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ROSETTA STONE INC (RST)
10-K
Annual report pursuant to section 13 and 15(d)
Filed on 03/10/2010
Filed Period 12/31/2009

Table of contents

  • Page 1
    ROSETTA STONE INC (RST) 10-K Annual report pursuant to section 13 and 15(d) Filed on 03/10/2010 Filed Period 12/31/2009

  • Page 2
    ... FINANCIAL STATEMENTS Table of Contents UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2009 Commission file number: 1-34283 Rosetta Stone...

  • Page 3
    ... non-affiliates of the registrant was approximately $300 million as of June 30, 2009 (based on the last sale price of such stock as quoted on the New York Stock Exchange). As of March 2, 2010, there were 20,251,027 shares of common stock outstanding. Documents incorporated by reference: Portions of...

  • Page 4
    ... Financial Data Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 7A. Quantitative and Qualitative Disclosures About Market Risk Item 8. Financial Statements and Supplementary Data Item 9. Changes in and Disagreements with Accountants on Accounting...

  • Page 5
    ... Contents PART I Item 1. Business Overview We are a leading provider of technology-based language learning solutions. We develop, market and sell language learning solutions consisting of software, online services and audio practice tools primarily under our Rosetta Stone brand. Our teaching method...

  • Page 6
    ...-based classroom instruction; self-study books, audio tapes and software that rely on grammar and translation; and free online offerings that provide basic content and opportunities to practice writing and speaking. Key Drivers of Demand in Language Learning Market. We believe that language learning...

  • Page 7
    ... upon a flexible software platform that supports multiple languages and is deployable on personal computers, on local networks and online. The platform incorporates a number of proprietary technologies that are key to enabling language learning, including: • • speech recognition that is focused...

  • Page 8
    ...multiple units, lessons and activities. In July 2009, we introduced Rosetta Stone TOTALe, an online language learning solution that integrates our online courses with coach-led practice sessions, fun and engaging language games, interaction with native speakers and live support from customer service...

  • Page 9
    ... of Contents online and locally installed, allowing for multiple delivery methods. We also use the same platform for all editions of our solutions: personal, enterprise, classroom and home school. Effective Multi-Channel Marketing and Distribution Model. We believe that our multi-channel marketing...

  • Page 10
    ... working on a variety of product development initiatives. For example, in July 2009, we introduced Rosetta Stone TOTALe, a new web-based service that extends our existing language courses by offering opportunities for practice with dedicated language conversation coaches and other language learners...

  • Page 11
    ... we released an additional seven languages in Version 3 in September 2008. In May 2009, we released Levels 4 and 5 in English (US) and Spanish (Latin America) as well as an additional four languages in Version 3. In July 2009, we released Rosetta Stone TOTALe, our new web-based service offering that...

  • Page 12
    ... 31, 2009, approximately 87% of our revenue was from CD-ROM sales to both consumers and institutions, while approximately 13% was from online subscriptions. We currently offer the following languages: Audio Version Version Level 1 Level 2 Level 3 Level 4 Level 5 Companion TOTALe 2 3 Arabic Chinese...

  • Page 13
    ...125,000 active SharedTalk users. In July 2009, we introduced Rosetta Stone TOTALe, an online language learning solution that integrates our online courses with coach-led practice sessions, fun and engaging language games, interaction with native speakers and live support from customer service agents...

  • Page 14
    ... future, we may develop customized versions for other industries, such as healthcare, business, real estate and retail. In addition to visual learning experiences, our Version 3 solutions incorporate an integrated speech program utilizing our voice recognition application, which works in languages...

  • Page 15
    ... Institutional Educational Institutions Based on our internal studies, 60% annually earn more than $75,000 and 44% earn more than $100,000 Amazon.com, Apple, Barnes & Noble, Borders, Office Depot, Books-A-Million, London Drugs Primary and Secondary Schools: New York City Department of Education (NY...

  • Page 16
    .... We receive our orders in the direct-to-consumer channel through our websites and call centers. Our marketing to this channel also supports the kiosk and retail channels. Rosetta Stone Kiosks. As of December 31, 2009, we operated 242 retail kiosks, including 3 full service retail outlets, in...

  • Page 17
    ... 16 years. Our product development focuses on both software and content development. Our development efforts include both creating new solutions and adding new languages to existing solutions. Our development team has specific expertise in speech recognition, interface design, immersion learning and...

  • Page 18
    ... the Audio Companion in the seven new Version 3 languages in September 2008. In May 2009, we released Levels 4 and 5 in English (US) and Spanish (Latin America) as well as an additional four languages in Version 3. In July 2009, we released Rosetta Stone TOTALe, our new web-based service offering...

  • Page 19
    ... use speech recognition technology for language learning solutions. We entered into the license agreement in December 2006, and paid the University of Colorado an up-front license fee. We have registered a variety of trademarks, including Rosetta Stone, Rosetta World, Rosetta Stone Language Learning...

  • Page 20
    ... results. Our actual operating results may differ significantly from our guidance. From time to time, we may release guidance in our quarterly earnings releases, quarterly earnings conference call, or otherwise, regarding our future performance that represent our management's estimates as of...

  • Page 21
    ... our consumer business, if we fail to accurately forecast consumer demand and trends in consumer preferences, our Rosetta Stone brand, sales and customer relationships may be harmed. Demand for our language learning software products and related services, and for consumer products and services in...

  • Page 22
    ... in customer requirements, reduce prices to win new customers and offer free language learning software or online services. We may not be able to compete successfully against current or future competitors. As the market for foreign language solutions continues to develop, a number of other companies...

  • Page 23
    ...may be forced to purchase time slots and publication dates at higher prices, which will increase our costs. Our business depends on our Rosetta Stone brand, and if we are not able to maintain and enhance our brand, our business and operating results may be harmed. We believe that market awareness of...

  • Page 24
    ... and maintaining financial and other internal controls over geographically dispersed operations; competition from local foreign language software providers and preferences for local products in some regions; expenses associated with customizing products, support services and websites for foreign...

  • Page 25
    ... learners to increase language socialization. These web-based services will have a much higher cost as a percentage of revenue than our software solutions. We expect to offer Rosetta Stone Version 4 TOTALe primarily by bundling the web-based services of TOTALe with our software and audio offerings...

  • Page 26
    ...offering, our business, financial results and reputation may be harmed. Product returns could exceed our estimates, which would diminish our reported revenue. We offer consumers who purchase our packaged software and audio practice products directly from us an unconditional full money-back six-month...

  • Page 27
    ... introduce new products, services and applications on a timely and cost-effective basis that keeps pace with technological developments and changing customer needs. For example, the number of individuals who access the internet through devices other than a personal computer, such as personal digital...

  • Page 28
    Table of Contents order basis and we receive orders when these customers need products and services. As a result, their orders are typically not evenly distributed throughout the year. Our quarterly results of operations also may fluctuate significantly as a result of a variety of other factors, ...

  • Page 29
    ... internal systems and external systems, networks and databases maintained by us and third-party providers to process customer orders, handle customer service requests, and host and deliver our internet-based language learning solutions, including our online language courses and Rosetta Stone TOTALe...

  • Page 30
    ...for new web-based online services. Rosetta Stone TOTALe enables individuals to exchange information and engage in various online activities on a domestic and an international basis. The law relating to the liability of providers of online services for activities of their users is currently unsettled...

  • Page 31
    ... importance because our online e-commerce systems and our online administration tools for our institutional business store proprietary and confidential customer, employee and other sensitive data, such as names, addresses, other personal information and credit card numbers. We and our vendors use...

  • Page 32
    ... market's perception of us and our products and services. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms, or at all, we could face significant financial losses. Our sales to U.S. government agencies and armed forces...

  • Page 33
    ... computer systems our customers use may damage our business. For example, our online Version 2 software subscriptions, which we offer in six languages, does not currently operate properly with the newly released Microsoft Windows 7 and Mac OS X operating systems. As our product and service offerings...

  • Page 34
    ...for the capital expenditures required to finance working capital requirements, continue our expansion, develop new products and services or make acquisitions or other investments. In addition, if our business plans change, general economic, financial or political conditions in our markets change, or...

  • Page 35
    ...independently develop or gain 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...

  • Page 36
    ... subject to material claims of infringement by competitors 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 substantially greater...

  • Page 37
    ... of our voice recognition software, which we license from the University of Colorado. From time to time we may be required to renegotiate with these third parties or negotiate with new third parties to include their technology or content in our existing products, in new versions of our existing...

  • Page 38
    ...or SEC, and the New York Stock Exchange, impose various requirements on public companies. Our management and other personnel devote substantial amounts of time to these requirements. Moreover, these requirements have significantly increased our legal and financial compliance costs and have made some...

  • Page 39
    ... if we fail to maintain proper and effective internal controls in future periods, we could become subject to potential review by the New York Stock Exchange, the SEC or other regulatory authorities, which could require additional financial and management resources, could result in our delisting by...

  • Page 40
    ..., Germany and London, United Kingdom. Our Boulder office serves as a research and development location while our Tokyo, Seoul and London offices serve as our regional sales offices. As of December 31, 2009, we also had site licenses for 242 kiosks. Most of our kiosk site licenses have terms of three...

  • Page 41
    ... 16, 2009 (the first day our stock began trading on the NYSE) through December 31, 2009, with the cumulative total return on the NYSE Composite Index and the SIC Code Index that includes all U.S. public companies in the Standard Industrial Classification (SIC) Code 7372-Prepackaged Software. The...

  • Page 42
    ... Contents COMPARISON OF 8 MONTH CUMULATIVE TOTAL RETURN* Among Rosetta Stone Inc., The NYSE Composite Index And SIC code 7372 index *$100 invested on 4/16/09 in stock or index, including reinvestment of dividends. Fiscal year ending December 31. Use of Proceeds from Public Offering of Common Stock...

  • Page 43
    ... acquisition by Rosetta Stone Inc. on January 4, 2006. Included in the expenses were $5.9 million related to restricted common stock, $3.1 million in cash bonuses and $1.2 million in acquisition-related bank fees. Successor Year Ended December 31, 2009 Statements of Operations Data: Revenue Cost of...

  • Page 44
    Diluted weighted average shares 19,930 16,924 16,533 1,598 0.299 0.275 41

  • Page 45
    ..., 2005 2007 2006 2006 (in thousands, except per share data) Other Data: Stock-based compensation included in: Cost of sales Sales and marketing Research and development General and administrative Transaction-related expenses Total stock-based compensation expense $ 34 $ 2$ 2 999 153 189 5,959 15...

  • Page 46
    ... this Annual Report on Form 10-K. Overview We are a leading provider of technology-based language learning solutions. We develop, market and sell language learning solutions consisting of software, online services and audio practice tools primarily under our Rosetta Stone brand. Our teaching method...

  • Page 47
    ... services by leveraging our advertising and kiosk network in order to drive website and call center traffic. Components of Our Statement of Operations Revenue We derive revenue from sales of language learning solutions consisting of packaged software and audio practice products and online software...

  • Page 48
    ... in future periods with the planned launch of Rosetta Stone Version 4 TOTALe which includes services that have higher direct costs to deliver to customers than our existing software solutions. Operating Expenses We classify our operating expenses into three categories: sales and marketing, research...

  • Page 49
    ...and evaluate the consolidated financial statements contained in this annual report on Form 10-K. Revenue Recognition Revenue is primarily derived from the sale of packaged software and audio practice products, online software subscriptions and professional services. Our professional services include...

  • Page 50
    ... met. Accounts receivable and deferred revenue are recorded at the time a customer enters into a binding subscription agreement and the subscription services are made available to the customer. In connection with packaged software product sales and online software subscriptions, technical support is...

  • Page 51
    ... stock included in the related financial statement line items (in thousands): Years Ended December 31, 2009 2008 2007 Included in cost of revenue: Cost of product revenue Cost of subscription and service revenue Total included in cost of revenue Included in operating expenses: Sales and marketing...

  • Page 52
    ... of options - - - Expected dividend yield 1.71%-2.46% 2.08%-3.36% 3.50%-4.96% Risk-free interest rate Prior to the completion of our initial public offering in April 2009, our stock was not publicly quoted and we had a limited history of stock option activity, so we reviewed a group of comparable...

  • Page 53
    ... acquired technology, including developed and core technology, customer related assets, trade name and trademark and other intangible assets. Those intangible assets with finite lives are recorded at cost and amortized on a straight line basis over their expected lives in accordance with Accounting...

  • Page 54
    ... liability approach to accounting for income taxes. Deferred tax assets and liabilities represent the future tax consequences of the differences between the financial statement carrying amounts of assets and liabilities versus the tax bases of assets and liabilities. Under this method, deferred tax...

  • Page 55
    ... stockholders Income per share attributable to common stockholders: Basic Diluted Common shares and equivalents outstanding: Basic weighted average shares Diluted weighted average shares Stock-based compensation included in: Cost of sales Sales and marketing Research and development General and...

  • Page 56
    ... to begin bundling time-based subscription licenses of our web-based TOTALe services with perpetual licenses of our Rosetta Stone Version 3 language learning solutions in the U.S. consumer market during the third quarter of 2010 with the planned launch of Rosetta Stone Version 4 TOTALe. As a result...

  • Page 57
    ... subscription licenses of our web-based TOTALe services with perpetual licenses of our Rosetta Stone Version 3 language learning solutions in the U.S. consumer market with the planned launch of Rosetta Stone Version 4 during the third quarter of 2010. Operating Expenses Year Ended December 31, 2009...

  • Page 58
    ...of new products and services that are complementary to our existing solutions. Research and development expenses without consideration of the stock compensation charge associated with the common stock grant to key employees in connection with our initial public offering would have been $21.2 million...

  • Page 59
    ... of common stock awarded to 10 of our key employees in April 2009. The following table presents the stock-based compensation charge by operating expense line item: Year Ended December 31, 2009 2008 Change (dollars in thousands) % Change Sales and marketing Research and development General and...

  • Page 60
    ... control. Based on our analysis, we made changes to the transfer pricing agreements effective January 1, 2009. The resulting change in geographic distributions of income contributed to a lower effective tax rate as compared to the year ended December 31, 2008. We do not currently record income tax...

  • Page 61
    ... tool product for all 14 thenavailable Version 3 languages. In September 2008, we released Version 3 and our Audio Companion in seven additional languages. This expansion of our product portfolio with higher price point options has resulted in the 28% increase in average selling price per unit...

  • Page 62
    ... due to a $0.9 million write down of inventory in the 2007 period associated with the transition from Version 2 to Version 3 product and packaging. Operating Expenses Year Ended December 31, 2008 2007 Change (dollars in thousands) % Change Sales and marketing Research and development General and...

  • Page 63
    ... primarily attributable to additional personnel and contract development costs associated with the transition of Version 2 languages to Version 3, as well as the development of new products and services that are complementary to our existing solutions. General and Administrative Expenses General and...

  • Page 64
    ... of our products, the levels of advertising and promotion required to launch additional products and improve our competitive position in the marketplace, the expansion of our sales, support and marketing organizations, the establishment of additional offices in the United States and worldwide and...

  • Page 65
    ... million in expense associated with the issuance of common stock to key employees in April 2009. Additionally, a $10.3 million increase in deferred revenue resulting from greater sales of subscription licenses contributed to net cash provided by operations. Net cash provided by operating activities...

  • Page 66
    ... need to raise additional funds through public or private financings or increased borrowings to develop or enhance products, to fund expansion, to respond to competitive pressures or to acquire complementary products, businesses or technologies. If required, additional financing may not be available...

  • Page 67
    ... establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Specifically, this statement requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financial statements...

  • Page 68
    ... and level of activity for the asset or liability has significantly decreased. ASC 820 also provides guidance on identifying circumstances that indicate a transaction is not orderly. In addition, ASC 820 requires disclosure in interim and annual periods of the inputs and valuation methods used in...

  • Page 69
    ... financial statements. In October 2009, the FASB issued ASU 2009-14 which amended the accounting requirements under the Software Topic, ASC 985-605 Revenue Recognition. The objective of this update is to address the accounting for revenue arrangements that contain tangible products and software...

  • Page 70
    ... by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes...

  • Page 71
    ... in the accompanying "Index to Consolidated Financial Information" are filed as part of this Annual Report. Consolidated Financial Statement Schedules. Schedules have been omitted because they are not applicable or are not required or the information required to be set forth in those schedules is...

  • Page 72
    ... index have been omitted as they are either not required or not applicable, or the required information is included in the consolidated financial statements or the notes thereto. (b) Exhibits The exhibits listed in the Index to Exhibits are filed as part of this Annual Report on Form 10-K. 69

  • Page 73
    ... undersigned, thereunto duly authorized. ROSETTA STONE INC. By: /s/ TOM P.H. ADAMS Tom P.H. Adams Chief Executive Officer Date: March 9, 2010 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant...

  • Page 74
    Table of Contents INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets Consolidated Statements of Operations F-2 F-3 F-4 Consolidated Statements of Changes in Stockholders' Equity F-5 Consolidated Statements of Cash ...

  • Page 75
    Table of Contents REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Rosetta Stone Inc. Arlington, VA We have audited the accompanying consolidated balance sheets of Rosetta Stone Inc. and subsidiaries (the "Company") as of December 31, 2009 and ...

  • Page 76
    Table of Contents ROSETTA STONE INC. CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts) As of December 31, 2009 Assets Current assets: Cash and cash equivalents Restricted cash Accounts receivable (net of allowance for doubtful accounts of $1,349 and $1,103, respectively) ...

  • Page 77

  • Page 78
    ... of Contents ROSETTA STONE INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands except per share amounts) Year Ended December 31, 2009 2008 2007 Revenue: Product Subscription and service Total revenue Cost of revenue: Cost of product revenue Cost of subscription and service revenue Total cost...

  • Page 79
    Table of Contents ROSETTA STONE INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (in thousands) Class A, Class A, Series A-1 Series A-2 Class B Class A Class B NonAccumulated Convertible Convertible Convertible Convertible Convertible Designated Other Preferred Stock Preferred Stock ...

  • Page 80
    net of tax 8 25,785 $ - (224) $ 13,342 156,435 prehensive me - mber 31, - 20,249 2 $ 130,872 See accompanying notes to consolidated financial statements. F-5

  • Page 81
    ... of Contents ROSETTA STONE INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Year Ended December 31, 2009 Cash Flows From Operating Activities: Net income Adjustments to reconcile net income to cash provided by operating activities, net of business acquisitions Stock-based compensation...

  • Page 82
    Accrued liability for purchase of property and equipment Equipment acquired under capital lease Contingent liability for acquisition $ $ $ 546 $ 14 $ 850 $ 1,076 $ - $ - $ 455 - - See accompanying notes to consolidated financial statements. F-6

  • Page 83
    ... "Successor") develops, markets and supports a suite of language learning software products under the Rosetta Stone brand name. The Company's software products are sold on a direct basis and through select retailers. The Company provides its software applications to customers through the sale of CD...

  • Page 84
    Table of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Revenue Recognition Revenue is primarily derived from the sale of packaged software and audio practice products, online software subscriptions and ...

  • Page 85
    ... met. Accounts receivable and deferred revenue are recorded at the time a customer enters into a binding subscription agreement and the subscription services are made available to the customer. In connection with packaged software product sales and online software subscriptions, technical support is...

  • Page 86
    ... to any significant credit risk related to cash. The Company sells products to retailers, resellers, government agencies, and individual consumers and extends credit based on an evaluation of the customer's financial condition, without requiring collateral. Exposure to losses on receivables is...

  • Page 87
    ... acquired technology, including developed and core technology, customer related assets, trade name and trademark and other intangible assets. Those intangible assets with finite lives are recorded at cost and amortized on a straight line basis over their expected lives in accordance with Accounting...

  • Page 88
    ... fixed assets used, and the cost of technical support for customers. Research and Development Research and development expenses include employee compensation costs, professional services fees and overhead costs associated with product development. Software products are developed for sale to external...

  • Page 89
    Table of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) plan exists or is being developed to market the software externally. Internally developed software is amortized over a three-year useful life. For ...

  • Page 90
    ... of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) the treasury stock method), restricted stock awards, restricted stock units and conversion of preferred shares (using the as-converted method). Common...

  • Page 91
    Table of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Foreign Currency Translation and Transactions The functional currency of the Company's foreign subsidiaries is their local currency. Accordingly, ...

  • Page 92
    ... and level of activity for the asset or liability has significantly decreased. ASC 820 also provides guidance on identifying circumstances that indicate a transaction is not orderly. In addition, ASC 820 requires disclosure in interim and annual periods of the inputs and valuation methods used in...

  • Page 93
    ... financial statements. In October 2009, the FASB issued ASU 2009-14 which amended the accounting requirements under the Software Topic, ASC 985-605 Revenue Recognition. The objective of this update is to address the accounting for revenue arrangements that contain tangible products and software...

  • Page 94
    ...for under Accounting Standards Codification topic 805, Business Combination("ASC 805"). The purchase price consisted of an initial cash payment of $100,000, followed by three annual cash installment payments, based on revenue performance in South Korea. The terms of the acquisition agreement provide...

  • Page 95
    ...from the acquisition of Rosetta Stone, Ltd. in January 2006 and the acquisition of certain assets of SGLC International Co. Ltd. in November 2009, as detailed in Note 4. The Company tests goodwill for impairment annually on June 30 of each year at the reporting unit level using a fair value approach...

  • Page 96
    ... during 2008. The estimated lives of the acquired core technology and customer relationships are between 18 to 36 months. The intangible asset associated with the trade name and trademark has an indefinite useful life. The estimated life of the website rights is 60 months. The Company computes F-20

  • Page 97
    ... Life Trade name / trademark Core technology Customer relationships Website Amortization expense consisted of the following (in thousands): Indefinite 24 months 33 months 60 months Years Ended December 31, 2009 2008 2007 Included in cost of revenue: Cost of product revenue Cost of subscription...

  • Page 98
    ... of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 9. BORROWING AGREEMENT On January 4, 2006, the Company entered into a Credit Agreement with Madison Capital, which provided the Company a $4.0 million revolving credit facility ("Revolver") and a $17.0 million...

  • Page 99
    ...straight-line basis over the requisite service period of the award. The Company uses the Black-Scholes pricing model to value its stock options, which requires the use of estimates, including future stock price volatility, expected term and forfeitures. Stock-based compensation expense recognized is...

  • Page 100
    ... of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 10. STOCK-BASED COMPENSATION (Continued) Prior to the completion of the Company's initial public offering in April 2009, the Company's stock was not publicly quoted and the Company had a limited history of stock...

  • Page 101
    Table of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 10. STOCK-BASED COMPENSATION (Continued) The following tables summarize the status of options outstanding under the Company's stock option plan as of December 31, 2009: Range of Exercise Prices Number ...

  • Page 102
    ...of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 10. STOCK-BASED COMPENSATION (Continued) Restricted Stock-The following table summarizes the Company's restricted stock activity for the year ended December 31, 2009: Nonvested Outstanding Weighted Average Grant...

  • Page 103
    ... stock included in the related financial statement line items (in thousands): Years Ended December 31, 2009 2008 2007 Included in cost of revenue: Cost of product revenue Cost of subscription and service revenue Total included in cost of revenue Included in operating expenses: Sales and marketing...

  • Page 104
    Table of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 11. COMMON STOCK (Continued) Dividends Holders of each class of Common Stock are entitled to dividends, in cash or stock in the same form and per share amount as declared by the Board of Directors. ...

  • Page 105
    Table of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 14. COMMITMENTS AND CONTINGENCIES (Continued) five years. Building, warehouse and office space leases range from three months to 85 months. Certain leases also include lease renewal options. The following ...

  • Page 106
    ... Company is developing. The agreement required a one-time, non-refundable payment of $0.3 million, which was expensed in full as research and development costs during 2006 because the products in which the licensed software were to be incorporated into had not yet reached technological feasibility...

  • Page 107
    Table of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 15. INCOME TAXES The following table summarizes the significant components of the Company's deferred tax assets and liabilities as of December 31, 2009 and 2008 (in thousands): As of December 31, 2009 2008...

  • Page 108
    ... ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 15. INCOME TAXES (Continued) Despite enacting certain tax planning strategies during the year ended December 31, 2009, neither subsidiary has produced sustainable pretax profits as of December 31, 2009. Company management...

  • Page 109
    ...The Company operates as one operating segment as the principal business activity relates to developing and selling language learning software. The chief operating decision maker, the Chief Executive Officer, evaluates the performance of the Company based upon software revenues. Products and services...

  • Page 110
    ... of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 16. SEGMENT INFORMATION (Continued) of the Company's revenues were generated from sales outside of the United States for the years ended December 31, 2008 and 2007, and approximately 8% of the Company's revenue...

  • Page 111
    ... 2.55 1,936 0.29 17,043 The second quarter of 2009 contained an IPO-related $18.8 million expense, consisting of $18.5 million in stock-based compensation expense and $0.3 million in payoll tax expense, related to common stock grants awarded to key employees equal to a total of 591,491 shares. F-35

  • Page 112
    ... of common stock Subscription Agreement dated as of January 4, 2006, by and among Rosetta Stone Inc., ABS...Language Technologies, Inc., as amended Sublease Agreement dated as of October 6, 2008, by and between The Corporate Executive Board Company and Rosetta Stone Ltd. Software License Agreement...

  • Page 113

  • Page 114
    ... Incorporation Rosetta Stone Holdings Inc. Rosetta Stone Ltd. (Formerly Fairfield & Sons Ltd., d/b/a Fairfield Language Technologies) Rosetta Stone (UK) Limited (Formerly Fairfield & Sons Limited) Rosetta Stone Japan Inc. (Formerly Rosetta World K.K.) Rosetta Stone International Inc. Rosetta Stone...

  • Page 115
    QuickLinks Exhibit 21.1

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    ... to the consolidated financial statements of Rosetta Stone Inc. and subsidiaries (which report expresses an unqualified opinion and includes an explanatory paragraph regarding the Company's adoption of a new accounting standard), appearing in this Annual Report on Form 10-K of Rosetta Stone Inc. and...

  • Page 117
    QuickLinks Exhibit 23.1

  • Page 118
    ... and resubstitution, for him and in his 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...

  • Page 119
    Signature Title /s/ THEODORE J. LEONSIS Theodore J. Leonsis /s/ JOHN E. LINDAHL John E. Lindahl Director Director

  • Page 120
    QuickLinks Exhibit 24.1

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    ... certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant's auditors and the audit committee of the Registrant's Board of Directors (or persons performing the equivalent functions): a. all significant deficiencies...

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    QuickLinks Exhibit 31.1

  • Page 123
    ... OF CHIEF FINANCIAL OFFICER OF ROSETTA STONE INC. PURSUANT TO 15 U.S.C. SECTION 7241, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Brian D. Helman, certify that: 1. 2. I have reviewed this Annual Report on Form 10-K of Rosetta Stone Inc. (the "Registrant"); Based on my...

  • Page 124
    QuickLinks Exhibit 31.2

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    ... ended December 31, 2009 filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Tom P. H. Adams, Chief Executive Officer of Rosetta Stone Inc. (the "Company"), hereby certify, to my knowledge, that: 1. 2. the Report fully complies with the requirements of Section 13...

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    QuickLinks Exhibit 32.1

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    ... ended December 31, 2009 filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Brian D. Helman, Chief Financial Officer of Rosetta Stone Inc. (the "Company"), hereby certify, to my knowledge, that: 1. 2. the Report fully complies with the requirements of Section 13...

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    QuickLinks Exhibit 32.2