrationfrom a packaged software business. For additional information regarding our segments, see Note 19 of Item 8, Financial Statements and Supplementary Data.Prior periods are presented consistently with our current operating segments and definition of segment contribution.Products and ServicesLiteracy:Literacy Solutions: Our Literacy segment is comprised solely of our Lexia business. The Lexia Learning suite of subscription-based English literacy-learning and assessment solutions provide explicit, systematic, personalized learning on foundational literacy skills for students of all abilities. This research-proven technology based approach accelerates reading4Table of Contentsskills development, predicts students' year-end performance and provides teachers with data-driven action plans to help differentiate instruction. LexiaReading Core5 is available for all abilities from pre-K through grade 5. PowerUp Literacy is designed for non-proficient readers in grades 6 and above. LexiaRAPID Assessment is a computer-adaptive screener and diagnostic tool for grades K-12 that identifies and monitors reading and language skills to provideactionable data for instructional planning. Lexia's solutions deliver performance data and analysis to enable teachers to monitor and modify their instructionto address specific student needs. These literacy solutions are provided under web-based subscriptions. Our service offerings provide schools with productimplementation services to support strong educator and student use. These services are purchased through annual or multi-year service contracts.E&E Language:E&E Language-Learning Solutions: Rosetta Stone provides a series of web-based subscriptions to interactive language-learning solutions for schools,business and other organizations that are primarily available online. Our core language-learning suite offers courses and practice applications in multiplelanguages, each leveraging our proprietary context-based immersion methodology, speech recognition engine and innovative technology features. Availablein 24 languages and designed for beginner to intermediate language learners, Rosetta Stone Foundations builds fundamental language skills. Rosetta StoneAdvantage is available for all proficiency levels in 9 of the 24 languages and focuses on improving everyday and business language skills. Our AdvancedEnglish for Business solution serves multinational companies seeking to build their employees’ English language proficiency so they are able tocommunicate and operate in a global business environment. In 2016, we completed the development of Catalyst, which consolidates and aligns ourFoundations, Advantage and Advanced English for Business products into a single solution for our enterprise customers. Catalyst provides streamlinedaccess and simplified pricing for the full suite of English and world language learning content, along with assessment, placement, ongoing reporting anddemonstration of results, all of which address important customer needs to focus and demonstrate payback. Specifically designed for use with our language-learning solutions, our E&E Language customers may also purchase our audio practice products and live tutoring sessions to enhance the learningexperience.Rosetta Stone offers tailored solutions to help organizations maximize the success of their learning programs. Our current custom solutions includecurriculum development, global collaboration programs that combine language education with business culture training, group and live tutoring, andlanguage courses for mission-critical government programs.Our E&E Language and Literacy customers can maximize their learning solutions with administrative tools, professional services and custom solutions.Administrative Tools: Our E&E Language and Literacy learning programs come with a set of administrative tools for performance monitoring, and tomeasure and track learner progress. Administrators can use these tools to access real-time dynamic reports and identify each learner's strengths andweaknesses.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 E&E Language and Literacy solutions into technical infrastructure.Consumer Language: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 25-year heritage in language-learning.Many of our consumer products and services are available in flexible and convenient formats for tablets and smartphones. Our mobile apps enablelearners to continue their lessons on the go and extend the learning experience away from a computer. Progress is automatically synchronized across devicesto meet our customers' 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 primarilyas a software subscription via the web, mobile in-app purchase, or through retail channels.Our 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 video service that provides either one-on-one or group conversational coaching sessionswith native speakers to practice skills and experience direct interactive dialogue. Our current suite of mobile language-learning apps5Table of Contentsincludes companions to our computer-based language-learning apps which enables learners to access their language program anytime anywhere.Software Development: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 teams buildnew solutions and enhance or maintain 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 $24.7 million, $26.3 million, and $29.9 million for the years ended December 31, 2017, 2016 and 2015,respectively.Customers and Distribution ChannelsNo customer accounted for more than 10% of consolidated revenue during the years ended December 31, 2017, 2016 or 2015. Our practice is to ship ourproducts promptly upon receipt of purchase orders from customers; consequently, backlog is not significant.Literacy:Our Literacy distribution channel in the United States utilizes a direct sales force as well as relationships with third-party resellers focused on the sale ofLexia solutions to K-12 schools. International distribution is primarily managed through independent resellers based in the United Kingdom, Australia andNew Zealand.E&E Language:Our E&E 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 E&E Language-learning customers 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.As part of our K-12 customer activities, our Literacy and E&E Language segments interact with employees of school districts including superintendents,procurement officers, principals and teachers. For instance, we participate in associations and events, including as a sponsor, at which such employees arepresent. We also invite these employees to events hosted by us, at which we discuss general educational developments as well as our products and services,and to serve on customer advisory boards to provide feedback on our products and services. We​, sometimes and as permissible, ​pay the travel expenses ofschool district employees who attend company-sponsored events or serve on an advisory board. Consumer Language:Our Consumer Language distribution channel comprises a mix of our websites, third party e-commerce websites, app-stores, consignment distributors,select retailers, and call centers. We believe these channels complement each other, as consumers who have seen our direct-to-consumer advertising maypurchase at our retailers, and vice versa.Direct to consumer. Sales generated through our e-commerce website at www.rosettastone.com, app stores such as Google Play and Apple App Storeand our call centers.Indirect to consumer. Sales generated through arrangements with third-party e-commerce websites and consignment distributors such as SoftwarePackaging Associates.6Table of ContentsRetailers. Our retailers enable us to provide additional points of contact to educate consumers about our solutions, expand our presence beyond ourown websites, and further strengthen and enhance our brand image. Our retail relationships include Amazon.com, Barnes & Noble, Target, Best Buy, Books-a-Million, Staples, and others in and outside of the U.S. We may also partner at times with daily deal and home shopping 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 Literacy and E&E Language segments, we have transitioned the Consumer Language segment away from CD-based product sales to a cloud-based software subscription in order to provide an improved learner experience with instant fulfillment and mobileavailability, which has also allowed us to, over time, reduce costs associated with physical packaging and distribution.Our physical inventory utilizes a flexible, diversified and low-cost manufacturing base. We use third-party contract manufacturers, suppliers anddistributors to obtain substantially all of our product and packaging components and to manufacture and, increasingly, fulfill finished products. We believethat we have good relationships with our vendors and that there are alternative sources in the event that one or more of these vendors 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 literacy, enterprise and educational languagelearning, and consumer language learning.With Lexia, we compete primarily in the K-12 digital literacy space in the U.S. with Imagine Learning, Scientific Learning, Odyssey (CompassLearning), Renaissance, Houghton Mifflin Harcourt, Curriculum Associates, and iStation.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.SeasonalityOur business is affected by variations in seasonal trends. Within our Literacy segment and K-12 Language education sales channel, sales are seasonallystronger in the second and third quarters of the calendar year corresponding to the end and beginning of school district budget years. E&E Language segmentsales in our government and corporate sales channels are seasonally stronger in the second half of the calendar year due to purchasing and budgeting cycles.Consumer Language sales are affected by seasonal trends associated with the holiday shopping season. In particular, we generate a significant portion of ourConsumer Language sales in the fourth 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 Language sales typically turn to cash more quickly than E&ELanguage 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.7Table of ContentsWe have twelve U.S. patents, sixteen foreign patents and several U.S. and foreign patent applications pending that cover various aspects of ourlanguage-learning and literacy technologies.We have registered a variety of trademarks, including our primary or house marks, Rosetta Stone, The Blue Stone Logo, Lexia, Lexia PowerUP Literacy,TruAccent, 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, 2017, we had 992 total employees, consisting of 701 full-time and 291 part-time employees. We have employees in France andSpain who benefit from 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 19 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 SEC. Our website address is www.rosettastone.com. Theinformation contained in, or that can be accessed through, our website is not part of, and is not incorporated into, 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 2, 2017 with the SEC for the period ended September 30, 2017. 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 carefully8Table of Contentsconsider the risk factors discussed below and in other documents we file with the SEC that could materially affect our business, financial condition, cashflows or future results.We might not be successful in executing our strategy of focusing on corporate and K-12 learners and passionate language learners.We are continuing to implement our strategy to emphasize the development of products and solutions for corporate and K-12 learners who need tospeak and read English. This focus extends to the Consumer Language segment, where we continue to make product investments serving the needs ofpassionate language learners who are mobile, results-focused and value a quality language-learning experience. If we do not successfully execute ourstrategy, our revenue and profitability could decline, which could have an adverse effect on our business and financial results.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 the current and potential competitors in our Literacy and E&E Language segments have substantially greater financial, technical, sales,marketing and other resources than we do, as well as greater name recognition in some locations, as well as in some cases, lower costs. Some competitors offermore differentiated products (for example, online learning as well as physical classrooms and textbooks) that may allow them to more flexibly meet changingcustomer preferences. The resources of our competitors also may enable them to respond more rapidly to new or emerging technologies and changes incustomer requirements and preferences and to offer lower prices than ours or to offer free language-learning software or online services. We may not be able tocompete successfully against current or future competitors.There are a number of free online language-learning opportunities to learn grammar, pronunciation, vocabulary (including specialties in areas such asmedicine and business), reading, and conversation by means of podcasts and MP3s, mobile applications, audio courses and lessons, videos, games, stories,news, digital textbooks, and through other means, which compete with our Consumer Language segment. We estimate that there are thousands of free mobileapplications on language-learning; free products are provided in at least 50 languages by private companies, universities, and government agencies. Lowbarriers to entry allow start-up companies with lower costs and less pressure for profitability to compete with us. Competitors that are focused more on useracquisition rather than profitability and funded by venture capital may be able to offer products at9Table of Contentssignificantly lower prices or for free. As free online translation services improve and become more widely available and used, people may generally becomeless interested in language learning. Although we also offer free products such as mobile apps, if we cannot successfully attract users of these free productsand convert a sufficient portion of these free users into paying customers, our business could be adversely affected. If free products become more engagingand competitive or gain widespread acceptance by the public, demand for our products could decline or we may have to lower our prices, which couldadversely impact our revenue and other results.Historically a substantial portion of our revenue has been generated from our Consumer Language business. If we fail to accurately anticipate consumerdemand and trends 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 Literacy and E&E Language businesses could be impaired.We depend on discretionary consumer spending in the Consumer Language segment of our business. Adverse trends in general economic conditions,including retail and online shopping patterns or consumer confidence, as well as other external consumer dynamics may compromise our ability togenerate 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.10Table of ContentsBecause a portion of our Consumer Language 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, and Staples, and consignment distributors such as 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 E&E Language customers. Any increase in the taxation of online sales could havethe effect of a price increase to consumers and could cause us to have to lower our prices or could cause sales to decline. It is uncertain whether we will needto 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;•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;11Table of Contents•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.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 may impose additional and unique risks.In March 2016, as part of the 2016 Restructuring Plan, we initiated actions to withdraw our direct sales presence in almost all of our non-U.S. and non-northern European geographies related to the distribution of the E&E Language offerings, transitioning to indirect sales channels through reseller and otherarrangements with third parties in those geographies. We also have optimized certain of our website sales channels in Europe, Asia and Latin America. If weare unable to conduct our international operations successfully and market, sell, deliver and support our products and services internationally to the extentwe expect, our business, revenue and financial results could be harmed.If we are unable to continually adapt our products and services to mobile devices and technologies other than personal computers and laptops, and toadapt to other technological changes and customer needs generally, we may be unable to attract and retain customers, and our revenue and business couldsuffer.We need to anticipate, develop and introduce new products, services and applications on a timely and cost-effective basis that keeps pace withtechnological developments and changing customer needs. The process of developing new high technology products, services and applications andenhancing existing products, services and applications is complex, costly and uncertain, and any failure by us to anticipate customers' changing needs andemerging technological trends accurately could significantly harm our ability to attract and retain customers and our results of operations. For example, thenumber of individuals who access the Internet through devices other than a personal computer, such as tablet computers, mobile devices, televisions and set-top box devices, has increased dramatically and this trend is likely to continue. Our products and services may not work or be viewable on these devicesbecause each manufacturer or distributor may establish unique technical standards for such devices. Accordingly, we may need to devote significantresources to the creation, support and maintenance of such versions. If we fail to develop or sell products and services on a cost-effective basis that respond tothese or other technological developments and changing customer needs, we may be harmed in our ability to attract and retain customers, and our revenueand business could suffer. Furthermore, our customers who view our advertising via mobile devices might not buy our products to the same extent that theydo when viewing our advertising via personal computers or laptops. Accordingly, if we cannot convince customers to purchase our products via mobiledevices, our business and results of operations could be harmed to the extent that the trend to mobile devices continues.We offer our software products on operating systems and platforms including Windows, Macintosh, Apple OS, Android, and Amazon apps. The demandfor 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.12Table of ContentsOur 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 E&E Language and Literacy customers. As a result, we must continually ensure that our products interoperate properly with thesevaried and customized systems. Changes in operating systems, the technologies we incorporate into our products or the computer systems our customers usemay damage our business.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 E&E Language and Literacy customers are colleges, universities, primary and secondary schools and school districts, other educationproviders, armed forces and government agencies that depend substantially on government funding. Accordingly, any general decrease, delay or change infederal, state or local funding for colleges, universities, primary and secondary schools and school districts, or other education providers or governmentagencies that use our products and services could cause our current and potential customers to reduce their purchases of our products and services, to exercisetheir right to terminate licenses, or to decide not to renew licenses, any of which could cause us to lose revenue. In addition, a specific reduction ingovernmental funding support for products such as ours would also cause us to lose revenue and could adversely affect our overall gross margins.Some of our E&E Language and Literacy business is characterized by a lengthy and unpredictable sales cycle, which could delay new sales.We face a lengthy sales cycle between our initial contact with some potential E&E Language and Literacy customers and the signing of licenseagreements with these customers. As a result of this lengthy sales cycle, we have only a limited ability to forecast the timing of such E&E Language andLiteracy sales. A delay in or failure to complete license transactions could cause us to lose revenue, and could cause our financial results to vary significantlyfrom quarter to quarter. Our sales cycle varies widely, reflecting differences in our potential E&E Language and Literacy customers' decision-makingprocesses, procurement requirements and budget cycles, and is subject to significant risks over which we have little or no control, including:•customers' budgetary constraints and priorities;•the timing of our customers' budget cycles;•the need by some customers for lengthy evaluations that often include administrators and faculties; and•the length and timing of customers' approval processes.13Table of ContentsAs we pursue a 100% SaaS-based model for our Consumer Language business and sell our solutions as subscriptions, rather than packaged software, ourrevenue, 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 12- to 36-months) subscriptions with a corresponding license term. Online subscription customers could be less likely to renew their subscriptionsbeyond the initial term with the effect that we could earn less revenue over time from each customer than historically which could have a substantiallynegative impact on our revenue, results of operations and cash flow in any quarterly reporting period.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 Language products and services in the fourth quarter, especially during theholiday selling 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 E&E Language customers on a purchase order basis and we receive orders when these customers needproducts and services. As a result, their orders are typically not evenly distributed throughout the year. Our quarterly results of operations also may fluctuatesignificantly as a result of a variety of other factors, including the timing of holidays and advertising initiatives, changes in our products, services andadvertising initiatives and changes in those of our competitors. Budgetary constraints of our E&E Language and Literacy customers may also cause ourquarterly 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 experience difficulty integrating new technology, employees, and business systems, that we divert management's attention from our otherbusinesses or that we acquire undiscovered liabilities such as patent infringement claims or violations of the U.S. Foreign Corrupt Practices Act and similarworldwide anti-bribery laws. It may take longer than expected to realize the full benefits, such as increased revenue, enhanced efficiencies, or more customers,or those benefits may ultimately be smaller than anticipated, or may not be realized. These events and circumstances could harm our operating results orfinancial condition.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 specifically14Table of Contentsdesigned to impede the performance of our products and offerings and harm our reputation as a company. If our systems are harmed or fail to functionproperly or if third parties improperly obtain and use the personal information of our customers or employees, we may be required to expend significantresources to repair or replace systems or to otherwise protect against security breaches or to address problems caused by the breaches. A major breach of ournetwork security and systems could have serious negative consequences for our businesses, including possible fines, penalties and damages, reducedcustomer demand for our products and services, harm to our reputation and brand, and loss of our ability to accept and process customer credit card orders.Any such access, disclosure or loss of information could result in legal claims or proceedings and regulatory penalties, disrupt our operations or result in aloss of confidence in our products and services, which could 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.Our 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.15Table of ContentsIf 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 may enact new or additional laws and regulations concerning privacy,data-retention and data-protection issues, including laws or regulations mandating disclosure to domestic or international law enforcement bodies, whichcould adversely impact our business, our brand or our reputation with customers. For example, some countries are considering laws mandating that personaldata regarding customers in their country be maintained solely in their country. Having to maintain local data centers and design product, service andbusiness operations to limit personal data processing within individual countries could increase our operating costs significantly. In addition, the EuropeanCommission has approved a data protection regulation, known as the General Data Protection Regulation (GDPR), which has been finalized and is due tocome into force in or around May 2018. The GDPR will include additional operational and other requirements for companies that receive or process personaldata of residents of the European Union that are different than those currently in place in the European Union, and that will include significant penalties fornon-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.We are subject to U.S. and foreign government regulation of online services which could subject us to claims, judgments, and remedies, including monetaryliabilities and limitations on our business practices.We are subject to regulations and laws directly applicable to providers of online services. The application of existing domestic and international lawsand regulations to us relating to issues such as user privacy and data protection, data security, defamation, promotions, billing, consumer protection,accessibility, content regulation, quality of services, and intellectual property ownership and infringement in many instances is unclear or unsettled. Also, thecollection and protection of information from children under the age of 13 is subject to the provisions of the Children's Online Privacy ProtectionAct (COPPA), which is particularly relevant to our learning solutions focused on children. In addition, we will also be subject to any new laws andregulations directly applicable to our domestic and international activities. Internationally, we may also be subject to laws regulating our activities in foreigncountries and to foreign laws and regulations that are inconsistent from country to country. We may incur substantial liabilities for expenses necessary todefend litigation in connection with such regulations and laws or to comply with these laws and regulations, as well as potential substantial penalties for anyfailure to comply.Changes in how network operators handle and charge for access to data that travel across their networks could adversely impact our business.We rely upon the ability of customers to access many of our products through the Internet. To the extent that network operators implement usage basedpricing, including meaningful bandwidth caps, or otherwise try to monetize access to their networks by data providers, we could incur greater operatingexpenses and our customer acquisition and retention could be negatively impacted. Furthermore, to the extent network operators were to create tiers ofInternet access service and either charge us for or prohibit us from being available through these tiers, our business could be negatively impacted.We are exposed to risks associated with credit card and payment fraud, and with our obligations under rules on credit card processing and alternativepayment methods, which could cause us to lose revenue or incur costs. We depend upon our credit card processors and payment card associations.As an e-commerce provider that accepts debit and credit cards for payment, we are subject to the Payment Card Industry Data Security Standard ("PCIDSS"), issued by the PCI Council. PCI DSS contains compliance guidelines and standards with regard to our network security surrounding the physical andelectronic storage, processing and transmission of individual cardholder data. Despite our compliance with these standards and other information securitymeasures, we cannot guarantee that all our information technology systems are able to prevent, contain or detect any cyber attacks, cyber terrorism, orsecurity16Table of Contentsbreaches from currently known viruses or malware, or viruses or malware that may be developed in the future. To the extent any disruption results in the loss,damage or misappropriation of information, we may be adversely affected by claims from customers, financial institutions, regulatory authorities, paymentcard associations and others. In addition, the cost of complying with stricter privacy and information security laws and standards could be significant.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 ultimate effects of Brexit on us will also depend on the terms of any agreements the United Kingdom and the European Union make to retainaccess to each other's respective markets either during a transitional period or more permanently. Any of these effects, among others, could materiallyadversely affect our business, business opportunities, results of operations, and financial condition.The U.S. Congress and Trump administration may make substantial changes to fiscal, political, regulatory and other federal policies that may adverselyaffect our business, financial condition, operating results and cash flows. Changes in general economic or political conditions in the United States or other regions could adversely affect our business. For example, theadministration under President Donald Trump has indicated that it may propose significant changes with respect to a variety of issues, including educationstandards and funding, international trade agreements, import and export regulations, tariffs and customs duties, foreign relations, and immigration laws, thatcould have a materially adverse effect on 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 government will take with respect to world affairs and events. This uncertainty mayinclude such issues as U.S. support for existing treaty and trade relationships with other countries. This uncertainty, together with other key global eventsduring recent years (such as the continuing uncertainty arising from the Brexit referendum in the United Kingdom as well as ongoing terrorist activity), mayadversely impact (i) the ability or willingness of non-U.S. companies to transact business in the United States, including with the Company (ii) regulation andtrade agreements affecting U.S. companies, (iii) global stock markets (including the New York Stock Exchange on which our common stock is traded), and(iv) general global economic conditions. All of these factors are outside of our control, but may nonetheless cause us to adjust our strategy in order tocompete effectively in global markets.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 to17Table of Contentssuccessfully expand or upgrade our systems or to manage these expansions or upgrades, or a failure of third-party call centers to handle higher volumes ofuse, could reduce our ability to receive and process orders and provide products and services, which could result in cancelled sales and loss of revenue anddamage to our brand and reputation. These risks are more important during the holiday season, when many sales of our 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 Language, Literacy and E&E 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 will require modification and refinement as our business needs change, which could prolong difficulties we experiencewith systems transitions, and we may not always employ the most effective systems for our purposes. If we experience difficulties in implementing new orupgraded information systems or experience significant system failures, or if we are unable to successfully modify our management information systems orrespond to changes in our business needs, we may not be able to effectively manage our business and we may fail to meet our reporting obligations. Inaddition, as a result of the automation of these manual processes, the data produced may cause us to question the accuracy of previously reported financialresults.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.18Table of ContentsWe 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 we face economic difficulties, 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 adequate additional funds are not available, we may be required to delay, reduce the scope of, or eliminatematerial parts of our business strategy, including potential additional 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.19Table of ContentsWe 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. For instance, on December 22, 2017, President Donald Trump signed into U.S. law the Tax Cuts and Jobs Act of 2017 (“Tax Reform”).The exact ramifications of the legislation are subject to interpretation and could have a material impact on our financial position and/or results of operations.We continue to analyze the full impact of enacted legislation and additional guidance as provided. Further, any changes to the U.S. or any foreignjurisdictions’ tax laws, tax rates, or the interpretation of such tax laws, including the Base Erosion Profit Shifting project being conducted by theOrganization for Economic Co-operation and Development could significantly impact how U.S. multinational corporations are taxed. Although we cannotpredict whether or in what form any other legislation changes may pass, if enacted it could have a material adverse impact on our tax expense, deferred taxassets 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.In addition to issued patents, we have several patent applications on file in the U.S. and other countries. However, we do not know whether any of ourpending patent applications will result in the issuance of patents or whether the examination process will require us to narrow our claims. Even if patents areissued from our patent applications, which are not certain, they may be challenged, circumvented or invalidated in the future. Moreover, the rights grantedunder any issued patents may 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 resellers20Table of Contentsto protect our confidential and proprietary information. We cannot guarantee that our confidentiality agreements with our employees, consultants and otherthird parties will not be breached, that we will be able to effectively enforce these agreements, that we will have adequate remedies for any breach, or that ourtrade secrets and other proprietary information will not be disclosed or will otherwise 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.Our trademarks are limited in scope and geographic coverage and might not significantly distinguish us from our competition.We own several U.S. trademark registrations, including registrations of Rosetta Stone, the Blue Stone logo, Lexia, TruAccent, Lexia PowerUP Literacyand Catalyst trademarks, as well as U.S. registrations of the color yellow as a trademark. In addition, we hold common law trademark rights and havetrademark applications pending in the U.S. and abroad for additional trademarks. Even if federal registrations and registrations in other countries are grantedto us, our trademark rights may be challenged. It is also possible that our competitors will adopt trademarks similar to ours, thus impeding our ability to buildbrand identity and possibly leading to customer confusion. In fact, various third parties have registered trademarks that are similar to ours in the U.S. andoverseas. Furthermore, notwithstanding the fact that we may have secured trademark rights for our various trademarks in the U.S. and in some countries wherewe do business, in other countries we may not have secured similar rights and, in those countries there may be third parties who have prior use and prior orsuperior rights to our own. That prior use, prior or superior right could limit use of our trademarks and we could be challenged in our efforts to use ourtrademarks. We could incur substantial costs in prosecuting or defending trademark infringement suits. If we fail to effectively enforce our trademark rights,our competitive position and brand 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 which21Table of Contentscustomers can view our products and engage in transactions with us. Moreover, the regulation of domain names in the U.S. and foreign countries is subject tochange. Governing bodies could appoint additional domain name registrars, modify the requirements for holding domain names or release additional TLDs.As a result, we may have to incur additional costs to maintain control over potentially relevant domain names or may not maintain exclusive rights to allpotentially relevant domain names in the U.S. or in other countries in which we conduct business, which could harm our 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 to make efforts to enforce our rightsagainst 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 development is inherently uncertain in a rapidly evolving technological environment in which there may benumerous patent applications pending, many of which are confidential when filed, with regard to similar technologies.We do not own all of the software, other technologies and content used in our products and services, and the failure to obtain rights to use such software,other technologies and content could harm our business.Some of our products and services contain intellectual property owned by third parties, including software that is integrated with internally developedsoftware and voice recognition software, which we license from third parties. From time 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 be22Table of Contentsaccomplished on a cost-effective and timely basis, or become subject to other consequences. In addition, open source licenses generally do not providewarranties or other contractual protections regarding infringement claims or the quality of the code. Thus, we may have little or no recourse if we becomesubject to infringement claims 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.We rely on highly skilled personnel and, if we are unable to retain or motivate key personnel or hire qualified personnel, we may not be able to ​achieveresults or ​grow effectively.Our performance is largely dependent on the talents and efforts of highly skilled individuals. Our future success depends on our continuing ability toidentify, hire, develop, motivate and retain highly skilled personnel for all areas of our organization.We compete with other companies both within and outside of our industry for talented employees, and we may lose talented employees or fail toattract, train, and retain other talented employees. Any such loss or failure could adversely affect our product sales, financial condition, and operating results.In addition, we may not be able to locate suitable replacements for certain critical employees who leave, or offer employment to potential replacements onreasonable terms, all of which could adversely affect our product sales, financial condition, and operating results.Our business could be impacted as a result of actions by activist stockholders 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, stockholder proposals,media campaigns and other such actions instituted by activist stockholders 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 stockholder 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.Provisions 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 third 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 third amended andrestated bylaws or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive apremium 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 could23Table of Contentsdiscourage unsolicited acquisition proposals or make it more difficult for a third party to gain control of our Company, or otherwise could adversely affectthe market price of our common stock. Further, as a Delaware corporation, we are subject to Section 203 of the Delaware General Corporation Law. Thissection generally prohibits us from engaging in mergers and other business combinations with stockholders that beneficially own 15% or more of our votingstock, or with their affiliates, unless our directors or stockholders approve the business combination in the prescribed manner.Item 1B. Unresolved Staff CommentsNone.Item 2. PropertiesAs of December 31, 2017, 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 14 of Item 8, Financial Statements and Supplementary Data. We currently own one facility in Harrisonburg, Virginia, that provides operations andcustomer support services.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 ProceedingsIn late December 2017, we received a demand letter on behalf of two California customers who allege that they were improperly charged for automaticrenewal of their products. We express no opinion on the outcome or the potential risk of liability to the Company.Additional information with respect to this item may be found in Note 16 of Item 8, Financial Statements and Supplementary Data, which isincorporated herein by 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 February 28, 2018 when the last reported sales price of our common stock on the NYSE was $13.69 per share. The following tablesets forth, 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, 2017 Fourth Quarter $13.46 $9.51Third Quarter 10.75 8.89Second Quarter 12.18 9.79First Quarter 9.75 7.58Year ended December 31, 2016 Fourth Quarter $9.20 $6.80Third Quarter 9.22 7.44Second Quarter 8.46 6.68First Quarter 8.60 6.17DividendsWe 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 Securities by the Issuer and Affiliated PurchasersThe following table presents the total number of shares of the Company’s common stock that it purchased during the fourth quarter of 2017, theaverage price paid per share, the number of shares that the Company purchased as part of its publicly announced repurchase program, and the approximatedollar value of shares that still could have been purchased at the end of the applicable fiscal period pursuant to the share repurchase program:Period Total Number ofShares Purchased Average Price Paid PerShare Total Number ofShares Purchased asPart of PubliclyAnnounced Program(1) Maximum Dollar Valueof Shares that May YetBe Purchased Under theProgram (in thousands)(1)October 2017 — $— — November 2017 — $— — December 2017 — $— — Total — $— — $13,565_____________________________________________________________________________(1)A program covering the repurchase of up to $25.0 million of the Company's common stock was initially announced on August 22, 2013.25Table of ContentsOur 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 31,2012 through December 31, 2017, 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, 2012 in our common stock and in each of the foregoing indices and assumes reinvestment of dividends, if any.The 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, 2017, 2016, 2015, 2014 and 2013, and the selected consolidatedbalance sheet data as of December 31, 2017, 2016, 2015, 2014 and 2013 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, 2017 2016(1) 2015(2) 2014(3) 2013(4) (in thousands, except per share data)Selected Statements of Operations Data: Revenue $184,593 $194,089 $217,670 $261,853 $264,645Gross profit 150,972 159,768 179,143 208,799 218,931Loss from operations (4,501) (26,920) (43,813) (78,850) (18,442)Net loss (1,546) (27,550) (46,796) (73,706) (16,134) Loss per share attributable to common stockholders: Basic $(0.07) $(1.25) $(2.17) $(3.47) $(0.75)Diluted $(0.07) $(1.25) $(2.17) $(3.47) $(0.75) Other Selected Data: Total stock-based compensation expense $4,141 $4,906 $7,195 $6,762 $9,241Total intangible amortization expense $3,839 $4,351 $5,192 $6,263 $1,822_______________________________________________________________________________(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 E&E Language offerings. Under this initiative, the Company made headcount reductions, office lease terminations, and other costreductions in France, China, Brazil, Canada, Spain, Mexico, U.S. and the U.K.(2)The Company undertook restructuring actions in the first quarter of 2015 to focus on the E&E Language business and optimize the ConsumerLanguage business for profitability. Under this initiative, the Company undertook headcount and cost reductions to areas including ConsumerLanguage sales and marketing, Consumer Language product investment, and general and 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. As of December 31, 2017 2016 2015 2014 2013 (in thousands)Selected Consolidated Balance Sheet Data: Cash and cash equivalents $42,964 $36,195 $47,782 $64,657 $98,825Total assets 194,755 194,310 228,543 288,173 290,776Total deferred revenue 151,263 141,457 142,748 128,169 78,857Notes payable and capital lease obligation 2,300 2,559 3,143 3,748 242Total stockholders' equity (deficit) 2,423 (1,659) 22,410 63,445 131,243Item 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-looking statements as a result of a number of factors, including those discussed under ("Risk Factors") and elsewhere in thisAnnual Report on Form 10-K.27Table of ContentsOverviewRosetta 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 foundationalreading skills through its rigorously researched, independently evaluated, and widely respected instruction and assessment programs. Rosetta Stone Inc. wasincorporated in Delaware in 2005.The Literacy segment derives the majority of its revenue from sales of literacy solutions to educational institutions serving grades K through 12. TheE&E Language segment derives revenue from sales of language-learning solutions to educational institutions, corporations, and government agenciesworldwide. The Consumer Language segment derives the majority of revenue from sales of language-learning solutions to individuals and retail partners. OurLiteracy distribution channel utilizes a direct sales force as well as relationships with third-party resellers focused on the sale of Lexia Learning solutions toK-12 schools. Our E&E Language distribution model is focused on targeted sales activity primarily through a direct sales force in five markets: K-12 schools;colleges and universities; federal government agencies; corporations; and not-for-profit organizations. Our Consumer Language distribution channelcomprises 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, Staples, consignment distributors such as Software Packaging Associates, and daily deal partners. In September 2017, WynitDistribution LLC, one of our retail partners, filed for bankruptcy. We are in the process of moving the impacted business to other retailers and do not expectthis to have a significant operational or financial impact to our business.As our Company has evolved, we believe that our current portfolio of language and literacy products and transition to a SaaS-based delivery modelprovides multiple opportunities for long-term value creation. We believe the demand is growing for e-learning based literacy solutions in the U.S. andEnglish language-learning around the globe, and we are uniquely positioned with the power of our global brand to meet the growing needs of global learners.We continue to emphasize the development of products and solutions for Corporate and K-12 learners who need to speak and read English. This focusextends to the Consumer Language segment where we continue to make product investments serving the needs of passionate language learners who aremobile, results-focused and value a quality language-learning experience.To position the organization for success, our focus is on the following priorities:1.Grow literacy sales by providing fully aligned digital instruction and assessment tools for K-12, building a direct distribution sales force to augmentour historical reseller model, and continuing to develop our implementation services business;2.Position our E&E Language business for profitable growth by focusing our direct sales on our best geographies and customer segments, partneringwith resellers in other geographies and successfully delivering our Catalyst product to Corporate customers. Catalyst integrates our Foundations,Advantage, and Advanced English for Business products with enhanced reporting, assessment, and administrator tools that offers a simple, moremodern, metrics-driven suite of tools that are results-oriented and easily integrated with leading corporate language-learning systems;3.Seek to maximize the benefit of the changes we have made in our Consumer Language products and successfully transition to SaaS delivery to seekadditional growth opportunities with a greater emphasis on a streamlined, mobile-oriented product portfolio focused on customers' demand, whileoptimizing 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 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 E&E Language offerings. These operations added sales, but attoo high a cost and without the near-term ability to capture scale efficiencies. Where appropriate, we will seek to operate through partners in the geographiesbeing exited. We have also substantially completed the closure of our software development operations in France and China. These actions were in additionto the 2015 Restructuring Plan to accelerate and prioritize our focus on satisfying the needs of the more passionate learners in the U.S. and select non-U.S.geographies in the Consumer Language segment. In March 2015, we initiated a plan (the "2015 Restructuring Plan") to make reductions to ConsumerLanguage sales and marketing, Consumer Language product28Table of Contentsinvestment, and general and administrative costs. See Note 2 and Note 13 of Item 8, Financial Statements and Supplementary Data for additionalinformation about these strategic undertakings.Over the last few years, our Consumer Language strategy has been to shift more and more of our Consumer Language business to online subscriptions,which feature access across the web and apps, and away from perpetual digital download and CD packages. We believe that these online subscription formatsprovide customers with an overall better experience, flexibility to use our products on multiple platforms (tablets, smartphones and computers), and provide amore economical and relevant way for us to deliver our products to customers. We expect the trend in Consumer Language subscription sales to continue ascustomer preferences move towards mobile experiences. We expect the final portion of this transition to subscription sales will be complete in the first half of2018.We currently have three operating segments, Literacy, E&E Language, and Consumer Language. We discuss the profitability of each segment in termsof segment contribution. Segment contribution is the measure of profitability used by our Chief Operating Decision Maker. Prior periods have beenreclassified to reflect our current segment presentation and definition of segment contribution. See Note 19 of Item 8, Financial Statements andSupplementary Data for additional information about recent changes to the definition and presentation of segment contribution.For the year ended December 31, 2017, Literacy segment contribution increased to $5.0 million with segment contribution margin of 11% as comparedto a segment contribution of $1.5 million and a segment contribution margin of 4% for the year ended December 31, 2016. The dollar and margin increaseswere primarily due to the larger revenue base on which segment contribution is calculated, partially offset by increases in direct research and developmentexpenses, cost of sales, and sales and marketing expenses due to the transition to a direct sales team and investments made to improve the Literacy productportfolio and infrastructure. Before shared Language research and development expense, E&E Language segment contribution decreased to $26.9 millionwith a segment contribution margin of 41% for the year ended December 31, 2017, compared to $29.1 million with a segment contribution margin of 40% forthe year ended December 31, 2016. The dollar decrease was primarily due to lower revenue while the slight margin improvement reflects lower directexpenses, primarily sales and marketing expenses and cost of sales. Consumer Language segment contribution increased to $24.8 million with a contributionmargin of 33% for the year ended December 31, 2017, from $21.5 million with a contribution margin of 24% for the year ended December 31, 2016. Thedollar and margin increases were primarily due to a reduction in direct sales and marketing expense year over year.For the year ended December 31, 2016, Literacy segment contribution increased to $1.5 million with segment contribution margin of 4% for the yearended December 31, 2016 as compared to a segment contribution of negative $3.5 million and a segment contribution margin of negative 16% for the yearended December 31, 2015. The dollar and margin increases were primarily due to the larger revenue base on which segment contribution is calculated, offsetby an increase in sales and marketing expense due to the transition to a direct sales team and support infrastructure. The margin improvement partially relatedto the effect of purchase accounting that will diminish over time. E&E Language segment contribution increased to $29.1 million with a segmentcontribution margin of 40%, compared to $22.8 million with a segment contribution margin of 30% for the year ended December 31, 2015. The dollar andmargin increases were primarily due to the cost reduction initiatives in early 2016 as compared to the prior year. Consumer Language segment contributiondecreased to $21.5 million with a contribution margin of 24% for the year ended December 31, 2016, from $30.7 million with a contribution margin of 26%for the year ended December 31, 2015. The dollar and margin decreases were primarily due to a decrease in Consumer Language revenue of $31.7 million.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 Language market, our perpetual product software is often bundled with our short-term online conversational coaching and onlinecommunity services and sold as a package. Approximately $39 in revenue per unit is derived from these short-term online services. As a result, we typicallydefer 10% to 35% of the revenue of each of these bundled sales to be recognized over the term of the service period. The content of our perpetual productsoftware and our web-29Table of Contentsbased language-learning subscription offerings are the same. We offer our customers the ability to choose which format they prefer without differentiating thelearning 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 Language products predominantly through our direct sales channels,primarily utilizing our websites and call centers, which we refer to as our direct-to-consumer channel. We also distribute our Consumer Language productsthrough select third-party retailers and distributors. For purposes of explaining variances in our revenue, we separately discuss changes in our E&E Language,Literacy, and our Consumer Language segments because the customers and revenue drivers of these channels are different.Literacy segment sales are seasonally strongest in the third quarter of the calendar year corresponding to school district budget years. Within our E&ELanguage segment, sales in our education, government, and corporate sales channels are seasonally stronger in the second half of the calendar year due topurchasing and budgeting cycles. Consumer Language sales are affected by seasonal trends associated with the holiday shopping season. We expect thesetrends 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, and commissions earned by our sales personnel. Sales commissions aregenerally paid at the time the customer is invoiced. However, sales commissions are deferred and recognized as expense in proportion to when the relatedrevenue is recognized.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 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.30Table of ContentsInterest and Other Income (Expense)Interest and other income (expense) primarily consist of interest income, interest expense, foreign exchange gains and losses, and income fromlitigation settlements. Interest income represents interest received on our cash and cash equivalents. Interest expense is primarily related to interest on ourcapital leases and amortization of deferred financing fees associated with our revolving credit facility. Fluctuations in foreign currency exchange rates in ourforeign subsidiaries cause foreign exchange gains and losses. Legal settlements are related to agreed upon settlement payments from various anti-piracyenforcement efforts.Income Tax (Benefit) ExpenseIncome tax (benefit) expense 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, mobile applications, and professional services. Revenue isrecognized when all of the following criteria are met: there is persuasive evidence of an arrangement; the product has been delivered or services have beenrendered; the fee is fixed or determinable; and collectability is reasonably assured. 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 Languagerevenue from the CD and digital download formats of the Rosetta Stone language-learning product which are typically multiple-element arrangements thatcontain two deliverables: perpetual software, delivered at the time of sale, and online service, which is considered an undelivered software-related element.The online service includes access to conversational coaching services. Because we only sell the perpetual language-learning software on a stand-alone basisin our homeschool 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 generally31Table of Contentsaccepted industry practice. Where VSOE of the undelivered online services cannot be established, revenue is deferred and recognized commensurate with thedelivery of the online services.For non-software multiple element arrangements we allocate revenue to all deliverables based on their relative selling prices. These arrangements caninclude web-based subscription services, audio practice products and professional services or any combination thereof. We do not have a sufficientconcentration of stand-alone sales of the various deliverables noted above to our customers, and therefore cannot establish VSOE for each deliverable. Thirdparty evidence of fair value does not exist for the web-based subscription, audio practice products and professional services due to the lack ofinterchangeable language-learning products and services within the market. Accordingly, we determine the relative selling price of the web-basedsubscription, audio practice 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 passes and risks of loss have been transferred. For many product sales, these criteria are met at thetime the product is shipped. For some sales to resellers and certain other sales, we defer revenue until the customer receives the product because we legallyretain a portion of the risk of loss on these sales during transit. In other cases where packaged software products are sold to resellers on a consignment basis,revenue is recognized for these consignment transactions once the end user sale has occurred, assuming the remaining revenue recognition criteria have beenmet. Cash sales incentives to resellers are accounted for as a reduction of revenue, unless a specific identifiable benefit is identified and the fair value isreasonably determinable. Price protection for changes in the manufacturer suggested retail value granted to resellers for the inventory that they have on handat the date the price protection is offered is recorded as a reduction to revenue at the time of sale.We offer our U.S. and Canada consumers the ability to make payments for packaged software purchases in installments over a period of time, whichtypically ranges between three and five months. Given that these installment payment plans are for periods less than 12 months, a successful collectionhistory has been established and these fees are fixed and determinable, revenue is recognized at the time of sale, assuming the remaining revenue recognitioncriteria have been met.In connection with packaged software product sales and web-based software subscriptions, technical support is provided to customers, includingcustomers of resellers, via telephone support at no additional cost for up to six months from the time of purchase. As the fee for technical support is includedin the initial licensing 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.32Table of ContentsSales 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. These methods require theuse of estimates, including future stock price volatility, expected term, risk-free interest rate, and forfeitures.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 for estimating theexpected term. We use our own historical stock price data to estimate a forfeiture rate and expected volatility over the most recent period commensurate withthe estimated expected term of the awards. For the risk free interest rate, we use a U.S. Treasury Bond rate consistent with the estimated expected term of theoption award.Our restricted stock and restricted stock unit grants are accounted for as equity awards. Stock-based compensation expense associated with service-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. Forequity awards granted with performance-based conditions, stock compensation expense is recognized in the statement of operations ratably for each vestingtranche based on the probability that operating performance conditions will be met and to what extent. Changes in the probability estimates associated withperformance-based awards are accounted for in the period of change using a cumulative catch-up adjustment to retroactively apply the new probabilityestimate. In any period in which we determine the achievement of the performance metrics is not probable, we cease recording compensation expense and allpreviously recognized compensation expense for the performance-based award is reversed. For equity awards granted with market-based conditions, stockcompensation expense is recognized in the statement of operations ratably for each vesting tranche regardless of meeting or not meeting the marketconditions. Stock compensation expense is recognized based on the estimated portion of the awards that are expected to vest. Estimated forfeiture rates wereapplied 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 theacquisition of Tell Me More in 2014.We routinely review goodwill at the reporting unit level for potential impairment as part of our internal control framework and we test goodwill forimpairment annually on June 30 of each year at the reporting unit level using a fair value approach or more frequently, if impairment indicators arise. Wehave the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carryingvalue. The factors that we consider important in a qualitative assessment and which could trigger a quantitative test 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. 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, weperform a quantitative impairment test by comparing the fair value of a reporting unit with its carrying amount. If the carrying value exceeds the fair value,we measure the amount of impairment loss, if any.For our annual goodwill test performed at June 30 2017, we began our annual test with the qualitative test. We concluded that there were no indicatorsof impairment that would cause us to believe that it is more likely than not that the fair value of our reporting units with remaining goodwill balances is lessthan the carrying value. Accordingly, a quantitative impairment test was not performed and no goodwill impairment charges were recorded in connectionwith the annual impairment test. There was no impairment of goodwill during the year ended December 31, 2017.We recognized $1.7 million and $5.6 million in goodwill impairment expense associated with our Fit Brains business during the years ended December31, 2016 and December 31, 2015, respectively. These impairment charges represent the full impairment of all intangible assets associated with the Fit Brainsbusiness.For additional risk factors which could affect the assumptions used in our qualitative and quantitative evaluations of our reporting units, see the sectiontitled "Risk Factors" in Part I, Item 1A of this Report. Accordingly, we cannot provide assurance that the assumptions, estimates and values used in ourassessment will be realized and actual results could vary materially.33Table of ContentsIntangible 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.For our annual indefinite-lived intangible asset test performed at December 31, 2017, we began our annual test with the qualitative test. As of December31, 2017, we concluded that there were no indicators of impairment that would cause us to believe that it is more likely than not that our indefinite-livedintangible asset was impaired.We recognized intangible asset impairment expense of $1.2 million in 2016 related to the full impairment of the tradename, developed technology, andcustomer relationship long-lived intangible assets associated with our Fit Brains business. There were no impairments of intangible assets during the yearsended December 31, 2017 and December 31, 2015.Valuation of Long-Lived AssetsAs part of our internal control framework we evaluate the recoverability of our long-lived assets. An impairment of long-lived assets is recognized inthe event that the net book value of such assets exceeds the future undiscounted net cash flows attributable to such assets. Impairment, if any, is recognized inthe period of identification to the extent the carrying amount of an asset exceeds the fair value of such asset. During 2016 and 2015, we recorded $1.0 millionand $1.1 million in impairment expense related to the abandonment of software projects that were previously capitalized, while there were no suchimpairments in 2017.Restructuring CostsRestructuring or other employee severance plans have been initiated in each of the years ended December 31, 2017, 2016 and 2015 to reduceheadcount and other costs in order to support our strategic shift in business focus. In connection with these plans, we incurred restructuring related costs,including employee severance and related benefit costs, contract termination costs, and other related costs. These costs are included in Cost of sales and theSales and marketing, Research and development, 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.During 2017, 2016, and 2015, we recorded $1.2 million, $5.2 million, and $8.8 million in restructuring costs related to our recent restructuring plansand other employee severance actions.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.34Table of ContentsWe use the asset and liability approach to accounting for income taxes. Deferred tax assets and liabilities represent the future tax consequences of thedifferences between the financial statement carrying amounts of assets and liabilities versus the tax bases of assets and liabilities. Under this method, deferredtax assets are recognized for deductible temporary differences, and operating loss and tax credit carryforwards. Deferred tax liabilities are recognized fortaxable temporary differences.We reduce the carrying amounts of deferred tax assets by a valuation allowance if, based on available evidence, it is more likely than not that suchassets will not be realized. Accordingly, the need to establish valuation allowances for deferred tax assets is assessed quarterly based on the more-likely-than-not realization threshold criterion. In the assessment, appropriate consideration is given to all positive and negative evidence related to the realization of thedeferred tax assets. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of futureprofitability, the duration of statutory carryforward periods, our experience with operating loss and tax credit carryforwards not expiring unused, and taxplanning alternatives. Significant judgment is required to determine whether a valuation allowance is necessary and the amount of such valuation allowance,if appropriate. The valuation allowance is reviewed quarterly and is maintained until sufficient positive evidence exists to support a reversal.In assessing the recoverability of our deferred tax assets, we consider all available evidence, including:•the nature, frequency, and severity of cumulative financial reporting losses in recent years;•the carryforward periods for the net operating loss, capital loss, and foreign tax credit carryforwards;•predictability of future operating profitability of the character necessary to realize the asset;•prudent and feasible tax planning strategies that would be implemented, if necessary, to protect against the loss of the deferred tax assets; and•the effect of reversing taxable temporary differences.The evaluation of the recoverability of the deferred tax assets requires that we weigh all positive and negative evidence to reach a conclusion that it ismore likely than not that all or some portion of the deferred tax assets will not be realized. The weight given to the evidence is commensurate with the extentto which it can be objectively verified. The more negative evidence that exists, the more positive evidence is necessary and the more difficult it is to supporta conclusion that a valuation allowance is not needed. Our valuation allowance analysis considers a number of factors, including our cumulative losses inrecent years, our expectation of future taxable income and the time frame over which our net operating losses expire.As of December 31, 2017, a full valuation allowance exists for the U.S., China, Hong Kong, Mexico, Spain, Brazil, and France where we havedetermined the deferred tax assets will not more likely than not be realized.All of the jurisdictions mentioned above have cumulative losses for the most recent year ended December 31, 2017. The establishment of a valuationallowance has no effect on the ability to use the deferred tax assets in the future to reduce cash tax payments. We will continue to assess the likelihood thatthe deferred tax assets will be realizable at each reporting period and the valuation allowance will be adjusted accordingly, which could materially affect ourfinancial position and results of operations.As of December 31, 2017 and 2016, our net deferred tax liability was $2.0 million and $6.2 million, respectively.The SEC staff issued Staff Accounting Bulletin No. 118 (SAB 118), which allows registrants to record provisional amounts during a one year“measurement period” similar to that used when accounting for business combinations. However, the measurement period is deemed to have ended earlierwhen the registrant has obtained, prepared and analyzed the information necessary to finalize its accounting. During the measurement period, impacts of TaxReform are expected to be recorded at the time a reasonable estimate for all or a portion of the effects can be made, and provisional amounts can berecognized and adjusted as information becomes available, prepared or analyzed.We have estimated the impact of certain tax effects of the Tax Reform enacted on December 22, 2017, including the reduction in the U.S. corporateincome tax rate to 21 percent, deferred tax assets scheduled to reverse in subsequent years will result in net operating losses with an unlimited carryforward,and a one-time mandatory repatriation transition tax on the net accumulated earnings and profits of a U.S. taxpayer’s foreign subsidiaries. The final impact ofTax Reform may differ from these estimates, due to, among other things, changes in interpretations, additional guidance that may be issued by the InternalRevenue Service or state and local authorities, and any updates or changes to estimates we have utilized to calculate the transition impact. Therefore, ouraccounting for the elements of Tax Reform is incomplete. However, we were able to make reasonable estimates of the effects of Tax Reform. We will completeour accounting for these items during 2018, after completion of our 2017 U.S. income tax return.35Table of ContentsThe Tax Reform also includes significant provisions that are not yet effective but may impact income taxes in future years. These provisions include:an exemption from U.S. tax on dividends of future foreign earnings, a limitation of net operating losses generated after 2017 to 80 percent of taxable income,the inclusion of commissions and performance-based compensation in determining the excess compensation limitation, and a minimum tax on certainforeign earnings in excess of 10 percent of the foreign subsidiaries tangible assets (i.e., global intangible low-taxed income or GILTI). We are still evaluatingwhat our policy election will be to treat the GILTI tax as a period expense or to provide U.S. deferred taxes on foreign temporary differences that are expectedto generate GILTI income when they reverse in future years.Going Concern AssessmentAs part of our internal control framework, we routinely perform an assessment to determine the Company's ability to continue as a going concern. Asfurther described below, we have concluded based on projections that the cash balance, funds available from the line of credit, and the cash flows fromoperations are sufficient to meet the liquidity needs through the one year period following the financial statement issuance date.The 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 7, 2018. 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 2018 cash flow forecast, 2018 operating budget, and long-term plan thatextends beyond 2018. 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 7, 2018, andconcluded 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, 2017 2016 2015 (in thousands, except per share data)Statements of Operations Data: Revenue: Subscription and service $168,442 $154,336 $151,701Product 16,151 39,753 65,969Total revenue 184,593 194,089 217,670Cost of revenue: Cost of subscription and service revenue 26,082 23,676 21,629Cost of product revenue 7,539 10,645 16,898Total cost of revenue 33,621 34,321 38,527Gross profit 150,972 159,768 179,143Operating expenses Sales and marketing 96,660 114,340 136,084Research and development 24,747 26,273 29,939General and administrative 34,066 40,501 50,124Impairment — 3,930 6,754Lease abandonment and termination — 1,644 55Total operating expenses 155,473 186,688 222,956Loss from operations (4,501) (26,920) (43,813)Other income and (expense): Interest income 66 46 23Interest expense (491) (470) (378)Other income and (expense) 881 2,297 (1,469)Total other income and (expense) 456 1,873 (1,824)Loss before income taxes (4,045) (25,047) (45,637)Income tax (benefit) expense (2,499) 2,503 1,159Net loss $(1,546) $(27,550) $(46,796)Loss per share: Basic $(0.07) $(1.25) (2.17)Diluted $(0.07) $(1.25) $(2.17)Common shares and equivalents outstanding: Basic weighted average shares 22,244 21,969 21,571Diluted weighted average shares 22,244 21,969 21,571Stock-based compensation included in: Cost of revenue 69 48 101Sales and marketing 561 998 1,327Research and development 255 709 841General and administrative 3,256 3,151 4,926Total stock-based compensation expense $4,141 $4,906 $7,19537Table of ContentsComparison of the Year Ended December 31, 2017 and the Year Ended December 31, 2016Our total revenue decreased $9.5 million to $184.6 million for the year ended December 31, 2017, from $194.1 million for the year ended December 31,2016. The change in total revenue was primarily due to a decrease in Consumer Language revenue of $12.2 million and a decrease in E&E Language revenueof $6.8 million, which were partially offset by an increase in Literacy revenue of $9.5 million.We reported an operating loss of $4.5 million for the year ended December 31, 2017, an improvement compared to an operating loss of $26.9 millionfor the year ended December 31, 2016. Operating expense decreased $31.2 million, comprised of decreases of $17.7 million in sales and marketing expense,$6.4 million in general and administrative expense, $3.9 million in impairment expense, $1.6 million in lease abandonment and termination expense, and$1.5 million in research and development expense. The declines in operating expense reflect the continued savings as a result of the 2015 and 2016Restructuring Plans and other ongoing expense reduction actions. The $31.2 million reduction in operating expenses was partially offset by a decrease ingross profit of $8.8 million, driven by a $9.5 million decrease in revenue.Revenue by Operating SegmentThe following table sets forth revenue for our three operating segments for the years ended December 31, 2017 and 2016: Year ended December 31, 2017 versus 2016 2017 2016 Change % Change (in thousands, except percentages)Literacy $43,608 23.6% $34,123 17.6% $9,485 27.8 %E&E Language 65,267 35.4% 72,083 37.1% $(6,816) (9.5)%Consumer Language 75,718 41.0% 87,883 45.3% $(12,165) (13.8)%Total Revenue $184,593 100.0% $194,089 100.0% $(9,496) (4.9)%Literacy SegmentLiteracy revenue increased $9.5 million, or 28%, from $34.1 million for the year ended December 31, 2016 to $43.6 million for the year endedDecember 31, 2017, partially reflecting the impact of purchase accounting. Adjusting for the impact of purchase accounting on Literacy revenue, revenuewould have been $45.4 million for the year ended December 31, 2017 compared to $38.4 million for the year ended December 31, 2016, and the Literacypro-forma growth would have been 18% year-over-year. The organic growth in Literacy revenue was primarily driven by a larger and more mature direct salesforce in 2017 as compared to 2016, which drove stronger renewal rates, an increase in new business, and an increase in professional services. We anticipateadditional investments in product and sales personnel in the Literacy business to grow this segment and achieve scale.E&E Language SegmentE&E Language revenue decreased $6.8 million, or 9%, from $72.1 million for the year ended December 31, 2016 to $65.3 million for the year endedDecember 31, 2017. The decrease in E&E Language revenue reflects a decrease of $3.6 million and $2.9 million in the corporate channel and educationchannel, respectively. Included within these declines is the reduction in revenue of $3.1 million from marketplaces exited due to the execution of ourstrategy to withdraw our direct presence in unprofitable geographies and manage the E&E Language business for profitable growth. Where appropriate, wewill seek to operate in the geographies we exit through partners. We expect to continue to balance investments and adjust our cost structure to align scalewithout impacting growth.Consumer Language SegmentConsumer Language revenue decreased $12.2 million, or 14%, from $87.9 million for the year ended December 31, 2016 to $75.7 million for the yearended December 31, 2017. This decrease was largely due to a deliberate $8.9 million reduction in revenue in the direct-to-consumer sales channel due to thecompleted transformation from perpetual products, that are recognized up front, to subscriptions that are recognized over time. Revenue from the global retailsales channel declined $1.7 million as the sales channel began to experience the delay in revenue recognition associated with the shift from perpetualpackaged products to subscription offerings. We expect revenue within the global retail sales channel will decline in 2018 as we complete the retailtransition from perpetual to subscriptions. In connection with our recent shift in strategy, we will invest in the mobile and English-learning to drive growth.Our Consumer business is seasonal and consumer sales typically peak in the fourth quarter during the holiday shopping season.38Table of ContentsRevenue 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, 2017 and 2016: Year ended December 31, 2017 versus 2016 2017 2016 Change % Change (in thousands, except percentages)Subscription and service revenue $168,442 91.3% $154,336 79.5% $14,106 9.1 %Product revenue 16,151 8.7% 39,753 20.5% (23,602) (59.4)%Total revenue $184,593 100.0% $194,089 100.0% $(9,496) (4.9)%Subscription and Service RevenueSubscription and service revenue increased $14.1 million, or 9%, to $168.4 million for the year ended December 31, 2017 from $154.3 million for theyear ended December 31, 2016. An increase in Literacy segment revenue, which entirely falls within the subscription and service revenue category,contributed $9.5 million of the $14.1 million increase. As earlier noted, the 28% increase in Literacy revenue was due to organic growth and maturity of thedirect sales force, which drove stronger renewal rates, an increase in new business, and an increase in professional services. Consumer Language subscriptionand service revenue increased by $9.3 million, reflecting the migration from perpetual products, which were historically recognized up-front, tosubscriptions, which are recognized over time. This SaaS migration was substantially completed in the direct-to-consumer sales channel in 2017. The revenueimpact for the Consumer Language retail channel SaaS migration is expected to occur in 2018. In the Consumer Language segment, we have begun shiftingsales from our box-based and perpetual download products to subscription products. Historically, customers in the Consumer Language segment using ourlonger-length subscription products (greater than a one-year term) have generally only stayed for the duration of the subscription period. We are sellingshorter duration subscriptions, which if we are successful in achieving an adequate level of renewals, will allow pricing that has the potential to open up newsegment demographics. As our Consumer Language products are sold through shorter-term subscriptions, cash from those sales will be spread over the initialsale period and any subsequent renewals. We expect the global retail transition to subscription sales will be complete in the first half of 2018. Within theE&E Language segment, the education channel and corporate channel declined by $2.4 million and $2.2 million, respectively, due in part to themarketplaces exited in unprofitable geographies.Product RevenueProduct revenue decreased $23.6 million, or 59%, to $16.2 million during the year ended December 31, 2017 from $39.8 million during the year endedDecember 31, 2016. Product revenue decreased $19.5 million in the direct-to-consumer sales channel due to the SaaS migration completed in 2017 fromperpetual products to subscription offerings. Product revenue also declined in the global retail channel by $1.5 million. We expect the revenue impact fromthe SaaS migration on the retail channel will be realized in 2018 which will result in a decline in product revenue in the future. We expect the global retailtransition to subscription sales will be complete in the first half of 2018.39Table of ContentsCost of Subscription and Service Revenue, Cost of Product Revenue, and Gross ProfitThe following table sets forth cost of subscription and service revenue, cost of product revenue, and gross profit for the years ended December 31, 2017and 2016: Year ended December 31, 2017 versus 2016 2017 2016 Change % Change (in thousands, except percentages)Revenue: Subscription and service $168,442 $154,336 $14,106 9.1 %Product 16,151 39,753 (23,602) (59.4)%Total revenue 184,593 194,089 (9,496) (4.9)%Cost of revenue: Cost of subscription and service revenue 26,082 23,676 2,406 10.2 %Cost of product revenue 7,539 10,645 (3,106) (29.2)%Total cost of revenue 33,621 34,321 (700) (2.0)%Gross profit $150,972 $159,768 $(8,796) (5.5)%Gross profit percentages 81.8% 82.3% (0.5)% Total cost of revenue slightly decreased $0.7 million, or 2%, for the year ended December 31, 2017 from $34.3 million for the year ended December 31,2016.Cost of Subscription and Service RevenueCost of subscription and service revenue for the year ended December 31, 2017 was $26.1 million, an increase of $2.4 million, or 10% from $23.7million for the year ended December 31, 2016. As a percentage of subscription and service revenue, cost of subscription and service revenue remained flat at15% for the years ended December 31, 2017 and December 31, 2016. The dollar increase in cost of subscription and service revenue was primarily due toincreases in allocated costs from a higher allocation rate associated with the shift in revenue mix in favor of subscription and service revenue. We expect thecost of subscription and service revenue will increase as we complete the migration of our Consumer Language business to our subscription-based products.Cost of Product RevenueCost of product revenue for the year ended December 31, 2017 was $7.5 million, a decrease of 29% compared to $10.6 million for the year endedDecember 31, 2016. As a percentage of product revenue, cost of product revenue increased to 47% for the year ended December 31, 2017 from 27% for theyear ended December 31, 2016. The increase in cost as a percentage of revenue was primarily attributable to the intentional decline in product revenue and a$1.9 million inventory write-down associated with our request to our retail partners to return inventory. The dollar decrease in cost of product revenue isprimarily due to the continued migration to subscription-based products, specifically declines of $1.2 million, $0.4 million, and $0.4 million in payroll andbenefits, inventory costs, and freight costs, respectively.Gross ProfitGross profit was $151.0 million for the year ended December 31, 2017, down $8.8 million compared to the year ended December 31, 2016. Gross profitpercentage remained flat at 82% for both the years ended December 31, 2017 and December 31, 2016. The dollar decrease in gross profit was primarily due tothe decrease in revenue.40Table of ContentsOperating Expenses Year ended December 31, 2017 versus 2016 2017 2016 Change % Change (in thousands, except percentages)Sales and marketing $96,660 $114,340 $(17,680) (15.5)%Research and development 24,747 26,273 (1,526) (5.8)%General and administrative 34,066 40,501 (6,435) (15.9)%Impairment — 3,930 (3,930) (100.0)%Lease abandonment and termination — 1,644 (1,644) (100.0)%Total operating expenses $155,473 $186,688 $(31,215) (16.7)%Included within our operating expenses are restructuring charges related to restructuring actions associated with employee severance and relatedbenefits costs incurred in connection with headcount reductions, contract termination costs, and other related costs. As a result of these actions, we realizedreductions in our operating expenses, primarily associated with reduced payroll and benefits costs. See Note 2 and Note 13 of Item 8, Financial Statementsand Supplementary Data for additional information about these strategic undertakings. The following table presents restructuring costs included in therelated line items of our results from operations: Year ended December 31, 2017 2016 (in thousands)Cost of revenue $378 $573Sales and marketing 411 2,324Research and development 318 913General and administrative 100 1,383Total $1,207 $5,193While there were restructuring costs associated with each of the years ended December 31, 2017 and 2016, the severance expenses in 2017 weresignificantly less than the severance expenses in 2016.Sales and Marketing ExpensesSales and marketing expenses for the year ended December 31, 2017 were $96.7 million, a decrease of $17.7 million, or 15%, from $114.3 million forthe year ended December 31, 2016. As a percentage of total revenue, sales and marketing expenses decreased to 52% for the year ended December 31, 2017,from 59% for the year ended December 31, 2016. The decrease in sales and marketing expense was primarily due to decreases in media spend, payroll andbenefits, professional services, and rent. Media expenses decreased $11.9 million due to the change in focus in the general consumer market. Payroll andbenefit expense decreased $3.2 million primarily due to salary savings from a reduction in headcount and lower severance expenses. Professional servicesexpenses declined $1.4 million related to reduced spending in call centers. Rent expense declined $0.8 million related to the relocation of the corporateheadquarters. In the near term, we expect sales and marketing expenses to increase as we make targeted investments for sales growth.Research and Development ExpensesResearch and development expenses were $24.7 million for the year ended December 31, 2017, a decrease of $1.5 million, or 6%, from $26.3 millionfor the year ended December 31, 2016. As a percentage of revenue, research and development expenses declined slightly to 13% for the year endedDecember 31, 2017, from 14% for the year ended December 31, 2016. In the near term we will focus our product investment on Lexia and key Languageinitiatives which are expected to increase our research and development expenses.General and Administrative ExpensesGeneral and administrative expenses for the year ended December 31, 2017 were $34.1 million, a decrease of $6.4 million, or 16%, from $40.5 millionfor the year ended December 31, 2016. As a percentage of revenue, general and administrative expenses decreased to 18% for the year ended December 31,2017 compared to 21% for year ended December 31, 2016. The decrease in general and administrative expenses was primarily due to reductions inprofessional41Table of Contentsservices, amortization expense, and bad debt expense. Professional services declined $3.3 million due to the absence of external strategic advisor costscompared to 2016 and also due to lower external audit fees and lower legal fees. Amortization expense decreased $1.4 million due to the completedamortization of multiple projects in 2016. Bad debt expense decreased $0.8 million due to better collection efforts and lower reserve balances. We expect ourgeneral and administrative expenses to increase slightly in the near term.ImpairmentThere were no impairment expenses for the year ended December 31, 2017. The $3.9 million impairment in the year ended December 31, 2016 was dueto the 2016 impairments related to Fit Brains goodwill of $1.7 million, Fit Brains intangible assets of $1.2 million, and a $1.0 million abandonment chargeassociated with a previously capitalized software project that no longer aligned to our strategic direction.Lease Abandonment and TerminationThere were no lease abandonment and termination expenses for the year ended December 31, 2017. The $1.6 million lease abandonment andtermination charge for the year ended December 31, 2016 related to the planned space consolidation of our former headquarters location in Arlington, VA inthe fourth quarter of 2016.Other Income and (Expense) Year ended December 31, 2017 versus 2016 2017 2016 Change % Change (in thousands, except percentages)Interest income $66 $46 $20 43.5 %Interest expense (491) (470) (21) 4.5 %Other income and (expense) 881 2,297 (1,416) (61.6)%Total other income and (expense) $456 $1,873 $(1,417) (75.7)%Interest income for the year ended December 31, 2017 was $0.1 million, a slight increase from the year ended December 31, 2016. Interest incomerepresents interest earned on our cash and cash equivalents.Interest expense for the years ended December 31, 2017 and December 31, 2016 was $0.5 million. Interest expense primarily represents interest on ourcapital leases and the recognition of our financing fees associated with our undrawn credit facility.Other income and (expense) for the year ended December 31, 2017 was income of $0.9 million, a decrease of $1.4 million, as compared to income of$2.3 million for the year ended December 31, 2016. The change was primarily attributable to foreign exchange fluctuations.Income Tax (Benefit) Expense Year ended December 31, 2017 versus 2016 2017 2016 Change % Change (in thousands, except percentages)Income tax (benefit) expense $(2,499) $2,503 $(5,002) (199.8)%Our income tax benefit for the year ended December 31, 2017 was $2.5 million, compared to an income tax expense of $2.5 million for the year endedDecember 31, 2016. The favorable change was primarily related to the reduction in the corporate tax rate from 35% to 21% under the Tax Reform. Thisresulted in a deferred tax benefit of $5.5 million, offset by current year tax expense due to profits of operations in Canada, Germany, and the U.K.Additionally, deferred tax expense in 2016 includes the tax impact of the amortization of U.S. indefinite-lived intangible assets and the inability to recognizetax benefits associated with current year losses of operations in certain foreign jurisdictions and in the U.S.42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 Language revenue of $31.7 million and a slight decrease in E&E Language revenue 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 and 2015 Restructuring Plans and otherongoing expense 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 a $23.6 million decrease in revenue, partially offset by a decrease of $4.2 million in cost of 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)Literacy $34,123 17.6% $21,928 10.1% $12,195 55.6 %E&E Language 72,083 37.1% 76,129 35.0% (4,046) (5.3)%Consumer Language 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)%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.E&E Language SegmentTotal E&E Language revenue decreased $4.0 million, or 5%, from $76.1 million for the year ended December 31, 2015 to $72.1 million for the yearended December 31, 2016. The decrease in E&E Language revenue reflects a decrease of $5.3 million in the corporate channel, which was partially offset byincreases of $0.7 million and $0.5 million in our non-profit and education sales channels, respectively.Consumer Language SegmentConsumer Language revenue decreased $31.7 million, or 27%, from the year ended December 31, 2015 to the year ended December 31, 2016. Thisdecrease was largely 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 theretail channel was due in part to the planned reduction in the suggested retail value in the U.S. which impacted Consumer Language revenue by $3.6 million.The reduction in homeschool revenue was primarily due to the sale of the Korea entity in the third quarter of 2015.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, 2016 and 2015:43Table of Contents 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 the E&ELanguage segment, the corporate sales channel decreased by $4.3 million, which was partially offset by an increase in the education sales channel of $0.9million. Consumer Language 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 Language decline in revenue associated with our recent shift in strategy to focus on thepassionate learner. In the Consumer Language segment, we have begun shifting sales from our box-based and perpetual download products to similarlypriced long-term subscription products. However, it is important to note that these subscribers generally only stay for the duration of the subscription period,which could negatively impact our revenue in the future.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 Language segment. The decrease in retail sales is due in part to the reduction in suggested retail value in the U.S. which negativelyimpacted product revenue by $3.6 million. Product revenue also decreased due to the ongoing transition of our sales model towards subscription sales ratherthan perpetual license and box product sales.Cost of Subscription and Service Revenue, Cost of Product Revenue, and Gross ProfitThe following table sets forth cost of subscription and service revenue, cost of product revenue, and gross profit for the years ended December 31, 2016and 2015: 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 Language segmenttowards subscriptions which resulted in decreases in inventory expense, freight and payment processing fees, and professional services. Inventory expensedeclined $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 was slightly offset by an increase in amortization of capitalized internal-use software costs.Cost of Subscription and Service Revenue44Table of ContentsCost 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)%In 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 E&E Language offerings and to close our software development operations in France and China. In the firstquarter of 2015, we announced and initiated actions to reduce headcount and other costs in order to support our 2015 strategic shift in business 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 $8,79145Table of ContentsWhile 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.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.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 consumer market and improvements in accounts receivablecollections. Other costs decreased due to the ongoing cost saving measures.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)%46Table of ContentsInterest 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 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.Liquidity and Capital ResourcesLiquidityOur principal source of liquidity at December 31, 2017 consisted of $43.0 million in cash and cash equivalents and short-term investments, an increaseof $6.8 million, from $36.2 million compared to December 31, 2016. Our primary operating cash requirements include the payment of salaries, employeebenefits and 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, 2017, we generated $19.3million cash flows from operations as reflected in our consolidated statements of cash flows.Our operating segments are affected by different sales-to-cash patterns. Within our E&E Language and Literacy segments, revenue in our education,government, and corporate sales channels are seasonally stronger in the second half of the calendar year due to purchasing and budgeting cycles. OurConsumer Language revenue is affected by seasonal trends associated with the holiday shopping season. Consumer Language sales typically turn to cashmore quickly than E&E Language and Literacy sales, which tend to have longer collection cycles. Historically, in the first half of the year we have been a netuser of cash and in the second half of the year we have been a net generator of cash. We expect the trend to use cash in the first half of the year and generatecash in the second half of the year to continue.On October 28, 2014, we executed a Loan and Security Agreement with Silicon Valley Bank ("Bank") to obtain a $25.0 million revolving creditfacility. Since the original date of execution, we have executed several amendments to the credit facility to reflect updates to our financial outlook andextend the credit facility. Under the amended agreement, we 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 has a term that expires on April 1, 2020, during which time we mayborrow 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 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 the Bank is greater than $25.0 million, then we may borrow up to an additional $5.0 million, but in no case can borrowingsexceed $25.0 million. Interest on borrowings accrues 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 $15.1 million ofavailable credit less $4.0 million in letters of credit have been issued by the Bank on our behalf, resulting in a net borrowing availability of $11.1 million.We are subject to certain financial and restrictive covenants under the credit facility. We are required to maintain compliance with a minimum liquidity ratioand maintain a minimum Adjusted EBITDA. As of December 31, 2017, we were in compliance with all of the covenants under the revolving credit agreement.47Table of ContentsThe total amount of cash that was held by foreign subsidiaries as of December 31, 2017 was $7.6 million. As of December 31, 2017, if we were torepatriate this foreign cash, no tax liability would result due to the current period and carryforward 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 cash flows from operations will be sufficient tomeet our cash needs for at least the next twelve months from the date of issuance of this report. We have generated significant operating losses as reflected inour accumulated loss and we may continue to incur operating losses in the future that may continue to require additional working capital to execute strategicinitiatives. Our future capital requirements will depend on many factors, including development of new products, market acceptance of our products, thelevels of advertising and promotion required to launch additional products and improve our competitive position in the marketplace, the expansion of oursales, support and marketing organizations, the optimization of office space in the U.S. and worldwide, building the infrastructure necessary to support ourgrowth, the response of competitors to our products and services, and our relationships with suppliers. We extend payments to certain vendors in order tominimize the amount of working capital deployed in the business. In order to maximize our cash position, we will continue to manage our existing inventory,accounts receivable, and accounts payable balances. Borrowings under our credit facility can be utilized to meet working capital requirements, anticipatedcapital expenditures, and other obligations.Cash Flow Analysis for the Year ended December 31, 2017 as compared to the year ended December 31, 2016 Year ended December 31, 2017 versus 2016 2017 2016 Change % Change (in thousands, except percentages)Net cash provided by operating activities $19,302 $1,240 $18,062 1,456.6 %Net cash used in investing activities $(12,822) $(12,476) $(346) 2.8 %Net cash used in financing activities $(118) $(658) $540 (82.1)%Net Cash Provided By Operating ActivitiesNet cash provided by operating activities was $19.3 million for the year ended December 31, 2017 compared to $1.2 million for the year endedDecember 31, 2016, a favorable change of $18.1 million. The factors affecting our operating cash flows during the year were our improvement in net lossfrom $27.6 million to $1.5 million, driven primarily by a reduction in operating expenses. For a summary of the factors that led to the net loss for the yearended December 31, 2017 see "Results of Operations" section above. Non-cash items primarily consisted of $12.0 million in depreciation and amortizationexpense and $4.1 million in stock-based compensation expense, partially offset by $4.2 million in deferred income tax benefit. The primary drivers of thechange in operating assets and liabilities were a decrease in accounts receivable of $7.6 million, an increase in deferred revenue of $8.9 million, a decrease ininventory of $3.3 million, partially offset by a decrease in other current liabilities of $6.5 million, a decrease in accounts payable of $1.8 million, and adecrease in other long-term liabilities of $1.2 million. The decrease in accounts receivable was primarily related to improved collection efforts and lowerrevenues. The increase in deferred revenue was primarily due to the increase in sales in the Literacy segment, a sales shift from our box-based and perpetualdownload products to subscription product, and the increase in deferred revenue related to a significant transaction in Japan with SOURCENEXT. Thedecrease in inventory was primarily due to an inventory write down of finished packaged perpetual products due to the transition from box-based andperpetual download products to subscription product. The declines in other current liabilities, accounts payable, and other long-term liabilities reflect theongoing cost reduction initiatives which resulted in lower operating expenses and fewer obligations due for marketing, advertising, rebates, and generalbusiness activities.The dollar change between the net cash provided by operating activities for the year ended December 31, 2017 as compared to December 31, 2016 wasdue in part to the positive cash inflows totaling $13.0 million related to the execution of agreements with SOURCENEXT Corporation for the perpetuallicense of certain intellectual property for exclusive use and sale in Japan. See Note 8 "Divestitures" of Item 8, Financial Statements and Supplementary Datafor a further description of the SOURCENEXT transaction.48Table of ContentsNet Cash Used in Investing ActivitiesNet cash used in investing activities was $12.8 million for the year ended December 31, 2017, compared to $12.5 million for the year endedDecember 31, 2016. Purchases of property and equipment, which primarily relates to capitalized labor on product and corporate IT projects was slightlyhigher in 2017 as compared to 2016.Net Cash Used in Financing ActivitiesNet cash used in financing activities was $0.1 million for the year ended December 31, 2017, compared to $0.7 million for the year ended December 31,2016. The favorable change was primarily driven by an increase in proceeds from the exercise of stock options due to the rise in our stock price in 2017 ascompared to 2016.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)%Net 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.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, 2017 andthe effect such obligations are expected to have on our liquidity and cash flow in future periods.49Table of Contents Total Less than1 Year 1-3 Years 3-5 Years More than5 Years (in thousands)Capitalized leases and other financing arrangements $2,572 $548 $1,085 $939 $—Operating leases 7,755 4,419 2,746 590 —Total $10,327 $4,967 $3,831 $1,529 $—Item 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 Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosurecontrols and procedures as of December 31, 2017. 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-50Table of Contentsbenefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of December 31, 2017, ourChief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonableassurance 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, 2017. Management's assessment was based on criteria set forth by the Committeeof Sponsoring Organizations of the Treadway Commission, or COSO, in Internal Control—Integrated Framework (2013).Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting andthe preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financialreporting includes those policies and procedures that:(1)pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect our transactions and dispositions of our assets;(2)provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generallyaccepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of management andBoard of Directors; and(3)provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could havea material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of anyevaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degreeof compliance with the policies or procedures may deteriorate.Based on using the COSO criteria, management believes our internal control over financial reporting as of December 31, 2017 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, 2017 that had materially affected, or is reasonably likely to materially affect,our internal control over financial reporting.Item 9B. Other InformationNone.51Table of ContentsPART IIICertain information required by Part III is omitted from this Annual Report on Form 10-K as we intend to file our definitive Proxy Statement for the2018 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," "Executive Officers," "Security Ownership of Certain Beneficial Owners and Management—Section 16(a) Beneficial Ownership ReportingCompliance," "Corporate Governance—Code of Ethics and Business Conduct," "Corporate Governance—Composition of our Board of Directors; ClassifiedBoard," "Corporate Governance—Committees of our 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 2018Annual Meeting of Stockholders to be filed with the SEC no later than 120 days after the fiscal year ended December 31, 2017 (the "2018 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 2018 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 Plan Information" in the 2018 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 2018 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 2018 Proxy Statement.52Table of ContentsPART IVItem 15. Exhibits and Financial Statement Schedules(a)Consolidated Financial Statements1.Consolidated Financial Statements. The consolidated financial statements as listed in the accompanying "Index to ConsolidatedFinancial Information" are filed as part of this Annual Report.2.Consolidated Financial Statement Schedules. Schedules have been omitted because they are not applicable or are not required or theinformation required to be set forth in those schedules is included in the consolidated financial statements or related notes.All other schedules not listed in the accompanying index have been omitted as they are either not required or not applicable, or the requiredinformation is included in the consolidated financial statements or the notes thereto.(b)ExhibitsThe exhibits listed in the Index to Exhibits are filed as part of this Annual Report on Form 10-K.EXHIBIT INDEX Index to exhibits2.1 Purchase and Sale Agreement by and among Rosetta Stone Ltd., Rosetta Stone Japan Inc., and SOURCENEXT Corporation, datedApril 25, 2017 (incorporated herein by reference to Exhibit 2.1 filed with the Company's Current Report on Form 8-K filed on April25, 2017).3.1 Second Amended and Restated Certificate of Incorporation (incorporated herein by reference to Exhibit 3.2 to Amendment No. 3 tothe Company’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 onForm 8-K filed 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).10.1+2009 Omnibus Incentive Plan, as amended and restated and effective June 12, 2015 (incorporated herein by reference to Exhibit 99.1filed with the Company’s Registration Statement on Form S-8 (No. 333-204904) filed on June 12, 2015).10.2+Director Form of Option Award Agreement under the 2009 Plan (incorporated herein by reference to Exhibit 10.6 to the Company’sAnnual Report on Form 10-K for the fiscal year ended December 31, 2014).10.3+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).10.4+Amended Executive Form of Option Award Agreement under 2009 Plan effective for awards after October 1, 2011 (incorporated hereinby reference to Exhibit 10.25 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011).10.5+Amended Executive Form of Option Award Agreement under 2009 Plan effective for awards granted May 9, 2016 (incorporated hereinby reference to Exhibit 10.3 in the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2016.)10.6+Form of Annual Performance-Based Nonqualified Stock Option Award Agreement, dated April 4, 2016, between the Company andJohn Hass (incorporated herein by reference to Exhibit 10.3 in the Company's Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2017).10.7+Form of Long-Term Performance-Based Nonqualified Stock Option Award Agreement, dated April 4, 2016, between the Company andJohn Hass (incorporated herein by reference to Exhibit 10.4 in the Company's Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2017).10.8+Form of Restricted Stock Award Agreement under the 2009 Plan (incorporated herein by reference to Exhibit 10.13 to Amendment No.4 to the Company’s Registration Statement on Form S-1 (No. 333-153632), filed on March 17, 2009).53Table of Contents Index to exhibits10.9+Amended Executive Form of Restricted Stock Award Agreement under 2009 Plan effective for awards after October 1, 2011(incorporated herein by reference to Exhibit 10.26 in the Company’s Annual Report on Form 10-K for the fiscal year ended December31, 2011).10.10+Amended Executive Form of Restricted Stock Award Agreement under 2009 Plan effective for awards after February 1, 2016(incorporated herein by reference to Exhibit 10.11 in the Company’s Annual Report on Form 10-K for the fiscal year ended December31, 2015).10.11+Director Form of Restricted Stock Unit Award Agreement under the 2009 Plan (incorporated herein by reference to Exhibit 10.12 inthe Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014).10.12+Director Form of Restricted Stock Unit Award Agreement under the 2009 Plan (for awards beginning June 2015) (incorporated hereinby reference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2015).10.13+Form of Annual Performance-Based Restricted Stock Award Agreement, dated April 4, 2016, between the Company and John Hass(incorporated herein by reference to Exhibit 10.1 in the Company's Quarterly Report on Form 10-Q for the quarter ended March 31,2017).10.14+Form of Long-Term Performance-Based Restricted Stock Award Agreement, dated April 4, 2016, between the Company and John Hass(incorporated herein by reference to Exhibit 10.2 in the Company's Quarterly Report on Form 10-Q for the quarter ended March 31,2017).10.15+Policy on Recoupment of Performance Based Compensation (Clawback Policy) (incorporated herein by reference to Exhibit 10.26 inthe Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014).10.16+Rosetta Stone Inc. Change in Control Severance Plan (incorporated herein by reference to Exhibit 10.18 in the Company's AnnualReport on Form 10-K for the fiscal year ended December 31, 2015.)10.17 Form of Indemnification Agreement entered into with each director and executive officer (incorporated herein by reference to Exhibit10.7 to the Company’s Registration Statement on Form S-1 (No. 333-153632) filed on September 23, 2008).10.18 Form of Indemnification Agreement to be entered into with each director and executive officer, revised as of August 2015(incorporated herein by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for the period ended September 30,2015).10.19+Executive Employment Agreement between Rosetta Stone Ltd. and Thomas Pierno effective as of May 2, 2012 (incorporated hereinby reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on May 1, 2012).10.20+Director Agreement between Rosetta Stone Inc. and A. John Hass III effective as of November 18, 2014 (incorporated herein byreference to Exhibit 10.31 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014).10.21+Executive Employment Agreement between Rosetta Stone Ltd. and A. John Hass III effective as of April 1, 2016 (incorporated hereinby reference to Exhibit 10.1 in the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2016.)10.22+Executive Employment Agreement between the Company and Sonia Cudd, effective as of January 2, 2015 (incorporated herein byreference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2015).10.23*+Executive Employment Agreement between the Company and Mathew Hulett, effective as of August 4, 2017.10.24*+Executive Employment Agreement between the Company and Nicholas Gaehde, effective as of August 21, 2017.10.25 Lease Agreement dated as of February 20, 2006, by and between Premier Flex Condos, LLC and Fairfield LanguageTechnologies, Inc., as amended (incorporated herein by reference to Exhibit 10.10 to Amendment No. 1 to the Company’s RegistrationStatement on Form S-1 (No. 333-153632), filed on November 5, 2008).10.26 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).10.27 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).10.28 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 December31, 2014).Table of Contents Index to exhibits10.29 Sub-Sublease Agreement dated as of July 14, 2016, by and between Rosetta Stone Ltd. and Snagajob.com, Inc. (incorporated herein byreference to Exhibit 10.37 in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2016).10.30 Software License Agreement by and between The Regents of the University of Colorado and Fairfield & Sons Ltd. dated as ofDecember 22, 2006 (incorporated herein by reference to Exhibit 10.12 to Amendment No. 2 to the Company’s Registration Statementon Form S-1 (No. 333-153632), filed on January 21, 2009).***10.31 Loan and Security Agreement between Rosetta Stone Ltd. and Silicon Valley Bank, executed on October 28, 2014 (incorporatedherein by reference to Exhibit 99.3 filed to the Company’s Current Report on Form 8-K filed on October 29, 2014).10.32 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 March31, 2015).10.33 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).10.34 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).10.35 Fourth Amendment to Loan and Security Agreement dated as of December 29, 2015 between Silicon Valley Bank and Rosetta StoneLtd (incorporated herein by reference to Exhibit 10.42 of the Company's Annual Report on Form 10-K for the fiscal year endedDecember 31, 2015.).10.36 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).10.37 Sixth Amendment to Loan and Security Agreement dated as of March 10, 2017 between Silicon Valley Bank and Rosetta Stone Ltd.(incorporated herein by reference to Exhibit 10.45 of the Company's Annual Report on Form 10-K for the fiscal year ended December31, 2016).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 2002.101.INS *XBRL Instance Document.101.SCH *XBRL Taxonomy Extension Schema.101.CAL *XBRL Taxonomy Extension Calculation Linkbase.101.DEF *XBRL Taxonomy Extension Definition Linkbase.101.LAB *XBRL Taxonomy Extension Label Linkbase.101.PRE *XBRL Taxonomy Extension Presentation Linkbase._______________________________________________________________________________* Filed herewith.*** Portions of this exhibit have been omitted pursuant to a request for confidential treatment.+ Identifies management contracts and compensatory plans or arrangements.Item 16. Form 10-K SummaryNot applicable.Table of ContentsSIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.ROSETTA STONE INC.By: /s/ A. JOHN HASS III A. John Hass III President, Chief Executive Officer,and Chairman of the BoardDate: March 7, 2018 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 7, 2018A. John Hass III /s/ THOMAS M. PIERNO Chief Financial Officer(Principal Financial Officer)March 7, 2018Thomas M. Pierno /s/ M. SEAN HARTFORD Vice President, Controller and Principal AccountingOfficer(Principal Accounting Officer)March 7, 2018M. Sean Hartford /s/ PATRICK W. GROSS DirectorMarch 7, 2018Patrick W. Gross /s/ LAURENCE FRANKLIN DirectorMarch 7, 2018Laurence Franklin /s/ DAVID P. NIERENBERG DirectorMarch 7, 2018David P. Nierenberg /s/ STEVEN P. YANKOVICH DirectorMarch 7, 2018Steven P. Yankovich /s/ CAROLINE J. TSAY DirectorMarch 7, 2018Caroline J. Tsay /s/ JESSIE WOOLLEY-WILSON DirectorMarch 7, 2018Jessie Woolley-Wilson 56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' Equity (Deficit)F-7Consolidated Statements of Cash FlowsF-8Notes to Consolidated Financial StatementsF-9F-1Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo the stockholders and Board of Directors of Rosetta Stone Inc.Opinion on the Financial StatementsWe have audited the accompanying consolidated balance sheets of Rosetta Stone Inc. and subsidiaries (the "Company") as of December 31, 2017 and 2016,and the related consolidated statements of operations, comprehensive loss, changes in stockholders' equity (deficit), and cash flows for each of the three yearsin the period ended December 31, 2017, and the related notes (collectively referred to as the "financial statements"). In our opinion the financial statementspresent fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of operations and its cashflows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States ofAmerica.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company'sinternal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued bythe Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 7, 2018, expressed an unqualified opinion on theCompany's internal control over financial reporting.Basis of OpinionThese financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financialstatements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Companyin accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing proceduresto assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks.Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also includedevaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financialstatements. We believe that our audits provide a reasonable basis for our opinion./s/ DELOITTE & TOUCHE LLPMcLean, VirginiaMarch 7, 2018We have served as the Company's auditor since 2004.F-2Table of ContentsREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo the stockholders and Board of Directors of Rosetta Stone Inc.Opinion on Internal Control over Financial ReportingWe have audited the internal control over financial reporting of Rosetta Stone Inc. and subsidiaries (the “Company”) as of December 31, 2017, based oncriteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, basedon criteria established in Internal Control - Integrated Framework (2013) issued by COSO.We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidatedfinancial statements as of and for the year ended December 31, 2017 of the Company and our report dated March 7, 2018, expressed an unqualified opinionon those financial statements.Basis for OpinionThe 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 are a public accounting firmregistered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and theapplicable rules and regulations of the Securities and Exchange Commission and the PCAOB.We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operatingeffectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. Webelieve that our audit provides a reasonable basis for our opinion.Definition and Limitations of Internal Control over Financial ReportingA company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal controlover financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are beingmade only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a 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 any evaluation ofeffectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliancewith the policies or procedures may deteriorate./s/ DELOITTE & TOUCHE LLPMcLean, VirginiaMarch 7, 2018F-3Table of ContentsROSETTA STONE INC.CONSOLIDATED BALANCE SHEETS(in thousands, except per share amounts) As of December 31, 2017 2016Assets Current assets: Cash and cash equivalents $42,964 $36,195Restricted cash 72 402Accounts receivable (net of allowance for doubtful accounts of $375 and $1,072, at December 31, 2017 and December31, 2016, respectively) 24,517 31,788Inventory 3,536 6,767Deferred sales commissions 14,466 14,085Prepaid expenses and other current assets 4,543 3,813Total current assets 90,098 93,050Deferred sales commissions 3,306 4,143Property and equipment, net 30,649 24,795Goodwill 49,857 48,251Intangible assets, net 19,184 22,753Other assets 1,661 1,318Total assets $194,755 $194,310Liabilities and stockholders' equity (deficit) Current liabilities: Accounts payable $8,984 $10,684Accrued compensation 10,948 10,777Income tax payable 384 785Obligations under capital lease 450 532Other current liabilities 16,454 22,150Deferred revenue 110,670 113,821Total current liabilities 147,890 158,749Deferred revenue 40,593 27,636Deferred income taxes 1,968 6,173Obligations under capital lease 1,850 2,027Other long-term liabilities 31 1,384Total liabilities 192,332 195,969Commitments and contingencies (Note 16) Stockholders' equity (deficit): Preferred stock, $0.001 par value; 10,000 and 10,000 shares authorized, zero and zero shares issued and outstanding atDecember 31, 2017 and December 31, 2016, respectively — —Non-designated common stock, $0.00005 par value, 190,000 and 190,000 shares authorized, 23,783 and 23,451 sharesissued and 22,783 and 22,451 shares outstanding at December 31, 2017 and December 31, 2016, respectively 2 2Additional paid-in capital 195,644 190,827Treasury stock, at cost; 1,000 and 1,000 shares at December 31, 2017 and December 31, 2016, respectively (11,435) (11,435)Accumulated loss (178,890) (177,344)Accumulated other comprehensive loss (2,898) (3,709)Total stockholders' equity (deficit) 2,423 (1,659)Total liabilities and stockholders' equity (deficit) $194,755 $194,310 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, 2017 2016 2015Revenue: Subscription and service $168,442 $154,336 $151,701Product 16,151 39,753 65,969Total revenue 184,593 194,089 217,670Cost of revenue: Cost of subscription and service revenue 26,082 23,676 21,629Cost of product revenue 7,539 10,645 16,898Total cost of revenue 33,621 34,321 38,527Gross profit 150,972 159,768 179,143Operating expenses Sales and marketing 96,660 114,340 136,084Research and development 24,747 26,273 29,939General and administrative 34,066 40,501 50,124Impairment — 3,930 6,754Lease abandonment and termination — 1,644 55Total operating expenses 155,473 186,688 222,956Loss from operations (4,501) (26,920) (43,813)Other income and (expense): Interest income 66 46 23Interest expense (491) (470) (378)Other income and (expense) 881 2,297 (1,469)Total other income and (expense) 456 1,873 (1,824)Loss before income taxes (4,045) (25,047) (45,637)Income tax (benefit) expense (2,499) 2,503 1,159Net loss $(1,546) $(27,550) $(46,796)Loss per share: Basic $(0.07) $(1.25) $(2.17)Diluted $(0.07) $(1.25) $(2.17)Common shares and equivalents outstanding: Basic weighted average shares 22,244 21,969 21,571Diluted weighted average shares 22,244 21,969 21,571 See accompanying notes to consolidated financial statementsF-5Table of ContentsROSETTA STONE INC.CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS(in thousands) Years Ended December 31, 2017 2016 2015Net loss $(1,546) $(27,550) $(46,796)Other comprehensive income (loss), net of tax: Foreign currency translation gain (loss) 811 (1,483) (1,548)Other comprehensive income (loss) 811 (1,483) (1,548)Comprehensive loss $(735) $(29,033) $(48,344)See accompanying notes to consolidated financial statementsF-6Table of ContentsROSETTA STONE INC.CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)(in thousands) Non-DesignatedCommon Stock AccumulatedOtherComprehensiveLoss TotalStockholders'Equity / (Deficit) AdditionalPaid-inCapital Treasury Stock AccumulatedLoss Shares Amount Balance—January 1, 2015 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)Stock Issued Upon the Exercise ofStock Options 79 — 676 — — — 676Restricted Stock Award Vesting 163 — — — — — —Stock-based CompensationExpense — — 4,141 — — — 4,141Net loss — — — — (1,546) — (1,546)Other comprehensive income — — — — — 811 811Balance—December 31, 2017 22,316 $2 $195,644 $(11,435) $(178,890) $(2,898) $2,423 See accompanying notes to consolidated financial statementsF-7Table of ContentsROSETTA STONE INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands) Years Ended December 31, 2017 2016 2015CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(1,546) $(27,550) $(46,796)Adjustments to reconcile net loss to cash provided by (used in) operating activities: Stock-based compensation expense 4,141 4,906 7,195(Gain) loss on foreign currency transactions (573) (2,449) 1,471Bad debt (recovery) expense (51) 709 1,657Depreciation and amortization 12,009 13,322 13,660Deferred income tax (benefit) expense (4,201) 1,162 849(Gain) loss on disposal of equipment (5) 179 (15)Amortization of deferred financing costs 296 274 160Loss on impairment — 3,930 6,754Loss from equity method investments 100 45 23Gain on divestiture of subsidiary (506) — (660)Net change in: Restricted cash 342 (378) 43Accounts receivable 7,584 14,681 26,376Inventory 3,266 538 (1,253)Deferred sales commissions 491 919 (4,121)Prepaid expenses and other current assets (604) (167) 1,080Income tax receivable or payable (447) 719 568Other assets (455) 668 (684)Accounts payable (1,765) (74) (8,636)Accrued compensation 69 2,701 (5,485)Other current liabilities (6,450) (13,261) (14,223)Other long-term liabilities (1,243) 558 (486)Deferred revenue 8,850 (192) 16,878Net cash provided by (used in) operating activities 19,302 1,240 (5,645)CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (12,944) (12,514) (8,856)Proceeds from sale of fixed assets 12 38 1,642Acquisitions, net of cash acquired — — (1,688)Proceeds (payments) on divestiture of subsidiary 110 — (186)Other investing activities — — (286)Net cash used in investing activities (12,822) (12,476) (9,374)CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from the exercise of stock options 676 58 114Payment of deferred financing costs (232) (183) (130)Payments under capital lease obligations (562) (533) (711)Net cash used in financing activities (118) (658) (727)Increase (decrease) in cash and cash equivalents 6,362 (11,894) (15,746)Effect of exchange rate changes in cash and cash equivalents 407 307 (1,129)Net increase (decrease) in cash and cash equivalents 6,769 (11,587) (16,875)Cash and cash equivalents—beginning of year 36,195 47,782 64,657Cash and cash equivalents—end of year $42,964 $36,195 $47,782SUPPLEMENTAL CASH FLOW DISCLOSURE: Cash paid during the periods for: Interest $195 $197 $218Income taxes, net of refund $1,896 $604 $601Noncash financing and investing activities: Accrued liability for purchase of property and equipment $967 $270 $258Equipment acquired under capital lease $— $27 $462See accompanying notes to consolidated financial statementsF-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 web-based software subscriptions, perpetual software products, 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 web-based software subscriptions and packaged software, domestically and in certain international markets.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.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.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 Language revenue from the CD and digital download formats of the Rosetta Stone language-learning product which are typicallymultiple-element arrangements that contain two deliverables: perpetual software, delivered at the time of sale, and online service, which is considered anundelivered software-related element. The online service includes access to conversational coaching services. Because the Company only sells the perpetuallanguage-learning software on a stand-alone basis in its homeschool version, the Company does not have a sufficient concentration of stand-alone sales toestablish VSOE for the perpetual product. Where VSOE of the undelivered online services can be established, arrangement consideration is allocated usingthe residual method. The Company determines VSOE by reference to the range of comparable stand-alone renewal sales of the online service. The Companyreviews these stand-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 amidpoint of the range of prices, consistent with generally accepted industry practice. Where VSOE of undelivered services cannot be established, revenue isdeferred and recognized commensurate with the delivery of the services.For non-software multiple element arrangements, the Company allocates revenue to all deliverables based on their relative selling prices. Thesearrangements can include web-based subscription services, audio practice products and professional services or any combination thereof. The Company doesnot have a sufficient concentration of stand-alone sales ofF-9Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)the various deliverables noted above to its customers, and therefore cannot establish VSOE for each deliverable. Third party evidence of fair value does notexist for the web-based subscription, audio practice products and professional services due to the lack of interchangeable language-learning products andservices within the market. Accordingly, the Company determines the relative selling price of the web-based subscription, audio practice products andprofessional services deliverables included in its non-software multiple element arrangements using the best estimated selling price. The Companydetermines the best estimated selling price based on its internally published price list which includes suggested sales prices for each deliverable based on thetype of client and volume purchased. This price list is derived from past experience and from the expectation of obtaining a reasonable margin based on whateach 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 its 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 the 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 passes and risks of loss have been transferred. For many product sales, these criteria are met at thetime the product is shipped. For some sales to resellers and certain other sales, the Company defers revenue until the customer receives the product becausethe Company legally retains a portion of the risk of loss on these sales during transit. In other cases where packaged software products are sold to resellers ona consignment basis, revenue is recognized for these consignment transactions once the end user sale has occurred, assuming the remaining revenuerecognition criteria have been met. In accordance with ASC subtopic 605-50, Revenue Recognition: Customer Payments and Incentives (“ASC 605-50”),cash sales incentives to resellers are accounted for as a reduction of revenue, unless a specific identified benefit is identified and the fair value is reasonablydeterminable. Price protection for changes in the manufacturer suggested retail value granted to resellers for the inventory that they have on hand at the datethe price protection is offered is recorded as a reduction to revenue at the time of sale.The Company offers customers the ability to make payments for packaged software purchases in installments over a period of time, which typicallyranges between three and five months. Given that these installment payment plans are for periods less than 12 months, a successful collection history hasbeen established and these fees are fixed and determinable, revenue is recognized at the time of sale, assuming the remaining revenue recognition criteriahave been met.In connection with packaged software product sales and web-based software subscriptions, technical support is provided to customers, includingcustomers of resellers, via telephone support at no additional cost for up to six months from the time of purchase. As the fee for technical support is includedin the initial licensing fee, the technical support and services are generally provided within one year, the estimated cost of providing such support is deemedinsignificant and no unspecified upgrades/F-10Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)enhancements are offered, technical support revenue is recognized together with the software product and web-based software subscription revenue. Costsassociated 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 as appropriate when evaluated under the variable interest entitymodel. The Company recognizes a gain or loss at divestiture equal to the difference between the fair value of any consideration received and the carryingamount of the former subsidiary’s assets and liabilities. Any resulting gain or loss is reported in "Other income and (expense)" on the consolidated statementof operations. See Note 8 "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.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, 2017, 2016 or 2015. The four largest distributor andreseller receivable balances collectively represented 17% and 23% of accounts receivable as of December 31, 2017 and 2016, respectively. No customeraccounted for more than 10% of accounts receivable as of December 31, 2017, while one customer accounted for 13% of accounts receivable as ofDecember 31, 2016. The Company maintains trade credit insurance for certain customers to provide coverage, up to a certain limit, in the event of insolvencyof 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:F-11Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)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 and Equipment" for the Company's additional disclosures.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. See Note 4 "Property and Equipment" for a discussion of the software developed for internal use.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").F-12Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)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 6 "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. If, based on areview of qualitative factors, it is more likely than not that the fair value of a reporting unit is less than its carrying value the Company performs aquantitative impairment test by comparing the fair value of a reporting unit with its carrying amount. If the carrying value exceeds the fair value, theCompany measures the amount of impairment loss, if any.See Note 5 "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 E&E Language and Literacy customers against claims of intellectual propertyinfringement made by third parties arising from the use of its products. The Company has not incurred any costs or accrued any liabilities as a result of suchobligations.Cost of 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, costs associated with product assembly, third-party royalty fees and inventory storage, obsolescence and shrinkage.Research and DevelopmentResearch and development expenses include employee compensation costs, consulting fees and overhead costs associated with the development ofthe Company's solutions. The Company develops a portion of its language-learning software products for perpetual sale to external customers. The Companyconsiders technological feasibility to be established when all planning, designing, coding, and testing has been completed according to designspecifications. The Company has determined that technological feasibility for such software products is reached shortly before the products are released tomanufacturing. Costs incurred after technological feasibility is established have not been material, and accordingly, the Company has expensed all researchand development costs when incurred.Income TaxesThe Company accounts for income taxes in accordance with ASC topic 740, Income Taxes ("ASC 740"), which provides for an asset and liabilityapproach to accounting for income taxes. Deferred tax assets and liabilities represent the future tax consequences of the differences between the financialstatement carrying amounts of assets and liabilities versus the tax basis of assets and liabilities. Under this method, deferred tax assets are recognized fordeductible temporary differences, and operating loss and tax credit carryforwards. Deferred liabilities are recognized for taxable temporary differences.Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of theF-13Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)deferred tax assets will not be realized. The impact of tax rate changes on deferred tax assets and liabilities is recognized in the year that the change isenacted.Significant judgment is required to determine whether a valuation allowance is necessary and the amount of such valuation allowance, if appropriate.The valuation allowance is reviewed at each reporting period and is maintained until sufficient positive evidence exists to support a reversal.When assessing the realization of the Company's deferred tax assets, the Company considers all available evidence, including:•the nature, frequency, and severity of cumulative financial reporting losses in recent years;•the carryforward periods for the net operating loss, capital loss, and foreign tax credit carryforwards;•predictability of future operating profitability of the character necessary to realize the asset;•prudent and feasible tax planning strategies that would be implemented, if necessary, to protect against the loss of the deferred tax assets;and•the effect of reversing taxable temporary differences.The evaluation of the recoverability of the deferred tax assets requires that the Company weigh all positive and negative evidence to reach aconclusion that it is more likely than not that all or some portion of the deferred tax assets will not be realized. The weight given to the evidence iscommensurate with the extent to which it can be objectively verified. The more negative evidence that exists, the more positive evidence is necessary and themore difficult it is to support a conclusion that a valuation allowance is not needed.The establishment of a valuation allowance has no effect on the ability to use the deferred tax assets in the future to reduce cash tax payments. TheCompany will continue to assess the likelihood that the deferred tax assets will be realizable at each reporting period and the valuation allowance will beadjusted accordingly, which could materially affect the Company's financial position and results of operations.See Note 15 "Income Taxes" for additional disclosures including the impact and additional disclosures associated with the recent Tax Reform enactedon December 22, 2017.Stock-Based CompensationThe Company accounts for its stock-based compensation in accordance with 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 date of grant 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. Changes in the probability estimatesassociated with performance-based awards will be accounted for in the period of change using a cumulative catch-up adjustment to retroactively apply thenew probability estimates. In any period in which the Company determines that achievement of the performance metrics is not probable, the Company ceasesrecording compensation expense and all previously recognized compensation expense for the performance-based award is reversed. For equity awardsgranted with market-based conditions,F-14Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)stock compensation expense is recognized in the statement of operations ratably for each vesting tranche regardless of meeting or not meeting the marketconditions. See Note 10 "Stock-Based Compensation" for additional disclosures.Restructuring CostsRestructuring plans have been initiated in each of the years ended December 31, 2017, 2016 and 2015 to reduce headcount and other costs in order tosupport the strategic shift in business focus. In connection with these plans, the Company incurred restructuring related costs, including employee severanceand related benefit costs, contract termination costs, and other related costs. These costs are included within Cost of sales and Sales and marketing, Researchand development, and General and administrative operating expense categories in the Company's 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 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.Basic and Diluted 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 by dividing net loss bythe weighted average number of common shares outstanding during the period. Diluted loss per share is computed by dividing net loss by the weightedaverage number of common shares and potential common shares outstanding during the period. Potential common shares are included in the dilutedcomputation when dilutive. Potentially dilutive shares are computed using the treasury stock method and primarily consist of shares issuable upon theexercise of stock options, restricted stock awards, restricted stock units and conversion of shares of preferred stock. Common stock equivalent shares areexcluded from the 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 thesewould be anti-dilutive. See Note 12 "Basic and Diluted Net Loss Per Share" for additional disclosures.Comprehensive LossComprehensive loss consists of net loss and other comprehensive income (loss). Other comprehensive income (loss) refers to revenues, expenses, gains,and losses that are not included in net loss, but rather are recorded directly in stockholders' equity (deficit). For the years ended December 31, 2017, 2016 and2015, the Company's comprehensive loss consisted of net loss and foreign currency translation gains (losses). The other comprehensive income (loss)presented in the consolidated financial statements and the notes are presented net of tax. There has been no tax expense or benefit associated with thecomponents other comprehensive income (loss) due to the presence of a full valuation allowance for each of the years ended December 31, 2017, 2016 and2015.Components of accumulated other comprehensive loss as of December 31, 2017 are as follows (in thousands): Foreign Currency TotalBalance at beginning of period $(3,709) $(3,709)Other comprehensive income before reclassifications 886 886Amounts reclassified from accumulated other comprehensive income (75) (75)Net current period other comprehensive income 811 811Accumulated other comprehensive loss $(2,898) $(2,898)F-15Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)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 income (loss) and reported as part of the gain or loss on sale or liquidation of the investment.During the year ended December 31, 2017, transfers totaling of $0.1 million were made from accumulated other comprehensive income (loss) and recognizedwithin net loss related to the sale of a foreign subsidiary.Foreign Currency Translation and TransactionsThe functional currency of the Company's foreign subsidiaries is their local currency. Accordingly, assets and liabilities of the foreign subsidiaries aretranslated into U.S. dollars at exchange rates in effect on the balance sheet date. Income and expense items are translated at average rates for the period.Translation adjustments are recorded as a component of other comprehensive income (loss) in stockholders' equity (deficit).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, 2017, 2016, and 2015 were $24.9 million, $37.0million and $46.9 million, respectively.Going Concern AssessmentAs part of its internal control framework, the Company routinely performs a quarterly going concern assessment in accordance with ASC sub-topic 205-40, Presentation of Financial Statements - Going Concern ("ASC 205-40"). Under ASC 205-40, management is required to assess the Company's ability tocontinue as a going concern. As further described below, management has concluded based on projections that the cash balance, funds available from the lineof credit, and the cash flows from operations are sufficient to meet the liquidity needs through the one year period following the financial statement issuancedate.The 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 7, 2018. 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 2018 cash flow forecast, 2018 operatingbudget, and long-term plan that extends beyond 2018. 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 7,2018, 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 2017, the Company adopted the following recently issued Accounting Standard Updates ("ASU"):In March 2016, the Financial Accounting Standards Board ("FASB") issued ASU No. 2016-09, Compensation - Stock Compensation (Topic 718):Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09"). Under ASU 2016-09, accounting for share-based payment award transactionswas simplified related to the accounting for (a) income tax effects; (b) minimum statutory tax withholding requirements; (c) and forfeitures. ASU 2016-09 iseffective for public entities in annual periods beginning after December 15, 2016, including interim periods within those annual periods. Early adoption ispermitted. The Company adopted this ASU as of January 1, 2017. Due to the historical cumulative shortfall position, theF-16Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)adoption of ASU 2016-09 did not result in a cumulative-effect adjustment to retained earnings. ASU 2016-09 allows for an entity-wide accounting policyelection, which would be applied prospectively, to either account for forfeitures when they occur or continue to estimate the number of awards that areexpected to vest. The Company has elected to continue to estimate the number of awards that are expected to vest. Other aspects of adoption ASU 2016-09 did not have a material impact to the Company’s consolidated financial statements.In January 2017, the FASB issued ASU No. 2017-01, Business Combination (Topic 805) Clarifying the Definition of a Business ("ASU 2017-01"). ASU2017-01 clarifies the definition of a business and requires that an entity apply certain criteria in order to determine when a set of assets and activities qualifiesas a business. ASU 2017-01 is effective for public entities for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years,and should be applied on a prospective basis. Early adoption is permitted. The Company early adopted this guidance as of January 1, 2017. Due to theprospective application of this ASU, there was no impact to historical financial statements and no additional disclosures are required.The following ASUs were recently issued but have not yet been adopted by the Company:In February 2018, the FASB issued ASU No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of CertainTax Effects from Accumulated Other Comprehensive Income ("ASU 2018-02"). ASU 2018-02 provides financial statement preparers with an option toreclassify stranded tax effects within accumulated other comprehensive income to retained earnings in each period in which the effect of the change in theU.S. federal corporate income tax rate in the Tax Reform (or portion thereof) is recorded. ASU 2018-02 is effective for fiscal years beginning after December15, 2018. Early adoption is permitted for any interim period for which financial statements have not been issued. The Company does not believe that theadoption of this guidance will have a material impact on the Company's consolidated financial statements due the presence of a full valuation allowance.However, the Company is in the process of evaluating the impact of this new guidance on the Company's consolidated financial statements and disclosures.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 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 will adopt thisnew guidance for its 2018 interim and annual reporting periods. The new guidance only impacts presentation of the Company's consolidated statement ofcash flows.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 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 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 notF-17Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in fair value in net income unless theinvestments qualify for the new practicability exception. The accounting for other financial instruments, such as loans and investments in debt securities islargely unchanged. ASU 2016-01 is effective for public entities in fiscal years beginning after December 15, 2017, including interim periods within thosefiscal years. The Company does not believe that the adoption of this guidance will have a material impact on the Company's consolidated financialstatements 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 will adopt the New Revenue Standard beginning in the first quarter of 2018. The New Revenue Standard provides the option betweentwo different methods of adoption. The Company will adopt the New Revenue Standard using the modified retrospective method. The modified retrospectivemethod requires the Company to calculate the cumulative effect of applying the new guidance as of the date of adoption via adjustment to retained earnings.The Company has substantially completed its evaluation of the impact the New Revenue Standard will have on its financial statements, disclosures,policies, processes, and system requirements. The Company has completed the development of its "recast tool" that enables the Company to determine thecumulative effect of adopting the new guidance as of January 1, 2018. As part of its evaluation, the Company has concluded the impact of the change in theNew Revenue Standard on the E&E Language and Literacy segments will be minimal as the accounting outcome for the vast majority of these transactionsremains unchanged. Due to the elimination of software specific accounting guidance, nearly all of the impact of adopting the New Revenue Standard willresult from changes to the accounting for the packaged perpetual software product line that also includes non-software elements within the ConsumerLanguage segment. Under the current revenue standard, the Company uses the residual method to allocate consideration between the software and non-software elements within a transaction. This results in a fixed amount being allocated to the non-software element, which is generally deferred and recognizedover time, and any discount being fully allocated to the software element, which is recognized as revenue at the time of sale. Under the New RevenueStandard, any discounts will be allocated to all of the elements within a software transaction based on relative selling price. Accordingly, this will result indifferent amounts allocated to the various elements which are recognized into revenue at different times. As such, the Company currently estimates theadoption of the New Revenue Standard will increase the 2018 beginning retained earnings balance by approximately $0.8 million, decrease deferred revenueby $0.6 million, and decrease other current liabilities by $0.2 million, associated with eliminating the Company's accrual for post-contract customer support.As part of the Consumer Language migration to a fully SaaS business, the Company began to phase out the sale of perpetual product bundled withshort-term online services (for which VSOE has been established) in the second half of 2017. The Company then began offering perpetual product bundledwith a long-term web-based software subscription (for which VSOE has not been established). This shift in product offerings has impacted the timing ofrevenue recognition under existing revenue recognition rules and is expected to impact the timing of revenue recognized under the New Revenue Standard.Under existing revenue recognition rules, perpetual product bundled with undelivered services without VSOE are deferred in full and recognized ratably overthe service period. Under the New Revenue Standard, the transaction price is allocated to each performance obligation based on relative selling price andrecognized when the performance obligations are satisfied. Accordingly, the Company estimates that the adoption of the New Revenue Standard will result inearlier recognition of revenue from sales of its current Consumer Language bundled offering than would have otherwise been recognized under the priorrevenue recognition rules. As the Company continues its path toward a 100% SaaS business, the timing of revenueF-18Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)recognition will shift from partial up-front recognition to full recognition over time. Further, the Company does not expect any tax impact due to thepresence of a full valuation allowance. The additional impacts to the financial statements include the new qualitative and quantitative disclosures that willbe required upon adoption of the New Revenue Standard. The Company continues to evaluate the impact of the New Revenue Standard and any assessmentsmade are subject to change.3. INVENTORYInventory consisted of the following (in thousands): As of December 31, 2017 2016Raw materials $2,893 $4,384Finished goods 643 2,383Total inventory $3,536 $6,767The finished goods inventory balance as of December 31, 2017 reflected the Company's ongoing efforts to transition the Consumer Language segmentto a SaaS model. In the third quarter of 2017, the Company requested its consignment retail partners to return inventory totaling $1.9 million of finishedpackaged perpetual products. This non-cash inventory write-down was reflected as a cost of product revenue on the Company's statements of operations.4. PROPERTY AND EQUIPMENTProperty and equipment consisted of the following (in thousands): As of December 31, 2017 2016Land $942 $876Buildings and improvements 10,030 9,503Leasehold improvements 1,468 1,645Computer equipment 15,635 15,866Software 54,600 43,688Furniture and equipment 2,427 2,393 85,102 73,971Less: accumulated depreciation (54,453) (49,176)Property and equipment, net $30,649 $24,795The Company leases certain computer equipment, software, buildings, and machinery under capital lease agreements. As of December 31, 2017 and2016, assets under capital lease included in property and equipment above were $5.9 million and $5.4 million, respectively. As of December 31, 2017 and2016, accumulated depreciation and amortization relating to property and equipment under capital lease arrangements totaled $2.8 million and $2.1 million,respectively.For the years ended December 31, 2017, 2016, and 2015 the Company capitalized $12.7 million, $11.4 million, and $7.1 million respectively, ofinternal-use software development costs. During the years ended December 31, 2016 and 2015, the Company recorded $1.0 million and $1.1 millionrespectively, in impairment expense related to the abandonment of previously capitalized internal-use software projects. There were no impairment chargesduring the year ended December 31, 2017.Depreciation and amortization expense related to property and equipment includes depreciation related to its physical assets and amortization expenserelated to amounts capitalized in the development of internal-use software. Depreciation and amortization expense associated with property and equipmentconsisted of the following (in thousands):F-19Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)4. PROPERTY AND EQUIPMENT Years Ended December 31, 2017 2016 2015Included in cost of revenue: Cost of subscription and service revenue $3,863 $3,057 $1,292Cost of product revenue 1,117 1,377 1,010Total included in cost of revenue 4,980 4,434 2,302Included in operating expenses: Sales and marketing 546 489 722Research and development 9 19 41General and administrative 2,635 4,029 5,403Total included in operating expenses 3,190 4,537 6,166Total $8,170 $8,971 $8,4685. 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 acquisition of 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 350, or more frequently, if impairment indicators arise. The Company also routinely reviews goodwill at the reporting unit level forpotential impairment.F-20Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)5. 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, 2017 and 2016 (in thousands): E&E Language Literacy Consumer Language TotalBalance as of January 1, 2016 Gross Goodwill $38,700 $9,962 $27,392 $76,054Accumulated Impairment — — (25,774) (25,774)Goodwill as of January 1, 2016 $38,700 $9,962 $1,618 $50,280 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 $27,514 $75,765Accumulated Impairment — — (27,514) (27,514)Goodwill as of December 31, 2016 $38,289 $9,962 $— $48,251 Effect of change in foreign currency rate 1,606 — — 1,606 Balance as of December 31, 2017 Gross Goodwill $39,895 $9,962 $27,514 $77,371Accumulated Impairment — — (27,514) (27,514)Goodwill as of December 31, 2017 $39,895 $9,962 $— $49,8572017 ActivityThe Company began its June 30, 2017 annual goodwill test with the qualitative test for the two reporting units with goodwill balances. The Companyconcluded that there were no indicators of impairment that would cause it to believe that it is more likely than not that the fair value of its reporting units isless than the carrying value. Accordingly, a quantitative impairment test was not performed and no goodwill impairment charges were recorded in connectionwith the annual impairment test. As such, there was no impairment of goodwill during the year ended December 31, 2017.2016 ActivityThe Company exercised its option to bypass the qualitative test for all reporting units with remaining goodwill balances in connection with the annualgoodwill impairment analysis performed as of June 30, 2016. The E&E Language and Literacy reporting units both resulted in fair values that substantiallyexceeded the carrying values, and therefore no goodwill impairment charges were recorded in connection 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. As a result, theCompany recorded a 2016 impairment loss of $1.7 million, which represented a full impairment of the remaining Consumer Fit Brains reporting unit'sgoodwill. The impairment charge was recorded in the "Impairment" line on the statement of operations. The Company had previously recorded a partialimpairment of the Consumer Fit Brains reporting unit in 2015 of $5.6 millionF-21Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)6. 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 $12,431 $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 Gross Carrying Amount $12,505 $15,636 $26,656 $312 $55,109Accumulated Amortization (1,755) (12,222) (20,515) (278) (34,770)Accumulated Impairment (26) (1,001) (128) — (1,155)Balance as of December 31, 2017 $10,724 $2,413 $6,013 $34 $19,184* 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 0.58 yearsCore technology 1.94 yearsCustomer relationships 5.00 yearsPatents 1.25 yearsAmortization expense consisted of the following (in thousands): Years Ended December 31, 2017 2016 2015Included in cost of revenue: Cost of subscription and service revenue $455 $404 $322Cost of product revenue 131 182 264Total included in cost of revenue 586 586 586Included in operating expenses: Sales and marketing 1,860 2,178 2,804Research and development 1,393 1,587 1,802General and administrative — — —Total included in operating expenses 3,253 3,765 4,606Total $3,839 $4,351 $5,192The following table summarizes the estimated future amortization expense related to intangible assets as of December 31, 2017 (in thousands):F-22Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)6. INTANGIBLE ASSETS (Continued) As ofDecember 31, 20172018 $3,3352019 1,5322020 1,2822021 9402022 940Thereafter 548Total $8,577The Company evaluates its indefinite-lived intangible assets annually as of December 31 for indicators of impairment. The Company also routinelyreviews indefinite-lived intangible assets and long-lived intangible assets for potential impairment as part of the Company’s internal control framework.The Company performed its annual indefinite-lived intangible asset impairment test on the Rosetta Stone tradename as of December 31, 2017 todetermine if indicators of impairment exist. The Company elected to first assess qualitative factors to determine whether it is more likely than not that theRosetta Stone trade name was impaired. Additionally, all other long-lived intangible assets were evaluated at December 31, 2017 to determine if indicators ofimpairment exist. As a result of these assessments, there were no indicators of impairment for the year ended December 31, 2017.2016 ActivityDuring 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.7. OTHER CURRENT LIABILITIESThe following table summarizes other current liabilities (in thousands): As ofDecember 31, 2017 2016Accrued marketing expenses $5,316 $8,460Accrued professional and consulting fees 1,609 2,050Sales return reserve 1,176 1,338Sales, withholding, and property taxes payable 3,616 3,772Other 4,737 6,530Total Other current liabilities $16,454 $22,1508. DIVESTITURESOn March 13, 2017, the Company entered into a Product and Intellectual Property Agreement, (the "PIPA") with SOURCENEXT Corporation,("SOURCENEXT"), a leading software distributor and developer in Japan. Under the PIPA, the Company provided a perpetual, exclusive license of certainbrands and trademarks, including the primary Rosetta Stone brand, and product code for exclusive development and sale of language and education-relatedproducts in Japan. In conjunction with the PIPA, the Company received approximately $9.0 million on March 13, 2017, and another $2.0 million on June 19,2017. In addition, the Company is guaranteed to receive minimum payments totaling an additional $6.0 million over the next ten years.F-23Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)8. DIVESTITURES (Continued)Finally, as part of the PIPA, the Company will have the first right to license and sell any products developed by SOURCENEXT under the Rosetta Stonetrademark in territories outside of Japan.On April 25, 2017, the Company and SOURCENEXT signed a Stock Purchase Agreement ("SPA") for the sale of the Company's Japanese subsidiary("RST Japan") and certain other assets related to the language market in Japan. The Company received $0.5 million associated with the SPA closure on June29, 2017 when 100% of the Company's capital stock of RST Japan and the other assets related to the language market in Japan were transferred toSOURCENEXT.The SPA and the PIPA were considered related and viewed as a multiple element arrangement. Of the nearly $11.5 million that was received under theterms of the PIPA and SPA, approximately $11.4 million was allocated to deferred revenue to be recognized over an estimated 20-year period. As thiscustomer relationship progresses, the Company may prospectively reassess the 20-year recognition period as needed. Approximately $0.1 million wasallocated to RST Japan and the other assets related to the language market in Japan and was included in the gain calculation. At the time of closing, RSTJapan was in a net liability position. The sale under the terms of the SPA resulted in a pre-tax gain of $0.4 million, reported in "Other income and (expense)"on the consolidated statement of operations. This gain was comprised of a gain of $0.5 million related to the sale of RST Japan and the other assets related tothe language market in Japan, partially offset by a $0.1 million loss on the transfer of the foreign subsidiary's cumulative translation adjustment on the date ofsale.In the third quarter of 2017, the PIPA was amended to provide SOURCENEXT with a two-year time-based license to the Company's speech recognitionengine ("SRE") and software development kit ("SDK") in exchange for the acceleration of $1.5 million of future cash receipts under the PIPA. The $1.5million associated with the amendment to the PIPA was collected and will be recognized as revenue ratably over the remaining life of the agreement.9. FINANCING ARRANGEMENTSCredit FacilityOn 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”). Since the original date of execution,the Company and the Bank have executed several amendments to the credit facility to reflect updates to the Company's financial outlook and extend thecredit facility.Under the amended agreement, the Company may borrow up to $25.0 million, including a sub-facility, which reduces available borrowings, for lettersof credit in the aggregate availability amount of $4.0 million. Borrowings by RSL under the credit facility are guaranteed by the Company as the ultimateparent. The credit facility has a term that expires on April 1, 2020, during which time RSL may borrow and re-pay loan amounts and re-borrow the loanamounts 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 accrues at the Prime Rate provided that the Company maintains aminimum cash and Availability balance of $17.5 million. If cash and Availability is below $17.5 million, interest will accrue at the Prime Rate plus 1%.Proceeds of loans made under the credit facility may be used as working capital or to fund general business requirements. All obligations under thecredit facility, including letters of credit, are secured by a security interest on substantially all of the Company’s assets including intellectual property rightsand by a stock pledge by the Company of 100% of its ownership interests in U.S. subsidiaries and 66% of its ownership interests in certain foreignsubsidiaries.The credit facility contains customary affirmative and negative covenants, including covenants that limit or restrict the 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, 2017, the Company was in compliance with all covenants.F-24Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)9. FINANCING ARRANGEMENTS (Continued)The credit facility contains customary events of default, including among others, non-payment defaults, covenant defaults, bankruptcy and insolvencydefaults, and a change of control default, in each case, subject to customary exceptions. The occurrence of a default event could result in the Bank’sacceleration of repayment obligations of any loan amounts then outstanding.As of December 31, 2017, there were no borrowings outstanding and the Company was eligible to borrow $15.1 million of available credit, less $4.0million in letters of credit that have been issued by the Bank on the Company's behalf, resulting in a net borrowing availability of $11.1 million. A quarterlycommitment 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, 2017, 2016, and 2015, the Company acquired equipment or software through the issuance of capital leasestotaling zero, $27 thousand and $0.5 million, respectively. This non-cash investing activity has been excluded from the consolidated statement of cash flows.As of December 31, 2017, the future minimum payments under capital leases with initial terms of one year or more are as follows (in thousands):Periods Ending December 31, 2018 $5482019 5452020 5402021 5372022 402Thereafter —Total minimum lease payments $2,572Less amount representing interest 272Present value of net minimum lease payments $2,300Less current portion 450Obligations under capital lease, long-term $1,85010. STOCK-BASED COMPENSATION2006 Stock Incentive PlanOn January 4, 2006, the Company established the Rosetta Stone Inc. 2006 Stock Incentive Plan (the "2006 Plan") under which the Company's Board ofDirectors, at its discretion, could grant stock options to employees and certain directors of the Company and affiliated entities. The 2006 Plan initiallyauthorized the grant of stock options for up to 1,942,200 shares of common stock. On May 28, 2008, the Board of Directors authorized the grant of additionalstock options for up to 195,000 shares of common stock under the plan, resulting in total stock options available for grant under the 2006 Plan of 2,137,200as of December 31, 2008. The stock options granted under the 2006 Plan generally expire at the earlier of a specified period after termination of service or thedate specified by the Board or its designated committee at the date of grant, but not more than ten years from such grant date. Stock issued as a result ofexercises of stock options will be issued from the Company's authorized available stock. All unissued stock associated with the 2006 Stock Incentive Planexpired 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 includingF-25Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)10. STOCK-BASED COMPENSATION (Continued)Incentive and Nonqualified Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units, Performance Units, Performance Shares,Performance based Restricted Stock, Share Awards, Phantom Stock and Cash Incentive Awards. Restricted stock awards are considered outstanding at thetime of grant as the stockholder is entitled to voting rights and to receive any dividends declared subject to the loss of the right to receive accumulateddividends if the award is forfeited prior to vesting. Unvested restricted stock awards are not considered outstanding in the computation of basic earnings pershare. The stock incentive awards and options granted under the 2009 Plan generally expire at the earlier of a specified period after termination of service orthe 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 theapproval of the 2009 Plan, the 2006 Plan was terminated for purposes of future grants. Since the establishment of the 2009 Plan, the Board of Directorsauthorized and the Company's shareholders' approved the allocation of additional shares of common stock to the 2009 Plan as follows:Authorization Dates of 2009 Plan Additions Number of Common Stock Shares Authorized to 2009 PlanFebruary 27, 2009 2,437,744May 26, 2011 1,000,000May 23, 2012 1,122,930May 23, 2013 2,317,000May 20, 2014 500,000June 12, 2015 1,200,000May 27, 2017 1,900,000At December 31, 2017 there were 2,206,689 shares available for future grant under the 2009 Plan.Valuation AssumptionsThe determination of fair value of stock-based awards is affected by assumptions regarding subjective and complex variables. Generally, assumptionsare based on historical information and judgment is required to determine if historical trends may be indicators of future outcomes. In accordance with ASC718, the fair value of stock-based awards to employees is calculated as of the date of grant. Compensation expense is then recognized over the requisiteservice period of the award. Stock-based compensation expense recognized is based on the estimated portion of the awards that are expected to vest.Estimated forfeiture rates are applied in the expense calculation. The Company determines the fair values of stock-based awards as follows:•Service-Based Restricted Stock Awards, Restricted Stock Units, Performance-Based Restricted Stock Awards, and Performance-Based Share Units:Fair value is determined based on the quoted market price of 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 is determined using a Monte-Carlo simulation model. TheMonte Carlo valuation also estimates the quantity that would be awarded which is reflected in the fair value on the grant date.For the years ended December 31, 2017, 2016, and 2015 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, 2017 2016 2015Expected stock price volatility 42%-45% 46%-47% 49%-63%Expected term of options 6 years 5.5-6.5 years 6 yearsExpected dividend yield — — —Risk-free interest rate 1.92%-2.05% 1.24%-1.50% 1.19%-1.75%F-26Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)10. STOCK-BASED COMPENSATION (Continued)For the years ended December 31, 2017, 2016, and 2015 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, 2017 2016 2015Expected stock price volatility none 45%-49% noneExpected term of options none 1.7 years-7 years noneExpected dividend yield none — noneRisk-free interest rate none .71%-1.53% 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. Changes in the probability estimates associated with performance-based awards 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 theperformance-based award is reversed. For equity awards granted with market-based conditions, stock compensation is recognized in the statement ofoperations ratably for each vesting 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, 2017 2016 2015Included in cost of revenue: Cost of subscription and service revenue $15 $(4) $44Cost of product revenue 54 52 57Total included in cost of revenue 69 48 101Included in operating expenses: Sales and marketing 561 998 1,327Research & development 255 709 841General and administrative 3,256 3,151 4,926Total included in operating expenses 4,072 4,858 7,094Total $4,141 $4,906 $7,195F-27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, 2017 and 2016, respectively: Nonvested Outstanding Weighted Average GrantDate Fair Value Aggregate IntrinsicValueNonvested Awards, January 1, 2016 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 3,348,080Awards granted 291,406 7.92 Awards vested (163,027) 9.84 Awards canceled (71,641) 8.03 Nonvested Awards, December 31, 2017 431,118 8.07 3,477,484During 2017 and 2016, 291,406 and 300,650 shares of service-based restricted stock were granted, respectively. The aggregate grant date fair value ofthe service-based restricted stock awards in 2017 and 2016 was $2.3 million and $2.3 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. Service-based restricted stock awards are granted at thediscretion of the Board of Directors or the Compensation Committee (or its authorized member(s)) and generally vest over a four-year period based uponrequired service conditions and do not have performance or market conditions. The Company's service-based restricted stock awards are accounted for asequity awards. The grant date fair value is based on the market price of the Company's common stock at the date of grant. The Company did not grant anyrestricted stock prior to April 2009.During 2017, 71,641 shares of restricted stock were forfeited. As of December 31, 2017 and 2016, future compensation cost, net of forfeitures, related tothe non-vested portion of the service-based restricted stock awards not yet recognized in the statement of operations was $2.2 million and $2.6 million and isexpected to be recognized over a period of 2.25 years and 2.06 years, respectively.Service-Based Stock OptionsThe following table summarizes the Company's service-based stock option activity from January 1, 2017 to December 31, 2017: OptionsOutstanding WeightedAverageExercisePrice WeightedAverageContractualLife (years) AggregateIntrinsicValueOptions Outstanding, January 1, 2017 1,793,930 $9.81 7.58 $1,154,498Options granted 55,610 11.24 Options exercised (79,365) 8.52 Options cancelled (141,464) 11.10 Options Outstanding, December 31, 2017 1,628,711 9.81 6.79 5,203,196Vested and expected to vest at December 31, 2017 1,594,473 9.86 6.77 5,044,582Exercisable at December 31, 2017 1,250,476 $10.19 6.47 $3,733,000As of December 31, 2017 and 2016, there was approximately $1.3 million and $3.1 million of unrecognized compensation expense, net of estimatedforfeitures, related to non-vested service-based stock options that is expected to be recognized over a weighted average period of 1.60 and 2.36 years,respectively.F-28Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)10. STOCK-BASED COMPENSATION (Continued)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 grant-date fair value per share of service-based stock options granted was $5.02 and $3.41for the years ended December 31, 2017 and 2016, 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, 2017, 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, 2017. This amount is subject to change based on changes tothe fair market value of the Company's common stock.Restricted Stock UnitsThe following table summarizes the Company's restricted stock unit activity from January 1, 2017 to December 31, 2017: Units Outstanding WeightedAverageGrant Date Fair Value AggregateIntrinsicValueUnits Outstanding, January 1, 2017 188,057 $9.93 $1,675,588Units granted 46,601 11.23 Units released — — Units cancelled — — Units Outstanding, December 31, 2017 234,658 10.19 2,926,185Vested and expected to vest at December 31, 2017 126,166 11.10 1,573,286Vested and deferred at December 31, 2017 100,754 $11.79 $1,256,402During 2017 and 2016, 46,601 and 67,663 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 2017 and 2016 was $0.5 million and $0.5 million, respectively. All restricted stock unit awards vest quarterly over a one year periodfrom the date of grant, with expense recognized straight-line over the vesting period. The Company's restricted stock units are accounted 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 did not grant any restricted stockunits prior to April 2009.Performance-Based Restricted Stock UnitsOn March 17, 2017, the Company granted performance-based restricted stock units ("PSUs") to certain employees which will become eligible to vestbased on the Company's achievement of certain pre-defined key operating performance goals during the cumulative period from January 1, 2017 toDecember 31, 2018, which will be certified by the Compensation Committee in February 2019. Any PSUs that become eligible to vest are subject toadditional service requirements where the eligible PSUs will vest annually on a pro-rata basis over the two-year period beginning March 17, 2019. The PSUswere granted at "target" (at 100% of target). Based upon actual attainment of the operating performance results relative to target and the recipient's terms,actual issuance of PSUs can be eligible for vest anywhere between a maximum of 200% and 0% of the target number of PSUs originally granted.F-29Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)10. STOCK-BASED COMPENSATION (Continued)The following table summarizes the Company's PSU activity from January 1, 2017 to December 31, 2017: PSUs WeightedAverageGrant DateFair Value AggregateIntrinsicValueNon-vested PSUs, January 1, 2017 — $— $—PSUs granted 462,870 9.43 PSUs vested — — PSUs canceled (29,282) 9.43 Non-vested PSUs, December 31, 2017 433,588 $9.43 $5,406,842As of December 31, 2017, future compensation cost, net of estimated forfeitures, related to the non-vested portion of the PSUs not yet recognized in theconsolidated statement of operations was $1.0 million and is expected to be recognized over a weighted average period of 1.5 years.CEO 2016 Performance and Market Conditioned Restricted Stock Awards and Stock Options GrantsOn 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 stockholder value. The package was comprised of 70,423 performance-based restrictedstock awards (PRSAs), 314,465 performance-based stock options (PSOs), 70,423 market-based restricted stock awards (MRSAs), and 314,465 market-basedstock options (MSOs). The April 4, 2016 grant date fair values associated with these grants were $7.10, $3.24, $6.17 and $0.94, respectively.PRSAs and PSOs were eligible to vest based on the achievement of certain operating performance targets during the 2016 calendar year, related todefined measures of revenue, sales, adjusted free cash flow, and adjusted EBITDA, certified by the Compensation Committee in the first quarter of 2017. ThePRSAs and PSOs are subject to additional service requirements where the eligible PRSAs and PSOs will vest 50%, 25%, and 25% on April 4, 2017, 2018 and2019, respectively. Awards also vest if a majority change in control of the Company occurs during the performance or vesting period.On February 20, 2017, the Compensation Committee approved 64,719 PRSAs and 144,497 PSOs as eligible under this plan, subject to theaforementioned service vesting requirements. The non-eligible 5,704 and 169,968 PRSAs and PSOs, respectively, were cancelled as of February 20, 2017. Asof December 31, 2017, 32,359 PRSAs were vested and 72,248 PSOs were vested. As of December 31, 2017, no PSOs have been exercised. As of December 31,2017 and 2016, future compensation cost related to the non-vested portion of the PRSAs and PSOs not yet recognized in the consolidated statement ofoperations was $0.1 million and $0.5 million and is expected to be recognized over a weighted average period of 1.09 years and 1.69 years, respectively.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 stockholder return for the two-year measurement period beginning on January 4, 2016and ending on December 29, 2017. Following the end of the market performance measurement period on December 29, 2017, the Compensation Committeewill certify the eligible quantity of MRSAs and MSOs which will vest annually on a pro-rata basis over three years beginning April 4, 2018. The Companyrecords compensation expense ratably for 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 the market conditions.The MRSAs were granted at "target" (at 100% of target). Based upon actual attainment of total stockholder return growth rate results through December29, 2017 relative to target, actual issuance of MRSAs can fall anywhere between a maximum of 200% and 0% of the target number of MRSAs originallygranted. The MSOs were granted at "maximum" (at 200% of target). Based on actual attainment of total stockholder return growth rate results throughDecember 29, 2017 relative to maximum, actual issuance of stock options can fall anywhere between 100% and 0% of the maximum number of MSOsoriginally granted.As of December 31, 2017 and 2016, future compensation cost related to the non-vested portion of the MRSAs and MSOs not yet recognized in theconsolidated statement of operations was $0.3 million and $0.5 million and is expected to be recognized over a weighted average period of 1.79 years and2.56 years, respectively.F-30Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)11. STOCKHOLDERS' EQUITY (DEFICIT)At December 31, 2017, 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, 2017 and 2016, the Company had shares of Common Stock issued of 23,782,773 and 23,450,864, respectively, and shares of Common Stockoutstanding of 22,782,773 and 22,450,864, 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, 2016, or 2017. Shares repurchased under the program were recorded as treasurystock on the Company’s consolidated balance sheet. The shares repurchased under this program during the year ended December 31, 2013 were not the resultof an accelerated share repurchase agreement. Management has not made a decision on whether shares purchased under this program will be retired orreissued.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. BASIC AND DILUTED NET LOSS PER SHAREThe following table sets forth the computation of basic and diluted net loss per common share: Years Ended December 31, 2017 2016 2015 (dollars in thousands, except per share amounts)Numerator: Net loss $(1,546) $(27,550) $(46,796)Denominator: Basic weighted average shares 22,244 21,969 21,571Diluted weighted average shares 22,244 21,969 21,571Loss per share: Basic $(0.07) $(1.25) $(2.17)Diluted $(0.07) $(1.25) $(2.17)The Company calculates dilutive common stock equivalent shares using the treasury stock method. In periods where the Company has a net loss, nodilutive common stock equivalent shares are included in the calculation for diluted shares as they are considered anti-dilutive. The following table sets forththe dilutive common stock equivalent shares calculated using the treasury stock method (in thousands).F-31Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)12. BASIC AND DILUTED NET LOSS PER SHARE (Continued) Years Ended December 31, 2017 2016 2015 (in thousands)Stock options 231 16 35Restricted stock units 209 174 39Restricted stocks 296 129 82Total common stock equivalent shares 736 319 156Share-based awards to purchase approximately 0.7 million, 2.0 million and 2.2 million shares of common stock that had an exercise price in excess ofthe average market price of the common stock during the years ended December 31, 2017, 2016 and 2015, respectively, were not included in the calculationof diluted loss per share because they were anti-dilutive.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 E&E Language offerings. The Company does not expect to incur any additional materialrestructuring costs in connection with the 2016 Restructuring Plan. The 2016 Restructuring Plan remaining balance is expected to be paid in early 2018.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 tables summarize activity with respect to the restructuring charges for the 2016 Restructuring Plan during the years ended December 31,2017 and 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 Balance at January 1,2017 Cost Incurred Cash Payments Other Adjustments (1) Balance at December 31,2017Severance costs $500 $(50) $(303) $— $147Contract termination costs 22 — (22) — —Other costs 70 14 (84) — —Total $592 $(36) $(409) $— $147(1) Other Adjustments includes non-cash period changes in the liability balance, which may include non-cash lease closure expense and foreigncurrency translation adjustments.F-32Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)13. RESTRUCTURING AND OTHER EMPLOYEE SEVERANCE (Continued)2015 Restructuring ActionsIn 2015, the Company announced and initiated actions to reduce headcount and other costs in order to support its strategic shift in business focus.During 2016, the final costs were incurred and final payments were made against the 2015 Restructuring Plan accruals. The Company does not expect toincur any additional restructuring costs in connection with the 2015 Plan.Other Employee Severance ActionsIn the first quarter of 2017, the Company initiated actions to reduce headcount in its Fit Brains business and in the U.S. and China locations withinconsumer product operations. Primarily comprised of severance costs associated with these actions, the Company recorded expense of $1.2 million. Of theseamounts, $1.1 million has been paid and the remaining $0.1 million is expected to be paid in the first half of 2018.Cost TableThe following table summarizes the major types of costs associated with the 2016 and 2015 Restructuring Plans and other employee severance actionsfor the years ended December 31, 2017, 2016, and 2015 and total costs incurred through December 31, 2017 (in thousands): Years endedDecember 31, Incurred through 2017 2016 2015 December 31, 2017Severance costs $1,144 $4,438 $7,240 $12,822Contract termination costs 37 165 1,134 1,336Other costs 26 590 417 1,033Total $1,207 $5,193 $8,791 $15,191As of December 31, 2017, the entire restructuring and other employee severance action liability of $0.3 million was classified as a current liabilitywithin accrued compensation and other current liabilities on the consolidated balance sheets.The following table presents restructuring costs associated with the 2016 and 2015 Restructuring Plans and other employee severance actions includedin the related line items of the Statement of Operations (in thousands): Years endedDecember 31, 2017 2016 2015Cost of revenue $378 $573 $113Sales and marketing 411 2,324 4,492Research and development 318 913 602General and administrative 100 1,383 3,584Total $1,207 $5,193 $8,791These restructuring expenses are not allocated to any reportable segment under the Company's definition of segment contribution as defined in Note 19"Segment Information."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.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 costsF-33Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)14. LEASE ABANDONMENT AND TERMINATION (Continued)in accordance with ASC 420, Exit or Disposal Cost Obligations ("ASC 420"), as the Company has no future economic benefit from the abandoned space andthe lease does not terminate until December 31, 2018. All leased space related to the 6th floor was abandoned and ceased to be used by the Company onJanuary 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, 2017 and 2016 is as follows (in thousands): As of December 31, 2017 2016Accrued lease abandonment costs, beginning of period $2,123 $1,282Costs incurred and charged to expense — 1,644Principal reductions (1,042) (803)Accrued lease abandonment costs, end of period $1,081 $2,123Accrued lease abandonment costs liability: Short-term $1,081 $1,047Long-term — 1,076Total $1,081 $2,12315. INCOME TAXESNew tax legislation, commonly referred to as the Tax Cuts and Jobs Act ("Tax Reform"), was enacted on December 22, 2017. ASC 740, Accounting forIncome Taxes, requires companies to recognize the effect of tax law changes in the period of enactment even though the effective date for most provisions isfor tax years beginning after December 31, 2017, or in the case of certain other provisions, January 1, 2018.Given the significance of the Tax Reform, the SEC staff issued Staff Accounting Bulletin No. 118 (SAB 118), which allows registrants to recordprovisional amounts during a one year “measurement period” similar to that used when accounting for business combinations. However, the measurementperiod is deemed to have ended earlier when the registrant has obtained, prepared and analyzed the information necessary to finalize its accounting. Duringthe measurement period, impacts of the Tax Reform law are expected to be recorded at the time a reasonable estimate for all or a portion of the effects can bemade, and provisional amounts can be recognized and adjusted as information becomes available, prepared or analyzed.SAB 118 summarizes the process to be applied at each reporting period to account for and qualitatively disclose: (1) the effects of the change in tax lawfor which accounting is complete; (2) provisional amounts (or adjustments to provisional amounts) for the effects of the tax law where accounting is notcomplete, but that a reasonable estimate has been determined; and (3) a reasonable estimate cannot yet be made and therefore taxes are reflected inaccordance with law prior to the enactment of the Tax Reform.Amounts recorded in the period ended December 31,2017, principally relate to the reduction in the U.S. corporate income tax rate from 35% to 21%,which resulted in the Company reporting an income tax benefit of $2.4 million to remeasure deferred tax liabilities associated with indefinite-livedintangible assets that will reverse at the new 21% rate. Absent this deferred tax liability, the Company is in a net deferred tax asset position that is offset by afull valuation allowance. Though the impact of the rate change has a net tax effect of zero, the accounting to determine the gross change in the deferred taxposition and the offsetting valuation resulted in a $26.3 million reduction in both. Under the Tax Reform, deferred tax assets scheduled to reverse in subsequent years will result in net operating losses with an unlimited carryforward.The change in the carryforward period to post-2017 net operating losses allowed the Company to release valuation allowance associated with the reversingdeferred tax assets to offset 80% of the deferred tax liability associated with indefinitely lived intangible asset. The release of valuation allowance resulted inthe Company reporting anF-34Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)15. INCOME TAXES (Continued)income tax benefit of $3.1 million.The Tax Reform includes a one-time mandatory repatriation transition tax on the net accumulated earnings and profits of a U.S. taxpayer’s foreignsubsidiaries.The final impact of Tax Reform may differ from these estimates, due to, among other things, changes in interpretations, additional guidance that may beissued by the Internal Revenue Service or state and local authorities, and any updates or changes to estimates the Company has utilized to calculate thetransition impact. Therefore, the Company's accounting for the elements of Tax Reform is incomplete. However, the Company was able to make reasonableestimates of the effects of Tax Reform. The Company will complete the accounting for these items during 2018, after completion of the 2017 U.S. income taxreturn.Other significant Tax Reform provisions that are not yet effective but may impact income taxes in future years include: an exemption from U.S. tax ondividends of future foreign earnings, a limitation of net operating losses generated after 2017 to 80% of taxable income, the inclusion of commissions andperformance based compensation in determining the excess compensation limitation, and a minimum tax on certain foreign earnings in excess of 10% of theforeign subsidiaries tangible assets (i.e., global intangible low-taxed income or GILTI). The Company is still evaluating its policy election to treat the GILTItax as a period expense or to provide U.S. deferred taxes on foreign temporary differences that are expected to generate GILTI income when they reverse infuture years.The following table summarizes the significant components of the Company's deferred tax assets and liabilities as of December 31, 2017 and 2016 (inthousands): As ofDecember 31, 2017 2016Deferred tax assets: Inventory $847 $735Net operating and capital loss carryforwards 46,683 61,174Deferred revenue 11,534 10,862Accrued liabilities 4,064 6,975Stock-based compensation 3,790 4,440Amortization and depreciation 773 1,056Bad debt reserve 90 389Foreign and other tax credits 2,047 1,881Gross deferred tax assets 69,828 87,512Valuation allowance (60,302) (78,363)Net deferred tax assets 9,526 9,149Deferred tax liabilities: Goodwill and indefinite lived intangibles (5,033) (6,098)Deferred sales commissions (4,996) (7,060)Prepaid expenses (619) (656)Foreign currency translation (846) (1,508)Gross deferred tax liabilities (11,494) (15,322)Net deferred tax liabilities $(1,968) $(6,173)For the year ended December 31, 2017, the Company recorded an income tax benefit of $2.5 million. The tax benefit primarily related to the reductionin the corporate tax rate from 35% to 21% which resulted in a tax benefit of $5.5 million, offset by current year profits of operations in Canada, Germany, andthe U.K. Additionally, the tax expense relates to the tax impact of the amortization of U.S. indefinite-lived intangible assets and the inability to recognize taxbenefits associated with current year losses of operations in certain foreign jurisdictions and in the U.S.F-35Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)15. INCOME TAXES (Continued)For the year ending December 31, 2016, the Company recorded income tax expense of $2.5 million. The tax expense was primarily related to currentyear profits in 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.As of December 31, 2017, a full valuation allowance was provided for domestic and certain foreign deferred tax assets in those jurisdictions where theCompany has determined the deferred tax assets will more likely than not be realized. If future events change the outcome of the Company's projected returnto profitability, a valuation allowance may not be required to reduce the deferred tax assets. The Company will continue to assess the need for a valuationallowance.As of December 31, 2017, 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 Spain Mexico Total2018-2022 $— $409 $— $— $— $— $4092023-2027 — 5,458 — — — 377 5,8352028-2032 471 17,784 — — — — 18,2552033-2037 125,759 108,086 — — 4 — 233,8492038-2042 3,234 2,702 — — — — 5,936Indefinite — — 4,160 7,673 697 — 12,530Totals $129,464 $134,439 $4,160 $7,673 $701 $377 $276,814As of December 31, 2017, 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 State2018-2022 $6,837 $2,3512023-2027 15,135 14,9902028-2032 — 1642033-2037 — 3622038-2042 — —Indefinite — —Totals $21,972 $17,867As of December 31, 2017, the Company had federal tax credit carryforward amounts and expiration periods as follows (in thousands):Year of Tax Credit Expiration U.S. Federal2018-2022 $—2023-2027 1,6382028-2032 1662033-2037 2182038-2042 —Indefinite 26Totals $2,048F-36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, 2017 2016 2015United States $(12,648) $(24,963) $(41,458)Foreign 8,603 (84) (4,179)Loss before income taxes $(4,045) $(25,047) $(45,637)The provision for taxes on income consists of the following (in thousands): Federal $— $— $(157)State (21) 78 96Foreign 1,701 1,250 444Total current $1,680 $1,328 $383Deferred: Federal $(4,541) $1,147 $1,148State 335 169 169Foreign 27 (141) (541)Total deferred (4,179) 1,175 776(Benefit) provision for income taxes $(2,499) $2,503 $1,159Reconciliation of income tax (benefit) provision computed at the U.S. federal statutory rate to income tax (benefit) expense is as follows (in thousands): Years Ended December 31, 2017 2016 2015Income tax benefit at statutory federal rate $(1,416) $(8,766) $(15,973)Remeasurement of deferred tax liability related to indefinite-lived intangible dueto U.S. rate reduction, effective January 1, 2018 (2,586) — —Release of valuation allowance due to change in U.S. net operating loss carryforward period (3,103) — —Shortfall in tax benefit - stock compensation 233 — —State income tax expense, net of federal income tax effect 314 219 231Tax capital loss in excess of book loss on sale of Japan subsidiary (5,297) — —Nondeductible goodwill impairment — 604 1,961Other nondeductible expenses 398 384 88Tax rate differential on foreign operations (816) (474) (1,019)Increase in valuation allowance 9,446 10,404 15,713Tax audit settlements — — (96)Change in prior year estimates 150 — 225Other tax credits 173 129 29Other 5 3 —Income tax (benefit) expense $(2,499) $2,503 $1,159The 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.F-37Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)15. INCOME TAXES (Continued)The Company recognizes interest and penalties related to unrecognized tax benefits as a component of income tax expense (benefit). As ofDecember 31, 2017 and 2016, the Company had no unrecognized tax benefits or interest and penalties.The Company is subject to taxation in the U.S. and various states and foreign jurisdictions. The Company's tax years 2011 and forward are subject toexamination by the tax authorities.Prior to the fourth quarter of 2017, the Company asserted that the unremitted earnings of its foreign subsidiaries with unremitted earnings were deemedindefinitely reinvested. As the Company is in an aggregate net foreign deficit position for U.S. tax purposes, the Company is not liable for the transition taxenacted as part of the Tax Reform. As such, all prior earnings of the foreign subsidiaries with unremitted earnings are deemed to be previously taxed incomefor U.S. tax purposes as of December 31, 2017. The Company's assessment is provisional and we continue to assess the impact of the transition tax onunremitted earnings and its impact to the Company's outside basis. The Company made income tax payments of $2.2 million, $0.8 million, and $1.4 million, in 2017, 2016 and 2015, 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.The following table summarizes future minimum operating lease payments as of December 31, 2017 and the years thereafter (in thousands): As ofDecember 31,2017Periods Ending December 31, 2018 $4,4192019 1,7422020 1,0042021 5902022 —Thereafter —Total future minimum operating lease payments $7,755Total expenses under operating leases were $2.6 million, $4.0 million and $5.1 million during the years ended December 31, 2017, 2016 and 2015,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. TheCompanyF-38Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)16. COMMITMENTS AND CONTINGENCIES (Continued)expenses these amounts to cost of sales or research and development expense, as appropriate. Royalty expense was $1.0 million, $0.3 million, and $0.2million for the years ended December 31 2017, 2016 and 2015, 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. 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 $2.1 million, $2.0 million, and $2.0 million for theyears ended December 31, 2017, 2016 and 2015, respectively.18. RELATED PARTIESAs of December 31, 2017 and 2016, the Company had outstanding receivables from employees in the amount of $0.1 million and $22,000,respectively.19. SEGMENT INFORMATIONThe Literacy segment derives the majority of its revenue from the sales of literacy solutions to educational institutions serving grades K through 12.The E&E Language segment derives revenue from sales of language-learning solutions to educational institutions, corporations, and government agenciesworldwide. The Consumer Language segment derives the majority of its revenue from sales of language-learning solutions to individuals and retail partners.Revenue from transactions between the Company's operating segments is not material. The Company's current operating segments also represent theCompany's reportable segments.The Company and its Chief Operating Decision Maker ("CODM") assess profitability and performance of each of its current operating segments interms of segment contribution. Segment contribution is calculated as segment revenue less expenses directly incurred by or allocated to the segment. Directsegment expenses include costs and expenses that are directly incurred by or allocated to the segment and include materials costs, service costs, customercare and coaching costs, sales and marketing expenses, and bad debt expense. In addition to the previously referenced expenses, the Literacy segmentincludes direct research and development expenses and Combined Language includes shared research and development expenses, cost of revenue, and salesand marketing expenses applicable to the Consumer Language and E&E Language segments. Segment contribution excludes depreciation, amortization,stock compensation, restructuring and other related expenses. The Company does not allocate expenses beneficial to all segments, which include certaingeneral and administrative expenses such as legal fees, payroll processing fees, accounting related expenses, lease abandonment, impairment, and non-operating income and expense. These expenses are included below the segment contribution line in the unallocated expenses section of the tables presentedbelow.Beginning on January 1, 2017, the Company modified its definition and presentation of segment contribution. E&E Language segment and ConsumerLanguage segment are now characterized as "Language" since both of these segments primarily address the language-learning market and share many of thesame costs. These shared language costs are included in the "Shared Services" column of the tables presented below. General and administrative expensesdirectly incurred by the Language segments consist only of bad debt expense, net of recoveries. Additionally, research and developments expenses are nowincluded in segment contribution. Further, the depreciation, amortization, stock compensation, restructuring and other related expenses which are included incost of revenue, sales and marketing, research and development, and general and administrative are presented in total as unallocated costs. Prior periods havebeen reclassified to reflect the current segment presentation and definition of segment contribution. The Company will continue to evaluate its managementreporting and will update its operating and reportable segments as appropriate.F-39Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)19. SEGMENT INFORMATION (Continued)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 year ended December 31, 2017 was as follows (in thousands, except percentages): Language LiteracySegment E&E LanguageSegment ConsumerLanguageSegment Shared Services CombinedLanguage Total Company Revenue $43,608 $65,267 $75,718 $— $140,985 $184,593 Cost of revenue 6,924 7,149 13,485 50 20,684 $27,608Sales and marketing 23,369 31,089 37,366 1,459 69,914 $93,283Research and development 6,479 — — 15,860 15,860 $22,339General and administrative 1,872 132 18 — 150 $2,022Segment contribution $4,964 $26,897 $24,849 $(17,369) $34,377 $39,341Segment contribution margin % 11.4% 41.2% 32.8% Unallocated depreciation and amortization,stock compensation, restructuring and otherexpenses (net) included in: Cost of revenue 6,013Sales and marketing 3,377Research and development 2,408General and administrative 6,348Subtotal 18,146 Corporate unallocated expenses, net: Unallocated general and administrative 25,696Unallocated lease abandonment expense (456)Subtotal 25,240 Loss before income taxes $(4,045)F-40Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)19. SEGMENT INFORMATION (Continued)Operating results by segment for the year ended December 31, 2016 was as follows (in thousands, except percentages): Language LiteracySegment E&E LanguageSegment ConsumerLanguageSegment Shared Services CombinedLanguage Total Company Revenue $34,123 $72,083 $87,883 $— $159,966 $194,089 Cost of revenue 4,753 9,245 14,698 (17) 23,926 $28,679Sales and marketing 21,650 33,441 51,508 1,902 86,851 $108,501Research and development 4,111 — — 18,874 18,874 $22,985General and administrative 2,077 315 175 — 490 $2,567Segment contribution $1,532 $29,082 $21,502 $(20,759) $29,825 $31,357Segment contribution margin % 4.5% 40.3% 24.5% Unallocated depreciation and amortization,stock compensation, restructuring and otherexpenses (net) included in: Cost of revenue 5,642Sales and marketing 5,839Research and development 3,288General and administrative 10,935Subtotal 25,704 Corporate unallocated expenses, net: Unallocated general and administrative 26,999Unallocated lease abandonment expense (1,873)Unallocated impairment 3,930Unallocated non-operating income 1,644Subtotal 30,700 Loss before income taxes $(25,047)F-41Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)19. SEGMENT INFORMATION (Continued)Operating results by segment for the year ended December 31, 2015 was as follows (in thousands, except percentages): Language Literacy Segment E&E LanguageSegment ConsumerLanguageSegment Shared Services CombinedLanguage Total Company Revenue $21,928 $76,129 $119,613 $— $195,742 $217,670 Cost of revenue 2,574 12,124 20,792 (19) 32,897 $35,471Sales and marketing 16,628 40,829 66,839 3,661 111,329 $127,957Research and development 4,542 — — 22,101 22,101 $26,643General and administrative 1,647 400 1,244 — 1,644 $3,291Segment contribution $(3,463) $22,776 $30,738 $(25,743) $27,771 $24,308Segment contribution margin % (15.8)% 29.9% 25.7% Unallocated depreciation and amortization,stock compensation, restructuring and otherexpenses (net) included in: Cost of revenue 3,056Sales and marketing 8,127Research and development 3,296General and administrative 15,565Subtotal 30,044 Corporate unallocated expenses, net: Unallocated general and administrative 31,268Unallocated lease abandonment expense 1,824Unallocated impairment 6,754Unallocated non-operating income 55Subtotal 39,901 Loss before income taxes $(45,637)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, 2017, 2016 and 2015, respectively (in thousands): Years Ended December 31, 2017 2016 2015United States $158,825 $162,815 $177,966International 25,768 31,274 39,704Total revenue $184,593 $194,089 $217,670F-42Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)19. SEGMENT INFORMATION (Continued)The information below summarizes long-lived assets by geographic area classified as held and used for the years ended December 31, 2017 and 2016,respectively (in thousands): As of December 31, 2017 2016United States $27,647 $21,652International 3,002 3,143Total property and equipment, net $30,649 $24,795Revenue 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, 2017, 2016 and 2015, respectively (in thousands): As of December 31, 2017 2016 2015Language learning $138,082 $155,532 $191,568Literacy 43,608 34,123 21,928Brain Fitness 2,903 4,434 4,174Total revenue $184,593 $194,089 $217,670F-43Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)20. VALUATION AND QUALIFYING ACCOUNTSThe following table includes the Company's valuation and qualifying accounts for the respective periods (in thousands): Years Ended December 31, 2017 2016 2015Allowance for doubtful accounts: Beginning balance $1,072 $1,196 $1,434Charged to costs and expenses (51) 709 1,657Deductions—accounts written off (646) (833) (1,895)Ending balance $375 $1,072 $1,196Promotional rebate and coop advertising reserves: Beginning balance $5,968 $16,910 $23,437Charged to costs and expenses 6,421 18,337 40,563Deductions - reserves utilized (10,014) (29,279) (47,090)Ending balance $2,375 $5,968 $16,910Sales return reserve: Beginning balance $1,338 $3,728 $3,570Charged against revenue 4,943 5,034 11,474Deductions—reserves utilized (5,105) (7,424) (11,316)Ending balance $1,176 $1,338 3,728Deferred income tax asset valuation allowance: Beginning balance $78,363 70,464 53,809Charged to costs and expenses (16,806) 7,899 16,655Deductions (1,255) — —Ending balance $60,302 $78,363 $70,464F-44Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)21. SUPPLEMENTAL QUARTERLY FINANCIAL INFORMATION (Unaudited)Summarized quarterly supplemental consolidated financial information for 2017 and 2016 are as follows (in thousands, except per share amounts): Three Months Ended March 31, June 30, September 30, December 31,2017 Revenue $47,693 $45,905 $46,206 $44,789Gross profit $39,552 $38,314 $36,758 $36,348Net income (loss) $454 $(1,135) $(3,231) $2,366Basic earnings (loss) per share $0.02 $(0.05) $(0.14) $0.11Shares used in basic per share computation 22,125 22,248 22,285 22,316Diluted earnings (loss) per share $0.02 $(0.05) $(0.14) $0.10Shares used in diluted per share computation 22,590 22,248 22,285 23,2482016 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 22,06522. SUBSEQUENT EVENTSOn February 26, 2018, the Company entered into the second amendment to the PIPA with SOURCENEXT. See Note 8 "Divestitures" for a description ofthe PIPA and the relationship with SOURCENEXT. Under the second amendment, the Company agreed to extend the SRE and SDK time-based license to afive-year term from the date of the second amendment and also provide additional foreign language speech modules under the same license term. Inexchange, the Company will receive an accelerated cash receipt of $4.5 million of the $6.0 million in guaranteed minimum payments that were scheduled tobe received in future periods under the terms of the PIPA.F-45Exhibit 10.23EXECUTIVE EMPLOYMENT AGREEMENTTHIS EXECUTIVE EMPLOYMENT AGREEMENT (this “Agreement”) is effective as of August 4, 2017, betweenRosetta Stone Ltd., a Virginia corporation (together with its successors and assigns, the “Company”), and Mr. Mathew N. Hulett(“Executive”).RecitalsThe Company and Executive desire to enter into an agreement pursuant to which the Company will employ Executive as itsPresident Language subject to the terms and conditions of this Agreement.AgreementNOW, THEREFORE, in consideration of the foregoing and the mutual covenants and promises contained herein, the partiesagree as follows:1.Employment.The Company hereby engages Executive to serve as the President Language of the Company and its Affiliates, and Executiveagrees to serve the Company and its Affiliates, during the Service Term (as defined in Section 4 below) in the capacities, and subject tothe terms and conditions, set forth in this Agreement.2. Duties.During the Service Term, Executive, as President Language of the Company, shall have all the duties and responsibilitiescustomarily rendered by President Language of companies of similar size and nature and such other duties and responsibilities as maybe delegated from time to time by the Chief Executive Officer of the Company (“Chief Executive Officer”) in his sole discretion.Executive will report to the Chief Executive Officer.Executive will devote his best efforts and substantially all of his business time and attention (except for vacation periods andperiods of illness or other incapacity) to the business of the Company and its Affiliates. With the prior written consent of the ChiefExecutive Officer, Executive will be permitted to serve on the boards of other companies so long as such service does notunreasonably interfere and/or create unmanageable conflicts of interest with his duties to the Company.3. Employment Term.Unless Executive’s employment under this Agreement is sooner terminated as a result of Executive’s resignation or terminationin accordance with the provisions of Section 5 below, Executive’s term of employment (“Service Term”) under this Agreement shallcommence on the date hereof and shall continue for a period of one (1) year, and at the end of each year it shall renew and extendautomatically for an additional one (1) year (such date and each annual anniversary thereof, a “Renewal Date”), unless the Companyor Executive provides written notice of its intention1not to extend the term of the Agreement at least 90 days’ prior to the applicable Renewal Date provided, however, that either partymay terminate this Agreement pursuant to Section 5.4. Salary, Bonus and Benefits.The Compensation Committee (the “Compensation Committee”) of the Board of Directors (the “Board”) shall make alldecisions related to Executive’s compensation(a) Base Salary. During the Service Term, the Company will pay Executive a base salary (the “Annual Base Salary”) as theBoard may designate from time to time. The initial Annual Base Salary shall be at the rate of $350,000 per annum paid in accordancewith the Company’s customary payroll practices (minus all applicable withholdings and deductions). Executive’s Annual Base Salaryfor any partial year will be prorated based upon the number of days elapsed in such year. The Annual Base Salary may be increased(but not decreased) from time to time during the Service Term by the Board based upon the Company’s and Executive’s performance.(b) Annual Bonus. The Executive will be eligible to participate in the annual bonus plan (the “Annual Bonus”) and beeligible to receive an Annual Bonus with a target value of Sixty percent (60%) of his Annual Base Salary upon one hundred percent(100%) achievement of annual objectives, beginning with the Company’s 2018 fiscal year. For subsequent years, the Annual Bonustarget as a percentage of then-current Annual Base Salary, may be adjusted, but may not be less than Sixty percent (60%) of theExecutive’s then-current Annual Base Salary. The bonus, if any, will be determined by the Board based upon the Company’sachievement of financial performance goals and other objectives, as determined by the Compensation Committee for each fiscal year ofthe Company.(c) Annual Equity. The Executive will be eligible to participate in the annual equity plan (the “Annual Equity”) and beeligible to receive an Annual Equity with a target value of Seventy-Five percent (75%) of his Annual Base Salary upon one hundredpercent (100%) achievement of annual objectives, beginning with the Company’s 2018 fiscal year. For subsequent years, the AnnualEquity target as a percentage of then-current Annual Base Salary, may be adjusted, but may not be less than Seventy-Five percent(75%) of the Executive’s then-current Annual Base Salary. The equity, if any, will be determined by the Board based upon theCompany’s achievement of financial performance goals and other objectives, as determined by the Compensation Committee for eachfiscal year of the Company. Executive shall be eligible to receive annual equity awards in accordance with equity compensationarrangements established by the Compensation Committee. The grants shall have such terms as are determined by the CompensationCommittee in accordance with the current stock plan in place at time of grant.(d) Benefits.(i) Executive and, to the extent eligible, his dependents, shall be entitled to participate in and receive all benefits underany welfare or pension benefit plans and programs made available to the Company’s senior level executives or to itsemployees generally (including, without limitation, medical, disability and life insurance programs, accidental death anddismemberment protection, leave and2participation in retirement plans and deferred compensation plans), subject to the generally applicable eligibility,participation, and other provisions of the various plans and programs and laws and regulations in effect from time totime.(ii) The Company shall reimburse Executive for all reasonable, ordinary and necessary business expenses incurredduring the Service Term in the performance of his services hereunder in accordance with the policies of the Companyas they are from time to time in effect and subject to Section 15.(iii) Executive shall be provided paid time off including vacation, sick days, holidays and shall be entitled to medical,disability, family and other leave in accordance with Company policies as in effect from time to time for seniorexecutives.(iv) Notwithstanding anything to the contrary contained above, the Company shall be entitled to terminate or reduceany employee benefit enjoyed by Executive pursuant to the provisions of this Section 3(d).(e) Sign-on Equity. Executive will receive an initial equity grant, of Twenty-Five Thousand Shares (with an estimated totalvalue of Two Hundred Sixty Seven Thousand Five Hundred Dollars ($267,500)), consisting of a performance stock unit awardrepresenting Fifty percent (50%) of such value and a restricted stock award grant representing Fifty percent (50%) of such value,subject to the terms of the Rosetta Stone Inc. 2009 Omnibus Incentive Plan, as amended, and the applicable form of award agreement.The performance stock unit award subject to being earned by the achievement of the 2018 financial performance targets of the2017/2018 LTIP set by the Compensation Committee, and to vest 50% by March 2018 and 50% by March 2019. The restricted stockaward shall each vest annually in four (4) equal installments on the first, second, third and fourth anniversaries of the date ofemployment, provided that Executive remains employed with the Company on such vesting date.(f) Sign On Bonus. Executive shall receive a one-time cash signing bonus in the amount of $50,000, subject to taxes andapplicable withholdings, payable within the first sixty (60) days following hire date. If Executive voluntarily terminates employmentwith the Company, without Good Reason, or if the Executive is terminated by the Company for Cause, as defined below, withintwelve (12) months of receiving the cash signing bonus, the Executive agrees to reimburse the Company 100% of the cash signingbonus within thirty (30) days of the effective date of termination.5. Termination.Executive’s employment with the Company shall cease upon the first of the following events to occur:(a) Immediately upon Executive’s death.(b) Upon thirty (30) days’ prior written notice by Executive to the Company of Executive’s voluntary retirement at age 65 orolder.3(c) Upon thirty (30) days’ prior written notice by the Company to Executive of the Executive’s termination due to Disability.“Disability” means (i) Executive is unable to engage in any substantial gainful activity by reason of any medically determinablephysical or mental impairment that can be expected to result in death or can be expected to last for a continuous period of not less thantwelve (12) months, or (ii) Executive is, by reason of any medically determinable physical or mental impairment that can be expectedto result in death or can be expected to last for a continuous period of not less than twelve (12) months, receiving income replacementbenefits for a period of not less than three (3) months under an accident and health plan covering employees of the Company. Adetermination of Disability may be made by a physician selected or approved by the Company and, in this respect, Executive shallsubmit to an examination by such physician upon request by the Company. Immediately upon delivery to Executive of a written noticefrom the Company that Executive has been terminated with or without Cause. “Cause” shall mean termination for any of thefollowing:(i) Executive (a) commits a felony or a crime involving moral turpitude or commits any other act or omission involvingfraud, embezzlement or any other act of dishonesty in the course of his employment by the Company which conductdamages the Company or an Affiliate; (b) substantially and repeatedly fails to perform duties of the office held byExecutive as reasonably directed by the Board of Directors (the “Board”) and/or the Chief Executive Officer,(c) commits gross negligence or willful misconduct with respect to the Company or an Affiliate; (d) commits a materialbreach of this Agreement that is not cured within ten (10) days after receipt of written notice thereof from the Boardand/or Chief Executive Officer; (e) fails, within ten (10) days after receipt by Executive of written notice thereof fromthe Board and/or Chief Executive Officer, to correct, cease or otherwise alter any failure to comply with instructions orother action or omission which the Board and/or Chief Executive Officer reasonably believes does or may materially oradversely affect the Company’s or an Affiliate’s business or operations, (h) misappropriates funds or assets of theCompany or an Affiliate for personal use or willfully violates the Company policies or standards of business conduct asdetermined in good faith by the Board and/or Chief Executive Officer.(d) Upon Executive’s voluntary resignation by the delivery to the Chief Executive Officer of a written notice from Executivethat Executive has resigned with or without Good Reason. “Good Reason” shall mean Executive’s resignation from employment withthe Company after the occurrence of any of the following events without Executive’s consent: (i) a material diminution in Executive’sAnnual Base Salary, duties, authority or responsibilities from the Annual Base Salary, duties, authority or responsibilities as in effect atthe commencement of the Service Term, (ii) a material breach of the Agreement by the Company, or (iii) a relocation of Executive’sprimary place of employment to a geographic area more than fifty (50) miles from the Company’s office in Seattle, Washington;provided, that the foregoing events shall not be deemed to constitute Good Reason unless Executive has notified the Company inwriting of the occurrence of such event(s) within sixty (60) days of such occurrence and the Company has failed to have cure suchevent(s) within thirty (30) business days of its receipt of such written notice and termination occurs within one hundred (100) days ofthe event.46. Rights on Termination.(a) If during the Service Term Executive’s employment is terminated under Section 5 above (x) by the Company withoutCause or (y) by Executive with Good Reason, then:(i) The Company shall pay to Executive, at the times specified in Section 6(a)(v) below, the following amounts:(1) the Accrued Obligation;(2) a single lump sum payment in cash equal to one times the Annual Base Salary in effect immediately priorto the Termination Date; and(3) a single lump sum payment in cash equal to the product of (x) the monthly basic life insurance premiumapplicable to Executive’s basic life insurance coverage immediately prior to the Termination Date and (y) twelve (12).(4) The Company will pay Executive his Annual Bonus for the fiscal year of termination, in an amount equalto a pro rata portion of the bonus payout based on actual performance as if Executive had remained an employeethroughout the fiscal year of the Termination Date, paid at the same time as other recipients receive their Annual Bonusfor that fiscal year and in accordance with the terms of the then-current Company bonus policy.The amounts described in Section 6(a)(i)(2), (3) and (4) above shall be referred to herein as the “Severance Payments.”(ii) The Company shall provide professional outplacement and counseling services through an outplacement firmchosen by the Company for twelve (12) months from the Termination Date to assist Executive in his search for otheremployment.(iii) Upon Executive’s termination, Executive and his spouse and eligible dependents, as applicable, may elect healthcare coverage for up to eighteen (18) months from his last day of work at the Company pursuant to the ConsolidatedOmnibus Budget Reconciliation Act of 1985, as amended (“COBRA”). Subject to Section 6(a)(v) below, theCompany will pay for up to [twelve (12) months], on an after-tax basis, the portion of Executive’s COBRA premiumsfor such coverage that exceeds the amount that Executive would have incurred in premiums for such coverage underthe Company’s health plan if then employed by the Company; provided, however, the Company’s obligation shall onlyapply to the extent COBRA coverage is elected and in effect and Executive remains eligible for COBRA coverageduring such period.The amounts described in Section 6(a)(ii) and (iii) above shall be referred to herein as the “Severance Benefits.”5(iv) Payments and benefits provided to Executive under this Section 6 (other than the Accrued Obligation) arecontingent upon Executive’s execution of a release substantially in the form of Exhibit A hereto and such releasebecoming irrevocable within sixty (60) days following his termination of employment.(v) The Company shall pay Executive the amounts specified in Sections 6(a)(i)(1), (2), and (3) within sixty (60) daysafter the Termination Date and the amounts specified in Section 6(a)(i)(4) in accordance with the terms of the then-current Company bonus policy, except that the Accrued Obligation will be paid earlier if required by law; provided,however, that in no event shall the timing of Executive’s execution of the release, directly or indirectly, result in hisdesignating the calendar year of payment, and if a payment that is subject to execution of the release could be made inmore than one taxable year, such payment shall be made in the later taxable year. Notwithstanding the forgoing, if theExecutive is deemed on the Termination Date to be a Specified Employee, then with regard to any Severance Paymentor other payment or benefit under this Agreement that is “deferred compensation” within the meaning of Section 409Aand which is paid as a result of the Executive’s Separation from Service, such payment or benefit shall be made orprovided at the date which is the earlier of (A) the expiration of the six (6)-month period measured from the date of suchSeparation from Service of the Executive, and (B) the date of the Executive’s death (the “Delay Period”). Upon theexpiration of the Delay Period, all payments and benefits delayed pursuant to the preceding sentence (whether theywould have otherwise been payable in a single sum or in installments in the absence of such delay) shall be paid orreimbursed to the Executive in a lump sum with interest at the six (6)-month U.S. Treasury Rate in effect on the date ofExecutive’s Separation From Service, and any remaining payments and benefits due under this Agreement shall be paidor provided in accordance with the normal payment dates specified for them herein.(b) If the Company terminates Executive's employment for Cause, if Executive dies or is Disabled, or if Executive resignswithout Good Reason, the Company's obligations to pay any compensation or benefits under this Agreement will cease effective as ofthe Termination Date and the Company shall pay to Executive the Accrued Obligation within sixty (60) days following theTermination Date or earlier if required by law. Following such payments, the Company shall have no further obligations to Executive,other than as may be required by law or the terms of an employee benefit plan of the Company.(c) Notwithstanding the foregoing, the Company's obligation to Executive for Severance Payments or Severance Benefitsunder Section 6(a) above shall cease if Executive is in violation of the provisions of Section 8 or 9 below.(d) Notwithstanding the foregoing, if Executive retires at age sixty-five (65) or older, the Company shall pay the Executive: (i)the Accrued Obligation within sixty (60) days after the Termination Date or earlier if required by law, and (ii) a pro rata portion of theAnnual Bonus payout based on actual performance as if Executive had remained an employee throughout the fiscal year6of the Termination Date, paid at the same time as other recipients receive their Annual Bonus for that fiscal year and in accordancewith the terms of the then-current Company bonus policy. No other amounts will be payable by the Company, other than as may berequired by law or the terms of an employee benefit plan of the Company.7. Representations of Executive.Executive hereby represents and warrants to the Company that the statements contained in this Section 7 are true and accurateas of the date of this Agreement and understands that [his/her] employment and the effectiveness of this agreement is subject to thesuccessful results of a pre-employment background check and verification of immigration status.(a) Employment Restrictions. Executive is not currently a party to any non- competition, non-solicitation, confidentiality orother work-related agreement that limits or restricts Executive’s ability to work in any particular field or in any particular geographicregion, whether or not such agreement would be violated by this Agreement.8. Confidential Information; Proprietary Information, etc.(a) Obligation to Maintain Confidentiality. Executive acknowledges that any Proprietary Information disclosed or madeavailable to Executive or obtained, observed or known by Executive as a direct or indirect consequence of his employment with orperformance of services for the Company or any of its Affiliates from the time the Executive enters this Agreement through theduration of his performance of services for, or employment with, any of the foregoing Persons (whether or not compensated for suchservices) are the property of the Company and its Affiliates. Therefore, Executive agrees that, other than in the course of performanceof his duties as an employee of the Company, he will not at any time from the time the Executive enters into this Agreement (whetherbefore, during or after Executive’s term of employment) disclose or permit to be disclosed to any Person or, directly or indirectly,utilize for his own account or permit to be utilized by any Person any Proprietary Information or records pertaining to the Company, itsAffiliates and their respective business for any reason whatsoever without the Chief Executive Officer’s consent, unless and to theextent that (except as otherwise provided in the definition of Proprietary Information) the aforementioned matters become generallyknown to and available for use by the public other than as a direct or indirect result of Executive’s acts or omissions to act. Executiveagrees to deliver to the Company at the termination of his employment, as a condition to receipt of the Severance Payments, or at anyother time the Company may request in writing (whether during or after Executive’s term of employment), all records pertaining to theCompany, its Affiliates and their respective business which he may then possess or have under his control. Executive further agreesthat any property situated on the Company’s or its Affiliates’ premises and owned by the Company or its Affiliates, including disks andother storage media, filing cabinets or other work areas, is subject to inspection by Company or its Affiliates and their personnel at anytime with or without notice. Nothing in this Section 8(a) shall be construed to prevent Executive from using his general knowledge andexperience in future employment so long as Executive complies with this Section 8(a) and the other restrictions contained in thisAgreement.7(b) Ownership of Property. Executive acknowledges that all inventions, innovations, improvements, developments,methods, processes, programs, designs, analyses, drawings, reports and all similar or related information (whether or not patentable)that relate to the Company’s or any of its Affiliates’ actual or anticipated business, research and development, or existing or futureproducts or services and that are conceived, developed, contributed to, made, or reduced to practice by Executive (either solely orjointly with others) while employed by the Company or any of its Affiliates (including any of the foregoing that constitutes anyProprietary Information or records) (“Work Product”) belong to the Company or such Affiliate and Executive hereby assigns, andagrees to assign, all of the above Work Product to the Company or such Affiliate. Any copyrightable work prepared in whole or in partby Executive in the course of his work for any of the foregoing entities shall be deemed a “work made for hire” under the copyrightlaws, and the Company or such Affiliate shall own all rights therein. To the extent that any such copyrightable work is not a “workmade for hire,” Executive hereby assigns and agrees to assign to Company or such Affiliate all right, title and interest, includingwithout limitation, copyright in and to such copyrightable work. Executive shall promptly disclose such Work Product andcopyrightable work to the Chief Executive Officer and perform all actions reasonably requested by the Chief Executive Officer(whether during or after Executive’s term of employment) to establish and confirm the Company’s or its Affiliate’s ownership(including, without limitation, execution of assignments, consents, powers of attorney and other instruments). Notwithstandinganything contained in this Section 8(b) to the contrary, the Company’s ownership of Work Product does not apply to any inventionthat Executive develops entirely on his own time without using the equipment, supplies or facilities of the Company or Affiliates or anyProprietary Information (including trade secrets), except that the Company’s ownership of Work Product does include those inventionsthat: (i) relate to the business of the Company or its Affiliates or to the actual or demonstrably anticipated research or developmentrelating to the Company’s business; or (ii) result from any work that Executive performs for the Company or its Affiliates.(c) Third Party Information. Executive understands that the Company and its Affiliates will receive from third partiesconfidential or proprietary information (“Third Party Information”) subject to a duty on the Company’s and its Affiliates’ part tomaintain the confidentiality of such information and to use it only for certain limited purposes. From the time Executive enters into thisAgreement, during the term of Executive’s employment and thereafter, and without in any way limiting the provisions of Sections 8(a)and 8(b) above, Executive shall hold Third Party Information in the strictest confidence and shall not disclose to anyone (other thanpersonnel of the Company or its Affiliates who need to know such information in connection with their work for the Company or itsAffiliates) or use, except in connection with his work for the Company or its Affiliates, Third Party Information unless expresslyauthorized by the Chief Executive Officer in writing.(d) Use of Information of Prior Employers, etc. Executive will abide by any enforceable obligations contained in anyagreements that Executive has entered into with his prior employers or other parties to whom Executive has an obligation ofconfidentiality.(e) Compelled Disclosure. If Executive is required by law or governmental regulation or by subpoena or other valid legalprocess to disclose any Proprietary Information or Third Party8Information to any Person, Executive will immediately provide the Company with written notice of the applicable law, regulation orprocess so that the Company may seek a protective order or other appropriate remedy. Executive will cooperate fully with theCompany and the Company’s representatives in any attempt by the Company, at its sole cost and expense, to obtain any suchprotective order or other remedy. If the Company elects not to seek, or is unsuccessful in obtaining, any such protective order or otherremedy in connection with any requirement that Executive disclose Proprietary Information or Third Party Information then Executivemay disclose such Proprietary Information or Third Party Information to the extent legally required; provided, however, that Executivewill use his reasonable best efforts to ensure that such Proprietary Information is treated confidentially by each Person to whom it isdisclosed.(f) Permitted Disclosure. Executive acknowledges that nothing in this Agreement, in any other agreement betweenExecutive and the Company, or in any policy of the Company, restricts or prohibits Executive from reporting possible violations of lawor regulation to, or from filing a claim or assisting with an investigation directly with, a self-regulatory authority or a governmentagency or entity, including without limitation the U.S. Equal Employment Opportunity Commission, the Department of Labor, theNational Labor Relations Board, the Department of Justice, the Securities and Exchange Commission, the Congress, and any agencyInspector General, or from making other disclosures that are protected under the whistleblower provisions of state or federal law orregulation, whether Executive does so as a result of Executive initiating communications directly with or responding to any inquiriesfrom such government agency or entity. Executive further acknowledges that Executive does not need the prior authorization of theCompany to engage in such conduct, and Executive does not need to notify the Company that Executive has engaged in such conduct.In addition, Executive acknowledges that such conduct shall not be deemed a breach of any provision of this Agreement or any otheragreement with or policy of the Company.(g) Defend Trade Secrets Act Notice. U.S. federal law (18 U.S.C. § 1833(b)) states that an individual shall not be heldcriminally or civilly liable under any Federal or State trade secret law for the disclosure of a trade secret that: (A) is made (i) inconfidence to a Federal, State, or local government official, either directly or indirectly, or to an attorney and (ii) solely for the purposeof reporting or investigating a suspected violation of law; or (B) is made in a complaint or other document filed in a lawsuit or otherproceeding, if such filing is made under seal. That law further states that an individual who files a lawsuit for retaliation by an employerfor reporting a suspected violation of law may disclose the trade secret to the attorney of the individual and use the trade secretinformation in the court proceeding, if the individual: (Y) files any document containing the trade secret under seal; and (Z) does notdisclose the trade secret, except pursuant to court order. For the avoidance of doubt, nothing in this Agreement is intended to, nor shallbe construed to, conflict with 18 U.S.C. § 1833(b).9. Noncompetition and Nonsolicitation.(a) Noncompetition and Nonsolicitation.During Executive’s employment, and for a period of twelve (12) months following the termination of Executive’s employmentfor any reason, Executive will not, directly or indirectly9through another entity, within any geographic area served or supervised by Executive during the twelve (12)-month periodimmediately preceding the Termination Date:(i) render or offer any Competing Service or Product to any client or customer for whom Executive provided aCompeting Service/Product on behalf of Company;(ii) render or offer any Competing Service or Product to any Prospective Customer of Company; or,(iii) participate in the recruitment or hiring of any Company Employee nor induce or attempt to induce any Companyemployee to leave the employ of the Company, or in any way interfere with the relationship between the Company andthe employee thereof.“Competing Service or Product” means producing or selling software or services used for learning foreign languages, includingEnglish as a foreign language, and any other business carried on by the Company during Executive’s employment. A “ProspectiveCustomer” means any Person that the Executive, or other employee working under the Executive, has entertained discussions with tobecome a client or customer of Company at any time during the twelve (12) -month periods immediately preceding the TerminationDate and who has not explicitly rejected a business relationship with the Company. A “Company Employee” is any person who wasan employee of the Company at any time within the six (6) months prior to the date of solicitation. For purposes of this Section 9(a),“Company” includes Company and any Affiliate to which Executive provided services during his employment.(b) Acknowledgment. Executive acknowledges that in the course of his employment with the Company and its Affiliates, hehas and will become familiar with the trade secrets and other Proprietary Information of the Company and its Affiliates. Executivefurther acknowledges that as the General Counsel and Secretary of the Company, Executive has and will have direct or indirectresponsibility, oversight or duties with respect to the businesses of the Company and its Affiliates and its and their current andprospective employees, vendors, customers, clients and other business relations, and that, accordingly, the geographical restrictioncontained in this Section 9 is reasonable in all respects and necessary to protect the goodwill and Proprietary Information of theCompany and that without such protection the Company’s customer and client relations and competitive advantage would bematerially adversely affected. It is specifically recognized by Executive that his services to the Company and its Affiliates are special,unique and of extraordinary value, that the Company has a protectable interest in prohibiting Executive as provided in this Section 9,that Executive is responsible for the growth and development of the Company and the creation and preservation of the Company’sgoodwill, that money damages are insufficient to protect such interests, that there is adequate consideration being provided toExecutive hereunder, that such prohibitions are necessary and appropriate without regard to payments being made to Executivehereunder and that the Company would not enter this Agreement with Executive without the restriction of this Section 9. Executivefurther acknowledges that the restrictions contained in this Section 9 do not impose an undue hardship on [her/him] and, since he hasgeneral business skills that may be used in industries other than that in which the Company and its Affiliates conduct their10business, do not deprive Executive of his livelihood. Executive further acknowledges that the provisions of this Section 9 are separateand independent of the other sections of this Agreement.(c) Enforcement, etc. The parties agree that, in the event that any provision of Section 8 or 9 hereof shall be determined byany court of competent jurisdiction to be unenforceable by reason of its being extended over too great a time or too great a range ofactivities, such provision shall be deemed to be modified to permit its enforcement to the maximum extent permitted by law. The lengthof time for which the non-compete and non-solicitation shall be in force shall be extended by an amount of time equal to the period oftime during which a violation of such covenant is deemed by a court of competent jurisdiction to have occurred (including any periodrequired for litigation during which the Company seeks to enforce such covenant). If, notwithstanding such provision, a courtconcludes that the restrictions stated herein are unenforceable or unreasonable under circumstances then existing, the parties heretoagree that the unenforceable or unreasonable restriction should be severed from the Agreement and shall not affect the validity ofenforceability of the other restrictions in Section 8 or 9. Because Executive’s services are unique, because Executive has access toProprietary Information and for the other reasons set forth herein, the parties hereto agree that money damages would be an inadequateremedy for any breach of this Agreement. Therefore, without limiting the generality of Section 12(f), in the event of a breach orthreatened breach of this Agreement, the Company or its successors or assigns may, in addition to other rights and remedies existing intheir favor, apply to any court of competent jurisdiction for specific performance and/or injunctive or other relief in order to enforce, orprevent any violations of, the provisions hereof (without posting a bond or other security).(d) Submission to Jurisdiction. The parties hereby: (i) submit to the jurisdiction of any state or federal court sitting in theCommonwealth of Virginia in any action or proceeding arising out of or relating to Section 8 and/or 9 of this Agreement; (ii) agree thatall claims in respect of such action or proceeding may be heard or determined in any such court; and (iii) agree not to bring any actionor proceeding arising out of or relating to Section 8 and/or 9 of this Agreement in any other court. The parties hereby waive anydefense of inconvenient forum to the maintenance of any action or proceeding so brought. The parties hereby agree that a finaljudgment in any action or proceeding so brought shall be conclusive and may be enforced by suit on the judgment or in any othermanner provided by law.GENERAL PROVISIONS10. Definitions.“Accrued Obligation” means the sum of (1) Executive’s Annual Base Salary, (2) reimbursement of any unreimbursedbusiness expenses existing on Executive’s Termination Date, in accordance with the Company’s normal reimbursement policies andpractices, (3) vested account balance under and subject to the terms and provisions of the Company’s 401(k) Plan, and (4) any otheramounts Executive is entitled to under the Company’s benefit plans through the Termination Date for periods through but notfollowing his Separation From Service to the extent not theretofore paid11“Affiliate” means, with respect to any particular Person, any other Person controlling, controlled by or under common controlwith such particular Person. A Subsidiary of the Company shall be an Affiliate of the Company.“Board” means the Board of Directors of the Company or any committee of the Board, such as the Compensation Committee,to which the Board has delegated applicable authority.“Code” means the Internal Revenue Code of 1986, as amended and the regulations and guidance issued thereunder.“Person” means any individual or corporation, association, partnership, limited liability company, joint venture, joint stock orother company, business trust, trust, organization, university, college, governmental authority or other entity of any kind.“Proprietary Information” means any and all data and information concerning the business affairs of the Company or any ofits Affiliates and not generally known in the industry in which the Company or any of its Affiliates is or may become engaged, and anyother information concerning any matters affecting or relating to the Company’s or its Affiliates businesses, but in any eventProprietary Information shall include, any of the Company’s and its Affiliates’ past, present or prospective business opportunities,including information concerning acquisition opportunities in or reasonably related to the Company’s or its Affiliates’ businesses orindustries, customers, customer lists, clients, client lists, the prices the Company and its Affiliates obtain or have obtained from the saleof, or at which they sell or have sold, their products, unit volume of sales to past or present customers and clients, or any otherinformation concerning the business of the Company and its Affiliates, their manner of operation, their plans, processes, figures, salesfigures, projections, estimates, tax records, personnel history, accounting procedures, promotions, supply sources, contracts, know-how, trade secrets, information relating to research, development, inventions, technology, manufacture, purchasing, engineering,marketing, merchandising or selling, or other data without regard to whether all of the foregoing matters will be deemed confidential,material or important. Proprietary Information does not include any information that Executive has obtained from a Person other thanan employee of the Company or an Affiliate, which was disclosed to [her/him] without a breach of a duty of confidentiality.“Section 409A” means Section 409A of the Code.“Separation From Service” shall have the meaning ascribed to such term in Section 409A.“Specified Employee” means a person who is a “specified employee” within the meaning of Section 409A.“Subsidiary” means any company of which the Company owns securities having a majority of the ordinary voting power inelecting the board of directors directly or through one or more subsidiaries.“Termination Date” means the effective date of the termination of Executive’s employment.1211. Notices.Any notice provided for in this Agreement must be in writing and must be mailed, personally delivered or sent by reputableovernight courier service (charges prepaid) to the recipient at the address below indicated:If to the Company:Rosetta Stone Ltd. 1621 North Kent Street12th FloorArlington, VA 22209Attention: Chief Executive OfficerWith a copy to:Rosetta Stone Ltd. 1621 North Kent Street12th FloorArlington, VA 22209Attention: General Counsel and SecretaryIf to Executive:The last address on file with the Company.Or such other addresses or to the attention of such other person as the recipient party shall have specified by prior written notice to thesending party. Any notice under this Agreement will be deemed to have been given when delivered or, if mailed, five (5) businessdays after deposit in the U.S. mail.12. Miscellaneous.(a) Clawback/Recoupment. Notwithstanding any other provisions in this Agreement to the contrary, any incentive-basedcompensation, or any other compensation, paid to Executive pursuant to this Agreement or any other agreement or arrangement withthe Company which is subject to recovery under any law, government regulation or stock exchange listing requirement, will be subjectto such deductions and clawback as may be required to be made pursuant to such law, government regulation or stock exchange listingrequirement (or any policy adopted by the Company to comply with any such law, government regulation or stock exchange listingrequirement).(b) Severability. Whenever possible, each provision of this Agreement will be interpreted in such manner as to be effectiveand valid under applicable law, but if any provision13of this Agreement is held to be invalid, illegal or unenforceable in any respect under any applicable law or rule in any jurisdiction, suchinvalidity, illegality or unenforceability will not affect any other provision or any other jurisdiction, but this Agreement will bereformed, construed and enforced in such jurisdiction as if such invalid, illegal or unenforceable provision had never been containedherein.(c) Complete Agreement. This Agreement, those documents expressly referred to herein and other documents of even dateherewith embody the complete agreement and understanding among the parties and supersede and preempt any prior understandings,agreements or representations by or among the parties, written or oral, which may have related to the subject matter hereof in any way.(d) Counterparts; Facsimile Transmission. This Agreement may be executed in separate counterparts, each of which isdeemed to be an original and all of which taken together constitute one and the same agreement. Each party to this Agreement agreesthat its own telecopied signature will bind it and that it accepts the telecopied signature of each other party to this Agreement.(e) Successors and Assigns. Except as otherwise provided herein, this Agreement shall bind and inure to the benefit of andbe enforceable by Executive, the Company and their respective successors and assigns; provided that the rights and obligations of theparties under this Agreement shall not be assignable without the prior written consent of the other party, except for assignments byoperation of law and assignments by the Company to any successor of the Company by merger, consolidation, combination or sale ofassets. Any purported assignment in violation of these provisions shall be void ab initio.(f) Choice of Law; Jurisdiction. All questions or disputes concerning this Agreement and the exhibits hereto will begoverned by and construed in accordance with the internal laws of the Commonwealth of Virginia, without giving effect to any choiceof law or conflict of law provision or rule (whether of the Commonwealth of Virginia or any other jurisdiction) that would cause theapplication of the laws of any jurisdiction other than the Commonwealth of Virginia. The parties hereby: (i) submit to the non-exclusive jurisdiction of any state or federal court sitting in the Commonwealth of Virginia in any action or proceeding arising out of orrelating to this Agreement; and (ii) agree that all claims in respect of such action or proceeding may be heard or determined in any suchcourt. Each party hereby waives any defense of inconvenient forum to the maintenance of any action or proceeding so brought. Theparties hereby agree that a final judgment in any action or proceeding so brought shall be conclusive and may be enforced by suit onthe judgment or in any other manner provided by law.(g) Remedies. Each of the parties to this Agreement will be entitled to enforce its rights under this Agreement specifically, torecover damages and costs (including attorney’s fees) caused by any breach of any provision of this Agreement and to exercise allother rights existing in its favor. The parties hereto agree and acknowledge that money damages may not be an adequate remedy forany breach of the provisions of this Agreement and that any party may in its sole discretion apply to any court of law or equity ofcompetent jurisdiction (without posting any bond or deposit) for specific performance and/or other injunctive relief in order to enforceor prevent any violations of the provisions of this Agreement.14(h) Amendment and Waiver. The provisions of this Agreement may be amended or waived only with the prior writtenconsent of the Company and Executive.(i) Termination. This Agreement (except for the provisions of Sections 1, 2, 3, and 4) shall survive the termination ofExecutive’s employment with the Company and shall remain in full force and effect after such termination.(j) No Waiver. A waiver by any party hereto of any right or remedy hereunder on any one occasion shall not be construed asa bar to any right or remedy that such party would otherwise have on any future occasion. Neither failure to exercise nor any delay inexercising on the part of any party hereto, any right, power or privilege hereunder shall preclude any other or further exercise thereof orthe exercise of any other right, power or privilege. The rights and remedies herein provided are cumulative and may be exercisedsingly or concurrently, and are not exclusive of any rights or remedies provided by law.(k) Taxes; Withholding of Taxes on Behalf of Executive. Executive shall be solely responsible for any and all taxesimposed on Executive by reason of any compensation and benefits provided under this Agreement, and all such compensation andbenefits shall be subject to applicable withholding. Without limiting the scope of the preceding sentence, the Company and itsAffiliates shall be entitled to deduct or withhold from any amounts owing from the Company or any of its Affiliates to Executive anyfederal, state, provincial, local or foreign withholding taxes, excise taxes, or employment taxes imposed with respect to Executive’scompensation or other payments from the Company or any of its Affiliates or Executive’s ownership interest in the Company,including, but not limited to, wages, bonuses, dividends, the receipt or exercise of stock options and/or the receipt or vesting ofrestricted stock.(l) Waiver of Jury Trial. BOTH PARTIES TO THIS AGREEMENT AGREE THAT ANY ACTION, DEMAND,CLAIM OR COUNTERCLAIM RELATING TO THE TERMS AND PROVISIONS OF THIS AGREEMENT, OR TOITS BREACH, MAY BE COMMENCED IN THE COMMONWEALTH OF VIRGINIA IN A COURT OF COMPETENTJURISDICTION. BOTH PARTIES TO THIS AGREEMENT FURTHER AGREE THAT ANY ACTION, DEMAND,CLAIM OR COUNTERCLAIM SHALL BE RESOLVED BY A JUDGE ALONE, AND BOTH PARTIES HEREBYWAIVE AND FOREVER RENOUNCE THAT RIGHT TO A TRIAL BEFORE A CIVIL JURY.13. Certain Additional Payments by the Company; Code Section 280G.(a) Anything in this Agreement to the contrary notwithstanding, if any payment or benefit Executive would receive pursuantto this Agreement ("Payment") would (i) constitute a "parachute payment" within the meaning of Section 280G of the Code, and (ii)but for this sentence, be subject to the excise tax imposed by Section 4999 of the Code (the "Excise Tax"), then such Payment shall bereduced to the Reduced Amount. The "Reduced Amount" shall be either (x) the largest portion of the Payment that would result in noportion of the Payment being subject to the Excise Tax or (y) the largest portion, up to and including the total, of the Payment,whichever amount, after taking into account all applicable federal, state and local employment taxes, income taxes, and the Excise Tax(all computed at the highest applicable marginal rate), results in Executive’s15receipt, on an after-tax basis, of the greater amount of the Payment notwithstanding that all or some portion of the Payment may besubject to the Excise Tax. If a reduction in payments or benefits constituting "parachute payments" is necessary so that the Paymentequals the Reduced Amount, reduction shall occur in the following order: (A) payments which do not constitute nonqualified deferredcompensation subject to Section 409A; (B) cash payments shall be reduced first and in reverse chronological order such that the cashpayment owed on the latest date following the occurrence of the event triggering such Excise Tax will be the first cash payment to bereduced; and (C) employee benefits shall be reduced last (but only to the extent such benefits may be reduced under applicable law,including, but not limited to the Code and the Employee Retirement Income Security Act of 1974, as amended) and in reversechronological order such that the benefit owed on the latest date following the occurrence of the event triggering such Excise Tax willbe the first benefit to be reduced. Any reduction shall be made in accordance with Section 409A.(b) The determinations and calculations required hereunder shall be made by nationally recognized accounting firm that isselected by the Company (the “Accounting Firm”). The Company shall bear all expenses with respect to the determinations by theAccounting Firm required to be made hereunder(c) The Accounting Firm engaged to make the determinations hereunder shall provide its calculations, together with detailedsupporting documentation, to the Company and Eligible Employee within fifteen (15) business days after the date on which right to aPayment is triggered (if requested at that time by the Company or Executive) or such other time as requested by the Company orExecutive. Any good faith determinations of the Accounting Firm made hereunder shall be final, binding and conclusive upon theCompany and Executive.14. Indemnification.During and following the employment period, the Company shall indemnify Executive and hold Executive harmless from andagainst any claim, loss or cause of action arising from or out of Executive’s performance as an officer, director or employee of theCompany or any of its Affiliates or in any other capacity, including any fiduciary capacity, in which Executive serves at the request ofCompany to the maximum extent permitted by applicable law and the Company’s By-Laws, as in effect from time to time. Expensesincurred in defending or investigating a threatened or pending action, suit or proceeding shall be paid directly by the Company inadvance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of Executive to repaysuch amount if it shall ultimately be determined that he is not entitled to be indemnified by the Company. To the extent that theCompany reduces the indemnity rights provided for under its By-Laws after execution of this Agreement, the Company’s indemnityobligations hereunder shall be unaffected (to the extent permitted by applicable law).15. Section 409A.Although the Company does not guarantee to Executive any particular tax treatment relating to the payments and benefitsunder this Agreement, the parties acknowledge that this Agreement is intended to comply with, or be exempt from, the requirements ofSection 409A.16For purposes of this Agreement, a termination of employment will mean a “separation from service” as defined in Section409A, where required for compliance with Section 409A.With regard to any provision of this Agreement that provides for reimbursement of costs and expenses or in-kind benefits,except as permitted by Section 409A, (i) the right to reimbursement or in-kind benefits shall not be subject to liquidation or exchangefor another benefit; (ii) the amount of expenses eligible for reimbursement, or in-kind benefits, provided during any taxable year shallnot affect the expenses eligible for reimbursement, or in-kind benefits to be provided, in any other taxable year; and (iii) such paymentsshall be made on or before the last day of the service provider’s taxable year following the taxable year in which the expense wasincurred.Whenever a payment under this Agreement specifies a payment period with reference to a number of days (e.g., “payment shallbe made within sixty (60) days after termination”), the actual date of payment within the specified period shall be within the solediscretion of the Company.[Signature pages follow]17IN WITNESS WHEREOF, the parties hereto have executed this Agreement on the date first written above.ROSETTA STONE LTD.By: /s/ A. John Hass III Name: A. John Hass IIITitle: President and Chief Executive OfficerEXECUTIVE/s/ Mathew N. Hulett Name: Mathew N. Hulett18EXHIBIT AForm of Release19CONSULT WITH AN ATTORNEY PRIOR TO SIGNING THIS AGREEMENT AND GENERAL RELEASE. BYSIGNING THIS AGREEMENT AND GENERAL RELEASE YOU GIVE UP AND WAIVE IMPORTANT LEGALRIGHTS.Agreement and General ReleaseThis Agreement and General Release (“Release”) is between Rosetta Stone Ltd. (the “Company”) and Mr. Mathew N. Hulett(“Executive”) (each a “Party,” and together, the “Parties”). For purposes of this Release “Effective Date” shall mean the date that isthe eighth day after the date on which Executive signs this Release, provided Executive has not revoked this Release pursuant toSection 2(c) below.RecitalsA. Executive and the Company are parties to an Employment Agreement to which this Release is appended as Exhibit A(the “Employment Agreement”).B. In addition to the Accrued Obligation (as defined in the Employment Agreement), Executive wishes to receive the otherpayments and benefits described Section 6(a) of the Employment Agreement.C. Executive and the Company wish to resolve, except as specifically set forth herein, all claims between them arising fromor relating to any act or omission predating the Separation Date defined below.AgreementThe Parties agree as follows:1. Confirmation of Severance Package Obligation. The Company shall pay or provide to Executive the entire SeverancePayments and Severance Benefits as provided in Section 6(a) of the Employment Agreement, if Executive executes and does notrevoke this Release. The Severance Payments, together with the Severance Benefits described in Sections 6(a)(i), (ii), (iii) and (iv) ofthe Employment Agreement, are referred to herein as the “Severance Package.”2. Legal Releases(a) Executive, on behalf of Executive and Executive’s heirs, personal representatives and assigns, and any otherperson or entity that could or might act on behalf of Executive, including, without limitation, Executive’s counsel (all of whom arecollectively referred to as “Executive Releasers”), hereby fully and forever releases and discharges the Company, its present andfuture affiliates and subsidiaries, and each of their past, present and future officers, directors, employees, shareholders, independentcontractors, attorneys, insurers and any and all other persons or entities that are now or may become liable to any Executive Releaserdue to any Executive Releasee’s act or omission, (all of whom are collectively referred to as “Executive20Releasees”) of and from any and all actions, causes of action, claims, demands, costs and expenses, including attorneys’ fees, of everykind and nature whatsoever, in law or in equity, whether now known or unknown, that Executive Releasers, or any person actingunder any of them, may now have, or claim at any future time to have, based in whole or in part upon any act or omission occurring onor before the Effective Date, without regard to present actual knowledge of such acts or omissions, including specifically, but not byway of limitation, matters which may arise at common law, such as breach of contract, express or implied, promissory estoppel,wrongful discharge, tortious interference with contractual rights, infliction of emotional distress, defamation, or under federal, state orlocal laws, such as the Fair Labor Standards Act, the Employee Retirement Income Security Act, the National Labor Relations Act,Title VII of the Civil Rights Act of 1964, the Age Discrimination in Employment Act, the Rehabilitation Act of 1973, the Equal PayAct, the Americans with Disabilities Act, the Family and Medical Leave Act, and any civil rights law of any state or othergovernmental body; PROVIDED, HOWEVER, that notwithstanding the foregoing or anything else contained in this Release, therelease set forth in this Section shall not extend to: (i) any rights arising under this Release; (ii) any vested rights under any pension,retirement, profit sharing or similar plan; (iii) any rights Executive has under any grants of stock options, restricted stock, or other formsof equity that may have been provided to Executive during Executive’s employment (such grants to be governed by the applicableequity plan and grant agreement); (iv) any rights Executive has under applicable workers compensation laws; (v) Executive’s rights, ifany, to indemnification, and/or defense under any Company certificate of incorporation, bylaw and/or policy or procedure, or underany insurance contract or any indemnification agreement with the Company, in connection with Executive’s acts and omissions withinthe course and scope of Executive’s employment with the Company; (vi) Executive’s ability to communicate with the EqualEmployment Opportunity Commission (EEOC) or any other governmental agency, provided Executive does not seek any personalrelief for any claims released herein; (vii) any claims arising after the date of Executive’s execution of this Release; (viii) anyobligations of the Company under the Employment Agreement which survive Executive’s termination of employment; or (viii) anyother claims that cannot lawfully be released. Executive hereby warrants that Executive has not assigned or transferred to any personany portion of any claim, which is released, waived and discharged above. Executive further states and agrees that Executive has notexperienced any illness, injury, or disability that is compensable or recoverable under the worker’s compensation laws of any state thatwas not reported to the Company by Executive before the Effective Date, and Executive agrees not to not file a worker’scompensation claim asserting the existence of any such previously undisclosed illness, injury, or disability. Executive has specificallyconsulted with counsel with respect to the agreements, representations, and declarations set forth in the previous sentence. Executiveunderstands and agrees that by signing this Release Executive is giving up any right to bring any legal claim against the Companyconcerning, directly or indirectly, Executive’s employment relationship with the Company, including Executive’s separation fromemployment. Executive agrees that this legal release is intended to be interpreted in the broadest possible manner in favor of theCompany, to include all actual or potential legal claims that Executive may have against the Company, except as specifically providedotherwise in this Release.(b) In order to provide a full and complete release, each of the Parties understands and agrees that this Release isintended to include all claims, if any, covered under this Section 2 that such Party may have and not now know or suspect to exist insuch Party’s favor against any21other Party and that this Release extinguishes such claims. Thus, each of the Parties expressly waives all rights under any statute orcommon law principle in any jurisdiction that provides, in effect, that a general release does not extend to claims which the releasingparty does not know or suspect to exist in such Party’s favor at the time of executing the release, which if known by such Party musthave materially affected such Party’s settlement with the party being released.(c) Executive acknowledges that he consulted with an attorney of his choosing before signing this Release, and thatthe Company provided [her/him] with no fewer than twenty-one (21) days during which to consider the provisions of this Release and,specifically the release set forth at Section 2(a) above, although Executive may sign and return the Release sooner if he so chooses.Executive further acknowledges that he has the right to revoke this Release for a period of seven (7) days after signing it and that thisRelease shall not become effective until such seven (7)-day period has expired. Executive acknowledges and agrees that if he wishes torevoke this Release, he must do so in writing, and that such revocation must be signed by Executive and received by the Company incare of the Chief Executive Officer no later than 5 p.m. (Eastern Time) on the seventh (7th) day after Executive has signed thisRelease. Executive acknowledges and agrees that, in the event that he revokes this Release, he shall have no right to receive theSeverance Package. Executive represents that he has read this Release, including the release set forth in Section 2(a), above, affirmsthat this Release provides [her/him] with benefits to which he would not otherwise be entitled, and understands its terms and that heenters into this Release freely, voluntarily, and without coercion.3. Executive acknowledges that he has received all compensation to which he is entitled for [her/him] work up to his last dayof employment with the Company, and that he is not entitled to any further pay or benefit of any kind, for services rendered or anyother reason, other than the Severance Package, and any expense reimbursement due pursuant Section 3(d)(ii) of the EmploymentAgreement.5. The Parties agree that their respective rights and obligations under the Employment Agreement shall survive the executionof this Release.6. The parties understand and agree that this Release shall not be construed as an admission of liability on the part of anyperson or entity, liability being expressly denied.7. Executive represents and warrants to the Company that, prior to the Effective Date, Executive did not disclose to anyperson, other than to Executive’s spouse, tax advisor and counsel, the terms of this Release or the circumstances under which thematter that is the subject of this Release has been resolved. After the Effective Date, neither Executive, counsel for Executive, nor anyother person under Executive’s control shall disclose any term of this Release or the circumstances of Executive’s separation from theCompany, except that Executive may disclose such information to Executive’s spouse, or as required by subpoena or court order, or toan attorney or accountant to the extent necessary to obtain professional advice. Executive shall not be entitled to rely upon theforegoing exception for disclosures pursuant to subpoena or court order unless Executive has given the Company written notice, withinthree business days following service of the subpoena or court order.228. During the Service Term and thereafter, Executive covenants never to, and the Company agrees not to and to cause itsBoard and Section 16 reporting officers not to, utter, publish, or communicate, or cause the utterance, publication or communication ofany defamatory, disparaging, or untrue, inaccurate, or misleading statements or opinions intended to cause the other to be held in lowerregard, nor shall Executive at any time harass or behave unprofessionally toward any past, present or future the Company employee,officer or director, nor or the Company, its Board and Section 16 reporting officers at any time harass or behave unprofessionallytoward the Executive.9. Executive acknowledges that because of Executive’s position with the Company, Executive may possess information thatmay be relevant to or discoverable in connection with claims, litigation or judicial, arbitral or investigative proceedings initiated by aprivate party or by a regulator, governmental entity, or self-regulatory organization, that relates to or arises from matters with whichExecutive was involved during Executive’s employment with the Company, or that concern matters of which Executive hasinformation or knowledge (collectively, a “Proceeding”). Executive agrees that Executive shall testify truthfully in connection withany such Proceeding, shall cooperate with the Company in connection with every such Proceeding, and that Executive’s duty ofcooperation shall include an obligation to meet with the Company representatives and/or counsel concerning all such Proceedings forsuch purposes, and at such times and places, as the Company reasonably requests, and to appear for deposition and/or testimony uponthe Company’s request and without a subpoena. The Company shall reimburse Executive for reasonable out-of-pocket expenses thatExecutive incurs in honoring Executive’s obligation of cooperation under this Section 9.10. Miscellaneous Terms and Conditions(a) Each party understands and agrees that Executive or it assumes all risk that the facts or law may be, or become,different than the facts or law as believed by the party at the time Executive or it executes this Release. Executive and the Companyacknowledge that their relationship precludes any affirmative obligation of disclosure, and expressly disclaim all reliance uponinformation supplied or concealed by the adverse party or its counsel in connection with the negotiation and/or execution of thisRelease.(b) The parties warrant and represent that they have been offered no promise or inducement except as expresslyprovided in this Release, and that this Release is not in violation of or in conflict with any other agreement of either party.(c) All covenants and warranties contained in this Release are contractual and shall survive the closing of this Release.(d) This Release shall be binding in all respects upon, and shall inure to the benefit of, the parties’ heirs, successorsand assigns.(e) This Release shall be governed by the internal laws of the Commonwealth of Virginia, irrespective of the choiceof law rules of any jurisdiction.23(f) Should any provision of this Release be declared illegal or unenforceable by any court of competent jurisdictionand cannot be modified to be enforceable, such provision shall immediately become null and void, leaving the remainder of thisRelease in full force and effect. Notwithstanding the foregoing, if Section 2(a), above, is declared void or unenforceable, then thisRelease shall be null and void and both parties shall be restored to the positions that they occupied before the Release’s execution(meaning that, among other things, all sums paid by the Company pursuant to Section 1, above, shall be immediately refunded to theCompany); provided that in such circumstances this Release and the facts and circumstances relating to its execution shall beinadmissible in any later proceeding between the parties, and the statutes of limitations applicable to claims asserted in the proceedingshall be deemed to have been tolled for the period between the Effective Date and 10 days after the date on which Section 2(a) isdeclared unenforceable.(g) This Release constitutes the entire agreement of the parties and a complete merger of prior negotiations andagreements.(h) This Release shall not be modified except in a writing signed by the parties.(i) No term or condition of this Release shall be deemed to have been waived, nor shall there be an estoppel againstthe enforcement of any provision of this Release, except by a writing signed by the party charged with the waiver or estoppel. Nowaiver of any breach of this Release shall be deemed a waiver of any later breach of the same provision or any other provision of thisRelease.(j) Headings are intended solely as a convenience and shall not control the meaning or interpretation of any provisionof this Release.(k) Pronouns contained in this Release shall apply equally to the feminine, neuter and masculine genders. Thesingular shall include the plural, and the plural shall include the singular.(l) Each party shall promptly execute, acknowledge and deliver any additional document or agreement that the otherparty reasonably believes is necessary to carry out the purpose or effect of this Release.(m) Any party contesting the validity or enforceability of any term of this Release shall be required to prove by clearand convincing evidence fraud, concealment, failure to disclose material information, unconscionability, misrepresentation or mistakeof fact or law.(n) The parties acknowledge that they have reviewed this Release in its entirety and have had a full and fairopportunity to negotiate its terms and to consult with counsel of their own choosing concerning the meaning and effect of this Release.Each party therefore waives all applicable rules of construction that any provision of this Release should be construed against itsdrafter, and agrees that all provisions of the agreement shall be construed as a whole, according to the fair meaning of the languageused.(o) Every dispute arising from or relating to this Release shall be tried only in the state or federal courts situated in theCommonwealth of Virginia. The parties consent to venue24in those courts, and agree that those courts shall have personal jurisdiction over them in, and subject matter jurisdiction concerning, anysuch action.(p) In any action relating to or arising from this Release, or involving its application, the party substantially prevailingshall recover from the other party the expenses incurred by the prevailing party in connection with the action, including court costs andreasonable attorneys’ fees. If Executive is the substantially prevailing party, the Company shall pay such expenses within 60 daysfollowing the determination that he is the substantially prevailing party.(q) This Release may be executed in counterparts, or by copies transmitted by telecopier, all of which shall be giventhe same force and effect as the original.[SIGNATURES FOLLOW]25NOTE: DO NOT SIGN THIS SUPPLEMENTAL LEGAL RELEASE UNTIL AFTER EXECUTIVE’S FINAL DAY OFEMPLOYMENT.ROSETTA STONE LTD. By: A. John Hass IIIDate: EXECUTIVE Mathew N. HulettDate: 26Exhibit 10.24EXECUTIVE EMPLOYMENT AGREEMENTTHIS EXECUTIVE EMPLOYMENT AGREEMENT (this “Agreement”) is effective as of August 21, 2017, betweenRosetta Stone Ltd., a Virginia corporation (together with its successors and assigns, the “Company”), and Nicholas C. Gaehde(“Executive”).RecitalsThe Company and Executive desire to enter into an agreement pursuant to which the Company will employ Executive as itsPresident, Literacy (Lexia) subject to the terms and conditions of this Agreement.AgreementNOW, THEREFORE, in consideration of the foregoing and the mutual covenants and promises contained herein, the partiesagree as follows:1.Employment.The Company hereby engages Executive to serve as the President, Literacy (Lexia) of the Company and its Affiliates, andExecutive agrees to serve the Company and its Affiliates, during the Service Term (as defined in Section 4 below) in the capacities,and subject to the terms and conditions, set forth in this Agreement.2. Duties.During the Service Term, Executive, as President, Literacy (Lexia) of the Company, shall have all the duties andresponsibilities customarily rendered by Presidents of companies of similar size and nature and such other duties and responsibilities asmay be delegated from time to time by the Chief Executive Officer of the Company (“Chief Executive Officer”) in their solediscretion. Executive will report to the Chief Executive Officer.Executive will devote his best efforts and substantially all of /his business time and attention (except for vacation periods andperiods of illness or other incapacity) to the business of the Company and its Affiliates. With the prior written consent of the ChiefExecutive Officer, Executive will be permitted to serve on the boards of other companies so long as such service does notunreasonably interfere with his duties to the Company.3. Employment Term.Unless Executive’s employment under this Agreement is sooner terminated as a result of Executive’s resignation or terminationin accordance with the provisions of Section 5 below, Executive’s term of employment (“Service Term”) under this Agreement shallcommence on the date hereof and shall continue for a period of one (1) year, and at the end of each year it shall renew and extendautomatically for an additional one (1) year (such date and each annual anniversary thereof, a “Renewal Date”), unless the Companyor Executive provides written notice of its intention1not to extend the term of the Agreement at least 90 days’ prior to the applicable Renewal Date provided, however, that either partymay terminate this Agreement pursuant to Section 5.4. Salary, Bonus and Benefits.The Compensation Committee of the Board (the “Compensation Committee”) shall make all decisions related to Executive’scompensation(a) Base Salary. During the Service Term, the Company will pay Executive a base salary (the “Annual Base Salary”) as theBoard may designate from time to time. The initial Annual Base Salary shall be at the rate of $300,000 per annum paid in accordancewith the Company’s customary payroll practices (minus all applicable withholdings and deductions). Executive’s Annual Base Salaryfor any partial year will be prorated based upon the number of days elapsed in such year. The Annual Base Salary may be increased(but not decreased) from time to time during the Service Term by the Board based upon the Company’s and Executive’s performance.(b) Annual Bonus. The Executive will be eligible to participate in the annual bonus plan (the “Annual Bonus”) and beeligible to receive an Annual Bonus target of sixty percent (60%) of his Annual Base Salary upon one hundred percent (100%)achievement of annual objectives, beginning with the Company’s 2017 fiscal year. For subsequent years, the Annual Bonus target as apercentage of then-current Annual Base Salary, may be adjusted, but may not be less than sixty percent (60%) of the Executive’s then-current Annual Base Salary. The bonus, if any, will be determined by the Board based upon the Company’s achievement of financialperformance goals and other objectives, as determined by the Compensation Committee for each fiscal year of the Company.(c) Annual Equity. The Executive will be eligible to participate in the annual equity plan (the “Annual Equity”) and beeligible to receive an Annual Equity with a target value of Seventy-Five percent (75%) of his Annual Base Salary upon one hundredpercent (100%) achievement of annual objectives. The Annual Equity target as a percentage of then-current Annual Base Salary, maybe adjusted, but may not be less than Seventy-Five percent (75%) of the Executive’s then-current Annual Base Salary. The equity, ifany, will be determined by the Board based upon the Company’s achievement of financial performance goals and other objectives, asdetermined by the Compensation Committee for each fiscal year of the Company. Executive shall be eligible to receive annual equityawards in accordance with equity compensation arrangements established by the Compensation Committee. The grants shall have suchterms as are determined by the Compensation Committee in accordance with the current stock plan in place at time of grant.(d) Benefits.(i) Executive and, to the extent eligible, his dependents, shall be entitled to participate in and receive all benefits underany welfare or pension benefit plans and programs made available to the Company’s senior level executives or to itsemployees generally (including, without limitation, medical, disability and life insurance programs, accidental death anddismemberment protection, leave and participation in retirement plans and deferred compensation plans), subject to the2generally applicable eligibility, participation, and other provisions of the various plans and programs and laws andregulations in effect from time to time.(ii) The Company shall reimburse Executive for all reasonable, ordinary and necessary business expenses incurredduring the Service Term in the performance of his services hereunder in accordance with the policies of the Companyas they are from time to time in effect and subject to Section 15.(iii) Executive shall be provided paid time off including vacation, sick days, holidays and shall be entitled to medical,disability, family and other leave in accordance with Company policies as in effect from time to time for seniorexecutives.(iv) Notwithstanding anything to the contrary contained above, the Company shall be entitled to terminate or reduceany employee benefit enjoyed by Executive pursuant to the provisions of this Section 3(d).5. Termination.Executive’s employment with the Company shall cease upon the first of the following events to occur:(a) Immediately upon Executive’s death.(b) Upon thirty (30) days’ prior written notice by Executive to the Company of Executive’s voluntary retirement at age 65 orolder.(c) Upon thirty (30) days’ prior written notice by the Company to Executive of the Executive’s termination due to Disability.“Disability” means (i) Executive is unable to engage in any substantial gainful activity by reason of any medically determinablephysical or mental impairment that can be expected to result in death or can be expected to last for a continuous period of not less thantwelve (12) months, or (ii) Executive is, by reason of any medically determinable physical or mental impairment that can be expectedto result in death or can be expected to last for a continuous period of not less than twelve (12) months, receiving income replacementbenefits for a period of not less than three (3) months under an accident and health plan covering employees of the Company. Adetermination of Disability may be made by a physician selected or approved by the Company and, in this respect, Executive shallsubmit to an examination by such physician upon request by the Company. Immediately upon delivery to Executive of a written noticefrom the Company that Executive has been terminated with or without Cause. “Cause” shall mean termination for any of thefollowing:(i) Executive (a) commits a felony or a crime involving moral turpitude or commits any other act or omission involvingfraud, embezzlement or any other act of dishonesty in the course of his employment by the Company which conductdamages the Company or an Affiliate; (b) substantially and repeatedly fails to perform duties of the office held byExecutive as reasonably directed by the Board3of Directors (the “Board”) and/or the Chief Executive Officer, (c) commits gross negligence or willful misconduct withrespect to the Company or an Affiliate; (d) commits a material breach of this Agreement that is not cured within ten (10)days after receipt of written notice thereof from the Board and/or Chief Executive Officer; (e) fails, within ten (10) daysafter receipt by Executive of written notice thereof from the Board and/or Chief Executive Officer, to correct, cease orotherwise alter any failure to comply with instructions or other action or omission which the Board and/or ChiefExecutive Officer reasonably believes does or may materially or adversely affect the Company’s or an Affiliate’sbusiness or operations, (h) misappropriates funds or assets of the Company or an Affiliate for personal use or willfullyviolates the Company policies or standards of business conduct as determined in good faith by the Board and/or ChiefExecutive Officer(d) Upon Executive’s voluntary resignation by the delivery to the Chief Executive Officer of a written notice from Executivethat Executive has resigned with or without Good Reason. “Good Reason” shall mean Executive’s resignation from employment withthe Company after the occurrence of any of the following events without Executive’s consent: (i) a material diminution in Executive’sAnnual Base Salary, duties, authority or responsibilities from the Annual Base Salary, duties, authority or responsibilities as in effect atthe commencement of the Service Term, (ii) a material breach of the Agreement by the Company, or (iii) a relocation of Executive’sprimary place of employment to a geographic area more than fifty (50) miles from the Company’s office in Concord, MA ; provided,that the foregoing events shall not be deemed to constitute Good Reason unless Executive has notified the Company in writing of theoccurrence of such event(s) within sixty (60) days of such occurrence and the Company has failed to have cure such event(s) withinthirty (30) business days of its receipt of such written notice and termination occurs within one hundred (100) days of the event.6. Rights on Termination.(a) If during the Service Term Executive’s employment is terminated under Section 5 above (x) by the Company withoutCause or (y) by Executive with Good Reason, then:(i) The Company shall pay to Executive, at the times specified in Section 6(a)(v) below, the following amounts:(1) the Accrued Obligation;(2) a single lump sum payment in cash equal to one times the Annual Base Salary in effect immediately priorto the Termination Date; and(3) a single lump sum payment in cash equal to the product of (x) the monthly basic life insurance premiumapplicable to Executive’s basic life insurance coverage immediately prior to the Termination Date and (y) twelve (12).(4) The Company will pay Executive his Annual Bonus for the fiscal year of termination, in anamount equal to a pro rata portion of the bonus payout4based on actual performance as if Executive had remained an employee throughout the fiscal year of the TerminationDate, paid at the same time as other recipients receive their Annual Bonus for that fiscal year and in accordance with theterms of the then-current Company bonus policy.The amounts described in Section 6(a)(i)(2), (3) and (4) above shall be referred to herein as the “Severance Payments.”(ii) The Company shall provide professional outplacement and counseling services through an outplacement firmchosen by the Company for twelve (12) months from the Termination Date to assist Executive in his search for other employment.(iii) Upon Executive’s termination, Executive and his spouse and eligible dependents, as applicable, may elect healthcare coverage for up to eighteen (18) months from his last day of work at the Company pursuant to the Consolidated Omnibus BudgetReconciliation Act of 1985, as amended (“COBRA”). Subject to Section 6(a)(v) below, the Company will pay for up to twelve (12)months, on an after-tax basis, the portion of Executive’s COBRA premiums for such coverage that exceeds the amount that Executivewould have incurred in premiums for such coverage under the Company’s health plan if then employed by the Company; provided,however, the Company’s obligation shall only apply to the extent COBRA coverage is elected and in effect and Executive remainseligible for COBRA coverage during such period.The amounts described in Section 6(a)(ii) and (iii) above shall be referred to herein as the “Severance Benefits.”(iv) Payments and benefits provided to Executive under this Section 6 (other than the Accrued Obligation) arecontingent upon Executive’s execution of a release substantially in the form of Exhibit A hereto and such release becomingirrevocable within sixty (60) days following his termination of employment.(v) The Company shall pay Executive the amounts specified in Sections 6(a)(i)(1), (2), and (3) within sixty (60) daysafter the Termination Date and the amounts specified in Section 6(a)(i)(4) in accordance with the terms of the then-current Companybonus policy, except that the Accrued Obligation will be paid earlier if required by law; provided, however, that in no event shall thetiming of Executive’s execution of the release, directly or indirectly, result in his designating the calendar year of payment, and if apayment that is subject to execution of the release could be made in more than one taxable year, such payment shall be made in thelater taxable year. Notwithstanding the forgoing, if the Executive is deemed on the Termination Date to be a Specified Employee, thenwith regard to any Severance Payment or other payment or benefit under this Agreement that is “deferred compensation” within themeaning of Section 409A and which is paid as a result of the Executive’s Separation from Service, such payment or benefit shall bemade or provided at the date which is the earlier of (A) the expiration of the six (6)-month period measured from the date of suchSeparation from Service of the Executive, and (B) the date of the Executive’s death (the “Delay Period”). Upon the expiration of theDelay Period, all payments and benefits delayed pursuant to the preceding sentence (whether they would have otherwise been payablein a single sum or in installments in the absence of such delay) shall be paid or reimbursed to the5Executive in a lump sum with interest at the six (6)-month U.S. Treasury Rate in effect on the date of Executive’s Separation FromService, and any remaining payments and benefits due under this Agreement shall be paid or provided in accordance with the normalpayment dates specified for them herein.(b) If the Company terminates Executive's employment for Cause, if Executive dies or is Disabled, or if Executive resignswithout Good Reason, the Company's obligations to pay any compensation or benefits under this Agreement will cease effective as ofthe Termination Date and the Company shall pay to Executive the Accrued Obligation within sixty (60) days following theTermination Date or earlier if required by law. Following such payments, the Company shall have no further obligations to Executive,other than as may be required by law or the terms of an employee benefit plan of the Company.(c) Notwithstanding the foregoing, the Company's obligation to Executive for Severance Payments or Severance Benefitsunder Section 6(a) above shall cease if Executive is in violation of the provisions of Section 8 or 9 below.(d) Notwithstanding the foregoing, if Executive retires at age sixty-five (65) or older, the Company shall pay the Executive: (i)the Accrued Obligation within sixty (60) days after the Termination Date or earlier if required by law, and (ii) a pro rata portion of theAnnual Bonus payout based on actual performance as if Executive had remained an employee throughout the fiscal year of theTermination Date, paid at the same time as other recipients receive their Annual Bonus for that fiscal year and in accordance with theterms of the then-current Company bonus policy. No other amounts will be payable by the Company, other than as may be required bylaw or the terms of an employee benefit plan of the Company.7. Representations of Executive.Executive hereby represents and warrants to the Company that the statements contained in this Section 7 are true and accurateas of the date of this Agreement and understands that his employment and the effectiveness of this agreement is subject to thesuccessful results of a pre-employment background check and verification of immigration status.(a) Employment Restrictions. Executive is not currently a party to any non- competition, non-solicitation, confidentiality orother work-related agreement that limits or restricts Executive’s ability to work in any particular field or in any particular geographicregion, whether or not such agreement would be violated by this Agreement.8. Confidential Information; Proprietary Information, etc.(a) Obligation to Maintain Confidentiality. Executive acknowledges that any Proprietary Information disclosed or madeavailable to Executive or obtained, observed or known by Executive as a direct or indirect consequence of his employment with orperformance of services for the Company or any of its Affiliates during the course of his performance of services for, or employmentwith, any of the foregoing Persons (whether or not compensated for such services) [and for the twelve (12) months following theTermination Date][NTD: Consider deleting this and6making the confidentiality obligation perpetual], are the property of the Company and its Affiliates. Therefore, Executive agrees that,other than in the course of performance of his duties as an employee of the Company, he will not at any time (whether during or afterExecutive’s term of employment) disclose or permit to be disclosed to any Person or, directly or indirectly, utilize for his own accountor permit to be utilized by any Person any Proprietary Information or records pertaining to the Company, its Affiliates and theirrespective business for any reason whatsoever without the Chief Executive Officer’s consent, unless and to the extent that (except asotherwise provided in the definition of Proprietary Information) the aforementioned matters become generally known to and availablefor use by the public other than as a direct or indirect result of Executive’s acts or omissions to act. Executive agrees to deliver to theCompany at the termination of his employment, as a condition to receipt of the Severance Payments, or at any other time the Companymay request in writing (whether during or after Executive’s term of employment), all records pertaining to the Company, its Affiliatesand their respective business which he may then possess or have under his control. Executive further agrees that any property situatedon the Company’s or its Affiliates’ premises and owned by the Company or its Affiliates, including disks and other storage media,filing cabinets or other work areas, is subject to inspection by Company or its Affiliates and their personnel at any time with or withoutnotice. Nothing in this Section 8(a) shall be construed to prevent Executive from using his general knowledge and experience in futureemployment so long as Executive complies with this Section 8(a) and the other restrictions contained in this Agreement.(b) Ownership of Property. Executive acknowledges that all inventions, innovations, improvements, developments,methods, processes, programs, designs, analyses, drawings, reports and all similar or related information (whether or not patentable)that relate to the Company’s or any of its Affiliates’ actual or anticipated business, research and development, or existing or futureproducts or services and that are conceived, developed, contributed to, made, or reduced to practice by Executive (either solely orjointly with others) while employed by the Company or any of its Affiliates (including any of the foregoing that constitutes anyProprietary Information or records) (“Work Product”) belong to the Company or such Affiliate and Executive hereby assigns, andagrees to assign, all of the above Work Product to the Company or such Affiliate. Any copyrightable work prepared in whole or in partby Executive in the course of his work for any of the foregoing entities shall be deemed a “work made for hire” under the copyrightlaws, and the Company or such Affiliate shall own all rights therein. To the extent that any such copyrightable work is not a “workmade for hire,” Executive hereby assigns and agrees to assign to Company or such Affiliate all right, title and interest, includingwithout limitation, copyright in and to such copyrightable work. Executive shall promptly disclose such Work Product andcopyrightable work to the Chief Executive Officer and perform all actions reasonably requested by the Chief Executive Officer(whether during or after Executive’s term of employment) to establish and confirm the Company’s or its Affiliate’s ownership(including, without limitation, execution of assignments, consents, powers of attorney and other instruments). Notwithstandinganything contained in this Section 8(b) to the contrary, the Company’s ownership of Work Product does not apply to any inventionthat Executive develops entirely on his own time without using the equipment, supplies or facilities of the Company or Affiliates or anyProprietary Information (including trade secrets), except that the Company’s ownership of Work Product does include those inventionsthat: (i) relate to the business of the Company or its Affiliates or to the actual or demonstrably anticipated research or development7relating to the Company’s business; or (ii) result from any work that Executive performs for the Company or its Affiliates.(c) Third Party Information. Executive understands that the Company and its Affiliates will receive from third partiesconfidential or proprietary information (“Third Party Information”) subject to a duty on the Company’s and its Affiliates’ part tomaintain the confidentiality of such information and to use it only for certain limited purposes. During the term of Executive’semployment and thereafter, and without in any way limiting the provisions of Sections 8(a) and 8(b) above, Executive shall hold ThirdParty Information in the strictest confidence and shall not disclose to anyone (other than personnel of the Company or its Affiliates whoneed to know such information in connection with their work for the Company or its Affiliates) or use, except in connection with hiswork for the Company or its Affiliates, Third Party Information unless expressly authorized by the Chief Executive Officer in writing.(d) Use of Information of Prior Employers, etc. Executive will abide by any enforceable obligations contained in anyagreements that Executive has entered into with his prior employers or other parties to whom Executive has an obligation ofconfidentiality.(e) Compelled Disclosure. If Executive is required by law or governmental regulation or by subpoena or other valid legalprocess to disclose any Proprietary Information or Third Party Information to any Person, Executive will immediately provide theCompany with written notice of the applicable law, regulation or process so that the Company may seek a protective order or otherappropriate remedy. Executive will cooperate fully with the Company and the Company’s representatives in any attempt by theCompany, at its sole cost and expense, to obtain any such protective order or other remedy. If the Company elects not to seek, or isunsuccessful in obtaining, any such protective order or other remedy in connection with any requirement that Executive discloseProprietary Information or Third Party Information then Executive may disclose such Proprietary Information or Third PartyInformation to the extent legally required; provided, however, that Executive will use his reasonable best efforts to ensure that suchProprietary Information is treated confidentially by each Person to whom it is disclosed.(f) Permitted Disclosure. Executive acknowledges that nothing in this Agreement, in any other agreement betweenExecutive and the Company, or in any policy of the Company, restricts or prohibits Executive from reporting possible violations of lawor regulation to, or from filing a claim or assisting with an investigation directly with, a self-regulatory authority or a governmentagency or entity, including without limitation the U.S. Equal Employment Opportunity Commission, the Department of Labor, theNational Labor Relations Board, the Department of Justice, the Securities and Exchange Commission, the Congress, and any agencyInspector General, or from making other disclosures that are protected under the whistleblower provisions of state or federal law orregulation, whether Executive does so as a result of Executive initiating communications directly with or responding to any inquiriesfrom such government agency or entity. Executive further acknowledges that Executive does not need the prior authorization of theCompany to engage in such conduct, and Executive does not need to notify the Company that Executive has engaged in such conduct.In addition, Executive acknowledges that such conduct8shall not be deemed a breach of any provision of this Agreement or any other agreement with or policy of the Company.(g) Defend Trade Secrets Act Notice. U.S. federal law (18 U.S.C. § 1833(b)) states that an individual shall not be heldcriminally or civilly liable under any Federal or State trade secret law for the disclosure of a trade secret that: (A) is made (i) inconfidence to a Federal, State, or local government official, either directly or indirectly, or to an attorney and (ii) solely for the purposeof reporting or investigating a suspected violation of law; or (B) is made in a complaint or other document filed in a lawsuit or otherproceeding, if such filing is made under seal. That law further states that an individual who files a lawsuit for retaliation by an employerfor reporting a suspected violation of law may disclose the trade secret to the attorney of the individual and use the trade secretinformation in the court proceeding, if the individual: (Y) files any document containing the trade secret under seal; and (Z) does notdisclose the trade secret, except pursuant to court order. For the avoidance of doubt, nothing in this Agreement is intended to, nor shallbe construed to, conflict with 18 U.S.C. § 1833(b).9. Noncompetition and Nonsolicitation.(a) Noncompetition and Nonsolicitation.During Executive’s employment, and for a period of twelve (12) months following the termination of Executive’s employmentfor any reason, Executive will not, directly or indirectly through another entity, within any geographic area served or supervised byExecutive during the twelve (12)-month period immediately preceding the Termination Date:(1) render or offer any Competing Service or Product to any client or customer for whom Executive provided a CompetingService/Product on behalf of Company;(2) render or offer any Competing Service or Product to any Prospective Customer of Company; or,(3) participate in the recruitment or hiring of any Company Employee nor induce or attempt to induce any Company employeeto leave the employ of the Company, or in any way interfere with the relationship between the Company and the employeethereof.“Competing Service or Product” means producing or selling software or services used for learning foreign languages, includingEnglish as a foreign language, and any other business carried on by the Company during Executive’s employment. A “ProspectiveCustomer” means any Person that the Executive, or other employee working under the Executive, has entertained discussions with tobecome a client or customer of Company at any time during the twelve (12) -month periods immediately preceding the TerminationDate and who has not explicitly rejected a business relationship with the Company. A “Company Employee” is any person who wasan employee of the Company at any time within the six (6) months prior to the date of solicitation. For purposes of this Section 9(a),“Company” includes Company and any Affiliate to which Executive provided services during his employment.9(b) Acknowledgment. Executive acknowledges that in the course of his employment with the Company and its Affiliates, hehas and will become familiar with the trade secrets and other Proprietary Information of the Company and its Affiliates. Executivefurther acknowledges that as the General Counsel and Secretary of the Company, Executive has and will have direct or indirectresponsibility, oversight or duties with respect to the businesses of the Company and its Affiliates and its and their current andprospective employees, vendors, customers, clients and other business relations, and that, accordingly, the geographical restrictioncontained in this Section 9 is reasonable in all respects and necessary to protect the goodwill and Proprietary Information of theCompany and that without such protection the Company’s customer and client relations and competitive advantage would bematerially adversely affected. It is specifically recognized by Executive that his services to the Company and its Affiliates are special,unique and of extraordinary value, that the Company has a protectable interest in prohibiting Executive as provided in this Section 9,that Executive is responsible for the growth and development of the Company and the creation and preservation of the Company’sgoodwill, that money damages are insufficient to protect such interests, that there is adequate consideration being provided toExecutive hereunder, that such prohibitions are necessary and appropriate without regard to payments being made to Executivehereunder and that the Company would not enter this Agreement with Executive without the restriction of this Section 9. Executivefurther acknowledges that the restrictions contained in this Section 9 do not impose an undue hardship on him and, since he has generalbusiness skills that may be used in industries other than that in which the Company and its Affiliates conduct their business, do notdeprive Executive of his livelihood. Executive further acknowledges that the provisions of this Section 9 are separate and independentof the other sections of this Agreement.(c) Enforcement, etc. The parties agree that, in the event that any provision of Section 8 or 9 hereof shall bedetermined by any court of competent jurisdiction to be unenforceable by reason of its being extended over too great a time ortoo great a range of activities, such provision shall be deemed to be modified to permit its enforcement to the maximum extentpermitted by law. The length of time for which the non-compete and non-solicitation shall be in force shall be extended by anamount of time equal to the period of time during which a violation of such covenant is deemed by a court of competentjurisdiction to have occurred (including any period required for litigation during which the Company seeks to enforce suchcovenant). If, notwithstanding such provision, a court concludes that the restrictions stated herein are unenforceable or unreasonableunder circumstances then existing, the parties hereto agree that the unenforceable or unreasonable restriction should be severed fromthe Agreement and shall not affect the validity of enforceability of the other restrictions in Section 8 or 9. Because Executive’s servicesare unique, because Executive has access to Proprietary Information and for the other reasons set forth herein, the parties hereto agreethat money damages would be an inadequate remedy for any breach of this Agreement. Therefore, without limiting the generality ofSection 12(f), in the event of a breach or threatened breach of this Agreement, the Company or its successors or assigns may, inaddition to other rights and remedies existing in their favor, apply to any court of competent jurisdiction for specific performance and/orinjunctive or other relief in order to enforce, or prevent any violations of, the provisions hereof (without posting a bond or othersecurity).10(d) Submission to Jurisdiction. The parties hereby: (i) submit to the jurisdiction of any state or federal court sitting in theCommonwealth of Virginia in any action or proceeding arising out of or relating to Section 8 and/or 9 of this Agreement; (ii) agree thatall claims in respect of such action or proceeding may be heard or determined in any such court; and (iii) agree not to bring any actionor proceeding arising out of or relating to Section 8 and/or 9 of this Agreement in any other court. The parties hereby waive anydefense of inconvenient forum to the maintenance of any action or proceeding so brought. The parties hereby agree that a finaljudgment in any action or proceeding so brought shall be conclusive and may be enforced by suit on the judgment or in any othermanner provided by law.GENERAL PROVISIONS10. Definitions.“Accrued Obligation” means the sum of (1) Executive’s Annual Base Salary, (2) reimbursement of any unreimbursedbusiness expenses existing on Executive’s Termination Date, in accordance with the Company’s normal reimbursement policies andpractices, (3) vested account balance under and subject to the terms and provisions of the Company’s 401(k) Plan, and (4) any otheramounts Executive is entitled to under the Company’s benefit plans through the Termination Date for periods through but notfollowing his Separation From Service to the extent not theretofore paid“Affiliate” means, with respect to any particular Person, any other Person controlling, controlled by or under common controlwith such particular Person. A Subsidiary of the Company shall be an Affiliate of the Company.“Board” means the Board of Directors of the Company or any committee of the Board, such as the Compensation Committee,to which the Board has delegated applicable authority.“Code” means the Internal Revenue Code of 1986, as amended and the regulations and guidance issued thereunder.“Person” means any individual or corporation, association, partnership, limited liability company, joint venture, joint stock orother company, business trust, trust, organization, university, college, governmental authority or other entity of any kind.“Proprietary Information” means any and all data and information concerning the business affairs of the Company or any ofits Affiliates and not generally known in the industry in which the Company or any of its Affiliates is or may become engaged, and anyother information concerning any matters affecting or relating to the Company’s or its Affiliates businesses, but in any eventProprietary Information shall include, any of the Company’s and its Affiliates’ past, present or prospective business opportunities,including information concerning acquisition opportunities in or reasonably related to the Company’s or its Affiliates’ businesses orindustries, customers, customer lists, clients, client lists, the prices the Company and its Affiliates obtain or have obtained from the saleof, or at which they sell or have sold, their products, unit volume of sales to past or present customers and clients, or any otherinformation concerning the business of the Company and its11Affiliates, their manner of operation, their plans, processes, figures, sales figures, projections, estimates, tax records, personnel history,accounting procedures, promotions, supply sources, contracts, know-how, trade secrets, information relating to research, development,inventions, technology, manufacture, purchasing, engineering, marketing, merchandising or selling, or other data without regard towhether all of the foregoing matters will be deemed confidential, material or important. Proprietary Information does not include anyinformation that Executive has obtained from a Person other than an employee of the Company or an Affiliate, which was disclosed to[her/him] without a breach of a duty of confidentiality.“Section 409A” means Section 409A of the Code.“Separation From Service” shall have the meaning ascribed to such term in Section 409A.“Specified Employee” means a person who is a “specified employee” within the meaning of Section 409A.“Subsidiary” means any company of which the Company owns securities having a majority of the ordinary voting power inelecting the board of directors directly or through one or more subsidiaries.“Termination Date” means the effective date of the termination of Executive’s employment.11. Notices.Any notice provided for in this Agreement must be in writing and must be mailed, personally delivered or sent by reputableovernight courier service (charges prepaid) to the recipient at the address below indicated:If to the Company:Rosetta Stone Ltd. 1621 North Kent St12th FloorArlington, VA 22209Attention: Chief Executive OfficerWith a copy to:Rosetta Stone Ltd. 1621 North Kent St12th FloorArlington, VA 22209Attention: General Counsel and SecretaryIf to Executive:12The last address on file with the Company.Or such other addresses or to the attention of such other person as the recipient party shall have specified by prior written notice to thesending party. Any notice under this Agreement will be deemed to have been given when delivered or, if mailed, five (5) businessdays after deposit in the U.S. mail.12. Miscellaneous.(a) Clawback/Recoupment. Notwithstanding any other provisions in this Agreement to the contrary, any incentive-basedcompensation, or any other compensation, paid to Executive pursuant to this Agreement or any other agreement or arrangement withthe Company which is subject to recovery under any law, government regulation or stock exchange listing requirement, will be subjectto such deductions and clawback as may be required to be made pursuant to such law, government regulation or stock exchange listingrequirement (or any policy adopted by the Company to comply with any such law, government regulation or stock exchange listingrequirement).(b) Severability. Whenever possible, each provision of this Agreement will be interpreted in such manner as to be effectiveand valid under applicable law, but if any provision of this Agreement is held to be invalid, illegal or unenforceable in any respectunder any applicable law or rule in any jurisdiction, such invalidity, illegality or unenforceability will not affect any other provision orany other jurisdiction, but this Agreement will be reformed, construed and enforced in such jurisdiction as if such invalid, illegal orunenforceable provision had never been contained herein.(c) Complete Agreement. This Agreement, those documents expressly referred to herein and other documents of even dateherewith embody the complete agreement and understanding among the parties and supersede and preempt any prior understandings,agreements or representations by or among the parties, written or oral, which may have related to the subject matter hereof in any way.(d) Counterparts; Facsimile Transmission. This Agreement may be executed in separate counterparts, each of which isdeemed to be an original and all of which taken together constitute one and the same agreement. Each party to this Agreement agreesthat its own telecopied signature will bind it and that it accepts the telecopied signature of each other party to this Agreement.(e) Successors and Assigns. Except as otherwise provided herein, this Agreement shall bind and inure to the benefit of andbe enforceable by Executive, the Company and their respective successors and assigns; provided that the rights and obligations of theparties under this Agreement shall not be assignable without the prior written consent of the other party, except for assignments byoperation of law and assignments by the Company to any successor of the Company by merger, consolidation, combination or sale ofassets. Any purported assignment in violation of these provisions shall be void ab initio.13(f) Choice of Law; Jurisdiction. All questions or disputes concerning this Agreement and the exhibits hereto will begoverned by and construed in accordance with the internal laws of the Commonwealth of Virginia, without giving effect to any choiceof law or conflict of law provision or rule (whether of the Commonwealth of Virginia or any other jurisdiction) that would cause theapplication of the laws of any jurisdiction other than the Commonwealth of Virginia. The parties hereby: (i) submit to the non-exclusive jurisdiction of any state or federal court sitting in the Commonwealth of Virginia in any action or proceeding arising out of orrelating to this Agreement; and (ii) agree that all claims in respect of such action or proceeding may be heard or determined in any suchcourt. Each party hereby waives any defense of inconvenient forum to the maintenance of any action or proceeding so brought. Theparties hereby agree that a final judgment in any action or proceeding so brought shall be conclusive and may be enforced by suit onthe judgment or in any other manner provided by law.(g) Remedies. Each of the parties to this Agreement will be entitled to enforce its rights under this Agreement specifically, torecover damages and costs (including attorney’s fees) caused by any breach of any provision of this Agreement and to exercise allother rights existing in its favor. The parties hereto agree and acknowledge that money damages may not be an adequate remedy forany breach of the provisions of this Agreement and that any party may in its sole discretion apply to any court of law or equity ofcompetent jurisdiction (without posting any bond or deposit) for specific performance and/or other injunctive relief in order to enforceor prevent any violations of the provisions of this Agreement.(h) Amendment and Waiver. The provisions of this Agreement may be amended or waived only with the prior writtenconsent of the Company and Executive.(i) Termination. This Agreement (except for the provisions of Sections 1, 2, 3, and 4) shall survive the termination ofExecutive’s employment with the Company and shall remain in full force and effect after such termination.(j) No Waiver. A waiver by any party hereto of any right or remedy hereunder on any one occasion shall not be construed asa bar to any right or remedy that such party would otherwise have on any future occasion. Neither failure to exercise nor any delay inexercising on the part of any party hereto, any right, power or privilege hereunder shall preclude any other or further exercise thereof orthe exercise of any other right, power or privilege. The rights and remedies herein provided are cumulative and may be exercisedsingly or concurrently, and are not exclusive of any rights or remedies provided by law.(k) Taxes; Withholding of Taxes on Behalf of Executive. Executive shall be solely responsible for any and all taxesimposed on Executive by reason of any compensation and benefits provided under this Agreement, and all such compensation andbenefits shall be subject to applicable withholding. Without limiting the scope of the preceding sentence, the Company and itsAffiliates shall be entitled to deduct or withhold from any amounts owing from the Company or any of its Affiliates to Executive anyfederal, state, provincial, local or foreign withholding taxes, excise taxes, or employment taxes imposed with respect to Executive’scompensation or other payments from the Company or any of its Affiliates or Executive’s ownership interest in the Company,including,14but not limited to, wages, bonuses, dividends, the receipt or exercise of stock options and/or the receipt or vesting of restricted stock.(l) Waiver of Jury Trial. BOTH PARTIES TO THIS AGREEMENT AGREE THAT ANY ACTION, DEMAND,CLAIM OR COUNTERCLAIM RELATING TO THE TERMS AND PROVISIONS OF THIS AGREEMENT, OR TOITS BREACH, MAY BE COMMENCED IN THE COMMONWEALTH OF VIRGINIA IN A COURT OF COMPETENTJURISDICTION. BOTH PARTIES TO THIS AGREEMENT FURTHER AGREE THAT ANY ACTION, DEMAND,CLAIM OR COUNTERCLAIM SHALL BE RESOLVED BY A JUDGE ALONE, AND BOTH PARTIES HEREBYWAIVE AND FOREVER RENOUNCE THAT RIGHT TO A TRIAL BEFORE A CIVIL JURY.13. Certain Additional Payments by the Company; Code Section 280G.(a) Anything in this Agreement to the contrary notwithstanding, if any payment or benefit Executive would receive pursuantto this Agreement ("Payment") would (i) constitute a "parachute payment" within the meaning of Section 280G of the Code, and (ii)but for this sentence, be subject to the excise tax imposed by Section 4999 of the Code (the "Excise Tax"), then such Payment shall bereduced to the Reduced Amount. The "Reduced Amount" shall be either (x) the largest portion of the Payment that would result in noportion of the Payment being subject to the Excise Tax or (y) the largest portion, up to and including the total, of the Payment,whichever amount, after taking into account all applicable federal, state and local employment taxes, income taxes, and the Excise Tax(all computed at the highest applicable marginal rate), results in Executive’s receipt, on an after-tax basis, of the greater amount of thePayment notwithstanding that all or some portion of the Payment may be subject to the Excise Tax. If a reduction in payments orbenefits constituting "parachute payments" is necessary so that the Payment equals the Reduced Amount, reduction shall occur in thefollowing order: (A) payments which do not constitute nonqualified deferred compensation subject to Section 409A; (B) cashpayments shall be reduced first and in reverse chronological order such that the cash payment owed on the latest date following theoccurrence of the event triggering such Excise Tax will be the first cash payment to be reduced; and (C) employee benefits shall bereduced last (but only to the extent such benefits may be reduced under applicable law, including, but not limited to the Code and theEmployee Retirement Income Security Act of 1974, as amended) and in reverse chronological order such that the benefit owed on thelatest date following the occurrence of the event triggering such Excise Tax will be the first benefit to be reduced. Any reduction shallbe made in accordance with Section 409A.(b) The determinations and calculations required hereunder shall be made by nationally recognized accounting firm that isselected by the Company (the “Accounting Firm”). The Company shall bear all expenses with respect to the determinations by theAccounting Firm required to be made hereunder(c) The Accounting Firm engaged to make the determinations hereunder shall provide its calculations, together with detailedsupporting documentation, to the Company and Eligible Employee within fifteen (15) business days after the date on which right to aPayment is triggered (if requested at that time by the Company or Executive) or such other time as requested by the15Company or Executive. Any good faith determinations of the Accounting Firm made hereunder shall be final, binding and conclusiveupon the Company and Executive.14. Indemnification.During and following the employment period, the Company shall indemnify Executive and hold Executive harmless from andagainst any claim, loss or cause of action arising from or out of Executive’s performance as an officer, director or employee of theCompany or any of its Affiliates or in any other capacity, including any fiduciary capacity, in which Executive serves at the request ofCompany to the maximum extent permitted by applicable law and the Company’s By-Laws, as in effect from time to time. Expensesincurred in defending or investigating a threatened or pending action, suit or proceeding shall be paid directly by the Company inadvance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of Executive to repaysuch amount if it shall ultimately be determined that he is not entitled to be indemnified by the Company. To the extent that theCompany reduces the indemnity rights provided for under its By-Laws after execution of this Agreement, the Company’s indemnityobligations hereunder shall be unaffected (to the extent permitted by applicable law).15. Section 409A.Although the Company does not guarantee to Executive any particular tax treatment relating to the payments and benefitsunder this Agreement, the parties acknowledge that this Agreement is intended to comply with, or be exempt from, the requirements ofSection 409A.For purposes of this Agreement, a termination of employment will mean a “separation from service” as defined in Section409A, where required for compliance with Section 409A.With regard to any provision of this Agreement that provides for reimbursement of costs and expenses or in-kind benefits,except as permitted by Section 409A, (i) the right to reimbursement or in-kind benefits shall not be subject to liquidation or exchangefor another benefit; (ii) the amount of expenses eligible for reimbursement, or in-kind benefits, provided during any taxable year shallnot affect the expenses eligible for reimbursement, or in-kind benefits to be provided, in any other taxable year; and (iii) such paymentsshall be made on or before the last day of the service provider’s taxable year following the taxable year in which the expense wasincurred.Whenever a payment under this Agreement specifies a payment period with reference to a number of days (e.g., “payment shallbe made within sixty (60) days after termination”), the actual date of payment within the specified period shall be within the solediscretion of the Company.[Signature pages follow]16IN WITNESS WHEREOF, the parties hereto have executed this Agreement on the date first written above.ROSETTA STONE LTD.By: /s/ John Hass Name: John HassTitle: President & Chief Executive OfficerEXECUTIVE/s/ Nicholas C. Gaehde Nicholas C. Gaehde17EXHIBIT AForm of Release18CONSULT WITH AN ATTORNEY PRIOR TO SIGNING THIS AGREEMENT AND GENERAL RELEASE. BYSIGNING THIS AGREEMENT AND GENERAL RELEASE YOU GIVE UP AND WAIVE IMPORTANT LEGALRIGHTS.Agreement and General ReleaseThis Agreement and General Release (“Release”) is between Rosetta Stone Ltd. (the “Company”) and Nicholas C. Gaehde(“Executive”) (each a “Party,” and together, the “Parties”). For purposes of this Release “Effective Date” shall mean the date that isthe eighth day after the date on which Executive signs this Release, provided Executive has not revoked this Release pursuant toSection 2(c) below.RecitalsA. Executive and the Company are parties to an Employment Agreement to which this Release is appended as Exhibit A(the “Employment Agreement”).B. In addition to the Accrued Obligation (as defined in the Employment Agreement), Executive wishes to receive the otherpayments and benefits described Section 6(a) of the Employment Agreement.C. Executive and the Company wish to resolve, except as specifically set forth herein, all claims between them arising fromor relating to any act or omission predating the Separation Date defined below.AgreementThe Parties agree as follows:1. Confirmation of Severance Package Obligation. The Company shall pay or provide to Executive the entire SeverancePayments and Severance Benefits as provided in Section 6(a) of the Employment Agreement, if Executive executes and does notrevoke this Release. The Severance Payments, together with the Severance Benefits described in Sections 6(a)(i), (ii), (iii) and (iv) ofthe Employment Agreement, are referred to herein as the “Severance Package.”2. Legal Releases(a) Executive, on behalf of Executive and Executive’s heirs, personal representatives and assigns, and any otherperson or entity that could or might act on behalf of Executive, including, without limitation, Executive’s counsel (all of whom arecollectively referred to as “Executive Releasers”), hereby fully and forever releases and discharges the Company, its present andfuture affiliates and subsidiaries, and each of their past, present and future officers, directors, employees, shareholders, independentcontractors, attorneys, insurers and any and all other persons or entities that are now or may become liable to any Executive Releaserdue to any Executive Releasee’s act or omission, (all of whom are collectively referred to as “Executive19Releasees”) of and from any and all actions, causes of action, claims, demands, costs and expenses, including attorneys’ fees, of everykind and nature whatsoever, in law or in equity, whether now known or unknown, that Executive Releasers, or any person actingunder any of them, may now have, or claim at any future time to have, based in whole or in part upon any act or omission occurring onor before the Effective Date, without regard to present actual knowledge of such acts or omissions, including specifically, but not byway of limitation, matters which may arise at common law, such as breach of contract, express or implied, promissory estoppel,wrongful discharge, tortious interference with contractual rights, infliction of emotional distress, defamation, or under federal, state orlocal laws, such as the Fair Labor Standards Act, the Employee Retirement Income Security Act, the National Labor Relations Act,Title VII of the Civil Rights Act of 1964, the Age Discrimination in Employment Act, the Rehabilitation Act of 1973, the Equal PayAct, the Americans with Disabilities Act, the Family and Medical Leave Act, and any civil rights law of any state or othergovernmental body; PROVIDED, HOWEVER, that notwithstanding the foregoing or anything else contained in this Release, therelease set forth in this Section shall not extend to: (i) any rights arising under this Release; (ii) any vested rights under any pension,retirement, profit sharing or similar plan; (iii) any rights Executive has under any grants of stock options, restricted stock, or other formsof equity that may have been provided to Executive during Executive’s employment (such grants to be governed by the applicableequity plan and grant agreement); (iv) any rights Executive has under applicable workers compensation laws; (v) Executive’s rights, ifany, to indemnification, and/or defense under any Company certificate of incorporation, bylaw and/or policy or procedure, or underany insurance contract or any indemnification agreement with the Company, in connection with Executive’s acts and omissions withinthe course and scope of Executive’s employment with the Company; (vi) Executive’s ability to communicate with the EqualEmployment Opportunity Commission (EEOC) or any other governmental agency, provided Executive does not seek any personalrelief for any claims released herein; (vii) any claims arising after the date of Executive’s execution of this Release; (viii) anyobligations of the Company under the Employment Agreement which survive Executive’s termination of employment; or (viii) anyother claims that cannot lawfully be released. Executive hereby warrants that Executive has not assigned or transferred to any personany portion of any claim, which is released, waived and discharged above. Executive further states and agrees that Executive has notexperienced any illness, injury, or disability that is compensable or recoverable under the worker’s compensation laws of any state thatwas not reported to the Company by Executive before the Effective Date, and Executive agrees not to not file a worker’scompensation claim asserting the existence of any such previously undisclosed illness, injury, or disability. Executive has specificallyconsulted with counsel with respect to the agreements, representations, and declarations set forth in the previous sentence. Executiveunderstands and agrees that by signing this Release Executive is giving up any right to bring any legal claim against the Companyconcerning, directly or indirectly, Executive’s employment relationship with the Company, including Executive’s separation fromemployment. Executive agrees that this legal release is intended to be interpreted in the broadest possible manner in favor of theCompany, to include all actual or potential legal claims that Executive may have against the Company, except as specifically providedotherwise in this Release.(b) In order to provide a full and complete release, each of the Parties understands and agrees that this Release isintended to include all claims, if any, covered under this Section 2 that such Party may have and not now know or suspect to exist insuch Party’s favor against any20other Party and that this Release extinguishes such claims. Thus, each of the Parties expressly waives all rights under any statute orcommon law principle in any jurisdiction that provides, in effect, that a general release does not extend to claims which the releasingparty does not know or suspect to exist in such Party’s favor at the time of executing the release, which if known by such Party musthave materially affected such Party’s settlement with the party being released.(c) Executive acknowledges that he consulted with an attorney of his choosing before signing this Release, and thatthe Company provided him with no fewer than twenty-one (21) days during which to consider the provisions of this Release and,specifically the release set forth at Section 2(a) above, although Executive may sign and return the Release sooner if he so chooses.Executive further acknowledges that he has the right to revoke this Release for a period of seven (7) days after signing it and that thisRelease shall not become effective until such seven (7)-day period has expired. Executive acknowledges and agrees that if he wishes torevoke this Release, he must do so in writing, and that such revocation must be signed by Executive and received by the Company incare of the Chief Executive Officer no later than 5 p.m. (Eastern Time) on the seventh (7th) day after Executive has signed thisRelease. Executive acknowledges and agrees that, in the event that he revokes this Release, he shall have no right to receive theSeverance Package. Executive represents that he has read this Release, including the release set forth in Section 2(a), above, affirmsthat this Release provides him with benefits to which she would not otherwise be entitled, and understands its terms and that he entersinto this Release freely, voluntarily, and without coercion.3. Executive acknowledges that he has received all compensation to which he is entitled for him work up to his last day ofemployment with the Company, and that he is not entitled to any further pay or benefit of any kind, for services rendered or any otherreason, other than the Severance Package, and any expense reimbursement due pursuant Section 3(d)(ii) of the EmploymentAgreement.5. The Parties agree that their respective rights and obligations under the Employment Agreement shall survive the executionof this Release.6. The parties understand and agree that this Release shall not be construed as an admission of liability on the part of anyperson or entity, liability being expressly denied.7. Executive represents and warrants to the Company that, prior to the Effective Date, Executive did not disclose to anyperson, other than to Executive’s spouse, tax advisor and counsel, the terms of this Release or the circumstances under which thematter that is the subject of this Release has been resolved. After the Effective Date, neither Executive, counsel for Executive, nor anyother person under Executive’s control shall disclose any term of this Release or the circumstances of Executive’s separation from theCompany, except that Executive may disclose such information to Executive’s spouse, or as required by subpoena or court order, or toan attorney or accountant to the extent necessary to obtain professional advice. Executive shall not be entitled to rely upon theforegoing exception for disclosures pursuant to subpoena or court order unless Executive has given the Company written notice, withinthree business days following service of the subpoena or court order.218. Executive covenants never to disparage or speak ill of the Company or any the Company product or service, or of any pastor present employee, officer or director of the Company, nor shall Executive at any time harass or behave unprofessionally toward anypast, present or future the Company employee, officer or director.9. Executive acknowledges that because of Executive’s position with the Company, Executive may possess information thatmay be relevant to or discoverable in connection with claims, litigation or judicial, arbitral or investigative proceedings initiated by aprivate party or by a regulator, governmental entity, or self-regulatory organization, that relates to or arises from matters with whichExecutive was involved during Executive’s employment with the Company, or that concern matters of which Executive hasinformation or knowledge (collectively, a “Proceeding”). Executive agrees that Executive shall testify truthfully in connection withany such Proceeding, shall cooperate with the Company in connection with every such Proceeding, and that Executive’s duty ofcooperation shall include an obligation to meet with the Company representatives and/or counsel concerning all such Proceedings forsuch purposes, and at such times and places, as the Company reasonably requests, and to appear for deposition and/or testimony uponthe Company’s request and without a subpoena. The Company shall reimburse Executive for reasonable out-of-pocket expenses thatExecutive incurs in honoring Executive’s obligation of cooperation under this Section 9.10. Miscellaneous Terms and Conditions(a) Each party understands and agrees that Executive or it assumes all risk that the facts or law may be, or become,different than the facts or law as believed by the party at the time Executive or it executes this Release. Executive and the Companyacknowledge that their relationship precludes any affirmative obligation of disclosure, and expressly disclaim all reliance uponinformation supplied or concealed by the adverse party or its counsel in connection with the negotiation and/or execution of thisRelease.(b) The parties warrant and represent that they have been offered no promise or inducement except as expresslyprovided in this Release, and that this Release is not in violation of or in conflict with any other agreement of either party.(c) All covenants and warranties contained in this Release are contractual and shall survive the closing of this Release.(d) This Release shall be binding in all respects upon, and shall inure to the benefit of, the parties’ heirs, successorsand assigns.(e) This Release shall be governed by the internal laws of the Commonwealth of Virginia, irrespective of the choiceof law rules of any jurisdiction.(f) Should any provision of this Release be declared illegal or unenforceable by any court of competent jurisdictionand cannot be modified to be enforceable, such provision shall immediately become null and void, leaving the remainder of thisRelease in full force and effect. Notwithstanding the foregoing, if Section 2(a), above, is declared void or unenforceable, then this22Release shall be null and void and both parties shall be restored to the positions that they occupied before the Release’s execution(meaning that, among other things, all sums paid by the Company pursuant to Section 1, above, shall be immediately refunded to theCompany); provided that in such circumstances this Release and the facts and circumstances relating to its execution shall beinadmissible in any later proceeding between the parties, and the statutes of limitations applicable to claims asserted in the proceedingshall be deemed to have been tolled for the period between the Effective Date and 10 days after the date on which Section 2(a) isdeclared unenforceable.(g) This Release constitutes the entire agreement of the parties and a complete merger of prior negotiations andagreements.(h) This Release shall not be modified except in a writing signed by the parties.(i) No term or condition of this Release shall be deemed to have been waived, nor shall there be an estoppel againstthe enforcement of any provision of this Release, except by a writing signed by the party charged with the waiver or estoppel. Nowaiver of any breach of this Release shall be deemed a waiver of any later breach of the same provision or any other provision of thisRelease.(j) Headings are intended solely as a convenience and shall not control the meaning or interpretation of any provisionof this Release.(k) Pronouns contained in this Release shall apply equally to the feminine, neuter and masculine genders. Thesingular shall include the plural, and the plural shall include the singular.(l) Each party shall promptly execute, acknowledge and deliver any additional document or agreement that the otherparty reasonably believes is necessary to carry out the purpose or effect of this Release.(m) Any party contesting the validity or enforceability of any term of this Release shall be required to prove by clearand convincing evidence fraud, concealment, failure to disclose material information, unconscionability, misrepresentation or mistakeof fact or law.(n) The parties acknowledge that they have reviewed this Release in its entirety and have had a full and fairopportunity to negotiate its terms and to consult with counsel of their own choosing concerning the meaning and effect of this Release.Each party therefore waives all applicable rules of construction that any provision of this Release should be construed against itsdrafter, and agrees that all provisions of the agreement shall be construed as a whole, according to the fair meaning of the languageused.(o) Every dispute arising from or relating to this Release shall be tried only in the state or federal courts situated in theCommonwealth of Virginia. The parties consent to venue in those courts, and agree that those courts shall have personal jurisdictionover them in, and subject matter jurisdiction concerning, any such action.23(p) In any action relating to or arising from this Release, or involving its application, the party substantially prevailingshall recover from the other party the expenses incurred by the prevailing party in connection with the action, including court costs andreasonable attorneys’ fees. If Executive is the substantially prevailing party, the Company shall pay such expenses within 60 daysfollowing the determination that he is the substantially prevailing party.(q) This Release may be executed in counterparts, or by copies transmitted by telecopier, all of which shall be giventhe same force and effect as the original.[SIGNATURES FOLLOW]24NOTE: DO NOT SIGN THIS SUPPLEMENTAL LEGAL RELEASE UNTIL AFTER EXECUTIVE’S FINAL DAY OFEMPLOYMENT.ROSETTA STONE LTD. By: A. John Hass IIIDate: EXECUTIVE By: Nicholas C. GaehdeDate: 25Exhibit 21.1ROSETTA STONE INC. SUBSIDIARIESAs of March 7, 2018 EntityJurisdiction of IncorporationRosetta Stone Holdings Inc. DelawareRosetta Stone Ltd. (Formerly Fairfield & Sons Ltd. d/b/a Fairfield Language Technologies)VirginiaRosetta Stone International Inc. DelawareRosetta Stone Brazil Holdings LLCDelawareRosetta Stone (UK) LimitedEngland and WalesRosetta Stone GmbHGermanyRosetta Stone Canada Inc. CanadaRosetta Stone Hong Kong LimitedHong KongRosetta (Shanghai) Software Trading Co., Ltd.ShanghaiRosetta Stone Ensino de Linguas Ltda. BrazilRosetta Stone France SASFranceLexia Learning Systems LLC (formerly Lexia Learning Systems Inc.)DelawareRosetta Stone S.A. (formerly Tell Me More S.A.)FranceAuralog Studios SARLFranceRosetta Stone Mexico SA de CV (formerly Auralog SA de CV)MexicoAuralog Software Development (Beijing) Company Ltd.ChinaRosetta Stone Spain SLSpainExhibit 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe consent to the incorporation by reference in Registration Statement Nos. 333-218215, 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 7, 2018, relating to the consolidatedfinancial statements of Rosetta Stone Inc. and subsidiaries, and the effectiveness of Rosetta Stone Inc. and subsidiaries' internal control over financialreporting, appearing in this Annual Report on Form 10-K of Rosetta Stone Inc. and subsidiaries for the year ended December 31, 2017./s/ DELOITTE & TOUCHE LLPMcLean, VirginiaMarch 7, 2018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 7, 2018Signature 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/ STEVEN P. YANKOVICH DirectorSteven P. Yankovich /s/ CAROLINE J. TSAY DirectorCaroline J. Tsay /s/ JESSIE WOOLLEY-WILSON DirectorJessie Woolley-Wilson 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 7, 2018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 7, 2018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, 2017, 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 7, 2018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, 2017, 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 7, 2018

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