Form 10-Q

(Mark One)

☑

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

~~QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934~~

For the quarterly period ended ~~September 30, 2017~~March 31, 2020

☐

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 1-34283

Rosetta Stone Inc.

(Exact name of registrant as specified in its charter)



Delaware (State of incorporation)		~~043837082~~ 04-3837082 (I.R.S. Employer Identification No.)

1621 North Kent Street, Suite 1200 Arlington, Virginia (Address of principal executive offices)		22209 (Zip Code)

703-387-5800

(Registrant’s telephone number, including area code)

N/A

(Former name or former address, if changed since last report)

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 ý☒ No o

☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 ý☒ No o

☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.



Large accelerated filer o ☐	Accelerated filer ý ☒	Non-accelerated filer o ☐	Smaller reporting company o ☐	Emerging growth company o ☐
		(Do not check if a smaller reporting company)

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o☐ No ý☒

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, par value $0.00005 per share	RST	New York Stock Exchange

Indicate the number of shares outstanding of each of the issuer’s classes of stock, as of the latest practicable date.

As of ~~October 27, 2017,~~April 29, 2020, there were ~~22,299,301~~24,576,366 shares of the registrant’s Common Stock, $.00005 par value, outstanding.

ROSETTA STONE INC.

Table of Contents

		Page

		~~Page~~
PART I. FINANCIAL INFORMATION
Item 1	Financial Statements (unaudited)	3
Item 2	Management's Discussion and Analysis of Financial Condition and Results of Operations	36 32
Item 3	Quantitative and Qualitative Disclosures About Market Risk	54 43
Item 4	Controls and Procedures	55 43
PART II. OTHER INFORMATION
Item 1	Legal Proceedings	56 44
Item 1A	Risk Factors	56 44
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	71 58
Item 3	Defaults Upon Senior Securities	71 58
Item 4	Mine Safety Disclosures	71 58
Item 5	Other Information	71 58
Item 6	Exhibits	72 59
Signatures		73 60

Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ROSETTA STONE INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share amounts)

(unaudited)

	As of
	March 31, 2020			December 31, 2019
Assets
Current assets:
Cash and cash equivalents	$	35,122		$	43,010
Restricted cash		49			54
Accounts receivable (net of allowance for doubtful accounts of $725 and $510 at March 31, 2020 and December 31, 2019, respectively)		15,391			22,919
Inventory		1,377			1,545
Deferred sales commissions		10,264			11,558
Prepaid expenses and other current assets		3,905			4,172
Total current assets		66,108			83,258
Deferred sales commissions		7,379			7,682
Property and equipment, net		39,124			39,251
Operating lease right-of-use assets		5,399			5,818
Intangible assets, net		13,936			14,317
Goodwill		48,807			48,958
Other assets		1,855			1,823
Total assets	$	182,608		$	201,107
Liabilities and stockholders' deficit
Current liabilities:
Accounts payable	$	6,831		$	7,534
Accrued compensation		10,955			9,854
Income tax payable		150			78
Operating lease liabilities		1,425			1,455
Other current liabilities		10,979			13,090
Deferred revenue		105,969			119,851
Total current liabilities		136,309			151,862
Deferred revenue		58,036			57,766
Deferred income taxes		2,635			2,590
Operating lease liabilities		3,831			4,167
Other long-term liabilities		786			914
Total liabilities		201,597			217,299
Commitments and contingencies (Note 11)
Stockholders' deficit:
Preferred stock, $0.001 par value; 10,000 and 10,000 shares authorized, 0 and 0 shares issued and outstanding at March 31, 2020 and December 31, 2019, respectively)		—			—
Non-designated common stock, $0.00005 par value, 190,000 and 190,000 shares authorized, 25,580 and 25,060 shares issued, and 24,580 and 24,060 shares outstanding, at March 31, 2020 and December 31, 2019, respectively)		2			2
Additional paid-in capital		214,208			210,846
Treasury stock, at cost; 1,000 and 1,000 shares at March 31, 2020 and December 31, 2019, respectively)		(11,435	)		(11,435	)
Accumulated loss		(218,654	)		(212,548	)
Accumulated other comprehensive loss		(3,110	)		(3,057	)
Total stockholders' deficit		(18,989	)		(16,192	)
Total liabilities and stockholders' deficit	$	182,608		$	201,107

~~(unaudited)~~

September 30,
2017 December 31,
2016
Assets
Current assets:
Cash and cash equivalents $ 40,147
$ 36,195
Restricted cash 49
402
Accounts receivable (net of allowance for doubtful accounts of $617 and $1,072, at September 30, 2017 and December 31, 2016, respectively) 29,801
31,788
Inventory 4,194
6,767
Deferred sales commissions 14,443
14,085
Prepaid expenses and other current assets 4,870
3,813
Total current assets 93,504
93,050
Deferred sales commissions 3,498
4,143
Property and equipment, net 28,822
24,795
Goodwill 49,654
48,251
Intangible assets, net 20,138
22,753
Other assets 1,142
1,318
Total assets $ 196,758
$ 194,310
Liabilities and stockholders' deficit
Current liabilities:
Accounts payable $ 8,661
$ 10,684
Accrued compensation 11,313
10,777
Income tax payable 533
785
Obligations under capital lease 440
532
Other current liabilities 16,755
22,150
Deferred revenue 113,932
113,821
Total current liabilities 151,634
158,749
Deferred revenue 36,961
27,636
Deferred income taxes 7,132
6,173
Obligations under capital lease 1,934
2,027
Other long-term liabilities 524
1,384
Total liabilities 198,185
195,969
Commitments and contingencies (Note 15)

Stockholders' deficit:
Preferred stock, $0.001 par value; 10,000 and 10,000 shares authorized, zero and zero shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively —
—
Non-designated common stock, $0.00005 par value, 190,000 and 190,000 shares authorized, 23,800 and 23,451 shares issued and 22,800 and 22,451 shares outstanding at September 30, 2017 and December 31, 2016, respectively 2
2
Additional paid-in capital 194,348
190,827
Accumulated loss (181,256 ) (177,344 )
Accumulated other comprehensive loss (3,086 ) (3,709 )
Treasury stock, at cost, 1,000 and 1,000 shares at September 30, 2017 and December 31, 2016, respectively (11,435 ) (11,435 )
Total stockholders' deficit (1,427 ) (1,659 )
Total liabilities and stockholders' deficit $ 196,758
$ 194,310

See accompanying notes to consolidated financial statements

Table of Contents

ROSETTA STONE INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

	Three months ended March 31,
	2020			2019
Revenue	$	47,179		$	44,611
Cost of revenue		11,101			8,426
Gross profit		36,078			36,185
Operating expenses
Sales and marketing		25,434			23,238
Research and development		6,917			5,738
General and administrative		9,562			8,692
Total operating expenses		41,913			37,668
Loss from operations		(5,835	)		(1,483	)
Other income and (expense):
Interest income		16			33
Interest expense		(53	)		(60	)
Other income and (expense)		71			796
Total other income and (expense)		34			769
Loss before income taxes		(5,801	)		(714	)
Income tax expense (benefit)		380			(170	)
Net loss	$	(6,181	)	$	(544	)
Loss per share:
Basic	$	(0.26	)	$	(0.02	)
Diluted	$	(0.26	)	$	(0.02	)
Common shares and equivalents outstanding:
Basic weighted average shares		23,803			23,036
Diluted weighted average shares		23,803			23,036

~~(unaudited)~~

Three Months Ended
September 30, Nine Months Ended
September 30,
2017 2016 2017 2016
Revenue:
Subscription and service $ 42,117
$ 39,027
$ 125,552
$ 114,755
Product 4,089
9,666
14,252
27,656
Total revenue 46,206
48,693
139,804
142,411
Cost of revenue:
Cost of subscription and service revenue 6,499
5,910
19,091
16,888
Cost of product revenue 2,949
2,461
6,089
7,495
Total cost of revenue 9,448
8,371
25,180
24,383
Gross profit 36,758
40,322
114,624
118,028
Operating expenses:
Sales and marketing 23,654
27,161
71,859
86,694
Research and development 6,381
6,347
19,143
19,666
General and administrative 9,035
9,969
25,654
30,864
Impairment —
1,028
—
3,930
Lease abandonment and termination —
—
—
30
Total operating expenses 39,070
44,505
116,656
141,184
Loss from operations (2,312 ) (4,183 ) (2,032 ) (23,156 )
Other income and (expense):
Interest income 13
11
43
34
Interest expense (138 ) (120 ) (383 ) (353 )
Other income and (expense) 85
633
821
2,788
Total other income and (expense) (40 ) 524
481
2,469
Loss before income taxes (2,352 ) (3,659 ) (1,551 ) (20,687 )
Income tax expense 879
1,793
2,361
1,250
Net loss $ (3,231 ) $ (5,452 ) $ (3,912 ) $ (21,937 )
Loss per share:
Basic $ (0.14 ) $ (0.25 ) $ (0.18 ) $ (1.00 )
Diluted $ (0.14 ) $ (0.25 ) $ (0.18 ) $ (1.00 )
Common shares and equivalents outstanding:
Basic weighted average shares 22,285
21,993
22,220
21,936
Diluted weighted average shares 22,285
21,993
22,220
21,936

See accompanying notes to consolidated financial statements

Table of Contents

ROSETTA STONE INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)

	Three months ended March 31,
	2020			2019
Net loss	$	(6,181	)	$	(544	)
Other comprehensive loss, net of tax:
Foreign currency translation (loss) gain		(53	)		213
Other comprehensive (loss) income		(53	)		213
Comprehensive loss	$	(6,234	)	$	(331	)

~~(unaudited)~~

Three Months Ended
September 30, Nine Months Ended
September 30,
2017 2016 2017 2016
Net loss $ (3,231 ) $ (5,452 ) $ (3,912 ) $ (21,937 )
Other comprehensive gain (loss), net of tax:
Foreign currency translation gain (loss) 289
(313 ) 623
(1,522 )
Other comprehensive gain (loss) 289
(313 ) 623
(1,522 )
Comprehensive loss $ (2,942 ) $ (5,765 ) $ (3,289 ) $ (23,459 )

See accompanying notes to consolidated financial statements

Table of Contents

ROSETTA STONE INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Three months ended March 31,
	2020			2019
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(6,181	)	$	(544	)
Non-cash adjustments to reconcile net loss to cash used in operating activities:
Stock-based compensation expense		2,261			1,220
Loss on foreign currency transactions		22			708
Bad debt expense (recovery)		258			(13	)
Depreciation and amortization		4,420			3,529
Operating lease costs		535			526
Deferred income tax expense (benefit)		115			(592	)
Gain loss on disposal or sale of assets		—			(1,395	)
Amortization of deferred financing costs		19			14
Net change in:
Accounts receivable		7,082			8,237
Inventory		168			(829	)
Deferred sales commissions		1,579			1,997
Prepaid expenses and other current assets		197			(789	)
Income tax receivable or payable		71			271
Other assets		(71	)		144
Accounts payable		(685	)		(1,595	)
Accrued compensation		2,178			2,441
Other current liabilities		(1,934	)		(2,622	)
Operating lease liabilities		(478	)		(544	)
Other long-term liabilities		—			(31	)
Deferred revenue		(13,038	)		(16,700	)
Net cash used in operating activities		(3,482	)		(6,567	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment		(3,786	)		(4,714	)
Proceeds from sale of assets		—			996
Net cash used in investing activities		(3,786	)		(3,718	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the exercise of stock options		42			744
Payment of deferred financing costs		(66	)		(2	)
Payments under financing lease liabilities		(115	)		(110	)
Net cash (used in) provided by financing activities		(139	)		632
Decrease in cash, cash equivalents, and restricted cash		(7,407	)		(9,653	)
Effect of exchange rate changes in cash, cash equivalents, and restricted cash		(486	)		(180	)
Net decrease in cash, cash equivalents, and restricted cash		(7,893	)		(9,833	)
Cash, cash equivalents, and restricted cash—beginning of period		43,064			38,174
Cash, cash equivalents, and restricted cash—end of period	$	35,171		$	28,341
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Cash paid during the periods for:
Interest	$	34		$	46
Income taxes, net of refund	$	207		$	258
Noncash operating, investing and financing activities:
Operating right-of-use assets obtained in exchange for operating lease liabilities	$	59		$	656
Financing right-of-use assets obtained in exchange for financing lease liabilities	$	—		$	—
Accrued liability for purchase of property and equipment	$	1,126		$	1,033

~~(unaudited)~~

Nine Months Ended September 30,
2017 2016
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (3,912 ) $ (21,937 )
Adjustments to reconcile net loss to cash provided by (used in) operating activities:
Stock-based compensation expense 3,058
3,457
Gain on foreign currency transactions (461 ) (2,831 )
Bad debt (recovery) expense (143 ) 471
Depreciation and amortization 9,077
9,812
Deferred income tax expense 963
857
Loss on disposal of equipment 5
132
Amortization of deferred financing fees 238
203
Loss on impairment —
3,930
Loss from equity method investments 100
46
Gain on sale of subsidiary (506 ) —
Net change in:
Restricted cash 365
(354 )
Accounts receivable 2,358
8,912
Inventory 2,605
(723 )
Deferred sales commissions 321
552
Prepaid expenses and other current assets (880 ) (705 )
Income tax receivable or payable (296 ) 48
Other assets 67
365
Accounts payable (2,084 ) (923 )
Accrued compensation 445
3,423
Other current liabilities (6,501 ) (13,077 )
Other long-term liabilities (750 ) 43
Deferred revenue 8,608
2,353
Net cash provided by (used in) operating activities 12,677
(5,946 )
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (8,903 ) (9,628 )
Proceeds from sale of fixed assets 2
38
Proceeds from the sale of subsidiary 110
—
Net cash used in investing activities (8,791 ) (9,590 )
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the exercise of stock options 463
47
Payment of deferred financing costs (232 ) (182 )
Payments under capital lease obligations (453 ) (440 )
Net cash used in financing activities (222 ) (575 )
Decrease in cash and cash equivalents 3,664
(16,111 )
Effect of exchange rate changes in cash and cash equivalents 288
550
Net increase (decrease) in cash and cash equivalents 3,952
(15,561 )
Cash and cash equivalents—beginning of period 36,195
47,782
Cash and cash equivalents—end of period $ 40,147
$ 32,221
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Cash paid during the periods for:
Interest $ 145
$ 150
Income taxes, net of refunds $ 1,474
$ 363
Noncash financing and investing activities:
Accrued liability for purchase of property and equipment $ 1,268
$ 565
Equipment acquired under capital lease $ —
$ 27

See accompanying notes to consolidated financial statements

Table of Contents

ROSETTA STONE INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' DEFICIT

(unaudited)

													Accumulated
	Non-Designated				Additional								Other			Total
	Common Stock				Paid-in		Treasury			Accumulated			Comprehensive			Stockholders'
	Shares		Amount		Capital		Stock			Loss			Loss			Deficit
Balance—January 1, 2020		23,667	$	2	$	210,846	$	(11,435	)	$	(212,548	)	$	(3,057	)	$	(16,192	)
Stock issued upon the exercise of stock options		6		—		42		—			—			—			42
Restricted stock award and performance stock unit vesting		299		—		—		—			—			—			—
Unrestricted common stock issued in lieu of cash bonus		68		—		1,322		—			—			—			1,322
Stock-based compensation expense		—		—		1,998		—			—			—			1,998
Net loss		—		—		—		—			(6,181	)		—			(6,181	)
Cumulative effect adjustment - adoption of CECL		—		—		—		—			75			—			75
Other comprehensive loss		—		—		—		—			—			(53	)		(53	)
Balance—March 31, 2020		24,040	$	2	$	214,208	$	(11,435	)	$	(218,654	)	$	(3,110	)	$	(18,989	)

													Accumulated
	Non-Designated				Additional								Other			Total
	Common Stock				Paid-in		Treasury			Accumulated			Comprehensive			Stockholders'
	Shares		Amount		Capital		Stock			Loss			Loss			Deficit
Balance—January 1, 2019		22,912	$	2	$	202,355	$	(11,435	)	$	(199,592	)	$	(3,338	)	$	(12,008	)
Stock issued upon the exercise of stock options		67		—		744		—			—			—			744
Restricted stock award and performance stock unit vesting		270		—		—		—			—			—			—
Unrestricted common stock issued in lieu of cash bonus		37		—		576		—			—			—			576
Stock-based compensation expense		—		—		1,220		—			—			—			1,220
Net loss		—		—		—		—			(544	)		—			(544	)
Other comprehensive income		—		—		—		—			—			213			213
Balance—March 31, 2019		23,286	$	2	$	204,895	$	(11,435	)	$	(200,136	)	$	(3,125	)	$	(9,799	)

See accompanying notes to consolidated financial statements

Table of Contents

ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

~~(UNAUDITED)~~

(Continued)

1. NATURE OF OPERATIONS

Rosetta Stone Inc. and its subsidiaries ("Rosetta Stone," or the "Company") develop, market and support a suite of language-learning and literacy solutions consisting of web-based software subscriptions, ~~perpetual software products,~~ online ~~and~~services, professional services, ~~audio practice products~~ and mobile applications. The Company's offerings are sold on a direct basis and through select third party retailers and distributors. The Company provides its solutions to customers ~~through the sale of packaged software and web-based software subscriptions,~~ domestically and in certain international markets.

~~In March 2016,~~

The impact of the COVID-19 pandemic continues to unfold. The extent of the pandemic’s effect on the Company ~~announced~~depends on future developments which cannot be predicted at this time. Future developments include the ~~withdrawal of direct sales presence in almost all of its non-U.S.~~duration, scope and ~~non-northern European geographies related to the distribution~~severity of the ~~Enterprise & Education Language offerings (the "2016 Restructuring Plan"). Where appropriate,~~pandemic, the ~~Company seeks~~actions taken to ~~operate through partners~~contain or mitigate its impact, the impact on governmental programs and budgets, the development of treatments or vaccines, and the resumption of widespread economic activity. These uncertainties have been considered in the ~~geographies being exited.~~development of these financial statements and the notes thereto. See ~~Note 2 "Summary of Significant Accounting Policies," Note 13 "Restructuring," Note 16 "Segment Information" and Item 2 "Management's~~“Management's Discussion and Analysis of Financial Condition and Results of ~~Operations" within Part 1~~Operations” for ~~additional~~more information about ~~these strategic undertakings and~~ the ~~associated impact~~Company’s response to the ~~Company's financial statements and financial results.~~

COVID-19 pandemic.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Rosetta Stone Inc. and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.

Basis of Presentation

The accompanying consolidated financial statements are unaudited. These unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") and applicable rules and regulations of the Securities and Exchange Commission ("SEC") regarding interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Accordingly, these interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s most recent Annual Report on Form 10-K filed with the SEC on March ~~14, 2017.~~11, 2020. The ~~September 30, 2017~~March 31, 2020 consolidated balance sheet included herein includes account balances as of December 31, ~~2016~~2019 that were derived from the audited financial statements as of that date. The Consolidated Financial Statements and the Notes to the Consolidated Financial Statements do not include all disclosures required for annual financial statements and notes.

The unaudited interim consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary for the fair presentation of the Company’s ~~statement~~statements of financial position at ~~September 30, 2017~~March 31, 2020 and December 31, ~~2016,~~2019, the Company’s results of operations and stockholders’ equity activity for the three ~~and nine~~ months ended ~~September 30, 2017~~March 31, 2020 and ~~2016~~2019, and its cash flows for the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2020 and ~~2016~~March 31, 2019 have been made. The results for the three ~~and nine~~ months ended ~~September 30, 2017~~March 31, 2020 are not necessarily indicative of the results to be expected for the year ending December 31, ~~2017.~~2020. All references to ~~September 30, 2017~~March 31, 2020 or to the three ~~and nine~~ months ended ~~September 30, 2017~~March 31, 2020 and ~~2016~~2019 in the notes to the consolidated financial statements are unaudited.

Use of Estimates

The preparation of financial statements in accordance with GAAP requires management to make certain estimates and assumptions. The amounts reported in the consolidated financial statements include significant estimates and assumptions that have been made, including, but not limited to, those related to revenue recognition, allowance for doubtful accounts, estimated sales returns and reserves, stock-based compensation, ~~restructuring costs,~~ fair value of intangibles and goodwill, disclosure of contingent assets and liabilities, disclosure of contingent litigation, allowance for valuation of deferred tax assets, and the Company's quarterly going concern assessment. The Company bases its estimates and assumptions on historical experience and on various other judgments that are believed to be reasonable under the circumstances. The Company continuously evaluates its estimates and assumptions. Actual results may differ from these estimates and assumptions.

Table of Contents

ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

~~2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)~~

Recently Issued Accounting Standards

Accounting Standards Adopted During the Period: During 2020, the Company adopted the following recently issued Accounting Standard Updates ("ASU"):

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"), as subsequently amended. ASU 2016-13 changed the methodology for measuring credit losses of financial instruments and the timing of when such losses are recorded. ASU 2016-13 was effective for fiscal years, and interim periods within those years, beginning after December 15, 2019. The Company adopted ASU 2016-13 beginning January 1, 2020 using a modified-retrospective approach. The impact of ASU 2016-13 was limited to credit losses associated with trade receivables as the Company does not hold additional significant financial instruments. Adoption of ASU 2016-13 resulted in less than a $0.1 million decrease in bad debt reserves as of January 1, 2020 which was recorded as a cumulative effect adjustment to accumulated loss.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement ("ASU 2018-13"). ASU 2018-13 modifies the disclosure requirements for fair value measurements by removing, modifying, or adding certain disclosures. ASU 2018-13 was effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The Company adopted this guidance effective January 1, 2020.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment ("ASU 2017-04"). ASU 2017-04 simplified the subsequent measurement of goodwill and eliminates Step 2 from the goodwill impairment test. ASU 2017-04 was effective for annual and interim goodwill tests beginning after December 15, 2019. The Company adopted this guidance effective January 1, 2020.

Accounting Standards Not Yet Adopted:

There are currently no accounting standards not yet adopted that are expected to have a material impact on the Company’s financial statements or disclosures.

Revenue Recognition

Nature of Revenue: The Company accounts for revenue contracts with customers by applying the requirements of ASC topic 606, Revenue from Contracts with Customers, ("ASC 606"), which includes the following five steps:

•

Identification of the contract, or contracts with a customer.

•

Identification of the performance obligations in the contract.

•

Determination of the transaction price.

•

Allocation of the transaction price to the performance obligations in the contract.

•

Recognition of the revenue when, or as, the Company satisfies a performance obligation.

The Company's primary sources of revenue are web-based software subscriptions, mobile applications, online services, ~~perpetual product software, and bundles of perpetual product software and online services. The Company also generates revenue from the sale of audio practice products, mobile applications,~~ and professional services.

Revenue is recognized upon transfer of control of promised goods or services to customers in an amount that reflects the consideration expected to be received in exchange for those goods or services. Revenue is recognized ~~when all~~net of allowances for returns. Revenue is also recognized net of any taxes collected from customers, which are subsequently remitted to governmental authorities.

The majority of our revenue is recognized from non-cancellable web-based software subscriptions, online services, professional services, and mobile applications. Subscription revenue is generated from contracts with customers that provide access to hosted software over a contract term without the customer taking possession of the ~~following criteria~~software. Subscription revenue is recognized ratably over the contract period as the performance obligation is satisfied. Subscription revenue is generated by all 3 reportable segments and range from short-term to multi-year contracts. Online services are ~~met: there~~typically sold in short-term service periods and include dedicated online conversational coaching services and access to online communities of language learners. Professional services include implementation services. Online services revenue and professional services revenue are recognized as the services are provided. Expired services are forfeited and revenue is ~~persuasive evidence of an arrangement; the product has been delivered~~recognized upon expiry.

Performance Obligations: A performance obligation is a promise in a contract to transfer a distinct good or ~~services have been rendered; the fee is fixed or determinable; and collectability is reasonably assured. Revenue is recorded net of discounts and net of taxes.~~

~~The Company identifies the units of accounting contained within sales arrangements in accordance with Accounting Standards Codification ("ASC") subtopic 605-25,~~ ~~Revenue Recognition - Multiple Element Arrangements~~ ~~("ASC 605-25"). In doing so, the Company evaluates a variety of factors including whether the undelivered element(s) have value~~service to the customer, onand is the unit of account in ASC 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

as revenue when, or as, the performance obligation is satisfied. The Company’s performance obligations are satisfied at a ~~stand-alone basis~~point in time or ~~if the undelivered element(s) could be sold by another vendor on a stand-alone basis.~~

For multiple element arrangements that contain perpetual software products and related online services, the Company allocates the total arrangement consideration to its deliverables based on the existence of vendor-specific objective evidence of fair value,over time as delivery occurs or ~~vendor-specific objective evidence ("VSOE"), in accordance with ASC subtopic 985-605-25,~~ ~~Software: Revenue Recognition-Multiple-Element Arrangements~~ ~~("ASC 985-605-25"). The Company generates a portion of its Consumer revenue from the CD and digital download formats~~as work progresses.

Significant Judgments: Some of the Rosetta Stone language-learning product which are typically multiple-element arrangements that contain two deliverables: perpetual software, delivered at the time of sale, and online service, which is considered an undelivered software-related element. The online service includes accessCompany’s contracts with customers include promises to conversational coaching services. Because the Company only sells the perpetual language-learning software on a stand-alone basis in its homeschool version, the Company does not have a sufficient concentration of stand-alone sales to establish VSOE for the perpetual product. Where VSOE of the undelivered online services can be established, arrangement consideration is allocated using the residual method. The Company determines VSOE by reference to the range of comparable stand-alone renewal sales of the online service. The Company reviews these stand-alone sales on a quarterly basis. VSOE is established if at least 80% of the stand-alone sales are within a range of plus or minus 15% of a midpoint of the range of prices, consistent with generally accepted industry practice. Where VSOE of the undelivered online services cannot be established, revenue is deferred and recognized commensurate with the delivery of the online services.

~~For non-software~~transfer multiple element arrangements the Company allocates revenue to all deliverables based on their relative selling prices. The Company's non-software multiple element arrangements primarily occur as sales to its Enterprise & Education Language and Literacy customers, and to a lesser extent its Consumer customers. These arrangements can include web-based subscription services, audio practice products and professional services or any combination thereof. The Company does not have a sufficient concentration of stand-alone sales of the various deliverables noted above to its customers, and therefore cannot establish VSOE for each deliverable. Third party evidence of fair value does not exist for the web-based subscription, audio practice products and professional services due to the lack of interchangeable language-learning products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately, versus together, requires significant judgment. This includes determining whether distinct services are part of a series of distinct services that are substantially the same. When subscription services are sold with professional services, judgment is required to determine whether the professional services are distinct and can be accounted for separately. In the E&E Language segment, the Company has concluded that each promised service within the ~~market. Accordingly,~~language-learning subscription is delivered concurrently with all other promised services over the ~~Company determines~~contract term and, as such, concluded that these promises are a single performance obligation that includes a series of distinct services that have the ~~relative selling price~~same pattern of transfer to the web-based subscription, audio practice products and professional services deliverables included in its non-software multiple-element arrangements using the best estimated selling price. The Company determines the best estimated selling pricecustomer. When there are multiple performance obligations, revenue is allocated to each performance obligation based on its relative standalone selling price (“SSP”). Judgment is required to determine the SSP for each distinct performance obligation where SSP is not directly observable, such as when the product or service is not sold separately, SSP is determined using internally published price ~~list~~lists which ~~includes~~include suggested sales prices for each ~~deliverable~~performance obligation based on the type of client and volume purchased. ~~This~~These price ~~list is~~lists are derived from past experience and from the expectation of obtaining a reasonable margin based on ~~what~~the cost to fulfill each ~~deliverable costs~~performance obligation.

Subscription revenue is recognized ratably over the ~~Company.~~

Incontract period as the ~~U.S.~~performance obligation is satisfied. Certain Consumer Language offerings have contracts with no fixed duration and Canada, the Company offers consumers who purchase packaged software and audio practice products directly from the Company a 30-day, unconditional, full money-back refund. The Company also permits some of our retailers and distributors to return unsold packaged products, subject to certain limitations. In accordance with ASC subtopic 985-605, ~~Software: Revenue Recognition~~ ~~("ASC 985-605"),~~are marketed as lifetime subscriptions. For these lifetime subscriptions, the Company estimates the expected contract period as the greater of the typical customer usage period or the longest fixed-period duration subscription that is currently marketed. The Company's current expected contract period for lifetime subscriptions is 24 months.

Certain Consumer Language offerings are sold with a right of return and ~~establishes~~the Company may provide other credits or incentives. These rights are accounted for as variable consideration when estimating the amount of revenue ~~reserves for packaged product returns~~to recognize by utilizing the expected value method. Returns and credits are estimated at ~~the time of sale~~contract inception based on historical return rates, estimated channel inventory levels, the timing of new product introductions and other factors.

Reserves for returns and credits are updated at the end of each reporting period as additional information becomes available.

The Company distributes its products and services both directly to the end customer and indirectly through resellers. Resellers earn commissions generally calculated as a fixed percentage of the gross sale amount to the end customer. The Company evaluates each of its reseller relationships ~~in accordance with ASC subtopic 605-45,~~ ~~Revenue Recognition - Principal Agent Considerations~~ ~~(“ASC 605-45”)~~ to determine whether it is the principal (where revenue is recognized ~~from indirect sales should be~~at the gross ~~amount~~amount) or agent (where revenue is recognized net of the ~~contract with the end customer or reduced for the~~ reseller ~~commission.~~commission). In making this determination the Company evaluates a variety of factors including ~~whether it~~the amount of control the Company is able to exercise over the ~~primary obligor~~transactions.

Contract Balances: The timing of revenue recognition, invoicing, and cash collection results in accounts receivable and deferred revenue in the consolidated balance sheets. Payment from customers is often received in advance of services being provided, resulting in deferred revenue. Accounts receivable is recorded when there is an executed customer contract and the right to the consideration becomes unconditional. Contract assets such as unbilled receivables are not material.

The allowance for doubtful accounts reflects the best estimate of probable losses inherent in the accounts receivable balance. The Company establishes an allowance for doubtful accounts based on specific risks identified, historical experience, and other currently available evidence.

Payment terms and conditions vary by contract type and customer. For the E&E Language and Literacy segments, payment terms generally range from 30 to 90 days. In the Consumer Language segment, resellers and mobile app stores are generally granted payment terms between 30 to 45 days. Within Consumer Language, sales to end ~~customer.~~

~~Table~~customers via the Rosetta Stone ecommerce website are done by credit card, which generally are settled within 7-10 days and may be made in installments. In instances where the timing of ~~Contents~~

~~ROSETTA STONE INC.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)~~

~~Revenue for web-based subscriptions~~revenue recognition differs from the timing of invoicing, the Company has determined that contracts generally do not include a significant financing component. The primary purpose of invoicing terms is to provide customers with simplified and ~~online~~predictable ways of purchasing products and services and not to provide customers with financing.

Deferred revenue is comprised mainly of unearned revenue related to subscription services which is recognized ratably over the ~~term of the~~ subscription ~~or service period, assuming all~~period. Deferred revenue ~~recognition criteria have been met. The CD~~also includes payments for professional services and ~~digital download formats of Rosetta Stone language-learning products are bundled with an online service where customers are allowed to begin their~~ online services ~~at any point during~~to be performed in the future which are earned as revenue when the service is provided. Most of our business is SaaS-based; consequently, backlog is not significant. See Note 10 "Revenue and Deferred Revenue" for additional disclosures.

Assets Recognized from Costs to Obtain a ~~registration window, which is typically up to six months from~~Contract with a Customer: The Company recognizes an asset for the ~~date~~incremental costs of purchase from us or an authorized reseller. The online services that are not activated during this registration window are forfeited and revenue is recognized upon expiry. Revenue from non-refundable upfront fees that are not related to products already delivered or services already performed is deferred and recognized ratably over the term of the related arrangement because the period over whichobtaining a contract with a customer, is expected to benefit from the service that is included within our subscription arrangements does not extend beyond the contractual period. Accounts receivable and deferred revenue are recorded at the timewhich primarily represents sales commissions paid when a customer ~~enters into a binding subscription agreement.~~

~~Software products are sold to end user customers and resellers. In many cases, revenue from sales to resellers~~contract is not contingent upon resale of the software to the end user and is recorded in the same manner as all other product sales. Revenue from sales of packaged software products and audio practice products is recognized as the products are shipped and title passes and risks of loss have been transferred. For many product sales, these criteria are met at the time the product is shipped. For some sales to resellers and certain other sales, the Company defers revenue until the customer receives the product because the Company legally retains a portion of the risk of loss on these sales during transit. In other cases where packaged software products are sold to resellers on a consignment basis, revenue is recognized for these consignment transactions once the end user sale has occurred, assuming the remaining revenue recognition criteria have been met. In accordance with ASC subtopic 605-50, ~~Revenue Recognition: Customer Payments and Incentives~~ (“ASC 605-50”), cash sales incentives to resellers are accounted for as a reduction of revenue, unless a specific identified benefit is identified and the fair value is reasonably determinable. Price protection for changes in the manufacturer suggested retail value granted to resellers for the inventory that they have on hand at the date the price protection is offered iseither recorded as ~~a reduction~~revenue or deferred revenue. Sales commission consists of variable commissions paid to ~~revenue at the time of sale.~~

The Company offers customers the ability to make payments for packaged software purchases in installments over a period of time, which typically ranges between three and five months. Given that these installment payment plans are for periods less than 12 months, a successful collection history has been established and thesesalespeople as well as third party costs such as fees ~~are fixed and determinable, revenue is recognized at the time of sale, assuming the remaining revenue recognition criteria have been met.~~

In connection with packaged software product sales and web-based 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 the fee for technical support is included in the initial licensing fee, the technical support and services are generally provided within one year, the estimated cost of providing such support is deemed insignificant and no unspecified upgrades/enhancements are offered, technical support revenue is recognized together with the software product and web-based software subscription revenue. Costs associated with ~~technical support are accrued at the time of sale.~~

sales made in App stores. Sales commissions ~~from~~paid to obtain non-cancellable ~~web-based software~~ subscription contracts are deferred and amortized in proportion to the period over which the revenue is recognized from the related contract.

~~Restructuring Costs~~

In recent periods, the Company announced and initiated actions to reduce headcount and other costs in order to support its strategic shift in business focus. In connection with these plans, the Company incurred restructuring related costs, including employee severance and related benefit costs, contract termination costs, and other related costs. These costs Deferred sales commissions are ~~included in Cost of sales and the Sales and marketing, Research and development, and General and administrative operating expense categories in the Company's statements of operations.~~

Employee severance and related benefit costs primarily include cash payments, outplacement services, continuing health insurance coverage, and other benefits. Where no substantive involuntary termination plan previously exists, these severance costs are generally considered “one-time” benefits and recognized at fair value in the period in which a detailed plan has been approved by management and communicated to the terminated employees. Severance costs pursuant to ongoing benefit arrangements, including termination benefits provided for in existing employment contracts, are recognized when probable and reasonably estimable.

Contract termination costs include penalties to cancel certain service and license contracts and costs to terminate operating leases. Contract termination costs are recognized at fair value in the period in which the contract is terminated in accordance with the contract terms.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

~~2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)~~

~~Other related costs generally include external consulting~~

amortized to sales and ~~legal costs~~marketing expense on the consolidated statements of operations. Deferred sales commissions are classified as non-current unless the associated ~~with the strategic shift in business focus. Such costs are recognized at fair value in the~~amortization period ~~in which the costs are incurred. See Note 13 "Restructuring" for additional disclosures.~~

is one year or less.

Income Taxes

The Company accounts for income taxes in accordance with ASC topic 740, Income Taxes(" ("ASC 740"), which provides for an asset and liability approach to accounting for income taxes. Deferred tax assets and liabilities represent the future tax consequences of the differences between the financial statement carrying amounts of assets and liabilities versus the tax basis of assets and liabilities. Under this method, deferred tax assets are recognized for deductible temporary differences, and operating loss and tax credit carryforwards. Deferred liabilities are recognized for taxable temporary differences. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The impact of tax rate changes on deferred tax assets and liabilities is recognized in the year that the change is enacted.

~~Deferred Tax Valuation Allowance~~

~~The Company has recorded~~

Significant judgment is required to determine whether a valuation allowance ~~offsetting certain~~is necessary and the amount of ~~its deferred tax assets as of September 30, 2017. When measuring the need for a~~such valuation allowance, on a jurisdiction by jurisdiction basis, the Company assesses both positive and negative evidence regarding whether these deferred tax assets are realizable. In determining deferred tax assets and valuation allowances, the Company is required to make judgments and estimates related to projections of profitability, the timing and extent of the utilization of temporary differences, net operating loss carryforwards, tax credits, applicable tax rates, transfer pricing methodologies and tax planning strategies.if appropriate. The valuation allowance is reviewed ~~quarterly~~at each reporting period and is maintained until sufficient positive evidence exists to support a reversal. ~~Because evidence such as~~

When assessing the ~~Company’s operating results during~~realization of the most recent three-year period is afforded more weight than forecasted results for future periods, the Company’s cumulative loss in certain jurisdictions represents significant negative evidence in the determination of whetherCompany's deferred tax assets, ~~are more likely than not to be utilized in certain jurisdictions. This determination resulted in~~ the ~~need for a valuation allowance on~~Company considers all available evidence, including:

•

the nature, frequency, and severity of cumulative financial reporting losses in recent years;

•

the carryforward periods for the net operating loss, capital loss, and foreign tax credit carryforwards;

•

predictability of future operating profitability of the character necessary to realize the asset;

•

prudent and feasible tax planning strategies that would be implemented, if necessary, to protect against the loss of the deferred tax assets; and

•

the effect of reversing taxable temporary differences.

The evaluation of the recoverability of the deferred tax assets ~~of certain jurisdictions. The~~requires that the Company ~~will release this valuation allowance when it is determined~~weigh all positive and negative evidence to reach a conclusion that it is more likely than not that ~~its~~all or some portion of the deferred tax assets will not be realized. The weight given to the evidence is commensurate with the extent to which it can be objectively verified. The more negative evidence that exists, the more positive evidence is necessary and the more difficult it is to support a conclusion that a valuation allowance is not needed.

The establishment of a valuation allowance has no effect on the ability to use the deferred tax assets in the future to reduce cash tax payments. The valuation allowance analysis considers a number of factors, including cumulative losses in recent years, expectations of future taxable income and the timeframe over which net operating losses expire. 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. The Company will continue to assess the need for a valuation allowance and the likelihood that the deferred tax assets will be ~~realized. Any future release of~~realizable at each reporting period. The valuation allowance ~~may~~will be ~~recorded as a tax benefit increasing net income.~~

adjusted accordingly, which could materially affect the Company's financial position and results of operations. See Note 15 "Income Taxes" for additional disclosures.

Fair Value of Financial Instruments

The Company values its assets and liabilities using the methods of fair value as described in ASC topic 820, Fair Value Measurements, ~~and Disclosures,~~ ("ASC 820"). ASC 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. The three levels of fair value hierarchy are described below:

Level 1: Quoted prices for identical instruments in active markets.

Level 2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

Level 3: Significant inputs to the valuation model are unobservable.

The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, restricted cash, accounts receivable, accounts payable and other accrued expenses approximate fair value due to relatively short periods to maturity.

~~Divestitures~~

The Company deconsolidates divested subsidiaries when there is a loss of control or when appropriate when evaluated under the variable interest entity model. The Company recognizes a gain or loss at divestiture equal to the difference between the fair value of any consideration received and the carrying amount of the former subsidiary’s assets and liabilities. Any resulting gain or loss is reported in "Other income and (expense)" on the consolidated statement of operations.

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

~~2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)~~

Stock-Based Compensation

The Company accounts for its stock-based compensation in accordance with ASC topic 718, Compensation—Stock Compensation ("ASC 718"). Under ASC 718, all stock-based awards, including employee stock option grants, are recorded at fair value as of the grant date. For options granted with service and/or performance conditions, the fair value of each grant is estimated on the date of grant using the Black-Scholes option pricing ~~model. For options granted with market-based conditions, the fair value of each grant is estimated on the date of grant using the Monte-Carlo simulation model. These methods~~model which require the use of estimates, including future stock price volatility, expected term and forfeitures.

~~As the Company does not have sufficient historical option exercise experience that spans the full 10-year~~

Stock options are granted to directors with a 10 -year contractual ~~term for determining the expected term of options granted, the~~term. The Company estimates the expected term of stock options using ~~a combination of~~ historical ~~information~~grant and ~~the simplified method for estimating the expected term.~~exercise information. The Company uses its own historical stock price data to estimate its forfeiture rate and expected volatility over the most recent period commensurate with the estimated expected term of the awards. For the risk-free interest rate, the Company uses a U.S. Treasury Bond rate consistent with the estimated expected term of the option award.

The Company’s restricted stock and restricted stock unit grants are accounted for as equity awards. Stock compensation expense associated with service-based equity awards is recognized in the ~~statement~~statements of operations ~~on a straight-line basis~~ratably over the requisite service period, which is the vesting period. If an award's service inception date precedes the grant date, compensation expense is initially measured at fair value at the service inception date based on probability of payout, and remeasured at subsequent reporting dates until all of the award’s key terms and conditions are known and the grant date is established. For equity awards granted with performance-based conditions, stock compensation expense is recognized in the ~~statement~~statements of operations ratably for each vesting tranche based on the probability that operating performance conditions will be met and to what extent. Changes in the probability estimates associated with performance-based awards will be accounted for in the period of change using a cumulative catch-up adjustment to retroactively apply the new probability estimates. In any period in which the Company determines that achievement of the performance metrics is not probable, the Company ceases recording compensation expense and all previously recognized compensation expense for the performance-based award is reversed. For equity awards granted with market-based conditions, stock compensation expense is recognized in the ~~statement~~statements of operations ratably for each vesting tranche regardless of meeting or not meeting the market conditions. See Note 1112 "Stock-Based Compensation" for additional disclosures.

Basic and Diluted Net Loss Per Share

Net loss per share is computed under the provisions of ASC topic 260, Earnings Per Share. Basic loss per share is computed by dividing net loss by the weighted average number of common shares outstanding during the period. Diluted loss per share is computed by dividing net loss by the weighted average number of common shares and potential common shares outstanding during the period. Potential common shares are included in the diluted computation when dilutive. Potentially dilutive shares are computed using the treasury stock method and primarily consist of shares issuable upon the exercise of stock options, restricted stock awards, restricted stock units and conversion of shares of preferred stock. Common stock equivalent shares are excluded from the diluted computation if their effect is anti-dilutive. When there is a net loss, there is a presumption that there are no dilutive shares as these would be anti-dilutive. See Note 14 "Basic and Diluted Net Loss Per Share" for additional disclosures.

Foreign Currency Translation and Transactions

The functional currency of the Company's foreign subsidiaries is their local currency. Accordingly, assets and liabilities of the foreign subsidiaries are translated into U.S. dollars at exchange rates in effect on the balance sheet date. Income and expense items are translated at average rates for the period. Translation adjustments are recorded as a component of accumulated other comprehensive loss in stockholders' deficit.

Cash flows of consolidated foreign subsidiaries, whose functional currency is their local currency, are translated to U.S. dollars using average exchange rates for the period. The Company reports the effect of exchange rate changes on cash balances held in foreign currencies as a separate item in the reconciliation of the changes in cash, ~~and~~ cash equivalents and restricted cash during the period.

The following table presents the effect of exchange rate changes on total comprehensive loss (in thousands):

	Three months ended March 31,
	2020			2019
Net loss	$	(6,181	)	$	(544	)
Foreign currency translation (loss) gain		(53	)		213
Comprehensive loss	$	(6,234	)	$	(331	)

Three Months Ended
September 30, Nine Months Ended
September 30,
2017 2016 2017 2016
Net loss $ (3,231 ) $ (5,452 ) $ (3,912 ) $ (21,937 )
Foreign currency translation gain (loss) 289
(313 ) 623
(1,522 )
Comprehensive loss $ (2,942 ) $ (5,765 ) $ (3,289 ) $ (23,459 )

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Comprehensive Loss

Comprehensive loss consists of net loss and other comprehensive income ~~(loss).~~or loss. Other comprehensive income ~~(loss)~~or loss refers to revenues, expenses, gains, and losses that are not included in net loss, but rather are recorded directly in stockholders' deficit. For the three ~~and nine~~ months ended ~~September 30, 2017~~March 31, 2020 and ~~2016,~~2019, the Company's comprehensive loss consisted of net loss and foreign currency translation ~~gains and (losses).~~

Upon sale of an investment in a foreign entity, the amount attributable to the accumulated translation adjustment component of that foreign entity is removed as a component of other comprehensive income (loss) and reported as part of the gainlosses or ~~loss on the sale of the investment. During the period ended September 30, 2017, a transfer of $0.1 million was made~~

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~~ROSETTA STONE INC.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)~~

~~from accumulated other comprehensive income (loss) and recognized as a loss within net loss related to the sale of a foreign subsidiary.~~

~~Components of accumulated other comprehensive loss as of September 30, 2017 are as follows (in thousands):~~

Foreign Currency Total
Balance at beginning of period on January 1, 2017 $ (3,709 ) $ (3,709 )
Other comprehensive income before reclassifications 719
719
Amounts reclassified from accumulated other comprehensive income related to the sale of a foreign subsidiary (96 ) (96 )
Net current period other comprehensive income 623
623
Accumulated other comprehensive loss at September 30, 2017 $ (3,086 ) $ (3,086 )

gains.

The other comprehensive ~~income (loss)~~loss presented in the consolidated financial statements and the notes are presented net of tax. There has been no0 tax expense or benefit associated with the components of other comprehensive ~~income (loss)~~loss due to the presence of a full valuation allowance for each of the three ~~and nine~~ months ended ~~September 30, 2017~~March 31, 2020 and ~~2016.~~

2019.

Advertising Costs

Costs for advertising are expensed as incurred. Advertising expense ~~for~~consisted of the three months ended September 30, 2017 and September 30, 2016 was $5.3 million and $8.7 million, respectively. Advertising expense for the nine months ended September 30, 2017 and September 30, 2016 was $18.1 million and $27.2 million, respectively.following (in thousands):

	Three months ended March 31,
	2020		2019
Advertising costs	$	6,168	$	4,735

Going Concern Assessment

~~The~~

As part of its internal control framework, the Company routinely performs ~~its~~a quarterly going concern assessment in accordance with ASC sub-topic 205-40, Presentation of Financial Statements - Going Concern ("ASC 205-40"). Under ASC 205-40, management is required to assess the Company's ability to continue as a going concern. As further described ~~in the discussion~~ below, ~~the Company~~management has concluded based on ~~its~~ projections that ~~its~~the cash balance, funds available from ~~its~~the line of credit, and ~~its~~the cash ~~flow~~flows from operations are sufficient to meet ~~its~~the liquidity needs through the one year period following the financial statement issuance date.

The consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Management has evaluated whether relevant conditions or events, considered in the aggregate, indicate that there is substantial doubt about the Company's ability to continue as a going concern. Substantial doubt exists when conditions and events, considered in the aggregate, indicate it is probable that the Company will be unable to meet its obligations as they become due within one year after the financial statement issuance date. The assessment is based on the relevant conditions that are known or ~~reasonable~~reasonably knowable as of ~~November 2, 2017.~~

May 6, 2020.

The assessment of the Company's ability to meet its future obligations is inherently judgmental, subjective and susceptible to change. The inputs that are considered important in the Company's going concern analysis, include, but are not limited to, the Company's ~~2017~~2020 cash flow forecast, ~~2017~~2020 operating budget, and long-term plan that extends beyond ~~2017.~~2020. These inputs consider information including, but not limited to, the Company’s financial condition, liquidity sources, obligations due within one year after the financial statement issuance date, funds necessary to maintain operations, and financial conditions, including negative financial trends or other indicators of possible financial difficulty.

The Company has considered both quantitative and qualitative factors as part of the assessment that are known or reasonably knowable as of ~~November 2, 2017,~~May 6, 2020, and concluded that conditions and events considered in the aggregate, do not indicate that it is probable that the Company will be unable to meet obligations as they become due through the one year period following the financial statement issuance date.

~~Recently Issued Accounting Standards~~

~~During 2017, the Company adopted the following recently issued Accounting Standard Updates ("ASU"):~~

~~In March 2016, the Financial Accounting Standards Board ("FASB") issued ASU No. 2016-09,~~ ~~Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting~~ ("ASU 2016-09"). Under ASU 2016-09, accounting for share-based payment award transactions was simplified related to the accounting for (a) income tax effects; (b) minimum statutory tax withholding requirements; (c) and forfeitures. ASU 2016-09 is effective for public entities

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~~ROSETTA STONE INC.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)~~

in annual periods beginning after December 15, 2016, including interim periods within those annual periods. Early adoption is permitted. The Company adopted this ASU as of January 1, 2017. Due to the historical cumulative shortfall position, the adoption of ASU 2016-09 did not result in a cumulative-effect adjustment to retained earnings. ASU 2016-09 allows for an entity-wide accounting policy election, which would be applied prospectively, to either account for forfeitures when they occur or continue to estimate the number of awards that are expected to vest. The Company has elected to continue to estimate the number of awards that are expected to vest. Other aspects of adoption ASU 2016-09 did not have a material impact to the Company’s consolidated financial statements.

~~In January 2017, the FASB issued ASU No. 2017-01,~~ ~~Business Combination (Topic 805) Clarifying the Definition of a Business~~ ("ASU 2017-01"). ASU 2017-01 clarifies the definition of a business and requires that an entity apply certain criteria in order to determine when a set of assets and activities qualifies as a business. ASU 2017-01 is effective for public entities for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years, and should be applied on a prospective basis. Early adoption is permitted. The Company has adopted this guidance as of January 1, 2017. Due to the prospective application of this ASU, there was no impact to historical financial statements and no additional disclosures are required.

~~The following ASUs were recently issued but have not yet been adopted by the Company:~~

~~In February 2017, the FASB issued ASU No. 2017-05,~~ Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets ("ASU 2017-05"). ASU 2017-05 clarifies the scope and accounting of a financial asset that meets the definition of an “in-substance nonfinancial asset” and defines the term, “in-substance nonfinancial asset.” ASU 2017-05 also adds guidance for partial sales of nonfinancial assets. ASU 2017-05 is effective at the same time Topic 606, ~~Revenue from Contracts with Customers~~ is effective. ASU 2017-05 may be applied retrospectively for all periods presented or retrospectively with a cumulative-effect adjustment at the date of adoption. The Company is in the process of evaluating the impact of the new guidance on the Company's financial statements and disclosures and the adoption method.

~~In January 2017, the FASB issued ASU No. 2017-04,~~ ~~Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment~~ ("ASU 2017-04"). ASU 2017-04 simplifies the subsequent measurement of goodwill and eliminates Step 2 from the goodwill impairment test. ASU 2017-04 is effective for annual and interim goodwill tests beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates on or after January 1, 2017. The Company is in the process of evaluating the guidance. Given the prospective adoption application, there is no impact on the Company's historical consolidated financial statements and disclosures.

~~In November 2016, the FASB issued ASU No. 2016-18,~~ ~~Statement of Cash Flows (Topic 230) Restricted Cash a consensus of the FASB Emerging Issues Task Force~~ ("ASU 2016-18"). Under ASU 2016-18, amounts generally described as restricted cash should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for public entities in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The Company anticipates adopting this guidance beginning in the first quarter of 2018. The new guidance only impacts presentation of the Company's consolidated statement of cash flows.

~~In June 2016, the FASB issued ASU No. 2016-13,~~ ~~Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments~~ ("ASU 2016-13"). ASU 2016-13 changes the methodology for measuring credit losses of financial instruments and the timing of when such losses are recorded. ASU 2016-13 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2019. Early adoption is permitted for fiscal years, and interim periods within those years, beginning after December 15, 2018. The Company is in the process of evaluating the impact of the new guidance on the Company's consolidated financial statements and disclosures.

~~In February 2016, the FASB issued ASU No. 2016-02,~~ ~~Leases (Topic 842)~~ ("ASU 2016-02"). Under ASU 2016-02, entities will be required to recognize a lease liability and a right-of-use asset for all leases. Lessor accounting is largely unchanged. ASU 2016-02 is effective for public entities in fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company is in the process of evaluating the impact of the new guidance on the Company's consolidated financial statements and disclosures.

~~In January 2016, the FASB issued ASU No. 2016-01,~~ ~~Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities~~ ~~("ASU 2016-01"). ASU 2016-01 changes how entities measure certain equity investments and present changes in the fair value of financial liabilities measured under the fair value option that~~

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~~ROSETTA STONE INC.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)~~

are attributable to their own credit. Under the new guidance, entities will be required to measure equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in fair value in net income unless the investments qualify for the new practicability exception. The accounting for other financial instruments, such as loans and investments in debt securities is largely unchanged. ASU 2016-01 is effective for public entities in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company does not believe that the adoption of this guidance will have a material impact on the Company's consolidated financial statements and disclosures.

~~In May 2014, the FASB issued ASU No. 2014-09,~~ ~~Revenue from Contracts with Customers (Topic 606), which replaces the current revenue accounting guidance. In August 2015, the FASB issued ASU No. 2015-14,~~ ~~Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date~~ ~~which defers the effective date of the updated guidance on revenue recognition by one year. In March 2016, the FASB issued ASU No. 2016-08,~~ ~~Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which clarifies and improves the operability and understandability of the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU No. 2016-10,~~ ~~Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing~~, which clarifies and improves the operability and understanding of the implementation guidance on identifying performance obligations and licensing. Collectively these ASUs comprise the new revenue standard ("New Revenue Standard"). The core principle of the New Revenue Standard is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply a five step model to 1) identify the contract(s) with a customer, 2) identify the performance obligations in the contract, 3) determine the transaction price, 4) allocate the transaction price to the performance obligations in the contract and 5) recognize revenue when (or as) the entity satisfies a performance obligation. The New Revenue Standard is effective for annual periods beginning after December 15, 2017.

The Company expects that it will adopt the New Revenue Standard beginning in the first quarter of 2018. The New Revenue Standard provides the option between two different methods of adoption. The full retrospective method calls for the Company to present each prior reported period shown in the financial statements under the new guidance. The modified retrospective method requires the Company to calculate the cumulative effect of applying the new guidance as of the date of adoption via adjustment to retained earnings. The Company is currently considering adopting the New Revenue Standard using the modified retrospective method.

The Company continues to evaluate the impact the New Revenue Standard will have on its financial statements, disclosures, policies, processes, and system requirements. The Company has completed the development of its "recast tool" that will enable the Company to determine the cumulative effect of adopting the new guidance as of January 1, 2018. As part of its evaluation, the Company believes the impact of the change in the New Revenue Standard on the Enterprise & Education Language and Literacy segments will be minimal as the accounting outcome for the vast majority of these transactions remains unchanged. Due to the elimination of software specific accounting guidance, the Company expects nearly all of the impact of adopting the New Revenue Standard will result from changes to the accounting for the packaged perpetual software product line that also includes non-software elements within the Consumer segment. Under the current revenue standard, the Company uses the residual method to allocate consideration between the software and non-software elements within a transaction. This results in a fixed amount being allocated to the non-software element, which is generally deferred and recognized over time, and any discount being fully allocated to the software element, which is recognized as revenue at the time of sale. Under the New Revenue Standard, any discounts will be allocated to all of the elements within a software transaction based on relative selling price. Accordingly, this will result in different amounts allocated to the various elements which are recognized into revenue at different times. However, given the Company's continued migration in its Consumer segment to a 100% SaaS business, we currently expect the cumulative effect to not be significant when compared to total deferred revenue because the revenue recognition for our SaaS products in the Consumer segment are materially the same under both the current and New Revenue Standard. However, it is important to note that the cumulative effect as of January 1, 2018 is dependent on the mix of sales in the Consumer segment in the fourth quarter of 2017, the Consumer segment's largest quarter. The Company expects the largest impacts to its financial statements to result from the new qualitative and quantitative disclosures that will be required upon adoption of the New Revenue Standard. The Company continues to evaluate the impact of the New Revenue Standard, and any assessments made, including the adoption method, are subject to change.

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~~ROSETTA STONE INC.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

3. ~~DIVESTITURE~~

On March 13, 2017, the Company entered into a Product and Intellectual Property Agreement, (the “PIPA”) with SOURCENEXT Corporation, (“SOURCENEXT”), a leading software distributor and developer in Japan. Under the PIPA, the Company provided a perpetual, exclusive license of certain brands and trademarks, including the primary Rosetta Stone brand, and product code for exclusive development and sale of language and education-related products in Japan. In conjunction with the PIPA, the Company received approximately $9.0 million on March 13, 2017, and another $2.0 million on June 19, 2017. In addition, the Company is guaranteed to receive minimum payments totaling an additional $6.0 million over the next ten years. Finally, as part of the Agreement, the Company will have the first right to license and sell any products developed by SOURCENEXT under the Rosetta Stone trademark in territories outside of Japan.

On April 25, 2017, the Company and SOURCENEXT signed a Stock Purchase Agreement ("SPA") for the sale of the Company's Japanese subsidiary ("RST Japan") and certain other assets related to the language market in Japan. The Company received $0.5 million associated with the SPA closure on June 29, 2017 when 100% of the Company's capital stock of RST Japan and the other assets related to the language market in Japan were transferred to SOURCENEXT.

The SPA and the PIPA were considered related and viewed as a multiple element arrangement. Of the nearly $11.5 million that was received to date under the terms of the PIPA and SPA, approximately $11.4 million was allocated to deferred revenue to be recognized over an estimated 20-year period. As this customer relationship progresses, the Company may prospectively reassess the 20-year recognition period as needed. Approximately $0.1 million was allocated to RST Japan and the other assets related to the language market in Japan to be included in the gain/loss calculation. At the time of closing, RST Japan was in a net liability position. The sale under the terms of the SPA resulted in a pre-tax gain of $0.4 million, reported in “Other income and (expense)” on the consolidated statement of operations. This gain was comprised of a gain of $0.5 million related to the sale of RST Japan and the other assets related to the language market in Japan, partially offset by a $0.1 million loss on the transfer of the foreign subsidiary's cumulative translation adjustment on the date of sale.

In the third quarter of 2017, the PIPA was amended to provide SOURCENEXT with a time based license to the Company's speech recognition engine and software development kit in exchange for the acceleration of $1.5 million of future cash receipts under the PIPA. The $1.5 million associated with the amendment to the PIPA was collected in full and is expected to be recognized ratably once delivery occurs.

~~4. NET LOSS PER SHARE~~

~~Net loss per share is computed under the provisions of ASC topic 260,~~ ~~Earnings Per Share~~. Basic loss per share is computed using net loss and the weighted average number of shares of common stock outstanding. Diluted earnings per share reflect the weighted average number of shares of common stock outstanding plus any dilutive shares outstanding during the period. Potentially dilutive shares consist of shares issuable upon the exercise of stock options, restricted stock awards, and restricted stock units.

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~~ROSETTA STONE INC.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~4. NET LOSS PER SHARE (Continued)~~

~~The following table sets forth the computation of basic and diluted net loss per common share (in thousands, except per share amounts):~~

Three Months Ended
September 30,
Nine Months Ended
September 30,
2017
2016
2017
2016
Numerator:

Net loss $ (3,231 ) $ (5,452 ) $ (3,912 ) $ (21,937 )
Denominator:

Basic shares:
Weighted average number of common shares - basic 22,285
21,993
22,220
21,936
Diluted shares:
Weighted average number of common shares - diluted 22,285
21,993
22,220
21,936
Loss per common share:

Basic $ (0.14 ) $ (0.25 ) $ (0.18 ) $ (1.00 )
Diluted $ (0.14 ) $ (0.25 ) $ (0.18 ) $ (1.00 )

The Company calculates dilutive common stock equivalent shares using the treasury stock method. In periods where the Company has a net loss, no dilutive common stock equivalent shares are included in the calculation for diluted shares as they are considered anti-dilutive. The following table sets forth dilutive common stock equivalent shares calculated using the treasury stock method (in thousands):

Three Months Ended
September 30, Nine Months Ended
September 30,
2017 2016 2017 2016
Stock options 219
96
209
18
Restricted stock units 223
183
203
171
Restricted stocks 286
132
250
116
Total common stock equivalent shares 728
411
662
305

Share-based awards to purchase approximately 0.7 million and 1.6 million shares of common stock that had an exercise price in excess of the average market price of the common stock during the three months ended September 30, 2017 and 2016, respectively, were not included in the calculation of diluted earnings per share because they were anti-dilutive. Share-based awards to purchase approximately 0.7 million and 2.0 million shares of common stock that had an exercise price in excess of the average market price of the common stock during the nine months ended September 30, 2017 and 2016, respectively, were not included in the calculation of diluted earnings per share because they were anti-dilutive.

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~~ROSETTA STONE INC.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

5. INVENTORY

Inventory consisted of the following (in thousands):

	As of
	March 31, 2020		December 31, 2019
Raw materials	$	735	$	834
Finished goods		642		711
Total inventory	$	1,377	$	1,545

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

4. PROPERTY AND EQUIPMENT

Depreciation and amortization expense related to property and equipment includes depreciation related to its physical assets and amortization expense related to amounts capitalized in the development of internal-use software. Depreciation and amortization expense associated with property and equipment consisted of the following (in thousands):

	Three months ended March 31,
	2020		2019
Cost of revenue	$	3,303	$	2,402
Sales and marketing		107		184
Research and development		68		2
General and administrative		561		553
Total depreciation expense	$	4,039	$	3,141

September 30,
2017 December 31,
2016
Raw materials $ 3,425
$ 4,384
Finished goods 769
2,383
Total inventory $ 4,194
$ 6,767

~~The finished goods inventory balance~~

5. INTANGIBLE ASSETS

Intangible assets consisted of the following items as of ~~September 30, 2017 reflected~~ the ~~Company's ongoing efforts~~dates indicated (in thousands):

	Trade name / trademark *			Core technology			Customer relationships			Patents and Other			Total
Gross Carrying Amount	$	12,311		$	13,356		$	25,608		$	312		$	51,587
Accumulated Amortization/Impairment		(1,704	)		(13,014	)		(22,240	)		(312	)		(37,270	)
Balance as of January 1, 2020	$	10,607		$	342		$	3,368		$	—		$	14,317

Gross Carrying Amount	$	12,305		$	13,315		$	25,566		$	312		$	51,498
Accumulated Amortization/Impairment		(1,698	)		(13,119	)		(22,433	)		(312	)		(37,562	)
Balance as of March 31, 2020	$	10,607		$	196		$	3,133		$	—		$	13,936

*	Included in the tradename/trademark line above is the Rosetta Stone tradename, which is the Company's only indefinite-lived intangible asset. As of January 1, 2020 and March 31, 2020, the Rosetta Stone tradename comprised the entire tradename/trademark net carrying amount of $10.6 million.

Amortization Expense for the Long-lived Intangible Assets

The following table presents amortization of intangible assets included in the related financial statement line items during the respective periods (in thousands):

	Three months ended March 31,
	2020		2019
Cost of revenue	$	146	$	146
Sales and marketing		235		235
Research and development		—		7
General and administrative		—		—
Total intangible amortization expense	$	381	$	388

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The following table summarizes the estimated future amortization expense related to ~~transition~~intangible assets for the ~~Consumer segment~~remaining months of 2020 and years thereafter (in thousands):

	As of March 31, 2020
2020 - remaining	$	901
2021		940
2022		940
2023		548
2024		—
Thereafter		—
Total	$	3,329

Impairment Reviews of Intangible Assets

The Company also routinely reviews indefinite-lived intangible assets and long-lived assets for potential impairment as part of the Company’s internal control framework. As an indefinite-lived intangible asset, the Rosetta Stone tradename was evaluated as of March 31, 2020 to ~~a software-as-a-service model. In~~determine if indicators of impairment exist, particularly in light of the ~~third quarter~~COVID-19 pandemic. The Company concluded that there were 0 potential indicators of ~~2017,~~impairment related to this indefinite-lived intangible asset. Additionally, all other long-lived intangible assets were evaluated to determine if indicators of impairment exist and the Company ~~requested its consignment retail partners to return inventory totaling $1.9 million~~concluded that there are 0 potential indicators of ~~finished packaged perpetual products. This non-cash inventory write-down was reflected as a cost of product revenue on the Company's statements of operations.~~

impairment.

6. GOODWILL

The value of goodwill is primarily derived from the acquisition of Rosetta Stone Ltd. (formerly known as Fairfield & Sons, Ltd.) in January 2006, the acquisition of certain assets of SGLC International Co. Ltd ("SGLC") in November 2009, the acquisition of Livemocha, Inc. ("Livemocha") in April 2013, the acquisition of Lexia Learning Systems, Inc. ("Lexia") in August 2013, and the acquisition of Tell Me More S.A. ("Tell Me More") in January 2014.

The Company tests goodwill for impairment annually on June 30 of each year at the reporting unit level using a fair value approach, in accordance with the provisions of ASC topic 350, Intangibles - Goodwill and other ("ASC 350"), or more frequently, if impairment indicators arise.

The following table shows the balance and changes in goodwill for the Company's operating segments for the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2020 (in thousands):

	Literacy		E&E Language			Consumer Language			Total
Balance as of January 1, 2020
Gross Goodwill	$	9,962	$	38,996		$	27,514		$	76,472
Accumulated Impairment		—		—			(27,514	)		(27,514	)
Goodwill as of January 1, 2020	$	9,962	$	38,996		$	—		$	48,958

Effect of change in foreign currency rate		—		(151	)		—			(151	)

Balance as of March 31, 2020
Gross Goodwill	$	9,962	$	38,845		$	27,514		$	76,321
Accumulated Impairment		—		—			(27,514	)		(27,514	)
Goodwill as of March 31, 2020	$	9,962	$	38,845		$	—		$	48,807

Literacy Segment Enterprise & Education Language Segment Consumer Segment Total
Balance as of January 1, 2017
Gross Goodwill $ 9,962
$ 38,289
$ 27,514
$ 75,765
Accumulated Impairment —
—
(27,514 ) (27,514 )
Goodwill as of January 1, 2017 $ 9,962
$ 38,289
$ —
$ 48,251

Effect of change in foreign currency rate —
1,403
—
1,403

Balance as of September 30, 2017
Gross Goodwill $ 9,962
$ 39,692
$ 27,514
$ 77,168
Accumulated Impairment —
—
(27,514 ) (27,514 )
Goodwill as of September 30, 2017 $ 9,962
$ 39,692
$ —
$ 49,654

~~In connection with~~

The Company routinely reviews goodwill at the ~~annual goodwill~~reporting unit level for potential impairment ~~test performed~~ as part of ~~June 30, 2017,~~ the ~~Company performed a qualitative goodwill impairment test for its~~Company's internal control framework. The Company's reporting units with ~~remaining goodwill.~~goodwill balances were evaluated to determine if a triggering event has occurred, particularly in light of the COVID-19 pandemic. As of ~~September 30, 2017,~~March 31, 2020, the Company concluded that there were no indicators of impairment that would cause us to believe that it is more likely than not that the fair value of our reporting units with goodwill is less than the carrying value. Accordingly, a quantitative impairment test has not been performed and no0 goodwill impairment charges were recorded in ~~2017~~2020 in connection with the ~~annual goodwill impairment test.~~

In connection with the annual goodwill impairment test performed as of June 30, 2016, the Consumer Fit Brains reporting unit was evaluated, which resulted in $1.7 million impairment loss for the remaining Consumer Fit Brains reporting unit's goodwill. The impairment charge was recorded in the "Impairment" line on the statement of operations.

interim review.

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

7. ~~INTANGIBLE ASSETS~~

~~Intangible~~LEASES

Under ASC 842, the Company determines if an arrangement is a lease at inception. Right-of-use assets ~~consisted~~represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the obligation to make lease payments arising from the lease. Some leases include options to extend or terminate the lease, which are included in the lease term when it is reasonably certain that the option will be exercised. Lease expense is recognized on a straight-line basis over the lease term.

The following table summarizes supplemental statement of ~~the following items~~operations information related to operating and finance lease costs as ~~of the dates~~ indicated (in thousands):

	Three months ended March 31,
Supplemental statement of operations information:	2020		2019
Operating lease cost	$	535	$	526

Amortization of right-to-use assets	$	114	$	113
Interest on lease liabilities		14		17
Finance lease cost	$	128	$	130

Trademark / tradename * Core technology Customer relationships Patents and Other Total

Gross Carrying Amount $ 12,431
$ 15,092
$ 26,149
$ 312
$ 53,984
Accumulated Amortization (1,481 ) (9,859 ) (18,485 ) (251 ) (30,076 )
Accumulated Impairment (26 ) (1,001 ) (128 ) —
(1,155 )
Balance as of January 1, 2017 $ 10,924
$ 4,232
$ 7,536
$ 61
$ 22,753

Gross Carrying Amount 12,500
15,637
26,612
312
55,061
Accumulated Amortization (1,700 ) (11,738 ) (20,058 ) (272 ) (33,768 )
Accumulated Impairment (26 ) (1,001 ) (128 ) —
(1,155 )
Balance as of September 30, 2017 $ 10,774
$ 2,898
$ 6,426
$ 40
$ 20,138

* Included in the tradename/trademark line above is the Rosetta Stone tradename, which is the Company's only indefinite-lived intangible asset. As of September 30, 2017, the carrying value of the tradename asset was $10.6 million.

~~Amortization Expense for the Long-lived Intangible Assets~~

The following table ~~presents amortization~~summarizes undiscounted future operating and finance lease payments as of ~~intangible assets included in~~March 31, 2020 and for the ~~related financial statement line items during the respective periods~~five years thereafter (in thousands):

As of March 31, 2020	Operating Leases		Finance Leases
2020 - remaining	$	1,281	$	393
2021		1,645		519
2022		1,621		394
2023		1,019		20
2024		102		13
Thereafter		76		—
Total undiscounted lease payments		5,744		1,339
Less: imputed interest		488		82
Total	$	5,256	$	1,257

The following table summarizes supplemental information related to operating and finance leases as indicated below:

	As of March 31, 2020
	Operating Leases			Finance Leases
Weighted-average remaining lease term	5 - 65 months			14 - 52 months
Weighted-average discount rate		5.4	%		4.8	%
Range of remaining term	41 months			34 months

The following table summarizes balance sheet information related to financing leases as indicated (in thousands):

	As of
Financing Lease Right-of-Use Assets and Liabilities:	March 31, 2020			December 31, 2019
Property and equipment, at cost	$	5,573		$	5,627
Accumulated depreciation		(3,780	)		(3,697	)
Property and equipment, net	$	1,793		$	1,930

Other current liabilities	$	473		$	474
Other long-term liabilities		784			914
Total finance lease liabilities	$	1,257		$	1,388

Three Months Ended
September 30, Nine Months Ended
September 30,
2017 2016 2017 2016
Included in cost of revenue:
Cost of subscription and service revenue $ 118
$ 104
$ 352
$ 305
Cost of product revenue 28
42
87
134
Total included in cost of revenue 146
146
439
439
Included in operating expenses:
Sales and marketing 472
463
1,387
1,720
Research and development 356
350
1,038
1,244
General and administrative —
—
—
—
Total included in operating expenses 828
813
2,425
2,964
Total $ 974
$ 959
$ 2,864
$ 3,403

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

~~7. INTANGIBLE ASSETS (Continued)~~

~~The following table summarizes the estimated future amortization expense related to intangible assets for the remaining three months of 2017 and years thereafter (in thousands):~~

As of September 30, 2017
2017 - remaining $ 977
2018 3,312
2019 1,532
2020 1,282
2021 940
2022 940
Thereafter 548
Total $ 9,531

~~Impairment Reviews of Intangible Assets~~

~~The Company also routinely reviews indefinite-lived intangible assets and long-lived assets for potential impairment as part of the Company’s internal control framework.~~

As an indefinite-lived intangible asset, the Rosetta Stone tradename was evaluated as of September 30, 2017 to determine if indicators of impairment exist. The Company concluded that there were no potential indicators of impairment related to this indefinite-lived intangible asset. Additionally all other long-lived intangible assets were evaluated to determine if indicators of impairment exist and the Company concluded that there are no potential indicators of impairment.

During the second quarter of 2016, the Company recorded an impairment loss of $1.2 million associated with the impairment of the remaining carrying value of the Consumer Fit Brains long-lived intangible assets as of June 30, 2016. The impairment charge is recorded in the "Impairment" line on the statement of operations.

8. ~~OTHER CURRENT LIABILITIES~~

~~The following table summarizes other current liabilities (in thousands):~~

September 30, 2017 December 31, 2016
Accrued marketing expenses $ 5,763
$ 8,460
Accrued professional and consulting fees 1,349
2,050
Sales return reserve 1,526
1,338
Sales, withholding and property taxes payable 3,446
3,772
Other 4,671
6,530
Total other current liabilities $ 16,755
$ 22,150

~~9. FINANCING~~BORROWING ARRANGEMENTS

Credit Facility

On October 28, 2014, Rosetta Stone ~~Ltd.~~Ltd (“RSL”), a wholly owned subsidiary of parent company Rosetta Stone Inc., executed a Loan and Security Agreement with Silicon Valley Bank (“Bank”) to obtain a ~~$25.0 million revolving~~ credit facility (the “credit facility”). Since the original date of execution, the Company and the Bank have executed several amendments to the credit facility to reflect updates to the Company's financial outlook, expand the availability, and extend the credit facility.

On March 10, 2020, the Company executed the eighth amendment to the credit facility. Under the amended agreement, the Company may borrow up to $25.0 ~~million, including a sub-facility, which reduces available borrowings, for letters of credit in an aggregate availability amount of $4.0~~ million. ~~Borrowings by RSL under the credit facility are guaranteed by the Company as the ultimate parent.~~ The credit facility has a term that expires on April 1, ~~2020,~~

~~Table of Contents~~

~~ROSETTA STONE INC.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~9. FINANCING ARRANGEMENTS (Continued)~~

2023, during which time RSL may borrow and re-pay loan amounts and re-borrow the loan amounts subject to customary borrowing conditions.

The total obligations under the credit facility cannot exceed the lesser of (i) the total revolving commitment of $25.0 million or (ii) the borrowing base, which is calculated as 80% of eligible accounts receivable. As a result, the borrowing base will fluctuate and However, the Company ~~expects it will follow the general seasonality of cash and accounts receivable (lower~~must have less than $5.0 million in ~~the first half~~outstanding borrowings for 30 consecutive days during each twelve month period beginning as of the ~~year and higher in the second half~~date of the year). If the borrowing base less any outstanding amounts, plus the cash held at the Bank ("Availability") is greater than $25.0 million, then the Company may borrow up to an additional $5.0 million, but in no case can borrowings exceed $25.0 million.execution. Interest on borrowings accrues at the greater of Prime Rate ~~provided that the Company maintains a minimum cash~~or 1.5% and ~~Availability balance of $17.5 million. If cash and Availability is below $17.5 million, interest will accrue at the Prime Rate plus 1%.~~

must be paid quarterly.

Proceeds of loans made under the credit facility may be used as working capital or to fund general business requirements. All obligations under the credit facility, including letters of credit, are secured by a security interest on substantially all of the Company’s assets including intellectual property rights and by a stock pledge by the Company of 100% of its ownership interests in U.S. subsidiaries and 66% of its ownership interests in certain foreign subsidiaries.

The credit facility contains customary affirmative and negative covenants, including covenants that limit or restrict ~~our~~the ability to, among other things, incur additional indebtedness, dispose of assets, execute a material change in business, acquire or dispose of an entity, grant liens, make share repurchases, and make distributions, including payment of dividends. The Company is required to maintain compliance with a minimum liquidity ~~amount~~coverage ratio of 1.75 and minimum financial performance requirements, as defined in the credit facility. As of ~~September 30, 2017,~~March 31, 2020, the Company was in compliance with all covenants.

The credit facility contains customary events of default, including among others, non-payment defaults, covenant defaults, bankruptcy and insolvency defaults, and a change of control default, in each case, subject to customary exceptions. The occurrence of a default event could result in the Bank’s acceleration of repayment obligations of any loan amounts then outstanding.

As of ~~September 30, 2017,~~March 31, 2020, there were no0 borrowings outstanding and the Company was eligible to borrow $19.5 million of available credit, less $4.0 million in letters of credit that have been issued by the Bank on the Company's behalf, resulting in a net borrowing availability of $15.5 million. outstanding.A quarterly commitment fee accrues on any unused portion of the credit facility at a nominal annual rate.

~~Capital Leases~~

9. OTHER CURRENT LIABILITIES

The ~~Company enters into capital leases under non-committed arrangements for equipment~~following table summarizes other current liabilities (in thousands):

	As of
	March 31, 2020		December 31, 2019
Accrued marketing expenses	$	3,584	$	5,394
Accrued professional and consulting fees		1,532		1,443
Sales return reserve		241		448
Sales, withholding, and property taxes payable		3,328		3,331
Other		2,294		2,474
Total other current liabilities	$	10,979	$	13,090

10. REVENUE AND DEFERRED REVENUE

The opening and ~~software. In addition, as a result~~closing balances of the ~~Tell Me More acquisition, the Company assumed a capital lease for a building near Versailles, France, where Tell Me More’s headquarters~~Company’s accounts receivable and deferred revenue are ~~located. The fair value of the lease liability at the date of acquisition was $4.0 million.~~as follows:

	Accounts Receivable			Deferred Revenue (current)			Deferred Revenue (non-current)
Opening balance as of January 1, 2020	$	22,919		$	119,851		$	57,766
Increase/(decrease), net		(7,528	)		(13,882	)		270
Ending balance as of March 31, 2020	$	15,391		$	105,969		$	58,036

During the nine months ended September 30, 2017, the Company acquired no equipment or software through the issuance of capital leases. During the nine months ended September 30, 2016, the Company acquired $27,000 of equipment or software through the issuance of capital leases.

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

~~9. FINANCING ARRANGEMENTS (Continued)~~

~~Future minimum payments under capital leases with initial terms~~

The amount of ~~one year or more are as follows (in thousands):~~

As of September 30, 2017
2017-remaining $ 136
2018 539
2019 536
2020 532
2021 529
2022 396
Thereafter —
Total minimum lease payments $ 2,668
Less amount representing interest 294
Present value of net minimum lease payments $ 2,374
Less current portion 440
Obligations under capital lease, long-term $ 1,934

~~10. INCOME TAXES~~

~~In accordance with ASC topic 740,~~ ~~Income Taxes~~ ~~(“ASC 740”), and ASC subtopic 740-270,~~ ~~Income Taxes: Interim Reporting~~,revenue recognized in the ~~income tax provision for the nine~~three months ended ~~September 30, 2017 is based on~~March 31, 2020 that was included in the opening January 1, 2020 deferred revenue balance was $42.7 million. The vast majority of this revenue consists of deferred subscription revenue. The amount of revenue recognized from performance obligations satisfied in prior periods was not material.

The following table sets forth deferred revenue by reportable segment which represents the Company's unfulfilled performance obligations as of March 31, 2020 and the estimated annual effective tax rate for fiscal year 2017. The estimated effective tax rate may be subject to adjustment in subsequent quarterly periods as the estimates of pretax income for the year, along with other items that may affect the rate, may change and may create a different relationship between domestic and foreign income and loss.

~~The Company accounts for uncertainty in income taxes under ASC subtopic 740-10-25,~~ ~~Income Taxes: Overall: Background~~ ~~(“ASC 740-10-25”). ASC 740-10-25 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or~~revenue expected to be ~~taken~~recognized in the future related to these performance obligations:

	As of March 31, 2020
	Total		Less than 1 Year		1-3 Years		3-5 Years		More than 5 Years
Literacy	$	41,256	$	32,782	$	8,089	$	381	$	4
E&E Language		55,065		33,498		8,961		2,743		9,863
Consumer Language		67,684		39,689		15,189		1,822		10,984
Total	$	164,005	$	105,969	$	32,239	$	4,946	$	20,851

In 2017, the Company entered into a ~~tax return. ASC 740-10-25 also provides guidance on derecognition, classification, interest~~series of agreements with SOURCENEXT Corporation, (“SOURCENEXT”), comprising a single performance obligation associated with the perpetual license of certain intellectual property, software, and ~~penalties, accounting~~product code for exclusive development and sale of language and education-related products in ~~interim periods, disclosure, and transition.~~

~~Valuation Allowance Recorded for Deferred Tax Assets~~

Japan. The Company ~~evaluates~~estimated a 20 year period to recognize the recoverability of its deferred tax assets at each reporting period for each tax jurisdiction and establishes a valuation allowance, if necessary, to reduce the deferred tax asset to an amount that is more likely than not to be recovered.performance obligation. As of ~~September 30, 2017,~~March 31, 2020, deferred revenue associated with SOURCENEXT totaled $15.5 million, which will be recognized ratably through April 2037 and comprised the ~~analysis~~majority of the ~~need for a valuation allowance on U.S.~~Consumer Language non-current deferred ~~tax assets considered that the U.S. entity has incurred a three-year cumulative loss.~~revenue. As ~~previously disclosed, if~~this customer relationship progresses, the Company ~~does not have sufficient objective positive evidence~~will prospectively reassess the recognition period as needed.

See Note 16 - “Segment Information” for further information on the disaggregation of revenue, including revenue by reportable segment and geographic area.

11. COMMITMENTS AND CONTINGENCIES

Litigation

From time to overcome a three-year cumulative loss, a valuation allowance may be necessary. In evaluating whether to record a valuation allowance, the guidance in ASC 740 deems that the existence of cumulative losses in recent years is a significant piece of objectively verifiable negative evidence that is difficult to overcome. An enterprise that has cumulative losses is generally prohibited from using an estimate of future earnings to support a conclusion that realization of an existing deferred tax asset is more likely than not.

~~Consideration has been given to the following positive and negative evidence:~~

~~Three-year cumulative evaluation period ended September 30, 2017 results in a cumulative U.S. pre-tax loss;~~

~~from 2006, when the U.S. entity began filing as a C-corporation for income tax purposes, through 2010, the U.S. entity generated taxable income each year;~~

time, the Company has been subject to various claims and legal actions in the ordinary course of its business. The Company is not currently involved in any legal proceeding the ultimate outcome of which, in its judgment based on information currently available, would have a ~~history~~material impact on its business, financial condition or results of ~~utilizing all operating tax loss carryforwards and has not had any tax loss carryforwards or credits expire unused;~~

~~lengthy loss carryforward periods of 20 years for U.S. federal and most state jurisdictions apply; and~~

operations.

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

~~10. INCOME TAXES (Continued)~~

the Company incurred a U.S. federal jurisdiction net operating loss for the most recently completed calendar year and has additional net operating loss carryforwards subject to limitation pursuant to IRC Section 382.

As of September 30, 2017, a valuation allowance was provided for the U.S., Hong Kong, Mexico, Spain, France, Brazil, and Canada where the Company has determined the deferred tax assets will not more likely than not be realized.

Evaluation of the remaining jurisdictions as of September 30, 2017, resulted in the determination that no additional valuation allowances were necessary at this time. However, the Company will continue to assess the need for a valuation allowance against its deferred tax assets in the future and the valuation will be adjusted accordingly, which could materially affect the Company’s financial position and results of operations.

As of September 30, 2017, and December 31, 2016, the Company’s U.S. deferred tax liability was $7.1 million and $6.1 million, respectively, related to its goodwill and indefinite lived intangibles. As of September 30, 2017 the Company had foreign net deferred tax liabilities of $46,000 compared to foreign net deferred tax liabilities of $0.1 million at December 31, 2016. As of September 30, 2017, and December 31, 2016, the Company had no unrecognized tax benefits.

For the nine months ended September 30, 2017 the Company recorded an income tax expense of $2.4 million for deferred tax expense related to the tax impact of amortization of indefinite lived intangible assets and current tax expense related to our operations in U.K., Germany, and China.

~~11.~~

12. STOCK-BASED COMPENSATION

~~2006 Stock Incentive Plan~~

On January 4, 2006, the Company established the Rosetta Stone Inc. 2006 Stock Incentive Plan (the "2006 Plan") under which the Company's Board of Directors, at its discretion, could grant stock options to employees and certain directors of the Company and affiliated entities. The 2006 Plan initially authorized the grant of stock options for up to 1,942,200 shares of common stock. On May 28, 2008, the Board of Directors authorized the grant of additional stock options for up to 195,000 shares of common stock under the plan, resulting in total stock options available for grant under the 2006 Plan of 2,137,200 as of December 31, 2008. The stock options granted under the 2006 Plan generally expire at the earlier of a specified period after termination of service or the date specified by the Board or its designated committee at the date of grant, but not more than ten years from such grant date. Stock issued as a result of exercises of stock options will be issued from the Company's authorized available stock. All unissued stock associated with the 2006 Stock Incentive Plan expired in 2016 at the end of the ten year contractual term.

2009 Omnibus Incentive Plan

On February 27, 2009, the Company's Board of Directors approved the 2009 Omnibus Incentive Plan (the "2009 Plan") that ~~provides for~~provided the ~~ability of~~Company the ~~Company~~ability to grant up to 2,437,744 of new stock incentive awards or options including Incentive and Nonqualified Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units, Performance Units, Performance Shares, Performance based Restricted Stock, Share Awards, Phantom Stock and Cash Incentive Awards. Service, performance and market-based restricted stock awards are considered outstanding at the time of grant as the stockholder is entitled to voting rights and to receive any dividends declared subject to the loss of the right to receive accumulated dividends if the award is forfeited prior to vesting. Performance units and restricted stock units do not have voting rights. The stock incentive awards and options granted under the 2009 Plan generally expire at the earlier of a specified period after termination of service or the date specified by the Board or its designated committee at the date of grant, but not more than ten years from such grant date. ~~Concurrent with~~On February 27, 2019, the ~~approval~~2009 plan expired and no additional grants will be made under this plan. Since the establishment of the 2009 Plan, ~~the 2006 Plan was terminated for purposes of future grants.~~

~~On May 26, 2011~~ the Board of Directors authorized and the Company's ~~stockholders'~~shareholders approved the allocation of ~~an additional 1,000,000 shares of common stock to the 2009 Plan. On May 23, 2012, the Board of Directors authorized and the Company's stockholders approved the allocation of 1,122,930~~ additional shares of common stock to the 2009 ~~Plan.~~ Plan as follows:

Authorization Dates of 2009 Plan Additions	Number of Common Stock Shares Authorized to 2009 Plan
February 27, 2009		2,437,744
May 26, 2011		1,000,000
May 23, 2012		1,122,930
May 23, 2013		2,317,000
May 20, 2014		500,000
June 12, 2015		1,200,000
May 27, 2017		1,900,000

2019 Omnibus Incentive Plan

On May ~~23, 2013,~~16, 2019, the Company's stockholders and Board of Directors ~~authorized and the Company's stockholders~~ approved the ~~allocation~~2019 Omnibus Incentive Plan (the "2019 Plan") that provided the Company the ability to grant up to 2,350,000 of ~~2,317,000 additional shares~~new stock incentive awards or options including Incentive and Nonqualified Stock Options, Stock Appreciation Rights, Restricted Stock, Restricted Stock Units, Performance Units, Performance Shares, Performance based Restricted Stock, Share Awards, Phantom Stock and Cash Incentive Awards. Service, performance and market-based restricted stock awards are considered outstanding at the time of ~~common stock~~grant as the stockholder is entitled to voting rights and to receive any dividends declared subject to the ~~2009 Plan. On May 20, 2014,~~loss of the right to receive accumulated dividends if the award is forfeited prior to vesting. Performance units and restricted stock units do not have voting rights. The stock incentive awards and options granted under the 2019 Plan generally expire at the earlier of a specified period after termination of service or the date specified by the Board or its designated committee at the date of Directors authorized and the Company's stockholders approved the allocation of 500,000 additional shares of common stock to the 2009 Plan. On June 12, 2015, the Board of Directors authorized and the Company's stockholders approved the allocation of 1,200,000 additional shares of common stock to the 2009 Plan. On May 24, 2017, the Board of Directors authorized and the Company's stockholders approved the allocation

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~~ROSETTA STONE INC.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~11. STOCK-BASED COMPENSATION (Continued)~~

~~of 1,900,000 additional shares of common stock to the 2009 Plan.~~grant, but not more than ten years from such grant date. At ~~September 30, 2017,~~March 31, 2020 there were ~~2,153,690~~1,369,882 shares available for future grant under the ~~2009~~2019 Plan.

Valuation Assumptions

The determination of fair value of our stock-based awards is affected by assumptions regarding subjective and complex variables. Generally, our assumptions are based on historical information and judgment is required to determine if historical trends may be indicators of future outcomes. In accordance with ASC 718, the fair value of stock-based awards to employees iscalculated as of the date of grant. Compensation expense is then recognized over the requisite service period of the award. Stock-based compensation expense recognized is based on the estimated portion of the awards that ~~are~~is expected to vest. Estimated forfeiture rates are applied in the expense calculation. The Company determines the fair values of stock-based awards as follows:

•

Service-Based Restricted Stock Awards, Restricted Stock Units, Performance-Based Restricted Stock Awards, and Performance Share Units: Fair value is determined based on the quoted market price of our common stock on the date of grant.

~~Service-Based Restricted Stock Awards, Restricted Stock Units, Performance-Based Restricted Stock Awards, and Performance Share Units: Fair value is determined based on the quoted market price~~

•

Service-Based Stock Options and Performance-Based Stock Options: Fair value is determined using the Black-Scholes pricing model, which requires the use of estimates, including the risk-free interest rate, expected volatility, expected dividends, and expected term.

Table of ~~our common stock on the date of grant.~~Contents

ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

•

Market-Based Restricted Stock Awards and Market-Based Stock Options: The fair value of the market-based awards is determined using a Monte-Carlo simulation model. The Monte Carlo valuation also estimates the number of market-based awards that would be awarded which is reflected in the fair value on the grant date. There have been no market based awards or options granted in the periods presented.

For the ~~nine~~three months ended ~~September 30, 2017, there were 48,830 stock options granted. For the nine months ended September 30, 2016,~~March 31, 2020 and March 31, 2019, the fair value of stock options granted was calculated using the following assumptions in the Black-Scholes model:

	Three months ended March 31,
	2020	2019
Expected stock price volatility	NaN	NaN
Expected term of options	none	none
Expected dividend yield	NaN	NaN
Risk-free interest rate	NaN	NaN

Nine Months Ended
September 30,
2017 2016
Expected stock price volatility 44.6% 46.1% - 47.0%
Expected term of options 6 years 5.5 - 6.5 years
Expected dividend yield — —
Risk-free interest rate 1.92% 1.24% - 1.50%

For the nine months ended September 30, 2017 and 2016, the fair value of market-based stock options and market-based restricted stock awards granted was calculated using the following assumptions in the Monte-Carlo simulation model:

Nine Months Ended
September 30,
2017 2016
Expected stock price volatility none 44.9%-49.1%
Expected term of options none 1.7 years-7 years
Expected dividend yield none —
Risk-free interest rate none .71%-1.53%

Stock-Based Compensation Expense

Stock compensation expense associated with service-based equity awards is recognized in the ~~statement~~statements of operations ~~on a straight-line basis~~ratably over the requisite service period, which is the vesting period. If an award's service inception date precedes the grant date, compensation expense is initially measured at fair value at the service inception date based on probability of payout, and remeasured at subsequent reporting dates until all of the award’s key terms and conditions are known and the grant date is established. For equity awards granted with performance-based conditions, stock compensation expense is recognized in the ~~statement~~statements of operations ratably for each vesting tranche based on the probability that operating performance conditions will be met and to what extent. Changes in the probability estimates associated with performance-based awards ~~will be~~are accounted for in the period of change using a cumulative catch-up adjustment to retroactively apply the new probability estimates. In any period in which the Company determines that

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~~ROSETTA STONE INC.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~11. STOCK-BASED COMPENSATION (Continued)~~

achievement of the performance metrics is not probable, the Company ceases recording compensation expense and all previously recognized compensation expense for the performance-based award is reversed. For equity awards granted with market-based conditions, stock compensation is recognized in the ~~statement~~statements of operations ratably for each vesting tranche regardless of meeting or not meeting the market conditions.

The following table presents stock-based compensation expense included in the related financial statement line items (in thousands):

	Three months ended March 31,
	2020		2019
Cost of revenue	$	9	$	(32	)
Sales and marketing		610		202
Research & development		240		23
General and administrative		1,402		1,027
Total stock based compensation expense	$	2,261	$	1,220

The following table presents the future stock-based compensation expense, net of forfeitures, for each equity award category as of March 31, 2020 and the weighted average period over which the expense will be recognized:

Service-based

Restricted

Stock Awards

Service-based

Stock Options

Restricted

Stock Units

Performance

Stock Units

Unrecognized compensation expense, net of forfeitures (in thousands)

5,923

141

3,500

Weighted average period over which the above expense will be recognized (in years)

3.01

0.14

1.16

1.68

Three Months Ended
September 30, Nine Months Ended
September 30,
2017 2016 2017 2016
Included in cost of revenue:
Cost of subscription and service revenue $ 9
$ 15
$ (2 ) $ 13
Cost of product revenue 12
7
36
14
Total included in cost of revenue 21
22
34
27
Included in operating expenses:
Sales and marketing 349
348
366
667
Research and development 185
391
215
561
General and administrative 997
878
2,443
2,202
Total included in operating expenses 1,531
1,617
3,024
3,430
Total $ 1,552
$ 1,639
$ 3,058
$ 3,457

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Service-Based Restricted Stock ~~Options~~

Awards

Shares of service-based restricted stock are generally recognized as expense ratably over the requisite service period of the awards, which is also the vesting period. Service-based restricted stock awards are granted at the discretion of the Board of Directors or the Compensation Committee (or its authorized member(s)) and generally vest over one-year, two-year or four -year period based upon required service conditions and do not have performance or market conditions. The Company's service-based restricted stock awards are accounted for as equity awards. The grant date fair value is based on the market price of the Company's common stock at the date of grant. The Company did not grant any restricted stock prior to April 2009.

The following table summarizes the Company's service-based restricted stock ~~option~~award activity from January 1, 2020 to March 31, 2020:

	Service-based Restricted Stock Awards			Weighted Average Grant Date Fair Value		Aggregate Intrinsic Value
Non-vested service-based awards, January 1, 2020		343,010		$	12.77	$	4,379,414
Service-based awards granted		279,078			19.45
Service-based awards vested		(130,103	)		11.69
Service-based awards cancelled		(614	)		16.97
Non-vested Service-based awards, March 31, 2020		491,371			16.85		8,277,194

The following table summarizes the Company's weighted average grant date fair value and vested fair value for the three months ended March 31, 2020 and March 31, 2019:

	Three months ended March 31,
	2020		2019
Weighted-average grant-date fair value of service-based restricted stock awards granted	$	19.45	$	15.28
Fair value of service-based restricted stock awards vested (in thousands)	$	2,497	$	1,981

Performance-Based Restricted Stock Units

Beginning in the first quarter of 2017, the Company began granting annual performance-based restricted stock units ("PSUs") to ~~September 30, 2017:~~

Service-based Options Weighted
Average
Exercise
Price Weighted
Average
Contractual
Life (years) Aggregate
Intrinsic
Value
Service-based Options Outstanding, January 1, 2017 1,793,930
$ 9.81
7.58 $ 1,154,498
Service-based options granted 48,830
11.42

Service-based options exercised (58,270 ) 7.94

Service-based options canceled (89,570 ) 9.99

Service-based Options Outstanding, September 30, 2017 1,694,920
9.92
6.86 2,409,690
Vested and expected to vest September 30, 2017 1,649,077
9.97
6.94 2,303,460
Exercisable at September 30, 2017 1,282,680
$ 10.32
6.62 $ 1,670,770

Ascertain employees which will become earned or eligible to vest based on the Company's achievement of ~~September 30, 2017, future compensation cost, net~~certain pre-defined key operating performance goals during a one to three -year period. The number of ~~estimated forfeitures, related~~PSUs earned or eligible to vest following the ~~non-vested portion~~performance period is subject to approval by the Compensation Committee of the ~~service-based stock option awards not yet recognized in~~Board of Directors. Once earned, certain PSUs are then subject to additional service and vesting requirements, while certain PSUs vest shortly after being earned. PSUs were granted at "target" (at 100% of target). Based upon actual attainment of the ~~consolidated statement~~operating performance results relative to target, actual issuance of ~~operations was $1.8 million~~PSUs can be eligible for vest anywhere between a maximum of 200% and ~~is expected~~0% of the target number of PSUs originally granted.

The following table summarizes the Company's PSU activity from January 1, 2020 to ~~be recognized over a~~March 31, 2020:

	Performance Stock Units			Weighted Average Grant Date Fair Value		Aggregate Intrinsic Value
Non-vested PSUs, January 1, 2020		615,614		$	13.84	$	11,167,238
PSUs granted		255,105			16.62
PSUs vested		(168,324	)		10.91
PSUs cancelled		(102,753	)		14.71
Non-vested PSUs, March 31, 2020		599,642		$	15.69	$	8,406,981

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The following table summarizes the Company's weighted average ~~period~~grant date fair value and fair value of ~~1.83 years.~~PSUs vested for the three months ended March 31, 2020 and March 31, 2019:

	Three months ended March 31,
	2020		2019
Weighted average grant date fair value of PSUs granted	$	16.62	$	15.21
Fair value of PSUs vested (in thousands)	$	2,302	$	3,120

Service-Based Stock Options

Service-based stock options are granted at the discretion of the Board of Directors or the Compensation Committee (or its authorized member(s)) and expire 10 years from the date of the grant. Service-based stock options to directors generally vest quarterly over a ~~four-year~~one year period based upon required service conditions and do not have performance or market conditions.

~~Table~~The aggregate intrinsic value disclosed below represents the total intrinsic value (the difference between the fair market value of ~~Contents~~

~~ROSETTA STONE INC.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~11. STOCK-BASED COMPENSATION (Continued)~~

~~Service-Based Restricted Stock Awards~~

the Company's common stock as of March 31, 2020, and the exercise price, multiplied by the number of in-the-money service-based stock options) that would have been received by the option holders had all option holders exercised their options on March 31, 2020. This amount is subject to change based on changes to the fair market value of the Company's common stock.

The following table summarizes the Company's service-based ~~restricted~~ stock ~~award~~option activity from January 1, ~~2017~~2020 to ~~September 30, 2017:~~March 31, 2020:

	Service-based Options			Weighted Average Exercise Price		Weighted Average Contractual Life (years)		Aggregate Intrinsic Value
Service-based options outstanding, January 1, 2020		1,081,592		$	10.06		5.57	$	9,022,107
Service-based options granted		—			—
Service-based options exercised		(5,625	)		7.47
Service-based options cancelled		(6,474	)		25.99
Service-based options outstanding, March 31, 2020		1,069,493			9.98		5.35		4,967,549
Vested and expected to vest at March 31, 2020		1,069,407			9.98		5.35		4,967,549
Exercisable at March 31, 2020		1,057,766			9.84		5.30	$	4,967,549

Service Based Awards Weighted
Average
Grant Date
Fair Value Aggregate
Intrinsic
Value
Non-vested Service-based Awards, January 1, 2017 374,380
$ 8.94
$ 3,348,080
Service-based awards granted 291,406
7.92

Service-based awards vested (128,013 ) 10.10

Service-based awards canceled (32,989 ) 8.11

Non-vested Service-Based Awards, September 30, 2017 504,784
$ 8.12
$ 4,096,322

As of September 30, 2017, future compensation cost, net of estimated forfeitures, related to the non-vested portion of the service-based restricted stock awards not yet recognized in the consolidated statement of operations was $2.7 million and is expected to be recognized over a weighted average period of 2.37 years.

Service-based restricted stock awards are granted at the discretion of the Board of Directors or Compensation Committee (or its authorized member(s)). Restricted stock awards generally vest over a four-year period based upon required service conditions.

~~Restricted Stock Units~~

The following table summarizes the Company's ~~restricted stock unit activity from January 1, 2017 to September 30, 2017:~~

Units Outstanding Weighted
Average
Grant Date Fair Value Aggregate
Intrinsic
Value
Units Outstanding, January 1, 2017 188,057
$ 9.93
$ 1,675,588
Units granted 40,718
11.42
465,000
Units released —
—

Units cancelled —
—

Units Outstanding, September 30, 2017 228,775
10.20
2,335,793
Vested and expected to vest at September 30, 2017 111,256
11.42
1,135,919
Vested and deferred at September 30, 2017 82,157
$ 12.44
$ 838,823

~~For~~weighted average grant date fair value and intrinsic value of options exercised for the ~~nine~~three months ended ~~September 30, 2017, there were 40,718 restricted stock units granted.~~ March 31, 2020 and March 31, 2019:

	Three months ended March 31,
	2020		2019
Weighted average grant date fair value of service-based stock options granted	$	—	$	—
Intrinsic value of options exercised (in thousands)	$	113	$	1,342

Restricted Stock Units

Restricted stock units are granted to members of the Board of Directors as part of their compensation packages. Restricted stock units to directors convert to common stock following the separation of service with the Company. ~~Restricted~~Director restricted stock ~~unit awards~~units vest quarterly over a one year period from the date of ~~grant, with~~grant. The Company also grants restricted stock units to international employees which typically vest over a two-year or four-year period. Restricted stock unit expense is recognized ~~straight-line~~ratably over the vesting period. The Company's restricted stock units are accounted for as equity awards. The grant date fair value is based on the market price of the Company's common stock at the date of grant. The Company did not grant any restricted stock units prior to April 2009.

~~Performance-Based Restricted Stock Units~~

On March 17, 2017, the Company granted performance-based restricted stock units ("PSUs") to certain employees which will become eligible to vest based on the Company's achievement of certain pre-defined key operating performance goals during the cumulative period from January 1, 2017 to December 31, 2018, which will be certified by the Compensation Committee in February 2019. Any PSUs that become eligible to vest are subject to additional service requirements where the eligible PSUs will vest annually on a pro-rata basis over the two year period beginning March 17, 2019. The PSUs were granted at "target" (at 100% of target). Based upon actual attainment of the operating performance results relative to target, actual issuance of PSUs can be eligible for vest anywhere between a maximum of 200% and 0% of the target number of PSUs originally granted.

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

~~11. STOCK-BASED COMPENSATION (Continued)~~

The following table summarizes the Company's ~~PSU~~restricted stock unit activity from January 1, ~~2017~~2020 to ~~September 30, 2017:~~March 31, 2020:

	Restricted Stock Units			Weighted Average Grant Date Fair Value		Aggregate Intrinsic Value
Units outstanding, January 1, 2020		265,913		$	12.56	$	4,823,662
Units granted		2,422			19.58
Units released		(432	)		15.11
Units cancelled		—			—
Units outstanding, March 31, 2020		267,903			12.62		3,756,000
Vested and expected to vest at March 31, 2020		266,858			12.60		3,741,344
Vested and deferred at March 31, 2020		256,294		$	12.22	$	3,593,242

PSUs Weighted
Average
Grant Date
Fair Value Aggregate
Intrinsic
Value
Non-vested PSUs, January 1, 2017 —
$ —
$ —
PSUs granted 462,870
9.43

PSUs vested —
—

PSUs canceled (16,241 ) 9.43

Non-vested PSUs, September 30, 2017 446,629
$ 9.43
$ 4,560,082

~~As of September 30, 2017, future compensation cost, net of estimated forfeitures, related to~~

The following table summarizes the ~~non-vested portion of the PSUs not yet recognized in the consolidated statement of operations was $2.2 million and is expected to be recognized over a~~Company's weighted average ~~period~~grant date fair value and fair value of ~~1.76 years.~~units converted for the three months ended March 31, 2020 and March 31, 2019:

	Three months ended March 31,
	2020		2019
Weighted average grant date fair value of restricted stock units granted	$	19.58	$	15.11
Fair value of restricted stock units converted (in thousands)	$	8	$	—

CEO 2016 Performance and Market Conditioned Restricted Stock Awards and Stock Options Grants

On April 4, 2016, the Company named Mr. John Hass as President, CEO and Chairman of the Board. In conjunction with his appointment, the Compensation Committee approved a stock-based compensation package for Mr. Hass aimed to provide significant reward potential for achieving outstanding Company operating performance results and building stockholder value. The package was comprised of 70,423 performance-based restricted stock awards (PRSAs), 314,465 performance-based stock options (PSOs), 70,423 market-based restricted stock awards (MRSAs), and 314,465 market-based stock options (MSOs). The April 4, 2016 grant date fair values associated with these grants were $7.10, $3.24, $6.17 and $0.94, respectively.

PRSAs and PSOs were eligible to vest based on the achievement of certain operating performance targets during the 2016 calendar year, related to defined measures of revenue, bookings, adjusted free cash flow, and adjusted EBITDA, certified by the Compensation Committee in the first quarter of 2017. The PRSAs and PSOs are subject to additional service requirements where the eligible PRSAs and PSOs will vest 50%, 25%, and 25% on April 4, 2017, 2018 and 2019, respectively. Awards also vest if a majority change in control of the Company occurs during the performance or vesting period.

On February 20, 2017, the Compensation Committee approved 64,719 PRSAs and 144,497 PSOs as eligible ~~under this plan, subject to the aforementioned~~for further service vesting requirements. The non-eligible 5,704 and 169,968 PRSAs and PSOs, respectively, were cancelled as of February 20, 2017. PRSAs and PSOs vested 50%, 25% and 25% on April 4, 2017, 2018 and 2019, respectively. As of ~~September 30, 2017, 32,359~~March 31, 2020, all PRSAs ~~were vested~~ and ~~72,248~~ PSOs were vested. ~~Future compensation cost related to the non-vested portion~~As of ~~the PRSAs and~~March 31, 2020, 0 PSOs ~~not yet recognized in the consolidated statement of operations was $0.2 million and is expected to be recognized over a weighted average period of 1.26 years.~~

~~In addition to the market condition, the MRSAs and MSOs also~~ have a service condition. Vesting of these MRSAs and MSOs are dependent upon whether the Company achieves predetermined growth rates of total stockholder return for the two-year measurement period beginning on January 4, 2016 and ending on December 29, 2017. Following the end of the market performance measurement period on December 29, 2017,been exercised.

On February 22, 2018, the Compensation Committee ~~will certify~~approved the ~~eligible~~maximum quantity of 140,846 MRSAs and 314,465 MSOs as eligible for further service vesting requirements. MRSAs and MSOs ~~which will~~ vest annually on a pro-rata basis over three years beginning April 4, 2018. ~~The Company records compensation expense ratably for each vesting tranche~~As of ~~the MRSAs and MSOs based on the Monte Carlo fair value estimated on the grant date, regardless of meeting or not meeting the market conditions.~~

~~The~~March 31, 2020, 46,948 MRSAs were granted at "target" (at 100% of target). Based upon actual attainment of total stockholder return growth rate results through December 29, 2017 relative to target, actual issuance of MRSAs can fall anywhere between a maximum of 200%unvested and ~~0% of the target number of MRSAs originally granted. The~~104,821 MSOs were ~~granted at "maximum" (at 200% of target). Based~~unvested, but will vest on actual attainment of total stockholder return growth rate results through December 29, 2017 relative to maximum, actual issuance of stock options can fall anywhere between 100% and 0% of the maximum number of MSOs originally granted.

April 4, 2020. As of ~~September 30, 2017,~~March 31, 2020, 0 MSOs have been exercised. As of March 31, 2020, future compensation cost related to the non-vested portion of the MRSAs and MSOs not yet recognized in the consolidated statement of operations was ~~$0.3~~less than $0.1 million and ~~is expected to~~the remaining expense will be recognized ~~over a weighted average period~~in the second quarter of ~~1.96 years.~~

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~~ROSETTA STONE INC.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~12.~~2020.

13. STOCKHOLDERS' DEFICIT

At ~~September 30, 2017,~~March 31, 2020, the Company's Board of Directors had the authority to issue 200,000,000 shares of stock, of which 190,000,000 were designated as Common Stock, with a par value of $0.00005 per share, and 10,000,000 were designated as Preferred Stock, with a par value of $0.001 per share. At ~~September 30, 2017,~~March 31, 2020, the Company had shares of common stock issued of ~~23,800,330~~25,580,107 and shares of common stock outstanding of ~~22,800,330.~~

On August 22, 2013, the Company’s Board of Directors approved a share repurchase program under which the Company is authorized to repurchase up to $25 million of its outstanding common stock from time to time in the open market or in privately negotiated transactions depending on market conditions, other corporate considerations, debt facility covenants and other contractual limitations, and applicable legal requirements. For the year ended December 31, 2013, the Company paid $11.4 million to repurchase 1,000,000 shares at a weighted average price of $11.44 per share as part of this program. No shares were repurchased during 2014, 2015, 2016, or the nine months ended September 30, 2017. Shares repurchased under the program were recorded as treasury stock on the Company’s consolidated balance sheet. The shares repurchased under this program during the year ended December 31, 2013 were not the result of an accelerated share repurchase agreement. Management has not made a decision on whether shares purchased under this program will be retired or reissued.

~~13. RESTRUCTURING~~

~~2016 Restructuring Plan~~

24,580,107.

In the first quarter of ~~2016,~~2020, the Company ~~announced and initiated actions to withdraw the direct sales presence~~issued 67,540 shares of unrestricted common stock in ~~almost all~~settlement of its non-U.S. and non-northern European geographies related to the distribution of Enterprise & Education Language offerings. The Company does not expect to incur any additional material restructuring costs in connection with the 2016 Restructuring Plan. The 2016 Restructuring Plan remaining balance is expected to be paid during 2017.

~~Restructuring charges included~~a previously accrued cash bonus liability; resulting in the ~~Company’s unaudited consolidated statement~~reclassification of ~~operations related~~$1.3 million to additional paid-in capital. In the ~~2016 Restructuring Plan include~~first quarter of 2019, the ~~following:~~

~~Employee severance and related benefits costs incurred~~Company issued 36,776 shares of unrestricted common stock in ~~connection with headcount reductions involving employees primarily in France, China, Brazil, Canada, Spain, Mexico, U.S. and the U.K.;~~

~~Contract termination costs associated with operating lease terminations from office closures; and~~

~~Other related costs.~~

~~The following table summarizes activity with respect to the restructuring charges for the 2016 Restructuring Plan during the nine months ended September 30, 2017 (in thousands):~~

Balance at January 1, 2017 Cost Incurred Cash Payments Balance at September 30, 2017
Severance costs $ 500
$ (12 ) $ (282 ) $ 206
Contract termination costs 22
—
—
22
Other costs 70
14
(81 ) 3
Total $ 592
$ 2
$ (363 ) $ 231

~~(1) Other Adjustments includes non-cash period changes~~settlement of a previously accrued cash bonus liability; resulting in the ~~liability balance, which may include non-cash lease closure expense and foreign currency translation adjustments.~~

~~2015 Restructuring Plan~~

~~In 2015, the Company announced and initiated actions~~reclassification of $0.6 million to reduce headcount and other costs in order to support its strategic shift in business focus. During 2016, the final costs were incurred and final payments were made against the 2015 Restructuring Plan accruals. The Company does not expect to incur any additional ~~restructuring costs in connection with the 2015 Plan.~~

paid-in capital.

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

~~13. RESTRUCTURING (Continued)~~

~~Other Employee Severance Actions~~

In the first quarter of 2017, the Company initiated actions to reduce headcount in its U.S. consumer product operations and its China locations. Primarily comprised of severance costs associated with these actions, the Company recorded expense of $0.8 million in the first quarter of 2017. The Company recorded an additional $0.2 million and $0.2 million in the second and third quarters of 2017, respectively, related to the reduction of headcount in the Fit Brains business and other terminations in consumer product operations. Of these amounts, $0.8 million has been paid and the remaining $0.4 million

14. BASIC AND DILUTED NET LOSS PER SHARE

Net loss per share is ~~expected to be paid before the end of 2017.~~

~~Restructuring Cost~~

The following table summarizes the major types of costs associated with the restructuring actions for the three and nine months ended September 30, 2017 and 2016, and total costs incurred through September 30, 2017 (in thousands):

Three Months Ended
September 30, Nine Months Ended
September 30, Incurred through
2017 2016 2017 2016 September 30, 2017
Severance costs $ 186
$ (8 ) $ 1,118
$ 4,478
$ 12,796
Contract termination costs 1
69
37
163
1,336
Other costs 9
101
26
542
1,033
Total $ 196
$ 162
$ 1,181
$ 5,183
$ 15,165

As of September 30, 2017, the entire restructuring liability of $0.6 million was classified as a current liability within accrued compensation and other current liabilities on the consolidated balance sheets.

~~The following table presents total restructuring costs associated with the restructuring actions included in the related line items of our Statement of Operations (in thousands):~~

Three Months Ended
September 30, Nine Months Ended
September 30,
2017 2016 2017 2016
Cost of revenue $ 108
$ (5 ) $ 313
$ 567
Sales and marketing 91
68
426
2,287
Research and development (13 ) (16 ) 332
912
General and administrative 10
115
110
1,417
Total $ 196
$ 162
$ 1,181
$ 5,183

~~These restructuring expenses are not allocated to any reportable segment under our definition of segment contribution as defined in Note 16 "Segment Information."~~

At each reporting date, the Company will evaluate its accrued restructuring costs to ensure the liabilities reported are still appropriate. Any changes to the estimated costs of executing approved restructuring plans will be reflected in the Company’s consolidated statements of operations.

~~14. LEASE ABANDONMENT AND TERMINATION~~

As part of the Company’s effort to reduce general and administrative expenses through a planned space consolidation at its Arlington, Virginia headquarters location, the Company incurred lease abandonment charges of $3.2 million in the first quarter of 2014. Prior to January 31, 2014, the Company occupied the 6th and 7th floors at its Arlington, Virginia headquarters. The Company estimated the liability under operating lease agreements and accrued lease abandonment costs in accordance with ASC 420, ~~Exit or Disposal Cost Obligation~~ ("ASC 420"), as the Company has no future economic benefit from the abandoned space and the lease does not terminate until December 31, 2018. All leased space related to the 6th floor was abandoned and ceased to be used by the Company on January 31, 2014.

In a further effort to reduce general and administrative expenses through a planned space consolidation, the Company relocated its headquarters location to 1621 North Kent Street, Suite 1200, Arlington, Virginia 22209. The previously leased

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~~ROSETTA STONE INC.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~14. LEASE ABANDONMENT AND TERMINATION (Continued)~~

space at the 7th floor of 1919 North Lynn Street was abandoned and ceased to be used by the Company on October 10, 2016 and resulted in $1.6 million in lease abandonment expense in the fourth quarter of 2016.

~~A summary of the Company’s lease abandonment activity for the nine months ended September 30, 2017 and 2016 is as follows (in thousands):~~

As of September 30,
2017 2016
Accrued lease abandonment costs, beginning of period $ 2,123
$ 1,281
Costs incurred and charged to expense —
30
Principal reductions (759 ) (328 )
Accrued lease abandonment costs, end of period $ 1,364
$ 983
Accrued lease abandonment costs liability:
Short-term $ 1,078
$ 422
Long-term 286
561
Total $ 1,364
$ 983

~~15. COMMITMENTS AND CONTINGENCIES~~

~~Operating Leases~~

~~The Company leases copiers, parking spaces, buildings, a warehouse and office space under operating lease and site license arrangements, some of which contain renewal options.~~

~~The following table summarizes future minimum operating lease payments for the remaining three months of 2017 and the years thereafter (in thousands):~~

As of September 30, 2017
Periods Ending December 31,
2017-remaining $ 927
2018 4,744
2019 1,742
2020 1,003
2021 590
Thereafter —
Total $ 9,006

Total expenses under operating leases are $0.6 million and $1.2 million for the three months ended September 30, 2017 and 2016, respectively. Total expenses under operating leases are $1.9 million and $3.3 million for the nine months ended September 30, 2017 and 2016, respectively.

~~The Company accounts for its leases~~computed under the provisions of ASC topic ~~840,~~ ~~Accounting~~260, Earnings Per Share. Basic loss per share is computed using net loss and the weighted average number of shares of common stock outstanding. Diluted loss per share reflects the weighted average number of shares of common stock outstanding plus any dilutive shares outstanding during the period. Potentially dilutive shares consist of shares issuable upon the exercise of stock options, restricted stock awards, and restricted stock units.

The following table sets forth the computation of basic and diluted net loss per common share (amounts in thousands, except per share amounts):

	Three months ended March 31,
	2020			2019
Numerator:
Net loss	$	(6,181	)	$	(544	)
Denominator:
Basic weighted average shares		23,803			23,036
Diluted weighted average shares		23,803			23,036
Loss per share:
Basic	$	(0.26	)	$	(0.02	)
Diluted	$	(0.26	)	$	(0.02	)

The Company calculates dilutive common stock equivalent shares using the treasury stock method. In periods where the Company has a net loss, no dilutive common stock equivalent shares are included in the calculation for ~~Leases~~ ("diluted shares as they are considered anti-dilutive. The following table sets forth dilutive common stock equivalent shares calculated using the treasury stock method (in thousands):

	Three months ended March 31,
	2020		2019
Stock options		589		721
Restricted stock units		261		232
Restricted stocks		451		551
Total common stock equivalent shares		1,301		1,504

Share-based awards to purchase approximately 0.2 and 0 million shares of common stock that had an exercise price in excess of the average market price of the common stock during the three months ended March 31, 2020 and March 31, 2019, respectively, were not included in the calculation of diluted loss per share because they were anti-dilutive..

15. INCOME TAXES

In accordance with ASC ~~840"~~topic 740, Income Taxes (“ASC 740”), and ASC subtopic 740-270, Income Taxes: Interim Reporting, the income tax provision for the three months ended March 31, 2020 is based on the estimated annual effective tax rate for fiscal year 2020. The estimated effective tax rate may be subject to adjustment in subsequent ~~amendments, which require~~quarterly periods as the estimates of pretax income for the year, along with other items that ~~leases~~may affect the rate, may change and may create a different relationship between domestic and foreign income and loss.

Valuation Allowance Recorded for Deferred Tax Assets

As of March 31, 2020, a valuation allowance was provided for the U.S., Hong Kong, Mexico, Spain, France, and Brazil where the Company previously determined in prior periods the deferred tax assets will not more likely than not be evaluated and classified as operating leases or capital leases for financial reporting purposes. Certain operating leases contain rent escalation clauses, which are recorded on a straight-line basis over the initial termrealized.

Evaluation of the ~~lease with~~remaining jurisdictions as of March 31, 2020, resulted in the ~~difference between~~determination that no additional valuation allowances were necessary at this time. However, the ~~rent paid~~Company will continue to assess the need for a valuation allowance against its deferred tax assets in the future and the ~~straight-line rent recorded as either a~~valuation allowance will be adjusted accordingly, which could materially affect the Company’s financial position and results of operations.

As of March 31, 2020, and December 31, 2019, the Company’s U.S. deferred ~~rent asset or~~tax liability ~~depending on~~was $2.6 million and $2.5 million, respectively, related to its goodwill and indefinite lived intangibles. As of March 31, 2020 the ~~calculation. Lease incentives received from landlords are recorded as~~Company had foreign net deferred ~~rent liabilities and are amortized on a straight-line basis over the lease term as a reduction to rent expense.~~

tax

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

~~15. COMMITMENTS AND CONTINGENCIES (Continued)~~

~~Litigation~~

~~From time~~

assets of $0.1 million compared to ~~time,~~foreign net deferred tax assets of $0.1 million at December 31, 2019. As of March 31, 2020, and December 31, 2019, the Company ~~has been subject~~had 0 unrecognized tax benefits.

For the three months ended March 31, 2020 the Company recorded an income tax expense of $0.4 million related to ~~various claims and legal actions~~profits of operations for foreign jurisdictions in the ~~ordinary course~~U.K., Germany, China, France and Canada and deferred tax expense related to the tax impact of ~~its business. The Company is not currently involved in any legal proceeding the ultimate outcome~~amortization of ~~which, in its judgment based on information currently available, would have a material impact on its business, financial condition or results of operations.~~

indefinite lived intangible assets.

16. SEGMENT INFORMATION

The Literacy segment derives the majority of its revenue from the sales of literacy solutions to educational institutions serving grades K through 12. The ~~Enterprise & Education ("~~E~~&E")~~&E Language segment derives revenue from sales of language-learning solutions to educational institutions, corporations, and government agencies worldwide. The Consumer Language segment derives the majority of its revenue from sales of language-learning solutions to individuals and retail partners. Revenue from transactions between the Company's operating segments is not material. ~~The Company's current operating segments also represent the Company's reportable segments.~~

The Company and its Chief Operating Decision Maker ("CODM") assess profitability and performance of each of its current operating segments in terms of segment contribution. Segment contribution is calculated as segment revenue less expenses directly incurred by or allocated to the segment. Direct segment expenses ~~include costs and expenses that are directly incurred by or allocated to the segment and~~ include materials costs, service costs, customer care and coaching costs, sales and marketing expenses, and bad debt expense. In addition to the previously referenced expenses, the Literacy segment includes direct research and development expenses and Combined Language includes shared research and development expenses, cost of revenue, and sales and marketing expenses applicable to the Consumer Language and ~~Enterprise & Education~~E&E Language segments. Segment contribution excludes depreciation, amortization, stock compensation, restructuring and other related expenses. The Company does not allocate expenses beneficial to all segments, which include certain general and administrative expenses such as legal fees, payroll processing fees, accounting related expenses, lease abandonment,impairment, and non-operating income and expense. These expenses are included below the segment contribution line in the unallocated expenses section of the tables presented below.

~~Beginning on January 1, 2017, the Company modified its definition and presentation of segment contribution.~~

The E&E Language segment and Consumer Language segment are ~~now~~ characterized as "Language" since both of these segments primarily address the language-learning market and share many of the same costs. These shared language costs are included in the "Shared Services" column of the tables presented below. General and administrative expenses directly incurred by the Language segments consist only of bad debt expense, net of recoveries. Additionally, research and ~~developments~~development expenses are ~~now~~ included in segment contribution. Further, the depreciation, amortization, stock compensation, restructuring and other related expenses which are included in cost of revenue, sales and marketing, research and development, and general and administrative are presented in total as ~~unallocated~~shared Language costs. ~~Prior periods have been reclassified to reflect our current segment presentation and definition of segment contribution.~~ The Company will continue to evaluate its management reporting and will update its operating and reportable segments as appropriate.

With the exception of goodwill, the Company does not identify or allocate its assets by operating segment. Consequently, the Company does not present assets or liabilities by operating segment.

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

~~16. SEGMENT INFORMATION (Continued)~~

Operating results by segment for the three months ended ~~September 30, 2017~~March 31, 2020 were as follows (in thousands):

				Language
	Literacy Segment			E&E Language Segment			Consumer Language Segment			Shared Services			Combined Language			Total Company
Revenue	$	17,486		$	13,552		$	16,141		$	—		$	29,693		$	47,179

Cost of revenue		2,936			2,271			2,437			(1	)		4,707			7,643
Sales and marketing		8,039			5,807			10,588			4			16,399			24,438
Research and development		3,142			—			—			3,182			3,182			6,324
General and administrative		552			(24	)		206			—			182			734
Segment contribution	$	2,817		$	5,498		$	2,910		$	(3,185	)	$	5,223		$	8,040
Segment contribution margin %		16.1	%		40.6	%		18.0	%					17.6	%

Unallocated depreciation and amortization, stock compensation, and other expenses (net) included in:
Cost of revenue																	3,458
Sales and marketing																	996
Research and development																	593
General and administrative																	1,963
Subtotal																	7,010

Corporate unallocated expenses, net:
Unallocated general and administrative																	6,865
Unallocated non-operating income																	(34	)
Subtotal																	6,831

Loss before income taxes																$	(5,801	)

Language
Literacy Segment E&E Segment Consumer Segment Shared Services Combined Language Total Company

Revenue $ 11,028
$ 16,529
$ 18,649
$ —
$ 35,178
$ 46,206

Cost of revenue 1,666
1,756
4,464
(3 ) 6,217
7,883
Sales and marketing 6,402
7,511
8,428
269
16,208
22,610
Research and development 1,820
—
—
3,882
3,882
5,702
General and administrative 558
86
74
—
160
718
Segment contribution $ 582
$ 7,176
$ 5,683
$ (4,148 ) $ 8,711
$ 9,293
Segment contribution margin % 5.3 % 43.4 % 30.5 %

Unallocated depreciation and amortization, stock compensation, restructuring and other expenses (net) included in:
Cost of revenue 1,565
Sales and marketing 1,044
Research and development 679
General and administrative 1,724
Subtotal 5,012

Corporate unallocated expenses, net:
Unallocated general and administrative 6,593
Unallocated non-operating income 40
Subtotal 6,633

Loss before income taxes $ (2,352 )

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

~~16. SEGMENT INFORMATION (Continued)~~

Operating results by segment for the three months ended ~~September 30, 2016~~March 31, 2019 were as follows (in thousands):

				Language
	Literacy Segment			E&E Language Segment			Consumer Language Segment			Shared Services			Combined Language			Total Company
Revenue	$	14,806		$	14,443		$	15,362		$	—		$	29,805		$	44,611

Cost of revenue		2,458			1,469			1,984			(1	)		3,452			5,910
Sales and marketing		6,909			6,846			8,833			30			15,709			22,618
Research and development		1,995			—			—			3,651			3,651			5,646
General and administrative		431			21			(3	)		—			18			449
Segment contribution	$	3,013		$	6,107		$	4,548		$	(3,680	)	$	6,975		$	9,988
Segment contribution margin %		20.3	%		42.3	%		29.6	%					23.4	%

Unallocated depreciation and amortization, stock compensation, and other expenses (net) included in:
Cost of revenue																	2,516
Sales and marketing																	620
Research and development																	92
General and administrative																	1,637
Subtotal																	4,865

Corporate unallocated expenses, net:
Unallocated general and administrative																	6,606
Unallocated non-operating income																	(769	)
Subtotal																	5,837

Loss before income taxes																$	(714	)

Language
Literacy Segment E&E Segment Consumer Segment Shared Services Combined Language Total Company

Revenue $ 8,786
$ 18,336
$ 21,571
$ —
$ 39,907
$ 48,693

Cost of revenue 1,446
2,220
3,370
(4 ) 5,586
$ 7,032
Sales and marketing 5,917
7,921
11,996
358
20,275
$ 26,192
Research and development 1,214
—
—
4,404
4,404
$ 5,618
General and administrative 573
131
(28 ) —
103
$ 676
Segment contribution $ (364 ) $ 8,064
$ 6,233
$ (4,758 ) $ 9,539
$ 9,175
Segment contribution margin % (4.1 )% 44.0 % 28.9 %

Unallocated depreciation and amortization, stock compensation, restructuring and other expenses (net) included in:
Cost of revenue 1,339
Sales and marketing 969
Research and development 729
General and administrative 2,534
Subtotal 5,571

Corporate unallocated expenses, net:
Unallocated general and administrative 6,759
Unallocated impairment 1,028
Unallocated non-operating income (524 )
Subtotal 7,263

Loss before income taxes $ (3,659 )

~~Table of Contents~~

~~ROSETTA STONE INC.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~16. SEGMENT INFORMATION (Continued)~~

~~Operating results by segment for the nine months ended September 30, 2017 were as follows (in thousands):~~

Language
Literacy Segment E&E Segment Consumer Segment Shared Services Combined Language Total Company

Revenue $ 31,568
$ 50,289
$ 57,947
$ —
$ 108,236
$ 139,804

Cost of revenue 4,823
5,455
10,376
(9 ) 15,822
20,645
Sales and marketing 17,542
23,166
27,385
1,175
51,726
69,268
Research and development 4,755
—
—
12,644
12,644
17,399
General and administrative 1,314
16
86
—
102
1,416
Segment contribution $ 3,134
$ 21,652
$ 20,100
$ (13,810 ) $ 27,942
$ 31,076
Segment contribution margin % 9.9 % 43.1 % 34.7 %

Unallocated depreciation and amortization, stock compensation, restructuring and other expenses (net) included in:
Cost of revenue 4,535
Sales and marketing 2,591
Research and development 1,744
General and administrative 4,916
Subtotal 13,786

Corporate unallocated expenses, net:
Unallocated general and administrative 19,322
Unallocated non-operating income (481 )
Subtotal 18,841

Loss before income taxes $ (1,551 )

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~~ROSETTA STONE INC.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~16. SEGMENT INFORMATION (Continued)~~

~~Operating results by segment for the nine months ended September 30, 2016 were as follows (in thousands):~~

Language
Literacy Segment E&E Segment Consumer Segment Shared Services Combined Language Total Company

Revenue $ 24,313
$ 54,157
$ 63,941
$ —
$ 118,098
$ 142,411

Cost of revenue 3,174
6,941
10,398
(13 ) 17,326
$ 20,500
Sales and marketing 16,572
25,597
38,310
1,332
65,239
$ 81,811
Research and development 2,997
—
—
13,878
13,878
$ 16,875
General and administrative 1,438
355
26
—
381
$ 1,819
Segment contribution $ 132
$ 21,264
$ 15,207
$ (15,197 ) $ 21,274
$ 21,406
Segment contribution margin % 0.5 % 39.3 % 23.8 %

Unallocated depreciation and amortization, stock compensation, restructuring and other expenses (net) included in:
Cost of revenue 3,883
Sales and marketing 4,883
Research and development 2,791
General and administrative 8,546
Subtotal 20,103

Corporate unallocated expenses, net:
Unallocated general and administrative 20,499
Unallocated lease abandonment expense 30
Unallocated impairment 3,930
Unallocated non-operating income (2,469 )
Subtotal 21,990

Loss before income taxes $ (20,687 )

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 distributors and resellers who purchase and resell the Company's products may be different from the geographic locations of end customers.

The information below summarizes revenue from customers by geographic area for the three ~~and nine~~ months ended ~~September 30, 2017~~March 31, 2020 and ~~2016~~2019 (in thousands):

	Three months ended March 31,
	2020		2019
United States	$	42,529	$	39,830
International		4,650		4,781
Total revenue	$	47,179	$	44,611

Three Months Ended
September 30, Nine Months Ended
September 30,
2017 2016 2017 2016
United States $ 39,661
$ 41,042
$ 120,286
$ 118,463
International 6,545
7,651
19,518
23,948
Total $ 46,206
$ 48,693
$ 139,804
$ 142,411

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~~ROSETTA STONE INC.~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)~~

~~16. SEGMENT INFORMATION (Continued)~~

The information below summarizes long-lived assets by geographic area classified as held and used as of ~~September 30, 2017~~March 31, 2020 and December 31, ~~2016~~2019 (in thousands):

	As of
	March 31, 2020		December 31, 2019
United States	$	37,384	$	37,378
International		1,740		1,873
Total property and equipment, net	$	39,124	$	39,251

September 30,
2017 December 31,
2016
United States $ 25,732
$ 21,652
International 3,090
3,143
Total $ 28,822
$ 24,795

~~Revenue by Type~~

~~The Company earns revenue from the sale~~

Table of ~~language-learning, literacy and brain fitness products and services. The information below summarizes revenue by type for the three and nine months ended September 30, 2017 and 2016 (in thousands):~~

Three Months Ended
September 30, Nine Months Ended
September 30,
2017 2016 2017 2016
Language learning $ 34,478
$ 38,711
$ 105,898
$ 114,550
Literacy 11,028
8,786
31,568
24,313
Brain fitness 700
1,196
2,338
3,548
Total $ 46,206
$ 48,693
$ 139,804
$ 142,411

Contents

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q (this "Report") and other statements or presentations made from time to time by the Company, including the documents incorporated by reference, contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by non-historical statements and often include words such as "outlook," "potential," "believes," "expects," "anticipates," "estimates," "intends," "plans," "seeks" or words of similar meaning, or future-looking or conditional verbs, such as "will," "should," "could," "may," "might," "aims," "intends," "projects," or similar words or phrases. These statements may include, but are not limited to, statements related to: our business strategy; guidance or projections related to revenue, Adjusted EBITDA, sales and bookings ~~(or "sales")~~(which is an operational metric that represents executed contracts received by the Company that are either recorded immediately as revenue or deferred revenue and in any one period is equal to revenue plus the change in deferred revenue), and other measures of future economic performance; the contributions and performance of our businesses including acquired businesses and international operations; projections for future capital expenditures; and other guidance, projections, plans, objectives, and related estimates and assumptions. A forward-looking statement is neither a prediction nor a guarantee of future events or circumstances. In addition, forward-looking statements are based on the Company’s current assumptions, expectations and beliefs and are subject to certain risks and uncertainties that could cause actual results to differ materially from our present expectations or projections. Some important factors that could cause actual results, performance or achievement to differ materially from those expressed or implied by these forward-looking statements include, but are not limited to: the impact of the COVID-19 pandemic on the global economy; the risk that we are unable to execute our business strategy; declining demand for our language learning and literacy solutions; the risk that we are not able to manage and grow our business; the impact of any revisions to our pricing strategy; the risk that we might not succeed in introducing and producing new products and services; the impact of foreign exchange fluctuations; the adequacy of internally generated funds and existing sources of liquidity, such as bank financing, as well as our ability to raise additional funds; the risk that we cannot effectively adapt to and manage complex and numerous technologies; the risk that businesses acquired by us might not perform as expected; and the risk that we are not able to successfully expand internationally. We expressly disclaim any obligation to update or revise any forward-looking statements, whether as a result of new information, future developments or otherwise, except as required by law. These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements risks and uncertainties that are more fully described in the Company's filings with the U.S. Securities and Exchange Committee (SEC), including those described below, those discussed in the sections titled "Risk Factors" in Part II, Item 1A of this Report and those updated from time to time in our future reports filed with the Securities and Exchange Commission. This section should be read together with our unaudited consolidated financial statements and related notes set forth elsewhere in this Report, "Management's Discussion and Analysis of Financial Condition and Results of Operations", and ~~should be read together with~~ our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March ~~14, 2017.~~

11, 2020.

Overview

Rosetta Stone Inc. ("Rosetta Stone," the "Company," "we" or "us") is dedicated to changing people's lives through the power of language and literacy education. Our innovative digital solutions drive positive learning outcomes for the inspired learner at home or in schools and workplaces around the world. Founded in 1992, Rosetta Stone's language division uses cloud-based solutions to help all types of learners read, write, and speak ~~more than 30~~world languages. Lexia Learning, Rosetta Stone's literacy education division, was founded more than 30 years ago and is a leader in the literacy education space. Today, Lexia helps students build foundational reading skills through its rigorously researched, independently evaluated, and widely respected instruction and assessment programs. Rosetta Stone Inc. was incorporated in Delaware in 2005.

The Literacy segment derives the majority of its revenue from ~~the~~ sales of literacy solutions to educational institutions serving grades K through 12. The Enterprise & Education ("E&E") Language segment derives revenue from sales of language-learning solutions to educational institutions, corporations, and government agencies worldwide. The Consumer Language segment derives the majority of revenue from sales of language-learning solutions to individuals and retail partners. Our Literacy distribution channel utilizes a direct sales force as well as relationships with third-party resellers focused on the sale of Lexia Learning solutions to K-12 schools. Our ~~Enterprise & Education~~E&E Language distribution model is focused on targeted sales activity primarily through a direct sales force in five markets: K-12 schools; ~~colleges and universities;~~higher education; federal government agencies; corporations; and not-for-profit organizations. Our Consumer Language distribution channel comprises a mix of our call centers, websites, app-stores, third party e-commerce websites, select retail resellers, such as Amazon.com, Barnes & Noble, Target, and Best Buy, ~~Books-a-Million, Sam's Club, Staples,~~ consignment distributors such as Software Packaging Associates, and daily deal ~~partners. In September 2017, Wynit Distribution LLC, one of our retail~~ partners ~~filed for bankruptcy. We are in the process of moving the impacted business to other retailers~~ and ~~do not expect this to have a significant operational or financial impact to our business.~~

home shopping resellers.

As our Company has evolved, we believe that our ~~Literacy~~current portfolio of language and ~~Enterprise & Education Language segments are~~literacy products and our ~~largest opportunity~~SaaS-based delivery model provides multiple opportunities for long-term value creation. The customers in these markets have demands that recur each year, creating a more predictable sales opportunity and higher lifetime value. This need profile also fits well with our suite of language and

~~literacy products and the well-known Rosetta Stone brand.~~ We also believe the demand is growing for e-learning based literacy solutions in the U.S. and English language-learning around the ~~globe.~~

~~As a result,~~globe, and we are ~~emphasizing~~uniquely positioned with the power of our global brand to meet the growing needs of global learners.

We continue to emphasize the development of products and solutions for ~~Corporate and K-12~~ learners who need to speak and read English. This focus extends to the Consumer Language segment, where we continue to make product investments serving the needs of passionate language learners who are ~~motivated,~~mobile, results focused and ~~willing to pay for~~value a quality language-learning experience.

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To position the organization for success, our focus is on the following priorities:


1.	Grow literacy sales by providing fully aligned digital instruction and assessment tools for K-12, building a direct distribution sales force to augment our historical reseller model, and continuing to develop our implementation services business;

~~Position our Enterprise & Education Language business for profitable~~

Continued growth ~~by focusing our direct sales on our best geographies and customer segments, partnering with resellers in other geographies and successfully delivering our Catalyst~~^TM product to Corporate customers. Catalyst integrates our Foundations, Advantage and Advanced English for Business products with enhanced reporting, assessment and administrator tools that offers a simple, more modern, metrics-driven suite of tools that are results-oriented and easily integrated with leading corporate language-learning systems;


3.	~~Maximize the profitability~~ of our ~~Consumer language business by providing an attractive value proposition and a streamlined, mobile-oriented product portfolio focused on consumers' demand, while optimizing~~K-12 business;

Leveraging our ~~marketing spend appropriately;~~


4.	~~Seek opportunities to leverage our language assets including our content, tools and pedagogy, as well as our well-known~~iconic Rosetta Stone ~~brand, through partnerships with leading players~~brand;

Position ourselves as a leader in ~~key markets around the world;~~adaptive blended learning; and


5. 4.	~~Continue to identify opportunities to become more efficient.~~ Accelerate growth and increase intrinsic value.

In pursuing these priorities, we will (i) allocate capital to the areas of our business that we believe have the greatest value creation potential, including our Lexia Learning business, (ii) focus our businesses on their best customers, including K-12 learners primarily in North America, Corporate learners primarily in North America and Northern Europe in our Enterprise & Education Language segment, and passionate learners in the U.S. and select non-U.S. markets in our Consumer language business, and (iii) optimize the sales and marketing costs for these businesses and the costs of our business overall.

In March 2016, we announced the 2016 Restructuring Plan ("2016 Restructuring Plan"), outlining our withdrawal of the direct sales presence in almost all of our non-U.S. and non-northern European geographies related to the distribution of the Enterprise & Education Language offerings. These operations added sales, but at too high a cost and without the near-term ability to capture scale efficiencies. Where appropriate, we will seek to operate through partners in the geographies being exited. We have also initiated processes to close our software development operations in France and China. See Note 2 "Summary of Significant Accounting Policies" and Note 13 "Restructuring" of Part 1 - Item 1, Financial Statements for additional information about these strategic undertakings.

As of ~~September 30, 2017,~~March 31, 2020, we currently have three operating segments, Literacy, ~~Enterprise & Education~~E&E Language, and ~~Consumer.~~Consumer Language. We discuss the profitability of each segment in terms of segment contribution. Segment contribution is the measure of profitability used by our Chief Operating Decision Maker ("CODM"). See Note 16 "Segment Information" of Part 1 - Item 1, Financial Statements for information about recent changes in the definition and presentation of segment contribution.

COVID-19 Update

In late 2019, a novel strain of coronavirus that causes the disease COVID-19 surfaced in Wuhan, China. COVID-19 quickly spread, causing a global pandemic. To combat the spread of COVID-19, authorities have taken a variety of steps to protect their citizens, including closing schools and workplaces and requiring people to stay at home and practice social distancing. These actions have had significant negative impacts on the global economy.

We recognize that COVID-19 has changed the way our employees work with each other and our customers, and we are committed to ensuring these changes cause the least disruption to our learners. All of our solutions can be used by learners remotely and we are capable of providing our services to our customers while following social distancing protocols. In response to extensive business and school closures around the world and the growing need to adopt distance-learning solutions, we have implemented the following initiatives:

•

communications to districts and schools regarding best practices for remote learning;

~~Literacy segment contribution increased~~

•

expanded access to our products for all of our existing K-12 customers through the end of the school year, with no additional charge, to help them move to remote learning;

•

leaving licenses on for customers who are dealing with a very disruptive change to the way they work, and to not push them to pay immediately;

•

Lexia Academy, which provides online implementation and training support for teachers, has been provisioned to help teachers implement our products with their students;

•

three months of a free language learning subscription available to any elementary, middle or high school student;

•

free unlimited group language tutoring for all paying consumer subscribers through June 30, 2020; and

•

upgrades, free of charge, for our “bronze” access level Enterprise customers to a “silver” access level to provide access to online group tutoring.

While we are confident of our ability to $0.6 million with segment contribution margin of 5% for the three months ended September 30, 2017, as compared to a segment contribution of negative $0.4 million and segment contribution margin of negative 4% for the three months ended September 30, 2016. The dollar and margin increases were primarily due to the larger revenue base on which segment contributionsupport learners during this period, there is ~~calculated, partially offset by increases in direct research and development expenses, sales and marketing expenses, and cost of sales~~uncertainty surrounding:

•

increased costs associated with the increase in our customer base as a result of the initiatives described above;

•

unprecedented levels of disruption that may distract our customers and delay purchasing decisions;

•

customers, particularly in our enterprise business, that may be facing financial difficulties that may lead to slower cash collection or cancellation due to lack of funds;

•

the length of the economic downturn and the impact on local K-12 school budgets and consumer discretionary spending; and

•

productivity disruptions caused by the distraction of our workforce in a remote work environment.

We are monitoring these risks and to date we have not experienced any significant negative financial or operational effects. The COVID-19 crisis may create opportunities to expand our relationships with existing customers who see the clear value of remote learning. We believe over time this period will serve to highlight the affordability and convenience of online training and coaching.

On March 16, 2020, our global employee base began to work from home. We have a distributed workforce that has historically operated out of multiple offices. As a result, we already had in place the appropriate technology tools to facilitate operating in a remote work environment. As such, to date, we have not identified any significant issues in the transition to a ~~direct sales team~~remote work environment. We have not had any COVID-19 related employment terminations or furloughs, however we have taken the following employee-related actions to decrease costs and ~~investments made~~preserve our cash flows to ~~improve~~provide cushion for future uncertainty:

•

adoption of the deferral on the payment of social security under the CARES Act through the remainder of 2020;

•

discontinuation of the 4% company match on 401(k) contributions beginning June 1, 2020 through the end of the calendar year;

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•

a pause on salary increases that have not already been communicated; and

•

restrict personnel hiring to only areas that are critical to the business or create or support bookings, especially in our K-12 and Consumer Language businesses.

In addition, in March 2020, we increased the Literacy product portfolio and infrastructure. The margin improvement related to the effect of purchase accounting will diminish over time. Enterprise & Education Language segment contribution decreased to $7.2 million with segment contribution margin of 43% for the three months ended September 30, 2017, as compared to segment contribution of $8.1 million and segment contribution margin of 44% for the three months ended September 30, 2016. The dollar and margin decreases were primarily due to lower Enterprise & Education Language segment revenue in part due to the unprofitable geographies exited in 2016. Consumer segment contribution decreased to $5.7 million with a segment contribution margin of 30% for the three months ended September 30, 2017, from $6.2 million with a segment contribution margin of 29% for the three months ended September 30, 2016. The dollar decrease in Consumer segment contribution was primarily attributable to

the lower segment revenue and a $1.9 million inventory obsolescence charge in cost of product revenue associated with the switch from packaged perpetual products to subscription-based offerings. The margin percentage increased from 29% to 30% primarily due to a significant year-over-year reduction in direct sales and marketing expenses partially offset by the $1.9 million inventory obsolescence charge described above.

~~Literacy segment contribution increased to $3.1 million with segment contribution margin of 10% for the nine months ended September 30, 2017, as compa~~red to a segment contribution of $0.1 million and segment contribution margin of 1% for the nine months ended September 30, 2016. The dollar and margin increases were primarily due to the larger revenue base on which segment contribution is calculated, partially offset by increases in direct research and development expenses, sales and marketing expenses, and cost of sales due to the transition to a direct sales team and investments made to improve the Literacy product portfolio and infrastructure. The margin improvement related to the effect of purchase accounting will diminish over time. Enterprise & Education Language segment contribution increased slightly to $21.7 million with segment contribution margin ~~of 43% for the nine months ended September 30, 2017, as compared to segment contribution of $21.3 million an~~d segment contribution margin of 39% for the nine months ended September 30, 2016. The dollar and margin increases were primarily due to lower sales and marketing expenses due to actions taken in early 2016 related to reducing headcount and other cost saving measures and lower cost of sales, partially offset by lower segment revenue in part due to the unprofitable geographies exited in 2016. Consumer segment contribution increased to $20.1 million with a segment contribution margin of 35% for the nine months ended September 30, 2017, from $15.2 million with a segment contribution margin of 24% for the nine months end~~ed September 30, 2016. The Consumer segment contribution dollar and margin increased primarily due to a reduction in direct sales and marketing expenses year over year.~~

~~Over the last few years, our Consumer strategy has been to shift more and more~~size of our ~~Consumer business~~credit facility to ~~online subscriptions (with mobile access across~~$25 million, which provides additional liquidity. Although we expect to make short-term borrowings in the ~~web and apps) and away from perpetual digital download and CD packages. We believe that these online subscription formats provide customers with an overall better experience, flexibility~~second quarter of 2020 to use our products on multiple platforms (tablets, smartphones and computers), and provide a more economical and relevant way for us to deliver our products to customers. One challenge to encouraging customers to enter into or renew a subscription arrangement is that usage of our product varies greatly, ranging from customers that purchase butaddress seasonal cash needs, we do not ~~have any usage~~expect to ~~customers with high usage. The majority~~need to draw down on the full amount of ~~purchasers tend towards~~ the lower end of that spectrum, with most usage coming in the first few months after purchase and declining over time - similar to a gym membership. We expect the trend in Consumer subscription sales to accelerate through the end of 2017 as customer preferences continue to move towards mobile experiences. Our goal is to move almost all of our Consumer business to subscription sales by the end of 2017.

For additional information regarding our segments, see Note 16 "Segment Information" of Part 1 - Item 1, Financial Statements. For additional information regarding fluctuations in segment revenue, see Results of Operations, below. Prior periods have been reclassified to reflect our current operating segment presentation and definition of segment contribution.

facility this year.

Components of Our ~~Statement~~Statements of Operations

Revenue

We derive revenue from sales of language-learning and literacy solutions. ~~Revenue is presented as subscription and service revenue or product revenue in our consolidated financial statements. Subscription and service~~Our revenue consists of ~~sales from~~fees associated with web-based software subscriptions, online services, professional services, and ~~certain~~ mobile applications. ~~Our online~~Subscription revenue is generated from contracts with customers that provide access to hosted software over a contract term without the customer taking possession of the software. Subscription revenue is recognized ratably over the contract period as the performance obligation is satisfied. Subscription revenue is generated by all three reportable segments and range from short-term to multi-year contracts. Online services are typically sold in short-term service periods and include dedicated online conversational coaching services and access to online communities of language learners. ~~Our professional~~Professional services include training and implementation services. ~~Product~~Online services revenue ~~primarily consists of~~and professional services revenue ~~from our perpetual language-learning product software, our audio practice products,~~are recognized as the services are provided. Expired services are forfeited and ~~certain mobile applications. Our audio practice products are often combined with our language-learning software and sold as a solution.~~

~~In the Consumer market, our perpetual product software~~revenue is often bundled with our short-term online conversational coaching and online community services and sold as a package. Approximately $39 in revenue per unit is derived from these short-term online services. As a result, we typically defer 10% to 35% of the revenue of each of these bundled sales to be recognized over the term of the service period. The content of our perpetual product software and our web-based language-learning subscription offerings are the same. We offer our customers the ability to choose which format they prefer without differentiating the learning experience.

upon expiry.

We sell our solutions directly and indirectly to individuals, educational institutions, corporations, and governmental agencies. We sell to enterprise and education organizations primarily through our direct sales force as well as through our network of resellers and organizations who typically gain access to our solutions under a web-based subscription service. We distribute our Consumer Language products predominantly through our direct sales channels, primarily utilizing our websites, mobile applications and call centers, which we refer to as our direct-to-consumer ("DTC") channel. We also distribute our Consumer Language products through select ~~third-~~

~~party~~third-party retailers and distributors. For purposes of explaining variances in our revenue, we separately discuss changes in our ~~Enterprise & Education~~E&E Language, Literacy, and our Consumer Language segments because the customers and revenue drivers of these channels are different.

Literacy segment sales are seasonally ~~stronger~~strongest in the second and third quarter of the calendar year corresponding to the end and beginning of school district budget years. Within our ~~Enterprise & Education~~E&E Language segment, sales in our education, government, and corporate sales channels are seasonally stronger in the second half of the calendar year due to purchasing and budgeting cycles. Consumer Language sales are affected by seasonal trends associated with the holiday shopping season. We expect these trends to ~~continue.~~

continue, but may be impacted by the COVID-19 pandemic.

Cost of ~~Subscription and Service and Product~~ Revenue

Cost of ~~subscription and service~~ revenue primarily represents costs associated with supporting our web-based subscription services and online language-learning services, which includes online language conversation coaching, hosting costs and depreciation. We also include the cost of credit card processing and customer technical support in ~~both~~ cost of ~~subscription and service revenue and cost of product~~ revenue. Cost of ~~product~~ revenue consists of the direct and indirect materials and labor costs to produce and distribute our products. Such costs include packaging materials, computer headsets, freight, inventory receiving, personnel costs associated with product assembly,also includes third-party royalty fees, and inventory storage, obsolescence and shrinkage.

Operating Expenses

We classify our operating expenses into the following categories: sales and marketing, research and development, and general and administrative. ~~When certain events occur, we also recognize operating expenses related to asset impairment and operating lease terminations.~~

Our operating expenses primarily consist of personnel costs, direct advertising and marketing expenses, and professional fees associated with contract product development, legal, accounting and consulting. Personnel costs for each category of operating expenses include salaries, bonuses, stock-based compensation and employee benefit costs. Included within our operating expenses are restructuring costs that consist primarily of employee severance and related benefit costs, contract termination costs, and other related costs associated with our restructuring activities.

Sales and Marketing. Our sales and marketing expenses consist primarily of direct advertising expenses related to television, print, radio, online and other direct marketing activities, personnel costs for our sales and marketing staff, and commissions earned by our sales ~~personnel.~~personnel and app stores. Sales commissions are generally paid ~~at the time the~~when a customer contract is ~~invoiced.~~either recorded as revenue or deferred revenue. However, sales commissions are deferred and recognized as expense in proportion to when the related revenue is recognized.

Research and Development. Research and development expenses consist primarily of employee compensation costs, consulting fees, and overhead costs associated with development of our solutions. Our development efforts are primarily based in the U.S. and are devoted to modifying and expanding our offering portfolio through the addition of new content, as well as new paid and complementary products and services to our language-learning and literacy solutions.

General and Administrative. General and administrative expenses consist primarily of shared services, such as personnel costs of our executive, finance, legal, human resources and other administrative personnel, as well as accounting and legal professional services fees including professional service fees related to ~~acquisitions and~~ other corporate expenses.

~~Impairment.~~ ~~Impairment expenses consist primarily~~

Table of ~~goodwill impairment, impairment of long-lived assets, and impairment expense related to the abandonment of previously capitalized internal-use software projects.~~

~~Lease Abandonment and Termination.~~ Lease abandonment and termination expenses include the recognition of costs associated with the termination or abandonment of our office operating leases, such as early termination fees and expected lease termination costs.

Contents

Interest and Other Income (Expense)

Interest and other income (expense) primarily consist of interest income, interest expense, and foreign exchange gains and ~~losses, income from litigation settlements, and income or loss from equity method investments.~~losses. Interest income represents interest received on our cash and cash equivalents. Interest expense is primarily related to interest on our ~~capital~~finance leases, interest on borrowings associated with our credit facility, and amortization of deferred financing fees associated with our ~~revolving~~ credit facility. Fluctuations in foreign currency exchange rates in our foreign subsidiaries cause foreign exchange gains and losses. ~~Legal settlements are related to agreed upon settlement payments from various anti-piracy enforcement efforts. Income or loss from equity method investments represents our proportionate share of~~Other income (expense) can also include the ~~net income or loss of our investment in entities accounted for under the equity method.~~

gains and losses associated with non-customer transactions.

Income Tax (Benefit) Expense

Income tax (benefit) expense consists of federal, state and foreign income taxes. We regularly evaluate the recoverability of our deferred tax assets and establish a valuation allowance, if necessary, to reduce the deferred tax assets to an amount that is more likely than not to be realized (a likelihood of more than 50 percent). Significant judgment is required to determine whether a valuation allowance is necessary and the amount of such valuation allowance, if appropriate.

The establishment of a valuation allowance has no effect on the ability to use the deferred tax assets in the future to reduce cash tax payments. We assess the likelihood that the deferred tax assets will be realizable at each reporting period, and the valuation allowance will be adjusted accordingly, which could materially affect our financial position and results of operations.

For the three months ended September 30, 2017, we incurred an income tax expense of $0.9 million with $2.4 million loss before taxes, resulting in a worldwide effective tax rate of (37.4)%. For the nine months ended September 30, 2017, we incurred an income tax expense of $2.4 million after incurring loss before taxes of $1.6 million, resulting in worldwide effective tax rate of (152.2)%. The three and nine month tax expense related to current year income from operations in Germany, China, and the U.K., as well as the tax impact of amortization of indefinite lived intangibles, and foreign withholding taxes.

For the year ended December 31, 2016, we recorded an income tax expense of $2.5 million primarily attributable to losses before tax of $25.0 million resulting in worldwide effective tax rate of (10.0)%. The tax rate resulted from tax expense related to income of operations in Germany and the U.K., foreign withholding taxes, and the tax impact of amortization of indefinite lived intangible assets.

Critical Accounting Policies and Estimates

In presenting our financial statements in conformity with ~~GAAP,~~U.S. generally accepted accounting principles ("GAAP"), we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses, and related disclosures.

Some of the estimates and assumptions we are required to make relate to matters that are inherently uncertain as they pertain to future events. We base these estimates and assumptions on historical experience or on various other factors that we believe to be reasonable and appropriate under the circumstances. On an ongoing basis, we reconsider and evaluate our estimates and assumptions. Our future estimates may change if the underlying assumptions change. Actual results may differ significantly from these estimates.

We believe that the following critical accounting policies involve our more significant judgments, assumptions and estimates and, therefore, could have the greatest potential impact on our consolidated financial statements. In addition, we believe that a discussion of these policies is necessary for readers to understand and evaluate our consolidated financial statements contained in this quarterly report on Form 10-Q:

•

Revenue Recognition

•~~Revenue Recognition~~

•

Stock-based Compensation

•~~Stock-based Compensation~~

•

Goodwill

•~~Goodwill~~

•

Going Concern Assessment

•~~Intangible Assets~~

•~~Valuation of Long-Lived Assets~~

•~~Restructuring Costs~~

•~~Income Taxes~~

•~~Going Concern Assessment~~

For further information on our critical and other significant accounting policies, see our Annual Report on Form 10-K filed with the SEC on March ~~14, 2017. There have been no significant changes in such critical accounting policies and estimates since those disclosed in our most recent Annual Report on Form 10-K.~~

~~Goodwill~~

~~We test goodwill for impairment annually on June 30~~11, 2020.

Table of each year at the reporting unit level in accordance with the provisions of Accounting Standards Codification topic 350, Intangibles—Goodwill and Other ("ASC 350") or more frequently, if impairment indicators arise. This guidance provides the option to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. The factors that we consider important, and which could trigger a quantitative test, include, but are not limited to: a significant decline in the market value of our common stock for a sustained period; a material adverse change in economic, financial market, industry or sector trends; a material failure to achieve operating results relative to historical levels or projected future levels; and significant changes in operations or business strategy. If, based on a review of qualitative factors, it is more likely than not that the fair value of a

reporting unit is less than its carrying value we perform a quantitative goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. If the carrying value exceeds the fair value, we measure the amount of impairment loss, if any, by comparing the implied fair value of the reporting unit goodwill to its carrying amount.

For our annual goodwill test performed at June 30, we began our annual test with the qualitative test. As of June 30, 2017, we concluded that there were no indicators of impairment that would cause us to believe that it is more likely than not that the fair value of our reporting units is less than the carrying value. Accordingly, a quantitative impairment test has not been performed and no goodwill impairment charges were recorded in connection with the annual impairment test. For additional risk factors which could affect the assumptions used in our valuation of our reporting units, see the section titled "Risk Factors" in Part II, Item 1A of this Report. Accordingly, we cannot provide assurance that the assumptions, estimates and values used in our assessment will be realized and actual results could vary materially.

Contents

Results of Operations

~~Comparison of the three months ended September 30, 2017 and the three months ended September 30, 2016~~

The following table sets forth our consolidated ~~statement~~statements of operations for the periods indicated (in thousands, except ~~percentages)~~per share amounts):

	Three months ended March 31,
	2020			2019
Revenue	$	47,179		$	44,611
Cost of revenue		11,101			8,426
Gross profit		36,078			36,185
Operating expenses
Sales and marketing		25,434			23,238
Research and development		6,917			5,738
General and administrative		9,562			8,692
Total operating expenses		41,913			37,668
Loss from operations		(5,835	)		(1,483	)
Other income and (expense):
Interest income		16			33
Interest expense		(53	)		(60	)
Other income and (expense)		71			796
Total other income and (expense)		34			769
Loss before income taxes		(5,801	)		(714	)
Income tax expense (benefit)		380			(170	)
Net loss	$	(6,181	)	$	(544	)
Loss per share:
Basic	$	(0.26	)	$	(0.02	)
Diluted	$	(0.26	)	$	(0.02	)
Common shares and equivalents outstanding:
Basic weighted average shares		23,803			23,036
Diluted weighted average shares		23,803			23,036

Three Months Ended September 30, 2017 Versus 2016
2017 2016 Change % Change
Revenue:
Subscription and service $ 42,117
$ 39,027
$ 3,090
7.9 %
Product 4,089
9,666
(5,577 ) (57.7 )%
Total revenue 46,206
48,693
(2,487 ) (5.1 )%
Cost of revenue:
Cost of subscription and service revenue 6,499
5,910
589
10.0 %
Cost of product revenue 2,949
2,461
488
19.8 %
Total cost of revenue 9,448
8,371
1,077
12.9 %
Gross profit 36,758
40,322
(3,564 ) (8.8 )%
Operating expenses:
Sales and marketing 23,654
27,161
(3,507 ) (12.9 )%
Research and development 6,381
6,347
34
0.5 %
General and administrative 9,035
9,969
(934 ) (9.4 )%
Impairment —
1,028
(1,028 ) (100.0 )%
Total operating expenses 39,070
44,505
(5,435 ) (12.2 )%
Loss from operations (2,312 ) (4,183 ) 1,871
(44.7 )%
Other income and (expense):
Interest income 13
11
2
18.2 %
Interest expense (138 ) (120 ) (18 ) 15.0 %
Other income and (expense) 85
633
(548 ) (86.6 )%
Total other income and (expense) (40 ) 524
(564 ) (107.6 )%
Loss before income taxes (2,352 ) (3,659 ) 1,307
(35.7 )%
Income tax expense 879
1,793
(914 ) (51.0 )%
Net loss $ (3,231 ) $ (5,452 ) $ 2,221
(40.7 )%

~~Total revenue decreased $2.5 million to $46.2 million for~~

Comparison of the three months ended ~~September 30, 2017 from $48.7 million for~~March 31, 2020 and the three months ended September 30, 2016. The overall decrease in revenue was due to a decrease in Consumer revenue of $2.9 million and a decrease in Enterprise & Education Language revenue of $1.8 million, partially offset by an increase in Literacy revenue of $2.2 million.

The operating loss for the three months ended September 30, 2017, totaled $2.3 million, compared to an operating loss of $4.2 million for the three months ended September 30, 2016. Operating expenses decreased $5.4 million, primarily comprised of decreases of $3.5 million in sales and marketing expenses, $0.9 million in general and administrative expenses, and the absence of $1.0 million in impairment charges related to our FitBrains business. The decrease in sales and marketing expenses and general and administrative expenses reflects the cost savings as a result of the 2016 Restructuring Plan and other ongoing expense reduction actions, and drove the improvement to net loss. The year over year improvement in operating expenses improved despite a $1.9 million inventory obsolescence charge in the third quarter of 2017 associated with the switch from packaged perpetual products to subscription-based offerings in the retail channel of the Consumer segment.

March 31, 2019:

The following table sets forth revenue for our three operating segments for the three months ended ~~September 30, 2017~~March 31, 2020 and ~~2016~~2019 (in thousands, except percentages):

	Three months ended March 31,										2020 versus 2019
	2020					2019					Change			% Change
	(in thousands, except percentages)
Revenue and Revenue as a Percent of Total Revenue
Literacy	$	17,486		37.1	%	$	14,806		33.2	%	$	2,680			18.1	%
Enterprise & Education Language		13,552		28.7	%		14,443		32.4	%		(891	)		(6.2	)%
Consumer Language		16,141		34.2	%		15,362		34.4	%		779			5.1	%
Total Revenue	$	47,179		100.0	%	$	44,611		100.0	%	$	2,568			5.8	%

Segment Contribution and Segment Contribution Margin
Literacy	$	2,817		16.1	%	$	3,013		20.3	%	$	(196	)		(6.5	)%
Enterprise & Education Language		5,498		40.6	%		6,107		42.3	%		(609	)		(10.0	)%
Consumer Language		2,910		18.0	%		4,548		29.6	%		(1,638	)		(36.0	)%
Language Shared Services		(3,185	)				(3,680	)				495			13.5	%
Total Segment Contribution	$	8,040				$	9,988				$	(1,948	)		(19.5	)%

Three Months Ended September 30, 2017 Versus 2016
2017 2016 Change % Change
Literacy 11,028
23.9 % 8,786
18.0 % 2,242
25.5 %
Enterprise & Education Language 16,529
35.8 % 18,336
37.7 % (1,807 ) (9.9 )%
Consumer 18,649
40.3 % 21,571
44.3 % (2,922 ) (13.5 )%
Total Revenue $ 46,206
100.0 % $ 48,693
100.0 % $ (2,487 ) (5.1 )%

Table of Contents

Literacy Segment

The increase in Literacy segment revenue ~~increased $2.2 million, or 26%, from the three months ended September 30, 2016, to $11.0 million for the three months ended September 30, 2017, reflecting the~~reflects sales growth and strong renewal and retention rates.As an impact of ~~purchase accounting. Adjusting for~~ the ~~impact~~COVID-19 disruptions, our Literacy customers could renew their sales contracts later, which could result in lower revenue recognized in period. Our Literacy business is seasonal with sales consolidating into the second and third calendar quarters corresponding to the end and beginning of ~~purchase accounting on~~the school district operating budget years. This typical seasonality may be impacted by slower than expected renewal and payment as a result of the COVID-19 disruptions.

The Literacy ~~revenue, revenue would have been $11.4 million in the third quarter of 2017 compared to $9.7 million in the third quarter of 2016,~~segment contribution dollar and ~~the Literacy pro-forma growth would have been 17% year-over-year. The organic growth in Literacy revenue was~~margin decreases were primarily due to ~~a larger~~higher direct expenses related to research and ~~more mature direct~~development, sales ~~force~~and marketing, and cost of sales. Lower amounts were capitalized as compared to the third quarter of 2016 which drove stronger renewal rates and an increase in new business and professional services. We will continue to experience the purchase accounting impacts for the Literacy segment through 2017internal-use software during 2020 due to the ~~typical subscription length.~~completion and release of several large projects in the prior year. Direct sales and marketing and cost of sales expenses increased due to the increase in the direct sales team, investments made to improve the Literacy product portfolio and infrastructure and higher implementation and training services costs in support of Literacy sales growth. As a result of the COVID-19 initiatives to expand our resources to all schools within the districts we ~~expect year-over-year revenues to become more comparable~~serve, we could incur additional support costs as we ~~move beyond~~rapidly bring new customers, teachers and students online.

E&E Language Segment

E&E Language segment revenue was down year over year across the ~~purchase accounting impact, which we expect to result in~~reseller and affiliate channels. Before shared Language research and development expense, the E&E Language segment contribution dollar and margin slightly decreased on lower ~~growth rates than what we expect to experience during 2017.~~revenue. We ~~anticipate additional investments in~~believe the ~~Literacy business to grow this segment.~~

~~Enterprise & Education~~enterprise portion of E&E Language ~~Segment~~

~~Enterprise & Education Language revenue decreased $1.8 million, or 10%, from~~is the ~~three months ended September 30, 2016,~~most economically sensitive to the ~~three months ended September 30, 2017. Revenue declined $1.0 million in marketplaces exited due~~COVID-19 crisis and could be negatively affected by the impact on businesses and the international response to the execution of our strategy to exit our direct presence in unprofitable geographies and manage this business for profitable growth. Where appropriate, we will seek to operate in the geographies we exit through partners. Our goal is to offset this decline with growth in our retained channels, which saw a slight decline of $0.8 million as compared to the year ago period.pandemic. We expect to continue to balance investments and adjust our cost structure to align ~~scale without impacting growth.~~

scale.

Consumer Language Segment

Consumer Language segment revenue ~~decreased $2.9~~increased as global app store revenue was higher by $0.6 million ~~or 14%, from the three months ended September 30, 2016,~~as compared to the ~~three months ended September 30, 2017. This decrease was primarily due to a decline in global retail~~prior year period. A large portion of sales ~~channel of $1.7 million and a decline~~ in the ~~direct-to-consumer~~first quarter of 2020 were from our Lifetime offering, which are recognized as revenue over 24 months, resulting in only a small increase in revenue. We expect Lifetime sales, ~~channel revenue~~which are collected in cash up front, will continue to be a significant portion of ~~$0.8 million. The decline in global retail sales channel was due primarily to a reduction in unit sales year over~~Consumer Language bookings this year. The ~~decline in the direct-to-consumer sales channel reflects an increased mix of shorter-duration subscriptions and lower unit volume. As more of~~COVID-19 pandemic has created demand for our ~~Consumer products are shifted from perpetual packaged product sales~~consumer offerings as learners use their time at home to shorter-term subscriptions it would have the effect of spreading the revenue from those sales over the subscription period as opposed to up front recognition. In connection with our recent shift in strategy, we continue to manage the Consumer business for a targeted bottom-line result which has resultedinvest in a ~~decline in scale which we expect to continue. Our~~new language, however, a prolonged economic downturn may create uncertainty for future sales. Typically, our Consumer business is seasonal and ~~typically peaks~~consumer sales usually peak in the fourth quarter during the holiday shopping season.

~~Revenue~~ This typical seasonality has been impacted by ~~Subscription~~the recent Lifetime and ~~Service Revenue~~unlimited offering launches and ~~Product Revenue~~

~~We categorize and report~~the demand for our ~~revenue in two categories—subscription and service revenue and product revenue. Subscription and service revenue includes web-based software subscriptions, online services,~~consumer offerings as ~~well as revenue from professional services. Subscription and service revenue are typically deferred at~~a result of the time of sale and then recognized ratably over the subscription or service period. Product revenue includes revenue allocated to our perpetual language-learning product software, revenue from the sale of audio practice products, and sales of certain mobile applications. We bundle our perpetual product software typically with online services.COVID-19 pandemic. As a result, we ~~typically defer 10%~~expect our first and second quarter Consumer Language bookings to ~~35%~~be higher than the fourth quarter holiday shopping season.

Before shared Language research and development expense, the Consumer Language segment contribution dollar and margin declines were primarily driven by $1.5 million in higher direct sales and marketing expenses related to increased media expenses related to targeted streaming television and native content campaigns to drive sales.We expect sales and marketing expense to increase in 2020 to drive bookings and build brand relevance. Any resulting increase in bookings may be recognized as revenue over periods up to 24 months, while the sales and marketing expense will be recognized as incurred, which may cause the segment contribution to decline. In the event of ~~the revenue of each of these bundled sales. We recognize the deferred revenue associated with the online services over the term of the service period~~.

a prolonged economic downturn, we will be able to manage our customer acquisition costs.

Revenue by Geographic Area

The following table sets forth revenue ~~for subscription~~by geographic area and ~~service and product~~the corresponding percent of total revenue for the three months ended ~~September 30, 2017~~March 31, 2020 and ~~2016~~2019 (in thousands, except percentages):

	Three months ended March 31,								2020 versus 2019
	2020				2019				Change			% Change
	(in thousands, except percentages)
United States	$	42,529	90.1	%	$	39,830	89.3	%	$	2,699			6.8	%
International		4,650	9.9	%		4,781	10.7	%		(131	)		(2.7	)%
Total revenue	$	47,179	100.0	%	$	44,611	100.0	%	$	2,568			5.8	%

Three Months Ended September 30, 2017 Versus 2016
2017 2016 Change % Change
Subscription and service $ 42,117
91.2 % $ 39,027
80.1 % $ 3,090
7.9 %
Product 4,089
8.8 % 9,666
19.9 % (5,577 ) (57.7 )%
Total revenue $ 46,206
100.0 % $ 48,693
100.0 % $ (2,487 ) (5.1 )%

~~Subscription and Service~~

United States Revenue

~~Subscription and service~~

United States revenue increased $3.1 million, or 8%, to $42.1 million for the three months ended September 30, 2017, from $39.0 million for the three months ended September 30, 2016. The increase in subscription and service revenue was primarily due to ~~increases of $3.5 million and $2.2 million in~~ the ~~direct-to-consumer sales channel and Lexia business, respectively, offset by the decline in Enterprise & Education Language subscription revenue of $1.7 million. As earlier noted, the 26%~~ increase in Literacy revenue is due, in part, to the write-down effects of purchase accounting on the pre-acquisition deferred revenue balances associated with the Lexia acquisition. In the Consumer segment, we have begun shifting sales from our ~~box-based and perpetual download products~~Lexia business, which is predominately recorded as domestic revenue. Additionally, app store revenue in the US increased $0.3 million as compared to subscription products. Historically, customers using our longer-length subscription products (greater than a one-year term) have generally only stayed for the duration of the subscription period. We are selling shorter duration subscriptions, which if we are successful in achieving an adequate level of renewals, will allow pricing that has the potential to open up new customer demographics. If, over time, more of our Consumer products are sold through shorter-term subscriptions it would have the effect of spreading the receipt of cash from those sales over the initial sale period and any subsequent renewals. Our goal is to be almost entirely subscription-based by the end of 2017.

~~Product~~prior year.

International Revenue

Product revenue decreased $5.6 million, or 58%, to $4.1 million during the three months ended September 30, 2017, from $9.7 million during the three months ended September 30, 2016. The primary driver of the decrease in product

International revenue was ~~a decline~~nearly flat year over year.

Table of $4.3 million in the direct-to-consumer sales channel and a decline in the global consumer retail sales channel of $1.3 million. Product revenue decreased due to the ongoing transition of our Consumer segment sales model towards subscription sales rather than perpetual license and box product sales, with an objective to be nearly all subscription-based by the end of 2017.

Contents

Cost of ~~Subscription and Service Revenue and Product~~ Revenue and Gross Profit

The following table sets forth cost of ~~subscription and service~~ revenue and ~~product revenue, as well as~~ gross profit for the three months ended ~~September 30, 2017~~March 31, 2020 and ~~2016~~2019 (in thousands, except percentages):

	Three months ended March 31,								2020 versus 2019
	2020				2019				Change			% Change
	(in thousands, except percentages)
Revenue	$	47,179	100.0	%	$	44,611	100.0	%	$	2,568			5.8	%
Cost of revenue		11,101	23.5	%		8,426	18.9	%		2,675			31.7	%
Gross profit	$	36,078	76.5	%	$	36,185	81.1	%	$	(107	)		(0.3	)%

Cost of ~~Subscription~~Revenue

The increase in cost of revenue was primarily due to an increase of $1.2 million in payroll and ~~Service Revenue~~

~~Cost~~benefits primarily resulting from headcount changes in the customer support and operations teams. Additionally, amortization of ~~subscription~~previously capitalized software costs increased $0.9 million related to projects that were recently placed into service. As a result of the COVID-19 initiatives, we expect to incur additional hosting, coaching and ~~service~~support costs as we execute our initiatives to help our learners.

Gross Profit

Gross profit was flat year over year while gross margin declined on the higher cost of revenue discussed above.

Operating Expenses

The following table sets forth operating expenses and the corresponding percentage of total revenue for the three months ended ~~September 30, 2017, was $6.5 million, an increase of $0.6 million, or 10%, from the three months ended September 30, 2016. As a percentage of subscription~~March 31, 2020 and ~~service revenue, cost of subscription and service revenue remained flat at 15% for both the three months ended September 30, 2017 and the~~2019 (in thousands, except percentages):

	Three months ended March 31,								2020 versus 2019
	2020				2019				Change		% Change
	(in thousands, except percentages, which reflect expense as a percentage of total revenue)
Sales and marketing	$	25,434	53.9	%	$	23,238	52.1	%	$	2,196		9.5	%
Research and development		6,917	14.7	%		5,738	12.9	%		1,179		20.5	%
General and administrative		9,562	20.3	%		8,692	19.5	%		870		10.0	%
Total operating expenses	$	41,913			$	37,668			$	4,245		11.3	%

same prior year period. The dollar increase was primarily due to increases in allocated costs from a higher allocation rate associated with the shift in revenue mix in favor of subscription and service revenue. We expect the cost of subscription and service revenue will increase as we focus our business around the Enterprise & Education business and accelerate the migration of our Consumer business to our subscription-based products.

~~Cost of Product Revenue~~

Cost of product revenue for the three months ended September 30, 2017, was $2.9 million, an increase of $0.5 million, or 20%, from the three months ended September 30, 2016. As a percentage of product revenue, cost of product revenue increased to 72% for the three months ended September 30, 2017, compared to 25% the three months ended September 30, 2016. The dollar and margin increase in cost of product revenue was primarily due to a $1.9 million inventory obsolescence charge in the third quarter of 2017 associated with the switch from packaged perpetual products to subscription-based offerings in the retail channel of the Consumer segment.

~~Gross Profit~~

Gross profit decreased $3.6 million to $36.8 million for the three months ended September 30, 2017, compared to the three months ended September 30, 2016. Gross profit percentage decreased to 80% for the three months ended September 30, 2017, from 83% for the three months ended September 30, 2016. The decline in gross profit margin was primarily driven by the year-over-year decline in third quarter revenue and the $1.9 million inventory obsolescence charge in the third quarter of 2017 associated with the switch from packaged perpetual products to subscription-based offerings in the retail channel of the Consumer segment.

~~Operating Expenses~~

Three Months Ended September 30, 2017 Versus 2016
2017 2016 Change % Change
(in thousands, except percentages)
Sales and marketing $ 23,654
$ 27,161
$ (3,507 ) (12.9 )%
Research and development 6,381
6,347
34
0.5 %
General and administrative 9,035
9,969
(934 ) (9.4 )%
Impairment —
1,028
(1,028 ) (100.0 )%
Total operating expenses $ 39,070
$ 44,505
$ (5,435 ) (12.2 )%

Sales and Marketing Expenses

Sales and marketing expenses for the three months ended September 30, 2017, were $23.7 million, a decrease of $3.5 million, or 13%, from the three months ended September 30, 2016. As a percentage of total revenue, sales and marketing expenses decreased to 51% from 56% for the three months ended September 30, 2017 compared to the three months ended September 30, 2016.

The ~~decrease~~increase in sales and marketing expense was primarily due to ~~a decrease~~$1.5 million in ~~media spend in the general consumer market. We intend to continue to optimize our Consumer media and marketing costs and manage the Consumer business for profitability and plan to manage the~~higher sales and marketing expenses related to increased media expenses related to targeted streaming television and native content campaigns to drive ~~these results.~~

Consumer Language sales, $0.4 million in higher stock based compensation expense as we shift more variable compensation from cash-based to equity-based, and $0.4 million in higher consulting expenses related to initiatives in certain upcoming K-12 programs. We expect sales and marketing expense to increase in 2020 to drive bookings and build brand relevance.

Research and Development Expenses

Research and development expenses ~~were $6.4~~increased primarily due to increased payroll expenses driven by $0.5 million for the three months ended September 30, 2017, nearly flat compared to $6.3 million for the three months ended September 30, 2016. As a percentage of total revenue, research and development expenses slightly increased to 14% from 13% for the three months ended September 30, 2017 comparedin lower capitalized labor costsduring 2020 due to the ~~three months ended September 30, 2016. In~~completion and release of several large projects in the ~~near term~~prior year, increased severance expense of $0.3 million which was unrelated to COVID-19, and an increase in stock based compensation expense of $0.2 million as we ~~will focus our product investment on Lexia and key Enterprise & Education Language initiatives.~~

shift more variable compensation from cash-based to equity-based.

General and Administrative Expenses

General and administrative expenses decreased 9% to $9.0 million for the three months ended September 30, 2017, compared to $10.0 million for the three months ended September 30, 2016. As a percentage of revenue, general and administrative expenses remained flat at 20% for the three months ended September 30, 2017 and for the three months ended September 30, 2016. The primary factors driving the decrease in general and administrative expenses were ~~a reduction in professional service fees which declined $0.9 million reflecting the absence of external strategic advisor costs compared to 2016 and also~~slightly up due to ~~lower IT consulting fees~~a $0.4 million increase in stock compensation expense as we shift more variable compensation from cash-based to equity-based, and ~~lower legal fees.~~

~~Impairment~~

~~There were no impairment expenses for the three months ended September 30, 2017. The $1.0~~an increase of $0.3 million ~~impairment~~ in ~~the three months ended September 30, 2016 was~~bad debt expense due ~~an impairment charge related~~ to the ~~abandonment~~increase in bookings and accounts receivable balance year over year.

Table of ~~a previously capitalized software project that no longer aligned to our strategic direction.~~

Contents

Interest and Other Income (Expense)

	Three months ended March 31,						2020 versus 2019
	2020			2019			Change			% Change
	(in thousands, except percentages)
Interest income	$	16		$	33		$	(17	)		(51.5	)%
Interest expense		(53	)		(60	)		7			11.7	%
Other income and (expense)		71			796			(725	)		(91.1	)%
Total other income and (expense)	$	34		$	769		$	(735	)		(95.6	)%

Three Months Ended September 30, 2017 Versus 2016
2017 2016 Change % Change
(in thousands, except percentages)
Interest income $ 13
$ 11
$ 2
18.2 %
Interest expense (138 ) (120 ) (18 ) 15.0 %
Other income and (expense) 85
633
(548 ) (86.6 )%
Total other income and (expense) $ (40 ) $ 524
$ (564 ) (107.6 )%

~~Interest income for the three months ended September 30, 2017 was $13,000, up slightly from $11,000 for the three months ended September 30, 2016.~~

Interest income represents interest earned on our cash and cash equivalents.

Interest expense ~~for the three months ended September 30, 2017 and September 30, 2016, was flat at $0.1 million, attributable to~~primarily represents interest on our ~~capital~~financing leases, interest on our short term borrowingassociated with our credit facility, and the recognition of our deferred financing fees associated with our ~~undrawn revolving~~ credit facility.

~~Other~~ The change in other income and expense for the three months ended September 30, 2017, was income of $0.1 million, an unfavorable change of $0.5 million, from income of $0.6 million for the three months ended September 30, 2016. The change is primarily attributable to unfavorable foreign exchange fluctuations.

~~Income Tax Expense~~

Three Months Ended September 30, 2017 Versus 2016
2017 2016 Change % Change
(in thousands, except percentages)
Income tax expense $ 879
$ 1,793
$ (914 ) (51.0 )%

Our income tax expense for the three months ended September 30, 2017, was $0.9 million, compared to $1.8 million for the three months ended September 30, 2016. The decrease to tax expense was primarily due to the lower pretax income in foreign jurisdictions in the current quarter.

~~Comparison of the nine months ended September 30, 2017 and the nine months ended September 30, 2016~~

~~The following table sets forth our consolidated statement of operations for the periods indicated (in thousands, except percentages):~~

Nine Months Ended September 30, 2017 Versus 2016
2017 2016 Change % Change
Revenue:
Subscription and service $ 125,552
$ 114,755
$ 10,797
9.4 %
Product 14,252
27,656
(13,404 ) (48.5 )%
Total revenue 139,804
142,411
(2,607 ) (1.8 )%
Cost of revenue:
Cost of subscription and service revenue 19,091
16,888
2,203
13.0 %
Cost of product revenue 6,089
7,495
(1,406 ) (18.8 )%
Total cost of revenue 25,180
24,383
797
3.3 %
Gross profit 114,624
118,028
(3,404 ) (2.9 )%
Operating expenses:
Sales and marketing 71,859
86,694
(14,835 ) (17.1 )%
Research and development 19,143
19,666
(523 ) (2.7 )%
General and administrative 25,654
30,864
(5,210 ) (16.9 )%
Impairment —
3,930
(3,930 ) (100.0 )%
Lease abandonment and termination —
30
(30 ) (100.0 )%
Total operating expenses 116,656
141,184
(24,528 ) (17.4 )%
Loss from operations (2,032 ) (23,156 ) 21,124
(91.2 )%
Other income and (expense):
Interest income 43
34
9
26.5 %
Interest expense (383 ) (353 ) (30 ) 8.5 %
Other income and (expense) 821
2,788
(1,967 ) (70.6 )%
Total other income and (expense) 481
2,469
(1,988 ) (80.5 )%
Loss before income taxes (1,551 ) (20,687 ) 19,136
(92.5 )%
Income tax expense 2,361
1,250
1,111
88.9 %
Net loss $ (3,912 ) $ (21,937 ) $ 18,025
(82.2 )%

Total revenue slightly declined to $139.8 million for the nine months ended September 30, 2017 compared to $142.4 million for the nine months ended September 30, 2016. Within the change in total revenue, Consumer revenue decreased $6.0 million and Enterprise & Education Language revenue decreased $3.9 million, almost entirely offset by an increase in Literacy revenue of $7.3 million,

Loss from operations for the nine months ended September 30, 2017 totaled $2.0 million, compared to an operating loss of $23.2 million for the nine months ended September 30, 2016. Operating expenses decreased $24.5 million, which was comprised primarily of decreases of $14.8 million in sales and marketing expenses, $5.2 million in general and administrative expenses, $3.9 million in impairment charges, and $0.5 million in research and development expenses. The decrease in sales and marketing, research and development, and general and administrative operating expenses reflects the continued cost savings initiatives.

~~The following table sets forth revenue for our three operating segments for the nine months ended September 30, 2017 and 2016 (in thousands, except percentages):~~

Nine Months Ended September 30, 2017 Versus 2016
2017 2016 Change % Change
Literacy $ 31,568
22.6 % $ 24,313
17.1 % $ 7,255
29.8 %
Enterprise & Education Language 50,289
36.0 % 54,157
38.0 % (3,868 ) (7.1 )%
Consumer 57,947
41.4 % 63,941
44.9 % (5,994 ) (9.4 )%
Total Revenue $ 139,804
100.0 % $ 142,411
100.0 % $ (2,607 ) (1.8 )%

~~Literacy Segment~~

Literacy revenue increased $7.3 million, or 30%, from $24.3 million for the nine months ended September 30, 2016 to $31.6 million for the nine months ended September 30, 2017, reflecting the impact of purchase accounting. Adjusting for the impact of purchase accounting on Literacy revenue, revenue would have been $33.1 million for the nine month period ending September 30, 2017 compared to $27.9 million in the nine month period ending September 30, 2016, and the Literacy pro-forma growth would have been 19% year-over-year. The organic growth in Literacy revenue was primarily due to a larger and more mature direct sales force as compared to 2016 which drove stronger renewal rates and an increase in new business and an increase in professional services. We will continue to experience the purchase accounting impacts for the Literacy segment through 2017 due to the typical subscription length. As a result, we expect year-over-year revenues to become more comparable as we move beyond the purchase accounting impact, which we expect to result in lower growth rates than what we expect to experience during 2017. We anticipate additional investments in the Literacy business to grow this segment.

~~Enterprise & Education Language Segment~~

Enterprise & Education Language revenue decreased $3.9 million, or 7%, from the nine months ended September 30, 2016 to the nine months ended September 30, 2017. The decrease in Enterprise & Education Language revenue reflects a decrease of $2.3 million in the corporate channel and $1.9 million in our education sales channels. Revenue declined $2.6 million in marketplaces exited due to the execution of our strategy to exit our direct presence in unprofitable geographies and manage this business for profitable growth. Where appropriate, we will seek to operate in the geographies we exit through partners. Our goal is to offset this decline with growth in our retained channels, which saw a slight decline of $1.3 million as compared to the year ago period. We expect to continue to balance investments and adjust our cost structure to align scale without impacting growth.

~~Consumer Segment~~

Consumer revenue decreased $6.0 million, or 9%, from $63.9 million for the nine months ended September 30, 2016 to $57.9 million for the nine months ended September 30, 2017. This decrease was largely due to a reduction in revenue from our direct-to-consumer sales channel of $7.2 million which was partially offset by an increase in our global retail sales channel of $2.2 million. The decline in the direct-to-consumer sale channel reflects an increased mix of shorter-duration subscriptions and lower unit volume. As more of our Consumer products are shifted from perpetual packaged product sales to shorter-term subscriptions it would have the effect of spreading the revenue from those sales over the subscription period as opposed to up front recognition. The year-to-date 2016 global retail sales channel revenue was lower due to the one-time price protection reduction in the suggested retail value in the U.S. of $3.6 million that did not recur in year-to-date 2017. In connection with our recent shift in strategy, we continue to manage the Consumer business for a targeted bottom-line result which has resulted in a decline in scale which we expect to continue. Our Consumer business is seasonal and typically peaks in the fourth quarter during the holiday shopping season.

~~Revenue by Subscription and Service Revenue and Product Revenue~~

~~The following table sets forth revenue for subscription and services and product for the nine months ended September 30, 2017 and 2016 (in thousands, except percentages):~~

Nine Months Ended September 30, 2017 Versus 2016
2017 2016 Change % Change
Subscription and service $ 125,552
89.8 % $ 114,755
80.6 % $ 10,797
9.4 %
Product 14,252
10.2 % 27,656
19.4 % (13,404 ) (48.5 )%
Total revenue $ 139,804
100.0 % $ 142,411
100.0 % $ (2,607 ) (1.8 )%

~~Subscription and Service Revenue~~

Subscription and service revenue was $125.6 million for the nine months ended September 30, 2017, an increase of $10.8 million from $114.8 million for the nine months ended September 30, 2016. As noted above, Literacy segment revenue increased by $7.3 million due, in part, to the write-down effects of purchase accounting on the pre-acquisition deferred revenue balances associated with the Lexia acquisition. Consumer subscription and service revenue increased by $7.7 million in the direct-to-consumer sales channel. Within the Enterprise & Education Language segment, the education sales channel declined by $1.4 million and the corporate sales channel decreased by $1.8 million, due primarily to the marketplaces exited in unprofitable geographies. As earlier noted, the 30% increase in Literacy revenue is due, in part, to the write-down effects of purchase accounting on the pre-acquisition deferred revenue balances associated with the Lexia acquisition. In the Consumer segment, we have begun shifting sales from our box-based and perpetual download products to subscription products. Historically, customers using our longer-length subscription products (greater than a one-year term) have generally only stayed for the duration of the subscription period. We are selling shorter duration subscriptions, which if we are successful in achieving an adequate level of renewals, will allow pricing that has the potential to open up new customer demographics. If, over time, more of our Consumer products are sold through shorter-term subscriptions it would have the effect of spreading the receipt of cash from those sales over the initial sale period and any subsequent renewals. Our goal is to be almost entirely subscription-based by the end of 2017.

~~Product Revenue~~

Product revenue decreased $13.4 million, or 48%, to $14.3 million during the nine months ended September 30, 2017 from $27.7 million during the nine months ended September 30, 2016. Product revenue decreased $14.9 million in the direct-to-consumer sales channel and increased $2.1 million in the global consumer retail sales channel. The year-to-date 2016 global consumer retail sales channel revenue was lower due to the one-time price protection reduction in the suggested retail value in the U.S. of $3.6 million that did not recur in year-to-date 2017. Product revenue also decreased due to the ongoing transition of our sales model towards subscription sales rather than perpetual license and box product sales, with an objective to be nearly all subscription-based by the end of 2017.

~~Cost of Subscription and Service Revenue and Product Revenue and Gross Profit~~

The following table sets forth cost of subscription and service revenue and product revenue, as well as gross profit for the nine months ended September 30, 2017 and 2016 (in thousands, except percentages):

~~Total cost of revenue increased $0.8 million for the nine months ended September 30, 2017 from $24.4 million for the nine months ended September 30, 2016.~~

~~Cost of Subscription and Service Revenue~~

Cost of subscription and service revenue for the nine months ended September 30, 2017 was $19.1 million, an increase of $2.2 million, or 13%, from the nine months ended September 30, 2016. As a percentage of subscription and service revenue, cost of subscription and service revenue was flat at 15% for the nine months ended September 30, 2017 and for the prior year period. The dollar increase was primarily due to increases in allocated costs from a higher allocation rate associated with the shift in revenue mix in favor of subscription and service revenue. We expect the cost of subscription and service revenue will

~~increase as we focus our business around the Enterprise & Education business and accelerate the migration of our Consumer business to our subscription-based products.~~

~~Cost of Product Revenue~~

Cost of product revenue for the nine months ended September 30, 2017 was $6.1 million, a decrease of $1.4 million, or 19%, from the nine months ended September 30, 2016. As a percentage of product revenue, cost of product revenue increased to 43% from 27% for the nine months ended September 30, 2017 compared to the same prior year period. The increase in cost as a percentage of revenue(expense) was primarily attributable to ~~a decline in product revenue. The dollar decrease in cost of product revenue was primarily due~~ the ~~continued migration to subscription-based products, partially offset by a $1.9 million inventory obsolescence charge in the third~~first quarter ~~of 2017 associated with the switch from packaged perpetual products to subscription-based offerings in the retail channel of the Consumer segment.~~

~~Gross Profit~~

Gross profit decreased $3.4 million to $114.6 million for the nine months ended September 30, 2017 compared to $118.0 million for the nine months ended September 30, 2016. Gross profit percentage decreased to 82% for the nine months ended September 30, 2017 as compared to 83% and the nine months ended September 30, 2016.

~~Operating Expenses~~

Nine Months Ended September 30, 2017 Versus 2016
2017 2016 Change % Change
(in thousands, except percentages)
Sales and marketing $ 71,859
$ 86,694
$ (14,835 ) (17.1 )%
Research and development 19,143
19,666
(523 ) (2.7 )%
General and administrative 25,654
30,864
(5,210 ) (16.9 )%
Impairment —
3,930
(3,930 ) (100.0 )%
Lease abandonment and termination —
30
(30 ) (100.0 )%
Total operating expenses $ 116,656
$ 141,184
$ (24,528 ) (17.4 )%

Included within our operating expenses are restructuring charges related to restructuring actions which relate to employee severance and related benefits costs incurred in connection with headcount reductions, contract termination costs, and other related costs. As a result of these actions, we realized reductions in our operating expenses, primarily associated with reduced payroll and benefits costs. See Note 13 "Restructuring" of Part I – Item 1, Financial Statements – for more detailed information about the restructuring actions. The following table presents restructuring costs included in the related line items of our results from operations:

Nine Months Ended
September 30,
2017 2016
(in thousands)
Cost of revenue $ 313
$ 567
Sales and marketing 426
2,287
Research and development 332
912
General and administrative 110
1,417
Total $ 1,181
$ 5,183

~~Sales and Marketing Expenses~~

Sales and marketing expenses for the nine months ended September 30, 2017 were $71.9 million, a decrease of $14.8 million, or 17%, from the nine months ended September 30, 2016. As a percentage of total revenue, sales and marketing expenses decreased to 51% for the nine months ended September 30, 2017 from 61% for the nine months ended September 30, 2016. The decrease in sales and marketing expense was primarily due to decreases in media spend, payroll and benefits, professional services, and rent expense. Media expenses decreased $9.1 million due to the change in focus in the general consumer market. Payroll and benefit expense decreased $3.4 million due primarily to salary savings from a reduction in headcount and lower severance expenses. Professional services expenses declined driven by reduced spending in call centers.

Rent expense decreased $0.8 million related to the relocation of the corporate headquarters. We intend to continue to optimize our Consumer media and marketing costs and manage the Consumer business for profitability and plan to manage the sales and marketing expenses to drive these results.

~~Research and Development Expenses~~

Research and development expenses were $19.1 million for the nine months ended September 30, 2017, a slight decrease of $0.5 million, or 3%, from the nine months ended September 30, 2016. As a percentage of total revenue, research and development expenses were flat at 14% for the nine months ended September 30, 2017 and the nine months ended September 30, 2016. In the near term we will focus our product investment on Lexia and key Enterprise & Education Language initiatives.

~~General and Administrative Expenses~~

General and administrative expenses decreased $5.2 million to $25.7 million for the nine months ended September 30, 2017 compared to $30.9 million for the nine months ended September 30, 2016. As a percentage of revenue, general and administrative expenses decreased to 18% for the nine months ended September 30, 2017 from 22% for the nine months ended September 30, 2016. The decrease in general and administrative expenses was due to reductions in professional services, amortization expense, and bad debt expense. Professional services fees declined $2.9 million due to the absence of external strategic advisor costs compared to 2016 and also due to lower external audit fees and decreased legal fees. Amortization expense decreased $1.2 million due to the completed amortization of multiple projects in 2016. Bad debt expense decreased $0.6 million due to better collection efforts.

~~Impairment~~

There were no impairment expenses for the nine months ended September 30, 2017. The $3.9 million impairment in the nine months ended September 30, 2016 was due to the 2016 impairments related to Fit Brains goodwill of $1.7 million, intangible assets of $1.2 million, and the abandonment of a previously capitalized software project that no longer aligned to our strategic direction.

~~Lease Abandonment and Termination~~

~~Lease abandonment and termination expenses were zero for the nine months ended September 30, 2017 as compared to $30,000 for the nine months ended September 30, 2016.~~

~~Interest and Other Income (Expense)~~

Nine Months Ended September 30, 2017 Versus 2016
2017 2016 Change % Change
(in thousands, except percentages)
Interest income $ 43
$ 34
$ 9
26.5 %
Interest expense (383 ) (353 ) (30 ) 8.5 %
Other income and (expense) 821
2,788
(1,967 ) (70.6 )%
Total other income and (expense) $ 481
$ 2,469
$ (1,988 ) (80.5 )%

Interest income for the nine months ended September 30, 2017 was $43,000, an increase of $9,000, from the nine months ended September 30, 2016. Interest income represents interest earned on our cash and cash equivalents.

Interest expense for the nine months ended September 30, 2017 was $0.4 million, flat as compared to the nine months ended September 30, 2016. Interest expense relates to interest on our capital leases and the recognition of our financing fees associated with our undrawn revolving credit facility.

Other income and expense for the nine months ended September 30, 2017 was income of $0.8 million, an unfavorable change of $2.0 million, from income of $2.8 million for the nine months ended September 30, 2016. The change is primarily attributable to unfavorable foreign exchange fluctuations partially offset by a $0.42019 $1.4 million gain on the sale of ~~our Japan entity.~~

certain idle assets that did not recur in 2020 and foreign exchange fluctuations.

Income Tax (Benefit) Expense

	Three months ended March 31,					2020 versus 2019
	2020		2019			Change		% Change
	(in thousands, except percentages)
Income tax expense (benefit)	$	380	$	(170	)	$	550		323.5	%

Nine Months Ended September 30, 2017 Versus 2016
2017 2016 Change % Change
(in thousands, except percentages)
Income tax expense $ 2,361
$ 1,250
$ 1,111
88.9 %

~~Our~~

The increase in income tax expense ~~for~~was related to the ~~nine months ended September 30, 2017 was $2.4~~Virginia state adoption of an indefinite carry forward of net operating losses that resulted in a release of our state valuation allowance and recognition of $0.6 million ~~compared to $1.3 million for~~in state tax benefit in the ~~nine months ended September 30, 2016. The increase to~~first quarter of 2019 which did not recur in 2020. Income tax expense ~~was primarily due to the tax benefits associated with the FitBrains intangible asset impairment~~ in the ~~second~~first quarter of ~~2016, in addition~~2020 was related to ~~the increased pretax income in~~profits of operations for foreign jurisdictions in the ~~current year-to-date period.~~

U.K., Germany, Canada, France and China and deferred tax expense related to the impact of amortization of indefinite lived intangible assets. For the three months ended March 31, 2020, our worldwide effective tax rate was (6.6)%.

Liquidity and Capital Resources

Liquidity

Our principal source of liquidity at ~~September 30, 2017,~~March 31, 2020, consisted of ~~$40.1~~$35.1 million in cash and cash equivalents and short-term ~~investments, an increase of $4.0 million compared to December 31, 2016.~~investments. Our primary operating cash requirements include the payment of salaries, employee benefits and other personnel related costs, as well as direct advertising expenses, costs of office facilities, and costs of information technology systems. Historically, we have primarily funded these requirements through cash flows from our operating activities.

As part of our strategic shift, we have begun and continue to reorganize our business around our Enterprise & Education Language and Literacy segments while we optimize our Consumer segment for profitability and cash generation.

Our operating segments are affected by different sales-to-cash patterns. Within our ~~Enterprise & Education~~E&E Language and Literacy segments, revenue in our education, government, and corporate sales channels are seasonally stronger in the second half of the calendar year due to purchasing and budgeting cycles. Our Consumer Language revenue is affected by seasonal trends associated with the holiday shopping season. Consumer Language sales typically turn to cash more quickly than ~~Enterprise & Education~~E&E Language and Literacy sales, which tend to have longer collection cycles. Historically, in the first half of the year we have been a net user of cash and in the second half of the year we have been a net generator of cash. We expect the trend to use cash in the first half of the year and generate cash in the second half of the year to continue.

On October 28, 2014, we executed a Loan and Security Agreement with Silicon Valley Bank ~~(“Bank”~~("Bank") to obtain a ~~$25.0 million revolving~~ credit facility. Since the original date of execution, we have executed several amendments to the credit facility to reflect updates to our financial outlook, expand availability, and extend the credit facility. Under the ~~amended agreement,~~eighth amendment executed on March 10, 2020, we may borrow up to $25.0 ~~million, including a sub-facility, which reduces available borrowings, for letters of credit in the aggregate availability amount of $4.0~~ million. The credit facility has a term that expires on April 1, ~~2020,~~2023, during which time we may borrow and re-pay loan amounts and re-borrow the loan amounts subject to customary borrowing conditions.

~~The total obligations under the credit facility cannot exceed the lesser of (i) the total revolving commitment of $25.0~~ However, we must have less than $5.0 million ~~or (ii) the borrowing base, which is calculated~~in outstanding borrowings for 30 consecutive days during each twelve month period beginning as ~~80% of eligible accounts receivable. As a result, the borrowing base will fluctuate and we expect it will follow the general seasonality of cash and accounts receivable (lower in the first half~~ of the ~~year and higher in the second half~~date of the year). If the borrowing base less any outstanding amounts, plus the cash held at the Bank is greater than $25.0 million, then we may borrow up to an additional $5.0 million, but in no case can borrowings exceed $25.0 million.execution. Interest ~~on borrowings accrues at the Prime Rate provided that we maintain a minimum cash and Availability balance of $17.5 million. If cash and Availability is below $17.5 million, interest~~ will accrue at the greater of Prime Rate ~~plus 1%.~~

or 1.5% and must be paid quarterly.

As of ~~the date of this filing,~~March 31, 2020, there were no borrowings ~~have been made~~outstanding under the ~~revolving~~ credit agreement and we were eligible to borrow $19.5 million of available credit less $4.0 million in letters of credit have been issued by the Bank on our behalf, resulting in a net borrowing availability of $15.5 million.facility. We are subject to certain financial and restrictive covenants ~~under~~as defined in the credit ~~facility. We are required to maintain compliance with a minimum liquidity ratio and maintain a minimum Adjusted EBITDA.~~facility As of ~~September 30, 2017,~~March 31, 2020, we were in compliance with all of the covenants under the ~~revolving~~ credit ~~agreement.~~

facility. Consistent with the seasonality of cash we saw in 2019, we expect to make short term borrowings under our credit facility in the second quarter of 2020 and expect to have no borrowings outstanding at the calendar end of 2020. We believe the borrowing availability under the credit facility is sufficient to provide liquidity during our mid-year seasonal cash low point. See the section at the beginning of this Item 2 titled “COVID-19 Update” for a discussion of the COVID-19 impact to liquidity.

The total amount of cash that was held by foreign subsidiaries as of ~~September 30, 2017~~March 31, 2020 was ~~$7.9~~$6.6 million. As of ~~September 30, 2017, we do not intend to repatriate the cash from our foreign subsidiaries, however,~~March 31, 2020, if we were to repatriate this foreign cash, no tax liability would result due to the current period and carryforward net operating losses.

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During the last three years, inflation has not had a material effect on our business and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future.

Capital Resources

We believe our current cash and cash equivalents, short-term investments, borrowings under our credit facility, and funds generated from our sales will be sufficient to meet our cash needs for at least the next twelve months from the date of issuance of this report. We have generated significant operating losses as reflected in our accumulated loss and we may continue to incur operating losses in the future that may continue to require additional working capital to execute strategic initiatives. Our future capital requirements will depend on many factors, including development of new products, market acceptance 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 optimization of office space in the U.S. and worldwide, building the infrastructure necessary to support our growth, the response of competitors to our products and services, and our relationships with suppliers. We extend payments to certain vendors in order to minimize the amount of working capital deployed in the business. In order to maximize our cash position, we will continue to manage our existing inventory, accounts receivable, and accounts payable balances. Borrowings under our credit facility can be utilized to meet working capital requirements, anticipated capital expenditures, and other obligations.

We expect the trends experienced with revenue and expenses during 2019 will continue for 2020.

Cash Flow Analysis

	Three months ended March 31,						2020 versus 2019
	2020			2019			Change			% Change
	(in thousands, except percentages)
Net cash used in operating activities	$	(3,482	)	$	(6,567	)	$	3,085			47.0	%
Net cash used in investing activities	$	(3,786	)	$	(3,718	)	$	(68	)		(1.8	)%
Net cash (used in) provided by financing activities	$	(139	)	$	632		$	(771	)		(122.0	)%

Nine Months Ended September 30, 2017 Versus 2016
2017 2016 Change % Change
(in thousands, except percentages)
Net cash provided by (used in) operating activities $ 12,677
$ (5,946 ) $ 18,623
(313.2 )%
Net cash used in investing activities $ (8,791 ) $ (9,590 ) $ 799
(8.3 )%
Net cash used in financing activities $ (222 ) $ (575 ) $ 353
(61.4 )%

Net Cash ~~Provided by (Used in)~~Used in Operating Activities

Net cash provided by operating activities for the nine months ended September 30, 2017, was $12.7 million. The factors affecting our operating cash flows during the period were our net loss of $3.9 million, adjusted for non-cash charges totaling $12.3 million and a favorable overall change in operating assets and liabilities of $4.3 million. Non-cash items primarily consisted of $9.1 million in depreciation and amortization expense and $3.1 million related to stock based compensation. The primary drivers of the change in operating assets and liabilities were a decrease in accounts receivable of $2.4 million and an $8.6 million increase in deferred revenue. The decrease in accounts receivable was primarily related to collection efforts. The increase in deferred revenue was primarily due to the increased bookings in the Literacy segment and a sales shift from our box-based and perpetual download products to subscription product.

Net cash used in operating activities ~~for~~was lower in the ~~nine months ended September 30, 2016~~first quarter of 2020 as compared to the same period in 2019. Operating cash flow was ~~$5.9 million. The factors affecting our operating cash flows during~~impacted by the ~~period were our net loss~~overall increase in year-over-year bookings of $21.9 million, adjusted for non-cash charges totaling $16.1 million, and an unfavorable overall change in operating assets and liabilities of $0.1 million. Non-cash items primarily consisted of $9.8 million in depreciation and amortization expense, $3.9 million in impairment charges, and $3.5 million in stock-based compensation expense, which were partially offset by a $2.8 million gain on foreign currency transactions. The primary drivers of the change in operating assets and liabilities were a decrease in other current liabilities of $13.1 $5.6million, which ~~were partially offset by a decrease~~resulted in ~~accounts receivable of $8.9 million,~~ an ~~increase in accrued compensation of $3.4 million, and a $2.4 million~~ increase in deferred revenue. The decrease in other current liabilities is related to having fewer obligations due for marketing, advertising, and rebates as a result of our shift in strategy and ongoing cost reduction efforts. Included within the decrease in other current liabilities is the $2.9 million cash impact of the reduction in suggested retail value that occurred in the second quarter of 2016. The decrease in accounts receivable was primarily related to the timing of sales compared to when payments are made along withPartially offsetting the increase in sales during the fourth quarter 2015 holiday season. The increase in accrued compensation is the result of severance accruals associated with a reduction in headcount and the increase in accrued salary expense due to the timing differences associated with year-over-year bi-weekly payroll processing. The increase in deferred revenue was primarily due to the seasonality of our offerings, specifically due to the timing of renewals in the Literacy segment and education sales channel within the Enterprise & Education language segment due to school budget calendars.

~~The dollar change between the net~~bookings were higher selling-related cash provided by operating activities for the nine months ended September 30, 2017 as compared to the net cash used in operating activities for the nine month ended September 30, 2016 was due in part to the positive cash inflows totaling $13.0 million related to the execution of agreements with SOURCENEXT Corporation for the perpetual license of certain intellectual property for exclusive use and sale in Japan. See Note 3 "Divestitures" of Part 1 - Item 1, Financial Statements for a further description of the SOURCENEXT transaction.

outflows.

Net Cash Used in Investing Activities

Net cash used in investing activities was ~~$8.8 million for~~higher in the ~~nine months ended September 30, 2017,~~first quarter of 2020 as compared to ~~$9.6 million for~~ the ~~nine months ended September 30, 2016,~~same period of 2019. Lower amounts were capitalized as internal-use software during 2020 due to the completion and release of several large projects in the prior year. Additionally, there was a ~~change of $0.8 million. Purchases of property and equipment, which primarily relates to capitalized labor on product and corporate IT projects, slightly decreased $0.7 million,~~cash inflow in 2019 related to the ~~completion~~sale of ~~development projects for Catalyst~~non-current idle assets that did not recur in 2020.

Net Cash (Used in) Provided by Financing Activities

Net cash related to financing activities decreased in the ~~second half~~first quarter of ~~2016.~~

~~Net Cash Used In Financing Activities~~

~~Net cash used~~2020 as compared to the same period of 2019. A $0.7 million decrease in proceeds from stock option exercises contributed to the decline in financing activities was $0.2 million for the nine-month period ended September 30, 2017, compared to $0.6 million for the nine-month period ended September 30, 2016, a change of $0.4 million. Proceeds from the exercise of stock options increased due to the rise in our stock price during the second quarter.

cash flow.

Off-Balance Sheet Arrangements

We do not engage in any off-balance sheet financing arrangements. We do not have any material interest in entities referred to as variable interest entities, which include special purpose entities and other structured finance entities.

~~Contractual Obligations~~

As discussed in Notes 9 and 15 of Part 1 - Item 1, Financial Statements, we lease buildings, parking spaces, equipment, and office space under operating lease agreements. We also lease a building in France, certain equipment, and certain software under capital lease agreements. The following table summarizes our future minimum rent payments under non-cancellable operating and capital lease agreements as of September 30, 2017, and the effect such obligations are expected to have on our liquidity and cash flow in future periods.

Total
Less than
1 Year
1-3 Years 3-5 Years
More than
5 Years
(in thousands)
Capitalized leases and other financing arrangements $ 2,668
$ 541
$ 1,070
$ 1,057
$ —
Operating leases 9,006
4,559
3,662
785
—
Total $ 11,674
$ 5,100
$ 4,732
$ 1,842
$ —

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency Exchange Risk

The functional currency of our foreign subsidiaries is their local currency. Accordingly, our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates. The volatility of the prices and applicable rates are dependent on many factors that we cannot forecast with reliable accuracy. In the event our foreign sales and expenses increase, our operating results may be more greatly affected by fluctuations in the exchange rates of the currencies in which we do business. At this time we do not, but we may in the future, invest in derivatives or other financial instruments in an attempt to hedge our foreign currency exchange risk.

Interest Rate Sensitivity

Interest income and expense are sensitive to changes in the general level of U.S. interest rates. However, based on the nature and current level of our marketable securities, which are primarily short-term investment grade and government securities and our notes payable, we believe that there is no material risk of interest rate exposure.

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Credit Risk

Accounts receivable and cash and cash equivalents present the highest potential concentrations of credit risk. We reserve for credit losses and do not require collateral on our trade accounts receivable. In addition, we maintain cash and investment balances in accounts at various banks and brokerage firms. We have not experienced any losses on cash and cash equivalent accounts to date. We sell products to retailers, resellers, government agencies, and individual consumers and extend credit based on an evaluation of the customer's financial condition, without requiring collateral. Exposure to losses on accounts receivable is principally dependent on each customer's financial condition. We monitor exposure for credit losses and maintain allowances for anticipated losses. We maintain trade credit insurance for certain customers to provide coverage, up to a certain limit, in the event of insolvency of some customers.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of ~~September 30, 2017.~~March 31, 2020. The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed 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 that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of ~~September 30, 2017,~~March 31, 2020, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

There ~~was~~were no ~~change~~changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) or 15d-15(d) of the Exchange Act that occurred during the quarter ended ~~September 30, 2017~~March 31, 2020 that had materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

See Note 1511 "Commitments and Contingencies" of Part I – Item 1, Financial Statements – for information about our legal proceedings.

Item 1A. Risk Factors

The following description of risk factors includes any material changes to, and supersedes the description of, risk factors associated with our business previously disclosed in our Annual Report on Form 10-K filed on March ~~14, 2017~~11, 2020 with the SEC for the period ended December 31, ~~2016.~~2019. An investment in our common stock involves a substantial risk of loss. Investors should carefully consider these risk factors, together with all of the other information included herewith, before deciding to purchase shares of our common stock. If any of the following risks actually occur, our business, financial condition, or results of operations could be materially adversely affected. In such case, the market price of our common stock could decline and all or part of an investment may be lost.

The risks described below are not the only ones facing us. Our business is also subject to the risks that affect many other companies, such as general economic conditions and geopolitical events. Further, additional risks not currently known to us or that we currently believe are immaterial could have a material adverse effect on our business, financial condition, cash flows and results of operations. In addition to the other information set forth in this quarterly report on Form 10-Q, you should carefully consider the risk factors discussed below and in other documents we file with the SEC that could materially affect our business, financial condition, cash flows or future results.

Our business, results of operations and financial condition may be adversely affected by pandemic infectious diseases, particularly the novel coronavirus strain known as COVID-19.

In late 2019, a novel strain of coronavirus that causes the disease COVID-19 surfaced in Wuhan, China. In January 2020, the World Health Organization declared the COVID-19 outbreak to be a public health emergency. Since that time, COVID-19 has quickly spread, causing a global pandemic. To combat the spread of COVID-19, governmental authorities have taken a variety of steps to protect their citizens, including closing schools and workplaces and requiring people to stay at home and practice social distancing. These actions have had significant negative impacts on the global economy. While all of our solutions can be used by learners remotely, and we are capable of providing our services to our customers while following social distancing protocols, there is uncertainty in our business surrounding:

•

unprecedented levels of disruption that may distract our customers and delay purchasing decisions;

•

customers, particularly in our enterprise business, that may be facing financial difficulties that may lead to slower cash collection or cancellation due to lack of funds;

•

the length and severity of the economic downturn;

•

productivity disruptions caused by the distraction of our workforce in a remote work environment; and

•

increased costs associated with the increase in our customer base as a result of the initiatives to support K-12 schools and consumers during the pandemic.

These uncertainties and the extent to which COVID-19 impacts our operations will depend on future developments. Such developments are highly uncertain and cannot be predicted with confidence, including the duration of the outbreak, new information which may emerge concerning the severity of COVID-19, and the actions to contain COVID-19 or treat its impact, among others. Furthermore, the success of our business depends to a significant extent upon spending by K-12 schools, governments, organizations and consumers, which is subject to a number of factors including general economic conditions, K-12 school budgets, consumer confidence, employment levels, business conditions, interest rates, availability of credit, inflation, and taxation. Adverse trends in any of these economic indicators, which may be impacted by COVID-19, may cause spending to decline, which could adversely affect our business, results of operations and financial condition. We continue to monitor the effects of COVID-19 on our business.

We might not be successful in executing our strategy of focusing on ~~the Enterprise & Education Language~~learners who need to speak and ~~Literacy segments~~read English and ~~on more~~ passionate language learners ~~in the Consumer segment, and our company reorganization and realignment might not produce the desired results.~~

who are mobile.

We are continuing to ~~undertake a strategic reorganization~~implement our strategy to emphasize the development of products and ~~realignment of our business to maximize profitable growth in our Enterprise & Education Language segment by serving the needs of corporate and K-12 language~~solutions for learners ~~and prioritizing those~~ who ~~wish~~need to speak and read English. ~~In addition,~~This focus extends to the Consumer Language segment, where we ~~are now focusing on~~continue to make product investments serving the needs of ~~more~~ passionate language learners ~~in our Consumer segment, rather than addressing the needs of the mass marketplace.~~who are mobile, results-focused and value a quality language-learning experience. If we do not successfully execute our strategy, our revenue and profitability could ~~decline. Our recent strategy changes include actions to reduce headcount, exit unprofitable geographies, and other savings initiatives. These cost reduction efforts~~decline, which could harm our business and results of operations by distracting management and employees, causing difficulty in hiring, motivating and retaining talented and skilled personnel, and creating uncertainty among our customers and vendors that could lead to delays or unexpected costs. Also, our ability to achieve anticipated cost savings and other benefits from these efforts is subject to many estimates and assumptions, which are subject to significant business, economic and competitive uncertainties and contingencies, some of which are beyond our control. If these estimates and assumptions are incorrect, or if other unforeseen events occur,have an adverse effect on our business and financial ~~results could be adversely affected.~~

results.

Our actual operating results may differ significantly from our guidance.

As a result, we may fail to meet or exceed the expectations of research analysts or investors, which could cause our stock price to decline.

Historically, our practice has been to release guidance regarding our future performance that represents management's estimates as of the date of release. This guidance, which includes forward-looking statements, is based on projections prepared by management. These projections are not prepared with a view toward compliance with published guidelines of the American Institute of Certified

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Public Accountants, and neither our registered public accountants nor any other independent expert or outside party confirms or examines the projections and, accordingly, no such person expresses any opinion or any other form of assurance with respect thereto.

Projections are based upon a number of assumptions and estimates that, while presented with numerical specificity, are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control and are based upon specific assumptions with respect to future business decisions, some of which will change. We generally state possible outcomes as high and low ranges or as single point estimates, but actual results could differ materially. The principal reason that we release guidance is to provide a basis for management to discuss our business outlook with analysts and investors. We do not accept any responsibility for any projections or reports published by any such persons.

Guidance is necessarily speculative in nature, and it can be expected that some or all of the assumptions in the guidance furnished by us will not materialize or will vary significantly from actual results. Accordingly, our guidance is only an estimate of what management believes is realizable as of the date of release. Actual results may vary from our guidance and the variations may be material. We expressly disclaim any obligations to update or revise any guidance, whether as a result of new

information, future events or otherwise, except as required by law. In light of the foregoing, investors are urged not to rely upon, or otherwise consider, our guidance in making an investment decision in respect of our common stock.

Any failure to successfully implement our strategy or the occurrence of any of the events or circumstances set forth in these "Risk Factors" and elsewhere in this quarterly report on Form 10-Q could result in the actual operating results being different from our guidance, and such differences may be adverse and material.

Intense competition in our industry may hinder our ability to attract and retain customers and generate revenue, and may diminish our margins.

The business environment in which we operate is rapidly evolving, highly fragmented and intensely competitive, and we expect competition to persist and intensify. Increased competition could adversely affect operating results by causing lower demand for our products and services, reduced revenue, more product returns, price reductions or concessions, reduced gross margins and loss of customers.

Many of ~~our~~the current and potential ~~domestic~~competitors in our Literacy and ~~international competitors~~E&E Language segments have substantially greater financial, technical, sales, marketing and other resources than we do, as well as greater name recognition in some locations, as well as in some cases, lower costs. Some competitors offer more differentiated products (for example, online learning as well as physical classrooms and textbooks) that may allow them to more flexibly meet changing customer preferences. The resources of our competitors also may enable them to respond more rapidly to new or emerging technologies and changes in customer requirements and preferences and to offer lower prices than ours or to offer free language-learning software or online services. We may not be able to compete successfully against current or future competitors.

There are a number of free online language-learning opportunities to learn grammar, pronunciation, vocabulary (including specialties in areas such as medicine and business), reading, and conversation by means of podcasts and MP3s, mobile applications, audio courses and lessons, videos, games, stories, news, digital textbooks, and through other ~~means.~~means, which compete with our Consumer Language segment. We estimate that there are thousands of free mobile applications on language-learning; free products are provided in at least 50 languages by private companies, universities, and government agencies. Low barriers to entry allow start-up companies with lower costs and less pressure for profitability to compete with us. Competitors that are focused more on user acquisition rather than profitability and funded by venture capital may be able to offer products at significantly lower prices or for free. As free online translation services improve and become more widely available and used, people may generally become less interested in language learning. Although we also offer free products such as mobile apps, if we cannot successfully attract users of these free products and convert a sufficient portion of these free users into paying customers, our business could be adversely affected. If free products become more engaging and competitive or gain widespread acceptance by the public, demand for our products could decline or we may have to lower our prices, which could adversely impact our revenue and other results.

Historically a substantial portion of our revenue has been generated from our Consumer Language business. If we fail to accurately anticipate consumer demand and trends in consumer preferences, our brands, sales and customer relationships may be harmed.

Demand for our consumer focused language-learning software products and related services is subject to rapidly changing consumer demand and trends in consumer preferences. Therefore, our success depends upon our ability to:

•

identify, anticipate, understand and respond to these trends in a timely manner;

~~identify, anticipate, understand and respond to these trends in a timely manner;~~

•

introduce appealing new products and performance features on a timely basis;

~~introduce appealing new products and performance features on a timely basis;~~

•

provide appealing solutions that engage our customers;

~~provide appealing solutions that engage our customers;~~

•

adapt and offer our products and services using rapidly evolving, widely varying and complex technologies;

~~adapt and offer our products and services using rapidly evolving, widely varying and complex technologies;~~

•

anticipate and meet consumer demand for additional languages, learning levels and new platforms for delivery;

~~anticipate and meet consumer demand for additional languages, learning levels and new platforms for delivery;~~

•

effectively position and market our products and services;

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•

identify and secure cost-effective means of marketing our products to reach the appropriate consumers;

~~effectively position and market our products and services;~~

•

identify cost-effective sales distribution channels and other sales outlets where interested consumers will buy our products;

~~identify and secure cost-effective means of marketing our products to reach the appropriate consumers;~~

•

anticipate and respond to consumer price sensitivity and pricing changes of competitive products; and

~~identify cost-effective sales distribution channels and other sales outlets where interested consumers will buy our products;~~

•

identify and successfully implement ways of building brand loyalty and reputation.

~~anticipate and respond to consumer price sensitivity and pricing changes of competitive products; and~~

~~identify and successfully implement ways of building brand loyalty and reputation.~~

We anticipate having to make investments in new products in the future and we may incur significant expenses without achieving the anticipated benefits of our investment or preserving our brand and reputation. Investments in new products and technology are speculative, the development cycle for products may exceed planned estimates and commercial success depends on many factors, including innovativeness, developer support, and effective distribution and marketing. Customers might not perceive our latest offerings as providing significant new value and may reduce their purchases of our offerings, unfavorably impacting revenue. We might not achieve significant revenue from new product and service investments for a number of years, if at all. We also might not be able to develop new solutions or enhancements in time to capture business opportunities or achieve sustainable acceptance in new or existing marketplaces. Furthermore, consumers may defer purchases of our solutions in anticipation of new products or new versions from us or our competitors. A decline in consumer demand for our solutions, or any failure on our part to satisfy such changing consumer preferences, could harm our business and profitability.

If the recognition by schools and other organizations of the value of technology-based education does not continue to grow, our ability to generate revenue from organizations could be impaired.

Our success depends in part upon the continued adoption by organizations and potential customers of technology-based education initiatives. Some academics and educators oppose online education in principle and have expressed concerns regarding the perceived loss of control over the education process that could result from offering courses online. If the acceptance of technology-based education does not continue to grow, our ability to continue to grow our ~~Enterprise & Education~~Literacy and E&E Language ~~business~~businesses could be impaired.

We depend on discretionary consumer spending in the Consumer Language segment of our business. Adverse trends in general economic conditions, including retail and online shopping patterns or consumer confidence, as well as other external consumer dynamics may compromise our ability to generate revenue.

The success of our business depends to a significant extent upon discretionary consumer spending, which is subject to a number of factors, including general economic conditions, consumer confidence, employment levels, business conditions, interest rates, availability of credit, inflation, and taxation. Adverse trends in any of these economic indicators may cause consumer spending to decline, which could adversely affect our sales and profitability.

Because a ~~significant~~ portion of our Consumer Language sales are made to or through retailers and distributors, none of which has any obligation to sell our products, the failure or inability of these parties to sell our products effectively could reduce our revenue and profitability.

We rely on retailers and distributors, together with our direct sales force, to sell our products. Our sales to retailers and distributors are concentrated on a key group that is comprised of a mix of websites, such as Amazon.com, ~~and~~app stores, such as the Apple App Store, Google Play Store, Amazon App Store for Android, and Samsung Galaxy App Store, select retail resellers, such as Barnes & Noble, Target, and Best Buy, ~~Target, Books-a-Million, Staples, and Sam's Club,~~ and consignment distributors such as ~~Wynit Distribution and~~ Software Packaging Associates.

We have no control over the quantity of products that ~~these~~ retailers and distributors purchase from us or sell on our behalf, we do not have long-term contracts with any of them, and they have no obligation to offer or sell our products or to give us any particular shelf space or product placement within their stores. Thus, there is no guarantee that this source of revenue will continue at the same level as it has in the past or that these retailers and distributors will not promote competitors' products over our products or enter into exclusive relationships with our competitors. Any material adverse change in the principal commercial terms, material decrease in the volume of sales generated by our larger retailers or distributors or major disruption or termination of a relationship with these retailers and distributors could result in a significant decline in our revenue and profitability. Furthermore, product display locations and promotional activities that retailers, websites and app stores undertake can affect the sales of our products. The fact that we also sell our products directly could cause retailers, websites, app stores or distributors to reduce their efforts to promote our products or stop selling our products altogether.

Many traditional physical retailers are experiencing diminished foot traffic and sales. For our retail business, even though online sales have increased in popularity and are growing in importance, we continue to depend on sales that take place in physical stores and shopping malls. Reduced customer foot traffic in these stores and malls is likely to reduce their sales of our products. In addition, if one or more of these retailers or distributors are unable to meet their obligations with respect to accounts payable to us, we could be forced to write off accounts receivable with such accounts. Any bankruptcy, liquidation, insolvency or other failure of any of these retailers or distributors could result in significant financial loss and cause us to lose revenue in future periods.

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Price changes, varying subscription terms, and other concessions could reduce our revenue.

We continue to test and offer changes to the pricing of our products. If we reduce our prices in an effort to increase our sales, this could have an adverse impact on our revenue to the extent that unit sales do not increase in a sufficient amount to compensate for the lower pricing. Reducing our pricing to individual consumers could also cause us to have to lower pricing to

our ~~Enterprise & Education~~E&E Language customers. Any increase in the taxation of online sales could have the effect of a price increase to consumers and could cause us to have to lower our prices or could cause sales to decline. It is uncertain whether we will need to lower prices to effectively compete and what other short-term or long-term impacts could be.

~~We also may provide~~

Additionally, our ~~retailers~~online and ~~distributors~~app-based products are sold under different subscription terms, from short-term (less than one year) to long-term (typically 12 to 24 months) subscriptions with ~~price protection on existing inventories, which would entitle these retailers~~a corresponding license term, and ~~distributors to credit against amounts owed with respect to unsold packaged product under certain conditions. These price protection reserves~~lifetime subscriptions without a fixed duration. Online and app-based subscription customers could be ~~material~~less likely to renew their subscriptions beyond the initial term and lifetime subscribers have no need to renew. Consequently, we could earn less revenue over time from each customer than historically, which could have a substantially negative impact on our revenue, results of operations and cash flow in ~~future periods.~~

any quarterly reporting period.

In the U.S. and Canada, we offer consumers who purchase our ~~packaged~~web-based software ~~and audio practice products~~ directly from us a 30-day, unconditional, full money-back refund. We also permit some of our retailers and distributors to return ~~packaged~~ products, subject to certain limitations. We establish revenue reserves for ~~packaged~~ product returns based on historical experience, estimated channel inventory levels, the timing of new product introductions and other factors. If ~~packaged~~ product returns exceed our reserve estimates, the excess would offset reported revenue, which could adversely affect our reported financial results.

Our future growth and profitability will depend in large part upon the effectiveness and efficiency of our marketing.

Our future growth and profitability will depend in large part upon the effectiveness and efficiency of our marketing, including our ability to:

•

appropriately and efficiently allocate our marketing for multiple products;

~~appropriately and efficiently allocate our marketing for multiple products;~~

•

accurately identify, target and reach our audience of potential customers with our marketing messages;

~~accurately identify, target and reach our audience of potential customers with our marketing messages;~~

•

select the right marketplace, media and specific media vehicle in which to advertise;

~~select the right marketplace, media and specific media vehicle in which to advertise;~~

•

identify the most effective and efficient level of spending in each marketplace, media and specific media vehicle;

~~identify the most effective and efficient level of spending in each marketplace, media and specific media vehicle;~~

•

determine the appropriate creative message and media mix for advertising, marketing and promotional expenditures;

~~determine the appropriate creative message and media mix for advertising, marketing and promotional expenditures;~~

•

effectively manage marketing costs, including creative and media expenses, in order to maintain acceptable customer acquisition costs;

~~effectively manage marketing costs, including creative and media expenses, in order to maintain acceptable customer acquisition costs;~~

•

differentiate our products as compared to other products;

~~differentiate our products as compared to other products;~~

•

create greater awareness of our new products, our brands and learning solutions;

~~create greater awareness of our new products our brands and learning solutions;~~

•

drive traffic to our e-commerce website, call centers, distribution channels and retail partners; and

~~drive traffic to our e-commerce website, call centers, distribution channels and retail partners; and~~

•

convert customer inquiries into actual orders.

~~convert customer inquiries into actual orders.~~

Our planned marketing may not result in increased revenue or generate sufficient levels of product and brand name awareness, and we may not be able to increase our net sales at the same rate as we increase our advertising expenditures.

We engage in an active public relations program, including through social media sites such as Facebook and Twitter. We also seek new customers through our online marketing efforts, including paid search listings, banner ads, text links and permission-based e-mails, as well as our affiliate and reseller programs. If one or more of the search engines or other online sources on which we rely for website traffic were to modify their general methodology for how they display our websites, resulting in fewer consumers clicking through to our websites, our sales could suffer. If any free search engine on which we rely begins charging fees for listing or placement, or if one or more of the search engines or other online sources on which we rely for purchased listings, modifies or terminates its relationship with us, our expenses could rise, we could lose customers and traffic to our websites could decrease.

We dynamically adjust our mix of marketing programs to acquire new customers at a reasonable cost with the intention of achieving overall financial goals. If we are unable to maintain or replace our sources of customers with similarly effective sources, or if the cost of our existing sources increases, our customer levels and marketing expenses may be adversely affected.

Our business depends on our strong brands, and failing to maintain or enhance the Rosetta Stone brands in a cost-effective manner could harm our operating results.

Maintaining and enhancing our brands is an important aspect of our efforts to attract new customers and expand our business. We believe that maintaining and enhancing our brands will depend largely on our ability to provide high-quality, innovative products, and services, which we might not do successfully. Our brands may be negatively impacted by a number of factors such as service outages, product malfunctions, data protection and security issues, and exploitation of our trademarks by others without permission.

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our brands in a cost-effective manner, or if we incur excessive expenses in these efforts, our business, operating results and financial condition could be harmed.

Our international businesses may not succeed and may impose additional and unique risks.

~~Our business strategy contemplates stabilizing~~

The success of our international operations depends on our ability to successfully market, sell, deliver and ~~reducing the losses we have experienced~~support our products and services internationally. In ~~March~~ 2016, ~~as part of the 2016 Restructuring Plan,~~ we ~~initiated actions~~decided to ~~withdraw~~eliminate our direct sales presence in almost all of our non-U.S. and non-northern European geographies related to the distribution of the ~~Enterprise & Education~~E&E Language ~~offerings. These operations added~~offerings, relying instead on indirect sales ~~but at too high a cost~~channels through reseller and ~~without the near-term ability to capture scale efficiencies.~~other arrangements with third parties in those geographies. We ~~continuously review and optimize~~also have optimized certain of our website sales channels in Europe, Asia and Latin America. In addition, ~~we continue~~our international businesses expose us to ~~optimize our indirect sales channels in Europe, Asia and Latin America through reseller and other arrangements~~risks including, but not limited to:

•

tariffs and trade barriers;

•

currency fluctuations, which could decrease our revenues or increase our costs in the United States;

~~with third parties.~~

•

regulations related to customs and import/export matters;

•

tax issues, such as tax law changes and variations in tax laws;

•

restrictions on the repatriation of profits or payment of dividends;

•

inadequate banking systems;

•

crime, strikes, riots, civil disturbances, terrorist attacks or wars;

•

impacts of public health epidemics on employees, consumers, and the global economy, such as the current COVID-19 pandemic;

•

law enforcement authorities and courts that are weak or inexperienced in commercial matters; and

•

deterioration of political relations among countries.

If we are unable to ~~stabilize and reduce losses in~~conduct our international operations successfully and in a timely manner, our business, revenue and financial results could be harmed. Such stabilization and reduction may be more difficult or take longer than we anticipate, and we may not be able to successfully market, sell, deliver and support our products and services internationally to the extent we ~~expect.~~

expect, our business, revenue and financial results could be harmed.

If we are unable to continually adapt our products and services to mobile devices and technologies other than personal computers and laptops, and to adapt to other technological changes and customer needs generally, we may be unable to attract and retain customers, and our revenue and business could suffer.

We need to anticipate, develop and introduce new products, services and applications on a timely and cost-effective basis that keeps pace with technological developments and changing customer needs. The process of developing new high technology products, services and applications and enhancing existing products, services and applications is complex, costly and uncertain, and any failure by us to anticipate customers' changing needs and emerging technological trends accurately could significantly harm our ability to attract and retain customers and our results of operations. For example, the number of individuals who access the Internet through devices other than a personal computer, such as tablet computers, mobile devices, televisions and set-top box devices, has increased dramatically and this trend is likely to continue. Our products and services may not work or be viewable on these devices because each manufacturer or distributor may establish unique technical standards for such devices. Accordingly, we may need to devote significant resources to the creation, support and maintenance of such versions. If we fail to develop or sell products and services on a cost-effective basis that respond to these or other technological developments and changing customer needs, we may be harmed in our ability to attract and retain customers, and our revenue and business could suffer. Furthermore, our customers who view our advertising via mobile devices might not buy our products to the same extent that they do when viewing our advertising via personal computers or laptops. Accordingly, if we cannot convince customers to purchase our products via mobile devices, our business and results of operations could be harmed to the extent that the trend to mobile devices continues.

We offer our software products on operating systems and platforms including Windows, Macintosh, Apple OS, Android, and Amazon apps. The demand for traditional desktop computers has been declining, while the demand for mobile devices such as notebook computers, smartphones and tablets ~~have~~has been increasing, which means that we must be able to market to potential customers and to provide customers with access to and use of our products and services on many platforms and operating systems, as they may be changed from time to time. To the extent new releases of operating systems, including for mobile and non-PC devices, or other third-party products, platforms or devices make it more difficult for our products to perform, and our customers use alternative technologies, our business could be harmed.

Our software products must interoperate with computer operating systems of our customers. If we are unable to ensure that our products interoperate properly with customer systems, our business could be harmed.

Our products must interoperate with our customers' computer systems, including the network, security devices and settings, and student learning management systems of our ~~Enterprise & Education~~E&E Language and Literacy customers. As a result, we must continually ensure that our products interoperate properly with these varied and customized systems. Changes in operating systems, the technologies we incorporate into our products or the computer systems our customers use may damage our business.

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Our products and internal systems rely on software that is highly technical and maintained by third ~~parties and if~~parties. If such third-party software contains undetected errors or vulnerabilities, or if it is not supported or updated to keep pace with current computer hardware, our business could be adversely affected.

Our products and internal systems rely on software, including software developed or maintained internally and/or by third parties, that is highly technical and complex. In addition, our products and internal systems depend on the ability of such software to store, retrieve, process, and manage immense amounts of data. Such software has contained, and may now or in the future contain, undetected errors, bugs, or vulnerabilities. Some errors may only be discovered after the code has been released for external or internal use. Errors, vulnerabilities, or other design defects within the software on which we rely may result in a negative experience for users and marketers who use our products, delay product introductions or enhancements, result in measurement or billing errors, compromise our ability to protect the data of our users and/or our intellectual property or lead to reductions in our ability to provide some or all of our services.

For example, although we have modified our products to eliminate reliance on Adobe Flash, we still have customers who use older versions of our products that rely on Adobe Flash as a platform for our software. Adobe Flash is one of the most versatile programming systems available and is unique in its ability to allow the integration of many forms of electronic formatted media into an interactive and user friendly system. However, inFlash. In July 2015, certain vulnerabilities discovered in Adobe Flash led to temporary interruption of support for Adobe Flash by popular ~~web browsers. As a result, some software makers are opting to exclude Adobe Flash from their~~ web browsers. If similar interruptions occur in the future and disrupt our ability to provide our products to some or all of our users, our ability to generate revenue would be harmed. Additionally, if Adobe Flash were to

become deleted from Adobe’s product line or become not supported or updated to keep pace with current computer hardware, then our software products that continue to rely on Adobe Flash would become obsolete very quickly. Any errors, bugs, vulnerabilities, or defects discovered in the software on which we rely, and any associated degradations or interruptions of service, could result in damage to our reputation, loss of users, loss of revenue, or liability for damages, any of which could adversely affect our business and financial results.

If there are changes in the spending policies or budget priorities for government funding of colleges, universities, schools, other education providers, or government agencies, we could lose revenue.

Many of our ~~Enterprise & Education~~E&E Language and Literacy customers are colleges, universities, primary and secondary schools and school districts, other education providers, armed forces and government agencies that depend substantially on government funding. Accordingly, any general decrease, delay or change in federal, state or local funding for colleges, universities, primary and secondary schools and school districts, or other education providers or government agencies that use our products and services, including in response to the COVID-19 pandemic, could cause our current and potential customers to reduce their purchases of our products and services, to exercise their right to terminate licenses, or to decide not to renew licenses, any of which could cause us to lose revenue. In addition, a specific reduction in governmental funding support for products such as ours would also cause us to lose revenue and could adversely affect our overall gross margins.

Some of our ~~Enterprise & Education~~E&E Language and Literacy business is characterized by a lengthy and unpredictable sales cycle, which could delay new sales.

We face a lengthy sales cycle between our initial contact with some potential ~~Enterprise & Education~~E&E Language and Literacy customers and the signing of license agreements with these customers. As a result of this lengthy sales cycle, we have only a limited ability to forecast the timing of such ~~Enterprise & Education~~E&E Language and Literacy sales. A delay in or failure to complete license transactions could cause us to lose revenue, and could cause our financial results to vary significantly from quarter to quarter. Our sales cycle varies widely, reflecting differences in our potential ~~Enterprise & Education~~E&E Language and Literacy customers' decision-making processes, procurement requirements and budget cycles, and is subject to significant risks over which we have little or no control, including:

•

customers' budgetary constraints and priorities;

~~customers' budgetary constraints and priorities;~~

•

the timing of our customers' budget cycles;

~~the timing of our customers' budget cycles;~~

•

the need by some customers for lengthy evaluations that often include administrators and faculties; and

~~the need by some customers for lengthy evaluations that often include administrators and faculties;~~

•

the length and timing of customers' approval processes.

~~the length and timing of customers' approval processes.~~

As we pursue a 100% SaaS-based model for our Consumer business and sell our solutions as subscriptions, rather than packaged software, our revenue, results of operations and cash flow could be negatively impacted.

Historically, we have predominantly sold our packaged software programs under a perpetual license for a single upfront fee and recognized 65-90% of the revenue at the time of sale. Certain of our online products are sold under different subscription terms, from short-term (less than one year) to long-term (typically 36-months) subscriptions with a corresponding license term. Typically, long-term subscriptions include substantially higher discounts, resulting in less cash and revenue from the initial sale to the customer and selling a higher proportion of long-term subscriptions could have a substantially negative impact on our revenue, results of operations and cash flow in any quarterly reporting period. Furthermore, to the extent that customers use our products and services for only a short time after purchase, online subscription customers could be less likely to renew their subscriptions beyond the initial term with the effect that we could earn less revenue over time from each customer than historically.

Our revenue is subject to seasonal and quarterly variations, which could cause our financial results to fluctuate significantly.

We have experienced, and we believe we will continue to experience, substantial seasonal and quarterly variations in our revenue, cash flows and net income. These variations are primarily related to increased sales of our Consumer Language products and services in the fourth quarter, especially during the holiday selling season, as well as higher sales to governmental, educational institutions, and corporations in the second half of the calendar year. We sell to a significant number of our retailers, distributors and ~~Enterprise & Education~~E&E Language customers on a purchase order basis and we receive orders when these customers need products and services. As a result, their orders are typically not evenly distributed throughout the year. Our quarterly results of operations also may fluctuate significantly as a result of a variety of other factors, including the COVID-19 pandemic, timing of holidays and advertising initiatives, changes in our products, services and advertising initiatives and changes in those of our competitors. Budgetary constraints of our ~~Enterprise & Education~~E&E Language and Literacy customers may also cause our quarterly results to fluctuate.

As a result of these seasonal and quarterly fluctuations, we believe that comparisons of our results of operations between different quarters are not necessarily meaningful and that these comparisons are not reliable as indicators of our future performance. In addition, these fluctuations could result in volatility and adversely affect our cash flows. Any seasonal or quarterly fluctuations that we report in

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the future may differ from the expectations of market analysts and investors, which could cause the price of our common stock to fluctuate significantly.

Acquisitions, joint ventures and strategic alliances may have an adverse effect on our business.

We have made and may continue to make acquisitions or enter into joint ventures and strategic alliances as part of our long-term business strategy. Such transactions may result in use of our cash resources, dilutive issuances of our equity securities, or incurrence of debt. Such transactions also involve significant challenges and risks including that the transaction does not advance our business strategy, that we do not realize a satisfactory return on our investment, that we experience difficulty integrating new technology, employees, and business systems, that we divert management's attention from our other businesses or that we acquire undiscovered liabilities such as patent infringement claims or violations of the U.S. Foreign Corrupt Practices Act and similar worldwide anti-bribery laws. It may take longer than expected to realize the full benefits, such as increased revenue, enhanced efficiencies, or more customers, or those benefits may ultimately be smaller than anticipated, or may not be realized. These events and circumstances could harm our operating results or financial condition.

~~Our~~

The possession and use of personal, financial and other information by us and our third party service providers presents risks and expenses that could harm our business. If we or our service providers are unable to protect our information technology ~~network~~networks against service interruption or failure, misappropriation or unauthorized disclosure or manipulation of data, whether through breach of our network security or otherwise, we could be subject to costly government enforcement actions and litigation and our reputation may be damaged.

Our business involves the collection, storage and transmission of personal, financial or other information that is entrusted to us by our customers and employees. Our information systems also contain the Company's proprietary and other confidential information related to our business. Our efforts to protect such information may be unsuccessful due to the actions of third parties, computer viruses, physical or electronic break-ins, catastrophic events, employee error or malfeasance or other attempts to harm our systems. Possession and use of personal information in conducting our business subjects us to legislative and regulatory obligations that could require notification of data breaches, restrict our use of personal information, and hinder our ability to acquire new customers or market to existing customers. ~~Some~~Our use of new and emerging technologies such as cloud-based services and mobile applications continues to evolve, presenting new and additional risks in managing access to our ~~commercial partners may~~data, including relying on third parties to manage and safeguard data. These third party service providers receive or store information provided by us, our users or our ~~users through our websites.~~employees. If these third parties fail to adopt or adhere to adequate information security practices, or fail to comply with our online policies, or in the event of a breach of their networks, our customers' or employees’ data may be improperly accessed, used or disclosed. As our business and the regulatory environment evolve in the U.S. and internationally, we may become subject to additional and even more stringent legal obligations concerning our treatment of customer information. We have incurred, and will continue to incur, expenses to comply with privacy and security standards and protocols imposed by law, regulation, industry standards or contractual obligations.

Despite our precautions and significant ongoing investments to protect against security risks, data protection breaches, cyber-attacks and other intentional disruptions of our products and offerings, we may be a target of attacks specifically designed to impede the performance of our products and offerings and harm our reputation as a company. If our systems are harmed or fail to function properly or if third parties improperly obtain and use the personal information of our customers or employees, we may be required to expend significant resources to repair or replace systems or to otherwise protect against security breaches or to address problems caused by the breaches. A major breach of our network security and systems could have serious negative consequences for our businesses, including possible fines, penalties and damages, reduced customer demand for our products and services, harm to our reputation and brand, and loss of our ability to accept and process customer credit card orders. Any such access, disclosure or loss of information could result in legal claims or proceedings and regulatory penalties, disrupt our operations or result in a loss of confidence in our products and services, which could lead to a material and adverse effect on our business, reputation or financial results.

We may incur significant costs related to maintaining data security and in the event of any data security breaches that could compromise our information technology network security, trade secrets and customer data.

The secure processing, maintenance and transmission of personal, financial or other information that is entrusted to us by our customers is critical to our operations and business strategy, and we devote significant resources to protecting such information. The expenses associated with protecting such information could reduce our operating margins. Additionally, threats to our information technology network security can take a variety of forms. Individual hackers and groups of hackers, and sophisticated organizations or individuals may threaten our information technology network security. Cyber attackers may develop and deploy malicious software to attack our services and gain access to our networks or data centers, hold access to critical systems or information for ransom, or act in a coordinated manner to launch distributed denial of service or other coordinated attacks. Cyber threats and attacks are constantly evolving, thereby increasing the difficulty of detecting and successfully implementing measures to defend against them. We may be unable to anticipate potential techniques or implement

adequate preventative measures in time. Cyber threats and attacks can have cascading impacts that unfold with increasing speed across internal networks and systems. Breaches of our network, credit card processing information, or data security could disrupt the security of our internal systems and business applications, impair our ability to provide services to our customers and protect the privacy of their data, cause product development delays, compromise confidential or technical business information harming our competitive position, result in theft or misuse of our intellectual property or other assets, expose us to contractual or regulatory audit or investigation, require us to allocate additional resources to alternative and potentially more costly technologies more frequently than anticipated, or otherwise adversely affect our business. We maintain cyber risk insurance,

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but our policy coverage limits may not be sufficient to cover all of our losses caused by any future information security-related breaches or events.

Our business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy and data protection. Changes in regulations or customer concerns regarding privacy and protection of customer data, or any failure to comply with such laws, could adversely affect our business.

Federal, state, and international laws and regulations govern the collection, use, retention, disclosure, sharing and security of data that we receive from and about our customers. The use of ~~consumer~~personal data by online service providers and advertising networks is a topic of active interest among federal, state, and international regulatory bodies, as well as among data subjects, and the regulatory environment is unsettled and rapidly evolving. Many ~~states~~jurisdictions have passed new laws impacting ~~required~~technical and organizational measures to be put in place and require notifications to ~~customers~~data subjects and/or state agencies where there is a security breach involving personal data, such as California’s Information Practices Act.

Despite the technical and organizational measures we have in place, we could suffer successful breaches, employee malfeasance, or human or technological error which could result in, for example, unauthorized access to, disclosure, modification, misuse, loss, or destruction of company, customer, or other third party data or systems; theft of sensitive, regulated, or confidential data including personal information; the loss of access to critical data or systems through ransomware, destructive attacks or other means; and business delays, service or system disruptions or denials of service.

We also face similar risks in international markets where our products, services and apps are offered. Foreign data protection, privacy, competition, and other laws and regulations can impose different obligations or be more restrictive than those in the ~~United States.~~U.S. We are subject to international laws and regulations that dictate whether, how, and under what circumstances we can transfer, process and/or receive transnational data that is critical to our operations and ability to provision our products and perform services for our customers, including data relating to users, customers, employees, or partners outside the ~~United States,~~U.S, and those laws and regulations are uncertain and subject to change.

~~Recent legal~~

Legal developments in Europe have created complexity and compliance uncertainty regarding certain transfers of information from Europe to the U.S. For example, in October 2015, the European Court of Justice invalidated the 2000 US-EU Safe Harbor program as a legitimate and legally authorized basis on which U.S. companies, including Rosetta Stone, could rely for the transfer of personal data from the European Union to the ~~United States.~~U.S. The European Union and ~~United States recently~~U.S. agreed to an alternative transfer framework for data transferred from the European Union to the ~~United States,~~U.S., called the Privacy Shield Framework. Rosetta Stone participates and has certified to its compliance to the Privacy Shield Framework. However, this ~~new~~ framework also faces a number of legal challenges, is subject to an annual review that could result in changes to our obligations, and also may be challenged by national regulators or private parties. In addition, other available bases on which to rely for the transfer of EUEuropean Union personal data outside of the European Economic Area, such as ~~standard Model~~Standard Contractual Clauses ~~(MCCs)~~(SCCs), have also been subjected to regulatory or judicial scrutiny. This has resulted in some uncertainty, and compliance obligations could cause us to incur costs or require us to change our business practices in a manner adverse to our business.

Additionally, the United Kingdom’s decision to withdraw from the European Union also has resulted in uncertainty with regard to compliance obligations for data transfers between the European Union and the United Kingdom and the U.S.

If one or more of the legal bases for transferring personal data from Europe to the ~~United States~~U.S. is invalidated, or if we are unable to transfer personal data between and among countries and regions in which Rosetta Stone operates, it could affect the manner in which we provide our services or adversely affect our financial results. Any failure, or perceived failure, by us to comply with or make effective modifications to our policies, or to comply with any federal, state, or international privacy, ~~data-retention or~~ data-protection-related laws, regulations, orders or industry self-regulatory principles could result in proceedings or actions against us by governmental entities or others, a loss of customer confidence, damage to the Rosetta Stone brands, and a loss of customers, which could potentially have an adverse effect on our business.

In addition, various federal, state and foreign legislative or regulatory bodies may enact new or additional laws and regulations concerning privacy, ~~data-retention and~~ data-protection issues, including laws or regulations mandating disclosure to domestic or international law enforcement bodies, which could adversely impact our business, our brand or our reputation with customers. For example, some countries are considering laws mandating that personal data regarding customers in their country be maintained solely in their country. Having to maintain local data centers and design product, service and business operations to limit personal data processing within individual countries could increase our operating costs significantly. In addition, the European Commission ~~has~~ approved a data protection regulation, known as the General Data Protection Regulation (GDPR), which ~~has been finalized and is due to come into force~~became effective in ~~or around~~ May 2018. The GDPR ~~will include~~includes additional operational and other requirements for companies that receive or process personal data of residents of the European Union ~~that are different than those currently in place in the European Union, and that will include~~as well as significant penalties for non-compliance.

California recently enacted the Consumer Privacy Act of 2018, effective January 1, 2020, which greatly expands the definition of what constitutes personal data and requires companies, among other things, to give California consumers information about what data they collect and delete data about consumers if requested.

The interpretation and application of privacy ~~data protection~~ and data ~~retention~~protection laws and regulations are often uncertain and in flux in the U.S. and internationally. Complying with these varying international requirements could cause us to incur

substantial costs or require us to change our business practices in a manner adverse to our business and operating results. In addition, these laws may be interpreted and applied inconsistently from country to country and inconsistently with our current policies and practices, complicating long-range business planning decisions. If privacy ~~data protection~~ or data ~~retention~~protection laws are interpreted and applied in a manner that is inconsistent with our current policies and practices we may be deemed non-compliant, subject to legal or regulatory process, fined or ordered to change our business practices in a manner that could cause use to incur substantial costs, or that adversely impacts our business or operating results.

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We are subject to U.S. and foreign government regulation of online services which could subject us to claims, judgments, and remedies, including monetary liabilities and limitations on our business practices.

We are subject to regulations and laws directly applicable to providers of online services. The application of existing domestic and international laws and regulations to us relating to issues such as user privacy and data protection, data security, defamation, promotions, billing, consumer protection, accessibility, content regulation, quality of services, and intellectual property ownership and infringement ~~in many instances~~ is unclear or ~~unsettled.~~unsettled in many instances. Also, the collection and protection of information from children under the age of 13 is subject to the provisions of the Children's Online Privacy Protection Act (COPPA), which is particularly relevant to our learning solutions focused on children. In addition, we will also be subject to any new laws and regulations directly applicable to our domestic and international activities. Internationally, we may also be subject to laws regulating our activities in foreign countries and to foreign laws and regulations that are inconsistent from country to country. We may incur substantial liabilities for expenses necessary to defend litigation in connection with such regulations and laws or to comply with these laws and regulations, as well as potential substantial penalties for any failure to comply.

Changes in how network operators handle and charge for access to data that travel across their networks could adversely impact our business.

We rely upon the ability of customers to access many of our products through the Internet. To the extent that network operators implement usage based pricing, including meaningful bandwidth caps, or otherwise try to monetize access to their networks by data providers, we could incur greater operating expenses and our customer acquisition and retention could be negatively impacted. Furthermore, to the extent network operators were to create tiers of Internet access service and either charge us for or prohibit us from being available through these tiers, our business could be negatively impacted.

We are exposed to risks associated with credit card and payment fraud, and with our obligations under rules on credit card processing and alternative payment methods, which could cause us to lose revenue or incur costs. We depend upon our credit card processors and payment card associations.

As an e-commerce provider that accepts debit and credit cards for payment, we are subject to the Payment Card Industry Data Security Standard ("PCI DSS"), issued by the PCI Council. PCI DSS contains compliance guidelines and standards with regard to our network security surrounding the physical and electronic storage, processing and transmission of individual cardholder data. Despite our compliance with these standards and other information security measures, we cannot guarantee that all our information technology systems are able to prevent, contain or detect any cyber attacks, cyber terrorism, or securitybreaches from currently known viruses or malware, or viruses or malware that may be developed in the future. To the extent any disruption results in the loss, damage or misappropriation of information, we may be adversely affected by claims from customers, financial institutions, regulatory authorities, payment card associations and others. In addition, the cost of complying with stricter privacy and information security laws and standards could be significant.

We are subject to rules, regulations and practices governing our accepted payment methods which could change or be reinterpreted to make it difficult or impossible for us to comply. A failure to comply with these rules or requirements could make us subject to fines and higher transaction fees and we could lose our ability to accept these payment methods. We depend upon our credit card processors to carry out our sales transactions and remit the proceeds to us. At any time, credit card processors have the right to withhold funds otherwise payable to us to establish or increase a reserve based on their assessment of the inherent risks of credit card processing and their assessment of the risks of processing our customers’ credit cards. If our credit card processors exercise their right to establish or increase a reserve, it may adversely impact our liquidity. Our business and results of operations could be adversely affected if these changes were to occur.

The uncertainty surrounding the terms of the United Kingdom's withdrawal from the European Union and its consequences could cause disruptions to, and create uncertainty in, to our ~~businesses and adversely impact consumer and investor confidence in our products and services.~~

~~In June 2016, a majority of voters in the~~businesses.

The United Kingdom ~~elected to withdraw from~~formally left the European Union inon January 31, 2020, immediately entering an eleven month transition period running until the end of December 2020. During this transition period, the United Kingdom’s trading relationship with the European Union will remain unchanged, allowing time to agree and implement a ~~national referendum (also referred to as "Brexit"). The referendum was advisory, and by~~new future trading relationship. However, the terms of the ~~Treaty on~~United Kingdom’s relationship with the European Union ~~any withdrawal is~~after the end of the transition period remain subject to ~~a negotiation period that could last at least two years after~~negotiations yet to come, and there is substantial uncertainty about the ~~government~~terms of the ~~United Kingdom formally initiates~~final agreements. Therefore, the ~~withdrawal process. The~~ ultimate effects of Brexit on us are difficult to predict, but because we currently

conduct business in the United Kingdom and in Europe, the results of the ~~referendum and any eventual~~ withdrawal could cause disruptions and create uncertainty to our businesses, including affecting the business of and/or our relationships with our customers and suppliers, as well as altering the relationship among tariffs and currencies, including the value of the British pound and the Euro relative to the U.S. dollar. Such disruptions and uncertainties could adversely affect our financial condition, operating results, and cash flows. Additionally, Brexit could result in legal uncertainty and potentially divergent national laws and regulations as new legal relationships between the United Kingdom and the European Union and between the United Kingdom and countries outside the European Union, including the United States of America, are established. The ultimate effects of Brexit on us will also depend on the terms of agreements, if any, ~~agreements~~ the United Kingdom and the European Union make to retain access to each other's respective markets either during aan additional transitional period or more permanently. There is also the risk that other countries may decide to leave the European Union. Any of these effects, among others, may have a materially adverse effect on global economic conditions and the stability of

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global financial markets, which in turn could materially adversely affect our business, business opportunities, results of operations, and financial condition.

~~Uncertainty~~

The United States government may make substantial changes to fiscal, political, regulatory and other federal or foreign policies that may adversely affect our business, financial condition, operating results and cash flows.

Changes or uncertainty in general economic or political conditions in the ~~global geopolitical landscape from recent events~~United States or other regions could adversely affect our business. For example, the administration under President Donald Trump has made, or has indicated that it may ~~impede the implementation~~propose, significant changes with respect to a variety of issues, including education standards and funding, international trade agreements, import and export regulations, tariffs and customs duties, foreign relations, and immigration laws, that could have a materially adverse effect on our ~~strategy outside the United States.~~

~~There may be~~business, business opportunities, results of operations and financial condition.

Furthermore, there is uncertainty as to the position the United States government will take with respect to world affairs and ~~events following the 2016 U.S. presidential election and related change in political agenda, coupled with the transition of administrations.~~events. This uncertainty may include such issues as U.S. support for existing treaty and trade relationships with other countries. This uncertainty, together with other key global events during ~~2016~~recent years (such as the COVID-19 pandemic, continuing uncertainty arising from the ~~Brexit referendum in~~United Kingdom’s withdrawal from the ~~United Kingdom~~EU as well as ongoing terrorist activity), may adversely impact (i) the ability or willingness of non-U.S. companies to transact business in the ~~United States,~~U.S., including with the Company (ii) regulation and trade agreements affecting U.S. companies, (iii) global stock markets (including the New York Stock Exchange on which our common stock is traded), and (iv) general global economic conditions. All of these factors are outside of our control, but may nonetheless cause us to adjust our strategy in order to compete effectively in global markets.

Any change in strategy may not be successful, and could have a materially adverse effect on our business, business opportunities, results of operations and financial condition.

Natural disasters, public health crises, political crises, and other catastrophic events or other events outside of our control may impact our facilities or thefacilities of third parties on which we depend, and could impact consumer spending.

If any of our facilities, facilities of third parties on which we depend, or our customers are affected by natural disasters, such as earthquakes, tsunamis, power shortages or outages, floods, public health crises, such as pandemics and epidemics, political crises, such as terrorism, war, political instability or other conflict, or other events outside of our control, our business and operating results could suffer. Disasters or public health crises or political crises affecting or occurring at our or our third party facilities could also impact our operations, our reputation and our customers’ perception of our brands. Moreover, these types of events could negatively impact consumer and business spending in the impacted regions or depending upon the severity, globally, which could adversely impact our operating results. For example, the COVID-19 global pandemic has had a significant negative effect on the global economy, which could have an adverse impact on our business and operating results.

Any significant interruptions in the operations of our website, call center or third-party call centers, especially during the holiday shopping season, could cause us to lose sales and disrupt our ability to process orders and deliver our solutions in a timely manner.

We rely on our website, an in-house call center and third-party call centers, over which we have little or no control, to sell our solutions, respond to customer service and technical support requests and process orders. These activities are especially important during the holiday season and in particular the period beginning on Black Friday through the end of the calendar year. Any significant interruption in the operation of these facilities, including an interruption caused by our failure tosuccessfully expand or upgrade our systems or to manage these expansions or upgrades, or a failure of third-party call centers to handle higher volumes of use, could reduce our ability to receive and process orders and provide products and services, which could result in cancelled sales and loss of revenue and damage to our brand and reputation. These risks are more important during the holiday season, when many sales of our products and services take place.

We structure our marketing and advertising to drive potential customers to our website and call centers to purchase our solutions. If we experience technical difficulties with our website or if our call center operators do not convert inquiries into sales at expected rates, our ability to generate revenue could be impaired. Training and retaining qualified call center operators is challenging due to the expansion of our product and service offerings and the seasonality of our business. If we do not adequately train our call center operators, they may not convert inquiries into sales at an acceptable rate.

If any of our products or services contain defects or errors or if new product releases or services are delayed, our reputation could be harmed, resulting in significant costs to us and impairing our ability to sell our solutions.

If our products or services contain defects, errors or security vulnerabilities, our reputation could be harmed, which could result in significant costs to us and impair our ability to sell our products in the future. In the past, we have encountered product development delays due to errors or defects. We would expect that, despite our testing, errors could be found in new products and product enhancements in the future. Significant errors in our products or services could lead to, among other things:

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delays in or loss of marketplace acceptance of our products and services;

~~delays in or loss~~

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diversion of our resources;

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a lower rate of license renewals or upgrades for Consumer Language, Literacy and E&E Language customers;

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injury to our reputation;

Table of ~~marketplace acceptance of our products and services;~~Contents

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increased service expenses or payment of damages; or

~~diversion of our resources;~~

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costly litigation.

~~a lower rate of license renewals or upgrades for Consumer, Literacy and Enterprise & Education Language customers;~~

~~injury to our reputation;~~

~~increased service expenses or payment of damages; or~~

~~costly litigation.~~

If we fail to effectively upgrade our information technology systems, we may not be able to accurately report our financial results or prevent fraud.

As part of our efforts to continue improving our internal control over financial reporting, we ~~plan to continue~~may decide to upgrade our existing 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. In addition, our management information systems will require modification and refinement as our business needs change, which could prolong difficulties we experience with systems transitions, and we may not always employ the most effective systems for our purposes. If we experience difficulties in implementing new or upgraded information systems or experience significant system failures, or if we are unable to successfully modify our management information systems or respond to changes in our business needs, we may not be able to effectively manage our business and we may fail to meet our reporting obligations. In addition, as a result of the automation of these manual processes, the data produced may cause us to question the accuracy of previously reported financial results.

Failure to maintain the availability of the systems, networks, databases and software required to operate and deliver our Internet-based products and services could damage our reputation and cause us to lose revenue.

We rely on internal and external systems, networks and databases maintained by us and third-party providers to process customer orders, handle customer service requests, and host and deliver our Internet-based learning solutions. Any damage, interruption or failure of our systems, networks and databases could prevent us from processing customer orders and result in degradation or interruptions in delivery of our products and services. Notwithstanding our efforts to protect against interruptions in the availability of our e-commerce websites and Internet-based products and services, we do occasionally experience unplanned outages or technical difficulties. In addition, we do not have complete redundancy for all of our systems. In the event of an interruption or system event we may be unable to meet contract service level requirements, or we could experience an unrecoverable loss of data which could cause us to lose customers and could harm our reputation and cause us to face unexpected liabilities and expenses. If we continue to expand our business, we will put additional strains on these systems. As we continue to move additional product features to online systems or place more of our business online, all of these considerations will become more significant.

We may also need to grow, reconfigure or relocate our data centers in response to changing business needs, which may be costly and lead to unplanned disruptions of service.

We may incur losses associated with currency fluctuations and may not be able to effectively hedge our exposure, which could impair our financial performance.

Our operating results are subject to fluctuations in foreign currency exchange rates. We currently do not attempt to mitigate a portion of these risks through foreign currency hedging, based on our judgment of the appropriate trade-offs among risk, opportunity and expense. In the future, we might choose to engage in foreign currency hedging transactions, which would involve different risks and uncertainties.

Our ~~revolving~~ credit facility contains ~~borrowing limitations~~financial and other restrictive covenants and the failure ~~to maintain a sufficient borrowing base or~~ to comply with such covenants could prevent us from borrowing funds, and could cause any outstanding debt to become immediately payable, which might adversely impact our business.

Our ~~revolving~~ credit facility contains ~~borrowing limitations based on a combination of our cash balance and eligible accounts receivable balances and financial covenants currently applicable to us, as well as~~ a number of restrictive covenants, including restrictions on incurring additional debt, making investments and other restricted payments, selling assets, paying dividends and redeeming or repurchasing capital stock and debt, subject to certain exceptions. Collectively, these ~~borrowing limitations and~~ covenants could constrain our ability to grow our business through acquisition or engage in other transactions. During the term of our $25.0 million ~~revolving~~ credit facility, we are also subject to certain financial covenants that require us to maintain a minimum liquidity ~~amount~~coverage ratio and minimum financial performance requirements, as defined in the credit ~~agreement.~~facility. If we are not able to comply with all of these covenants, for any reason, we would not be able to borrow funds under the facility, and some or all of any outstanding debt could become immediately due and payable which could have a material adverse effect on our liquidity and ability to conduct our business.

~~A significant deterioration in our profitability and/or cash flow caused by prolonged economic instability could reduce our liquidity and/or impair our financial ratios, and trigger a need~~

We might be required to raise additional funds from the capital markets and/or renegotiate our banking ~~covenants.~~

covenants to support our business, which might not be available on acceptable terms or at all.

To the extent we face economic difficulties, ~~continue,~~ our revenue, profitability and cash flows could be significantly reduced. A liquidity shortfall may delay certain development initiatives or may expose us to a need to negotiate further funding. While we anticipate that our existing cash and cash equivalents, together with availability under our existing ~~revolving~~ credit facility, cash

balances and cash from operations, will be sufficient to fund our operations for at least the next 12 months, we may need to raise additional capital ~~to fund operations in the future or to finance acquisitions. If we seek to raise additional capital~~ in order to meet ~~various~~our business objectives ~~including~~in the future. Such objectives may include, among other things, developing or enhancing future technologies and

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services, funding expansion, increasing working capital, acquiring businesses, products or technologies, and responding to competitive ~~pressures, capital may not~~pressures. To the extent we face economic difficulties, our revenue, profitability, and cash flows could be ~~available on favorable terms or may not be available at all.~~significantly reduced. A lack of sufficient capital resources could significantly limit our ability to take advantage of business and strategic ~~opportunities. Any additional capital raised through the sale of equity securities would dilute our stock ownership. If adequate additional funds are not available, we may be required~~opportunities, require us to ~~delay,~~ reduce ~~the scope of, or eliminate material parts~~costs, requiring a renegotiation of our ~~business strategy, including potential additional acquisitions~~banking covenants or ~~development of new products, services and technologies.~~

~~We might~~ require ~~additional funds from what we internally generate~~us to ~~support our business which might not be available on acceptable terms or at all.~~

~~We might need to further reduce costs or~~ raise additional funds through public or private financings or borrowings in order to maintain our operations at their current ~~level, develop or enhance products, fund expansion, respond~~level. If we seek to ~~competitive pressures or~~raise additional capital in order to ~~acquire complementary products, businesses or technologies. If required,~~meet various objectives additional financing might not be available on terms that are favorable to us, if at all. If we raise additional funds through the issuance of debt, equity or convertible debt securities, these securities might have rights, preferences and privileges senior to those of our current stockholders.

Any additional capital raised through the sale of equity securities would also dilute our stock ownership. If adequate additional funds are not available, our business, business opportunities, results of operations and financial condition may be harmed.

If our goodwill or indefinite-lived intangible assets become impaired, we may be required to record a significant non-cash charge to earnings.

Under ~~GAAP,~~accounting principles generally accepted in the U.S. ("GAAP"), we review our goodwill and indefinite lived intangible assets for impairment at least annually and when there are changes in circumstances. Factors that may be considered a change in circumstances include a decline in stock price and market capitalization, expected future cash flows and slower growth rates in our industry. We may be required to record significant charges to earnings in our financial statements during the period in which any impairment of our goodwill or indefinite lived intangible assets is determined, resulting in a negative effect on our results of operations.

We may have exposure to greater than anticipated tax liabilities.

We are subject to income and indirect tax in the U.S. and many foreign jurisdictions. The application of indirect taxes (such as sales and use tax, value-added tax, goods and services tax, business tax and gross receipt tax) to our businesses and to our users is complex, uncertain and evolving, in part because many of the fundamental statutes and regulations that impose indirect taxes were established before the adoption and growth of the Internet and e-commerce. We are subject to audit by multiple tax authorities throughout the world. Although we believe our tax estimates are reasonable and accurate, the final determination of tax audits and any related litigation could be materially different from our historical tax provisions and accruals. The results of an audit or litigation could have a material adverse effect on our financial statements in the period or periods for which that determination is made.

In addition, the United States government and other governments ~~are considering and~~ may adopt tax ~~reform~~ measures that could impact future effective tax rates favorably or unfavorably affected by changes in tax rates, changes in the valuation of our deferred tax assets or liabilities, or changes in tax laws or their interpretation. Such changes could have a material adverse impact on our financial results. Further, any changes to the U.S. or any foreign jurisdictions’ tax laws, tax rates, or the interpretation of such tax laws, including the Base Erosion Profit Shifting project being conducted by the Organization for Economic Co-operation and Development could significantly impact how U.S. multinational corporations are taxed. Although we cannot predict whether or in what form any other legislation changes may pass, if enacted it could have a material adverse impact on our tax expense, deferred tax assets and cash flows.

Our deferred tax assets may not be fully realizable.

We record tax valuation allowances to reflect uncertainties about whether we will be able to realize some of our deferred tax assets before they expire. Our tax valuation allowance is based on our estimates of taxable income for the jurisdictions in which we operate and the period over which our deferred tax assets will be realizable. In the future, we could be required to increase the valuation allowance to take into account additional deferred tax assets that we may be unable to realize. An increase in the valuation allowance would have an adverse impact, which could be material, on our income tax provision and net income in the period in which we record the increase.

Protection of our intellectual property is limited, and any misuse of our intellectual property by others, including software piracy, could harm our business, reputation and competitive position.

Our intellectual property is important to our success. We believe our trademarks, copyrights, trade secrets, patents, pending patent applications, trade dress and designs are valuable and integral to our success and competitive position. To

protect our proprietary rights, we rely on a combination of patents, copyrights, trademarks, trade dress, trade secret laws, confidentiality procedures, contractual provisions and technical measures. However, even if we are able to secure such rights in the United States, the laws of other countries in which our products are sold may not protect our intellectual property rights to the same extent as the laws of the United States.

In addition to issued patents, we have several patent applications on file in the U.S. and other countries. However, we do not know whether any of our pending patent applications will result in the issuance of patents or whether the examination process will require us to narrow our claims. Even if patents are issued from our patent applications, which are not certain, they may be challenged, circumvented or invalidated in the future. Moreover, the rights granted under any issued patents may not provide us with proprietary protection or competitive advantages, and, as with any technology, competitors may be able to develop similar or superior technologies now or in the future. In addition, we have not emphasized patents as a source of significant competitive advantage and have instead sought to primarily protect our proprietary rights under laws affording protection for trade secrets, copyright and trademark protection of our products, brands, and other intellectual property where available and appropriate. These measures afford only limited protection and may be challenged, invalidated or circumvented by third parties. In addition, these protections may not be adequate to prevent our competitors or customers from copying or reverse-engineering our products. Third parties could copy all or portions of our products or otherwise obtain, use, distribute and sell our proprietary information without authorization. Third parties may also develop similar or superior

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technology independently by designing around our intellectual property, which would decrease demand for our products. In addition, our patents may not provide us with any competitive advantages and the patents of others may seriously impede our ability to conduct our business.

We protect our products, trade secrets and proprietary information, in part, by requiring all of our employees to enter into agreements providing for the maintenance of confidentiality and the assignment of rights to inventions made by them while employed by us. We also enter into non-disclosure agreements with our technical consultants, customers, vendors and resellers to protect our confidential and proprietary information. We cannot guarantee that our confidentiality agreements with our employees, consultants and other third parties will not be breached, that we will be able to effectively enforce these agreements, that we will have adequate remedies for any breach, or that our trade secrets and other proprietary information will not be disclosed or will otherwise be protected.

We rely on contractual and license agreements with third parties in connection with their use of our products and technology. There is no guarantee that such parties will abide by the terms of such agreements or that we will be able to adequately enforce our rights, in part because we rely, in many instances, on "click-wrap" and "shrink-wrap" licenses, which are not negotiated or signed by individual licensees. Accordingly, some provisions of our licenses, including provisions protecting against unauthorized use, copying, transfer, resale and disclosure of the licensed software program, could be unenforceable under the laws of several jurisdictions.

Protection of trade secret and other intellectual property rights in the places in which we operate and compete is highly uncertain and may involve complex legal questions. The laws of countries in which we operate may afford little or no protection to our trade secrets and other intellectual property rights. Although we defend our intellectual property rights and combat unlicensed copying and use of software and intellectual property rights through a variety of techniques, preventing unauthorized use or infringement of our intellectual property rights is inherently difficult. Despite our enforcement efforts against software piracy, we could lose significant revenue due to illegal use of our software and from counterfeit copies of our software. If piracy activities increase, it could further harm our business.

We also suspect that competitors might try to illegally use our proprietary information and develop products that are similar to ours, which may infringe on our proprietary rights. In addition, we could potentially lose trade secret protection for our source code if any unauthorized disclosure of such code occurs. The loss of trade secret protection could make it easier for third parties to compete with our products by copying functionality. In addition, any changes in, or unexpected interpretations of, the trade secret and other intellectual property laws in any country in which we operate may compromise our ability to enforce our trade secret and intellectual property rights. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our confidential information and trade secret protection. If we are unable to protect our proprietary rights or 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' websites, which could harm our reputation and cause us to lose sales.

Competitors and other third parties, including counterfeiters, purchase our trademarks and confusingly similar terms as keywords in Internet search engine advertising programs in order to divert potential customers to their websites. Preventing such unauthorized use is inherently difficult. If we are unable to protect our trademarks and confusingly similar terms from

such unauthorized use, competitors and other third parties may drive potential online customers away from our websites to competing and unauthorized websites, which could harm our reputation and cause us to lose sales.

Our trademarks are limited in scope and geographic coverage and might not significantly distinguish us from our competition.

We own several U.S. trademark registrations, including registrations of ~~the~~ Rosetta Stone, the Blue Stone logo, Lexia, ~~Learning,FitBrains,~~ Lexia PowerUP Literacy,and ~~Catalyst~~ TruAccenttrademarks, as well as U.S. registrations of the color yellow as a trademark. In addition, we hold common law trademark rights and have trademark applications pending in the U.S. and abroad for additional trademarks. Even if federal registrations and registrations in other countries are granted to us, our trademark rights may be challenged. It is also possible that our competitors will adopt trademarks similar to ours, thus impeding our ability to build brand identity and possibly leading to customer confusion. In fact, various third parties have registered trademarks that are similar to ours in the U.S. and overseas. Furthermore, notwithstanding the fact that we may have secured trademark rights for our various trademarks in the U.S. and in some countries where we do business, in other countries we may not have secured similar rights and, in those countries there may be third parties who have prior use and prior or superior rights to our own. That prior use, prior or superior right could limit use of our trademarks and we could be challenged in our efforts to use our trademarks. We could incur substantial costs in prosecuting or defending trademark infringement suits. If we fail to effectively enforce our trademark rights, our competitive position and brand recognition may be diminished.

We must monitor and protect our Internet domain names to preserve their value. We may be unable to prevent third parties from acquiring domain names that are similar to, infringe on or otherwise decrease the value of our trademarks.

We own several domain names related to our business. Third parties may acquire substantially similar domain names or Top Level Domains ("TLDs") that decrease the value of our domain names and trademarks and other proprietary rights which may adversely affect our business. Third parties also may acquire country-specific domain names in the form of Country Code TLDs that include our trademarks or similar terms and which prevent us from operating country-specific websites from which customers can view our products and engage in transactions with us. Moreover, the regulation of domain names in the U.S. and foreign countries is subject to change. Governing bodies could appoint additional domain name registrars, modify the requirements for holding domain names or release

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additional TLDs. As a result, we may have to incur additional costs to maintain control over potentially relevant domain names or may not maintain exclusive rights to all potentially relevant domain names in the U.S. or in other countries in which we conduct business, which could harm our business or reputation. Moreover, attempts may be made to register our trademarks as new TLDs or as domain names within new TLDs and we will have to make efforts to enforce our rights against such registration attempts.

~~Our business depends on our strong brands, and failing to maintain or enhance the Rosetta Stone brands in a cost-effective manner could harm our operating results.~~

Further, while we attempt to ensure that the quality of our brands is maintained by our licensees, our licensees might take actions that could impair the value of our brands, our proprietary rights, or the reputation of our products. If we are unable to maintain or enhance our brands in a cost-effective manner, or if we incur excessive expenses in these efforts, our business, operating results and financial condition could be harmed.

Claims that we misuse the intellectual property of others could subject us to significant liability and disrupt our business.

As we expand our business and develop new technologies, products and services, we may become subject to material claims of infringement by competitors and other third parties with respect to current or future products, e-commerce and other web-related technologies, online business methods, trademarks or other proprietary rights. Our competitors, some of which may have made significant investments in competing products and technologies, and may have, or seek to apply for and obtain, patents, copyrights or trademarks that will prevent, limit or interfere with our ability to make, use and sell our current and future products and technologies, and we may not be successful in defending allegations of infringement of these patents, copyrights or trademarks. Further, we may not be aware of all of the patents and other intellectual property rights owned by third parties that may be potentially adverse to our interests. We may need to resort to litigation to enforce our proprietary rights or to determine the scope and validity of a third-party's patents or other proprietary rights, including whether any of our products, technologies or processes infringe the patents or other proprietary rights of third parties. We may incur substantial expenses in defending against third-party infringement claims regardless of the merit of such claims. The outcome of any such proceedings is uncertain and, if unfavorable, could force us to discontinue advertising and sale of the affected products or

impose significant penalties, limitations or restrictions on our business. We do not conduct comprehensive patent searches to determine whether the technologies used in our products infringe upon patents held by others. In addition, product development is inherently uncertain in a rapidly evolving technological environment in which there may be numerous patent applications pending, many of which are confidential when filed, with regard to similar technologies.

We do not own all of the software, other technologies and content used in our products and services, and the failure to obtain rights to use such software, other technologies and content could harm our business.

Some of our products and services contain intellectual property owned by third parties, including software that is integrated with internally developed software and voice recognition software, which we license from third parties. From time to time we may be required to renegotiate with these third parties or negotiate with new third parties to include their technology or content in our existing products, in new versions of our existing products or in wholly new products. We may not be able to negotiate or renegotiate licenses on commercially reasonable terms, or at all, and the third-party software may not be appropriately supported, maintained or enhanced by the licensors. If we are unable to obtain the rights necessary to use or continue to use third-party technology or content in our products and services, this could harm our business, by resulting 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 source software could impose limitations on our ability to commercialize our products.

We incorporate open source software into our products and may use more open source software in the future. The use of open source software is governed by license agreements. The terms of many open source licenses have not been interpreted by U.S. courts, and there is a risk that these licenses could be construed in a manner that could impose unanticipated conditions or restrictions on our ability to commercialize our products. Therefore, we could be required to seek licenses from third parties in order to continue offering our products, make generally available, in source code form, proprietary code that links to certain open source modules, re-engineer our products, discontinue the sale of our products if re-engineering could not be accomplished on a cost-effective and timely basis, or become subject to other consequences. In addition, open source licenses generally do not provide warranties or other contractual protections regarding infringement claims or the quality of the code. Thus, we may have little or no recourse if we become subject to infringement claims relating to the open source software or if the open source software is defective in any manner.

We offer Consumer language-learning packages that ~~include perpetual~~bundle software and online services that have increased our costs as a percentage of revenue, and these and future product introductions may not succeed and may harm our business, financial results and reputation.

Our Consumer language-learning packages integrate our language-learning software solutions with online services, which provide opportunities for practice with dedicated language conversation coaches and other language learners to increase language socialization. The costs associated with the online services included with these software packagesdecrease margins. Customers may choose to not engage with conversation coaches or be willing to pay higher prices to do so. ~~In addition, we are required to defer recognition of all or a portion of each sale of this packaged software over the duration of our online service periods.~~ We cannot ~~assure you~~provide assurances that our future software package offeringswill be successful or profitable, or if they are profitable, that they will provide an adequate return on invested capital. If our software package offerings are not successful, our business, financial results and reputation may be harmed.

Substantially all of our inventory is ~~located in one warehouse facility. Any damage~~managed by a single third party logistics company. A disagreement with, or production disruption at, this ~~facility~~entity could cause ~~significant~~ financial loss, including loss of revenue and harm to our reputation.

Substantially all of our inventory, which consists primarily of boxes for our language learning product and reference materials, is ~~located in one warehouse facility.~~produced by a single third party logistics company. We could experience ~~significant~~an interruption in ~~the operation of~~our operations if we have a disagreement with this ~~facility~~company or if this company suffers a production disruption or event that results in the damage or destruction of our inventory due to natural disasters, accidents, failures of the inventory locator or automated packing and shipping systems or other events. If a material portion of our inventory were to be damaged or destroyed, weinventory. We might be unable to meet our contractual obligations as a result of such an interruption, which could cause us ~~significant~~ financial loss, including loss of revenue and harm to our reputation. As our business ~~continues to move~~has moved online, we expect that this risk will diminish over time.

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We rely on highly skilled personnel and, if we are unable to retain or motivate key personnel or hire qualified personnel, we may not be able to ~~achieve~~achieve results or ~~grow~~grow effectively.

Our performance is largely dependent on the talents and efforts of highly skilled individuals. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly skilled personnel for all areas of our organization.

We compete with other companies both within and outside of our industry for talented employees, and we may lose talented employees or fail to attract, train, and retain other talented employees. Any such loss or failure could adversely affect

our product sales, financial condition, and operating results. In addition, we may not be able to locate suitable replacements for certain critical employees who leave, or offer employment to potential replacements on reasonable terms, all of which could adversely affect our product sales, financial condition, and operating results.

Our stock price is volatile and purchasers of our common stock could incur substantial losses.

The market price of our common stock could fluctuate significantly for many reasons, including in response to the risks described in this "Risk Factors" section, or for reasons unrelated to our operations, such as reports by media or industry analysts, investor perceptions or negative announcements about our performance, as well as industry conditions and general financial, economic and political instability. From January 1, 2019 through March 3, 2020, our common stock has traded as high as $26.33 per share and as low as $14.34 per share. The stock market in general has experienced extreme volatility that has often been unrelated to the operating performance of particular companies. The market price of our common stock may be influenced by many factors, including, among others:

•

announcements of acquisitions, collaborations, financings or other strategic business transactions by us;

•

termination or delay of a product;

•

public concern as to the efficacy of our products;

•

the recruitment or departure of key personnel; and

•

the other factors described in this “Risk Factor” section.

Our business could be impacted as a result of actions by activist stockholders or others.

We may be subject, from time to time, to legal and business challenges in the operation of our company due to proxy contests, stockholder proposals, media campaigns and other such actions instituted by activist stockholders or others. Responding to such actions could be costly and time-consuming, disrupt our operations, may not align with our business strategies and could divert the attention of our Board of Directors and senior management from the pursuit of current business strategies. Perceived uncertainties as to our future direction as a result of stockholder activism or potential changes to the composition of the Board of Directors may lead to the perception of a change in the direction of the business or other instability that may make it more difficult to attract and retain qualified personnel and business partners, and could have a materially adverse effect on the ~~Company's~~Company’s stock price.

If securities or industry analysts do not publish research or reports, or publish inaccurate or unfavorable research or reports about our business, our share price and trading volume could decline.

The trading market for our shares of common stock depends, in part, on the research and reports that securities or industry analysts publish about us or our business. We do not have any control over these analysts. If securities or industry analysts do not continue to cover us, the trading price for our shares of common stock may be negatively impacted. If one or more of the analysts who covers us downgrades our shares of common stock, changes their opinion of our shares or publishes inaccurate or unfavorable research about our business, our share price would likely decline. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, demand for our shares of common stock could decrease and we could lose visibility in the financial markets, which could cause our share price and trading volume to decline.

Provisions in our organizational documents and in the Delaware General Corporation Law may prevent takeover attempts that could be beneficial to our stockholders.

Provisions in our second amended and restated certificate of incorporation and ~~second~~third amended and restated bylaws, and in the Delaware General Corporation Law, may make it difficult and expensive for a third party to pursue a takeover attempt we oppose even if a change in control of our Company would be beneficial to the interests of our stockholders. Any provision of our second amended and restated certificate of incorporation or ~~second~~third amended and restated bylaws or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also affect the price that some investors are willing to pay for our common stock. Our Board of Directors has the authority to issue up to 10,000,000 shares of preferred stock in one or more series and to fix the powers, preferences and rights of each series without stockholder approval. The ability to issue preferred stock could discourage unsolicited acquisition proposals or make it more difficult for a third party to gain control of our Company, or otherwise could adversely affect the market price of our common stock. Further, as a Delaware corporation, we are subject to Section 203 of the Delaware General Corporation Law. This section generally prohibits us from engaging in mergers and other business combinations with stockholders that beneficially own 15% or more of our voting stock, or with their affiliates, unless our directors or stockholders approve the business combination in the prescribed manner.

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Our bylaws designate the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers, employees or agents.

Pursuant to the Company’s bylaws, unless the Company consents in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware shall be the sole and exclusive forum for (i) any derivative action or proceeding brought on behalf of the Company, (ii) any action asserting a claim for breach of a fiduciary duty owed by an director, officer, employee or agent of the Company to the Company or the Company’s stockholders, (iii) any action asserting a claim arising pursuant to any provision of the DGCL, the certificate of incorporation or the bylaws of the Company or (iv) any action asserting a claim governed by the internal affairs doctrine, in each case subject to the Court of Chancery having personal jurisdiction over the indispensable parties named as defendants therein. Any person of entity purchasing or otherwise acquiring any interest in shares of capital stock of the Company shall be deemed to have notice of and consented to these provisions of the Company’s bylaws. This choice of forum provision may limit the Company’s stockholders’ ability to bring a claim in a judicial forum that they find favorable for disputes with the Company or the Company’s directors, officers, employees or agents, which may discourage such lawsuits against the Company and the Company’s directors, officers, employees and agents even though an action, if successful, might benefit the Company’s stockholders. Stockholders who do bring a claim in the Court of Chancery could face additional litigation costs in pursuing any such claim, particularly if they do not reside in or near Delaware. The Court of Chancery may also reach different judgments or results than would other courts, including courts where a stockholder considering an action may be located or would otherwise choose to bring the action, and such judgments or results may be more favorable to the Company than to the Company’s stockholders. Alternatively, if a court were to find these provisions of the Company’s bylaws inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, the Company may incur additional costs associated with resolving such matters in other jurisdictions, which could have a material adverse effect on the Company’s business, financial condition or results of operations.

Section 27 of the Exchange Act creates exclusive federal jurisdiction over all suits brought to enforce any duty or liability created by the Exchange Act or the rules and regulations thereunder. As a result, the exclusive forum provision will not apply to suits brought to enforce any duty or liability created by the Exchange Act or any other claim for which the federal courts have exclusive jurisdiction. In addition, Section 22 of the Securities Act creates concurrent jurisdiction for federal and state courts over all suits brought to enforce any duty or liability created by the Securities Act or the rules and regulations thereunder. As a result, the exclusive forum provision will not apply to suits brought to enforce any duty or liability created by the Securities Act or any other claim for which the federal and state courts have concurrent jurisdiction.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None.

~~Item 2. Unregistered Sales of Equity Securities and Use of Proceeds~~

~~None.~~

Item 3.

Defaults Upon Senior Securities

None.

~~Item 3. Defaults Upon Senior Securities~~

~~None.~~

~~Item 4.~~

Item 4.

Mine Safety Disclosures

Not applicable.

Item 5.

Other Information

None.

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~~Item 5. Other Information~~

~~None.~~

~~Item 6.~~

Item 6.

Exhibits

Exhibits

~~Exhibits~~ 2.1+
~~2.1~~		Purchase and Sale Agreement by and among Rosetta Stone Ltd., Rosetta Stone Japan Inc., and SOURCENEXT Corporation, dated April 25, 2017 (incorporated herein by reference to Exhibit 2.1 filed with the Company's Current Report on Form 8-K filed on April 25, 2017).
~~3.1~~
3.1		Second Amended and Restated Certificate of Incorporation of the Company (incorporated herein by reference to Exhibit 3.2 to Amendment No. 3 to the Company’s Registration Statement on Form S-1 (No. 333-153632) filed on February 23, 2009).
~~3.2~~
3.2		Third Amended and Restated Bylaws (incorporated herein by reference to Exhibit 3.1 filed with the Company's Current Report on Form 8-K filed on November 22, 2016).
~~4.1~~
4.1		Specimen certificate evidencing shares of Common Stock of the Company (incorporated herein by reference to Exhibit 4.1 to Amendment No. 3 to the Company’s Registration Statement on Form S-1 (No. 333-153632) filed on February 23, 2009).
~~4.2~~		Registration Rights Agreement dated January 4, 2006 among the Company and the Investor Shareholders and other Shareholders listed on Exhibit A thereto (incorporated herein by reference to Exhibit 4.3 to Amendment No. 1 to the Company’s Registration Statement on Form S-1 (No. 333-153632) filed on November 5, 2008).
31.1*		Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, with respect to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended ~~September 30, 2017.~~March 31, 2020.
31.2*
31.2*		Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, with respect to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended ~~September 30, 2017.~~March 31, 2020.

32**		Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, with respect to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended ~~September 30, 2017.~~March 31, 2020.
101.INS*
101.INS*		Inline XBRL Instance Document.
101.SCH*
101.SCH*		Inline XBRL Taxonomy Extension Schema.
101.CAL*
101.CAL*		Inline XBRL Taxonomy Extension Calculation Linkbase.
101.DEF*
101.DEF*		Inline XBRL Taxonomy Extension Definition Linkbase.
101.LAB*
101.LAB*		Inline XBRL Taxonomy Extension Label Linkbase.
101.PRE*
101.PRE*		Inline XBRL Taxonomy Extension Presentation Linkbase.

104*		Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

*	Filed herewith

**	Furnished herewith

+	Certain schedules and attachments referenced in this agreement have been omitted in accordance with Item 601(b)(2) of Regulation S-K. A copy of any omitted schedule and attachment will be furnished supplementally to the SEC upon request.

*~~Filed herewith~~

**~~Furnished herewith~~

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



	ROSETTA STONE INC.
	/s/ THOMAS M. PIERNO
	Thomas M. Pierno
	Chief Financial Officer

Date: May 6, 2020

~~Date: November 2, 2017~~



	September 30, 2017			December 31, 2016
Assets
Current assets:
Cash and cash equivalents	$	40,147		$	36,195
Restricted cash	49			402
Accounts receivable (net of allowance for doubtful accounts of $617 and $1,072, at September 30, 2017 and December 31, 2016, respectively)	29,801			31,788
Inventory	4,194			6,767
Deferred sales commissions	14,443			14,085
Prepaid expenses and other current assets	4,870			3,813
Total current assets	93,504			93,050
Deferred sales commissions	3,498			4,143
Property and equipment, net	28,822			24,795
Goodwill	49,654			48,251
Intangible assets, net	20,138			22,753
Other assets	1,142			1,318
Total assets	$	196,758		$	194,310
Liabilities and stockholders' deficit
Current liabilities:
Accounts payable	$	8,661		$	10,684
Accrued compensation	11,313			10,777
Income tax payable	533			785
Obligations under capital lease	440			532
Other current liabilities	16,755			22,150
Deferred revenue	113,932			113,821
Total current liabilities	151,634			158,749
Deferred revenue	36,961			27,636
Deferred income taxes	7,132			6,173
Obligations under capital lease	1,934			2,027
Other long-term liabilities	524			1,384
Total liabilities	198,185			195,969
Commitments and contingencies (Note 15)
Stockholders' deficit:
Preferred stock, $0.001 par value; 10,000 and 10,000 shares authorized, zero and zero shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively	—			—
Non-designated common stock, $0.00005 par value, 190,000 and 190,000 shares authorized, 23,800 and 23,451 shares issued and 22,800 and 22,451 shares outstanding at September 30, 2017 and December 31, 2016, respectively	2			2
Additional paid-in capital	194,348			190,827
Accumulated loss	(181,256		)	(177,344		)
Accumulated other comprehensive loss	(3,086		)	(3,709		)
Treasury stock, at cost, 1,000 and 1,000 shares at September 30, 2017 and December 31, 2016, respectively	(11,435		)	(11,435		)
Total stockholders' deficit	(1,427		)	(1,659		)
Total liabilities and stockholders' deficit	$	196,758		$	194,310



	Three Months Ended September 30,						Nine Months Ended September 30,
	2017			2016			2017			2016
Revenue:
Subscription and service	$	42,117		$	39,027		$	125,552		$	114,755
Product	4,089			9,666			14,252			27,656
Total revenue	46,206			48,693			139,804			142,411
Cost of revenue:
Cost of subscription and service revenue	6,499			5,910			19,091			16,888
Cost of product revenue	2,949			2,461			6,089			7,495
Total cost of revenue	9,448			8,371			25,180			24,383
Gross profit	36,758			40,322			114,624			118,028
Operating expenses:
Sales and marketing	23,654			27,161			71,859			86,694
Research and development	6,381			6,347			19,143			19,666
General and administrative	9,035			9,969			25,654			30,864
Impairment	—			1,028			—			3,930
Lease abandonment and termination	—			—			—			30
Total operating expenses	39,070			44,505			116,656			141,184
Loss from operations	(2,312		)	(4,183		)	(2,032		)	(23,156		)
Other income and (expense):
Interest income	13			11			43			34
Interest expense	(138		)	(120		)	(383		)	(353		)
Other income and (expense)	85			633			821			2,788
Total other income and (expense)	(40		)	524			481			2,469
Loss before income taxes	(2,352		)	(3,659		)	(1,551		)	(20,687		)
Income tax expense	879			1,793			2,361			1,250
Net loss	$	(3,231	)	$	(5,452	)	$	(3,912	)	$	(21,937	)
Loss per share:
Basic	$	(0.14	)	$	(0.25	)	$	(0.18	)	$	(1.00	)
Diluted	$	(0.14	)	$	(0.25	)	$	(0.18	)	$	(1.00	)
Common shares and equivalents outstanding:
Basic weighted average shares	22,285			21,993			22,220			21,936
Diluted weighted average shares	22,285			21,993			22,220			21,936



	Nine Months Ended September 30,
	2017			2016
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(3,912	)	$	(21,937	)
Adjustments to reconcile net loss to cash provided by (used in) operating activities:
Stock-based compensation expense	3,058			3,457
Gain on foreign currency transactions	(461		)	(2,831		)
Bad debt (recovery) expense	(143		)	471
Depreciation and amortization	9,077			9,812
Deferred income tax expense	963			857
Loss on disposal of equipment	5			132
Amortization of deferred financing fees	238			203
Loss on impairment	—			3,930
Loss from equity method investments	100			46
Gain on sale of subsidiary	(506		)	—
Net change in:
Restricted cash	365			(354		)
Accounts receivable	2,358			8,912
Inventory	2,605			(723		)
Deferred sales commissions	321			552
Prepaid expenses and other current assets	(880		)	(705		)
Income tax receivable or payable	(296		)	48
Other assets	67			365
Accounts payable	(2,084		)	(923		)
Accrued compensation	445			3,423
Other current liabilities	(6,501		)	(13,077		)
Other long-term liabilities	(750		)	43
Deferred revenue	8,608			2,353
Net cash provided by (used in) operating activities	12,677			(5,946		)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment	(8,903		)	(9,628		)
Proceeds from sale of fixed assets	2			38
Proceeds from the sale of subsidiary	110			—
Net cash used in investing activities	(8,791		)	(9,590		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the exercise of stock options	463			47
Payment of deferred financing costs	(232		)	(182		)
Payments under capital lease obligations	(453		)	(440		)
Net cash used in financing activities	(222		)	(575		)
Decrease in cash and cash equivalents	3,664			(16,111		)
Effect of exchange rate changes in cash and cash equivalents	288			550
Net increase (decrease) in cash and cash equivalents	3,952			(15,561		)
Cash and cash equivalents—beginning of period	36,195			47,782
Cash and cash equivalents—end of period	$	40,147		$	32,221
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Cash paid during the periods for:
Interest	$	145		$	150
Income taxes, net of refunds	$	1,474		$	363
Noncash financing and investing activities:
Accrued liability for purchase of property and equipment	$	1,268		$	565
Equipment acquired under capital lease	$	—		$	27



	Foreign Currency			Total
Balance at beginning of period on January 1, 2017	$	(3,709	)	$	(3,709	)
Other comprehensive income before reclassifications	719			719
Amounts reclassified from accumulated other comprehensive income related to the sale of a foreign subsidiary	(96		)	(96		)
Net current period other comprehensive income	623			623
Accumulated other comprehensive loss at September 30, 2017	$	(3,086	)	$	(3,086	)



	Literacy Segment		Enterprise & Education Language Segment		Consumer Segment			Total
Balance as of January 1, 2017
Gross Goodwill	$	9,962	$	38,289	$	27,514		$	75,765
Accumulated Impairment	—		—		(27,514		)	(27,514		)
Goodwill as of January 1, 2017	$	9,962	$	38,289	$	—		$	48,251

Effect of change in foreign currency rate	—		1,403		—			1,403

Balance as of September 30, 2017
Gross Goodwill	$	9,962	$	39,692	$	27,514		$	77,168
Accumulated Impairment	—		—		(27,514		)	(27,514		)
Goodwill as of September 30, 2017	$	9,962	$	39,692	$	—		$	49,654



	Trademark / tradename *			Core technology			Customer relationships			Patents and Other			Total

Gross Carrying Amount	$	12,431		$	15,092		$	26,149		$	312		$	53,984
Accumulated Amortization	(1,481		)	(9,859		)	(18,485		)	(251		)	(30,076		)
Accumulated Impairment	(26		)	(1,001		)	(128		)	—			(1,155		)
Balance as of January 1, 2017	$	10,924		$	4,232		$	7,536		$	61		$	22,753

Gross Carrying Amount	12,500			15,637			26,612			312			55,061
Accumulated Amortization	(1,700		)	(11,738		)	(20,058		)	(272		)	(33,768		)
Accumulated Impairment	(26		)	(1,001		)	(128		)	—			(1,155		)
Balance as of September 30, 2017	$	10,774		$	2,898		$	6,426		$	40		$	20,138



	As of September 30, 2017
2017 - remaining	$	977
2018	3,312
2019	1,532
2020	1,282
2021	940
2022	940
Thereafter	548
Total	$	9,531



	September 30, 2017		December 31, 2016
Accrued marketing expenses	$	5,763	$	8,460
Accrued professional and consulting fees	1,349		2,050
Sales return reserve	1,526		1,338
Sales, withholding and property taxes payable	3,446		3,772
Other	4,671		6,530
Total other current liabilities	$	16,755	$	22,150



	As of September 30, 2017
2017-remaining	$	136
2018	539
2019	536
2020	532
2021	529
2022	396
Thereafter	—
Total minimum lease payments	$	2,668
Less amount representing interest	294
Present value of net minimum lease payments	$	2,374
Less current portion	440
Obligations under capital lease, long-term	$	1,934



	Service-based Options		Weighted Average Exercise Price		Weighted Average Contractual Life (years)	Aggregate Intrinsic Value
Service-based Options Outstanding, January 1, 2017	1,793,930		$	9.81	7.58	$	1,154,498
Service-based options granted	48,830		11.42
Service-based options exercised	(58,270	)	7.94
Service-based options canceled	(89,570	)	9.99
Service-based Options Outstanding, September 30, 2017	1,694,920		9.92		6.86	2,409,690
Vested and expected to vest September 30, 2017	1,649,077		9.97		6.94	2,303,460
Exercisable at September 30, 2017	1,282,680		$	10.32	6.62	$	1,670,770



	Service Based Awards		Weighted Average Grant Date Fair Value		Aggregate Intrinsic Value
Non-vested Service-based Awards, January 1, 2017	374,380		$	8.94	$	3,348,080
Service-based awards granted	291,406		7.92
Service-based awards vested	(128,013	)	10.10
Service-based awards canceled	(32,989	)	8.11
Non-vested Service-Based Awards, September 30, 2017	504,784		$	8.12	$	4,096,322



	Units Outstanding	Weighted Average Grant Date Fair Value		Aggregate Intrinsic Value
Units Outstanding, January 1, 2017	188,057	$	9.93	$	1,675,588
Units granted	40,718	11.42		465,000
Units released	—	—
Units cancelled	—	—
Units Outstanding, September 30, 2017	228,775	10.20		2,335,793
Vested and expected to vest at September 30, 2017	111,256	11.42		1,135,919
Vested and deferred at September 30, 2017	82,157	$	12.44	$	838,823



	PSUs		Weighted Average Grant Date Fair Value		Aggregate Intrinsic Value
Non-vested PSUs, January 1, 2017	—		$	—	$	—
PSUs granted	462,870		9.43
PSUs vested	—		—
PSUs canceled	(16,241	)	9.43
Non-vested PSUs, September 30, 2017	446,629		$	9.43	$	4,560,082



	Balance at January 1, 2017		Cost Incurred			Cash Payments			Balance at September 30, 2017
Severance costs	$	500	$	(12	)	$	(282	)	$	206
Contract termination costs	22		—			—			22
Other costs	70		14			(81		)	3
Total	$	592	$	2		$	(363	)	$	231



	Three Months Ended September 30,					Nine Months Ended September 30,				Incurred through
	2017		2016			2017		2016		September 30, 2017
Severance costs	$	186	$	(8	)	$	1,118	$	4,478	$	12,796
Contract termination costs	1		69			37		163		1,336
Other costs	9		101			26		542		1,033
Total	$	196	$	162		$	1,181	$	5,183	$	15,165



	As of September 30,
	2017			2016
Accrued lease abandonment costs, beginning of period	$	2,123		$	1,281
Costs incurred and charged to expense	—			30
Principal reductions	(759		)	(328		)
Accrued lease abandonment costs, end of period	$	1,364		$	983
Accrued lease abandonment costs liability:
Short-term	$	1,078		$	422
Long-term	286			561
Total	$	1,364		$	983



	As of September 30, 2017
Periods Ending December 31,
2017-remaining	$	927
2018	4,744
2019	1,742
2020	1,003
2021	590
Thereafter	—
Total	$	9,006



				Language
	Literacy Segment			E&E Segment			Consumer Segment			Shared Services			Combined Language		Total Company

Revenue	$	11,028		$	16,529		$	18,649		$	—		$	35,178	$	46,206

Cost of revenue	1,666			1,756			4,464			(3		)	6,217		7,883
Sales and marketing	6,402			7,511			8,428			269			16,208		22,610
Research and development	1,820			—			—			3,882			3,882		5,702
General and administrative	558			86			74			—			160		718
Segment contribution	$	582		$	7,176		$	5,683		$	(4,148	)	$	8,711	$	9,293
Segment contribution margin %	5.3		%	43.4		%	30.5		%

Unallocated depreciation and amortization, stock compensation, restructuring and other expenses (net) included in:
Cost of revenue															1,565
Sales and marketing															1,044
Research and development															679
General and administrative															1,724
Subtotal															5,012

Corporate unallocated expenses, net:
Unallocated general and administrative															6,593
Unallocated non-operating income															40
Subtotal															6,633

Loss before income taxes															$	(2,352	)



	Three Months Ended September 30,						2017 Versus 2016
	2017			2016			Change			% Change
Revenue:
Subscription and service	$	42,117		$	39,027		$	3,090		7.9	%
Product	4,089			9,666			(5,577		)	(57.7	)%
Total revenue	46,206			48,693			(2,487		)	(5.1	)%
Cost of revenue:
Cost of subscription and service revenue	6,499			5,910			589			10.0	%
Cost of product revenue	2,949			2,461			488			19.8	%
Total cost of revenue	9,448			8,371			1,077			12.9	%
Gross profit	36,758			40,322			(3,564		)	(8.8	)%
Operating expenses:
Sales and marketing	23,654			27,161			(3,507		)	(12.9	)%
Research and development	6,381			6,347			34			0.5	%
General and administrative	9,035			9,969			(934		)	(9.4	)%
Impairment	—			1,028			(1,028		)	(100.0	)%
Total operating expenses	39,070			44,505			(5,435		)	(12.2	)%
Loss from operations	(2,312		)	(4,183		)	1,871			(44.7	)%
Other income and (expense):
Interest income	13			11			2			18.2	%
Interest expense	(138		)	(120		)	(18		)	15.0	%
Other income and (expense)	85			633			(548		)	(86.6	)%
Total other income and (expense)	(40		)	524			(564		)	(107.6	)%
Loss before income taxes	(2,352		)	(3,659		)	1,307			(35.7	)%
Income tax expense	879			1,793			(914		)	(51.0	)%
Net loss	$	(3,231	)	$	(5,452	)	$	2,221		(40.7	)%