Rosetta Stone Inc Annual Report 2018

Plain-text annual report

Table of Contents UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549 Form 10-K ☐☐ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2018Commission file number: 1-34283Rosetta Stone Inc.(Exact name of registrant as specified in its charter) Delaware 043837082(State of incorporation) (I.R.S. EmployerIdentification No.) 1621 North Kent Street, Suite 1200 22209Arlington, Virginia (Zip Code)(Address of principal executive offices) 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 Exchange Securities 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 ☐ No ☒Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ☐ No ☒Indicate 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 1934 during the preceding12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit andpost such files). Yes ☒ No ☐Indicate 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, to the best of the registrant'sknowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growthcompany. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Checkone): Large accelerated filer ☐ Smaller reporting company ☐Accelerated filer ☒(Do not check if a smaller reporting company) Emerging growth company ☐Non-accelerated filer ☐ If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financialaccounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒The aggregate market value of the common stock held by non-affiliates of the registrant was approximately $ 267.9 million as of June 30, 2018 (based on the last sale price ofsuch stock as quoted on the New York Stock Exchange). All executive officers and directors of the registrant and all persons filing a Schedule 13D with the Securities and ExchangeCommission in respect of registrant's common stock have been deemed, solely for the purpose of the foregoing calculation, to be "affiliates" of the registrant.As of February 27, 2019, there were 23,640,971 shares of common stock outstanding.Documents incorporated by reference: Portions of the definitive Proxy Statement to be delivered to stockholders in connection with the 2019 Annual Meeting ofStockholders to be held on May 16, 2019 are incorporated by reference into Part III. Table of Contents TABLE OF CONTENTS PagePART IItem 1.Business4Item 1A.Risk Factors8Item 1B.Unresolved Staff Comments22Item 2.Properties23Item 3.Legal Proceedings23Item 4.Mine Safety Disclosures23PART IIItem 5.Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities24Item 6.Selected Financial Data26Item 7.Management's Discussion and Analysis of Financial Condition and Results of Operations27Item 7A.Quantitative and Qualitative Disclosures About Market Risk47Item 8.Financial Statements and Supplementary Data47Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure47Item 9A.Controls and Procedures47Item 9B.Other Information48PART IIIItem 10.Directors, Executive Officers and Corporate Governance49Item 11.Executive Compensation49Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters49Item 13.Certain Relationships and Related Transactions, and Director Independence49Item 14.Principal Accounting Fees and Services49PART IVItem 15.Exhibits and Financial Statement Schedules50Item 16.Form 10-K Summary53 Table of Contents PART IFORWARD-LOOKING STATEMENTSThis 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 Contents Item 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 learners who need to speak and read English. This focus extends to theConsumer Language segment, where we continue to make product investments serving the needs of passionate language-learners who are mobile, results-focused and value a quality language-learning experience.To position the organization for success, our focus is on the following priorities: 1.Focus on growing our K-12 business; 2.Position ourselves as a leader in virtual blended learning; and 3.Accelerate growth and increase intrinsic value.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 recently completed a SaaS migration from apackaged software business. For additional information regarding our segments, see Note 18 of Item 8, Financial Statements and Supplementary Data. Priorperiods 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 reading skills development, predicts students' year-end performance and provides teachers with data-drivenaction plans to help differentiate instruction. Lexia Reading Core5 is available for all abilities from pre-K through grade 5. PowerUp Literacy is designed fornon-proficient readers in grades 6 and above. Lexia RAPID Assessment is a computer-adaptive screener and diagnostic tool for grades K-12 that identifiesand monitors reading and language skills to provide actionable data for instructional planning. Lexia's solutions deliver performance data and analysis toenable teachers to monitor and modify their instruction to address specific student needs. These literacy solutions are provided under web-basedsubscriptions. Our service offerings provide schools with product implementation services to support strong educator and student use. These services arepurchased 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 solution4Table of Contents serves multinational companies seeking to build their employees’ English language proficiency so they are able to communicate and operate in a globalbusiness environment. Our Catalyst product consolidates and aligns our Foundations, Advantage and Advanced English for Business products into a singlesolution for our enterprise customers. Catalyst provides streamlined access and simplified pricing for the full suite of English and world language learningcontent, along with assessment, placement, ongoing reporting and demonstration of results, all of which address important customer needs to focus anddemonstrate payback. Specifically designed for use with our language-learning solutions, our E&E Language customers may also purchase our audio practiceproducts and live tutoring sessions to enhance the learning experience.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 customsolutions.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. Ourteam works 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 more than 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, Amazon App Store for Android andSamsung Galaxy App Store.Rosetta Stone Language-Learning Solutions: Rosetta Stone provides intuitive, easy-to-use language-learning programs that can be purchasedprimarily as 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 apps includes companions toour 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.Customers and Distribution ChannelsNo customer accounted for more than 10% of consolidated revenue during the years ended December 31, 2018, 2017, and 2016. Most of our businessis SaaS based; consequently, backlog is not significant.5Table of Contents 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 saleof Lexia 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 includingsuperintendents, procurement officers, principals and teachers. For instance, we participate in associations and events, including as a sponsor, at which suchemployees are present. We also invite these employees to events hosted by us, at which we discuss general educational developments as well as our productsand services, and to serve on customer advisory boards to provide feedback on our products and services. We sometimes, and as permissible, pay the travelexpenses of school 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 (“DTC”). Sales generated through our e-commerce website at www.rosettastone.com, app stores such as Google Play and AppleApp Store and our call centers.Indirect to consumer. Sales generated through arrangements with third-party e-commerce websites and consignment distributors such as SoftwarePackaging Associates.Retailers. Our retailers enable us to provide additional points of contact to educate consumers about our solutions, expand our presence beyond ourown websites, and further strengthen and enhance our brand image. Our retail relationships include Amazon.com, Barnes & Noble, Target, Best Buy, 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. Consequently, physical inventory isnot significant.Our physical inventory utilizes a flexible and low-cost manufacturing base. We use a third-party logistics company to obtain substantially all of ourpackaging components, which primarily consist of boxes for our language learning product and audio practice products, and to manufacture and fulfillfinished product. We believe that we have good relationships with our vendors and that there are alternative sources in the event that one or more of thesevendors is not available. We continually review our manufacturing and supply needs against the capacity of our contract manufacturers and suppliers with aview to ensuring that we are able to meet our production goals, reduce costs and operate more efficiently.6Table of Contents 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. The language-learning market ishighly fragmented globally and consists of a variety of instructional and learning modes: classroom instruction utilizing the traditional approach ofmemorization, grammar and translation; immersion-based classroom instruction; self-study books, audio recordings and software that rely primarily ongrammar and translation; and free online and mobile offerings that provide content and opportunities to practice writing and speaking.SeasonalityOur business is affected by variations in seasonal trends. Within our Literacy segment and K-12 Language education sales channel, sales areseasonally stronger in the second and third quarters of the calendar year corresponding to the end and beginning of school district budget years. E&ELanguage segment sales in our government and corporate sales channels are seasonally stronger in the second half of the calendar year due to purchasing andbudgeting cycles. Consumer Language sales are affected by seasonal trends associated with the holiday shopping season. In particular, we generate a largeportion of our Consumer 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.We have sixteen U.S. patents, thirteen 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 PowerUPLiteracy, TruAccent, and Catalyst. These trademarks are the subject of either registrations or pending applications in the U.S., as well as numerous countriesworldwide where we do business. We have been issued trademark registrations for our yellow color from the U.S. Patent and Trademark Office. We intend tocontinue to strategically register, both domestically and internationally, trademarks we use today and those we develop in the future. We believe that thedistinctive marks that we use in connection with our solutions are important in building our brand image and distinguishing our offerings from those of ourcompetitors. 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.We intend to continue to strategically register copyrights in our various products. We also place significant value on our trade dress, which is the overallimage and 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, 2018, we had 1,040 total employees, consisting of 723 full-time and 317 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.7Table of Contents 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 reportsfiled or 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 ourwebsite as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our website address iswww.rosettastone.com. The information contained in, or that can be accessed through, our website is not part of, and is not incorporated into, this AnnualReport 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.These materials may be obtained electronically by accessing the SEC's website at www.sec.gov.Item 1A. Risk FactorsThe following description of risk factors includes any material changes to, and supersedes the description of, risk factors associated with our businesspreviously disclosed in our Quarterly Report on Form 10-Q filed on November 6, 2018 with the SEC for the period ended September 30, 2018. An investmentin our common stock involves a substantial risk of loss. Investors should carefully consider these risk factors, together with all of the other informationincluded herewith, before deciding to purchase shares of our common stock. If any of the following risks actually occur, our business, financial condition, orresults of operations could be materially adversely affected. In such case, the market price of our common stock could decline and all or part of an investmentmay be lost.The risks described below are not the only ones facing us. Our business is also subject to the risks that affect many other companies, such as generaleconomic conditions and geopolitical events. Further, additional risks not currently known to us or that we currently believe are immaterial could have amaterial adverse effect on our business, financial condition, cash flows and results of operations. In addition to the other information set forth in this annualreport on Form 10-K, you should carefully consider the risk factors discussed below and in other documents we file with the SEC that could materially affectour business, financial condition, cash flows or future results.We might not be successful in executing our strategy of focusing on learners who need to speak and read English and passionate language learners whoare mobile.We are continuing to implement our strategy to emphasize the development of products and solutions for learners who need to speak and read English.This focus extends to the Consumer Language segment, where we continue to make product investments serving the needs of passionate language learnerswho are mobile, results-focused and value a quality language-learning experience. If we do not successfully execute our strategy, our revenue andprofitability 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 ofrelease. This guidance, which includes forward-looking statements, is based on projections prepared by management. These projections are not prepared witha view toward compliance with published guidelines of the American Institute of Certified Public Accountants, and neither our registered public accountantsnor any other independent expert or outside party confirms or examines the projections and, accordingly, no such person expresses any opinion or any otherform of assurance with respect thereto.Projections are based upon a number of assumptions and estimates that, while presented with numerical specificity, are inherently subject tosignificant business, economic and competitive uncertainties and contingencies, many of which are beyond our control and are based upon specificassumptions with respect to future business decisions, some of which will change. We generally state possible outcomes as high and low ranges or as singlepoint estimates, but actual results could differ materially. The principal reason that we release guidance is to provide a basis for management to discuss ourbusiness outlook with analysts 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.8Table of Contents 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 at significantly lower prices or for free. As free onlinetranslation services improve and become more widely available and used, people may generally become less interested in language learning. Although wealso offer free products such as mobile apps, if we cannot successfully attract users of these free products and convert a sufficient portion of these free usersinto paying customers, our business could be adversely affected. If free products become more engaging and competitive or gain widespread acceptance bythe public, demand for our products could decline or we may have to lower our prices, which could adversely impact our revenue and other results.Historically a substantial portion of our revenue has been generated from our Consumer 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 andtrends in consumer preferences. Therefore, our success depends upon our ability to: •identify, anticipate, understand and respond to these trends in a timely manner; •introduce appealing new products and performance features on a timely basis; •provide appealing solutions that engage our customers; •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.9Table of Contents 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.Because 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 ona key group that is comprised of a mix of websites, such as Amazon.com, app stores, such as the Apple App Store and the Google Play Store, select retailresellers, such as Barnes & Noble, Best Buy, Target, and Staples, and consignment distributors such as Software Packaging Associates.We have no control over the quantity of products that 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, websites and app stores undertake can affect the sales of our products. The fact that we also sell our products directlycould cause retailers, websites, app stores or distributors 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.In the U.S. and Canada, we offer consumers who purchase our web-based software, packaged software and audio practice products directly from us a30-day, unconditional, full money-back refund. We also permit some of our retailers and distributors to return products, subject to certain limitations. Weestablish revenue reserves for product returns based on historical experience, estimated channel inventory levels, the timing of new product introductions andother factors. If product returns exceed our reserve estimates, the excess would offset reported revenue, which could adversely affect our reported financialresults.10Table of Contents Our future growth and profitability will depend in large part upon the effectiveness and efficiency of our marketing.Our future growth and profitability will depend in large part upon the effectiveness and efficiency of our marketing, including our ability to: •appropriately and efficiently allocate our marketing for multiple products; •accurately identify, target and reach our audience of potential customers with our marketing messages; •select the right marketplace, media and specific media vehicle in which to advertise; •identify the most effective and efficient level of spending in each marketplace, media and specific media vehicle; •determine the appropriate creative message and media mix for advertising, marketing and promotional expenditures; •effectively manage marketing costs, including creative and media expenses, in order to maintain acceptable customer acquisition costs; •differentiate our products as compared to other products; •create greater awareness of our new products, 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 2016, we decided to eliminate our direct sales presence in almost all of our non-U.S. and non-northern European geographies related to thedistribution of the E&E Language offerings, relying on indirect sales channels through reseller and other arrangements with third parties in thosegeographies. We also have optimized certain of our website sales channels in Europe, Asia and Latin America. If we are unable to conduct our internationaloperations successfully and market, sell, deliver and support our products and services internationally to the extent we expect, our business, revenue andfinancial 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.11Table of Contents We offer our software products on operating systems and platforms including Windows, Macintosh, Apple OS, Android, and Amazon apps. Thedemand for traditional desktop computers has been declining, while the demand for mobile devices such as notebook computers, smartphones and tablets hasbeen increasing, which means that we must be able to market to potential customers and to provide customers with access to and use of our products andservices on many platforms and operating systems, as they may be changed from time to time. To the extent new releases of operating systems, including formobile and non-PC devices, or other third-party products, platforms or devices make it more difficult for our products to perform, and our customers usealternative technologies, our business could be harmed.Our software products must interoperate with computer operating systems of our customers. If we are unable to ensure that our products interoperateproperly with customer systems, our business could be harmed.Our products must interoperate with our customers' computer systems, including the network, security devices and settings, and student learningmanagement systems of our 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 although we are in the process of modifying our products to eliminate that reliance.Adobe Flash is one of the most versatile programming systems available and is unique in its ability to allow the integration of many forms of electronicformatted media into an interactive and user friendly system. However, in July 2015, certain vulnerabilities discovered in Adobe Flash led to temporaryinterruption of support for Adobe Flash by popular web browsers. As a result, some software makers are opting to exclude Adobe Flash from their webbrowsers. If similar interruptions occur in the future and disrupt our ability to provide our products to some or all of our users, our ability to generate revenuewould be harmed. Additionally, if Adobe Flash were to become deleted from Adobe’s product line or become not supported or updated to keep pace withcurrent computer hardware, then our software products would become obsolete very quickly. Any errors, bugs, vulnerabilities, or defects discovered in thesoftware 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 financial results.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.12Table of Contents We have completed our transition to a 100% SaaS-based model for our Consumer Language business and sell our solutions as subscriptions, rather thanpackaged software, our revenue, which could negatively affect our results of operations and cash flow.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. Our online and app-based products are sold under different subscription terms, from short-term (less than one year) to long-term (typically 12- to 24-months) subscriptions with a corresponding license term. Online and app-based subscription customers could be less likely to renewtheir subscriptions beyond the initial term with the effect that we could earn less revenue over time from each customer than historically which could have asubstantially negative 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.The possession and use of personal, financial and other information by us and our third party service providers presents risks and expenses that couldharm our business. If we or our service providers are unable to protect our information technology networks against service interruption or failure,misappropriation or unauthorized disclosure or manipulation of data, whether through breach of our network security or otherwise, we could be subject tocostly 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. Our use of new and emerging technologies such as cloud-based services and mobile applications continues toevolve, presenting new and additional risks in managing access to our data, including relying on third parties to manage and safeguard data. These thirdparty service providers receive or store information provided by us, our users or our employees. If these third parties fail to adopt or adhere to adequateinformation security practices, or fail to comply with our online policies, or in the event of a breach of their networks, our customers' or employees’ data maybe improperly accessed, used or disclosed. As our business and the regulatory environment evolve in the U.S. and internationally, we may become subject toadditional 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, industry standards or contractual obligations.13Table of Contents Despite our precautions and significant ongoing investments to protect against security risks, data protection breaches, cyber-attacks and otherintentional disruptions of our products and offerings, we may be a target of attacks specifically designed to impede the performance of our products andofferings and harm our reputation as a company. If our systems are harmed or fail to function properly or if third parties improperly obtain and use thepersonal information of our customers or employees, we may be required to expend significant resources to repair or replace systems or to otherwise protectagainst security breaches or to address problems caused by the breaches. A major breach of our network security and systems could have serious negativeconsequences for our businesses, including possible fines, penalties and damages, reduced customer demand for our products and services, harm to ourreputation and brand, and loss of our ability to accept and process customer credit card orders. Any such access, disclosure or loss of information could resultin legal claims or proceedings and regulatory penalties, disrupt our operations or result in a loss of confidence in our products and services, which could leadto 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 toour operations 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 agreed to an alternative transfer framework for data transferred from the European Union to the United States, calledthe Privacy Shield Framework. Rosetta Stone participates and has certified to its compliance to the Privacy Shield Framework. However, this framework alsofaces a number of legal challenges, is subject to an annual review that could result in changes to our obligations, and also may be challenged by nationalregulators or private parties. In addition, other available bases on which to rely for the transfer of EU personal data outside of the European Economic Area,such as standard Model Contractual Clauses (MCCs), have also been subjected to regulatory or judicial scrutiny. This has resulted in some uncertainty, andcompliance obligations could cause us to incur costs or require us to change our business practices in a manner adverse to our business. The UnitedKingdom’s decision to withdraw from the EU also has resulted in uncertainty with respect to compliance obligations with respect to data transfers betweenthe EU and the United Kingdom and the U.S. and the United Kingdom.14Table of Contents If one or more of the legal bases for transferring personal data from Europe to the United States is invalidated, or if we are unable to transfer personaldata between and among countries and regions in which Rosetta Stone operates, it could affect the manner in which we provide our services or adverselyaffect our financial results. Any failure, or perceived failure, by us to comply with or make effective modifications to our policies, or to comply with anyfederal, state, or international privacy, data-retention or data-protection-related laws, regulations, orders or industry self-regulatory principles could result inproceedings or actions against us by governmental entities or others, a loss of customer confidence, damage to the Rosetta Stone brands, and a loss ofcustomers, which could potentially have an adverse effect on our business.In addition, various federal, state and foreign legislative or regulatory bodies 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 came into force in May 2018. TheGDPR includes additional operational and other requirements for companies that receive or process personal data of residents of the European Union as wellas significant penalties for non-compliance. California recently enacted the Consumer Privacy Act of 2018, which will become effective January 1, 2020 andwill require companies to give California consumers information about what data they collect, as well as to delete data about consumers if requested.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 is unclear or unsettled in many instances. 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 usagebased pricing, including meaningful bandwidth caps, or otherwise try to monetize access to their networks by data providers, we could incur greateroperating expenses and our customer acquisition and retention could be negatively impacted. Furthermore, to the extent network operators were to createtiers of Internet access service and either charge us for or prohibit us from being available through these tiers, our business could be negatively impacted.15Table of Contents We are exposed to risks associated with credit card and payment fraud, and with our obligations under rules on credit card processing and alternativepayment methods, which could cause us to lose revenue or incur costs. We depend upon our credit card processors and payment card associations.As an e-commerce provider that accepts debit and credit cards for payment, we are subject to the Payment Card Industry Data Security Standard ("PCIDSS"), issued by the PCI Council. PCI DSS contains compliance guidelines and standards with regard to our network security surrounding the physical andelectronic storage, processing and transmission of individual cardholder data. Despite our compliance with these standards and other information securitymeasures, we cannot guarantee that all our information technology systems are able to prevent, contain or detect any cyber attacks, cyber terrorism, orsecurity breaches from currently known viruses or malware, or viruses or malware that may be developed in the future. To the extent any disruption results inthe loss, damage or misappropriation of information, we may be adversely affected by claims from customers, financial institutions, regulatory authorities,payment card associations and others. In addition, the cost of complying with stricter privacy and information security laws and standards could besignificant.We are subject to rules, regulations and practices governing our accepted payment methods which could change or be reinterpreted to make it difficultor impossible for us to comply. A failure to comply with these rules or requirements could make us subject to fines and higher transaction fees and we couldlose our ability to accept these payment methods. We depend upon our credit card processors to carry out our sales transactions and remit the proceeds to us.At any time, credit card processors have the right to withhold funds otherwise payable to us to establish or increase a reserve based on their assessment of theinherent risks of credit card processing and their assessment of the risks of processing our customers’ credit cards. If our credit card processors exercise theirright to establish or increase a reserve, it may adversely impact our liquidity. Our business and results of operations could be adversely affected if thesechanges were to occur.The uncertainty surrounding the terms of the United Kingdom's withdrawal from the European Union and its consequences could cause disruptions andcreate uncertainty to our businesses and adversely impact consumer and investor confidence in our products and services.In June 2016, a majority of voters in the United Kingdom elected to withdraw from the European Union in a national referendum (also referred to as"Brexit"). The referendum was advisory, and by the terms of the Treaty on European Union, withdrawal is subject to a negotiation period that is scheduled toexpire in March 2019. The ultimate effects of Brexit on us are difficult to predict, but because we currently conduct business in the United Kingdom and inEurope, the results of the referendum and any eventual withdrawal could cause disruptions and create uncertainty to our businesses, including affecting thebusiness of and/or our relationships with our customers and suppliers, as well as altering the relationship among tariffs and currencies, including the value ofthe British pound and the Euro relative to the U.S. dollar. Such disruptions and uncertainties could adversely affect our financial condition, operating results,and cash flows. Additionally, Brexit could result in legal uncertainty and potentially divergent national laws and regulations as new legal relationshipsbetween the United Kingdom and the European Union are established. The ultimate effects of Brexit on us will also depend on the terms of agreements, ifany, the United Kingdom and the European Union make to retain access to each other's respective markets either during a transitional period or morepermanently. Any of these effects, among others, could materially adversely affect our business, business opportunities, results of operations, and financialcondition.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 or uncertainty in general economic or political conditions in the United States or other regions could adversely affect our business. Forexample, the administration under President Donald Trump has made, or has indicated that it may propose, significant changes with respect to a variety ofissues, including education standards and funding, international trade agreements, import and export regulations, tariffs and customs duties, foreign relations,and immigration laws, that could 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 United Kingdom’s planned withdrawal from the EU as well as ongoing terroristactivity), may adversely impact (i) the ability or willingness of non-U.S. companies to transact business in the United States, including with the Company (ii)regulation and trade agreements affecting U.S. companies, (iii) global stock markets (including the New York Stock Exchange on which our common stock istraded), and (iv) general global economic conditions. All of these factors are outside of our control, but may nonetheless cause us to adjust our strategy inorder to compete effectively in global markets.16Table of Contents Any significant interruptions in the operations of our website, call center or third-party call centers, especially during the holiday shopping season, couldcause us to lose sales and disrupt our ability to process orders and deliver our solutions in a timely manner.We rely on our website, an in-house call center and third-party call centers, over which we have little or no control, to sell our solutions, respond tocustomer service and technical support requests and process orders. These activities are especially important during the holiday season and in particular theperiod beginning on Black Friday through the end of the calendar year. Any significant interruption in the operation of these facilities, including aninterruption caused by our failure to successfully expand or upgrade our systems or to manage these expansions or upgrades, or a failure of third-party callcenters to handle higher volumes of use, could reduce our ability to receive and process orders and provide products and services, which could result incancelled sales and loss of revenue and damage to our brand and reputation. These risks are more important during the holiday season, when many sales ofour products and services take place.We structure our marketing and advertising to drive potential customers to our website and call centers to purchase our solutions. If we experiencetechnical difficulties with our website or if our call center operators do not convert inquiries into sales at expected rates, our ability to generate revenue couldbe impaired. Training and retaining qualified call center operators is challenging due to the expansion of our product and service offerings and theseasonality of our business. If we do not adequately train our call center operators, they may not convert inquiries into sales at an acceptable rate.If any of our products or services contain defects or errors or if new product releases or services are delayed, our reputation could be harmed, resulting insignificant costs to us and impairing our ability to sell our solutions.If our products or services contain defects, errors or security vulnerabilities, our reputation could be harmed, which could result in significant costs tous and 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 may decide to upgrade our existing financial informationtechnology systems in order to automate controls that are currently performed manually. We may experience difficulties in transitioning to these upgradedsystems, including loss of data and decreases in productivity, as personnel become familiar with these new systems. In addition, our management informationsystems will require modification and refinement as our business needs change, which could prolong difficulties we experience with systems transitions, andwe may not always employ the most effective systems for our purposes. If we experience difficulties in implementing new or upgraded information systems orexperience significant system failures, or if we are unable to successfully modify our management information systems or respond to changes in our businessneeds, we may not be able to effectively manage our business and we may fail to meet our reporting obligations. In addition, as a result of the automation ofthese manual processes, the data produced may cause us to question the accuracy of previously reported financial results.Failure to maintain the availability of the systems, networks, databases and software required to operate and deliver our Internet-based products andservices could damage our reputation and cause us to lose revenue.We rely on internal and external systems, networks and databases maintained by us and third-party providers to process customer orders, handlecustomer service requests, and host and deliver our Internet-based learning solutions. Any damage, interruption or failure of our systems, networks anddatabases could prevent us from processing customer orders and result in degradation or interruptions in delivery of our products and services.Notwithstanding our efforts to protect against interruptions in the availability of our e-commerce websites and Internet-based products and services, we dooccasionally experience unplanned outages or technical difficulties. In addition, we do not have complete redundancy for all of our systems. In the event ofan interruption or system event we may be unable to meet contract service level requirements, or we could experience an unrecoverable loss of data whichcould cause us to lose customers and could harm our reputation and cause us to face unexpected liabilities and expenses. If we continue to expand ourbusiness, we will put additional strains on these systems. As we continue to move additional product features to online systems or place more of our businessonline, all of these considerations will become more significant.17Table of Contents We may also need to grow, reconfigure or relocate our data centers in response to changing business needs, which may be costly and lead tounplanned disruptions of service.We may incur losses associated with currency fluctuations and may not be able to effectively hedge our exposure, which could impair our financialperformance.Our operating results are subject to fluctuations in foreign currency exchange rates. We currently do not attempt to mitigate a portion of these risksthrough foreign currency hedging, based on our judgment of the appropriate trade-offs among risk, opportunity and expense. In the future, we might chooseto engage in foreign currency hedging transactions, which would involve different risks and uncertainties.Our revolving credit facility contains borrowing limitations and other restrictive covenants and the failure to maintain a sufficient borrowing base or tocomply with such covenants could prevent us from borrowing funds, and could cause any outstanding debt to become immediately payable, which mightadversely impact our business. Our revolving credit facility contains borrowing limitations based on a combination of our cash balance and eligible accounts receivable balances andfinancial covenants currently applicable to us, as well as a number of restrictive covenants, including restrictions on incurring additional debt, makinginvestments and other restricted payments, selling assets, paying dividends and redeeming or repurchasing capital stock and debt, subject to certainexceptions. Collectively, these borrowing limitations and covenants could constrain our ability to grow our business through acquisition or engage in othertransactions. During the term of our $25.0 million revolving credit facility, we are also subject to certain financial covenants that require us to maintain aminimum liquidity amount and minimum financial performance requirements, as defined in the credit agreement. If we are not able to comply with all ofthese covenants, for any reason, we would not be able to borrow funds under the facility, and some or all of any outstanding debt could become immediatelydue and payable which could have a material adverse effect on our liquidity and ability to conduct our business.A significant deterioration in our profitability and/or cash flow caused by prolonged economic instability could reduce our liquidity and/or impair ourfinancial ratios, and trigger a need to raise additional funds from the capital markets and/or renegotiate our banking covenants.To the extent 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 operationsat their 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.18Table of Contents We may have exposure to greater than anticipated tax liabilities.We are subject to income and indirect tax in the U.S. and many foreign jurisdictions. The application of indirect taxes (such as sales and use tax, value-added tax, goods and services tax, business tax and gross receipt tax) to our businesses and to our users is complex, uncertain and evolving, in part becausemany of the fundamental statutes and regulations that impose indirect taxes were established before the adoption and growth of the Internet and e-commerce.We are subject to audit by multiple tax authorities throughout the world. Although we believe our tax estimates are reasonable and accurate, the finaldetermination of tax audits and any related litigation could be materially different from our historical tax provisions and accruals. The results of an audit orlitigation could have a material adverse effect on our financial statements in the period or periods for which that determination is made. In addition, the United States government and other governments may adopt tax measures that could impact future effective tax rates favorably orunfavorably affected by changes in tax rates, changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws or their interpretation.Although we cannot predict whether or in what form any other legislation changes may pass, if enacted it could have a material adverse impact on our taxexpense, deferred tax assets and cash flows.Our deferred tax assets may not be fully realizable.We record tax valuation allowances to reflect uncertainties about whether we will be able to realize some of our deferred tax assets before they expire.Our tax valuation allowance is based on our estimates of taxable income for the jurisdictions in which we operate and the period over which our deferred taxassets will be realizable. In the future, we could be required to increase the valuation allowance to take into account additional deferred tax assets that wemay be unable to realize. An increase in the valuation allowance would have an adverse impact, which could be material, on our income tax provision andnet income in the period in which we record the increase.Protection of our intellectual property is limited, and any misuse of our intellectual property by others, including software piracy, could harm our business,reputation and competitive position.Our intellectual property is important to our success. We believe our trademarks, copyrights, trade secrets, patents, pending patent applications, tradedress and designs are valuable and integral to our success and competitive position. To protect our proprietary rights, we rely on a combination of patents,copyrights, trademarks, trade dress, trade secret laws, confidentiality procedures, contractual provisions and technical measures. However, even if we are ableto secure such rights in the United States, the laws of other countries in which our products are sold may not protect our intellectual property rights to thesame extent as the laws of the United States.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 resellers to protect our confidential and proprietary information. We cannot guarantee that ourconfidentiality agreements with our employees, consultants and other third parties will not be breached, that we will be able to effectively enforce theseagreements, that we will have adequate remedies for any breach, or that our trade secrets and other proprietary information will not be disclosed or willotherwise be protected.19Table of Contents 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 Literacy,and 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 which customers can view our products and engage in transactions with us. Moreover, the regulation of domain names in theU.S. and foreign countries is subject to change. Governing bodies could appoint additional domain name registrars, modify the requirements for holdingdomain names or release additional TLDs. As a result, we may have to incur additional costs to maintain control over potentially relevant domain names ormay not maintain exclusive rights to all potentially relevant domain names in the U.S. or in other countries in which we conduct business, which could harmour business or reputation. Moreover, attempts may be made to register our trademarks as new TLDs or as domain names within new TLDs and we will have tomake efforts to enforce our rights against such registration attempts.20Table of Contents 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 be accomplished on a cost-effective and timely basis, or become subject to other consequences. In addition, open source licenses generally do not provide warranties or othercontractual protections regarding infringement claims or the quality of the code. Thus, we may have little or no recourse if we become subject to infringementclaims relating to the open source software or if the open source software is defective in any manner.21Table of Contents We offer Consumer language-learning packages that bundle software and online services that have increased our costs as a percentage of revenue, andthese 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. We cannot assure you that our future software package offerings will be successful or profitable, or if they are profitable, that they will providean adequate return on invested capital. If our software package offerings are not successful, our business, financial results and reputation may be harmed.Substantially all of our inventory is managed by a single third party logistics company. A disagreement with, or production disruption at, this entity couldcause financial loss, including loss of revenue and harm to our reputation.Substantially all of our inventory, which consists primarily of boxes for our language learning product and our audio practice products, is produced bya single third party logistics company. We could experience an interruption in our operations if we have a disagreement with this company or this companysuffers a production disruption or event that results in the damage or destruction of our inventory. We might be unable to meet our contractual obligations asa result of such an interruption, which could cause us financial loss, including loss of revenue and harm to our reputation. As our business has moved online,we expect that this risk will 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 could discourage unsolicited acquisition proposals or make it more difficult for a thirdparty to gain control of our Company, or otherwise could adversely affect the market price of our common stock. Further, as a Delaware corporation, we aresubject to Section 203 of the Delaware General Corporation Law. This section generally prohibits us from engaging in mergers and other businesscombinations with stockholders that beneficially own 15% or more of our voting stock, or with their affiliates, unless our directors or stockholders approvethe business combination in the prescribed manner.Item 1B. Unresolved Staff CommentsNone.22Table of Contents Item 2. PropertiesAs of December 31, 2018, our corporate headquarters are located in Arlington, Virginia, where we occupy approximately 13,000 square feet of spaceon the 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 13 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 ProceedingsInformation with respect to this item may be found in Note 15 of Item 8, Financial Statements and Supplementary Data, which is incorporated hereinby reference.Item 4. Mine Safety DisclosuresNot applicable.23Table of Contents PART 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 105 stockholders ofrecord of our common stock as of February 27, 2019 when the last reported sales price of our common stock on the NYSE was $15.66 per share.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 2018, 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 PricePaid Per Share Total Number of SharesPurchased as Part ofPublicly AnnouncedProgram (1) Maximum DollarValue of Shares thatMay Yet BePurchased Under theProgram (inthousands) (1) October 2018 — $— — November 2018 — $— — December 2018 — $— — 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.Our revolving credit facility contains financial and restrictive covenants that, among other restrictions and subject to certain limitations, limit ourability to repurchase our shares.24Table of Contents 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 December31, 2013 through December 31, 2018, 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, 2013 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.25Table of Contents 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, 2018, 2017, 2016, 2015, and 2014, and the selected consolidatedbalance sheet data as of December 31, 2018, 2017, 2016, 2015, and 2014 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. Year Ended December 31, 2018 2017 2016(1) 2015(2) 2014(3) (in thousands, except per share data) Selected Statements of Operations Data: Revenue $173,634 $184,593 $194,089 $217,670 $261,853 Gross profit 137,712 150,972 159,768 179,143 208,799 Loss from operations (19,619) (4,501) (26,920) (43,813) (78,850)Net loss (21,473) (1,546) (27,550) (46,796) (73,706) Loss per share attributable to common stockholders: Basic $(0.95) $(0.07) $(1.25) $(2.17) $(3.47)Diluted $(0.95) $(0.07) $(1.25) $(2.17) $(3.47) Other Selected Data: Total stock-based compensation expense $4,475 $4,141 $4,906 $7,195 $6,762 Total intangible amortization expense $3,311 $3,839 $4,351 $5,192 $6,263 (1)As discussed in Note 12 of Item 8, Financial Statements and Supplementary Data, the Company announced and initiated restructuring actions inthe 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 othercost reductions 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 theseentities have been included from the acquisition date. As of December 31, 2018 2017 2016 2015 2014 (in thousands) Selected Consolidated Balance Sheet Data: Cash and cash equivalents $38,092 $42,964 $36,195 $47,782 $64,657 Total assets 187,258 194,755 194,310 228,543 288,173 Total deferred revenue 162,885 151,263 141,457 142,748 128,169 Notes payable and capital lease obligation 1,787 2,300 2,559 3,143 3,748 Total stockholders' equity (deficit) (12,008) 2,423 (1,659) 22,410 63,445 26Table of Contents Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsThis Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") contains forward-looking statementswithin the meaning of the Private Securities Litigation Reform Act of 1995. The MD&A should be read in conjunction with our consolidated financialstatements and notes thereto which appear elsewhere in this Annual Report on Form 10-K. Our actual results may differ materially from those currentlyanticipated and expressed in such forward-looking statements as a result of a number of factors, including those discussed under ("Risk Factors") andelsewhere in this Annual Report on Form 10-K.OverviewRosetta Stone is dedicated to changing people's lives through the power of language and literacy education. Our innovative digital solutions drivepositive learning outcomes for the inspired learner at home or in schools and workplaces around the world. Founded in 1992, Rosetta Stone's languagedivision uses cloud-based solutions to help all types of learners read, write, and speak more than 30 languages. Lexia Learning, Rosetta Stone's literacyeducation division, was founded more than 30 years ago and is a leader in the literacy education space. Today, Lexia helps students build 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, Staples, consignment distributors such as Software Packaging Associates, and daily deal partners.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 also 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 learners who need to speak and read English. This focus extends to theConsumer Language segment where we continue to make product investments serving the needs of passionate language learners who are mobile, results-focused and value a quality language-learning experience.To position the organization for success, our focus is on the following priorities: 1.Focus on growing our K-12 business; 2.Position ourselves as a leader in virtual blended learning; and 3.Accelerate growth and increase intrinsic value.Over the last few years, our Consumer Language strategy has been to shift our Consumer Language business to online subscriptions, which featureaccess across the web and apps, and away from perpetual digital download and CD packages. We believe that these online subscription formats providecustomers with an overall better experience, flexibility to use our products on multiple platforms (tablets, smartphones and computers), and provide a moreeconomical 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.Components of Our Statements of OperationsRevenueWe derive revenue from sales of language-learning and literacy solutions. Revenue is presented as subscription and service revenue or productrevenue in our consolidated financial statements. Subscription and service revenue consists of fees associated with web-based software subscriptions, onlineservices, professional services, and certain mobile applications. As discussed in Note 2 of Item 8, Financial Statements and Supplementary Data, we adoptedthe new revenue recognition accounting standard ("ASC 606") effective January 1, 2018 using the modified retrospective method. As such, the comparativeinformation has not been restated under ASC 606 and continues to be reported under the accounting standards in effect for those prior comparative periods.27Table of Contents Subscription revenue is generated from contracts with customers that provide access to hosted software over a contract term without the customertaking possession of the software. Subscription revenue is recognized ratably over the contract period as the performance obligation is satisfied. Subscriptionrevenue is generated by all three reportable segments and range from short-term to multi-year contracts. Online services are typically sold in short-termservice periods and include dedicated online conversational coaching services and access to online communities of language learners. Professional servicesinclude training and implementation services. Online services revenue and professional services revenue are recognized as the services are provided. Expiredservices are forfeited and revenue is recognized upon expiry.Product revenue primarily consists of revenue from perpetual language-learning software and audio practice products. Audio practice products areoften combined with language-learning software and sold as a solution. Perpetual software revenue is recognized at the point in time when the software ismade available to the customer. Audio practice products are recognized at the point in time that the audio practice products are delivered to the customer. Aspost-contract support ("PCS") is provided to customers who purchase perpetual software at no charge, a portion of the transaction price is allocated to PCSservice revenue and recognized as the PCS services are provided, which is typically three months from the date of purchase. With the completion of the SaaStransition, perpetual software sales are no longer a significant portion of the business.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, mobile applications and call centers, which we refer to as our direct-to-consumer (“DTC”) channel. We also distribute ourConsumer Language products through select third-party retailers and distributors. For purposes of explaining variances in our revenue, we separately discusschanges 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 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 and app stores. Salescommissions are generally paid when a customer contract is recorded either as revenue or as deferred revenue. However, sales commissions are deferred andrecognized as expense in proportion to when the related revenue is recognized.Research and Development. Research and development expenses consist primarily of employee compensation costs, consulting fees, and overheadcosts associated with development of our solutions. Our development efforts are primarily based in the U.S. and are devoted to modifying and expanding ouroffering portfolio through the addition of new content, as well as new paid and complementary products and services to our language-learning and literacysolutions.28Table of Contents 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.Interest and Other Income (Expense)Interest and other income (expense) primarily consist of interest income, interest expense, and foreign exchange gains and losses. Interest incomerepresents interest received on our cash and cash equivalents. Interest expense is primarily related to interest on our capital leases and amortization ofdeferred financing fees associated with our revolving credit facility. Fluctuations in foreign currency exchange rates in our foreign subsidiaries cause foreignexchange gains and losses.Income Tax Expense (Benefit)Income tax expense (benefit) consists of federal, state and foreign income taxes.We regularly evaluate the recoverability of our deferred tax assets and establish a valuation allowance, if necessary, to reduce the deferred tax assets toan amount that is more likely than not to be realized (a likelihood of more than 50 percent). Significant judgment is required to determine whether avaluation allowance is necessary and the amount of such valuation allowance, if appropriate.The establishment of a valuation allowance has no effect on the ability to use the deferred tax assets in the future to reduce cash tax payments. Weassess the likelihood that the deferred tax assets will be realizable at each reporting period, and the valuation allowance will be adjusted accordingly, whichcould materially affect our financial position and results of operations.Critical Accounting Policies and EstimatesIn presenting our financial statements in conformity with GAAP, we are required to make estimates and assumptions that affect the reported amounts ofassets, liabilities, revenues, costs and expenses, and related disclosures.Some of the estimates and assumptions we are required to make relate to matters that are inherently uncertain as they pertain to future events. We basethese estimates and assumptions on historical experience or on various other factors that we believe to be reasonable and appropriate under thecircumstances. On an ongoing basis, we reconsider and evaluate our estimates and assumptions. Our future estimates may change if the underlyingassumptions change. Actual results may differ significantly from these estimates.We believe that the following critical accounting policies involve our more significant judgments, assumptions and estimates and, therefore, couldhave the greatest potential impact on our consolidated financial statements. In addition, we believe that a discussion of these policies is necessary for readersto understand and evaluate our consolidated financial statements contained in this annual report on Form 10-K. See Note 2 of Item 8, Financial Statementsand Supplementary Data for a complete description of our significant accounting policies.Effective January 1, 2018, we adopted the new revenue recognition standard ("ASC 606") using the modified retrospective method. As such, thecomparative information has not been restated under ASC 606 and continues to be reported under the accounting standards in effect for those priorcomparative periods. See our Annual Report on Form 10-K filed with the SEC on March 7, 2018 for revenue recognition policies that were in effect in priorperiods before adoption of ASC 606.Revenue RecognitionNature of Revenue: We account for revenue contracts with customers by applying the following steps: •Identification of the contract, or contracts with a customer. •Identification of the performance obligations in the contract. •Determination of the transaction price. •Allocation of the transaction price to the performance obligations in the contract. •Recognition of the revenue when, or as, a performance obligation is satisfied.29Table of Contents Our primary sources of revenue are web-based software subscriptions, mobile application, online services, perpetual product software, and bundles ofperpetual product software and online services. We also generate revenue from the sale of audio practice products and professional services. With thecompletion of the SaaS transition, perpetual software sales are no longer a significant portion of the business.Revenue is recognized upon transfer of control of promised goods or services to customers in an amount that reflects the consideration expected to bereceived in exchange for those goods or services. Revenue is recognized net of allowances for returns. Revenue is also recognized net of any taxes collectedfrom customers, which are subsequently remitted to governmental authorities.Subscription and service revenue consists of fees associated with non-cancellable web-based software subscriptions, online services, professionalservices, and mobile applications. Subscription revenue is generated from contracts with customers that provide access to hosted software over a contract termwithout the customer taking possession of the software. Subscription revenue is recognized ratably over the contract period as the performance obligation issatisfied. Subscription revenue is generated by all three reportable segments and range from short-term to multi-year contracts. Online services are typicallysold in short-term service periods and include dedicated online conversational coaching services and access to online communities of language learners.Professional services include implementation services. Online services revenue and professional services revenue are recognized as the services are provided.Expired services are forfeited and revenue is recognized upon expiry.Product revenue primarily consists of revenue from perpetual language-learning software and audio practice products. Audio practice products areoften combined with language-learning software and sold as a solution. Perpetual software revenue is recognized at the point in time when the software ismade available to the customer. Audio practice products are recognized at the point in time that the audio practice products are delivered to the customer. Aspost-contract support (“PCS”) is provided to customers who purchase perpetual software at no charge, a portion of the transaction price is allocated to PCSservice revenue and recognized as the PCS services are provided, which is typically up to three months from the date of purchase. With the completion of theSaaS transition, perpetual software sales are no longer a significant portion of the business.Performance Obligations: A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit ofaccount. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligationis satisfied. Performance obligations are satisfied at a point in time or over time as delivery occurs or as work progresses.Significant Judgments: Some contracts with customers include promises to transfer multiple products and services to a customer. Determining whetherproducts and services are considered distinct performance obligations that should be accounted for separately, versus together, requires significant judgment.This includes determining whether distinct services are part of a series of distinct services that are substantially the same. When subscription services are soldwith professional services, judgment is required to determine whether the professional services are distinct and can be accounted for separately. In the E&ELanguage segment, we have concluded that each promised service within the language-learning subscription is delivered concurrently with all otherpromised services over the contract term and, as such, concluded that these promises are a single performance obligation that includes a series of distinctservices that have the same pattern of transfer to the customer. When there are multiple performance obligations, revenue is allocated to each performanceobligation based on its relative standalone selling price (“SSP”). Judgment is required to determine the SSP for each distinct performance obligation whereSSP is not directly observable, such as when the product or service is not sold separately, SSP is determined using internally published price lists whichinclude suggested sales prices for each performance obligation based on the type of client and volume purchased. These price lists are derived from pastexperience and from the expectation of obtaining a reasonable margin based on the cost to fulfill each performance obligation.Subscription revenue is recognized ratably over the contract period as the performance obligation is satisfied. Certain Consumer Language offeringshave contracts with no fixed duration and are marketed as lifetime subscriptions. For these lifetime subscriptions, we estimate the expected contract period asthe greater of the typical customer usage period or the longest fixed-period duration subscription that is currently marketed. Our current expected contractperiod for lifetime subscriptions is 24 months.Certain Consumer Language offerings are sold with a right of return and we may provide other credits or incentives. These rights are accounted for asvariable consideration when estimating the amount of revenue to recognize by utilizing the expected value method. Returns and credits are estimated atcontract inception based on historical return rates, estimated channel inventory levels, the timing of new product introductions and other factors. Reserves forreturns and credits are updated at the end of each reporting period as additional information becomes available.We distribute products and services both directly to the end customer and indirectly through resellers. Resellers earn commissions generally calculatedas a fixed percentage of the gross sale amount to the end customer. We evaluate each of our reseller relationships to determine whether it is the principal(where revenue is recognized at the gross amount) or agent (where revenue is recognized net of the reseller commission). In making this determination weevaluate a variety of factors including the amount of control we are able to exercise over the transactions.30Table of Contents Contract Balances: The timing of revenue recognition, invoicing, and cash collection results in accounts receivable and deferred revenue in theconsolidated balance sheets. Payment from customers is often received in advance of services being provided, resulting in deferred revenue. Accountsreceivable is recorded when there is an executed customer contract and the right to the consideration becomes unconditional. Contract assets such asunbilled receivables are not material.The allowance for doubtful accounts reflects the best estimate of probable losses inherent in the accounts receivable balance. We establish anallowance for doubtful accounts based on specific risks identified, historical experience, and other currently available evidence.Payment terms and conditions vary by contract type and customer. For the E&E Language and Literacy segments, payment terms generally range from30 to 90 days. In the Consumer Language segment, resellers are generally granted payment terms of 45 days. Within Consumer Language, sales to endcustomers via the Rosetta Stone ecommerce website are done by credit card, which generally are settled within 7-10 days and may be made in installments. Ininstances where the timing of revenue recognition differs from the timing of invoicing, we have determined that contracts generally do not include asignificant financing component. The primary purpose of invoicing terms is to provide customers with simplified and predictable ways of purchasingproducts and services and not to provide customers with financing.Deferred revenue is comprised mainly of unearned revenue related to subscription services which is recognized ratably over the subscription period.Deferred revenue also includes payments for professional services and online services to be performed in the future which are earned as revenue when theservice is provided. Our practice is to ship our products promptly upon receipt of purchase orders from customers; consequently, contract backlog is notmaterial.Assets Recognized from Costs to Obtain a Contract with a Customer: We recognize an asset for the incremental costs of obtaining a contract with acustomer, which primarily represents sales commissions paid when a customer contract is either recorded as revenue or deferred revenue. Sales commissionspaid to obtain non-cancellable subscription contracts are deferred and amortized in proportion to the period over which the revenue is recognized from therelated contract. Deferred sales commissions are amortized to sales and marketing expense on the consolidated statements of operations. Deferred salescommissions are classified as non-current unless the associated amortization period is one year or less.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 2014.31Table of Contents 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, 2018, we exercised our option to bypass the qualitative assessment and began our annual test withthe quantitative test using a fair value approach. In estimating the fair value of our reporting units, we used a variety of techniques including the incomeapproach (i.e., the discounted cash flow method) and the market approach (i.e., the guideline public company method). Our projections are estimates that cansignificantly affect the outcomes of the analysis, both in terms of our ability to accurately project future results and in the allocation of fair value betweenreporting units. As of June 30, 2018, we determined that the fair values of our reporting units with remaining goodwill balances substantially exceeded theircarrying values. Accordingly, no goodwill impairment charges were recorded in connection with the annual impairment test.For additional risk factors which could affect the assumptions used in our valuation of our reporting units, see the section titled "Risk Factors" in Part I,Item 1A of this Report. Accordingly, we cannot provide assurance that the assumptions, estimates and values used in our assessment will be realized andactual results could vary materially.We recognized $1.7 million in goodwill impairment expense associated with our Fit Brains business during the year ended December 31, 2016 whichrepresented the impairment of all remaining goodwill associated with the Fit Brains business. There was no goodwill impairment during the years endedDecember 31, 2018 and 2017.Intangible AssetsIntangible assets consist of acquired technology, including developed and core technology, customer related assets, trade name and trademark, andother intangible assets. Those intangible assets with finite lives are recorded at cost and amortized on a straight line basis over their expected lives. Intangibleassets with finite lives are reviewed routinely for potential impairment as part of our internal control framework. Annually, as of December 31, and morefrequently if a triggering event occurs, we review the Rosetta Stone trade name, our only indefinite-lived intangible asset, to determine if indicators ofimpairment exist. We have the option to first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible assetis impaired as a basis for determining whether it is necessary to perform the quantitative test. If necessary, the quantitative test is performed by comparing thefair value of indefinite-lived intangible assets to the carrying value. In the event the carrying value exceeds the fair value of the assets, the assets are writtendown to their fair value.For our annual indefinite-lived intangible asset test performed at December 31, 2018, we began our annual test with the qualitative test. As ofDecember 31, 2018, we concluded that there were no indicators of impairment that would cause us to believe that it is more likely than not that ourindefinite-lived intangible 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,and customer relationship long-lived intangible assets associated with our Fit Brains business. There were no impairments of intangible assets during theyears ended December 31, 2018 and 2017.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, we recorded $1.0 million inimpairment expense related to the abandonment of software projects that were previously capitalized. There were no such impairments in 2018 and 2017.32Table of Contents Restructuring CostsIn 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 geographieswe exited. We have also completed the closure of our software development operations in France and China. See Note 2 and Note 12 of Item 8, FinancialStatements and Supplementary Data for additional information about this strategic undertaking.Restructuring or other employee severance plans have been initiated in each of the years ended December 31, 2017 and 2016 to reduce headcount andother costs in order to support our strategic shift in business focus. In connection with these plans, we incurred restructuring related costs, including employeeseverance and related benefit costs, contract termination costs, and other related costs. These costs are included in cost of sales and the sales 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, andother benefits. 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. Contracttermination costs 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, and 2016, we recorded $1.2 million, and $5.2 million, respectively, in restructuring costs related to our recent restructuring plans andother employee severance actions. Restructuring and other employee severance expense was not significant during 2018.Income TaxesWe believe that the accounting estimate for the realization of deferred tax assets is a critical accounting estimate because judgment is required inassessing the likely future tax consequences of events that have been recognized in our financial statements or tax returns. Although it is possible there willbe changes that are not anticipated in our current estimates, we believe it is unlikely such changes would have a material period-to-period impact on ourfinancial position or results of operations.We use the asset and liability approach to accounting for income taxes. Deferred tax assets and liabilities represent the future tax consequences of thedifferences between the financial statement carrying amounts of assets and liabilities versus the tax bases of assets and liabilities. Under this method, deferredtax assets are recognized for deductible temporary differences, and operating loss and tax credit carryforwards. Deferred tax liabilities are recognized fortaxable temporary differences.We reduce the carrying amounts of deferred tax assets by a valuation allowance if, based on available evidence, it is more likely than not that suchassets will not be realized. Accordingly, the need to establish valuation allowances for deferred tax assets is assessed quarterly based on the more-likely-than-not realization threshold criterion. In the assessment, appropriate consideration is given to all positive and negative evidence related to the realization of thedeferred tax assets. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of futureprofitability, the duration of statutory carryforward periods, our experience with operating loss and tax credit carryforwards not expiring unused, and taxplanning alternatives. Significant judgment is required to determine whether a valuation allowance is necessary and the amount of such valuation allowance,if appropriate. The valuation allowance is reviewed quarterly and is maintained until sufficient positive evidence exists to support a reversal.In assessing the recoverability of our deferred tax assets, we consider all available evidence, including: •the nature, frequency, and severity of cumulative financial reporting losses in recent years; •the carryforward periods for the net operating loss, capital loss, and foreign tax credit carryforwards; •predictability of future operating profitability of the character necessary to realize the asset; •prudent and feasible tax planning strategies that would be implemented, if necessary, to protect against the loss of the deferred tax assets; and •the effect of reversing taxable temporary differences.33Table of Contents 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, 2018, a full valuation allowance exists for the U.S., Hong Kong, Mexico, Spain, Brazil, and France where we have determined thedeferred 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, 2018. 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, 2018 and 2017, our net deferred tax liability was $2.8 million and $2.0 million, respectively.New tax legislation, commonly referred to as the Tax Cuts and Jobs Act of 2017 (the “Tax Act”), was enacted on December 22, 2017. During the yearof enactment, we recorded reasonable estimates of the effects of the Tax Act which principally related to a) the reduction in the U.S. corporate income tax ratefrom 35% to 21% and b) the change in the carryforward period of net operating losses. In the fourth quarter of 2017, we recorded an income tax benefit of$2.4 million to remeasure deferred tax liabilities associated with indefinite-lived intangible assets that will reverse at the new 21% rate. Absent this deferredtax liability, we were in a net deferred tax asset position that was offset by a full valuation allowance. Though the impact of the rate change has a net taxeffect of zero, the accounting to determine the gross change in the deferred tax position and the offsetting valuation resulted in a $26.3 million reduction inboth. Additionally, we recorded an income tax benefit of $3.1 million in the fourth quarter of 2017 related to the release of the valuation allowanceassociated with the post-2017 reversing deferred tax assets to offset 80% of the deferred tax liability associated with our indefinite-lived intangible asset. Inthe third quarter of 2018, we recorded a $0.2 million tax expense in addition to the estimates made in the year of enactment. The accounting for the Tax Actare considered final as we obtained, prepared, and analyzed the information necessary to finalize the accounting and the 2017 U.S. income tax return. TheTax Act included a one-time mandatory repatriation transition tax on the net accumulated earnings and profits of a U.S. taxpayer’s foreign subsidiaries. Wehad a deficit in net accumulated earnings and profits so no transition tax was reported on our 2017 U.S. income tax return.Other Tax Act provisions that may impact income taxes include: a limitation of net operating losses generated after 2017 to 80% of taxable income,the inclusion of commissions and performance based compensation in determining the excess compensation limitation, and a minimum tax on certain foreignearnings in excess of 10% of the foreign subsidiaries tangible assets (i.e., global intangible low-taxed income or GILTI). The Company has elected to treatGILTI as a period expense.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 satisfactionof liabilities in the normal course of business. Management has evaluated whether relevant conditions or events, considered in the aggregate, indicate thatthere is 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 reasonably knowable as of March 6, 2019.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 2019 cash flow forecast, 2019 operating budget, and long-term plan thatextends beyond 2019. 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 6, 2019,and concluded that conditions and events considered in the aggregate, do not indicate that it is probable that we will be unable to meet obligations as theybecome due through the one year period following the financial statement issuance date.34Table of Contents 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.Results of OperationsThe following table sets forth our consolidated statement of operations for the periods indicated. Year Ended December 31, 2018 2017 2016 (in thousands, except per share data) Statements of Operations Data: Revenue: Subscription and service $170,685 $168,442 $154,336 Product 2,949 16,151 39,753 Total revenue 173,634 184,593 194,089 Cost of revenue: Cost of subscription and service revenue 32,010 26,082 23,676 Cost of product revenue 3,912 7,539 10,645 Total cost of revenue 35,922 33,621 34,321 Gross profit 137,712 150,972 159,768 Operating expenses Sales and marketing 98,911 96,660 114,340 Research and development 25,210 24,747 26,273 General and administrative 33,210 34,066 40,501 Impairment — — 3,930 Lease abandonment and termination — — 1,644 Total operating expenses 157,331 155,473 186,688 Loss from operations (19,619) (4,501) (26,920)Other income and (expense): Interest income 103 66 46 Interest expense (313) (491) (470)Other income and (expense) 165 881 2,297 Total other income and (expense) (45) 456 1,873 Loss before income taxes (19,664) (4,045) (25,047)Income tax expense (benefit) 1,809 (2,499) 2,503 Net loss $(21,473) $(1,546) $(27,550)Loss per share: Basic $(0.95) $(0.07) $(1.25)Diluted $(0.95) $(0.07) $(1.25)Common shares and equivalents outstanding: Basic weighted average shares 22,705 22,244 21,969 Diluted weighted average shares 22,705 22,244 21,969 Comparison of the Year Ended December 31, 2018 and the Year Ended December 31, 2017Our total revenue decreased $11.0 million to $173.6 million for the year ended December 31, 2018, from $184.6 million for the year endedDecember 31, 2017. The decrease in total revenue was primarily due to a decrease in Consumer Language revenue of $15.2 million and a decrease in E&ELanguage revenue of $4.9 million, which were partially offset by an increase in Literacy revenue of $9.2 million.We reported an operating loss of $19.6 million for the year ended December 31, 2018, compared to an operating loss of $4.5 million for the year endedDecember 31, 2017. Total operating expenses increased $1.9 million, comprised of an increase of $2.3 million in sales and marketing expense and anincrease of $0.5 million in research and development expense, partially offset by a decrease of $0.9 million in general and administrative expense. Grossprofit decreased $13.3 million, driven by a $11.0 million decrease in revenue.35Table of Contents Segment Revenue, Segment Contribution and Segment Contribution Margin by Operating SegmentWe 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 18 of Item 8, Financial Statements andSupplementary Data for additional information about the definition, calculation, and presentation of segment contribution.The following table sets forth revenue, the corresponding percent of total revenue, segment contribution, and segment contribution margin for each ofour operating segments for the years ended December 31, 2018 and 2017: Year ended December 31, 2018 versus 2017 2018 2017 (1) Change % Change (in thousands, except percentages) Revenue and Revenue as a Percent of Total Revenue Literacy $52,766 30.4% $43,608 23.6% $9,158 21.0%Enterprise & Education Language 60,376 34.8% 65,267 35.4% (4,891) (7.5)%Consumer Language 60,492 34.8% 75,718 41.0% (15,226) (20.1)%Total Revenue $173,634 100.0% $184,593 100.0% $(10,959) (5.9)% Segment Contribution and Segment Contribution Margin Literacy $7,173 13.6% $4,964 11.4% $2,209 44.5%Enterprise & Education Language 22,852 37.8% 26,897 41.2% (4,045) (15.0)%Consumer Language 12,771 21.1% 24,849 32.8% (12,078) (48.6)%Language Shared Services (16,153) (17,369) 1,216 (7.0)%Total Segment Contribution $26,643 $39,341 $(12,698) (32.3)% (1)Effective January 1, 2018 we adopted ASC 606 using the modified retrospective approach. Revenue in prior comparative periods reflects amountspreviously reported and has not been restated. See Note 2 of Item 8, Financial Statements and Supplementary Data, for additional disclosuresregarding revenue recognition and the impact of adoption of ASC 606. Literacy SegmentThe increase in Literacy segment revenue reflects sales growth and strong retention rates, which has been positively impacted by increases in ourimplementation and training services as well as the release of PowerUp in early 2018, which has been incorporated into our suite of Literacy solutions. Weanticipate additional investments in product and sales personnel in the Literacy business to grow this segment and achieve scale.The Literacy segment contribution dollar and margin increases were primarily due to the larger revenue base on which segment contribution iscalculated, partially offset by increases in direct sales and marketing, cost of sales, and research and development expenses due to the transition to a directsales team, and investments made to improve the Literacy product portfolio and infrastructure. Additionally, the higher direct Literacy expenses reflect thehigher implementation and training services costs in support of Literacy sales growth.E&E Language SegmentThe decrease in E&E Language segment revenue reflects lower performance from non-strategic custom-content and affiliate sales channels. Revenuedeclined approximately $3.0 million, or 8% in the enterprise category and approximately $1.9 million, or 7% in the North America K-12 category. Theenterprise revenue decline was driven by $2.0 million in lower revenue from the reseller channel. We expect to continue to balance investments and adjustour cost structure to align scale without impacting growth. Before shared Language research and development expense, the E&E Language segment contribution dollar and margin decreases were primarily dueto lower revenue as direct costs were comparable year-over-year.36Table of Contents Consumer Language SegmentThe decrease in Consumer Language segment revenue was largely due to the transition of the segment to subscription-based sales, which arerecognized over time, from the sale of perpetual products that were historically recognized up front at the time of sale. The SaaS transition within theConsumer Language segment’s DTC channel was largely completed by the end of 2017 and the migration from CD-based product sales to subscriptions inthe retail channel was largely complete in the middle of 2018. The decline in Consumer Language segment revenue also reflects the absence of $2.5 millionin FitBrains subscription revenue from our brain fitness business that was recently shuttered. In connection with our recent shift in strategy, we will invest inmobile and English-learning to drive growth. Our Consumer business is seasonal and consumer sales typically peak in the fourth quarter during the holidayshopping season.Before shared Language research and development expense, the Consumer Language segment contribution dollar and margin decreases were primarilydue to lower revenue recognized year over year, primarily due to the SaaS transition and absence of FitBrains revenue described above. The declines insegment revenue were partially offset by year-over-year reductions in direct cost of sales and a direct sales and marketing expense.Revenue by Geographic AreaThe following table sets forth revenue by geographic area and the corresponding percent of total revenue for the years ended December 31, 2018 and2017: Year ended December 31, 2018 versus 2017 2018 2017 (1) Change % Change (in thousands, except percentages) United States $152,407 87.8% $158,825 86.0% $(6,418) (4.0)%International 21,227 12.2% 25,768 14.0% (4,541) (17.6)%Total revenue $173,634 100.0% $184,593 100.0% $(10,959) (5.9)% (1)Effective January 1, 2018 we adopted ASC 606 using the modified retrospective approach. Revenue in prior comparative periods reflects amountspreviously reported and has not been restated. See Note 2 of Item 8, Financial Statements and Supplementary Data, for additional disclosuresregarding revenue recognition and the impact of adoption of ASC 606. United States RevenueThe decrease in United States revenue reflects the Consumer SaaS transition described above as the majority of Consumer sales are made domestically.The decline in United States revenue was partially offset by the increase in Literacy revenue from our Lexia business, which is predominately recorded asdomestic revenue.International RevenueNearly half of the decrease in international revenue reflects the absence of Fit Brains subscription revenue associated with our Canadian brain fitnessconsumer business that was recently shuttered. Revenue in the E&E Language France and Spain education business declined $1.9 million due to the exit ofthose unprofitable geographies as part of the 2016 Restructuring Plan.37Table of Contents Revenue, Cost of Revenue, and Gross Profit by Subscription and Service Revenue and Product RevenueThe following table sets forth revenue, cost of revenue, and gross profit by subscription and service revenue and product revenue for the years endedDecember 31, 2018 and 2017: Year ended December 31, 2018 versus 2017 2018 2017 (1) Change % Change (in thousands, except percentages) Revenue: Subscription and service $170,685 98.3% $168,442 91.3% $2,243 1.3%Product 2,949 1.7% 16,151 8.7% (13,202) (81.7)%Total revenue 173,634 100.0% 184,593 100.0% (10,959) (5.9)%Cost of revenue and cost of revenue as a percentage ofrelated revenue Cost of subscription and service revenue 32,010 18.8% 26,082 15.5% 5,928 22.7%Cost of product revenue 3,912 132.7% 7,539 46.7% (3,627) (48.1)%Total cost of revenue 35,922 20.7% 33,621 18.2% 2,301 6.8%Gross profit and gross profit percentage $137,712 79.3% $150,972 81.8% $(13,260) (8.8)% (1)Effective January 1, 2018 we adopted ASC 606 using the modified retrospective approach. Revenue in prior comparative periods reflects amountspreviously reported and has not been restated. See Note 2 of Item 8, Financial Statements and Supplementary Data, for additional disclosuresregarding revenue recognition and the impact of adoption of ASC 606. Beginning in 2019, we expect to collapse “Subscription and service revenue” and “Product revenue” in a single revenue line and collapse “Cost ofsubscription and service revenue” and “Cost of product revenue” in a single cost of revenue line to better reflect our operational activity, offerings andstrategy. Subscription and Service RevenueThe Literacy segment falls entirely within the subscription and service revenue category, which increased $9.2 million year-over-year. As earliernoted, the 21% growth in Literacy revenue was driven by sales growth, strong retention rates, and an increase in implementation and training services.Consumer Language subscription and service revenue decreased by $3.0 million, which included a decrease of $2.5 million due to the absence of Fit Brainssubscription revenue, a business that was recently shuttered. E&E Language service and subscription revenue decreased $3.9 million primarily due to lowerrevenue in the reseller channel.Product RevenueThe decrease in product revenue was primarily due to the Consumer Language segment SaaS migration. Product revenue decreased $8.8 million in theDTC sales channel and $2.3 million in the global consumer retail sales channel due to the SaaS migration.Cost of Subscription and Service RevenueThe increase in cost of subscription and service revenue was primarily due to higher amortization expense from capitalized internal-use software costsassociated with the Literacy PowerUp SaaS offering that was released in early 2018 and an increase in allocated costs from a higher allocation rate associatedwith the shift in revenue mix in favor of subscription and service revenue.Cost of Product RevenueThe dollar decrease in cost of product revenue is primarily due to the transition from packaged perpetual products to SaaS-based offerings in the retailand DTC channels of the Consumer Language segment. Cost of product revenue exceeded product revenue due to a $2.1 million inventory obsolescencecharge during 2018 associated with the SaaS transition. Additionally, product margin declined as 2018 product sales were primarily comprised of audiopractice materials, like headsets, which have a higher inventory cost than packaged software product.Gross Profit and Gross Profit PercentageThe declines in gross profit and gross profit percentage were primarily attributable to the decline in revenue previously discussed.38Table of Contents Operating ExpensesThe following table sets forth operating expenses and the corresponding percentage of total revenue for the years ended December 31, 2018 and 2017: Year ended December 31, 2018 versus 2017 2018 2017 Change % Change (in thousands, except percentages, which reflect expense as a percentage of total revenue) Sales and marketing $98,911 57.0% $96,660 52.4% $2,251 2.3%Research and development 25,210 14.5% 24,747 13.4% 463 1.9%General and administrative 33,210 19.1% 34,066 18.5% (856) (2.5)%Total operating expenses $157,331 $155,473 $1,858 1.2%Sales and Marketing ExpensesThe slight increase in sales and marketing expense was primarily due to investments in sales and marketing for Lexia. We anticipate sales andmarketing expenses will increase year-over-year as the Company funds its growth initiatives in the Literacy, E&E Language and Consumer Languagesegments.Research and Development ExpensesResearch and development expense was nearly flat year-over-year. We expect research and development expenses will decline slightly in the nearfuture as we anticipate more of our internal-use software development costs will be capitalizable as we execute our SaaS software development plans.General and Administrative ExpensesGeneral and administrative expenses were down slightly year-over-year. The dollar reduction was primarily due to lower variable incentivecompensation expenses based on reduced funding expectations. We expect general and administrative expenses will increase in the near term.Other Income and (Expense) Year ended December 31, 2018 versus 2017 2018 2017 Change % Change (in thousands, except percentages) Interest income $103 $66 $37 56.1%Interest expense (313) (491) 178 (36.3)%Other income and (expense) 165 881 (716) (81.3)%Total other income and (expense) $(45) $456 $(501) (109.9)% Interest income represents interest earned on our cash and cash equivalents. Interest expense primarily represents interest on our capital leases and therecognition of our financing fees associated with our undrawn credit facility. The change in other income and (expense) was primarily attributable to foreignexchange fluctuations and the absence of the gain on sale associated with the sale of our Korea subsidiary in 2017.Income Tax Expense (Benefit) Year ended December 31, 2018 versus 2017 2018 2017 Change % Change (in thousands, except percentages) Income tax expense (benefit) $1,809 $(2,499) $4,308 (172.4)% The 2017 income tax benefit reflects the $5.5 million deferred tax benefit associated with the reduction in the corporate tax rate from 35% to 21%under the Tax Act. The 2018 income tax expense relates to current year tax expense due to profits of operations in certain foreign jurisdictions and deferredtax expense related to indefinite-lived intangible assets.39Table of Contents Comparison 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 December31, 2016. The decrease in total revenue was primarily due to a decrease in Consumer Language revenue of $12.2 million and a decrease in E&E Languagerevenue of $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 our restructuring plans andother ongoing expense reduction actions. The $31.2 million reduction in operating expenses was partially offset by a decrease in gross profit of $8.8 million,driven by a $9.5 million decrease in revenue.Revenue, Segment Contribution, and Segment Contribution Margin by Operating SegmentThe following table sets forth revenue, the corresponding percent of total revenue, segment contribution, and segment contribution margin for each ofour 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) Revenue and Revenue as a Percent of Total Revenue Literacy $43,608 23.6% $34,123 17.6% $9,485 27.8%Enterprise & Education 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)% Segment Contribution and Segment Contribution Margin Literacy $4,964 11.4% $1,532 4.5% $3,432 224.0%Enterprise & Education Language 26,897 41.2% 29,082 40.3% (2,185) (7.5)%Consumer Language 24,849 32.8% 21,502 24.5% 3,347 15.6%Language Shared Services (17,369) (20,759) 3,390 (16.3)%Total Segment Contribution $39,341 $31,357 $7,984 25.5% Literacy SegmentLiteracy revenue increased partially reflecting the impact of purchase accounting. Adjusting for the impact of purchase accounting on Literacyrevenue, revenue would 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 Literacy pro-forma growth would have been 18% year-over-year. The organic growth in Literacy revenue was primarily driven by a larger and moremature direct sales force in 2017 as compared to 2016, which drove stronger renewal rates, an increase in new business, and an increase in professionalservices.The Literacy segment contribution dollar and margin increases were primarily due to the larger revenue base on which segment contribution iscalculated, partially offset by increases in direct research and development expenses, cost of sales, and sales and marketing expenses due to the transition to adirect sales team and investments made to improve the Literacy product portfolio and infrastructure.E&E Language SegmentThe decrease in E&E Language revenue reflects a decrease of $3.6 million and $2.9 million in the corporate channel and education channel,respectively. Included within these declines is the reduction in revenue of $3.1 million from marketplaces exited due to the execution of our strategy towithdraw our direct presence in unprofitable geographies and manage the E&E Language business for profitable growth.40Table of Contents Before shared Language research and development expense, the E&E Language segment contribution dollar decrease was primarily due to lowerrevenue while the slight margin improvement reflects lower direct expenses, primarily sales and marketing expenses and cost of sales.Consumer Language SegmentConsumer Language revenue decreased largely due to a deliberate $8.9 million reduction in revenue in the direct-to-consumer sales channel due tothe completed transformation from perpetual products that are recognized up front, to subscriptions that are recognized over time. Revenue from the globalretail sales 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.Before shared Language research and development expense, the Consumer Language segment dollar and margin increases were primarily due to areduction in direct sales and marketing expense year over year.Revenue by Geographic AreaThe following table sets forth revenue by geographic area and the corresponding percent of total revenue for the years ended December 31, 2017 and2016: Year ended December 31, 2017 versus 2016 2017 2016 Change % Change (in thousands, except percentages) United States $158,825 86.0% $162,815 83.9% $(3,990) (2.5)%International 25,768 14.0% 31,274 16.1% (5,506) (17.6)%Total revenue $184,593 100.0% $194,089 100.0% $(9,496) (4.9)% United States RevenueThe decrease in United States revenue reflects the Consumer DTC SaaS transition described above as most Consumer sales are made domestically. Thedecline in United States revenue was partially offset by an increase in Literacy revenue from our Lexia business, which is predominantly recorded as domesticrevenue.International RevenueThe decrease in international revenue reflects a decrease in the E&E Language revenue in France and Spain, which declined $3.2 million due to theexit of those unprofitable geographies as part of the 2016 Restructuring Plan. Additionally, FitBrains subscription revenue associated with the deemphasizedCanadian brain fitness consumer business, declined $1.5 million.Revenue, Cost of Revenue, and Gross Profit by Subscription and Service Revenue and Product RevenueThe following table sets forth revenue, cost of revenue, and gross profit by subscription and service revenue and product revenue for the years endedDecember 31, 2017 and 2016: Year ended December 31, 2017 versus 2016 2017 2016 Change % Change (in thousands, except percentages) Revenue: Subscription and service $168,442 91.3% $154,336 79.5% $14,106 9.1%Product 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)%Cost of revenue and cost of revenue as a percentage ofrelated revenue Cost of subscription and service revenue 26,082 15.5% 23,676 15.3% 2,406 10.2%Cost of product revenue 7,539 46.7% 10,645 26.8% (3,106) (29.2)%Total cost of revenue 33,621 18.2% 34,321 17.7% (700) (2.0)%Gross profit and gross profit percentage $150,972 81.8% $159,768 82.3% $(8,796) (5.5)% 41Table of Contents Subscription and Service RevenueAn 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 the direct sales force, which drovestronger renewal rates, an increase in new business, and an increase in professional services. Consumer Language subscription and service revenue increasedby $9.3 million, reflecting the migration from perpetual products, which were historically recognized up-front, to subscriptions, which are recognized overtime. This SaaS migration was substantially completed in the direct-to-consumer sales channel in 2017. In the Consumer Language segment, we beganshifting sales from our box-based and perpetual download products to subscription products. Historically, customers in the Consumer Language segmentusing our longer-length subscription products (greater than a one-year term) have generally only stayed for the duration of the subscription period. We areselling shorter duration subscriptions, which if we are successful in achieving an adequate level of renewals, will allow pricing that has the potential to openup new segment demographics. As our Consumer Language products are sold through shorter-term subscriptions, cash from those sales will be spread over theinitial sale period and any subsequent renewals. Within the E&E Language segment, the education channel and corporate channel declined by $2.4 millionand $2.2 million, respectively, due in part to the marketplaces exited in unprofitable geographies.Product RevenueProduct revenue decreased $19.5 million in the direct-to-consumer sales channel due to the SaaS migration completed in 2017 from perpetualproducts to subscription offerings. Product revenue also declined in the global retail channel by $1.5 million.Cost of Subscription and Service RevenueThe dollar increase in cost of subscription and service revenue was primarily due to increases in allocated costs from a higher allocation rate associatedwith the shift in revenue mix in favor of subscription and service revenue.Cost of Product RevenueThe increase in cost as a percentage of revenue was primarily attributable to the intentional decline in product revenue and a $1.9 million inventorywrite-down associated with our request to our retail partners to return inventory. The dollar decrease in cost of product revenue is primarily due to thecontinued migration to subscription-based products, specifically declines of $1.2 million, $0.4 million, and $0.4 million in payroll and benefits, inventorycosts, and freight costs, respectively.Gross ProfitThe dollar decrease in gross profit was primarily due to the decrease in revenue.Operating ExpensesThe following table sets forth operating expenses and the corresponding percentage of total 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, which reflect expense as a percentage of total revenue) Sales and marketing $96,660 52.4% $114,340 58.9% $(17,680) (15.5)%Research and development 24,747 13.4% 26,273 13.5% (1,526) (5.8)%General and administrative 34,066 18.5% 40,501 20.9% (6,435) (15.9)%Impairment — 0.0% 3,930 2.0% (3,930) (100.0)%Lease abandonment and termination — 0.0% 1,644 0.8% (1,644) (100.0)%Total operating expenses $155,473 $186,688 $(31,215) (16.7)% 42Table of Contents 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 12 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 $573 Sales and marketing 411 2,324 Research and development 318 913 General and administrative 100 1,383 Total $1,207 $5,193 While 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 ExpensesThe decrease in sales and marketing expense was primarily due to decreases in media spend, payroll and benefits, professional services, and rent.Media expenses decreased $11.9 million due to the change in focus in the general consumer market. Payroll and benefit expense decreased $3.2 millionprimarily due to salary savings from a reduction in headcount and lower severance expenses. Professional services expenses declined $1.4 million related toreduced spending in call centers. Rent expense declined $0.8 million related to the relocation of the corporate headquarters.Research and Development ExpensesResearch and development expenses were relatively flat for the year ended December 31, 2017 as compared to the year ended December 31, 2016.General and Administrative ExpensesThe decrease in general and administrative expenses was primarily due to reductions in professional services, amortization expense, and bad debtexpense. Professional services declined $3.3 million due to the absence of external strategic advisor costs compared to 2016 and also due to lower externalaudit fees and lower legal fees. Amortization expense decreased $1.4 million due to the completed amortization of multiple projects in 2016. Bad debtexpense decreased $0.8 million due to better collection efforts and lower reserve balances.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)% 43Table of Contents Interest income represents interest earned on our cash and cash equivalents. Interest expense primarily represents interest on our capital leases and therecognition of our financing fees associated with our undrawn credit facility. The change in other income and (expense) was primarily attributable to foreignexchange 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)% The favorable change from income tax expense to income tax benefit was primarily related to the reduction in the corporate tax ratefrom 35% to 21% under the Tax Act. This resulted in a deferred tax benefit of $5.5 million, offset by current year tax expense due to profits of operations inCanada, Germany, and the U.K. Additionally, deferred tax expense in 2016 includes the tax impact of the amortization of U.S. indefinite-lived intangibleassets and the inability to recognize tax benefits associated with current year losses of operations in certain foreign jurisdictions and in the U.S.Liquidity and Capital ResourcesLiquidityOur principal source of liquidity at December 31, 2018 consisted of $38.1 million in cash and cash equivalents and short-term investments, a decreaseof $4.9 million, from $43.0 million compared to December 31, 2017. 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, 2018, we generated $10.4million in 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 revolving credit facility. Since theoriginal date of execution, we have executed several amendments to the credit facility to reflect updates to our financial outlook and extend the creditfacility. Under the seventh amendment executed on March 4, 2019, we may borrow up to $15.0 million, including a sub-facility, which reduces availableborrowings, for letters of credit in the aggregate availability amount of $4.0 million. The credit facility has a term that expires on April 1, 2021, during whichtime we may borrow and re-pay loan amounts and re-borrow the loan amounts subject to customary borrowing conditions. However, we must not have morethan $5.0 million in outstanding borrowings for 30 consecutive days during each twelve month period beginning as of the date of execution. Interest willaccrue at the Prime Rate and must be paid quarterly.As of the date of this filing, no borrowings are outstanding under the revolving credit agreement. During the third quarter of 2018, a $4.0 million letterof credit that was previously issued by the Bank on our behalf was cancelled as it was deemed no longer necessary. We are subject to certain financial andrestrictive covenants under the credit facility As of December 31, 2018, we were in compliance with all of the covenants under the revolving creditagreement. Effective as of March 4, 2019, our financial covenants were modified and we are required to maintain compliance with a minimum liquiditycoverage ratio and maintain minimum financial performance requirements as defined in the credit facility.The total amount of cash that was held by foreign subsidiaries as of December 31, 2018 was $4.9 million. As of December 31, 2018, 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.44Table of Contents 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, 2018 as compared to the year ended December 31, 2017 Year ended December 31, 2018 versus 2017 2018 2017 Change % Change (in thousands, except percentages) Net cash provided by operating activities $10,443 $18,960 (8,517) (44.9)%Net cash used in investing activities $(16,872) $(12,822) (4,050) 31.6%Net cash provided by (used in) financing activities $1,791 $(118) 1,909 (1617.8)% Net Cash Provided By Operating ActivitiesNet cash provided by operating activities was $10.4 million for the year ended December 31, 2018 compared to $19.0 million for the year endedDecember 31, 2017. One factor impacting the decline in cash provided by operating activities was the timing of cash receipts from our contractualrelationship with SOURCENEXT. We received cash inflows of approximately $4.5 million in 2018, a decrease of $8.7 million as compared to the cashinflows of $13.2 million in 2017. After normalizing for the non-recurring cash received from SOURCENEXT, cash flows provided by operating activities isnearly flat year-over-year.Net Cash Used in Investing ActivitiesNet cash used in investing activities was $16.9 million for the year ended December 31, 2018, compared to $12.8 million for the year endedDecember 31, 2017. The increase in cash used was primarily driven by an increase in capitalized software costs primarily related projects in connection withour Adobe Flash phase-out, our mobile English tutoring offering, and our English language learning offering for children.Net Cash Provided by (Used in) Financing ActivitiesNet cash provided by financing activities was $1.8 million for the year ended December 31, 2018, compared to net cash used in financing activities of$0.1 million for the year ended December 31, 2017. The favorable change was primarily driven by an increase in proceeds from the exercise of stock optionsin 2018 as compared to 2017.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 $18,960 $1,618 17,342 1071.8%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 $19.0 million for the year ended December 31, 2017 compared to $1.6 million for the year endedDecember 31, 2016, a favorable change of $17.3 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 operating45Table of Contents assets and liabilities were a decrease in accounts receivable of $7.6 million, an increase in deferred revenue of $8.9 million, a decrease in inventory of $3.3million, partially offset by a decrease in other current liabilities of $6.5 million, a decrease in accounts payable of $1.8 million, and a decrease in other long-term liabilities of $1.2 million. The decrease in accounts receivable was primarily related to improved collection efforts and lower revenues. The increase indeferred revenue was primarily due to the increase in sales in the Literacy segment, a sales shift from our box-based and perpetual download products tosubscription product, and the increase in deferred revenue related to a significant transaction in Japan with SOURCENEXT. The decrease in inventory wasprimarily due to an inventory write down of finished packaged perpetual products due to the transition from box-based and perpetual download products tosubscription product. The declines in other current liabilities, accounts payable, and other long-term liabilities reflect the ongoing cost reduction initiativeswhich resulted in lower operating expenses and fewer obligations due for marketing, advertising, rebates, and general business 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 $13.2 million related to the execution of agreements with SOURCENEXT Corporation for the perpetuallicense of certain intellectual property for exclusive use and sale in Japan.Net 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 ended December31, 2016. Purchases of property and equipment, which primarily relates to capitalized labor on product and corporate IT projects was slightly higher in 2017as 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 December31, 2016. The favorable change was primarily driven by an increase in proceeds from the exercise of stock options in 2017 as compared to 2016.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 8 and 15 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, 2018 andthe effect such obligations are expected to have on our liquidity and cash flow in future periods. Total Less than1 Year 1-3 Years 3-5 Years More than5 Years (in thousands) Capitalized leases and other financing arrangements $1,951 $525 $1,037 $389 $— Operating leases 6,157 2,334 2,103 1,720 — Total $8,108 $2,859 $3,140 $2,109 $— 46Table of Contents 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, 2018. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended (the "Exchange Act"), means controls and other procedures of a company that are designed to ensure thatinformation required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized andreported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls andprocedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act isaccumulated and communicated to the Company's management, including its principal executive and principal financial officers, as appropriate to allowtimely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, canprovide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationshipof possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of December 31, 2018, our Chief Executive Officerand Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.47Table of Contents 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, 2018. 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 withgenerally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations ofmanagement and Board of Directors; and (3)provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that couldhave 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 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, 2018 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, 2018 that had materially affected, or is reasonably likely to materially affect,our internal control over financial reporting.Item 9B. Other InformationOn March 4, 2019, Rosetta Stone Ltd. and Lexia Learning Systems LLC, wholly-owned subsidiaries of the Company, entered into the SeventhAmendment to Loan and Security Agreement with Silicon Valley Bank. Please see Item 7, Management's Discussion and Analysis of Financial Conditionand Results of Operations -- Liquidity and Capital Resources and Note 8. Financing Arrangements of the Company's Consolidated Financial Statementscontained in Item 8, Financial Statements and Supplementary Data, for a description of this amendment.48Table of Contents PART 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 the2019 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 2019Annual Meeting of Stockholders to be filed with the SEC no later than 120 days after the fiscal year ended December 31, 2018 (the "2019 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 2019 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 2019 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 2019 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 2019 Proxy Statement.49Table of Contents PART IVItem 15. Exhibits and Financial Statement Schedules(a)Consolidated Financial Statements 1.Consolidated Financial Statements. The consolidated financial statements as listed in the accompanying "Index to Consolidated FinancialInformation" 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.50Table of Contents EXHIBIT INDEX Index to exhibits 2.1 Purchase and Sale Agreement by and among Rosetta Stone Ltd., Rosetta Stone Japan Inc., and SOURCENEXT Corporation, dated April25, 2017 (incorporated herein by reference to Exhibit 2.1 filed with the Company's Current Report on Form 8-K filed on April 25, 2017). 3.1 Second Amended and Restated Certificate of Incorporation (incorporated herein by reference to Exhibit 3.2 to Amendment No. 3 to theCompany’s Registration Statement on Form S-1 (No. 333-153632) filed on February 23, 2009). 3.2 Third Amended and Restated Bylaws (incorporated herein by reference to Exhibit 3.1 filed with the Company's Current Report on Form 8-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 May 19, 2017 (incorporated herein by reference to Appendix A tothe Company’s Definitive Proxy Statement filed on April 7, 2017). 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 herein byreference to Exhibit 10.25 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011). 10.5+ Amended Executive Form of Option Award Agreement under 2009 Plan effective for awards granted May 9, 2016 (incorporated herein byreference to Exhibit 10.3 in the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2016.) 10.6+ Form of Annual Performance-Based Nonqualified Stock Option Award Agreement, dated April 4, 2016, between the Company and JohnHass (incorporated herein by reference to Exhibit 10.3 in the Company's Quarterly Report on Form 10-Q for the quarter ended March 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 ended March31, 2017). 10.8+ Form of Restricted Stock Award Agreement under the 2009 Plan (incorporated herein by reference to Exhibit 10.13 to Amendment No. 4to the Company’s Registration Statement on Form S-1 (No. 333-153632), filed on March 17, 2009). 10.9+ Amended Executive Form of Restricted Stock Award Agreement under 2009 Plan effective for awards after October 1, 2011 (incorporatedherein by reference to Exhibit 10.26 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011). 10.10+ Amended Executive Form of Restricted Stock Award Agreement under 2009 Plan effective for awards after February 1, 2016 (incorporatedherein by reference to Exhibit 10.11 in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015). 10.11+ Director Form of Restricted Stock Unit Award Agreement under the 2009 Plan (incorporated herein by reference to Exhibit 10.12 in theCompany’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014). 10.12+ Director Form of Restricted Stock Unit Award Agreement under the 2009 Plan (for awards beginning June 2015) (incorporated herein byreference to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2015). 51Table of Contents 10.13+ Form of Annual Performance-Based Restricted Stock Award Agreement, dated April 4, 2016, between the Companyand John Hass (incorporated herein by reference to Exhibit 10.1 in the Company's Quarterly Report on Form 10-Q for the quarter endedMarch 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 in theCompany’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 Annual Reporton 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 (incorporatedherein by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2015). 10.19+ Executive Employment Agreement between Rosetta Stone Ltd. and Thomas Pierno effective as of May 2, 2012 (incorporated herein byreference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on May 1, 2012). 10.20+ Director Agreement between Rosetta Stone Inc. and A. John Hass III effective as of November 18, 2014 (incorporated herein by referenceto 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 herein byreference 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 (incorporated herein byreference to Exhibit 10.23 of the Company’s Annual Report on Form 10-K for the period ended December 31, 2017). 10.24+ Executive Employment Agreement between the Company and Nicholas Gaehde, effective as of August 21, 2017 (incorporated herein byreference to Exhibit 10.24 of the Company’s Annual Report on Form 10-K for the period ended December 31, 2017). 10.25+ Form of 2018 Annual Performance Stock Award Agreement with CEO (incorporated herein by reference to Exhibit 10.1 of the Company’sQuarterly Report on Form 10-Q for the period ended March 31, 2018). 10.26+ Form of 2018 Long-Term Performance Stock Award Agreement with executive officers (incorporated herein by reference to Exhibit 10.2of the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2018). 10.27 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 Statement onForm S-1 (No. 333-153632), filed on January 21, 2009). *** 10.28 Loan and Security Agreement between Rosetta Stone Ltd. and Silicon Valley Bank, executed on October 28, 2014 (incorporated hereinby reference to Exhibit 99.3 filed to the Company’s Current Report on Form 8-K filed on October 29, 2014). 10.29 First Amendment to Loan and Security Agreement between Rosetta Stone Ltd. and Silicon Valley Bank, effective as of March 31, 2015(incorporated herein by reference to Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2015). 52Table of Contents 10.30 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). 10.31 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). 10.32 Fourth Amendment to Loan and Security Agreement dated as of December 29, 2015 between Silicon Valley Bank and Rosetta Stone Ltd(incorporated herein by reference to Exhibit 10.42 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31,2015.). 10.33 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). 10.34 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 December 31,2016). 10.35 * Seventh Amendment to Loan and Security Agreement dated as of March 4, 2019 between Silicon Valley Bank and Rosetta Stone Ltd. andLexia Learning Systems LLC 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.53Table of Contents SIGNATURESPursuant 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 onits behalf by the undersigned, thereunto duly authorized. ROSETTA STONE INC. By: /s/ A. JOHN HASS III A. John Hass III Chief Executive Officerand Chairman of the BoardDate: March 6, 2019Pursuant 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 Title Date /s/ A. JOHN HASS III Chief Executive Officerand Chairman of the Board(Principal Executive Officer) March 6, 2019A. John Hass III /s/ THOMAS M. PIERNO Chief Financial Officer(Principal Financial Officer) March 6, 2019Thomas M. Pierno /s/ M. SEAN HARTFORD Vice President, Controller andPrincipal Accounting Officer(Principal Accounting Officer) March 6, 2019M. Sean Hartford /s/ PATRICK W. GROSS Director March 6, 2019Patrick W. Gross /s/ LAURENCE FRANKLIN Director March 6, 2019Laurence Franklin /s/ DAVID P. NIERENBERG Director March 6, 2019David P. Nierenberg /s/ STEVEN P. YANKOVICH Director March 6, 2019Steven P. Yankovich /s/ JESSIE WOOLLEY-WILSON Director March 6, 2019Jessie Woolley-Wilson /s/ GEORGE A. LOGUE Director March 6, 2019George A. Logue 54Table of Contents INDEX TO CONSOLIDATED FINANCIAL STATEMENTS PageReports of Independent Registered Public Accounting Firm F-2Consolidated Balance Sheets F-4Consolidated Statements of Operations F-5Consolidated Statements of Comprehensive Loss F-6Consolidated Statements of Changes in Stockholders' Equity (Deficit) F-7Consolidated Statements of Cash Flows F-8Notes to Consolidated Financial Statements F-9 F-1Table of Contents REPORT 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, 2018 and 2017,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, 2018, 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, 2018 and 2017, and the results of operations and its cashflows for each of the three years in the period ended December 31, 2018, 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, 2018, 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 6, 2019, 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 6, 2019We have served as the Company's auditor since 2004.F-2Table of Contents REPORT 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, 2018, 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, 2018, 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, 2018 of the Company and our report dated March 6, 2019, 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 6, 2019F-3Table of Contents ROSETTA STONE INC.CONSOLIDATED BALANCE SHEETS(in thousands, except per share amounts) As of December 31, 2018 2017 Assets Current assets: Cash and cash equivalents $38,092 $42,964 Restricted cash 82 72 Accounts receivable (net of allowance for doubtful accounts of $372 and $375, at December 31, 2018and December 31, 2017, respectively) 21,950 24,517 Inventory 933 3,536 Deferred sales commissions 11,597 14,466 Prepaid expenses and other current assets 4,041 4,543 Total current assets 76,695 90,098 Deferred sales commissions 6,933 3,306 Property and equipment, net 36,405 30,649 Goodwill 49,239 49,857 Intangible assets, net 15,850 19,184 Other assets 2,136 1,661 Total assets $187,258 $194,755 Liabilities and stockholders' (deficit) equity Current liabilities: Accounts payable $8,938 $8,984 Accrued compensation 9,046 10,948 Income tax payable 328 384 Obligations under capital lease 450 450 Other current liabilities 13,475 16,454 Deferred revenue 113,378 110,670 Total current liabilities 145,615 147,890 Deferred revenue 49,507 40,593 Deferred income taxes 2,776 1,968 Obligations under capital lease 1,337 1,850 Other long-term liabilities 31 31 Total liabilities 199,266 192,332 Commitments and contingencies (Note 15) Stockholders' (deficit) equity: Preferred stock, $0.001 par value; 10,000 and 10,000 shares authorized, zero and zero shares issuedand outstanding at December 31, 2018 and December 31, 2017, respectively) — — Non-designated common stock, $0.00005 par value, 190,000 and 190,000 shares authorized, 24,426and 23,783 shares issued, and 23,426 and 22,783 shares outstanding, at December 31, 2018 andDecember 31, 2017, respectively) 2 2 Additional paid-in capital 202,355 195,644 Treasury stock, at cost; 1,000 and 1,000 shares at December 31, 2018 and December 31, 2017,respectively) (11,435) (11,435)Accumulated loss (199,592) (178,890)Accumulated other comprehensive loss (3,338) (2,898)Total stockholders' (deficit) equity (12,008) 2,423 Total liabilities and stockholders' (deficit) equity $187,258 $194,755 See accompanying notes to consolidated financial statementsF-4Table of Contents ROSETTA STONE INC.CONSOLIDATED STATEMENTS OF OPERATIONS(in thousands, except per share amounts) Years Ended December 31, 2018 2017 2016 Revenue: Subscription and service $170,685 $168,442 $154,336 Product 2,949 16,151 39,753 Total revenue 173,634 184,593 194,089 Cost of revenue: Cost of subscription and service revenue 32,010 26,082 23,676 Cost of product revenue 3,912 7,539 10,645 Total cost of revenue 35,922 33,621 34,321 Gross profit 137,712 150,972 159,768 Operating expenses Sales and marketing 98,911 96,660 114,340 Research and development 25,210 24,747 26,273 General and administrative 33,210 34,066 40,501 Impairment — — 3,930 Lease abandonment and termination — — 1,644 Total operating expenses 157,331 155,473 186,688 Loss from operations (19,619) (4,501) (26,920)Other income and (expense): Interest income 103 66 46 Interest expense (313) (491) (470)Other income and (expense) 165 881 2,297 Total other income and (expense) (45) 456 1,873 Loss before income taxes (19,664) (4,045) (25,047)Income tax expense (benefit) 1,809 (2,499) 2,503 Net loss $(21,473) $(1,546) $(27,550)Loss per share: Basic $(0.95) $(0.07) $(1.25)Diluted $(0.95) $(0.07) $(1.25)Common shares and equivalents outstanding: Basic weighted average shares 22,705 22,244 21,969 Diluted weighted average shares 22,705 22,244 21,969 See accompanying notes to consolidated financial statementsF-5Table of Contents ROSETTA STONE INC.CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS(in thousands) Years Ended December 31, 2018 2017 2016 Net loss $(21,473) $(1,546) $(27,550)Other comprehensive (loss) income, net of tax: Foreign currency translation (loss) gain (440) 811 (1,483)Other comprehensive (loss) income (440) 811 (1,483)Comprehensive loss $(21,913) $(735) $(29,033) See accompanying notes to consolidated financial statementsF-6Table of Contents ROSETTA STONE INC.CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' (DEFICIT) EQUITY(in thousands) Accumulated Total Non-Designated Additional Other Stockholders' Common Stock Paid-in Treasury Accumulated Comprehensive (Deficit) / Shares Amount Capital Stock Loss Loss Equity Balance—January 1, 2016 21,806 $2 $185,863 $(11,435) $(149,794) $(2,226) $22,410 Stock issued upon the exercise of stock options 13 — 58 — — — 58 Restricted stock award vesting 255 — — — — — — Stock-based compensation expense — — 4,906 — — — 4,906 Net 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 of stock options 79 — 676 — — — 676 Restricted stock award vesting 163 — — — — — — Stock-based compensation expense — — 4,141 — — — 4,141 Net loss — — — — (1,546) — (1,546)Other comprehensive income — — — — — 811 811 Balance—December 31, 2017 22,316 $2 $195,644 $(11,435) $(178,890) $(2,898) $2,423 Stock issued upon the exercise of stock options 207 — 2,236 — — — 2,236 Restricted stock award and performance stock unitvesting 389 — — — — — — Stock-based compensation expense — — 4,475 — — — 4,475 Net loss — — — — (21,473) — (21,473)Cumulative effect adjustment - adoption of ASC606 — — — — 771 — 771 Other comprehensive loss — — — — — (440) (440)Balance—December 31, 2018 22,912 $2 $202,355 $(11,435) $(199,592) $(3,338) $(12,008) See accompanying notes to consolidated financial statementsF-7Table of Contents ROSETTA STONE INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands) Years Ended December 31, 2018 2017 2016 CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(21,473) $(1,546) $(27,550)Adjustments to reconcile net loss to cash provided by operating activities: Stock-based compensation expense 4,475 4,141 4,906 Gain on foreign currency transactions (298) (573) (2,449)Bad debt expense (recovery) 168 (51) 709 Depreciation and amortization 14,616 12,009 13,322 Deferred income tax expense (benefit) 792 (4,201) 1,162 Loss (gain) on disposal of equipment 21 (5) 179 Amortization of deferred financing costs 114 296 274 Loss on impairment — — 3,930 Loss from equity method investments — 100 45 Gain on divestiture of subsidiary — (506) — Net change in: Accounts receivable 2,219 7,584 14,681 Inventory 2,603 3,266 538 Deferred sales commissions (781) 491 919 Prepaid expenses and other current assets 375 (604) (167)Income tax receivable or payable (60) (447) 719 Other assets (525) (455) 668 Accounts payable 4 (1,765) (74)Accrued compensation (1,863) 69 2,701 Other current liabilities (2,885) (6,450) (13,261)Other long-term liabilities — (1,243) 558 Deferred revenue 12,941 8,850 (192)Net cash provided by operating activities 10,443 18,960 1,618 CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (16,889) (12,944) (12,514)Proceeds from sale of fixed assets 17 12 38 Proceeds on divestiture of subsidiary — 110 — Net cash used in investing activities (16,872) (12,822) (12,476)CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from the exercise of stock options 2,236 676 58 Payment of deferred financing costs (4) (232) (183)Payments under capital lease obligations (441) (562) (533)Net cash provided by (used in) financing activities 1,791 (118) (658)(Decrease) increase in cash, cash equivalents, and restricted cash (4,638) 6,020 (11,516)Effect of exchange rate changes in cash, cash equivalents, and restricted cash (224) 419 251 Net (decrease) increase in cash, cash equivalents, and restricted cash (4,862) 6,439 (11,265)Cash, cash equivalents, and restricted cash—beginning of year 43,036 36,597 47,862 Cash, cash equivalents, and restricted cash—end of year $38,174 $43,036 $36,597 SUPPLEMENTAL CASH FLOW DISCLOSURE: Cash paid during the periods for: Interest $199 $195 $197 Income taxes, net of refund $1,626 $1,896 $604 Noncash financing and investing activities: Accrued liability for purchase of property and equipment $1,277 $967 $270 Equipment acquired under capital lease $25 $— $27 See accompanying notes to consolidated financial statements F-8Table of Contents ROSETTA 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, mobile applications, and packaged software, domestically and in certain internationalmarkets.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.Basis of PresentationAs discussed in this Note 2, the Company adopted certain recently issued accounting standards effective January 1, 2018. The new revenuerecognition standard ("ASC 606") was adopted using the modified retrospective method. As such, the comparative information has not been restated underASC 606 and continues to be reported under the accounting standards in effect for those prior comparative periods. See the Company’s Annual Report onForm 10-K filed with the SEC on March 7, 2018 for revenue recognition policies that were in effect in prior periods before adoption of ASC 606.Additionally, accounting standard update 2016-18 ("ASU 2016-18") related to the presentation of restricted cash in the statements of cash flow was adoptedretrospectively for all comparative periods.Recently Issued Accounting StandardsAccounting Standards Adopted During the Period: During 2018, the Company adopted the following recently issued Accounting Standard Updates("ASU"):In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230) Restricted Cash a consensus of the FASB Emerging IssuesTask Force. Under ASU 2016-18, amounts generally described as restricted cash should be included with cash and cash equivalents when reconciling thebeginning-of-period and end-of-period total amounts shown on the statements of cash flows. The Company retrospectively adopted ASU 2016-18 beginningJanuary 1, 2018. The Company does not consider its restricted cash balances to be material for further disclosure or reconciliation. The adoption of thisguidance did not impact the Company’s consolidated financial position, results of operations, or footnote disclosures.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 provided 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 Cuts and Jobs Act of 2017 (or portion thereof) was recorded. ASU 2018-02 is effective for fiscal yearsbeginning after December 15, 2018. Early adoption is permitted for any interim period for which financial statements have not been issued. The Companyadopted ASU 2018-02 effective January 1, 2018. Due to the presence of a full valuation allowance, adoption did not have a material impact on theCompany's consolidated financial statements and the disclosure requirements under ASU 2018-02 were not applicable.F-9Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) In May 2014, the FASB issued ASC 606 which provided a new standard related to revenue recognition. Under ASC 606, revenue is recognized when acustomer obtains control of promised goods or services in an amount that reflects the consideration the entity expects to receive in exchange for those goodsor services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts withcustomers.The Company adopted ASC 606 effective January 1, 2018. As a result, the Company has changed its accounting for revenue. The Company adoptedASC 606 using the modified retrospective method applied using hindsight to those contracts that were not complete as of January 1, 2018. The cumulativeeffect of initially applying ASC 606 totaled $0.8 million and was recognized as an adjustment to reduce the opening balance of accumulated loss at January1, 2018. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods.The Company implemented or modified certain internal controls and key system functionality to enable the preparation of financial information underASC 606.The most significant impact of ASC 606 to the Company related to the accounting for offerings that contained perpetual software for which customerstook possession, which occurs only in the Company's Consumer Language segment. Prior to the adoption of ASC 606, revenue was recognized at the time ofdelivery for these perpetual software products due to the fact that the Company had established vendor specific objective evidence of the fair value ("VSOE")for the undelivered services in the arrangement. To the extent that VSOE was not established for undelivered services bundled with perpetual software, allrevenue was deferred and recognized as the services were provided. Under the new guidance in ASC 606, the requirement to establish VSOE of theundelivered services in order to recognize revenue at the time of delivery no longer exists and revenue is allocated to performance obligations by estimatingthe standalone selling price and using a relative value allocation method. Revenue recognition related to subscription services and professional servicesremained substantially unchanged. Adoption had no tax impact due to the presence of a full valuation allowance. The impact of adoption to the Company’sconsolidated statement of operations for the year ended December 31, 2018 was as follows (in thousands except for per share amounts): Year ended December 31, 2018 As reported Effect of changehigher/(lower) Balances withoutadoption ofASC 606 Revenue: Subscription and service $170,685 $(1,593) $172,278 Product 2,949 3,337 (388)Total revenue 173,634 1,744 171,890 Gross profit 137,712 1,744 135,968 Loss from operations (19,619) 1,744 (21,363)Loss before income taxes (19,664) 1,744 (21,408)Net loss $(21,473) $1,744 $(23,217)Loss per share: Basic $(0.95) $0.07 $(1.02)Diluted $(0.95) $0.07 $(1.02) F-10Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Adoption of ASC 606 had impacts to the consolidated balance sheet as well, primarily related to the presentation of deferred commissions and thereduction to deferred revenue. The Company's prior methodology was to bifurcate deferred commissions between current and non-current classifications.Under ASC 606, deferred commissions are classified as non-current unless the original amortization period is one year or less. Deferred revenue decreased onadoption of ASC 606 due to the changes in the timing of revenue recognition noted above. The impact of adoption to the Company’s consolidated balancesheet as of December 31, 2018 was as follows (in thousands): As of December 31, 2018 As reported Effect of changehigher/(lower) Balances withoutadoption ofASC 606 Deferred sales commissions - current 11,597 (3,935) 15,532 Total current assets 76,695 (3,935) 80,630 Deferred sales commissions - non-current 6,933 3,935 2,998 Other current liabilities 13,475 (172) 13,647 Deferred revenue 113,378 (2,343) 115,721 Total current liabilities 145,615 (2,515) 148,130 Total liabilities 199,266 (2,515) 201,781 Accumulated loss (199,592) 2,515 (202,107)Total stockholders' deficit (12,008) 2,515 (14,523) The impact of adoption to the Company’s reportable segments for the year ended December 31, 2018 was as follows (in thousands): Year ended December 31, 2018 Segment Revenue: As reported Effect of changehigher/(lower) Balances withoutadoption ofASC 606 Literacy $52,766 $(136) $52,902 E&E Language 60,376 14 60,362 Consumer Language 60,492 1,866 58,626 Total revenue $173,634 $1,744 $171,890 Accounting Standards Not Yet Adopted: The following ASUs were recently issued but have not yet been adopted by the Company:In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the DisclosureRequirements for Fair Value Measurement ("ASU 2018-13"). ASU 2018-13 modifies the disclosure requirements for fair value measurements by removing,modifying, or adding certain disclosures. ASU 2018-13 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscalyears, with early adoption permitted for any eliminated or modified disclosures. The Company is in the process of evaluating the effect of adopting this newaccounting guidance to determine the impact it may have on the Company’s consolidated financial statements.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.F-11Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 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. However based on a preliminary assessment and as the Companydoes not hold significant financial instruments, the Company does not expect the adoption of this guidance to have a material impact on its consolidatedfinancial statements.In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) ("ASU 2016-02") that requires lessees to recognize assets and liabilities formost leases. In July 2018, the FASB issued ASU No. 2018-10, Leases (Topic 842): Codification Improvements which impacts narrow aspects of the guidanceissued under ASU 2016-02. In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements which provides a new transitionmethod and a practical expedient for separating components of a contract. Collectively these ASUs comprise the new lease standard ("New Lease Standard").Under the New Lease Standard, entities will be required to record most leases on their balance sheets. A lessee would recognize a lease liability for theobligation to make lease payments and a right-of-use asset for the right to use the underlying asset for the lease term. Lease expense recognition is largelyunchanged. The New Lease Standard is effective for public entities in fiscal years beginning after December 15, 2018, including interim periods within thosefiscal years. Early adoption is permitted, however the Company has not early adopted this guidance. The New Lease Standard is required to be adopted usinga modified retrospective approach. The Company does not expect to recognize a cumulative-effect adjustment to the opening balance of retained earnings inthe period of adoption as the Company expects to elect the package of practical expedients. The Company will continue to report comparative prior periodinformation under the accounting standards in effect for those prior comparative periods. The Company expects its leases designated as operating leases inNote 15, "Commitments and Contingencies," will be reported on the consolidated balance sheets upon adoption. Upon adoption effective January 1, 2019,the Company expects to record right-of-use assets of approximately $5.4 million and corresponding lease liabilities of approximately $5.4 million on theconsolidated balance sheets for its operating leases. The New Lease Standard is not expected to have a material impact on the consolidated statements ofoperations and comprehensive loss or the consolidated statements of cash flows. The Company is in the process of implementing the New Lease Standard.Revenue RecognitionNature of Revenue: The Company accounts for revenue contracts with customers by applying the requirements of ASC 606, which includes thefollowing steps: •Identification of the contract, or contracts with a customer. •Identification of the performance obligations in the contract. •Determination of the transaction price. •Allocation of the transaction price to the performance obligations in the contract. •Recognition of the revenue when, or as, the Company satisfies a performance obligation.The Company's primary sources of revenue are web-based software subscriptions, mobile applications, online services, perpetual product software, andbundles of perpetual product software and online services. The Company also generates revenue from the sale of audio practice products and professionalservices. With the completion of the SaaS transition, perpetual software sales are no longer a significant portion of the business.Revenue is recognized upon transfer of control of promised goods or services to customers in an amount that reflects the consideration expected to bereceived in exchange for those goods or services. Revenue is recognized net of allowances for returns. Revenue is also recognized net of any taxes collectedfrom customers, which are subsequently remitted to governmental authorities.Subscription and service revenue consists of fees associated with non-cancellable web-based software subscriptions, online services, professionalservices, and mobile applications. Subscription revenue is generated from contracts with customers that provide access to hosted software over a contract termwithout the customer taking possession of the software. Subscription revenue is recognized ratably over the contract period as the performance obligation issatisfied. Subscription revenue is generated by all three reportable segments and range from short-term to multi-year contracts. Online services are typicallysold in short-term service periods and include dedicated online conversational coaching services and access to online communities of language learners.Professional services include implementation services. Online services revenue and professional services revenue are recognized as the services are provided.Expired services are forfeited and revenue is recognized upon expiry.F-12Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Product revenue primarily consists of revenue from perpetual language-learning software and audio practice products. Audio practice products areoften combined with language-learning software and sold as a solution. Perpetual software revenue is recognized at the point in time when the software ismade available to the customer. Audio practice products are recognized at the point in time that the audio practice products are delivered to the customer. Aspost-contract support (“PCS”) is provided to customers who purchase perpetual software at no charge, a portion of the transaction price is allocated to PCSservice revenue and recognized as the PCS services are provided, which is typically up to three months from the date of purchase. With the completion of theSaaS transition, perpetual software sales are no longer a significant portion of the business.See Note 18 - “Segment Information” for further information on the disaggregation of revenue, including revenue by reportable segment, geographicarea, and revenue type.Performance Obligations: A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit ofaccount in ASC 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, theperformance obligation is satisfied. The Company’s performance obligations are satisfied at a point in time or over time as delivery occurs or as workprogresses.Significant Judgments: Some of the Company’s contracts with customers include promises to transfer multiple products and services to a customer.Determining whether products and services are considered distinct performance obligations that should be accounted for separately, versus together, requiressignificant judgment. This includes determining whether distinct services are part of a series of distinct services that are substantially the same. Whensubscription services are sold with professional services, judgment is required to determine whether the professional services are distinct and can beaccounted for separately. In the E&E Language segment, the Company has concluded that each promised service within the language-learning subscriptionis delivered concurrently with all other promised services over the contract term and, as such, concluded that these promises are a single performanceobligation that includes a series of distinct services that have the same pattern of transfer to the customer. When there are multiple performance obligations,revenue is allocated to each performance obligation based on its relative standalone selling price (“SSP”). Judgment is required to determine the SSP for eachdistinct performance obligation where SSP is not directly observable, such as when the product or service is not sold separately, SSP is determined usinginternally published price lists which include suggested sales prices for each performance obligation based on the type of client and volume purchased.These price lists are derived from past experience and from the expectation of obtaining a reasonable margin based on the cost to fulfill each performanceobligation.Subscription revenue is recognized ratably over the contract period as the performance obligation is satisfied. Certain Consumer Language offeringshave contracts with no fixed duration and are marketed as lifetime subscriptions. For these lifetime subscriptions, the Company estimates the expectedcontract period as the greater of the typical customer usage period or the longest fixed-period duration subscription that is currently marketed. TheCompany's current expected contract period for lifetime subscriptions is 24 months.Certain Consumer Language offerings are sold with a right of return and the Company may provide other credits or incentives. These rights areaccounted for as variable consideration when estimating the amount of revenue to recognize by utilizing the expected value method. Returns and credits areestimated at contract inception based on historical return rates, estimated channel inventory levels, the timing of new product introductions and other factors.Reserves for returns and credits are updated at the end of each reporting period as additional information becomes available.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 amount to the end customer. The Company evaluates each of its reseller relationships to determinewhether it is the principal (where revenue is recognized at the gross amount) or agent (where revenue is recognized net of the reseller commission). In makingthis determination the Company evaluates a variety of factors including the amount of control the Company is able to exercise over the transactions.Contract Balances: The timing of revenue recognition, invoicing, and cash collection results in accounts receivable and deferred revenue in theconsolidated balance sheets. Payment from customers is often received in advance of services being provided, resulting in deferred revenue. Accountsreceivable is recorded when there is an executed customer contract and the right to the consideration becomes unconditional. Contract assets such as unbilledreceivables are not material.The allowance for doubtful accounts reflects the best estimate of probable losses inherent in the accounts receivable balance. The Companyestablishes an allowance for doubtful accounts based on specific risks identified, historical experience, and other currently available evidence.F-13Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Payment terms and conditions vary by contract type and customer. For the E&E Language and Literacy segments, payment terms generally range from30 to 90 days. In the Consumer Language segment, resellers are generally granted payment terms of 45 days. Within Consumer Language, sales to endcustomers via the Rosetta Stone ecommerce website are done by credit card, which generally are settled within 7-10 days and may be made in installments. Ininstances where the timing of revenue recognition differs from the timing of invoicing, the Company has determined that contracts generally do not include asignificant financing component. The primary purpose of invoicing terms is to provide customers with simplified and predictable ways of purchasingproducts and services and not to provide customers with financing.Deferred revenue is comprised mainly of unearned revenue related to subscription services which is recognized ratably over the subscription period.Deferred revenue also includes payments for professional services and online services to be performed in the future which are earned as revenue when theservice is provided. Our practice is to ship our products promptly upon receipt of purchase orders from customers; consequently, contract backlog is notmaterial.The opening and closing balances of the Company’s accounts receivable and deferred revenue are as follows (in thousands): AccountsReceivable DeferredRevenue(current) DeferredRevenue(non-current) Opening balance as of January 1, 2018 $24,517 $110,670 $40,593 Increase/(decrease), net (2,567) 2,708 8,914 Ending balance as of December 31, 2018 $21,950 $113,378 $49,507 The amount of revenue recognized in the year ended December 31, 2018 that was included in the opening January 1, 2018 deferred revenue balancewas $116.5 million. The vast majority of this revenue consists of deferred subscription revenue. The amount of revenue recognized from performanceobligations satisfied in prior periods was not material.The following table sets forth deferred revenue by reportable segment which represents the Company's unfulfilled performance obligations as ofDecember 31, 2018 and the estimated revenue expected to be recognized in the future related to these performance obligations (in thousands): As of December 31, 2018 Total Less than1 Year 1-3 Years 3-5 Years More than5 Years Literacy $47,457 $38,252 $8,458 $711 $36 E&E Language 58,047 41,721 9,955 1,918 4,453 Consumer Language 57,381 33,405 10,462 1,764 11,750 Total $162,885 $113,378 $28,875 $4,393 $16,239 The Company entered into a series of agreements with SOURCENEXT Corporation (“SOURCENEXT”), comprised of a single performance obligationassociated with the perpetual license of certain intellectual property, software, and product code for exclusive development and sale of language andeducation-related products in Japan. The Company estimated a 20 year period to recognize the performance obligation. As of December 31, 2018, deferredrevenue associated with SOURCENEXT totaled $16.2 million, which will be recognized ratably through April 2037 and comprised the majority of theConsumer Language non-current deferred revenue. As this customer relationship progresses, the Company will prospectively reassess the recognition periodas needed.Assets Recognized from Costs to Obtain a Contract with a Customer: Assets are recognized for the incremental costs of obtaining a contract with acustomer, which primarily represent sales commissions paid when a customer contract is either recorded as revenue or deferred revenue. Sales commissionspaid to obtain non-cancellable subscription contracts are deferred and amortized in proportion to the period over which the revenue is recognized from therelated contract. Deferred sales commissions are amortized to sales and marketing expense on the consolidated statements of operations. Deferred salescommissions are classified as non-current unless the associated amortization period is one year or less. As of December 31, 2018, the total deferred salescommissions balance was $18.5 million. Amortization of deferred sales commissions recognized during the year ended December 31, 2018 was $23.0million.F-14Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 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, 2018, 2017 or 2016. The four largest distributor andreseller receivable balances collectively represented 19% and 17% of accounts receivable as of December 31, 2018 and 2017, respectively. One customeraccounted for 12% of accounts receivable as of December 31, 2018. No customer accounted for more than 10% of accounts receivable as of December 31,2017. The Company maintains trade credit insurance for certain customers to provide coverage, up to a certain limit, in the event of insolvency of somecustomers.Fair Value of Financial InstrumentsThe Company values its assets and liabilities using the methods of fair value as described in ASC topic 820, Fair Value Measurements andDisclosures, ("ASC 820"). ASC 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. The three levels ofthe fair value hierarchy are described below:Level 1: Quoted prices for identical instruments in active markets.Level 2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; andmodel-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.F-15Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 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 years Computer equipment 3-5 years Automobiles 5 years Furniture and equipment 5-7 years Building 39 years Building improvements 15 years Leasehold improvements lesser of lease term or economic life Assets under capital leases lesser of lease term or economic life Expenses for repairs and maintenance that do not extend the life of equipment are charged to expense as incurred. Expenses for major renewals andbetterments, which significantly extend the useful lives of existing property and equipment, are capitalized and depreciated. Upon retirement or dispositionof property and equipment, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized. 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").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.F-16Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 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 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 thedeferred tax assets will not be realized. The impact of tax rate changes on deferred tax assets and liabilities is recognized in the year that the change isenacted.Significant judgment is required to determine whether a valuation allowance is necessary and the amount of such valuation allowance, if appropriate.The valuation allowance is reviewed at each reporting period and is maintained until sufficient positive evidence exists to support a reversal.When assessing the realization of the Company's deferred tax assets, the Company considers all available evidence, including: •the nature, frequency, and severity of cumulative financial reporting losses in recent years; •the carryforward periods for the net operating loss, capital loss, and foreign tax credit carryforwards;F-17Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) •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 14 "Income Taxes" for additional disclosures including the impact and additional disclosures associated with the tax legislation commonlyreferred to as the Tax Cuts and Jobs Act of 2017 (the “Tax Act”), that was enacted on December 22, 2017.Stock-Based CompensationThe Company accounts for its stock-based compensation in accordance with ASC topic 718, Compensation—Stock Compensation ("ASC 718").Under ASC 718, all stock-based awards, including employee stock option grants, are recorded at fair value as of the grant date. For options granted withservice and/or performance conditions, the fair value of each grant is estimated on the date of grant using the Black-Scholes option pricing model. Foroptions granted with market-based conditions, the fair value of each grant is estimated on the date of grant using the Monte-Carlo simulation model. Thesemethods require 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 theexpected term of options granted, the Company estimates the expected term of options using a combination of historical information and the simplifiedmethod for estimating the expected term. The Company uses its own historical stock price data to estimate its forfeiture rate and expected volatility over themost recent period commensurate with the estimated expected term of the awards. For the risk-free interest rate, the Company uses a U.S. Treasury Bond rateconsistent with 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, stock compensation expense is recognized in the statement of operations ratably for each vesting tranche regardless ofmeeting or not meeting the market conditions. See Note 9 "Stock-Based Compensation" for additional disclosures.Restructuring CostsRestructuring plans have been initiated in each of the years ended December 31, 2017 and 2016 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.F-18Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Employee severance and related benefit costs primarily include cash payments, outplacement services, continuing health insurance coverage, andother benefits. 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. Contracttermination costs 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 12 "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 11 "Basic and Diluted Net Loss Per Share" for additional disclosures.Comprehensive LossComprehensive loss consists of net loss and other comprehensive (loss) income. Other comprehensive (loss) income refers to revenues, expenses, gains,and losses that are not included in net loss, but rather are recorded directly in stockholders' (deficit) equity. For the years ended December 31, 2018, 2017,and 2016, the Company's comprehensive loss consisted of net loss and foreign currency translation (losses) gains. The other comprehensive (loss) incomepresented 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 (loss) income due to the presence of a full valuation allowance for each of the years ended December 31, 2018, 2017, and2016.Components of accumulated other comprehensive loss as of December 31, 2018 are as follows (in thousands): Foreign Currency Total Balance at beginning of period $(2,898) $(2,898)Other comprehensive loss before reclassifications (440) (440)Amounts reclassified from accumulated other comprehensive loss — — Net current period other comprehensive loss (440) (440)Accumulated other comprehensive loss $(3,338) $(3,338) Upon divestiture of an investment in a foreign entity, the amount attributable to the accumulated translation adjustment component of that foreignentity is removed as a component of other comprehensive (loss) income and reported as part of the gain or loss on sale or liquidation of the investment. Foreign Currency Translation and TransactionsThe functional currency of the Company's foreign subsidiaries is their local currency. Accordingly, assets and liabilities of the foreign subsidiaries aretranslated into U.S. dollars at exchange rates in effect on the balance sheet date. Income and expense items are translated at average rates for the period.Translation adjustments are recorded as a component of other comprehensive (loss) income in stockholders' (deficit) equity.Cash flows of consolidated foreign subsidiaries, whose functional currency is the local currency, are translated to U.S. dollars using average exchangerates for the period. The Company reports the effect of exchange rate changes on cash balances held in foreign currencies as a separate item in thereconciliation of the changes in cash and cash equivalents during the period.F-19Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Advertising CostsCosts for advertising are expensed as incurred. Advertising expense for the years ended December 31, 2018, 2017, and 2016 were $23.4 million, $24.9million and $37.0 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-topic205-40, Presentation of Financial Statements - Going Concern ("ASC 205-40"). Under ASC 205-40, management is required to assess the Company's abilityto continue as a going concern. As further described below, management has concluded based on projections that the cash balance, funds available from theline of credit, and the cash flows from operations are sufficient to meet the liquidity needs through the one year period following the financial statementissuance date.The consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfactionof liabilities in the normal course of business. Management has evaluated whether relevant conditions or events, considered in the aggregate, indicate thatthere is 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 reasonably knowable as of March 6, 2019.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 2019 cash flow forecast, 2019 operatingbudget, and long-term plan that extends beyond 2019. 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 6,2019, 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.3. INVENTORYInventory consisted of the following (in thousands): As of December 31, 2018 2017 Raw materials $797 $2,893 Finished goods 136 643 Total inventory $933 $3,536 The total inventory balance as of December 31, 2018 reflected the Company's ongoing efforts to transition the Consumer Language segment to a SaaSmodel. During 2018, the Company recorded $2.1 million in inventory obsolescence charges in the retail and direct-to-consumer channels of the ConsumerLanguage business. In the third quarter of 2017, the Company requested its consignment retail partners to return inventory totaling $1.9 million of finishedpackaged perpetual products. These non-cash inventory write-downs were reflected as a cost of product revenue on the Company's statements of operations.F-20Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 4. PROPERTY AND EQUIPMENTProperty and equipment consisted of the following (in thousands): As of December 31, 2018 2017 Land $916 $942 Buildings and improvements 9,760 10,030 Leasehold improvements 644 1,468 Computer equipment 16,178 15,635 Software 70,010 54,600 Furniture and equipment 2,184 2,427 99,692 85,102 Less: accumulated depreciation (63,287) (54,453)Property and equipment, net $36,405 $30,649 The Company leases certain computer equipment, software, buildings, and machinery under capital lease agreements. As of December 31, 2018 and2017, assets under capital lease included in property and equipment above were $5.7 million and $5.9 million, respectively. As of December 31, 2018 and2017, accumulated depreciation and amortization relating to property and equipment under capital lease arrangements totaled $3.3 million and $2.8 million,respectively.For the years ended December 31, 2018, 2017, and 2016 the Company capitalized $15.9 million, $12.7 million, and $11.4 million respectively, ofinternal-use software development costs. During the year ended December 31, 2016, the Company recorded $1.0 million in impairment expense related to theabandonment of previously capitalized internal-use software projects. There were no impairment charges during the years ended December 31, 2018 and2017.Depreciation and amortization expense related to property and equipment includes depreciation related to its physical assets and amortizationexpense related to amounts capitalized in the development of internal-use software. Depreciation and amortization expense associated with property andequipment consisted of the following (in thousands): Years Ended December 31, 2018 2017 2016 Included in cost of revenue: Cost of subscription and service revenue $7,467 $3,863 $3,057 Cost of product revenue 913 1,117 1,377 Total included in cost of revenue 8,380 4,980 4,434 Included in operating expenses: Sales and marketing 764 546 489 Research and development 7 9 19 General and administrative 2,153 2,635 4,029 Total included in operating expenses 2,924 3,190 4,537 Total $11,304 $8,170 $8,971 5. 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 accordancewith the provisions of ASC 350, or more frequently, if impairment indicators arise. The Company also routinely reviews goodwill at the reporting unit levelfor potential impairment.F-21Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (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, 2018 and 2017 (in thousands): E&ELanguage Literacy ConsumerLanguage Total Balance as of January 1, 2017 Gross Goodwill $38,289 $9,962 $27,514 $75,765 Accumulated Impairment — — (27,514) (27,514)Goodwill as of January 1, 2017 $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 $77,371 Accumulated Impairment — — (27,514) (27,514)Goodwill as of December 31, 2017 $39,895 $9,962 $— $49,857 Effect of change in foreign currency rate (618) — — (618) Balance as of December 31, 2018 Gross Goodwill $39,277 $9,962 $27,514 $76,753 Accumulated Impairment — — (27,514) (27,514)Goodwill as of December 31, 2018 $39,277 $9,962 $— $49,239 2018 ActivityThe Company exercised its option to bypass the qualitative assessment for all reporting units with remaining goodwill balances and began our June30, 2018 annual goodwill test with the quantitative test. The tested reporting units resulted in fair values that substantially exceeded the carrying values andtherefore, no goodwill impairment charges were recorded in connection with the annual test.2016 ActivityThe Consumer Fit Brains reporting unit was 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.6. INTANGIBLE ASSETSIntangible assets consisted of the following items as of the dates indicated (in thousands): Trade name /trademark * Coretechnology Customerrelationships Patents andOther Total Gross Carrying Amount $12,505 $15,636 $26,656 $312 $55,109 Accumulated Amortization/Impairment (1,781) (13,223) (20,643) (278) (35,925)Balance as of December 31, 2017 $10,724 $2,413 $6,013 $34 $19,184 Gross Carrying Amount $12,322 $13,432 $25,689 $312 $51,755 Accumulated Amortization/Impairment (1,715) (12,505) (21,380) (305) (35,905)Balance as of December 31, 2018 $10,607 $927 $4,309 $7 $15,850 F-22Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) * 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: WeightedAverage LifeTrade name / trademark IndefiniteCore technology 1.58Customer relationships 4.58Patents 0.25 Intangible asset amortization expense consisted of the following (in thousands): Years Ended December 31, 2018 2017 2016 Included in cost of revenue: Cost of subscription and service revenue $522 $455 $404 Cost of product revenue 64 131 182 Total included in cost of revenue 586 586 586 Included in operating expenses: Sales and marketing 1,810 1,860 2,178 Research and development 915 1,393 1,587 General and administrative — — — Total included in operating expenses 2,725 3,253 3,765 Total $3,311 $3,839 $4,351 The following table summarizes the estimated future amortization expense related to intangible assets as of December 31, 2018 (in thousands): As ofDecember 31, 2018 2019 $1,533 2020 1,282 2021 940 2022 940 2023 548 Thereafter — Total $5,243 The 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.2018 ActivityThe Company performed its annual indefinite-lived intangible asset impairment test on the Rosetta Stone tradename as of December 31, 2018 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, 2018 to determine if indicators ofimpairment exist. As a result of these assessments, there were no indicators of impairment for the year ended December 31, 2018.F-23Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2016 ActivityDuring 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 the Consumer Fit Brainsreporting unit ("Consumer Fit Brains Intangible Assets"). The carrying values of the Consumer Fit Brains Intangible Assets exceeded the estimated fairvalues. As a result, the Company recorded an impairment loss of $1.2 million associated with the impairment of the remaining carrying value of theConsumer Fit Brains Intangible Assets as of June 30, 2016. The impairment charge was included in the "Impairment" line on the statement of operations.7. OTHER CURRENT LIABILITIESThe following table summarizes other current liabilities (in thousands): As of December 31, 2018 2017 Accrued marketing expenses $4,382 $5,316 Accrued professional and consulting fees 1,273 1,609 Sales return reserve 579 1,176 Sales, withholding, and property taxes payable 3,391 3,616 Other 3,850 4,737 Total Other current liabilities $13,475 $16,454 8. 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 revolving credit facility (the “credit facility”). Since the original date of execution, the Companyand the Bank have executed several amendments to the credit facility to reflect updates to the Company's financial outlook and extend the credit facility.On March 4, 2019, the Company executed the seventh amendment to the credit facility. Under the amended agreement, the Company may borrow upto $15.0 million, including a sub-facility, which reduces available borrowings, for letters of credit in the aggregate availability amount of $4.0 million.Borrowings by RSL under the credit facility are guaranteed by the Company as the ultimate parent. The credit facility has a term that expires on April 1,2021, during which time RSL may borrow and re-pay loan amounts and re-borrow the loan amounts subject to customary borrowing conditions. However, theCompany must have no more than $5.0 million in outstanding borrowings for 30 consecutive days during each twelve month period beginning as of the dateof execution. Interest on borrowing accrues at the Prime Rate and must be paid quarterly. 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. Effective as of March 4, 2019, the Company is required to maintain compliance with a minimumliquidity coverage ratio of 1.75 and minimum financial performance requirements, as defined in the credit facility. As of December 31, 2018, the Companywas in compliance with all covenants in effect as of that date.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, 2018, under the agreement prior to the seventh amendment, there were no borrowings outstanding . During the third quarter of2018, a $4.0 million letter of credit that was previously issued by the Bank on the Company's behalf was cancelled asF-24Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) it was deemed no longer necessary. A quarterly commitment fee accrues on any unused portion of the credit facility at a nominal annual rate.Capital LeasesThe Company enters into capital leases under non-committed arrangements for equipment and software. In addition, as a result of the merger with TellMe More, the Company assumed a capital lease for a building near Versailles, France, where Tell Me More’s headquarters were located. The fair value of thelease liability at the date of acquisition was $4.0 million.As of December 31, 2018, the future minimum payments under capital leases with initial terms of one year or more are as follows (in thousands): Periods Ending December 31, 2019 $525 2020 520 2021 517 2022 388 2023 1 Thereafter — Total minimum lease payments $1,951 Less amount representing interest 164 Present value of net minimum lease payments $1,787 Less current portion 450 Obligations under capital lease, long-term $1,337 Effective January 1, 2019, the Company will adopt the New Lease Standard as described in Note 2 "Summary of Significant Accounting Policies". 9. 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 Boardof Directors, 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 including Incentive and Nonqualified Stock Options, Stock AppreciationRights, Restricted Stock, Restricted Stock Units, Performance Units, Performance Shares, Performance based Restricted Stock, Share Awards, Phantom Stockand Cash Incentive Awards. Restricted stock awards are considered outstanding at the time of grant as the stockholder is entitled to voting rights and toreceive any dividends declared subject to the loss of the right to receive accumulated dividends if the award is forfeited prior to vesting. Unvested restrictedstock awards are not considered outstanding in the computation of basic earnings per share. The stock incentive awards and options granted under the 2009Plan generally expire at the earlier of a specified period after termination of service or the date specified by the Board or its designated committee at the dateof grant, but not more than ten years from such grant date. Concurrent with the approval of the 2009 Plan, the 2006 Plan was terminated for purposes of futuregrants. Since the establishment of the 2009 Plan, the Board of Directors authorized and the Company's shareholders' approved the allocation of additionalshares of common stock to the 2009 Plan as follows: F-25Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Authorization Dates of 2009 Plan Additions Number of Common Stock Shares Authorized to 2009 Plan February 27, 2009 2,437,744 May 26, 2011 1,000,000 May 23, 2012 1,122,930 May 23, 2013 2,317,000 May 20, 2014 500,000 June 12, 2015 1,200,000 May 27, 2017 1,900,000 At December 31, 2018 there were 1,161,160 shares available for future grant under the 2009 Plan, which expires in 2019.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 ShareUnits: 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, whichrequires the 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.The Monte 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, 2018, 2017, and 2016 the fair value of service-based stock options and performance-based stock options grantedwas calculated using the following assumptions in the Black-Scholes model: Years Ended December 31, 2018 2017 2016 Expected stock price volatility 39%-40% 42%-45% 46%-47% Expected term of options 6 years 6 years 5.5-6.5 years Expected dividend yield — — — Risk-free interest rate 2.73%-2.85% 1.92%-2.05% 1.24%-1.50% For the years ended December 31, 2018, 2017, and 2016 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, 2018 2017 2016 Expected stock price volatility none none 45%-49% Expected term of options none none 1.7 years-7 years Expected dividend yield none none — Risk-free interest rate none none .71%-1.53% Stock-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 withF-26Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) performance-based awards will be accounted for in the period of change using a cumulative catch-up adjustment to retroactively apply the new probabilityestimates. In any period in which the Company determines that achievement of the performance metrics is not probable, the Company ceases recordingcompensation expense and all previously recognized compensation expense for the performance-based award is reversed. For equity awards granted withmarket-based conditions, stock compensation is recognized in the statement of operations ratably for each vesting tranche regardless of meeting or notmeeting 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, 2018 2017 2016 Included in cost of revenue: Cost of subscription and service revenue $1 $15 $(4)Cost of product revenue (9) 54 52 Total included in cost of revenue (8) 69 48 Included in operating expenses: Sales and marketing 759 561 998 Research & development 439 255 709 General and administrative 3,285 3,256 3,151 Total included in operating expenses 4,483 4,072 4,858 Total $4,475 $4,141 $4,906 The following table presents the future stock-based compensation expense, net of forfeitures, for each equity award category as of December 31, 2018and the weighted average period over which the expense will be recognized: Service-basedRestricted StockAwards Service-based StockOptions Restricted StockUnits Performance StockUnits Unrecognized compensation expense, net of forfeitures (inthousands) $2,426 $493 $207 $1,670 Weighted average period over which the above expense will berecognized (in years) 2.41 0.85 0.46 1.07 Service-Based Restricted Stock Awards Shares of service-based restricted stock are generally recognized as expense on a straight-line basis over the requisite service period of the awards,which is also the vesting period. Service-based restricted stock awards are granted at the discretion of the Board of Directors or the Compensation Committee(or its authorized member(s)) and generally vest over a four -year period based upon required service conditions and do not have performance or marketconditions. The Company's service-based restricted stock awards are accounted for as equity awards. The grant date fair value is based on the market price ofthe Company's common stock at the date of grant. The Company did not grant any restricted stock prior to April 2009.The following table summarizes the Company's service-based restricted stock activity from January 1, 2018 to December 31, 2018: Service-based RestrictedStock Awards WeightedAverage GrantDate FairValue AggregateIntrinsic Value Non-vested service-based awards, January 1, 2018 431,118 $8.07 $3,477,484 Service-based awards granted 218,006 13.87 Service-based awards vested (208,238) 8.82 Service-based awards cancelled (39,934) 9.14 Non-vested Service-based awards, December 31, 2018 400,952 10.72 4,299,689 F-27Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The following table summarizes the Company's weighted average grant date fair value and vested fair value for the years ended December 31, 2018,2017, and 2016: Years Ended December 31, 2018 2017 2016 Weighted-average grant-date fair value of service-based restricted stockawards granted $13.87 $7.92 $7.59 Fair value of service-based restricted stock awards vested (in thousands) $3,881 $1,545 $1,511 Service-Based Stock OptionsService-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 aggregate intrinsic value disclosed below represents the total intrinsic value (the difference between the fair market value of the Company'scommon stock as of December 31, 2018, 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, 2018. This amount is subject to change based on changes tothe fair market value of the Company's common stock.The following table summarizes the Company's service-based stock option activity from January 1, 2018 to December 31, 2018: Service-basedOptions WeightedAverageExercisePrice WeightedAverageContractualLife (years) AggregateIntrinsicValue Service-based options outstanding, January 1, 2018 1,628,711 $9.81 6.79 $5,203,196 Service-based options granted 60,603 16.05 Service-based options exercised (207,218) 10.79 Service-based options cancelled (80,148) 14.09 Service-based options outstanding, December 31, 2018 1,401,948 9.69 6.17 9,492,949 Vested and expected to vest at December 31, 2018 1,394,022 9.70 6.16 9,429,510 Exercisable at December 31, 2018 1,194,092 9.80 5.97 $7,974,164 The following table summarizes the Company's weighted average grant date fair value and intrinsic value of options exercised for the years endedDecember 31, 2018, 2017, and 2016: Years Ended December 31, 2018 2017 2016 Weighted average grant date fair value of service-based stock options granted $6.76 $5.02 $3.41 Intrinsic value of options exercised (in thousands) $3,324 $878 $99 Restricted Stock UnitsRestricted stock units are granted to members of the Board of Directors as part of their compensation package. Restricted stock units convert tocommon stock following the separation of service with the Company. All restricted stock unit awards vest quarterly over a one year period from the date ofgrant, with expense recognized straight-line over the vesting period. The Company's restricted stock units are accounted for as equity awards. The grant datefair 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 stock units prior toApril 2009.F-28Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) The following table summarizes the Company's restricted stock unit activity from January 1, 2018 to December 31, 2018: UnitsOutstanding WeightedAverageGrant DateFair Value AggregateIntrinsicValue Units outstanding, January 1, 2018 234,658 $10.19 $2,926,185 Units granted 31,929 16.03 Units released (30,682) 8.74 Units cancelled — — Units outstanding, December 31, 2018 235,905 11.17 3,868,842 Vested and expected to vest at December 31, 2018 235,483 11.16 3,861,917 Vested and deferred at December 31, 2018 220,550 $10.82 $3,617,020 The following table summarizes the Company's weighted average grant date fair value and fair value of units converted for the years endedDecember 31, 2018, 2017, and 2016: Years Ended December 31, 2018 2017 2016 Weighted average grant date fair value of restricted stock units granted $16.03 $11.23 $7.70 Fair value of restricted stock units converted (in thousands) $495 $— $427 Performance-Based Restricted Stock UnitsBeginning in the first quarter of 2017, the Company began granting annual performance-based restricted stock units ("PSUs") to certain employeeswhich will become earned or eligible to vest based on the Company's achievement of certain pre-defined key operating performance goals during a one tothree-year period. The number of PSUs earned or eligible to vest following the performance period is subject to approval by the Compensation Committee ofthe Board of Directors. Once earned, certain PSUs are then subject to additional service and vesting requirements, while certain PSUs vest shortly after beingearned. The PSUs were granted at "target" (at 100% of target). Based upon actual attainment of the operating performance results relative to target and therecipient'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 originallygranted.The following table summarizes the Company's PSU activity from January 1, 2018 to December 31, 2018: PSUs WeightedAverageGrant DateFair Value AggregateIntrinsicValue Non-vested PSUs, January 1, 2018 433,588 $9.43 $5,406,842 PSUs granted 334,714 13.85 PSUs vested (54,298) 9.43 PSUs cancelled (54,344) 10.47 Non-vested PSUs, December 31, 2018 659,660 $11.59 $10,818,424 The following table summarizes the Company's weighted average grant date fair value and fair value of PSUs vested for the years ended December 31,2018, 2017, and 2016: Years Ended December 31, 2018 2017 2016 Weighted average grant date fair value of PSUs granted $13.85 $9.43 $— Fair value of PSUs vested (in thousands) $724 $— $—F-29Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 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.On February 20, 2017, the Compensation Committee approved 64,719 PRSAs and 144,497 PSOs as eligible for further service vesting requirements.The non-eligible 5,704 and 169,968 PRSAs and PSOs, respectively, were cancelled as of February 20, 2017. PRSAs and PSOs vest 50%, 25% and 25% onApril 4, 2017, 2018 and 2019, respectively. As of December 31, 2018, 48,540 PRSAs were vested and 108,372 PSOs were vested. As of December 31, 2018,no PSOs have been exercised. As of December 31, 2018, future compensation cost related to the non-vested portion of the PRSAs and PSOs not yetrecognized in the consolidated statement of operations was $20,000 and is expected to be recognized over a weighted average period of 0.26 years. OnFebruary 22, 2018, the Compensation Committee approved the maximum quantity of 140,846 MRSAs and 314,465 MSOs as eligible for further servicevesting requirements. MRSAs and MSOs vest annually on a pro-rata basis over three years beginning April 4, 2018. As of December 31, 2018, 46,949 MRSAswere vested and 104,822 MSOs were vested. As of December 31, 2018, no MSOs have been exercised. As of December 31, 2018, future compensation costrelated to the non-vested portion of the MRSAs and MSOs not yet recognized in the consolidated statement of operations was $0.1 million and is expected tobe recognized over a weighted average period of 1.09 years.10. STOCKHOLDERS' (DEFICIT) EQUITYAt December 31, 2018, the Company's Board of Directors had the authority to issue 200,000,000 shares of stock, of which 190,000,000 weredesignated as 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 pershare. At December 31, 2018 and 2017, the Company had shares of Common Stock issued of 24,426,248 and 23,782,773, respectively, and shares ofCommon Stock outstanding of 23,426,248 and 22,782,773, 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, 2017, or 2018. Shares repurchased under the program were recorded astreasury stock on the Company’s consolidated balance sheet. The shares repurchased under this program during the year ended December 31, 2013 were notthe result of an accelerated share repurchase agreement. Management has not made a decision on whether shares purchased under this program will be retiredor reissued.Holders of the Company's common stock are entitled to receive dividends when and if declared by the Board of Directors out of assets or funds legallyavailable for that purpose. Future dividends are dependent on the Company's financial condition and results of operations, the capital requirements of itsbusiness, covenants associated with financing arrangements, other contractual restrictions, legal requirements, regulatory constraints, industry practice andother factors deemed relevant by its Board of Directors. The Company has not paid any cash dividends on its common stock and does not intend to do so inthe foreseeable future.F-30Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 11. 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, 2018 2017 2016 (amounts in thousands, except per share amounts) Numerator: Net loss $(21,473) $(1,546) $(27,550)Denominator: Basic weighted average shares 22,705 22,244 21,969 Diluted weighted average shares 22,705 22,244 21,969 Loss per share: Basic $(0.95) $(0.07) $(1.25)Diluted $(0.95) $(0.07) $(1.25) 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). Years Ended December 31, 2018 2017 2016 (in thousands) Stock options 663 231 16 Restricted stock units 230 209 174 Restricted stocks 681 296 129 Total common stock equivalent shares 1,574 736 319 Share-based awards to purchase approximately 0.2 million, 0.7 million, and 2.0 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, 2018, 2017, and 2016, respectively, were not included in the calculationof diluted loss per share because they were anti-dilutive.12. 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. Restructuring charges included in the Company’s consolidatedstatement 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 31,2018, 2017 and 2016 (in thousands): Balance atJanuary 1,2016 CostIncurred CashPayments OtherAdjustments(1) Balance atDecember31, 2016 Severance costs $— $4,367 $(3,867) $— $500 Contract termination costs — 165 (74) (69) 22 Other costs — 590 (399) (121) 70 Total $— $5,122 $(4,340) $(190) $592F-31Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Balance atJanuary 1,2017 CostIncurred CashPayments OtherAdjustments(1) Balance atDecember31, 2017 Severance costs $500 $(50) $(303) $— $147 Contract termination costs 22 — (22) — — Other costs 70 14 (84) — — Total $592 $(36) $(409) $— $147 Balance atJanuary 1,2018 CostIncurred CashPayments OtherAdjustments(1) Balance atDecember31, 2018 Severance costs $147 $(34) $(19) $— $94 Contract termination costs — — — — — Other costs — — — — — Total $147 $(34) $(19) $— $94 (1)Other Adjustments includes non-cash period changes in the liability balance, which may include non-cash lease closure expense and foreigncurrency translation adjustments. As of December 31, 2018, the remaining 2016 Restructuring Plan liability of $0.1 million was classified as a current liability within accruedcompensation and other current liabilities on the consolidated balance sheets. The Company does not expect to incur any additional restructuring costs inconnection with the 2016 Restructuring Plan. In future financial statements, detailed activity of the 2016 Restructuring Plan will no longer be disclosed asthe remaining balance is considered minor.Other Employee Severance ActionsIn 2017, the Company initiated actions to reduce headcount in its Fit Brains business and in the U.S. and China locations within consumer productoperations. Primarily comprised of severance costs associated with these actions, the Company recorded expense of $1.2 million in 2017. Of these amounts,$1.1 million was paid in 2017. During 2018, the Company made final payments of $0.1 million in accrued severance costs.Cost TableThe following table summarizes the major types of costs associated with the Company’s restructuring plans and other employee severance actions forthe years ended December 31, 2018, 2017, and 2016 and total costs incurred through December 31, 2018 (in thousands): Years ended December 31, 2018 2017 2016 Severance costs $(24) $1,144 $4,438 Contract termination costs — 37 165 Other costs 21 26 590 Total $(3) $1,207 $5,193 The following table presents restructuring costs associated with the Company’s restructuring plans and other employee severance actions included inthe related line items of the Statement of Operations (in thousands): Years ended December 31, 2018 2017 2016 Cost of revenue $16 $378 $573 Sales and marketing (2) 411 2,324 Research and development (2) 318 913 General and administrative (15) 100 1,383 Total $(3) $1,207 $5,193 F-32Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) These restructuring expenses are not allocated to any reportable segment under the Company's definition of segment contribution as defined in Note18 "Segment Information."13. 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 during 2014. Prior to January 31, 2014, the Company occupied the6th and 7th floors at its Arlington, Virginia headquarters. The Company estimated the liability under the operating lease agreements and accrued leaseabandonment costs in accordance with ASC 420, Exit or Disposal Cost Obligations ("ASC 420"), as the Company had no future economic benefit from theabandoned space. All leased space related to the 6th floor was abandoned and ceased to be used by the Company on January 31, 2014. The operating leaseperiod for this space terminated on December 31, 2018. In a further effort to reduce general and administrative expenses through a planned space consolidation, the Company relocated its headquarterslocation to 1621 North Kent Street, Suite 1200, Arlington, Virginia 22209. The previously leased space at the 7th floor of 1919 North Lynn Street wasabandoned and ceased to be used by the Company on October 10, 2016 and resulted in $1.6 million in lease abandonment expense in 2016. The operatinglease period for this space terminated on December 31, 2018.A summary of the Company’s lease abandonment activity for the years ended December 31, 2018, 2017 and 2016 is as follows (in thousands): As of December 31, 2018 2017 2016 Accrued lease abandonment costs, beginning of period $1,081 $2,123 $1,282 Costs incurred and charged to expense — — 1,644 Principal reductions (816) (1,042) (803)Accrued lease abandonment costs, end of period $265 $1,081 $2,123 Accrued lease abandonment costs liability: Short-term $265 $1,081 $1,047 Long-term — — 1,076 Total $265 $1,081 $2,123 In January 2019, the Company paid the remaining $0.3 million in accrued lease abandonment costs. F-33Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 14. INCOME TAXESThe new Tax Act legislation, was enacted on December 22, 2017. ASC 740, Accounting for Income Taxes, requires companies to recognize the effectof tax law changes in the period of enactment even though the effective date for most provisions is for tax years beginning after December 31, 2017, or in thecase of certain other provisions, January 1, 2018.During the year of enactment, the Company recorded reasonable estimates of the effects of the Tax Act, which principally related to a) the reduction inthe U.S. corporate income tax rate from 35% to 21%, and b) the change in the carryforward period of net operating losses. In the fourth quarter of 2017, theCompany recorded an income tax benefit of $2.4 million to remeasure deferred tax liabilities associated with indefinite-lived intangible assets that willreverse at the new 21% rate. Absent this deferred tax liability, the Company was in a net deferred tax asset position that is offset by a full 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 tax position and the offsettingvaluation resulted in a $26.3 million reduction in both. Additionally, the Company recorded an income tax benefit of $3.1 million in the fourth quarter of2017 related to the release of the valuation allowance associated with the post-2017 reversing deferred tax assets to offset 80% of the deferred tax liabilityassociated with our indefinite-lived intangible asset.In the third quarter of 2018, the Company recorded a $0.2 million tax expense in addition to the estimates made in the year of enactment. Theaccounting for the Tax Act are considered final as the Company obtained, prepared, and analyzed the information necessary to finalize the accounting andthe 2017 U.S. income tax return.The Tax Act included a one-time mandatory repatriation transition tax on the net accumulated earnings and profits of a U.S. taxpayer’s foreignsubsidiaries. The Company had a deficit in net accumulated earnings and profits so no transition tax was reported on the 2017 U.S. income tax return. OtherTax Act provisions that may impact income taxes include: a limitation of net operating losses generated after 2017 to 80% of taxable income, the inclusionof commissions and performance based compensation in determining the excess compensation limitation, and a minimum tax on certain foreign earnings inexcess of 10% of the foreign subsidiaries tangible assets (i.e., global intangible low-taxed income or GILTI). The Company has elected to treat GILTI as aperiod expense.The following table summarizes the significant components of the Company's deferred tax assets and liabilities as of December 31, 2018 and 2017 (inthousands): As of December 31, 2018 2017 Deferred tax assets: Inventory $351 $847 Net operating and capital loss carryforwards 51,806 46,683 Deferred revenue 14,401 11,534 Accrued liabilities 2,853 4,064 Stock-based compensation 3,854 3,790 Amortization and depreciation 1,157 773 Bad debt reserve 86 90 Foreign and other tax credits 2,175 2,047 Gross deferred tax assets 76,683 69,828 Valuation allowance (66,431) (60,302)Net deferred tax assets 10,252 9,526 Deferred tax liabilities: Goodwill and indefinite lived intangibles (6,106) (5,033)Deferred sales commissions (5,392) (4,996)Prepaid expenses (475) (619)Foreign currency translation (1,039) (846)Gross deferred tax liabilities (13,012) (11,494)Net deferred tax liabilities $(2,760) $(1,968) F-34Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) For the year ended December 31, 2018, the Company recorded an income tax expense of $1.8 million. The tax expense primarily related to currentyear profits of operations in the U.K., Germany, Canada, and China. Additionally, the tax expense relates to the tax impact of the amortization of U.S.indefinite-lived intangible assets.For the year ending December 31, 2017, the Company recorded an income tax benefit of $2.5 million. The tax benefit primarily related to thereduction in 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, and the U.K. Additionally, the tax expense relates to the tax impact of the amortization of U.S. indefinite-lived intangible assets and the inability torecognize tax benefits associated with current year losses of operations in certain foreign jurisdictions and in the U.S.As of December 31, 2018, 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, 2018, 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 Total 2019-2023 $— $415 $— $— $— $— $415 2024-2028 — 6,624 — — — 396 7,020 2029-2033 16,313 18,015 — — 258 9 34,595 2034-2038 114,059 115,527 — — — — 229,586 2039-2043 — 21,434 — — — — 21,434 Indefinite 19,761 1,531 3,464 3,804 522 — 29,082 Totals $150,133 $163,546 $3,464 $3,804 $780 $405 $322,132 As of December 31, 2018, 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 State 2019-2023 $21,972 $17,341 2024-2028 — — 2029-2033 — 526 2034-2038 — — 2039-2043 — — Indefinite — — Totals $21,972 $17,867 As of December 31, 2018, the Company had federal tax credit carryforward amounts and expiration periods as follows (in thousands): Year of Tax Credit Expiration U.S. Federal 2019-2023 $967 2024-2028 836 2029-2033 128 2034-2038 218 2039-2043 — Indefinite 26 Totals $2,175 F-35Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (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, 2018 2017 2016 United States $(21,873) $(12,648) $(24,963)Foreign 2,209 8,603 (84)Loss before income taxes $(19,664) $(4,045) $(25,047)The provision for taxes on income consists of the following (in thousands): Federal $— $— $— State 12 (21) 78 Foreign 1,006 1,701 1,250 Total current $1,018 $1,680 $1,328 Deferred: Federal $60 $(4,541) $1,147 State 750 335 169 Foreign (19) 27 (141)Total deferred 791 (4,179) 1,175 Provision (benefit) for income taxes $1,809 $(2,499) $2,503 Reconciliation of income tax (benefit) provision computed at the U.S. federal statutory rate to income tax expense (benefit) is as follows (inthousands): Years Ended December 31, 2018 2017 2016 Income tax benefit at statutory federal rate $(4,129) $(1,416) $(8,766)Rate differential on income tax related to global intangible low-taxed income ("GILTI") 450 — — Remeasurement of deferred tax liability related to indefinite-lived intangible due to U.S.rate reduction, effective January 1, 2018 — (2,586) — Release of valuation allowance due to change in U.S. net operating loss carry forwardperiod 206 (3,103) — (Windfall) shortfall in tax benefit - stock compensation (4) 233 — State income tax expense, net of federal income tax effect 556 314 219 Tax capital loss in excess of book loss on sale of Japan subsidiary — (5,297) — Nondeductible goodwill impairment — — 604 Other nondeductible expenses 528 398 384 Tax rate differential on foreign operations 172 (816) (474)Increase in valuation allowance 3,902 9,446 10,404 Change in prior year estimates — 150 — Other tax credits 128 173 129 Other — 5 3 Income tax expense (benefit) $1,809 $(2,499) $2,503 The Company accounts for uncertainty in income taxes under ASC topic 740-10-25, Income Taxes: Overall: Recognition, ("ASC 740-10-25"). ASC740-10-25 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. ASC 740-10-25 also provides guidance on derecognition, classification, interest and penalties, accounting in interimperiods, disclosure, and transition.The Company recognizes interest and penalties related to unrecognized tax benefits as a component of income tax expense (benefit). As ofDecember 31, 2018 and 2017, the Company had no unrecognized tax benefits or interest and penalties.F-36Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 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.The Company was in an aggregate net foreign deficit position for U.S. tax purposes so the Company was not liable for the transition tax enacted as partof the Tax Act on its 2017 U.S. income tax return. As such, all prior earnings of the foreign subsidiaries with unremitted earnings are deemed to be previouslytaxed income for U.S. tax purposes.The Company made income tax payments of $1.6 million, $2.2 million, and $0.8 million, in 2018, 2017 and 2016, respectively.15. 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, 2018 and the years thereafter (in thousands): As ofDecember 31, 2018 Periods Ending December 31, 2019 $2,334 2020 1,155 2021 948 2022 977 2023 743 Thereafter — Total future minimum operating lease payments $6,157 Total expenses under operating leases were $2.5 million, $2.6 million and $4.0 million during the years ended December 31, 2018, 2017, and 2016,respectively.The Company accounts for its leases under the provisions of ASC topic 840, Accounting for Leases ("ASC 840"), which require that leases beevaluated and classified as operating leases or capital leases for financial reporting purposes. Certain operating leases contain rent escalation clauses, whichare recorded 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. Effective January 1, 2019, the Company will adopt the New LeaseStandard as described in Note 2 "Summary of Significant Accounting Policies".Royalty AgreementsThe Company has entered into agreements to license software from vendors for incorporation in the Company's offerings. Pursuant to some of theseagreements, the Company is required to pay minimum royalties or license fees over the term of the agreement regardless of actual license sales. In addition,such agreements typically specify that, in the event the software is incorporated into specified Company products, royalties will be due at a contractual ratebased on actual sales volumes. These agreements are subject to various royalty rates typically calculated based on the level of sales for those products. TheCompany expenses these amounts to cost of sales or research and development expense, as appropriate. Royalty expense was $0.9 million, $1.0 million, and$0.3 million for the years ended December 31, 2018, 2017, and 2016, 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.F-37Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 16. EMPLOYEE BENEFIT PLANThe Company maintains a defined contribution 401(k) Plan. The Company matches employee contributions to the 401(k) Plan up to 4% of theircompensation. The Company recorded Company contribution matching expenses for the 401(k) Plan totaling $2.3 million, $2.1 million, and $2.0 million forthe years ended December 31, 2018, 2017, and 2016, respectively.17. RELATED PARTIESAs of December 31, 2018 and 2017, there were no outstanding receivables from stockholders and there were outstanding receivables from employeesin the amount of $10 thousand and $0.1 million, respectively.18. 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. Effective January 1, 2018 the Company adopted ASC 606 using the modified retrospective approach. Segment revenue inprior comparative periods reflects amounts previously reported and has not been restated. See Note 2 "Summary of Significant Accounting Policies" foradditional disclosures regarding revenue recognition and the impact of adoption of ASC 606.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. The E&E Language segment and Consumer Language segment are characterized as "Language" since both of these segments primarily address thelanguage-learning market and share many of the same costs. These shared language costs are included in the "Shared Services" column of the tables presentedbelow. General and administrative expenses directly incurred by the Language segments consist only of bad debt expense, net of recoveries. Additionally,research and development expenses are included in as shared Language costs. The depreciation, amortization, stock compensation, restructuring and otherrelated expenses which are included in cost of revenue, sales and marketing, research and development, and general and administrative are presented in totalas unallocated costs. The Company will continue to evaluate its management reporting and will update its operating and reportable segments as appropriate.With the exception of goodwill, the Company does not identify or allocate its assets by operating segment. Consequently, the Company does not presentassets or liabilities by operating segment.F-38Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Operating results by segment for the year ended December 31, 2018 was as follows (in thousands, except percentages): Language LiteracySegment E&ELanguageSegment ConsumerLanguageSegment SharedServices CombinedLanguage TotalCompany Revenue $52,766 $60,376 $60,492 $— $120,868 $173,634 Cost of revenue 8,665 6,780 11,436 69 18,285 26,950 Sales and marketing 27,100 30,699 36,178 1,228 68,105 95,205 Research and development 7,785 — — 14,856 14,856 22,641 General and administrative 2,043 45 107 — 152 2,195 Segment contribution $7,173 $22,852 $12,771 $(16,153) $19,470 $26,643 Segment contribution margin % 13.6% 37.8% 21.1% Unallocated depreciation and amortization, stockcompensation, restructuring and other expenses (net)included in: Cost of revenue 8,972 Sales and marketing 3,706 Research and development 2,569 General and administrative 5,453 Subtotal 20,700 Corporate unallocated expenses, net: Unallocated general and administrative 25,562 Unallocated non-operating expense 45 Subtotal 25,607 Loss before income taxes $(19,664) F-39Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Operating results by segment for the year ended December 31, 2017 was as follows (in thousands, except percentages): Language LiteracySegment E&ELanguageSegment ConsumerLanguageSegment SharedServices CombinedLanguage TotalCompany Revenue (1) $43,608 $65,267 $75,718 $— $140,985 $184,593 Cost of revenue 6,924 7,149 13,485 50 20,684 27,608 Sales and marketing 23,369 31,089 37,366 1,459 69,914 93,283 Research and development 6,479 — — 15,860 15,860 22,339 General and administrative 1,872 132 18 — 150 2,022 Segment contribution $4,964 $26,897 $24,849 $(17,369) $34,377 $39,341 Segment contribution margin % 11.4% 41.2% 32.8% Unallocated depreciation and amortization, stockcompensation, restructuring and other expenses (net)included in: Cost of revenue 6,013 Sales and marketing 3,377 Research and development 2,408 General and administrative 6,348 Subtotal 18,146 Corporate unallocated expenses, net: Unallocated general and administrative 25,696 Unallocated non-operating income (456)Subtotal 25,240 Loss before income taxes $(4,045) (1)Effective January 1, 2018 the Company adopted ASC 606 using the modified retrospective approach. Segment revenue in prior comparativeperiods reflects amounts previously reported and has not been restated. See Note 2 "Summary of Significant Accounting Policies" for additionaldisclosures regarding revenue recognition and the impact of adoption of ASC 606. F-40Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) Operating results by segment for the year ended December 31, 2016 was as follows (in thousands, except percentages): Language LiteracySegment E&ELanguageSegment ConsumerLanguageSegment SharedServices CombinedLanguage TotalCompany Revenue (1) $34,123 $72,083 $87,883 $— $159,966 $194,089 Cost of revenue 4,753 9,245 14,698 (17) 23,926 28,679 Sales and marketing 21,650 33,441 51,508 1,902 86,851 108,501 Research and development 4,111 — — 18,874 18,874 22,985 General and administrative 2,077 315 175 — 490 2,567 Segment contribution $1,532 $29,082 $21,502 $(20,759) $29,825 $31,357 Segment contribution margin % 4.5% 40.3% 24.5% Unallocated depreciation and amortization, stockcompensation, restructuring and other expenses (net)included in: Cost of revenue 5,642 Sales and marketing 5,839 Research and development 3,288 General and administrative 10,935 Subtotal 25,704 Corporate unallocated expenses, net: Unallocated general and administrative 26,999 Unallocated lease abandonment expense 1,644 Unallocated impairment 3,930 Unallocated non-operating income (1,873)Subtotal 30,700 Loss before income taxes $(25,047) (1)Effective January 1, 2018 the Company adopted ASC 606 using the modified retrospective approach. Segment revenue in prior comparativeperiods reflects amounts previously reported and has not been restated. See Note 2 "Summary of Significant Accounting Policies" for additionaldisclosures regarding revenue recognition and the impact of adoption of ASC 606. 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, 2018, 2017, and 2016, respectively (in thousands): Years Ended December 31, 2018 2017 (1) 2016 (1) United States $152,407 $158,825 $162,815 International 21,227 25,768 31,274 Total revenue $173,634 $184,593 $194,089 F-41Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (1)Effective January 1, 2018 the Company adopted ASC 606 using the modified retrospective approach. Segment revenue in prior comparativeperiods reflects amounts previously reported and has not been restated. See Note 2 "Summary of Significant Accounting Policies" for additionaldisclosures regarding revenue recognition and the impact of adoption of ASC 606. The information below summarizes long-lived assets by geographic area classified as held and used for the years ended December 31, 2018 and 2017,respectively (in thousands): As of December 31, 2018 2017 United States $34,029 $27,647 International 2,376 3,002 Total property and equipment, net $36,405 $30,649 Revenue by TypeThe 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, 2018, 2017, and 2016, respectively (in thousands): Years Ended December 31, 2018 2017 (1) 2016 (1) Language learning $119,957 $138,082 $155,532 Literacy 52,766 43,608 34,123 Brain Fitness 911 2,903 4,434 Total revenue $173,634 $184,593 $194,089 (1)Effective January 1, 2018 the Company adopted ASC 606 using the modified retrospective approach. Segment revenue in prior comparativeperiods reflects amounts previously reported and has not been restated. See Note 2 "Summary of Significant Accounting Policies" for additionaldisclosures regarding revenue recognition and the impact of adoption of ASC 606. F-42Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 19. VALUATION AND QUALIFYING ACCOUNTSThe following table includes the Company's valuation and qualifying accounts for the respective periods (in thousands): Years Ended December 31, 2018 2017 2016 Allowance for doubtful accounts: Beginning balance $375 $1,072 $1,196 Charged to costs and expenses 168 (51) 709 Deductions—accounts written off (171) (646) (833)Ending balance $372 $375 $1,072 Promotional rebate and coop advertising reserves: Beginning balance $2,375 $5,968 $16,910 Charged to costs and expenses 4,224 6,421 18,337 Deductions - reserves utilized (4,569) (10,014) (29,279)Ending balance $2,030 $2,375 $5,968 Sales return reserve: Beginning balance $1,176 $1,338 $3,728 Charged against revenue 2,212 4,943 5,034 Deductions—reserves utilized (2,809) (5,105) (7,424)Ending balance $579 $1,176 $1,338 Deferred income tax asset valuation allowance: Beginning balance $60,302 $78,363 $70,464 Charged to costs and expenses 6,129 (16,806) 7,899 Deductions — (1,255) — Ending balance $66,431 $60,302 $78,363 20. SUPPLEMENTAL QUARTERLY FINANCIAL INFORMATION (Unaudited)Summarized quarterly supplemental consolidated financial information for 2018 and 2017 are as follows (in thousands, except per share amounts): Three Months Ended March 31, June 30, September 30, December 31, 2018 (1) Revenue $42,808 $43,502 $42,750 $44,574 Gross profit $33,374 $35,572 $33,982 $34,784 Net loss $(6,402) $(4,158) $(6,489) $(4,424)Basic loss per share $(0.29) $(0.18) $(0.28) $(0.19)Shares used in basic per share computation 22,425 22,663 22,814 22,877 Diluted loss per share $(0.29) $(0.18) $(0.28) $(0.19)Shares used in diluted per share computation 22,425 22,663 22,814 22,877 2017 Revenue $47,693 $45,905 $46,206 $44,789 Gross profit $39,552 $38,314 $36,758 $36,348 Net income (loss) $454 $(1,135) $(3,231) $2,366 Basic earnings (loss) per share $0.02 $(0.05) $(0.14) $0.11 Shares used in basic per share computation 22,125 22,248 22,285 22,316 Diluted earnings (loss) per share $0.02 $(0.05) $(0.14) $0.10 Shares used in diluted per share computation 22,590 22,248 22,285 23,248F-43Table of ContentsROSETTA STONE INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) (1)The September 30, 2018 Quarterly Report on Form 10-Q filed with the SEC on November 8, 2018 included a clerical error. The number of commonshares outstanding presented for the basic and diluted share computation for the three-months ended September 30, 2018 was reported as20,831,000 shares, resulting in a basic and diluted loss per share of $0.31. The correct number of common shares outstanding to be used in thebasic and diluted share computation for the three-months ended September 30, 2018 should have been 22,814,000 shares, resulting in a correctedbasic and diluted loss per share of $0.28. This correction is reflected in the above table. This error had no impact to the unaudited consolidatedbalance sheets, statements of cash flow, or statements of stockholders’ equity/deficit, and notes to the financial statements as of, and for the threeand nine months ended September 30, 2018. The materiality of the error was assessed in accordance with the SEC’s Staff Accounting Bulletin 99and the Company concluded that the previously issued consolidated financial statements were not materially misstated. In accordance with theSEC’s Staff Accounting Bulletin 108, this immaterial error will be corrected and the revision will be presented prospectively here and in futurefilings. 21. SUBSEQUENT EVENTS On March 4, 2019, the Company entered into the seventh amendment to its credit facility as described in Note 8 “Financing Arrangements”. F-44 Exhibit 10.35SEVENTH AMENDMENT TO LOAN AND SECURITY AGREEMENTThis Seventh Amendment to Loan and Security Agreement (this “Amendment”) is entered into this 4th day of March,2019, by and between (i) SILICON VALLEY BANK, a California corporation with a loan production office located at 275 GroveStreet, Suite 2-200, Newton, Massachusetts 02466 (“Bank”), and (ii) ROSETTA STONE LTD., a Virginia corporation, andLEXIA LEARNING SYSTEMS LLC, a Delaware limited liability company (individually and collectively, jointly and severally,the “Borrower”).RecitalsA.Bank and Borrower have entered into that certain Loan and Security Agreement dated as of October 28, 2014, asamended by a certain First Amendment to Loan and Security Agreement dated March 31, 2015, as further amended by a certainSecond Amendment to Loan and Security Agreement dated May 1, 2015, as further amended by a certain Third Amendment to Loanand Security Agreement dated June 26, 2015, as further amended by a certain Fourth Amendment to Loan and Security Agreementdated December 29, 2015, as further amended by a certain Joinder and Fifth Amendment to Loan and Security Agreement datedMarch 14, 2016, and as further amended by a certain Sixth Amendment to Loan and Security Agreement dated March 10, 2017 (as thesame may from time to time be further amended, modified, supplemented or restated, the “Loan Agreement”). B.Bank has extended credit to Borrower for the purposes permitted in the Loan Agreement. C.Borrower has requested that Bank amend the Loan Agreement to make certain revisions to the Loan Agreementas more fully set forth herein.D.Bank has agreed to so amend certain provisions of the Loan Agreement, but only to the extent, in accordance withthe terms, subject to the conditions and in reliance upon the representations and warranties set forth below.AgreementNow, Therefore, in consideration of the foregoing recitals and other good and valuable consideration, the receipt andadequacy of which is hereby acknowledged, and intending to be legally bound, the parties hereto agree as follows:1.Definitions. Capitalized terms used but not defined in this Amendment shall have the meanings given to them inthe Loan Agreement. 2.Amendments to Loan Agreement.2.1Section 2.1.2(f) (Letters of Credit). Section 2.1.2(f) is hereby inserted immediately following Section2.1.2(e):“(f)The Borrower and Bank hereby acknowledge and agree that from and after the SeventhAmendment Effective Date that certain Letter of Credit No. SVBSF012042, expiry date February 28, 2019, in theamount of $351,911.25, in the name of ROSETTA STONE LTD. and for the benefit of CEB Inc. shall bedeemed issued under the Revolving Line.”2.2Section 2.3 (Overadvances). Section 2.3 is amended in its entirety and replaced with the following:“2.3Overadvances. If, at any time, the outstanding principal amount of the Advances exceedsthe Revolving Line, Borrower shall immediately pay to Bank in cash the amount of such excess (such excess, the“Overadvance”). Without limiting Borrower’s obligation to repay Bank any Overadvance, Borrower agrees topay Bank interest on the outstanding amount of any Overadvance, on demand, at the Default Rate.”2.3Section 2.4(a) (Payment of Interest on the Advances; Advances). Subsection (a) of Section 2.4 isamended in its entirety and replaced with the following:“(a)Advances. Subject to Section 2.4(b), the principal amount outstanding under the RevolvingLine shall accrue interest at a floating per annum rate equal to the Prime Rate. Interest shall be payable quarterlyin accordance with Section 2.4(d) below.”2.4Section 2.5(b) (Fees; Termination Fee). Subsection (b) of Section 2.5 is deleted in its entirety andreplaced with the following:“(b)Termination Fee. Upon termination of this Agreement by Borrower for any reason (or uponthe acceleration of the Obligations in accordance with Section 9.1 hereof) prior to the first anniversary of theSeventh Amendment Effective Date, in addition to the payment of any other amounts then-owing, a terminationfee in an amount equal to one percent (1.00%) of the Revolving Line; provided that no termination fee shall becharged if the credit facility hereunder is replaced with a new facility from Bank;”2.5Section 2.5(c) (Fees; Unused Revolving Line Facility Fee). Subsection (c) of Section 2.5 isamended in its entirety and replaced with the following:“(c)Unused Revolving Line Facility Fee. Payable quarterly in arrears on the first day of eachcalendar quarter occurring after the Effective Date and on the Revolving Line Maturity Date, a fee (the “UnusedRevolving Line Facility Fee”) in an amount equal to forty-five hundredths of one percent (0.45%) per annum ofthe average unused portion of the Revolving Line, as determined by Bank(which determination shall, absent manifest error in calculation, be presumed correct). The unused portion of theRevolving Line, for purposes of this calculation, shall be calculated on a calendar year basis and shall equal thedifference between (i) the Revolving Line, and (ii) the average for the period of the daily closing balance of theRevolving Line Advances outstanding plus the sum of the aggregate amount of outstanding Letters of Credit(including drawn but unreimbursed Letters of Credit and any Letter of Credit Reserve);”2.6Section 5.12 (Accounts Receivable). Section 5.12 is deleted in its entirety and replaced with thefollowing:“5.12 Reserved.”2.7Section 6.2(h) (Financial Statements, Reports, Certificates). Subsection (h) of Section 6.2 is deletedin its entirety and replaced with the following:“6.2(h) Reserved.”2.8Section 6.2(i) (Financial Statements, Reports, Certificates). Subsection (i) of Section 6.2 is deletedin its entirety and replaced with the following:“6.2(i) Reserved.”2.9Section 6.4 (Collection of Accounts). Section 6.4 is deleted in its entirety and replaced with thefollowing:“6.4 Reserved.”2.10Section 6.15 (Remittance of Proceeds). Section 6.15 is deleted in its entirety and replaced with thefollowing:“6.15Remittance of Proceeds. Except (i) if no Advances are outstanding under the RevolvingLine, or (ii) in respect of a Permitted Transfer, deliver, in kind, all proceeds arising from the disposition of anyCollateral to Bank in the original form in which received by Borrower not later than the following Business Dayafter receipt by Borrower, to be applied to the Obligations (a) prior to an Event of Default, pursuant to the terms ofSection 2.6(b) hereof, and (b) after the occurrence and during the continuance of an Event of Default, pursuant tothe terms of Section 9.4 hereof; provided that, if no Event of Default has occurred and is continuing, Borrowershall not be obligated to remit to Bank the proceeds of the sale of worn out or obsolete Equipment disposed of byBorrower in good faith in an arm’s length transaction for an aggregate purchase price of One Hundred ThousandDollars ($100,000) or less (for all such transactions in any fiscal year). Borrower agrees that it will not commingleproceeds of Collateral with any of Borrower’s other funds or property, but will hold such proceeds separate andapart from such other funds and property and in an express trust for Bank. Nothing in this Section limits therestrictions on disposition of Collateral set forth elsewhere in this Agreement.”2.11The contact information for the Bank’s counsel set forth in Section 10 is hereby amended in itsentirety and replaced with the following:“Morrison & Foerster LLP200 Clarendon Street, 20th FloorBoston, Massachusetts 02116Attention: Charles W. Stavros, Esq.Facsimile No.: (617) 830-0460E-Mail: cstavros@mofo.com”2.12Section 13 (Definitions). The following terms and their respective definitions set forth inSection 13.1 are deleted in their entirety and replaced with the following:“Adjusted EBITDA” means (a) GAAP Net Income plus (b) Interest Expense (less interest income),(c) income tax benefit and expense, (c) depreciation, (d) amortization and (e) stock-based compensationexpense, (f) other non-operating expense (less other income) (as such amount is shown on the “Other income and(expense)” line item below the operating income line in the Ultimate Parent's relevant income statement,determined in accordance with GAAP), (g) goodwill impairment, (h) the change in Deferred Revenue (excludingacquired Deferred Revenue), less (i) the change in deferred commissions, (j) restructuring and related wind downcosts, consulting and other related costs associated with development and implementation of Borrower’s revisedbusiness strategy, severance costs and transaction and other costs associated with mergers and acquisitions, and (k)all adjustments related to recording the non-cash tax valuation allowance for deferred tax assets (with items (j) and(k) not to exceed an aggregate amount of $6,000,000 in the trailing twelve (12) month period following theSeventh Amendment Effective Date).“Availability Amount” is (a) the Revolving Line (which for the avoidance of doubt, is reduced by theface amount of all outstanding Letters of Credit (including drawn but unreimbursed Letters of Credit and anyLetter of Credit Reserve)) minus (b) the outstanding principal balance of any Advances.“Revolving Line” is an aggregate principal amount equal to $15,000,000, as such amount may bereduced pursuant to Section 2.8.“Revolving Line Maturity Date” is April 1, 2021.2.13Section 13 (Definitions). The following new defined terms are hereby inserted alphabetically inSection 13.1:“Liquidity Coverage Ratio” is, at any time, (x) the sum of (a) the aggregate amount of unrestrictedcash held at such time by Borrower in Deposit Accounts or Securities Accounts maintained with Bank or itsAffiliates plus (b) accounts receivable owing to Ultimate Parent and its Subsidiaries divided by (y) the outstandingObligations.“Seventh Amendment Effective Date” is March 4, 2019.2.14Section 13 (Definitions). The following defined terms set forth in Section 13.1 are deleted in theirentirety:“Borrowing Base” is (a) eighty percent (80%) of Eligible Accounts, as determined by Bank fromBorrower’s most recent Borrowing Base Report (and as may subsequently be updated by Bank in Bank’s solediscretion based upon information received by Bank including, without limitation, Accounts that are paid and/orbilled following the date of the Borrowing Base Report) (provided, however, Eligible Accounts with respect toclauses (b), (c), (d) and (q) shall not include Accounts in excess of ninety (90) days of invoice date to the extentthe aggregate amount of such Accounts exceeds ten percent (10%) of Eligible Accounts), plus (b) during a Non-Formula Period, the Non-Formula Amount; provided, however, that Bank has the right to decrease the foregoingpercentage in its good faith business judgment upon prior consultation with Borrower to mitigate the impact ofevents, conditions, contingencies, or risks which may adversely affect the Collateral or its value; provided, furtherthat in the event Bank exercises such right to decrease the foregoing percentage, such circumstance shall not inand of itself constitute a Material Adverse Change or create an inference that a Material Adverse Change hasoccurred.“Borrowing Base Report” is that certain report of the value of certain Collateral in the form attachedhereto as Exhibit B.“Cash Collateral Account” is defined in Section 6.4(c).“Eligible Accounts” means Accounts which arise in the ordinary course of Borrower’s business thatmeet all Borrower’s representations and warranties in Section 5.12, that have been, at the option of Bank,confirmed in accordance with Section 6.4(e) of this Agreement, and are due and owing from Account Debtorsdeemed creditworthy by Bank in its good faith business judgment. Bank reserves the right, upon priorconsultation with Borrower, at any time after the Effective Date to adjust any of the criteria set forth below and toestablish new criteria in its good faith business judgment. Unless Bank otherwise agrees in writing, EligibleAccounts shall not include:a)Accounts for which the Account Debtor is Borrower’s Affiliate, officer, employee, or agent;b)Accounts that the Account Debtor has not paid within one hundred twenty (120) days ofinvoice date regardless of invoice payment period terms;c)Accounts with credit balances over one hundred twenty (120) days from invoice date;d)Accounts owing from an Account Debtor if fifty percent (50%) or more of the Accountsowing from such Account Debtor have not been paid within one hundred twenty (120) days of invoice date;e)Accounts owing from an Account Debtor which does not have its principal place of businessin the United States or such other jurisdictions approved by Bank in writing in its sole and absolute discretion on acase-by-case basis;f)Accounts billed from and/or payable to Borrower outside of the United States unless Bank hasa first priority, perfected security interest or other enforceable Lien in such Accounts under all applicable laws,including foreign laws (sometimes called foreign invoiced accounts);g)Accounts owing from an Account Debtor to the extent that Borrower is indebted or obligatedin any manner to the Account Debtor (as creditor, lessor, supplier or otherwise - sometimes called “contra”accounts, accounts payable, customer deposits or credit accounts);h)Accounts owing from an Account Debtor which is a United States government entity or anydepartment, agency, or instrumentality thereof unless Borrower has assigned its payment rights to Bank and theassignment has been acknowledged under the Federal Assignment of Claims Act of 1940, as amended;i)Accounts for demonstration or promotional equipment, or in which goods are consigned, orsold on a “sale guaranteed”, “sale or return”, “sale on approval”, or other terms if Account Debtor’s payment maybe conditional;j)Accounts owing from an Account Debtor where goods or services have not yet been renderedto the Account Debtor (sometimes called memo billings or pre-billings), other than any such Accounts withrespect to which Borrower has recorded Deferred Revenue;k)Accounts subject to contractual arrangements between Borrower and an Account Debtorwhere payments shall be scheduled or due according to completion or fulfillment requirements where the AccountDebtor has a right of offset for damages suffered as a result of Borrower’s failure to perform in accordance withthe contract (sometimes called contracts accounts receivable, progress billings, milestone billings, or fulfillmentcontracts);l)Accounts owing from an Account Debtor the amount of which may be subject to withholdingbased on the Account Debtor’s satisfaction of Borrower’s complete performance (but only to the extent of theamount withheld; sometimes called retainage billings);m)Accounts subject to trust provisions, subrogation rights of a bonding company, or a statutorytrust;n)Accounts owing from an Account Debtor that has been invoiced for goods that have not beenshipped to the Account Debtor unless Bank, Borrower, and the Account Debtor have entered into an agreementacceptable to Bank wherein the Account Debtor acknowledges that (i) it has title to and has ownership of thegoods wherever located, (ii) a bona fide sale of the goods has occurred, and (iii) it owes payment for such goodsin accordance with invoices from Borrower (sometimes called “bill and hold” accounts);o)Accounts for which the Account Debtor has not been invoiced;p)Accounts that represent non-trade receivables or that are derived by means other than in theordinary course of Borrower’s business;q)Accounts for which Borrower has permitted Account Debtor’s payment to extend beyond onehundred twenty (120) days;r)Accounts arising from chargebacks, debit memos or other payment deductions taken by anAccount Debtor;s)Accounts arising from product returns and/or exchanges (sometimes called “warranty” or“RMA” accounts);t)Accounts in which the Account Debtor disputes liability or makes any claim (but only up tothe disputed or claimed amount), or if the Account Debtor is subject to an Insolvency Proceeding, or becomesinsolvent, or goes out of business;u)Accounts owing from an Account Debtor, whose total obligations to Borrower exceedtwenty-five percent (25%) of all Accounts, except for Amazon.com, Inc., for which such percentage is fortypercent (40%), for the amounts that exceed that percentage, unless Bank approves in writing; andv)Accounts for which Bank in its good faith business judgment determines collection to bedoubtful, including, without limitation, accounts represented by “refreshed” or “recycled” invoices.“Liquidity” is, at any time, the sum of (a) the aggregate amount of unrestricted cash held at such timeby Borrower in Deposit Accounts or Securities Accounts maintained with Bank or its Affiliates plus (b) theAvailability Amount (excluding the Non-Formula Amount from the Borrowing Base).“Non-Formula Amount” is Five Million Dollars ($5,000,000)“Non-Formula Period” is, on and after the Fifth Amendment Effective Date, provided no Event ofDefault has occurred and is continuing, the period (a) commencing on the first day of the month following the daythat Borrower provides to Bank a written report that Borrower has, for each consecutive day in the immediatelypreceding calendar month, Liquidity in an amount at all times greaterthan Twenty Five Million Dollars ($25,000,000) (the “Non-Formula Balance”); and (b) terminating on theearlier to occur of (i) the occurrence of an Event of Default, and (ii) the first day thereafter in which Borrower failsto maintain the Non-Formula Balance, subject, however, to Bank’s reasonable determination made within areasonable time after its receipt of the relevant report that Borrower has maintained the requisite Liquidity in therelevant time periods.“Streamline Period” is, on and after the Sixth Amendment Effective Date, provided no Event ofDefault has occurred and is continuing, the period (a) commencing on the first day of the month following the daythat Borrower provides to Bank a written report that Borrower has maintained, for each consecutive day in theimmediately preceding calendar month, Liquidity in an amount at all times greater than (A) from April 1st throughand including August 31st of each year, Fourteen Million Dollars ($14,000,000) and (B) from September 1stthrough and including March 31st of each year, Seventeen Million Five Hundred Thousand Dollars ($17,500,000)(either such amount, the “Streamline Balance”); and (b) terminating on the earlier to occur of (i) the occurrenceof an Event of Default, and (ii) the first day thereafter in which Borrower fails to maintain the StreamlineBalance. Upon the termination of a Streamline Period, Borrower must maintain the Streamline Balance eachconsecutive day for one (1) calendar month prior to entering into a subsequent Streamline Period. Borrower shallgive Bank prior written notice of Borrower’s election to enter into any such Streamline Period, and each suchStreamline Period shall commence on the first day of the monthly period following the date the Bank determines,in its reasonable discretion, that the Streamline Balance has been achieved, subject, however, in each such case toBank’s reasonable determination made within a reasonable time after receipt of the relevant report that Borrowerhas maintained the requisite Liquidity in the relevant time periods.2.15Exhibit B (Borrowing Base Report). The Borrowing Report (as defined in the Loan Agreementuntil the date of this Amendment) appearing as Exhibit B to the Loan Agreement is deleted in its entirety and intentionally omitted.2.16Exhibit D (Compliance Certificate). The Compliance Certificate appearing as Exhibit D to theLoan Agreement is deleted in its entirety and replaced with the Compliance Certificate in the form of Exhibit D attached hereto.2.17Exhibit E (Financial Covenants). The financial covenants set forth in Exhibit E to the LoanAgreement are deleted in their entirety and replaced with the financial covenants set forth on Exhibit E attached hereto.3.Conditions Precedent to Effectiveness. This Amendment shall not be effective until each of the followingconditions precedent have been fulfilled to the satisfaction of Bank:3.1This Amendment shall have been duly executed and delivered by the respective parties hereto. Bankshall have received a fully executed copy hereof.3.2All necessary consents and approvals to this Amendment shall have been obtained by Borrower.3.3After giving effect to this Amendment, no Default or Event of Default shall have occurred and becontinuing.3.4Bank shall have received the fees, costs and expenses required to be paid pursuant to Section 5 of thisAmendment (including the reasonable and documented fees and disbursements of legal counsel required to be paid thereunder). 4.Representations and Warranties. Borrower hereby represents and warrants to Bank as follows:4.1This Amendment is, and each other Loan Document to which it is or will be a party, when executedand delivered by Borrower, will be the legally valid and binding obligation of Borrower, enforceable against Borrower in accordancewith its respective terms, except as enforcement may be limited by bankruptcy, insolvency, reorganization, moratorium or similar lawsrelating to or limiting creditors’ rights generally and equitable principals (whether enforcement is sought by proceedings in equity or atlaw).4.2Its representations and warranties set forth in this Amendment, the Loan Agreement, as amended bythis Amendment and after giving effect hereto, and the other Loan Documents to which it is a party are (i) to the extent qualified bymateriality, true and correct in all respects and (ii) to the extent not qualified by materiality, true and correct in all material respects, ineach case, on and as of the date hereof, as though made on such date (except to the extent that such representations and warrantiesrelate solely to an earlier date, in which case such representations and warranties shall have been true and correct in all material respectsas of such earlier date).4.3The execution and delivery by Borrower of this Amendment, the performance by Borrower of itsobligations hereunder and the performance of Borrower under the Loan Agreement, as amended by this Amendment, (i) have beenduly authorized by all necessary organizational action on the part of Borrower and (ii) will not (A) violate any provisions of thecertificate of incorporation or formation or organization or by-laws or limited liability company agreement or limited partnershipagreement of Borrower or (B) constitute a violation by Borrower of any applicable material Requirement of Law.Borrower acknowledges that Bank has acted in good faith and have conducted in a commercially reasonable manner theirrelationships with Borrower in connection with this Amendment and in connection with the other Loan Documents. Borrowerunderstands and acknowledges that Bank is entering into this Amendment in reliance upon, and in partial consideration for, the aboverepresentations, warranties, and acknowledgements, and agrees that such reliance is reasonable and appropriate. 5.Amendment Fee; Payment of Costs and Expenses. Borrower shall pay to Bank a fully-earned, non-refundableamendment fee equal to Twenty Two Thousand Five Hundred Dollars ($22,500), which fee shall be paid on the Seventh AmendmentEffective Date. In addition, Borrower shall pay to Bank all reasonable costs and out-of-pocket expenses of every kind inconnection with the preparation, negotiation, execution and delivery of this Amendment and any documents and instruments relatinghereto or thereto (which costs include, without limitation, the reasonable and documented fees and expenses of any attorneys retainedby Bank).6.Choice of Law. THIS AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE PARTIESHEREUNDER SHALL BE GOVERNED BY, AND SHALL BE CONSTRUED AND ENFORCED IN ACCORDANCEWITH, THE LAWS OF THE STATE OF NEW YORK. Each party hereto submits to the exclusive jurisdiction of the State andFederal courts in the Southern District of the State of New York; provided, however, that nothing in the Loan Agreement as amendedby this Amendment shall be deemed to operate to preclude Bank from bringing suit or taking other legal action in any other jurisdictionto realize on the Collateral or any other security for the Obligations, or to enforce a judgment or other court order in favor of suchAgent. TO THE EXTENT PERMITTED BY APPLICABLE LAW, EACH PARTY HERETO WAIVES ITS RIGHT TOA JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION ARISING OUT OF OR BASED UPON THISAMENDMENT, THE OTHER LOAN DOCUMENTS OR ANY CONTEMPLATED TRANSACTION, INCLUDINGCONTRACT, TORT, BREACH OF DUTY AND ALL OTHER CLAIMS. EACH PARTY HERETO ACKNOWLEDGESTHAT THIS WAIVER IS A MATERIAL INDUCEMENT TO ENTER INTO A BUSINESS RELATIONSHIP, THATEACH HAS ALREADY RELIED ON THIS WAIVER IN ENTERING INTO THIS AMENDMENT, AND THAT EACHWILL CONTINUE TO RELY ON THIS WAIVER IN ITS RELATED FUTURE DEALINGS. EACH PARTY HERETOFURTHER WARRANTS AND REPRESENTS THAT IT HAS REVIEWED THIS WAIVER WITH ITS LEGALCOUNSEL AND THAT IT KNOWINGLY AND VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS FOLLOWINGCONSULTATION WITH LEGAL COUNSEL. 7.Counterpart Execution. This Amendment may be executed in any number of counterparts and by differentparties on separate counterparts, each of which, when executed and delivered, shall be deemed to be an original, and all of which,when taken together, shall constitute but one and the same Amendment. Delivery of an executed counterpart of this Amendment bytelefacsimile or by e-mail transmission of an Adobe file format document (also known as a PDF file) shall be equally as effective asdelivery of an original executed counterpart of this Amendment. Any party delivering an executed counterpart of this Amendment bytelefacsimile or by e-mail transmission of an Adobe file format document (also known as a PDF file) also shall deliver an originalexecuted counterpart of this Amendment but the failure to deliver an original executed counterpart shall not affect the validity,enforceability, and binding effect of this Amendment.8.Effect on Loan Documents.8.1The amendments set forth herein shall be limited precisely as written and shall not be deemed (a) to bea forbearance, waiver, or modification of any other term or condition of the Loan Agreement or of any Loan Documents or toprejudice any right or remedy which Bank may now have or may have in the future under or in connection with the Loan Documents;(b) to be a consent to any future consent or modification, forbearance, or waiver to the Loan Agreement or any other Loan Document,or to any waiver of any of the provisions thereof; or (c) to limit or impair Bank’s right to demand strict performance of all terms andcovenants as of any date. Borrower hereby ratifies and reaffirms its obligations under the Loan Agreement and the other Loan Documents to which it is a partyand agrees that none of the amendments or modifications to the Loan Agreement set forth in this Amendment shall impair Borrower’sobligations under the Loan Documents or Bank’s rights under the Loan Documents. Borrower hereby further ratifies and reaffirms thevalidity and enforceability of all of the Liens heretofore granted, pursuant to and in connection with the Loan Agreement or any otherLoan Document, to Bank as collateral security for the obligations under the Loan Documents, in accordance with their respectiveterms, and acknowledges that all of such Liens, and all collateral heretofore pledged as security for such obligations, continues to beand remain collateral for such obligations from and after the date hereof. Borrower acknowledges and agrees that the Loan Agreementand each other Loan Document is still in full force and effect and acknowledges as of the date hereof that Borrower has no defenses toenforcement of the Loan Documents. Borrower waives any and all defenses to enforcement of the Loan Agreement as amendedhereby and each other Loan Documents that might otherwise be available as a result of this Amendment of the Loan Agreement. Tothe extent any terms or provisions of this Amendment conflict with those of the Loan Agreement or other Loan Documents, the termsand provisions of this Amendment shall control.8.2To the extent that any terms and conditions in any of the Loan Documents shall contradict or be inconflict with any terms or conditions of the Loan Agreement, after giving effect to this Amendment, such terms and conditions arehereby deemed modified or amended accordingly to reflect the terms and conditions of the Loan Agreement as modified or amendedhereby.8.3This Amendment is a Loan Document. 9.Entire Agreement. This Amendment constitutes the entire agreement between Borrower and Bank pertaining tothe subject matter contained herein and supersedes all prior agreements, understandings, offers and negotiations, oral or written, withrespect hereto and no extrinsic evidence whatsoever may be introduced in any judicial or arbitration proceeding, if any, involving thisAmendment. All of the terms and provisions of this Amendment are hereby incorporated by reference into the Loan Agreement, asapplicable, as if such terms and provisions were set forth in full therein, as applicable. All references in the Loan Agreement to “thisAgreement”, “hereto”, “hereof”, “hereunder” or words of like import shall mean the Loan Agreement as amended hereby. 10.Release. Borrower may have certain Claims against the Released Parties, as those terms are defined below,regarding or relating to the Loan Agreement or the other Loan Documents. Bank and Borrower desire to resolve each and every oneof such Claims in conjunction with the execution of this Amendment and thus Borrower makes the releases contained in this Section10. In consideration of Bank entering into this Amendment, Borrower hereby fully and unconditionally releases and foreverdischarges Bank and its directors, officers, employees, subsidiaries, branches, affiliates, attorneys, agents, representatives, successorsand assigns and all persons, firms, corporations and organizations acting on any of their behalf (collectively, the “Released Parties”),of and from any and all claims, allegations, causes of action, costs or demands and liabilities, of whatever kind or nature, from thebeginning of the world to the date on which this Amendment is executed, whether known or unknown, liquidated or unliquidated,fixed or contingent, asserted or unasserted, foreseen or unforeseen, matured orunmatured, suspected or unsuspected, anticipated or unanticipated, which Borrower has, had, claims to have had or hereafter claims tohave against the Released Parties by reason of any act or omission on the part of the Released Parties, or any of them, occurring priorto the date on which this Amendment is executed, including all such loss or damage of any kind heretofore sustained or that may ariseas a consequence of the dealings among the parties up to and including the date on which this Amendment is executed, including theadministration or enforcement of the Loans, the Obligations, the Loan Agreement or any of the Loan Documents (collectively, all ofthe foregoing, the “Claims”). Borrower represents and warrants that it has no knowledge of any claim by it against the ReleasedParties or of any facts or acts of omission of the Released Parties which on the date hereof would be the basis of a claim by Borroweragainst the Released Parties which is not released hereby. Borrower represents and warrants that the foregoing constitutes a full andcomplete release of all Claims.11.Severability. The provisions of this Amendment are severable, and if any clause or provision shall be heldinvalid or unenforceable in whole or in part in any jurisdiction, then such invalidity or unenforceability shall affect only such clause orprovision, or part thereof, in such jurisdiction and shall not in any manner affect such clause or provision in any other jurisdiction, orany other clause or provision in this Amendment in any jurisdiction.[Remainder of page intentionally left blank; signature page follows] In Witness Whereof, the parties hereto have caused this Amendment to be duly executed and delivered by their proper andduly authorized officers as of the day and year first above written. BORROWER: ROSETTA STONE LTD. By: /s/ Thomas PiernoName: Thomas PiernoTitle: Chief Financial Officer LEXIA LEARNING SYSTEMS LLC By: /s/ Sonia GalindoName: Sonia GalindoTitle: Manager BANK: SILICON VALLEY BANK By: /s/ Will DeevyName: Will DeevyTitle: Director Each Guarantor hereby acknowledges and confirms that it has reviewed and approved the terms and conditions of theAmendment. Each Guarantor hereby consents to the Amendment and agrees that the Guaranty of such Guarantor relating to theObligations of Borrower under the Loan Agreement shall continue in full force and effect, shall be valid and enforceable and shall notbe impaired or otherwise affected by the execution of the Amendment or any other document or instruction delivered in connectionherewith. Each Guarantor represents and warrants that, after giving effect to the Amendment, all representations and warrantiescontained in each Loan Document which such Guarantor is a party are true, accurate and complete as if made the date hereof, and allsuch Loan Documents are hereby ratified and confirmed and shall remain in full force and effect. GUARANTORS: ROSETTA STONE INC. By: /s/ Thomas PiernoName: Thomas PiernoTitle: CFO ROSETTA STONE HOLDINGS INC. By: /s/ Thomas PiernoName: Thomas PiernoTitle: CFO and Treasurer ROSETTA STONE INTERNATIONAL INC. By: /s/ Thomas PiernoName: Thomas PiernoTitle: CFO and Treasurer EXHIBIT DCOMPLIANCE CERTIFICATE TO:SILICON VALLEY BANKDate: FROM:ROSETTA STONE LTD. and LEXIA LEARNING SYSTEMS LLC The undersigned authorized officer of Rosetta Stone Ltd. and Lexia Learning Systems LLC (each and together, jointly and severally, “Borrower”)certifies that under the terms and conditions of the Loan and Security Agreement between Borrower and Bank (the “Agreement”): (1) Each Credit party is incomplete compliance for the period ending _______________ with all required covenants except as noted below; (2) there are no Events of Default; (3) allrepresentations and warranties in the Agreement are true and correct in all material respects on this date except as noted below; provided, however, that suchmateriality qualifier shall not be applicable to any representations and warranties that already are qualified or modified by materiality in the text thereof; andprovided, further that those representations and warranties expressly referring to a specific date shall be true, accurate and complete in all material respects asof such date; (4) each Credit Party and each of its Subsidiaries, has timely filed all required tax returns and reports, and each Credit Party and each of itsSubsidiaries has timely paid all foreign, federal, state and local taxes, assessments, deposits and contributions owed by such Credit Party or Subsidiary exceptas otherwise permitted pursuant to the terms of Section 5.8 of the Agreement; and (5) no Liens have been levied or claims made against any Credit Party orany of its Subsidiaries relating to unpaid employee payroll or benefits of which Borrower has not previously provided written notification to Bank. Attached are the required documents supporting the certification. The undersigned certifies that these are prepared in accordance with GAAPconsistently applied from one period to the next except as explained in an accompanying letter or footnotes. The undersigned acknowledges that noborrowings may be requested at any time or date of determination that Borrower is not in compliance with any of the terms of the Agreement, and thatcompliance is determined not just at the date this certificate is delivered. Capitalized terms used but not otherwise defined herein shall have the meaningsgiven them in the Agreement. Please indicate compliance status by circling Yes/No under “Complies” column. Reporting CovenantsRequiredComplies Monthly or Quarterly financial statements withCompliance CertificateMonthly within 30 dayswhen there are Advances outstanding;quarterly within 45 days when there areno Advances outstandingYes NoAnnual financial statement (CPA Audited) withCompliance CertificateFYE within 90 daysYes No10‑Q, 10‑K and 8-KWithin 5 days after filing with SECYes NoProjectionsFYE within 90 daysYes No The following Intellectual Property was registered (or a registration application submitted) after the Effective Date (if no registrations, state “None”)___________________________________________________________________________________________ Financial CovenantsRequiredActualComplies Achieve on a Quarterly Basis: Minimum Liquidity Coverage Ratio1.75 to 1.00 Yes NoMinimum Adjusted EBITDA*$Yes No Clean DownThe Borrower will cause the aggregate outstandingprincipal balance of Advances under the Revolving Lineto be less than Five Million Dollars ($5,000,000) for aperiod of at least thirty (30) consecutive days during eachtwelve month period. Yes No*See Exhibit E The following financial covenant analyses and information set forth in Schedule 1 attached hereto are true and accurate as of the date of thisCertificate.Other Matters Have there been any amendments of or other changes to the capitalization table of the Credit Parties and to theOperating Documents of any Credit Party or any of its Subsidiaries since the date of the most recently deliveredCompliance Certificate? If yes, provide copies of any such amendments or changes with this Compliance Certificateto the extent not previously delivered to Bank.YesNo The following are the exceptions with respect to the certification above: (If no exceptions exist, state “No exceptions to note.”) ROSETTA STONE LTD. BANK USE ONLYLEXIA LEARNING SYSTEMS LLC Received by: By: authorized signerName: Date: Title: Verified: authorized signer Date: Compliance Status:Yes No Schedule 1 to Compliance CertificateFinancial Covenants of BorrowerIn the event of a conflict between this Schedule and the Loan Agreement, the terms of the Loan Agreement shall govern.I.Liquidity Coverage Ratio (Section 6.8(a))Required:1.75 to 1.00Actual:A.Aggregate value of the unrestricted cash maintained in Deposit Accounts or Securities Accounts at Bank or its Affiliates$B.Accounts receivable owing to Ultimate Parent and its Subsidiaries$C.Line A plus Line B$D.The outstanding Obligations$ E.Line C divided by Line D Is line E equal to or greater than 1.75 to 1.00? No, not in compliance Yes, in compliance II.ADJUSTED EBITDA (Section 6.8(b))Required:Adjusted EBITDA, measured on a trailing twelve (12) month basis as of the end of each fiscal quarter during the periods specified below on aconsolidated basis with respect to Ultimate Parent and its Subsidiaries, of at least (loss not worse than) the following:Quarterly PeriodAdjusted EBITDAMarch 31, 2019($5,000,000)June 30, 2019($5,000,000)September 30, 2019($5,000,000)December 31, 2019 and each fiscal quarter thereafter$1.00Actual (for the cumulative period referenced):A.Net Income$B.To the extent included in the determination of Net Income 1. Interest Expense$ 2. Income tax benefit and expense$ 3. Depreciation expense$ 4. Amortization expense$ 5. Stock-based compensation expense$ 6. other non-operating expense (less other income) (as such amount is shown on the “Other income and (expense)”" line itembelow the operating income line in the Ultimate Parent's relevant income statement, determined in accordance with GAAP)$ 7. Goodwill impairment$ 8. Change in Deferred Revenue$ 9. Change in deferred commissions$ 10. restructuring and related wind down costs, consulting and other related costs associated with development andimplementation of Borrower’s revised business strategy, severance costs and transaction and other costs associated with mergersand acquisitions (not to exceed an aggregate amount, when added to the adjustments listed in line 11, of $6,000,000 in thetrailing twelve (12) month period following the Seventh Amendment Effective Date)$ 11. adjustments related to recording the non-cash tax valuation allowance for deferred tax assets (not to exceed an aggregateamount, when added to the costs listed in line 10, of $6,000,000 in the trailing twelve (12) month period following the SeventhAmendment Effective Date)$ 12. Total Line B: The sum of lines 1 through 8 minus lines 9 through 11$C.ADJUSTED EBITDA (line A plus line B)$ Is line C at least (loss not worse than) $______________? No, not in compliance Yes, in compliance EXHIBIT EFINANCIAL COVENANTS (a)Liquidity Coverage Ratio. Maintain, to be certified to Bank as of the last day of each fiscal quarter, a Liquidity CoverageRatio of at least 1.75 to 1.00.(b)Adjusted EBITDA. Adjusted EBITDA, measured on a trailing twelve (12) month basis as of the end of each fiscal quarterduring the periods specified below on a consolidated basis with respect to Ultimate Parent and its Subsidiaries, of at least (loss not worse than) the following:Quarterly PeriodAdjusted EBITDAMarch 31, 2019($5,000,000)June 30, 2019($5,000,000)September 30, 2019($5,000,000)December 31, 2019 and each fiscal quarter thereafter$1.00 (c)Clean Down. [The Borrower will cause the aggregate outstanding principal balance of Advances under the RevolvingLine to be less than Five Million Dollars ($5,000,000) for a period of at least thirty (30) consecutive days during each twelve month period.Exhibit 21.1ROSETTA STONE INC. SUBSIDIARIESAs of March 6, 2019 Entity Jurisdiction 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 LLC DelawareRosetta Stone (UK) Limited England and WalesRosetta Stone GmbH GermanyRosetta Stone Canada Inc. CanadaRosetta Stone Hong Kong Limited Hong KongRosetta (Shanghai) Software Trading Co., Ltd. ShanghaiRosetta Stone Ensino de Linguas Ltda. BrazilRosetta Stone France SAS FranceLexia Learning Systems LLC (formerly Lexia Learning Systems Inc.) DelawareRosetta Stone S.A. (formerly Tell Me More S.A.) FranceAuralog Studios SARL FranceRosetta Stone Mexico SA de CV (formerly Auralog SA de CV) MexicoAuralog Software Development (Beijing) Company Ltd. ChinaRosetta Stone Spain SL Spain 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 of our reports dated March 6, 2019, relating to the consolidated financial statements of Rosetta Stone Inc. and subsidiaries, andthe effectiveness of Rosetta Stone Inc. and subsidiaries' internal control over financial reporting, appearing in this Annual Report on Form 10-K of RosettaStone Inc. and subsidiaries for the year ended December 31, 2018. /s/ DELOITTE & TOUCHE LLP McLean, VirginiaMarch 6, 2019 Exhibit 24.1 ROSETTA 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 6, 2019 Signature Title /s/ A. JOHN HASS III 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/ JESSIE WOOLLEY-WILSON DirectorJessie Woolley-Wilson /s/ GEORGE A. LOGUE DirectorGeorge A. Logue 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 mostrecent fiscal quarter (the Registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materiallyaffect, the Registrant'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 arereasonably likely 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 internalcontrol over financial reporting. By: /s/ A. JOHN HASS A. John Hass( Principal Executive Officer )Date: March 6, 2019Exhibit 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 mostrecent fiscal quarter (the Registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materiallyaffect, the Registrant'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 arereasonably likely 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 internalcontrol over financial reporting. By: /s/ THOMAS M. PIERNO Thomas M. Pierno( Principal Financial Officer )Date: March 6, 2019Exhibit 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, 2018, 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 6, 2019Exhibit 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, 2018, 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 6, 2019

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