Rosetta Stone 2012 Annual Report Download

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TABLE OF CONTENTS
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Table of Contents


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
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



(Exact name of registrant as specified in its charter)

(State of incorporation)

(I.R.S. Employer
Identification No.)


(Address of principal executive
offices)

(Zip Code)
Registrant's telephone number, including area code:

Securities Registered Pursuant to Section 12(b) of the Act:
 
Common Stock, par value $0.00005 per
share New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act:

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o 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 o 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 preceding 12 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 o
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 and posted 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 and post such files). Yes No o

Table of contents

  • Page 1
    ... FINANCIAL STATEMENTS Table of Contents UNITED STTTES SECURITIES TND EXCHTNGE COMMISSION Washington, D.C. 20549 Form 10-K TNNUTL REPORT PURSUTNT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHTNGE TCT OF 1934 For the fisgal year ended Degember 31, 2012 Commission file number: 1-34283 Rosetta Stone...

  • Page 2
    ...-2 of the Act). Yes o No  The aggregate market value of the common stock held by non-affiliates of the registrant was approximately $169.0 million as of June 30, 2012 (based on the last sale price of such stock as quoted on the New York Stock Exchange). As of February 22, 2013, there were 21...

  • Page 3
    ... Issuer Purchases of Equity Securities Selected Financial Data Management's Discussion and Analysis of Financial Condition and Results of Operations Quantitative and Qualitative Disclosures About Market Risk Financial Statements and Supplementary Data Changes in and Disagreements with Accountants on...

  • Page 4
    ... our future financial performance; our projected plans and objectives; our development of new products including an English remediation solution; international expansion and our development of a business model to drive growth; the sufficiency of our cash flows from operations and available sources...

  • Page 5
    ...of technology-based, language-learning solutions. We develop, market, and sell language-learning solutions consisting of software, online services, mobile applications and audio practice tools primarily under our Rosetta Stone brand. Our teaching method, which we call Dynamic Immersion , is designed...

  • Page 6
    ... to Rosetta Course with the exception of the review and writing path steps, for use on tablet devices. TOTALe Companion HD includes our speech recognition technology. TOTALe Companion includes a series of practice lessons which use images, audio and our speech recognition technology to help users...

  • Page 7
    ... Amazon.com, Barnes & Noble, Best Buy, Books-a-Million, Costco, Groupon, Staples, and others outside of the U.S. Home School. We promote interest in this market through advertising in publications focused on home schooling, attending local trade shows, seminars and direct mailings. Rosetta Stone...

  • Page 8
    ..., grammar and translation; immersion-based classroom instruction; self-study books, audio recordings and software that relies primarily on grammar and translation; and free online and mobile offerings that provide content and opportunities to practice writing and speaking. Our competitors include...

  • Page 9
    ...currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating 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...

  • Page 10
    ... same time, we expect to provide augmented, free peer-to-peer language practice. The services associated with Rosetta Stone Version 4 TOTALe and ReuLEX have decreased our margins. Rosetta Stone Version 4 TOTALe sells at a higher price per unit than our Version 3 software solutions and customers may...

  • Page 11
    ... revenue is generated from 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...

  • Page 12
    ... features on a timely basis; provide appealing solutions that engage our customers; 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...

  • Page 13
    ... and business models. The intense competition we face in the sales of our language learning solutions and general economic and business conditions can put pressure on us to change our prices. If our competitors offer deep discounts on certain products or services or develop products that...

  • Page 14
    ... and changes 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...

  • Page 15
    ... centers, distribution channels and kiosks; and convert customer inquiries into actual orders. Our planned marketing expenditures may not result in increased revenue or generate sufficient levels of product and brand name awareness, and we may not be able to increase our net sales at the same rate...

  • Page 16
    ... costs; • • inability to drive traffic to our websites, call centers, kiosks and distribution channels; inability to register domain names for "Rosetta Stone" in Country Code Top Level Domains in order to operate country specific websites to permit consumers to easily locate our products...

  • Page 17
    ... and appealing products to suit consumer preferences and capabilities in these markets, such as the potential need to customize English language software solutions for local markets; difficulties with establishing successful sales channels; inability to successfully develop relationships with...

  • Page 18
    16

  • Page 19
    ... versions. If we fail to develop or sell products and services that respond to these or other technological developments and changing customer needs, such as the demand for products designed for children, cost effectively, we may lose market share and revenue and our business could suffer. We offer...

  • Page 20
    ... our revenues in the future from subscriptions to our cloud-based offerings. This subscription model prices and delivers our products in a way that differs from the historical pricing and delivery methods of our language learning solutions. These changes reflect a shift from perpetual license sales...

  • Page 21
    ... to our business, and could be unsuccessful. We do not carry key person life insurance covering any of our employees. Our future success also depends on our continued ability to attract and retain highly qualified technical, development, sales, services and management personnel. Competition...

  • Page 22
    ... 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 23
    ... liability for Cloud-based online services and for data security breaches which could compromise our information technology network security, trade secrets and customer data. Rosetta Stone TOTALe enables individuals to exchange information and engage in various online activities on a domestic and...

  • Page 24
    ... card orders. We are exposed to risks associated with credit card and payment fraud, and with credit card processing and alternative payment methods, which could cause us to lose revenue. Many of our customers use credit cards or automated payment systems to pay for our products and services. We...

  • Page 25
    ... to provide service at the current levels. We structure our marketing and advertising to drive potential customers to our call centers and websites to purchase our solutions. If our call center operators do not convert inquiries into sales at expected rates, our ability to generate revenue could be...

  • Page 26
    ... financial information technology systems in order to automate several controls that are currently performed manually. We may experience difficulties in transitioning to these upgraded systems, including loss of data and decreases in productivity, as personnel become familiar with these new systems...

  • Page 27
    ... a CD-ROM based desktop software model to digital services, combining self-study with live online conversational coaching in a multi-device platform. In 2012, we transitioned our distribution to more online in the consumer business. The accounting policies that apply to these sources of revenue may...

  • Page 28
    ..., or market share, or those benefits may ultimately be smaller than anticipated, or may not be realized. These events could harm our operating results or financial condition. Changes in applicable accounting principles could negatively affect our financial performance. Our financial statements are...

  • Page 29
    ... disrupt our business and may not be manageable under our Crisis Management .olicy. We rely on our network infrastructure and enterprise applications, internal technology systems and our website for our development, marketing, operational, support, hosted services and sales activities. A disruption...

  • Page 30
    ... 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, pending patents, trade dress and designs are valuable and integral to...

  • Page 31
    ...if third parties 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...

  • Page 32
    ...to 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, ecommerce and other web-related technologies, online business methods, trademarks or other proprietary rights...

  • Page 33
    ... analysts do not publish research or reports about our business or if they publish negative evaluations of our stock, the price of our stock could decline. The trading market for our common stock depends in part on the research and reports that industry or financial analysts publish about us or...

  • Page 34
    ... may affect the market price for our common stock, including: shortfalls in revenue, margins, earnings or key performance metrics, confusion on the part of industry analysts and investors about the impact of our subscription offerings, shortfalls in the number of subscribers, changes in analyst...

  • Page 35
    .... In June 2011, Rosetta Stone GmbH was served with a writ filed by Langenscheidt KG ("Langenscheidt") in the District Court of Cologne, Germany alleging trademark infringement due to Rosetta Stone GmbH's use of the color yellow on its packaging of its language-learning software and the advertising...

  • Page 36
    ... in the ordinary course of our business. We are not currently involved in any legal proceeding the ultimate outcome of which, in our judgment based on information currently available, would have a material impact on our business, financial condition or results of operations. Item 4. Mine Safety...

  • Page 37
    ... common stock and do not intend to do so in the foreseeable future. We 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. Segurities Tuthorized For Issuange Under Equity Compensation Plans For...

  • Page 38
    ... balance sheet data as of December 31, 2012, 2011, 2010, 2009 and 2008 have been derived from Rosetta Stone Inc. audited consolidated financial statements. This information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and...

  • Page 39
    ... be expected in any future period. Year Ended Degember 31, 2012(1) 2011(2) 2010 2009(3) 2008(4) (in thousands, exgept per share data) Statements of Operations Data: Revenue Cost of revenue Gross profit Operating expenses: Sales and marketing Research and development General and administrative Lease...

  • Page 40
    ("LTIP") and then subsequently cancelled the LTIP on November 30, 2011, resulting in $4.9 million additional operating expense. (3) In April, 2009 shares of common stock were awarded to key employees as part of the IPO resulting in $18.8 million of additional operating expense. 37

  • Page 41
    ... 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 designed to leverage...

  • Page 42
    ... from service revenues associated with this short-term online subscription. Paid online learners. The number of paid, active learners derived from the sale of a primarily online offering as of the end of a specified period. Applicable online offerings include purchases of subscription-based licenses...

  • Page 43
    ... includes sales of our Rosetta Stone Version 4 TOTALe product. We anticipate the mix of product units will shift from our traditional CD-ROM product to digital downloads in future periods. There is no difference in price between the two options. Revenue from product software decreased $1.9 million...

  • Page 44
    ... licenses of our web-based TOTALe services with perpetual licenses of our Rosetta Stone language learning solutions in the North America Consumer market. As a result, we typically defer 10%-35% of each of these bundled sales over the term of the subscription license. We sell our solutions directly...

  • Page 45
    ...and closed the German office in June 2012. We expect sales and marketing expenses to continue to increase in future periods as we seek to stabilize and expand our operations in existing and new markets. Research and Development. Research and development expenses consist primarily of personnel costs...

  • Page 46
    ... Poligies and Estimates In presenting our financial statements in conformity with accounting principles generally accepted in the U.S., we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. 43

  • Page 47
    ... online subscription bundled with perpetual software available as a CD-ROM or download. Rosetta Stone TOTALe online was released in July 2009 and Rosetta Stone Version 4 TOTALe was released in September 2010. We also derive revenue from the sale of audio practice products and professional services...

  • Page 48
    ... are based on historical return rates. In connection with packaged software product sales and online software subscriptions, technical support is provided to customers, including customers of resellers, via telephone support at no additional cost for up to six months from the time of purchase. As...

  • Page 49
    ... presents the stock-based compensation expense for stock options and restricted stock included in the related financial statement line items (in thousands): Years Ended Degember 31, 2012 2011 2010 Included in cost of revenue: Cost of product revenue Cost of subscription and service revenue $ 110...

  • Page 50
    ... 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: Common Stogk Fair Value Per Share at Grant Date Grant Date Number of Options Granted Exergise Prige 2006 2007 2008 2009 2010 2011 2012 Accounts Receivable and...

  • Page 51
    ... in operations or business strategy. Although no such indicators occurred during 2012, we will continue to review for impairment indicators. Intangible Assets Intangible assets consist of acquired technology, including developed and core technology, customer related assets, trade name and trademark...

  • Page 52
    ...could materially affect our financial position and results of operations. As of December 31, 2012, our net deferred tax liability was $8.1 million compared to a net deferred tax assets of $19.0 million as of December 31, 2011. During the second and third quarters of 2012, we established a valuation...

  • Page 53
    ...time to utilize net operating loss carryforwards. As a result we have concluded that the valuation allowance established as of September 30, 2012 for the Japan deferred tax assets remained at December 31, 2012. Our evaluation of the Korea subsidiary as of December 31, 2012 has resulted in no change...

  • Page 54
    ... indicated. Year Ended Degember 31, 2012 2011 2010 (in thousands, exgept per share data) Statements of Operations Data: Revenue Product Subscription and service Total Revenue Cost of revenue Cost of product revenue Cost of subscription and service revenue Total cost of revenue $ 180,919 $ 195,382...

  • Page 55
    ... the change in North America consumer deferred revenue, increased to $179.2 million for the year ended December 31, 2012 from $157.4 million for the year ended December 31, 2011. The increase in North America Consumer bookings was driven by higher sales volume on lower prices. ROW Consumer revenue...

  • Page 56
    ... TOTALe services, as well as revenues from training and professional services. We began bundling time-based subscription licenses of our web-based TOTALe services with product licenses of our Rosetta Stone Version 3 language-learning solutions in the U.S. consumer market during the third quarter...

  • Page 57
    ... sales of renewing online subscriptions as well as due to a decline in Federal stimulus funding which drove sales of our network CD product. Consumer product revenue decreased $9.6 million driven by lower prices on our Rosetta Stone Version 4 TOTALe product software bundle. Subscription and Service...

  • Page 58
    ... online subscribers. Our web-based service offerings in our Version 4 TOTALe and ReuLEX products include a component of dedicated online language conversation coaching and higher direct costs to deliver to customers than our previous software solutions. This increase in costs includes a $1.8 million...

  • Page 59
    ... second quarter of 2012 and an increase of $0.3 million in sign-on bonuses and stock compensation as a result of our improved financial performance year over year. We will continue to develop new products, including a children's product offering, and improve our offering to educational organizations...

  • Page 60
    ...education and corporate channels. Bookings, calculated as revenue plus the change in deferred revenue, decreased to $273.2 million for the year ended December 31, 2011 from $279.9 million for the year ended December 31, 2010. The decrease was due to a $16.3 million decrease in North America Consumer...

  • Page 61
    ... our web-based services offering Version 4 TOTALe that include higher direct costs to deliver to customers than our previous software solutions. The increase in operating expenses was primarily due to $16.2 million in personnelrelated costs, $20.2 million in increased media and marketing activities...

  • Page 62
    ... TOTALe services, as well as revenues from training and professional services. We began bundling time-based subscription licenses of our web-based TOTALe services with product licenses of our Rosetta Stone Version 3 language-learning solutions in the U.S. consumer market during the third quarter...

  • Page 63
    ...to our web-based service offerings in our Version 4 TOTALe and ReuLEX products that include a component of dedicated online language conversation coaching and higher direct costs to deliver to customers than our previous software solutions. Operating Expenses Year Ended Degember 31, 2011 2010 2011...

  • Page 64
    ... decrease in hardware and software expenses related to the increased costs in 2010 associated with the development of new products and services as we launched our new Version 4 product in the fourth quarter of 2010. Additionally, communications expenses decrease $0.2 million as a result of decreased...

  • Page 65
    ...LTIP to any executive prior to its cancellation. Total stock-based compensation by expense line item is as follows: Year Ended Degember 31, 2011 2010 Change % Change (dollars in thousands) Cost of revenue Sales and marketing Research and development General and administrative Total $ 55 $ 39 $ 16...

  • Page 66
    ... 31, 2012 and 2011, respectively. Our primary operating cash requirements include the payment of salaries, incentive compensation, employee benefits and other personnel related costs, as well as direct advertising expenses, costs of office facilities and costs of information technology systems. We...

  • Page 67
    ...of increased online subscription revenue, an increase in accrued compensation of $5.1 million related to an increase in our accrued bonus, and a decrease in our net loss after adjusted for depreciation, amortization, stock compensation, and valuation allowance. The net loss totaled $35.8 million for...

  • Page 68
    ...it be required to calculate the fair value of the reporting unit. The Company adopted this guidance beginning in fiscal year 2012, and the adoption of such guidance did not have a material impact on the Company's reported results of operations or financial position. In July 2012, the FASB issued new...

  • Page 69
    ... is no material risk of exposure. Item 8. Finangial Statements and Supplementary Data Our consolidated financial statements, together with the related notes and the report of independent registered public accounting firm, are set forth on the pages indicated in Item 15. Item 9. Changes In and...

  • Page 70
    .... Based on using the COSO criteria, management believes our internal control over financial reporting as of December 31, 2012 was effective. Our independent registered public accounting firm, Deloitte & Touche LLP, has audited the financial statements included in this Annual Report on Form 10...

  • Page 71
    ... Governance-Corporate Governance and Nominating Committee" in our definitive proxy statement for the 2012 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission no later than 120 days after the fiscal year ended December 31, 2012 (the "2013 Proxy Statement"). Code of...

  • Page 72
    ... as part of this Annual Report. Consolidated uinancial 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. All other...

  • Page 73
    ... by the undersigned, thereunto duly authorized. ROSETTA STONE INC. By: /s/ STEPHEN M. SWAD Stephen M. Swad Chief Executive Officer Date: March 7, 2013 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...

  • Page 74
    Table of Contents Signature Title /s/ PATRICK W. GROSS Patrick W. Gross /s/ MARGUERITE W. KONDRAKE Marguerite W. Kondrake Director Director /s/ THEODORE J. LEONSIS Theodore J. Leonsis Director /s/ JOHN E. LINDAHL John E. Lindahl Director /s/ LAURA L. WITT Laura L. Witt Director 71

  • Page 75
    ... Registered Public Accounting Firm Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Comprehensive Income (Loss) Consolidated Statements of Changes in Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements...

  • Page 76
    ... management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan...

  • Page 77
    ... audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31, 2012 of the Company and our report dated March 7, 2013 expressed an unqualified opinion on those consolidated...

  • Page 78
    ...equity Current liabilities: Accounts payable Accrued compensation Other current liabilities Deferred revenue $ 275,855 $ 277,181 $ 6,064 $ 16,830 36,387 59,195 7,291 11,703 34,911 49,375 103,280 2,520 - 176 105,976 Total current liabilities Deferred revenue Deferred income taxes Other long-term...

  • Page 79
    See accompanying notes to consolidated financial statements. F-4

  • Page 80
    ... of Contents ROSETTT STONE INC. CONSOLIDTTED STTTEMENTS OF OPERTTIONS (in thousands, exgept per share amounts) Year Ended Degember 31, 2012 2011 2010 Revenue: Product Subscription and service Total revenue Cost of revenue: Cost of product revenue Cost of subscription and service revenue $ 180,919...

  • Page 81
    ... ROSETTT STONE INC. CONSOLIDTTED STTTEMENTS OF COMPREHENSIVE INCOME (LOSS) (in thousands) Years Ended Degember 31, 2012 2011 2010 Net income (loss) Other comprehensive income (loss), net of tax: Foreign currency translation gain (loss) Unrealized gain (loss) on available-for-sale securities...

  • Page 82
    ...$139,022 $ 39,069 $ 223 $ 178,316 Stock Issued Upon the Exercise of Stock Options Restricted Stock Award Vesting Stock-based Compensation Expense Tax Benefit on Stock Option Exercised Net loss Other comprehensive income Balance -December 31, 2011 182 87 - - 800 - - - - - 800 - - - 12,353...

  • Page 83
    the Exercise of Stock Options Restricted Stock Award Vesting Stock-based Compensation Expense Tax Benefit on Stock Option Exercised Net loss Other comprehensive income Balance -December 31, 2012 118 134 - - 861 - - - - - 861 - - - 8,009 - - 8,009 - - - - 0 - - (35,831) - - 0 (35,...

  • Page 84
    ... by (used in) operating activities: Stock-based compensation expense Bad debt expense Depreciation and amortization Deferred income tax expense (benefit) Loss on disposal of equipment Net change in: Restricted cash Accounts receivable Inventory Prepaid expenses and other current assets Income tax...

  • Page 85
    Noncash financing and investing activities: Accrued liability for purchase of property and equipment Equipment acquired under capital lease $ $ 1,228 $ - $ 204 $ 1,567 - 16 $ See accompanying notes to consolidated financial statements F-8

  • Page 86
    ... online subscription bundled with perpetual software available as a CD-ROM or download. Rosetta Stone TOTALe online was released in July 2009 and Rosetta Stone Version 4 TOTALe was released in September 2010. Revenue is also derived from the sale of audio practice products and professional services...

  • Page 87
    ...Rosetta Stone Version 4 TOTALe bundles, which include packaged software and an online service subscription including conversational coaching, allow customers to begin their online services at any point during a registration window, which is up to six months from the date of purchase from the Company...

  • Page 88
    ... and no unspecified upgrades/enhancements are offered, technical support revenues are recognized together with the software product and license revenue. Costs associated with the technical support are accrued at the time of sale. The Company has been engaged to develop language-learning software for...

  • Page 89
    ... 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, without requiring collateral. Exposure to losses on...

  • Page 90
    ..., this transaction was accounted for under ASC topic 805, Business Combinations ("ASC 805"). The purchase price consisted of an initial cash payment of $100,000, followed by three annual cash installment payments if the acquired company's revenues exceed certain targeted levels each of these years...

  • Page 91
    ... consist of 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...

  • Page 92
    ... and customer technical support in both cost of product revenue and cost of subscription and service revenue. Researgh and Development Research and development expenses include employee compensation costs, professional services fees and overhead costs associated with product development. Software...

  • Page 93
    ... plan exists or is being developed to market the software externally. Internally developed software is amortized over a three-year useful life. For the years ended December 31, 2012, 2011 and 2010, the Company capitalized $2.2 million, $2.5 million, and zero in internal-use software, respectively...

  • Page 94
    ... will be realizable at each reporting period and the valuation allowance will be adjusted accordingly, which could materially affect the Company's financial position and results of operations. Stogk-Based Compensation The Company accounts for its stock-based compensation in accordance ASC topic 718...

  • Page 95
    ... of the Company's diluted net income (loss) per share (in thousands): Year Ended Degember 31, 2012 2011 2010 Equity Instruments: Restricted common stock units Restricted common stock Stock options Total common stock equivalent shares - - - - - - - - 11 86 651 748 Share-based awards to purchase...

  • Page 96
    ... following table presents the effect of exchange rate changes and the net unrealized gains and losses from the available-for-sale securities on total comprehensive income (loss) (dollars in thousands): Year Ended Degember 31, 2012 2011 2010 Net income (loss) Foreign currency translation gain (loss...

  • Page 97
    ..., this transaction was accounted for under ASC topic 805, Business Combinations ("ASC 805"). The purchase price consisted of an initial cash payment of $100,000, followed by three annual cash installment payments, if the acquired company's revenues exceed certain targeted levels each of these years...

  • Page 98
    ... method of accounting, the total purchase price was allocated to the tangible and intangible assets acquired on the basis of their respective estimated fair values at the date of acquisition. The valuation of the identifiable intangible assets and their useful lives acquired reflects management...

  • Page 99
    ...acquisition of Rosetta Stone Ltd. in January 2006, and $0.1 million with the acquisition of certain assets of SGLC in November 2009. During 2010, the Company recorded the purchase of two patents associated with the development of new products in the amount of $0.3 million. The estimated lives of the...

  • Page 100
    ...) 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 amortization...

  • Page 101
    ...2011, the Company allowed its $12.5 million revolving line of credit with Wells Fargo to expire and we had no borrowings outstanding for any of the periods presented. 10. STOCK-BTSED COMPENSTTION 2006 Stock Incentive Plan On January 4, 2006, the Company established the Rosetta Stone Inc. 2006 Stock...

  • Page 102
    ..., 2012 2011 2010 Expected stock price volatility Expected term of options Expected dividend yield Risk-free interest rate 64%-66% 6 years - 0.60%-0.88% 57%-64% 6 years - 1.14%-2.59% 58%-66% 6 years - 1.14%-2.59% Prior to the completion of the Company's initial public offering in April 2009, the...

  • Page 103
    ... generally vest over a four-year period based upon required service conditions. No options have performance or market conditions. The Company calculates the pool of additional paid-in capital associated with excess tax benefits using the "simplified method" in accordance with ASC 718. The weighted...

  • Page 104
    ... fair value is based on the market price of the Company's common stock at the date of grant. The Company did not grant any restricted stock units prior to April 2009. Long Term Incentive .rogram-On January 4, 2011, the Company's Board of Directors approved the Rosetta Stone Inc. Long Term Incentive...

  • Page 105
    ...motivate senior management to achieve key financial and strategic business objectives of the Company; offer eligible executives a competitive total compensation package; reward executives in the success of the Company; provide ownership in the Company; and retain key talent. Executives designated by...

  • Page 106
    ... presents the stock-based compensation expense for stock options and restricted stock included in the related financial statement line items (in thousands): Years Ended Degember 31, 2012 2011 2010 Included in cost of revenue: Cost of product revenue Cost of subscription and service revenue $ 110...

  • Page 107
    ... 28, 2006 the Company entered into an agreement to license software from a vendor for incorporation in software products that the 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...

  • Page 108
    ... 2012, the German Patent and Trademark Office rendered a decision in the cancellation proceeding denying Rosetta Stone's request to cancel Langenscheidt's German trademark registration. The Company has appealed that decision and a hearing on the appeal is scheduled to be held in April 2013 before...

  • Page 109
    ... based on information currently available, would have a material impact on its business, financial condition or results of operations. 14. INCOME TTXES The following table summarizes the significant components of the Company's deferred tax assets and liabilities as of December 31, 2012 and 2011...

  • Page 110
    ... have an unlimited carryforward, Korea of $2.9 million which expire in 2024, and German trade tax of $0.7 million which expire in 2018. If future events change the outcome of the Company's projected return to profitability, a valuation allowance may not be required to reduce the deferred tax assets...

  • Page 111
    ...(7,980) $ (411) Income tax expense (benefit) The Company accounts for uncertainty in income taxes under ASC topic 740-10-25, Income Taxes: Overall: Recognition, ("ASC 740-10-25"). ASC 740-10-25 prescribes a recognition threshold and measurement attribute for the financial statement recognition and...

  • Page 112
    ... to be consistent with the current year presentation. Segment contribution includes segment revenue and expenses incurred directly by the segment, including material costs, service costs, customer care and coaching costs, and sales and marketing expense. The Company does not allocate expenses...

  • Page 113
    ... Unallocated non-operating income/(expense) Total unallocated expenses, net Ingome (loss) before ingome taxes Geographic Information Revenue by major geographic region is based primarily upon the geographic location of the customers who purchase the Company's products. The geographic locations of...

  • Page 114
    ... The following table includes the Company's valuation and qualifying accounts for the respective periods (in thousands): Year Ended Degember 31, 2012 2011 2010 Allowance for doubtful accounts: Beginning balance Charged to costs and expenses Deductions-accounts written off Ending balance $ 1,951...

  • Page 115
    ...reserved under the Plan. The purpose of the 2013 LTIP is to: motivate senior management to achieve key financial and strategic business objectives of the Company; offer eligible employees of the Company a competitive total compensation package; reward employees in the success of the Company; provide...

  • Page 116
    ...of payout levels depending on the achievement of the goal ranging from zero to 200% of the incentive target. The maximum number of shares to be issued as performance share awards is 883,262 and the maximum cash payout is $3.17 million, although executives hired after the approval of the plan may be...

  • Page 117
    ..., by and between The Corporate Executive Board Company and Rosetta Stone Ltd. 10.10(1) Software License Agreement by and between The Regents of the University of Colorado and Fairfield & Sons, Ltd. dated as of December 22, 2006*** 10.11+(1) Form of Restricted Stock Award under the 2009 Plan 10.12...

  • Page 118
    ... Agreement between Rosetta Stone Ltd. and Stephen Swad effective as of February 22, 2012 10.19+(3) Amended Executive Form of Option Award Agreement under 2009 Plan effective for awards after October 1, 2011. 10.20+(3) Amended Executive Form of Restricted Stock Award Agreement under 2009 Plan...

  • Page 119
    ...registration statement on Form S-1 (File No. 333-153632), as amended. Incorporated by reference to exhibit filed with Rosetta Stone's Current Report on Form 8-K dated October 13, 2010. Incorporated by reference to exhibit filed with Rosetta Stone Form 10-K for the fiscal year ended December 31, 2011...

  • Page 120

  • Page 121
    ... 10.23 Execution Copy FIRST AMENDMENT TO SUBLEASE AGREEMENT THIS FIRST AMENDMENT TO SUBLEASE AGREEMENT (this tFirst Amendment ") is made this 1st day of November, 2012 (the tEffective Date "), by and between THE CORPORATE EXECUTIVE BOARD COMPANY (tSublessor") and ROSETTA STONE LTD. ( tSubtenant...

  • Page 122
    ... condition required by Section 5, below. Notwithstanding anything contained in this First Amendment or Original Sublease to the contrary, in the event that Sublessor is unable to deliver possession of the Expansion Area to Subtenant on or before December 31, 2013 due to either (i) failure of the new...

  • Page 123
    ...deliver the mechanical, electrical, and plumbing systems servicing the Expansion Area in good working order and condition as of the Expansion Date. Subtenant acknowledges that, except as specifically set forth in this First Amendment, no representations, statements, or warranties, express or implied...

  • Page 124
    ... Furniture in good order and condition, reasonable wear and tear excepted, and shall insure the Expansion Area Walls/Partitions and Expansion Area Systems Furniture under the special cause of loss business property insurance required by Section 17.A.(1) of the Prime Lease, naming Sublessor as loss...

  • Page 125
    ... Area Systems Furniture, Expansion Area Modular Walls/Partitions, Expansion Area Personal Property and Expansion Area Sublessor's HVAC shall be delivered by Sublessor and accepted by Subtenant in its "as is, where is" condition. 6. Annual Base Subrent . A. Annual Base Subrent for the Original...

  • Page 126
    ...Subtenant shall pay, in addition to the Annual Base Subrent payable for the Original Sublet Premises, Annual Base Subrent and Monthly Base Subrent for the Expansion Area as follows: Annual Base Subrent Per Square Sublet Term Foot Annual Base Subrent Monthly Base Subrent January 1, 2015 to January...

  • Page 127
    ... of reconfigurations to the Systems Furniture and Walls/Partitions in order to accommodate its employees in the Sublet Premises, so long as (i) Subtenant provides written notice to Sublessor (including a description of the modifications performed, but without need of plans preparation or approval of...

  • Page 128
    ... to storage shall be borne by Subtenant, but the costs to store such Walls/Partitions or Systems Furniture shall be borne by Sublessor. B. Restoration; Surrender . Section 15 of the Original Sublease is hereby amended by adding the following to the end of such Section: tNotwithstanding anything...

  • Page 129
    ... agrees to cause the Garage Operator to offer Subtenant twelve (12) additional parking contracts (the t Additional Parking Spaces ") for unreserved parking spaces subject to, and in accordance with the terms and conditions set forth in Section 18 of the Original Sublease. Subtenant shall enter into...

  • Page 130
    ...hereof. This First Amendment may not be modified or changed in whole or in part in any manner other than by an instrument in writing duly signed by the parties hereto. In the event of any inconsistencies between the provisions of the Original Sublease and this First Amendment, the provisions of this...

  • Page 131
    ... the day and year first hereinabove written. SUBLESSOR: THE CORPORATE EXECUTIVE BOARD COMPANY By: /s/ Richard Lindahl Name: Richard Lindahl Title: Chief Financial Officer [Seal] SUBTENANT: ROSETTA STONE LTD. By: /s/ Stephen Swad Name: Stephen Swad Title: Chief Executive Officer [Seal] 11

  • Page 132
    E X H I B I T A E x p a n s i o n S p a c e W a t e r v i e w 1 9 1 9 N o r t h L y n n S t r e e t , A r l i n g t o n , V A 2 2 2 0 9 FLOOR 0 6 E x h i b i t A

  • Page 133
    E X H I B I T B - 1 6 t h F l o o r W a l l s / P a r t i t o n s a n d S y s t e m s F u r n i t u r e E x h i b i t B - 1 W a t e r v i e w 1 9 1 9 N o r t h L y n n S t r e e t A r l i n g t o n , V A 2 2 2 0 9 F L O O R 0 6 A l C a p a c i t y U n d e r U t i l i z e d O v e r U t i l i z e d

  • Page 134
    E X H I B I T B - 2 6 t h F l o o r P e r s o n a l P r o p e r t y C o n f e r e n c e R o o m s B l a c k M e s h C o n f e r e n c e R o o m C h a i r ( C C . 1 ) 5 0 P r o p e l l e r T a b l e s i n 1 2 - p e r s o n C o n f R o o m ( T T . 1 ) 1 R o u n d T a b l e i n 8 - P e r s o n C o n f ...

  • Page 135
    ... between THE CORPORATE EXECUTIVE BOARD COMPANY (tSublessor"), and ROSETTA STONE LTD. (...located at 1919 N. Lynn Street, Arlington, Virginia. Sublessor and Subtenant have entered into that certain First Amendment to Sublease Agreement dated , 2012, (the tAmendment "), which, among other things, added...

  • Page 136
    ...as of the Expansion Date. b. c. Sublessor is not required to perform any work or furnish any improvements to the Expansion Area under the...amended, except as follows: d. ; and e. there are no set-offs or credits against Annual Base Subrent, and no Security Deposit or prepaid Subrent has been paid...

  • Page 137
    ... attached to and made a part of the Sublease. SUBLESSOR: THE CORPORATE EXECUTIVE BOARD COMPANY By: /s/ Richard Lindahl Name: Richard Lindahl Title: Chief Financial Officer [Seal] SUBTENANT: ROSETTA STONE LTD By: /s/ Stephen Swad Name: Stephen Swad Title: Chief Executive Officer [Seal] 2

  • Page 138
    ... Language Technologies) Rosetta Stone (UK) Limited (Formerly Fairfield & Sons Limited) England and Wales Rosetta Stone Japan Inc. (Formerly Rosetta World K.K.) Rosetta Stone International Inc. Japan Delaware Germany Republic of Korea Canada Rosetta Stone GmbH Rosetta Stone Korea Ltd. Rosetta...

  • Page 139
    QuickLinks Exhibit 21.1

  • Page 140
    ...h-8 of our reports dated March 7, 2013, relating to the consolidated financial statements of Rosetta htone Inc. and subsidiaries, and the effectiveness of Rosetta htone Inc. and subsidiaries' internal control over financial reporting, appearing in this Annual Report on Form 10-K of Rosetta htone Inc...

  • Page 141
    QuickLinks Exhibit 23.1

  • Page 142
    ... 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 143
    Signature Title /s/ PATRICK W. GROSS Patrick W. Gross /s/ MARGUERITE W. KONDRACKE Marguerite W. Kondracke Director Director /s/ THEODORE J. LEONSIS Theodore J. Leonsis Director /s/ JOHN E. LINDAHL John E. Lindahl Director /s/ LAURA L. WITT Laura L. Witt Director

  • Page 144
    QuickLinks Exhibit 24.1

  • Page 145
    ... M. Swad, certify that: 1. 2. I have reviewed this Annual Report on Form 10-K of Rosetta Stone Inc. (the "Registrant"); 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 the statements made, in light of the...

  • Page 146
    By: /s/ STEPHEN M. SWAD Stephen M. Swad (Principal Executive Officer ) Date: March 7, 2013

  • Page 147
    QuickLinks Exhibit 31.1

  • Page 148
    ...OF PRINCIPAL FINANCIAL OFFICER OF ROSETTA STONE INC. PURSUANT TO 15 U.S.C. SECTION 7241, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARIANES-OXLEY ACT OF 2002 I, Thomas M. Pierno, certify that: 1. 2. I have reviewed this Annual Report on Form 10-K of Rosetta Stone Inc. (the "Registrant"); Based on my...

  • Page 149
    By: /s/ THOMAS M. PIERNO Thomas M. Pierno (Principal Financial Officer ) Date: March 7, 2013

  • Page 150
    QuickLinks Exhibit 31.2

  • Page 151
    ... In connection with the accompanying Annual Report on Form 10-K for the calendar year ended December 31, 2012 filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Stephen M. Swad, Chief Executive Officer of Rosetta Stone Inc. (the "Company"), hereby certify, to my...

  • Page 152
    QuickLinks Exhibit 32.1

  • Page 153
    ... In connection with the accompanying Annual Report on Form 10-K for the calendar year ended December 31, 2012 filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Thomas M. Pierno, Chief Financial Officer of Rosetta Stone Inc. (the "Company"), hereby certify, to my...

  • Page 154
    QuickLinks Exhibit 32.2

  • Page 155