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ROSETTA STONE INC (RST)
10-K
Annual report pursuant to section 13 and 15(d)
Filed on 03/14/2011
Filed Period 12/31/2010

Table of contents

  • Page 1
    ROSETTA STONE INC (RST) 10-K Annual report pursuant to section 13 and 15(d) Filed on 03/14/2011 Filed Period 12/31/2010

  • 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, 2010 Commission file number: 1-34283 Rosetta Stone...

  • Page 3
    ...261 million as of June 30, 2010 (based on the last sale price of such stock as quoted on the New York Stock Exchange). As of February 16, 2011, there were 20,979,574 shares of common stock outstanding. Documents incorporated by reference: Portions of the definitive Proxy Statement to be delivered to...

  • Page 4
    ... About Market Risk Item 8. Financial Statements and Supplementary Data Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Item 9A Controls and Procedures Item 9B Other Information PART III Item 10. Directors, Executive Officers and Corporate Governance Item...

  • Page 5
    ... 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, which we call Dynamic Immersion, is...

  • Page 6
    ...-study books, audio tapes and software that rely primarily 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 is important and valued...

  • Page 7
    ...and software tools to help learning in both consumer and institutional markets, supported by the rapid increase in computing technologies and internet use. Given busy lifestyles, adult language learners seek solutions that work flexibly and do not require physical classroom attendance. Educators are...

  • 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
    ... offering in our other foreign markets. Extend Our Technological and Product Leadership. We intend to apply new technologies to maintain our product leadership. We currently are working on a variety of product development initiatives. For example, Rosetta Stone Version 4 TOTALe, which was released...

  • Page 10
    ..., fun and engaging language games, interaction with native speakers and live support from customer service agents. TOTALe is also available in an online only subscription based service. In November 2010, we released Rosetta Stone Discover, a stand-alone mobile application for Apple iPhone and...

  • Page 11
    ... reinforces material learned from our software program. TOTALe Mobile Companion is an additional practice tool that is available on Apple iPhone and iPod Touch. TOTALe Mobile Companion includes a series of practice lessons which use images, audio and our speech recognition technology to help users...

  • Page 12
    ...upiaq. In 2010, we continued our work with Native American communities by adding a product for Navajo. Technology We develop most of our own technology, including our proprietary unified language learning software platform. Our newest application, Version 4, currently supports up to five levels of...

  • Page 13
    ...the program less and less frequently as the learner remembers over extended periods of time. We have developed a proprietary student management system, which is designed to allow teachers and administrators to configure their own lesson plans using our content and exercises and to review reports for...

  • Page 14
    ... multiple units, lessons and activities. Customers Our customers include individuals, home school parents, educational institutions, armed forces, government agencies, corporations and not-for-profit institutions. We sell to our customers through a direct-to-consumer and institutional marketing and...

  • Page 15
    ..., Best Buy, Staples, Costco and Office Depot. Sales in the retail channel are highly correlated with our media expenditures in the direct-to-consumer channel. In February 2011, Borders filed for Chapter 11 bankruptcy reorganization and announced plans to close approximately 200 stores. Home Schools...

  • Page 16
    ..., offering literacy programs and preparing members for overseas missions and accounted for approximately 28% of our institutional revenue for the year ended December 31, 2010. Many customers in this market license our products through online subscriptions. We have recently been adding sales...

  • Page 17
    ... competition from a wide variety of companies providing language learning solutions including language learning center operators; audio CD and MP3 download providers; pre-packaged software producers; textbook publishers; online tutoring service providers; and online peer-to-peer practice providers...

  • Page 18
    ... 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 19
    ... costs as a percentage of revenue, may not succeed and may harm our business, financial results and reputation. We released Rosetta Stone Version 4 TOTALe in the third quarter of 2010. Rosetta Stone Version 4 TOTALe integrates our existing language learning software solutions with web-based services...

  • Page 20
    ... preferences, our Rosetta Stone brand, sales and customer relationships may be harmed. In 2010, unit sales of our products decreased compared to 2009 and initial sales of Version 4 TOTALe have been less than expected. Demand for our language learning software products and related services, and for...

  • Page 21
    ... with our direct sales force, to sell our products. Our sales to retailers are highly concentrated on a small group, including Amazon.com, Apple, Barnes & Noble, Borders, Staples, Best Buy, Costco and Office Depot. Sales to or through our retailer and distributors accounted for approximately 18...

  • 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
    ... are some online services offering limited free lessons and learning tools, including one sponsored by the U.S. Department of Education to help immigrants learn English. Many of these websites offer free language practice opportunities with other language learners. If these free products become more...

  • Page 24
    ...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 25
    ... 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 26
    ... of the recently released TOTALe Mobile Companion and Rosetta Stone Discover, we have no experience to date in operating versions of our products and services developed or optimized for users of alternative devices, and new devices and new platforms are continually being released. Accordingly, it is...

  • Page 27
    ...institutional demand and to avail ourselves of new market opportunities. The expanding scope of our business and growth in the number of our employees, customers and sales locations will continue to place a significant strain on our management team, information technology systems and other resources...

  • Page 28
    ... 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, and our SharedTalk online peer-to-peer collaborative and interactive community. Any damage...

  • Page 29
    ...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 30
    Table of Contents credit card numbers. We and our vendors use commercially available encryption technology to transmit personal information when taking orders. We use security and business controls to limit access and use of personal information. However, third parties may be able to circumvent ...

  • Page 31
    ... 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 32
    ... our customers use may damage our business. For example, our online Version 2 software subscriptions, which we offer in four 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 become...

  • Page 33
    ... 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 other circumstances arise that have a material...

  • Page 34
    ...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 35
    ... significant liability and disrupt our business. We may become 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...

  • Page 36
    ...-party technology or content in our products and services, the inability to support, maintain and enhance any software could result in increased costs, or in delays or reductions in product shipments until equivalent software could be developed, identified, licensed and integrated. Our use of open...

  • Page 37
    ... Contents compliance costs and have made some activities more time-consuming and costly. In addition, we incur additional costs associated with our public company reporting requirements. These rules and regulations also make it more difficult and more expensive for us to obtain director and officer...

  • Page 38
    ... to sales operations. We also lease space for our three full service retail outlets in Missouri, New Jersey, and New York and for small offices in Boulder, Colorado, Tokyo, Japan, Seoul, South Korea, Munich, Germany and London, United Kingdom. Our Boulder office serves as a research and development...

  • Page 39
    ... currently intend to retain all available funds and any future earnings to support the operation of and to finance the growth and development of our business. We do not anticipate paying any cash dividends in the foreseeable future. Securities Authorized For Issuance Under Equity Compensation Plans...

  • Page 40
    ... our initial public offering for working capital and other general corporate purposes, which may include the acquisition of other businesses, products or technologies. We do not, however, have agreements or commitments for any specific acquisitions at this time. Pending such uses, we plan to invest...

  • Page 41
    ..."Management's Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements contained elsewhere in this Annual Report on Form 10-K. Our historical results for any prior period are not necessarily indicative of results to be expected in any future...

  • Page 42
    ... average shares 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 Intangible amortization included in: Cost of sales Sales and marketing Total...

  • Page 43
    40

  • Page 44
    ... 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, which we call Dynamic Immersion, is...

  • Page 45
    ... 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 subscriptions. Revenue is presented as product revenue...

  • Page 46
    ...subscription and service revenue. Cost of revenue will also increase as a percentage of revenue in future periods as a result of our 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...

  • Page 47
    Table of Contents an office in Germany. In each case we established local sales offices and call centers, added employees and launched marketing and public relations campaigns within the region. We intend to continue to expand our sales activities within these regions as well as to expand our ...

  • Page 48
    ... coaching and an online software subscription. Rosetta Stone Version 4 TOTALe, which was released in September 2010, combines packaged software and dedicated conversational coaching. We recognize revenue for software products and related services in accordance with Accounting Standards Codification...

  • Page 49
    ... recognition criteria have been 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...

  • Page 50
    ... of the online services. The language learning software cost of sales are generally recognized at the time of sale. Costs for online services and sales and marketing are expensed as incurred. We account for multiple element arrangements that consist only of software or software related products, in...

  • Page 51
    ... in the related financial statement line items (in thousands): Years Ended December 31, 2010 2009 2008 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 Research and...

  • Page 52
    Table of Contents The following table sets forth a summary of stock option grants since the date of plan inception, through the date of this Annual Report on Form 10-K: Grant Date Number of Options Granted Exercise Price Common Stock Fair Value Per Share at Grant Date 1,704,950 $3.85-$3.85 $4....

  • Page 53
    ...which clarify the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with ASC 740 and prescribe a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be...

  • Page 54
    ... table sets forth our consolidated statement of operations for the periods indicated. Year Ended December 31, 2010 2009 2008 (in thousands, except per share data) Statements of Operations Data: Revenue Cost of revenue Gross profit Operating expenses: Sales and marketing Research and development...

  • Page 55
    .... We began 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 launch of Rosetta Stone Version 4 TOTALe. As a result, we...

  • Page 56
    .... In 2009, we began offering home school edition products through other sales channels, including direct-to-consumer call centers and our retail channels. As the availability of home school products in other sales channels increased during 2010, consumers began utilizing these new channels to make...

  • Page 57
    ...web-based service offering in our Version 4 TOTALe product that includes a component of dedicated online language conversation coaching and higher direct costs to deliver to customers than our previous software solutions. We expect our cost of subscription and service revenue will increase in future...

  • Page 58
    ... associated with this development. We expect research and development expenses to increase in 2011 as we develop our English remediation solution for our Asian markets, invest in new digital platforms such as the iPad, roll out our Version 4 TOTALe product in our international markets, and support...

  • Page 59
    ...our key employees in April 2009. The following table presents the stock-based compensation charge by operating expense line item: Year Ended December 31, 2010 2009 Change (dollars in thousands) % Change Sales and marketing Research and development General and administrative Total Lease Abandonment...

  • Page 60
    ... Year Ended December 31, 2009 2008 (dollars in thousands) Change % Change Product revenue Subscription and service revenue Total revenue Revenue by sales channel: Direct-to-consumer Kiosk Retail Home school Total consumer Institutional Total revenue Revenue $ 218,549 33,722 $ 252,271 $ 115,791 40...

  • Page 61
    ...attributable to subscription and service revenue. With the launch of Rosetta Stone Version 4 TOTALe during the third quarter of 2010, we began bundling time-based subscription licenses of our web-based TOTALe services with perpetual licenses of our Rosetta Stone Version 3 language learning solutions...

  • Page 62
    Table of Contents to core technology associated with the acquisition of Fairfield & Sons, Ltd., which was fully amortized in 2008. Cost of subscription and service revenue increased by $1.0 million or 48% as we released Rosetta Stone TOTALe, our new web-based service offering that included a ...

  • Page 63
    ...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 administrative Total Lease Abandonment...

  • Page 64
    ... and other deferred tax assets for these jurisdictions. As we continue operations in accordance with the revised transfer pricing agreements, we will monitor actual results and updated projections on a quarterly basis. When and if the subsidiaries realize or realistically anticipate sustainable...

  • Page 65
    ... 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 66
    ...Net cash used in financing activities during this period was primarily related to principal payments on our long-term debt. Additionally, for the year ended December 31, 2008, net cash used in financing activities also included payments associated with our planned initial public offering. We believe...

  • Page 67
    ..., the Company was required to account for online services bundled with auxiliary items, such as headsets and audio companions, using the residual method or by treating the arrangements as one unit of accounting. ASU No. 2009-13 requires the Company to account for the sale of online services 64

  • Page 68
    ...and its application did not have a material impact on our consolidated 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...

  • Page 69
    ... 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 70
    ... or principal accounting officer. Copies of both the code of conduct, as well as any 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-Highlights...

  • Page 71
    ..." 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 included in the consolidated financial statements or related notes...

  • Page 72
    .... ROSETTA STONE INC. By: /s/ TOM P.H. ADAMS Tom P. H. Adams Chief Executive Officer Date: March 14, 2011 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 and in the capacities on the 14th day...

  • Page 73
    Table of Contents INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Page Reports of Independent Registered Public Accounting Firm Consolidated Balance Sheets Consolidated Statements of Operations F-2 F-4 F-5 Consolidated Statements of Changes in Stockholders' Equity F-6 Consolidated Statements of Cash...

  • Page 74
    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, 2010 and ...

  • Page 75
    ... 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 internal control over financial reporting of Rosetta Stone Inc. and subsidiaries (the "Company") as of December 31, 2010, based on...

  • Page 76
    Table of Contents ROSETTA STONE INC. CONSOLIDATED BALANCE SHEETS (in thousands, except per share amounts) As of December 31, 2010 2009 Assets Current assets: Cash and cash equivalents Restricted cash Short term investments Accounts receivable (net of allowance for doubtful accounts of $1,761 and ...

  • Page 77
    ... of Contents ROSETTA STONE INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands except per share amounts) Year Ended December 31, 2010 2009 2008 Revenue: Product Subscription and service Total revenue Cost of revenue: Cost of product revenue Cost of subscription and service revenue Total cost...

  • Page 78
    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 79
    ...,284 - 13,284 - - -$ - - - - - -$ - - - - - -$ - - - - - - $ - - - - - - $ - - - - $ - - - - $ - - 39,069 $ 447 - 223 $ 447 13,731 178,316 prehensive me - mber 31, - 20,667 2 $ 139,022 See accompanying notes to consolidated financial statements. F-6

  • Page 80
    ... of Contents ROSETTA STONE INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Year Ended December 31, 2010 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 81
    Equipment acquired under capital lease Contingent liability for acquisition $ $ - $ - $ 14 $ 850 $ - - See accompanying notes to consolidated financial statements. F-7

  • Page 82
    ... OF OPERATIONS Rosetta Stone Inc. and its subsidiaries ("Rosetta Stone," the "Company" or the "Successor") develops, markets and supports a suite of language learning solutions consisting of software products, online services and audio practice tools under the Rosetta Stone brand name. The Company...

  • Page 83
    ... and an online software subscription. Rosetta Stone V4 TOTALe, which was released in September 2010, combines packaged software and dedicated conversational coaching. The Company recognizes revenue for software products and related services in accordance with Accounting Standards Codification...

  • Page 84
    ... recognition criteria have been 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...

  • Page 85
    ... online services. The language learning software cost of sales are generally recognized at the time of sale. Costs for online services and sales and marketing are expensed as incurred. The Company accounts for multiple element arrangements that consist only of software or software related products...

  • Page 86
    ... equivalent accounts to date and the Company believes it is not exposed 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...

  • Page 87
    ... of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions...

  • Page 88
    Table of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Expenses for repairs and maintenance that do not extend the life of equipment are charged to expense as incurred. Expenses for major renewals and ...

  • Page 89
    ...expenses include employee compensation costs, professional services fees and overhead costs associated with product development. Software products are developed for sale to external customers. The Company considers technological feasibility to be established when all planning, designing, coding, and...

  • Page 90
    Table of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) to have the following characteristics: (a) the software is internally developed, or modified solely to meet the entity's internal needs, and (b) ...

  • Page 91
    Table of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Net Income Per Share Net income per share is computed under the provisions of Accounting Standards Codification topic 260, Earnings Per Share. Basic ...

  • Page 92
    ...Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 2. SUMMARY OF SIGNIFICANT ACCOUNTING...years ended December 31, 2010, 2009 and 2008, the Company's comprehensive income consisted of...using average exchange rates for the period. The Company reports the effect of exchange...

  • Page 93
    ...and its application did not have a material impact on its consolidated 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...

  • Page 94
    ... 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
    ...asset associated with the trade name and trademark has an indefinite useful life. The estimated life of the website rights is 60 months, and estimated useful life of the patents are based on the effective date of the purchase agreement through the expiration date of the patents. The Company computes...

  • Page 97
    ... 2012 Thereafter Total 8. OTHER CURRENT LIABILITIES The following table summarizes other current liabilities (in thousands): $ $ 84 40 217 341 December 31, 2010 2009 Marketing expenses Professional and consulting fees Sales return reserve Taxes payable Other 9. BORROWING AGREEMENT $ $ 11,075...

  • Page 98
    ... of stock-based awards to employees is calculated as of the date of grant. Compensation expense is then recognized on a 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...

  • Page 99
    ... dividend yield 1.14% - 2.59% 1.71% - 2.46% 2.08% - 3.36% Risk-free interest rate 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 option activity, so the Company reviewed...

  • Page 100
    Table of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 10. STOCK-BASED COMPENSATION (Continued) The weighted average grant-date fair value per share of stock options granted was $13.60, $10.32 and $7.19 for the years ended December 31, 2010, 2009 and 2008, ...

  • Page 101
    ... in the related financial statement line items (in thousands): Years Ended December 31, 2010 2009 2008 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 Research and...

  • Page 102
    Table of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 11. COMMON STOCK (Continued) per share, and 10,000,000 were designated as Preferred Stock, with a par value of $0.001 per share. At December 31, 2010 and 2009, the Company had shares of Common Stock issued ...

  • Page 103
    Table of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 14. COMMITMENTS AND CONTINGENCIES (Continued) The Company accounts for its leases under the provisions of Accounting Standards Codification topic 840, Accounting for Leases ("ASC 840"), and subsequent ...

  • Page 104
    ... 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 105
    Table of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 14. COMMITMENTS AND CONTINGENCIES (Continued) other persons similarly situated who are or were employed as salaried managers by the Company in its retail locations in California are due unpaid wages and ...

  • Page 106
    Table of Contents ROSETTA STONE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued) 15. INCOME TAXES (Continued) During the quarter ended December 31, 2010, the Company determined that the relative weight of positive and negative evidence supports that it is more likely than not that the ...

  • Page 107
    ... INFORMATION 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. F-33

  • Page 108
    ..., of long-lived assets held outside of the United States. No single customer accounted for more than 10% of the Company's revenue for the years ended December 31, 2010, 2009 and 2008, respectively. 17. RELATED PARTIES As of December 31, 2010 and 2009, the Company had outstanding receivables from...

  • Page 109
    ... 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. 20. SUBSEQUENT EVENTS On January 4, 2011, the Company's board of directors approved the Rosetta Stone Inc. Long Term Incentive Program...

  • Page 110
    ... vest (or restrictions will lapse) 25% after each six month interval over 2 years. Restricted stock is 100% vested two years after the date of the award. There will be no subsequent holding period requirement. On January 17, 2011, the Company allowed its $12.5 million revolving line of credit with...

  • Page 111
    .... Identifies management contracts and compensatory plans or arrangements. Incorporated by reference to exhibit filed with Registrant's registration statement on Form S-1 (File No. 333-153632), as amended. Filed as Exhibit 10.1 to the Rosetta Stone's Current Report on Form 8-K dated October 13, 2010.

  • Page 112

  • Page 113
    ... publicly traded companies so long as such service does not unreasonably interfere with her duties to the Company. 3. Salary, Bonus, Benefits and Equity. The CEO and the Board shall make all decisions related to Executive's base salary and the payment of bonuses, if any. Executive's Annual Base...

  • Page 114
    ... of the Executive's then-current Annual Base Salary upon 100% achievement of the annual objectives as set out in the Company's Executive Bonus Plan. (ii.) Executive shall receive a one-time signing bonus upon the date of hire in the amount of $35,000, subject to taxes and applicable withholdings. If...

  • Page 115
    ... be eligible to receive subsequent annual grants of stock options and other equity awards in accordance with equity compensation arrangements established by the Board. The grants shall have such terms as are determined by the Board in accordance with the current stock plan in place at time of grant...

  • Page 116
    ...) days after receipt by Executive of written notice thereof from the Company, to correct, cease or otherwise alter any failure to comply with instructions or other action or omission which the Board or the CEO reasonably believes does or may materially or adversely affect its business or operations...

  • Page 117
    ... 1/12 of the amount of the Annual Base Salary in effect immediately prior to the Termination Date and (y) 12; and (4) a lump sum in cash equal to the product of (x) the monthly basic life insurance premium applicable to Executive's basic life insurance coverage immediately prior to the Termination...

  • Page 118
    ... Date. The Company shall pay to Executive her Annual Base Salary for periods following her Separation From Service, to the extent not theretofore paid, within thirty (30) days following her Separation From Service if she is not a Specified Employee or on the date that is six months following...

  • Page 119
    ...and correct in all material respects, and accurately reflects Executive's prior work history. Executive has the full legal right to be employed on a full-time basis by the Company in the United States under all applicable immigration laws on the basis of the Company's continued willingness to employ...

  • Page 120
    ... (b) methods, processes, programs, designs, analyses, drawings, reports and all similar or related information (whether or not patentable) that relate to the Company's or any of its Subsidiaries' actual or anticipated business, research and development, or existing or future products or services and...

  • Page 121
    ... or provide services related to the Business to any Person who was a customer or client of the Company or any Subsidiary at any time during the 12-month period immediately preceding the Termination Date; or (v) solicit or provide services related to the Business to any Prospective Customer. For...

  • Page 122
    ... herein, the parties hereto agree that money damages would be an inadequate remedy for any breach of this Agreement. Therefore, without limiting the generality of Section 12(f), in the event of a breach or threatened breach of this Agreement, the Company or its successors or assigns may, in addition...

  • Page 123
    ...products, unit volume of sales to past or present customers and clients, or any other information concerning the business of the Company and its Subsidiaries, their manner of operation, their plans, processes, figures, sales figures, projections, estimates, tax records, personnel history, accounting...

  • Page 124
    ...or sent by reputable overnight courier service (charges prepaid) to the recipient at the address below indicated: If to the Company: Rosetta Stone Ltd. 1919 North Lynn Street 7th Floor Arlington, VA 22209 Attention: Chief Executive Officer With a copy to Rosetta Stone Ltd. 1919 North Lynn Street 7th...

  • Page 125
    ... of the parties under this Agreement shall not be assignable without the prior written consent of the other party, except for assignments by operation of law and assignments by the Company to any successor of the Company by merger, consolidation, combination or sale of assets. Any purported...

  • Page 126
    ...Company and Executive. (h) Business Days. If any time period for giving notice or taking action hereunder expires on a day which is a Saturday, Sunday or holiday in the state in which the Company's chief executive office is located, the time period shall be automatically extended to the business day...

  • Page 127
    ...280G of the Code) or any Affiliate of such person and (ii) agreed upon by the Company and Executive (the "Accounting Firm"). The Accounting Firm shall provide detailed supporting calculations both to the Company and Executive within 15 business days after appointment by the Company and Executive and...

  • Page 128
    ... in the application of section 4999 of the Code at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross-Up Payments that will not have been made by the Company should have been made ("Underpayment"), consistent with the calculations required to be...

  • Page 129
    ... in such payments or benefits ultimately paid or provided to Executive) until the date that is six months following her termination of employment with the Company (or the earliest date as is permitted under Section 409A) and (ii) if any other payments of money or other benefits due to Executive...

  • Page 130
    ... after execution of this Agreement, the Company's indemnity obligations hereunder shall be unaffected (to the extent permitted by applicable law). The Company shall maintain an insurance policy covering Executive for actions taken by Executive as an officer, manager and/or director of Employer and...

  • Page 131
    IN WITNESS WHEREOF, the parties hereto have executed this Agreement on the date first written above. Rosetta Stone Ltd. By: /s/ Tom Adams Tom Adams, Chief Executive Officer EXECUTIVE /s/ Helena Wong Helena Wong 19 EXHIBIT A Form of Release 20

  • Page 132
    ... equity, whether now known or unknown, that Executive Releasers, or any person acting under any of them, may now have, or claim at any future time to have, based in whole or in part upon any act or omission occurring on or before the Effective Date, without regard to present actual knowledge of such...

  • Page 133
    ...now known or unknown, that the Company Releasers, or any person acting under any of them, may now have, or claim at any future time to have, based in whole or in part upon any act or omission relating to Employee's employment with the Company or separation therefrom, without regard to present actual...

  • Page 134
    ... work up to her last day of employment with the Company, and that she is not entitled to any further pay or benefit of any kind, for services rendered or any other reason, other than the Severance Benefit. 4. Executive agrees that the only thing of value that she will receive by signing this Release...

  • Page 135
    ... has given the Company written notice, within three business days following service of the subpoena or court order. 8. Executive covenants never to disparage or speak ill of the Company or any the Company product or service, or of any past or present employee, officer or director of the Company, nor...

  • Page 136
    ... applicable to claims asserted in the proceeding shall be deemed to have been tolled for the period between the Effective Date and 10 days after the date on which Section 2(a) is declared unenforceable. (g) and agreements. (h) This Agreement shall not be modified except in a writing signed...

  • Page 137
    ...meaning of the language used. (o) Every dispute arising from or relating to this Agreement shall be tried only in the state or federal courts situated in the Commonwealth of Virginia. The parties consent to venue in those courts, and agree that those courts shall have personal jurisdiction over them...

  • Page 138
    NOTE: DO NOT SIGN THIS SUPPLEMENTAL LEGAL RELEASE UNTIL AFTER EXECUTIVE'S FINAL DAY OF EMPLOYMENT. ROSETTA STONE LTD. By: Tom Adams, Chief Executive Officer Date: EXECUTIVE Helena Wong Date: 27

  • Page 139
    ... Inc. Rosetta Stone Brazil Holding, LLC 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 GmbH...

  • Page 140
    QuickLinks Exhibit 21.1

  • Page 141
    ... OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in Registration Statement No. 333-158828 on Form S-8 of our reports dated March 11, 2011, relating to the consolidated financial statements of Rosetta Stone Inc. and subsidiaries (the "Company"), and the...

  • Page 142
    QuickLinks Exhibit 23.1

  • Page 143
    ... 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 144
    Laura L. Witt

  • Page 145
    QuickLinks Exhibit 24.1

  • Page 146
    ... and report financial information; and any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. b. By: /s/ TOM P. H. ADAMS Tom P. H. Adams Chief Executive Officer Date: March...

  • Page 147
    QuickLinks Exhibit 31.1

  • Page 148
    ... and report financial information; and any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal control over financial reporting. b. By: /s/ STEPHEN M. SWAD Stephen M. Swad Chief Financial Officer Date: March...

  • Page 149
    QuickLinks Exhibit 31.2

  • Page 150
    ... ended December 31, 2010 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...

  • Page 151
    QuickLinks Exhibit 32.1

  • Page 152
    ... ended December 31, 2010 filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Stephen M. Swad, 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...

  • Page 153
    QuickLinks Exhibit 32.2