SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Policies)

9 Months Ended

Sep. 30, 2013

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

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

Basis of Presentation

The accompanying consolidated financial statements are unaudited. These unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“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 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 Annual Report on Form 10-K filed with the SEC on March 7, 2013. The December 31, 2012 consolidated balance sheet included herein was derived from the audited financial statements as of that date, but does not include all disclosures, including notes, required by GAAP, except for the Company’s voluntary change for sales commissions as described below.

The unaudited interim consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and in the opinion of management include all normal recurring adjustments necessary for the fair presentation of the Company’s consolidated statement of financial position at September 30, 2013 and December 31, 2012, the Company’s results of operations for the three and nine months ended September 30, 2013 and 2012 and its cash flows for the nine months ended September 30, 2013 and 2012. The results for the three and nine months ended September 30, 2013 are not necessarily indicative of the results to be expected for the year ending December 31, 2013.  All references to September 30, 2013 or to the three and nine months ended September 30, 2013 and 2012 in the notes to the consolidated financial statements are unaudited.

Use of Estimates

Use of Estimates

The preparation of financial statements in accordance with GAAP requires that management make certain estimates and assumptions. Significant estimates and assumptions have been made regarding the allowance for doubtful accounts, estimated sales returns, stock-based compensation, fair value of intangibles and goodwill, inventory reserve, disclosure of contingent assets and liabilities, disclosure of contingent litigation, and allowance for valuation of deferred tax assets. Actual results may differ from these estimates.

Changes in Accounting Principle

Changes in Accounting Principle

In the third quarter of 2013, the Company voluntarily changed its accounting policy for sales commissions related to non-cancellable Software-as-a-Service (“SaaS”) contracts, from recording an expense when incurred, to deferral of the sales commission in proportion to the consideration allocated to each of the elements in the arrangement and in, or over, the same period the revenue is recognized for each of the elements in the arrangement (i.e. over the non-cancellable term of the contract for the SaaS deliverable).  The Company is anticipating a significant increase in contracts with multi-year subscriptions and a corresponding increase in sales commissions due, among other reasons, to its acquisition of Lexia Learning Systems, Inc. (“Lexia”) in August 2013.  Lexia provides services using a SaaS model and has historically had long-term arrangements with material sales commissions paid to its network of resellers and has applied a sales commission deferral and amortization policy.

The Company believes the deferral method described above is preferable primarily because (i) the sales commission charges are so closely related to obtaining the revenue from the non-cancellable contracts that they should be deferred and charged to expense over the same period that the related revenue is recognized; and (ii) it provides a single accounting policy, consistent with that used by Lexia, that makes it easier for financial statement users to understand. Deferred commission amounts are recoverable through the future revenue streams under the non-cancellable arrangements.

Short-term deferred commissions are included in prepaid expenses and other current assets, while long-term deferred commissions are included in other assets in the accompanying consolidated balance sheets. The amortization of deferred commissions is included in sales and marketing expense in the accompanying consolidated statements of operations.

The accompanying consolidated financial statements and related notes have been adjusted to reflect the impact of this change and the associated deferred tax impact retrospectively to all prior periods. Under the as previously reported basis, there was no book / tax basis difference related to commission expense.  Under the as adjusted basis, the deferred commission asset creates a deferred tax liability related to commissions expense which has been deducted for tax purposes.

The following tables present the effects of the retrospective application of the voluntary change in accounting principle for sales commissions related to non-cancellable SaaS contracts for all periods presented, effective as of January 1, 2012 (in thousands):

Consolidated Balance Sheet (in thousands)

	September 30, 2013									December 31, 2012
	Computed under Prior Method			Impact of Commission Adjustment			As Reported			As Previously Reported			Impact of Commission Adjustment			As Adjusted
Prepaid expenses and other current assets	$	6,457		$	3,934		$	10,391		$	5,204		$	3,447		$	8,651
Deferred income taxes (current)	$	141		$	(62	)	$	79		$	79		$	(49	)	$	30
Total current assets	$	173,809		$	3,872		$	177,681		$	211,177		$	3,398		$	214,575
Other assets	$	3,060		$	165		$	3,225		$	1,484		$	196		$	1,680
Deferred income taxes (non-current)	$	221		$	(3	)	$	218		$	260		$	(3	)	$	257
Total assets	$	274,892		$	4,034		$	278,926		$	275,855		$	3,591		$	279,446
Accumulated loss	$	(29,478	)	$	4,034		$	(25,444	)	$	(16,749	)	$	3,591		$	(13,158	)
Total stockholders’ equity	$	139,219		$	4,034		$	143,253		$	144,603		$	3,591		$	148,194
Total liabilities and stockholders’ equity	$	274,892		$	4,034		$	278,926		$	275,855		$	3,591		$	279,446

Consolidated Statement of Operations (in thousands, except per share data)

	Three Months Ended March 31, 2012
	As Previously Reported			Impact of Commission Adjustment			As Adjusted
Sales and marketing	$	38,404		$	166		$	38,570
Loss from operations	$	(2,359	)	$	(166	)	$	(2,525	)
Income tax provision (benefit)	$	(742	)	$	(66	)	$	(808	)
Net loss	$	(1,903	)	$	(100	)	$	(2,003	)
Basic net loss per share	$	(0.09	)	$	(0.01	)	$	(0.10	)
Diluted net loss per share	$	(0.09	)	$	(0.01	)	$	(0.10	)
Shares used in computing basic net loss per share	20,942			—			20,942
Shares used in computing diluted net loss per share	20,942			—			20,942

	Three Months Ended June 30, 2012									Six Months Ended June 30, 2012
	As Previously Reported			Impact of Commission Adjustment			As Adjusted			As Previously Reported			Impact of Commission Adjustment			As Adjusted
Sales and marketing	$	35,125		$	(6	)	$	35,119		$	73,529		$	160		$	73,689
Loss from operations	$	(5,045	)	$	6		$	(5,039	)	$	(7,404	)	$	(160	)	$	(7,564	)
Income tax provision (benefit)	$	(160	)	$	16		$	(144	)	$	(902	)	$	(50	)	$	(952	)
Net loss	$	(4,544	)	$	(10	)	$	(4,554	)	$	(6,447	)	$	(110	)	$	(6,557	)
Basic net loss per share	$	(0.22	)	$	0.00		$	(0.22	)	$	(0.31	)	$	—		$	(0.31	)
Diluted net loss per share	$	(0.22	)	$	0.00		$	(0.22	)	$	(0.31	)	$	—		$	(0.31	)
Shares used in computing basic net loss per share	20,995			—			20,995			20,969			—			20,969
Shares used in computing diluted net loss per share	20,995			—			20,995			20,969			—			20,969

Consolidated Statement of Operations (in thousands, except per share data), continued

	Three Months Ended September 30, 2012									Nine Months Ended September 30, 2012
	As Previously Reported			Impact of Commission Adjustment			As Adjusted			As Previously Reported			Impact of Commission Adjustment			As Adjusted
Sales and marketing	$	37,113		$	(283	)	$	36,830		$	110,641		$	(123	)	$	110,518
Loss from operations	$	(3,670	)	$	283		$	(3,387	)	$	(11,074	)	$	123		$	(10,951	)
Income tax provision (benefit) (1)	$	29,735		$	(1,044	)	$	28,691		$	28,833		$	(1,094	)	$	27,739
Net loss	$	(33,390	)	$	1,327		$	(32,063	)	$	(39,837	)	$	1,217		$	(38,620	)
Basic net loss per share	$	(1.58	)	$	0.06		$	(1.52	)	$	(1.90	)	$	0.06		$	(1.84	)
Diluted net loss per share	$	(1.58	)	$	0.06		$	(1.52	)	$	(1.90	)	$	0.06		$	(1.84	)
Shares used in computing basic net loss per share	21,073			—			21,073			21,004			—			21,004
Shares used in computing diluted net loss per share	21,073			—			21,073			21,004			—			21,004

(1) During the third quarter of 2012 the Company established a full valuation allowance to reduce the deferred tax assets of its operations in Brazil, Japan and the U.S.  The amount of the valuation allowance recorded in the third quarter of 2012 would have been reduced by the amount of the deferred tax liability arising from the deferred commission asset had commissions expense been accounted for under the as adjusted policy which resulted in the $1.0 million and $1.1 million income tax benefit shown as the adjustment for the three and nine month periods ended September 30, 2012, respectively.

	Three Months Ended March 31, 2013
	As Previously Reported			Impact of Commission Adjustment			As Adjusted
Sales and marketing	$	37,060		$	213		$	37,273
Loss from operations	$	(4,138	)	$	(213	)	$	(4,351	)
Income tax provision (benefit)	$	977		$	(9	)	$	968
Net loss	$	(4,700	)	$	(204	)	$	(4,904	)
Basic net loss per share	$	(0.22	)	$	(0.01	)	$	(0.23	)
Diluted net loss per share	$	(0.22	)	$	(0.01	)	$	(0.23	)
Shares used in computing basic net loss per share	21,360			—			21,360
Shares used in computing diluted net loss per share	21,360			—			21,360

	Three Months Ended June 30, 2013									Six Months Ended June 30, 2013
	As Previously Reported			Impact of Commission Adjustment			As Adjusted			As Previously Reported			Impact of Commission Adjustment			As Adjusted
Sales and marketing	$	33,144		$	(357	)	$	32,787		$	70,203		$	(144	)	$	70,059
Loss from operations	$	(3,991	)	$	357		$	(3,634	)	$	(8,130	)	$	144		$	(7,986	)
Income tax provision (benefit)	$	(400	)	$	13		$	(387	)	$	576		$	4		$	580
Net loss	$	(3,557	)	$	344		$	(3,213	)	$	(8,257	)	$	140		$	(8,117	)
Basic net loss per share	$	(0.16	)	$	0.01		$	(0.15	)	$	(0.38	)	$	—		$	(0.38	)
Diluted net loss per share	$	(0.16	)	$	0.01		$	(0.15	)	$	(0.38	)	$	—		$	(0.38	)
Shares used in computing basic net loss per share	21,569			—			21,569			21,465			—			21,465
Shares used in computing diluted net loss per share	21,569			—			21,569			21,465			—			21,465

Consolidated Statement of Operations (in thousands, except per share data), continued

	Three Months Ended September 30, 2013									Nine Months Ended September 30, 2013
	Computed under Prior Method			Impact of Commission Adjustment			As Adjusted			Computed under Prior Method			Impact of Commission Adjustment			As Adjusted
Sales and marketing	$	35,156		$	(312	)	$	34,844		$	105,360		$	(456	)	$	104,904
Loss from operations	$	(7,819	)	$	312		$	(7,507	)	$	(15,950	)	$	456		$	(15,494	)
Income tax provision (benefit)	$	(3,640	)	$	9		$	(3,631	)	$	(3,065	)	$	13		$	(3,052	)
Net loss	$	(4,472	)	$	303		$	(4,169	)	$	(12,729	)	$	443		$	(12,286	)
Basic net loss per share	$	(0.20	)	$	0.01		$	(0.19	)	$	(0.59	)	$	0.02		$	(0.57	)
Diluted net loss per share	$	(0.20	)	$	0.01		$	(0.19	)	$	(0.59	)	$	0.02		$	(0.57	)
Shares used in computing basic net loss per share	21,827			—			21,827			21,587			—			21,587
Shares used in computing diluted net loss per share	21,827			—			21,827			21,587			—			21,587

Consolidated Statement of Comprehensive Loss (in thousands)

	Three Months Ended March 31, 2012
	As Previously Reported			Impact of Commission Adjustment			As Adjusted
Net loss	$	(1,903	)	$	(100	)	$	(2,003	)
Other comprehensive income (loss)	$	(1,601	)	$	(100	)	$	(1,701	)
	Three Months Ended June 30, 2012									Six Months Ended June 30, 2012
	As Previously Reported			Impact of Commission Adjustment			As Adjusted			As Previously Reported			Impact of Commission Adjustment			As Adjusted
Net loss	$	(4,544	)	$	(10	)	$	(4,554	)	$	(6,447	)	$	(110	)	$	(6,557	)
Other comprehensive income (loss)	$	(4,853	)	$	(10	)	$	(4,863	)	$	(6,454	)	$	(110	)	$	(6,564	)
	Three Months Ended September 30, 2012									Nine Months Ended September 30, 2012
	As Previously Reported			Impact of Commission Adjustment			As Adjusted			As Previously Reported			Impact of Commission Adjustment			As Adjusted
Net loss	$	(33,390	)	$	1,327		$	(32,063	)	$	(39,837	)	$	1,217		$	(38,620	)
Other comprehensive income (loss)	$	(33,155	)	$	1,327		$	(31,828	)	$	(39,609	)	$	1,217		$	(38,392	)

	Three Months Ended March 31, 2013
	As Previously Reported			Impact of Commission Adjustment			As Adjusted
Net loss	$	(4,700	)	$	(204	)	$	(4,904	)
Other comprehensive income (loss)	$	(5,181	)	$	(204	)	$	(5,385	)
	Three Months Ended June 30, 2013									Six Months Ended June 30, 2013
	As Previously Reported			Impact of Commission Adjustment			As Adjusted			As Previously Reported			Impact of Commission Adjustment		As Adjusted
Net loss	$	(3,557	)	$	344		$	(3,213	)	$	(8,257	)	$	140	$	(8,117	)
Other comprehensive income (loss)	$	(3,437	)	$	344		$	(3,093	)	$	(8,618	)	$	140	$	(8,478	)
	Three Months Ended September 30, 2013									Nine Months Ended September 30, 2013
	Computed under Prior Method			Impact of Commission Adjustment			As Adjusted			Computed under Prior Method			Impact of Commission Adjustment		As Adjusted
Net loss	$	(4,472	)	$	303		$	(4,169	)	$	(12,729	)	$	443	$	(12,286	)
Other comprehensive income (loss)	$	(4,099	)	$	303		$	(3,796	)	$	(12,717	)	$	443	$	(12,274	)

Consolidated Statement of Cash Flows (in thousands)

	Three Months Ended March 31, 2012
	As Previously Reported			Impact of Commission Adjustment			As Adjusted
Net loss	$	(1,903	)	$	(100	)	$	(2,003	)
Deferred income tax provision (benefit)	$	(1,314	)	$	(66	)	$	(1,380	)
Prepaid expenses and other current assets	$	503		$	118		$	621
Other assets	$	(1,209	)	$	48		$	(1,161	)
Net cash provided by (used in) operating activities	$	2,656		$	—		$	2,656

	Six Months Ended June 30, 2012
	As Previously Reported			Impact of Commission Adjustment			As Adjusted
Net loss	$	(6,447	)	$	(110	)	$	(6,557	)
Deferred income tax provision (benefit)	$	(1,156	)	$	(50	)	$	(1,206	)
Prepaid expenses and other current assets	$	649		$	140		$	789
Other assets	$	(1,065	)	$	20		$	(1,045	)
Net cash provided by (used in) operating activities	$	6,068		$	—		$	6,068

	Nine Months Ended September 30, 2012
	As Previously Reported			Impact of Commission Adjustment			As Adjusted
Net loss	$	(39,837	)	$	1,217		$	(38,620	)
Deferred income tax provision (benefit)	$	26,940		$	(1,094	)	$	25,846
Prepaid expenses and other current assets	$	785		$	(123	)	$	662
Other assets	$	(78	)	$	—		$	(78	)
Net cash provided by (used in) operating activities	$	11,492		$	—		$	11,492

Consolidated Statement of Cash Flows (in thousands)

	Three Months Ended March 31, 2013
	As Previously Reported			Impact of Commission Adjustment			As Adjusted
Net loss	$	(4,700	)	$	(204	)	$	(4,904	)
Deferred income tax provision (benefit)	$	298		$	(9	)	$	289
Prepaid expenses and other current assets	$	(2,559	)	$	113		$	(2,446	)
Other assets	$	5		$	100		$	105
Net cash provided by (used in) operating activities	$	(5,635	)	$	—		$	(5,635	)

	Six Months Ended June 30, 2013
	As Previously Reported			Impact of Commission Adjustment			As Adjusted
Net loss	$	(8,257	)	$	140		$	(8,117	)
Deferred income tax provision (benefit)	$	(627	)	$	4		$	(623	)
Prepaid expenses and other current assets	$	(2,568	)	$	(176	)	$	(2,744	)
Other assets	$	10		$	32		$	42
Net cash provided by (used in) operating activities	$	(3,147	)	$	—		$	(3,147	)

	Nine Months Ended September 30, 2013
	Computed under Prior Method			Impact of Commission Adjustment			As Adjusted
Net loss	$	(12,729	)	$	443		$	(12,286	)
Deferred income tax provision (benefit)	$	(4,539	)	$	12		$	(4,527	)
Prepaid expenses and other current assets	$	(1,106	)	$	(487	)	$	(1,593	)
Other assets	$	(1,694	)	$	32		$	(1,662	)
Net cash provided by (used in) operating activities	$	(3,734	)	$	—		$	(3,734	)

The change in accounting principle resulted in an increase to accumulated income of $2,878 thousand as of January 1, 2012 to $21,960 thousand from $19,082 thousand, as previously reported.

Revenue Recognition

Revenue Recognition

The Company’s primary products include Rosetta Stone TOTALe online and Rosetta Stone Version 4 TOTALe. Rosetta Stone TOTALe online combines an online software subscription with conversational coaching and is available in a selection of time-based offers (e.g. three, six and 12 month durations). Version 4 TOTALe includes a TOTALe online subscription bundled with perpetual software available as a CD-ROM or download. Revenue is also derived from the sale of audio practice products and professional services, which include training and implementation services.

Revenue is recognized when all of the following criteria are met: there is persuasive evidence of an arrangement; the product has been delivered or services have been rendered; the fee is fixed or determinable; and collectability is reasonably assured. Revenues are recorded net of discounts. The Company recognizes revenue for software products and related services in accordance with Accounting Standards Codification (“ASC”) subtopic 985-605, Software: Revenue Recognition (“ASC 985-605”).

For multiple element arrangements that include TOTALe online software subscriptions bundled with auxiliary items, such as headsets and audio practice products which provide stand-alone value to the customer, the Company allocates revenue to all deliverables based on their relative selling prices in accordance with ASC subtopic 605-25—  Revenue Recognition — Multiple-Element Arrangements (“ASC 605-25”). The Company has identified two deliverables generally contained in sales of Rosetta Stone TOTALe online software subscriptions. The first deliverable is the auxiliary items, which are delivered at the time of sale, and the second deliverable is the online services.

For Rosetta Stone Version 4 TOTALe, which is a multiple-element arrangement that includes perpetual software bundled with the subscription and conversational coaching components of the TOTALe online service, the Company allocates revenue to all deliverables based on vendor-specific objective evidence of fair value (“VSOE”), in accordance with ASC subtopic 985-605-25  Software: Revenue Recognition —  Multiple-Element Arrangements (“ASC 985-605-25”). The Company has identified two deliverables generally contained in Rosetta Stone V4 TOTALe software arrangements. The first deliverable is the perpetual software, which is delivered at the time of sale, and the second deliverable is subscription service. Revenue is allocated between these two deliverables using the residual method based on the existence of VSOE of the subscription service.

Revenue for online service subscriptions including conversational coaching is recognized ratably over the term of the subscription period, assuming all revenue recognition criteria have been met, which typically ranges between three and 12 months. Rosetta Stone Version 4 TOTALe bundles, which include packaged software and an online service subscription including conversational coaching, allow customers to begin their online services at any point during a registration window, which is up to six months from the date of purchase from the Company or an authorized reseller. Online service subscriptions that are not activated during this registration window are forfeited and revenue is recognized upon expiry. Some online licensing arrangements include a specified number of licenses that can be activated over a period of time, which typically ranges between six and 24 months. Revenue for these arrangements is recognized on a per license basis ratably over the term of the individual license subscription period, assuming all revenue recognition criteria have been met, which typically ranges between three and 12 months. Revenue for set-up fees related to online licensing arrangements is recognized ratably over the term of the online licensing arrangement, assuming all revenue recognition criteria have been met. Accounts receivable and deferred revenue are recorded at the time a customer enters into a binding subscription agreement.

Software products include sales to end user customers and resellers. In most cases, revenue from sales to resellers 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 most 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 Rosetta Stone legally retains a portion of the risk of loss on these sales during transit. A limited amount of 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 985-605-50, Software: Revenue Recognition: Customer Payments and Incentives (“ASC 985-605-50”), 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 is recorded as a reduction to revenue. In accordance with ASC 985-605-50, 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.

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 and a successful collection history has been established, revenue is recognized at the time of sale, assuming the remaining revenue recognition criteria have been met. Packaged software is provided to customers who purchase directly from the Company with a limited right of return. The Company also allows its retailers to return unsold products, subject to some limitations. In accordance with ASC subtopic 985-605-15, Software: Revenue Recognition: Products (“ASC 985-605-15”), product revenue is reduced for estimated returns, which are based on historical return rates.

In connection with packaged software product sales and online software subscriptions, technical support is provided to customers, including customers of resellers, via telephone support at no additional cost for up to six months from 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 revenues are recognized together with the software product and license revenue. Costs associated with the technical support are accrued at the time of sale.

Sales commissions from non-cancellable SaaS contracts are deferred and amortized in proportion to the revenue recognized from the related contract.

On April 1, 2013, the Company completed its acquisition of Livemocha, Inc. (“Livemocha”).  Online subscription revenue from Livemocha is recognized ratably over the term of the subscription and is included in the Company’s results from operations after the acquisition date.

On August 1, 2013, the Company completed its acquisition of Lexia.  The Lexia product offering includes term licenses with software hosting arrangements and subscriptions.  License and hosting revenues are recognized over the term of the arrangement.  Subscription fees are recognized on a straight line basis over the term of the subscription. As part of the Lexia acquisition, the Company acquired $1.2 million of deferred revenue. The deferred revenue will be recognized as revenue, on a contract by contract basis over the remaining term of the arrangements, which expire at various dates through 2022.  The Company is the primary obligor to its end-user customers and therefore acts as principal in customer sales transactions, with its resellers acting as agents.  Revenue is recognized on a gross basis accordingly, with related reseller commissions charged to sales and marketing expense.

Income Taxes

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 respective tax bases of such 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

Deferred Tax Valuation Allowance

The Company has recorded a valuation allowance offsetting certain of its deferred tax assets as of September 30, 2013. When measuring the need for a 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. The valuation allowance is reviewed quarterly and is maintained until sufficient positive evidence exists to support a reversal. Because evidence such as the Company’s operating results during 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 whether 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 the deferred tax assets of certain jurisdictions. The Company will release this valuation allowance when it is determined that it is more likely than not that its deferred tax assets will be realized. Any future release of valuation allowance may be recorded as a tax benefit increasing net income.

Fair Value of Financial Instruments

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 in the 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.

On November 1, 2009, the Company acquired certain assets from SGLC International Co. Ltd. (“SGLC”), a software reseller headquartered in Seoul, South Korea. As the assets acquired constituted a business, this transaction was accounted for under ASC topic 805, Business Combinations (“ASC 805”). The purchase price consisted of an initial cash payment of $100,000, followed by three annual cash installment payments if the acquired company’s revenues exceed certain targeted levels each of these years. The amount was calculated as the lesser of a percentage of the revenue generated or a fixed amount for each year, based on the terms of the agreement.

Based on these terms, the minimum additional cash payment would have been zero if none of the minimum revenue targets were met, and the maximum additional payment would have been $1.1 million, which amount was recorded as contingent consideration at its fair value of $850,000, resulting in a total purchase price of $950,000 including the initial cash payment of $100,000 above. Together with the initial cash payment and the first two contingent payments made, additional payments of zero and $300,000 were made in accordance with the terms of the purchase in 2013 and 2012, respectively.

See table below for a summary of the opening balances to the closing balances of the contingent purchase consideration (in thousands):

	As of September 30,
	2013		2012
Contingent purchase price accrual, beginning of period	$	—	$	300
Minimum revenue target met, increase in contingent liability charged to expense in the period	—		—
Payment of contingent purchase liability	—		—
Contingent purchase price accrual, end of period	$	—	$	300

See table below for a summary of the Company’s financial instruments accounted for at fair value on a recurring basis, which consist only of short-term investments that are marked to fair value at each balance sheet date, as well as the fair value of the accrual for the contingent purchase price of the acquisition of SGLC in 2009 (in thousands):

	Fair Value as of September 30, 2013 using:								Fair Value as of September 30, 2012 using:
			Quoted Prices								Quoted Prices
			in Active								in Active
			Markets for				Significant				Markets for				Significant
			Identical		Significant Other		Unobservable				Identical		Significant Other		Unobservable
	September 30,		Assets		Observable Inputs		Inputs		September 30,		Assets		Observable Inputs		Inputs
	2013		(Level 1)		(Level 2)		(Level 3)		2012		(Level 1)		(Level 2)		(Level 3)
Assets:
Short-term investments	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Total	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Liabilities:
Contingent purchase price accrual	$	—	$	—	$	—	$	—	$	300	$	—	$	—	$	300
Total	$	—	$	—	$	—	$	—	$	300	$	—	$	—	$	300

There were no changes in the valuation techniques or inputs used as the basis to calculate the contingent purchase price accrual.

Business Combinations

Business Combinations

The Company recognizes all of the assets acquired, liabilities assumed and contractual contingencies from the acquired company as well as contingent consideration at fair value on the acquisition date. The excess of the total purchase price over the fair value of the assets and liabilities acquired is recognized as goodwill. Acquisition-related costs are recognized separately from the acquisition and expensed as incurred. Generally, restructuring costs incurred in periods subsequent to the acquisition date are expensed when incurred. Subsequent changes to the purchase price (i.e., working capital adjustments) or other fair value adjustments determined during the measurement period are recorded as adjustments to goodwill.

Stock-Based Compensation

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 and recognized as expense in the consolidated statement of operations on a straight-line basis over the requisite service period, which is the vesting period.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model. For the nine months ended September 30, 2013 and 2012, the fair value of options granted was calculated using the following assumptions:

	Nine Months Ended
	September 30,
	2013	2012
Expected stock price volatility	64.4% - 68.0%	65.0% - 66.1%
Expected term of options	6 years	6 years
Expected dividend yield	—	—
Risk-free interest rate	0.75% - 1.65%	0.60% - 0.88%

Since the Company’s stock has been publicly quoted since April 2009 and the Company has a limited history of stock option activity, the Company reviewed a group of comparable industry-related companies to estimate its expected volatility over the most recent period commensurate with the estimated expected term of the awards. In addition to analyzing data from the peer group, the Company also considered the contractual option term and vesting period when determining the expected option life and forfeiture rate. 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. The grant date fair value is based on the market price of the Company’s common stock at the date of grant.

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

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2013		2012		2013		2012
Cost of revenue	$	86	$	64	$	108	$	225
Sales and marketing	669		320		1,067		753
Research & development	348		338		971		1,243
General and administrative	1,422		1,755		4,083		3,987
Total	$	2,525	$	2,477	$	6,229	$	6,208

Foreign Currency Translation and Transactions

Foreign Currency Translation and Transactions

The functional currency of each 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 income in stockholders’ equity.

Cash flows of consolidated foreign subsidiaries 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 during the period. The following table presents the effect of exchange rate changes and the net unrealized gains and losses from the available-for-sale securities on total comprehensive income (loss) (dollars in thousands):

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2013			2012			2013			2012
				(As Adjusted)*						(As Adjusted)*
Net Loss	$	(4,169	)	$	(32,063	)	$	(12,286	)	$	(38,620	)
Foreign currency translation gain (loss)	373			230			12			205
Unrealized gain on available-for-sale securities	—			5			—			23
Total comprehensive loss	$	(3,796	)	$	(31,828	)	$	(12,274	)	$	(38,392	)

* Certain amounts have been adjusted for the retrospective change in accounting principle for sales commissions (See Note 2).

Advertising Costs

Advertising Costs

Costs for advertising are expensed as incurred. Advertising expense for the three and nine months ended September 30, 2013 was $15.9 million and $43.4 million, respectively, and for the three and nine months ended September 30, 2012 was $16.9 million and $47.6 million, respectively.

Recently Issued Accounting Standards

Recently Issued Accounting Standards

In July 2012, the Financial Accounting Standards Board (“FASB”) issued new guidance on the impairment testing of indefinite-lived intangible assets (Accounting Standards Update (“ASU”) 2012-02, Intangibles—Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment), effective for calendar years beginning after September 15, 2012. Early adoption is permitted. The objective of this standard update is to simplify how an entity tests indefinite-lived intangible assets for impairment. The amendments in this standard will allow an entity to first assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test. Only if an entity determines, based on qualitative assessment, that it is more likely than not that the indefinite-lived intangible asset is impaired will it be required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test. The Company adopted this guidance beginning in fiscal year 2013, and the adoption of such guidance did not have a material impact on the Company’s reported results of operations or financial position.

In February 2013, the FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (“ASU 2013-02”), which requires disclosure of significant amounts reclassified out of accumulated other comprehensive income by component and their corresponding effect on the respective line items of net income. The Company adopted this guidance beginning in fiscal year 2013, and the adoption of such guidance did not have a material impact on the Company’s reported results of operations or financial position.

In July 2013, the FASB issued ASU No. 2013-11, Income Taxes (Topic 740): Presentation of Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (“ASU 2013-11”), which requires that an unrecognized tax benefit be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except for a situation in which some or all of such net operating loss carryforward, a similar loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable tax jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. ASU 2013-11 is effective for the Company beginning January 1, 2014. The Company believes the adoption of ASU 2013-11 will not have a material impact on the Company’s reported results of operations or financial position.