10-Q 1 rst-10q_20190331.htm 10-Q rst-10q_20190331.htm

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

 

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

For the quarterly period ended March 31, 2019

Commission file number: 1-34283

 

Rosetta Stone Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

(State of incorporation)

 

043837082

(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    No 

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    No 

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

 

Accelerated filer

 

Non-accelerated filer

 

Smaller reporting company 

 

Emerging growth company

 

 

 

 

 (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.     

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

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 April 30, 2019, there were 23,820,186 shares of the registrant’s Common Stock, $.00005 par value, outstanding.

 

 

 


 

ROSETTA STONE INC.

 

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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, 2019

 

 

December 31, 2018

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

28,287

 

 

$

38,092

 

Restricted cash

 

 

54

 

 

 

82

 

Accounts receivable (net of allowance for doubtful accounts of $289 and $372 at March 31, 2019 and December 31, 2018, respectively)

 

 

13,738

 

 

 

21,950

 

Inventory

 

 

1,763

 

 

 

933

 

Deferred sales commissions

 

 

10,204

 

 

 

11,597

 

Prepaid expenses and other current assets

 

 

5,121

 

 

 

4,041

 

Total current assets

 

 

59,167

 

 

 

76,695

 

Deferred sales commissions

 

 

6,332

 

 

 

6,933

 

Property and equipment, net

 

 

37,693

 

 

 

36,405

 

Operating lease right-of-use assets

 

 

5,533

 

 

 

 

Intangible assets, net

 

 

15,462

 

 

 

15,850

 

Goodwill

 

 

49,000

 

 

 

49,239

 

Other assets

 

 

1,615

 

 

 

2,136

 

Total assets

 

$

174,802

 

 

$

187,258

 

Liabilities and stockholders' deficit

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

7,345

 

 

$

8,938

 

Accrued compensation

 

 

10,906

 

 

 

9,046

 

Income tax payable

 

 

603

 

 

 

328

 

Operating lease liabilities

 

 

1,800

 

 

 

 

Other current liabilities

 

 

10,697

 

 

 

13,925

 

Deferred revenue

 

 

99,443

 

 

 

113,378

 

Total current liabilities

 

 

130,794

 

 

 

145,615

 

Deferred revenue

 

 

46,811

 

 

 

49,507

 

Deferred income taxes

 

 

2,184

 

 

 

2,776

 

Operating lease liabilities

 

 

3,612

 

 

 

 

Other long-term liabilities

 

 

1,200

 

 

 

1,368

 

Total liabilities

 

 

184,601

 

 

 

199,266

 

Commitments and contingencies (Note 11)

 

 

 

 

 

 

 

 

Stockholders' deficit:

 

 

 

 

 

 

 

 

Preferred stock, $0.001 par value; 10,000 and 10,000 shares authorized, zero and zero shares issued and outstanding at March 31, 2019 and December 31, 2018, respectively)

 

 

 

 

 

 

Non-designated common stock, $0.00005 par value, 190,000 and 190,000 shares authorized, 24,812 and 24,426 shares issued, and 23,812 and 23,426 shares outstanding, at March 31, 2019 and December 31, 2018, respectively)

 

 

2

 

 

 

2

 

Additional paid-in capital

 

 

204,895

 

 

 

202,355

 

Treasury stock, at cost; 1,000 and 1,000 shares at March 31, 2019 and December 31, 2018, respectively)

 

 

(11,435

)

 

 

(11,435

)

Accumulated loss

 

 

(200,136

)

 

 

(199,592

)

Accumulated other comprehensive loss

 

 

(3,125

)

 

 

(3,338

)

Total stockholders' deficit

 

 

(9,799

)

 

 

(12,008

)

Total liabilities and stockholders' deficit

 

$

174,802

 

 

$

187,258

 

 

See accompanying notes to consolidated financial statements

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ROSETTA STONE INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

 

 

 

Three months ended March 31,

 

 

 

2019

 

 

2018

 

Revenue

 

$

44,611

 

 

$

42,808

 

Cost of revenue

 

 

8,426

 

 

 

9,434

 

Gross profit

 

 

36,185

 

 

 

33,374

 

Operating expenses

 

 

 

 

 

 

 

 

Sales and marketing

 

 

23,238

 

 

 

24,191

 

Research and development

 

 

5,738

 

 

 

6,306

 

General and administrative

 

 

8,692

 

 

 

8,532

 

Total operating expenses

 

 

37,668

 

 

 

39,029

 

Loss from operations

 

 

(1,483

)

 

 

(5,655

)

Other income and (expense):

 

 

 

 

 

 

 

 

Interest income

 

 

33

 

 

 

25

 

Interest expense

 

 

(60

)

 

 

(83

)

Other income and (expense)

 

 

796

 

 

 

(228

)

Total other income and (expense)

 

 

769

 

 

 

(286

)

Loss before income taxes

 

 

(714

)

 

 

(5,941

)

Income tax (benefit) expense

 

 

(170

)

 

 

461

 

Net loss

 

$

(544

)

 

$

(6,402

)

Loss per share:

 

 

 

 

 

 

 

 

Basic

 

$

(0.02

)

 

$

(0.29

)

Diluted

 

$

(0.02

)

 

$

(0.29

)

Common shares and equivalents outstanding:

 

 

 

 

 

 

 

 

Basic weighted average shares

 

 

23,036

 

 

 

22,425

 

Diluted weighted average shares

 

 

23,036

 

 

 

22,425

 

 

See accompanying notes to consolidated financial statements

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ROSETTA STONE INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(unaudited)

 

 

 

Three months ended March 31,

 

 

 

2019

 

 

2018

 

Net loss

 

$

(544

)

 

$

(6,402

)

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

Foreign currency translation gain

 

 

213

 

 

 

529

 

Other comprehensive income

 

 

213

 

 

 

529

 

Comprehensive loss

 

$

(331

)

 

$

(5,873

)

 

See accompanying notes to consolidated financial statements

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ROSETTA STONE INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

 

Three months ended March 31,

 

 

 

2019

 

 

2018

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

 

 

 

Net loss

 

$

(544

)

 

$

(6,402

)

Non-cash adjustments to reconcile net loss to cash used in operating activities:

 

 

 

 

 

 

 

 

Stock-based compensation expense

 

 

1,220

 

 

 

583

 

Loss on foreign currency transactions

 

 

708

 

 

 

245

 

Bad debt recovery

 

 

(13

)

 

 

(75

)

Depreciation and amortization

 

 

3,529

 

 

 

3,610

 

Operating lease costs

 

 

526

 

 

 

 

Deferred income tax (benefit) expense

 

 

(592

)

 

 

36

 

Gain on disposal or sale of assets

 

 

(1,395

)

 

 

 

Amortization of deferred financing costs

 

 

14

 

 

 

34

 

Net change in:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

8,237

 

 

 

11,038

 

Inventory

 

 

(829

)

 

 

1,467

 

Deferred sales commissions

 

 

1,997

 

 

 

1,655

 

Prepaid expenses and other current assets

 

 

(789

)

 

 

(639

)

Income tax receivable or payable

 

 

271

 

 

 

(91

)

Other assets

 

 

144

 

 

 

(166

)

Accounts payable

 

 

(1,595

)

 

 

(58

)

Accrued compensation

 

 

2,441

 

 

 

1,597

 

Other current liabilities

 

 

(2,622

)

 

 

(2,413

)

Operating lease liabilities

 

 

(544

)

 

 

 

Other long-term liabilities

 

 

(31

)

 

 

 

Deferred revenue

 

 

(16,700

)

 

 

(10,839

)

Net cash used in operating activities

 

 

(6,567

)

 

 

(418

)

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(4,714

)

 

 

(3,948

)

Proceeds from sale of assets

 

 

996

 

 

 

 

Net cash used in investing activities

 

 

(3,718

)

 

 

(3,948

)

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

 

 

 

Proceeds from the exercise of stock options

 

 

744

 

 

 

467

 

Payment of deferred financing costs

 

 

(2

)

 

 

 

Payments under financing lease liabilities

 

 

(110

)

 

 

(115

)

Net cash provided by financing activities

 

 

632

 

 

 

352

 

Decrease in cash, cash equivalents, and restricted cash

 

 

(9,653

)

 

 

(4,014

)

Effect of exchange rate changes in cash, cash equivalents, and restricted cash

 

 

(180

)

 

 

193

 

Net decrease in cash, cash equivalents, and restricted cash

 

 

(9,833

)

 

 

(3,821

)

Cash, cash equivalents, and restricted cash—beginning of period

 

 

38,174

 

 

 

43,036

 

Cash, cash equivalents, and restricted cash—end of period

 

$

28,341

 

 

$

39,215

 

SUPPLEMENTAL CASH FLOW DISCLOSURE:

 

 

 

 

 

 

 

 

Cash paid during the periods for:

 

 

 

 

 

 

 

 

Interest

 

$

46

 

 

$

49

 

Income taxes, net of refund

 

$

258

 

 

$

437

 

Noncash operating, investing and financing activities:

 

 

 

 

 

 

 

 

Operating right-of-use assets obtained in exchange for operating lease liabilities

 

$

656

 

 

$

-

 

Accrued liability for purchase of property and equipment

 

$

1,033

 

 

$

1,121

 

Equipment acquired under finance leases

 

$

-

 

 

$

25

 

 

See accompanying notes to consolidated financial statements

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ROSETTA STONE INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (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, 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

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

Non-Designated

 

 

Additional

 

 

 

 

 

 

 

 

 

 

Other

 

 

Total

 

 

 

Common Stock

 

 

Paid-in

 

 

Treasury

 

 

Accumulated

 

 

Comprehensive

 

 

Stockholders'

 

 

 

Shares

 

 

Amount

 

 

Capital

 

 

Stock

 

 

Loss

 

 

Loss

 

 

Equity / (Deficit)

 

Balance—January 1, 2018

 

 

22,316

 

 

$

2

 

 

$

195,644

 

 

$

(11,435

)

 

$

(178,890

)

 

$

(2,898

)

 

$

2,423

 

Stock issued upon the exercise of stock options

 

 

54

 

 

 

 

 

 

467

 

 

 

 

 

 

 

 

 

 

 

 

467

 

Restricted stock award and performance stock unit vesting

 

 

167

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock-based compensation expense

 

 

 

 

 

 

 

 

583

 

 

 

 

 

 

 

 

 

 

 

 

583

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(6,402

)

 

 

 

 

 

(6,402

)

Cumulative effect adjustment - adoption of ASC 606

 

 

 

 

 

 

 

 

 

 

 

 

 

 

771

 

 

 

 

 

 

771

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

529

 

 

 

529

 

Balance—March 31, 2018

 

 

22,537

 

 

$

2

 

 

$

196,694

 

 

$

(11,435

)

 

$

(184,521

)

 

$

(2,369

)

 

$

(1,629

)

 

See accompanying notes to consolidated financial statements

 

 

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (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 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 web-based software subscriptions, mobile applications, and packaged software, domestically and in certain international markets.

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. Certain numbers in the prior period consolidated financial statements have been reclassified to conform to the current period presentation.

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 6, 2019. The March 31, 2019 consolidated balance sheet included herein includes account balances as of December 31, 2018 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.

As discussed in this Note 2 and Note 7, the Company adopted the new lease standard (“ASC 842”) effective January 1, 2019 using the modified retrospective approach. The Company elected the comparatives under 840 option, and as such, the comparative information has not been restated under ASC 842 and continues to be reported under the accounting standards in effect for those prior comparative periods. See the Company’s Annual Report on Form 10-K filed with the SEC on March 6, 2019 for lease policies that were in effect in prior periods before adoption of ASC 842.

Except as noted above, 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 statements of financial position at March 31, 2019 and December 31, 2018, the Company’s results of operations and stockholders’ equity activity for the three months ended March 31, 2019 and 2018, and its cash flows for the three months ended March 31, 2019 and March 31, 2018 have been made. The results for the three months ended March 31, 2019 are not necessarily indicative of the results to be expected for the year ending December 31, 2019. All references to March 31, 2019 or to the three months ended March 31, 2019 and 2018 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, 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.

Recently Issued Accounting Standards

Accounting Standards Adopted During the Period: During 2019, the Company adopted the following recently issued Accounting Standard Updates ("ASU"):

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which was further amended by additional ASUs that collectively created ASC 842. Under ASC 842, entities are required to record most leases on their balance sheets. A lessee would recognize a lease liability for the obligation to make lease payments and a right-of-use asset for the right to use the underlying asset for the lease term. Lease expense recognition guidance was largely unchanged. ASC 842 was effective for the Company on January 1, 2019

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

and was adopted on that date using the modified retrospective approach and the Company elected the comparatives under 840 option. In accordance with the standard, the comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. ASC 842 provided a package of practical expedients that allow an entity to not reassess (1) whether any expired or existing contracts contain a lease, (2) the lease classification of any expired or existing lease, and (3) initial direct costs for any existing leases. The Company elected to apply the package of practical expedients and adoption of ASC 842 did not result in the recognition of a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The most significant impacts of ASC 842 adoption as of January 1, 2019 related to (1) the recognition of $5.3 million in operating right-of-use assets and a corresponding total of $5.2 million in total operating lease liabilities on the Company’s balance sheet, and (2) the additional presentation and disclosure requirements that are further discussed in Note 7 “Leases”. Prior to the adoption of ASC 842, operating leases were not included on the balance sheets.

Accounting Standards Not Yet Adopted: The following ASUs were recently issued but have not yet been adopted by the Company:

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 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, with early adoption permitted for any eliminated or modified disclosures. The Company is in the process of evaluating the effect of adopting this new accounting guidance to determine the impact it may have on the Company’s consolidated financial statements.

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 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, however the Company anticipates adopting ASU 2016-13 effective January 1, 2020. The Company is in the process of evaluating the impact of the new guidance on the Company's consolidated financial statements and disclosures. However based on a preliminary assessment and as the Company does not hold significant financial instruments, the Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.

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 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, 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 net of allowances for returns. Revenue is also recognized net of any taxes collected from customers, which are subsequently remitted to governmental authorities.

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

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 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. 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 recognized upon expiry.

Performance Obligations: A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in ASC 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The Company’s performance obligations are satisfied at a point in time or over time as delivery occurs or as work progresses.

Significant Judgments: Some of the Company’s contracts with customers include promises to transfer multiple 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 language-learning subscription is delivered concurrently with all other promised services over the contract term and, as such, concluded that these promises are a single performance obligation that includes a series of distinct services that have the same pattern of transfer to the customer. 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 lists which include suggested sales prices for each performance obligation based on the type of client and volume purchased. These price lists are derived from past experience and from the expectation of obtaining a reasonable margin based on the cost to fulfill each performance obligation.

Subscription revenue is recognized ratably over the contract period as the performance obligation is satisfied. Certain Consumer Language offerings have contracts with no fixed duration and 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 the Company may provide other credits or incentives. These rights are accounted for as variable consideration when estimating the amount of revenue to recognize by utilizing the expected value method. Returns and credits are estimated at 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 to determine whether it is the principal (where revenue is recognized at the gross amount) or agent (where revenue is recognized net of the reseller commission). In making this determination the Company evaluates a variety of factors including the amount of control the Company is able to exercise over the 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 are generally granted payment terms of 45 days. Within Consumer Language, sales to end 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 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 predictable ways of purchasing products and services and not to provide customers with financing.

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Deferred revenue is comprised mainly of unearned revenue related to subscription services which is recognized ratably over the subscription period. Deferred revenue also includes payments for professional services and online services to be performed in the future which are earned as revenue when the service is provided. Our practice is to ship our products promptly upon receipt of purchase orders from customers; consequently, contract backlog is not material. See Note 10 "Revenue and Deferred Revenue" for additional disclosures.

Assets Recognized from Costs to Obtain a Contract with a Customer: The Company recognizes an asset for the incremental costs of obtaining a contract with a customer, which primarily represents sales commissions paid when a customer contract is either recorded as revenue or deferred revenue. Sales commissions paid to obtain non-cancellable subscription contracts are deferred and amortized in proportion to the period over which the revenue is recognized from the related contract. Deferred sales commissions are amortized to sales and marketing expense on the consolidated statements of operations. Deferred sales commissions are classified as non-current unless the associated amortization period 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. See Note 15 "Income Taxes" for additional disclosures.

Deferred Tax Valuation Allowance

The Company has recorded a valuation allowance offsetting certain of its deferred tax assets as of March 31, 2019. 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. 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

The Company values its assets and liabilities using the methods of fair value as described in ASC topic 820, Fair Value Measurements, ("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.

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 which require the use of estimates, including future stock price volatility, expected term and forfeitures.

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

As the Company does not have sufficient historical option exercise experience that spans the full 10 -year contractual term for determining the expected term of options granted, the Company estimates the expected term of options using a combination of historical information and the simplified method for estimating the expected term. 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 statements of operations on a straight-line basis over the requisite service period, which is the vesting period. For equity awards granted with performance-based conditions, stock compensation expense is recognized in the 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 statements of operations ratably for each vesting tranche regardless of meeting or not meeting the market conditions. See Note 12 "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, 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,

 

 

 

2019

 

 

2018

 

Net loss

 

$

(544

)

 

$

(6,402

)

Foreign currency translation gain

 

 

213

 

 

 

529

 

Comprehensive loss

 

$

(331

)

 

$

(5,873

)

 

Comprehensive Loss

Comprehensive loss consists of net loss and other comprehensive income. Other comprehensive income 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 months ended March 31, 2019 and 2018, the Company's comprehensive loss consisted of net loss and foreign currency translation gains.

The other comprehensive income presented in the consolidated financial statements and the notes are presented net of tax. There has been no tax expense or benefit associated with the components of other comprehensive income due to the presence of a full valuation allowance for each of the three months ended March 31, 2019 and 2018.

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

Advertising Costs

Costs for advertising are expensed as incurred. Advertising expense consisted of the following (in thousands):

 

 

 

Three months ended March 31,

 

 

 

2019

 

 

2018

 

Advertising costs

 

$

4,735

 

 

$

6,018

 

 

Going Concern Assessment

As part of its internal control framework, the Company routinely performs 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 below, management has concluded based on projections that the cash balance, funds available from the line of credit, and the cash flows from operations are sufficient to meet 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 reasonably knowable as of May 7, 2019.

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 2019 cash flow forecast, 2019 operating budget, and long-term plan that extends beyond 2019. 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 May 7, 2019, 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.

3. INVENTORY

Inventory consisted of the following (in thousands):

 

 

 

As of

 

 

 

March 31, 2019

 

 

December 31, 2018

 

Raw materials

 

$

1,023

 

 

$

797

 

Finished goods

 

 

740

 

 

 

136

 

Total inventory

 

$

1,763

 

 

$

933

 

 

 

4. PROPERTY AND EQUIPMENT

The Company capitalizes certain internal use software costs into property and equipment. Capitalized internal use software costs consisted of the following (in thousands):

 

 

 

Three months ended March 31,

 

 

 

2019

 

 

2018

 

Capitalized internal use software

 

$

4,628

 

 

$

3,923

 

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

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,

 

 

 

2019

 

 

2018

 

Cost of revenue

 

$

2,402

 

 

$

1,860

 

Sales and marketing

 

 

184

 

 

 

181

 

Research and development

 

 

2

 

 

 

2

 

General and administrative

 

 

553

 

 

 

576

 

Total depreciation

 

$

3,141

 

 

$

2,619

 

 

5. INTANGIBLE ASSETS

Intangible assets consisted of the following items as of the dates indicated (in thousands):

 

 

 

Trade name /

trademark *

 

 

Core

technology

 

 

Customer

relationships

 

 

Patents and

Other

 

 

Total

 

Gross Carrying Amount

 

$

12,322

 

 

$

13,432

 

 

$

25,689

 

 

$

312

 

 

$

51,755

 

Accumulated Amortization/Impairment

 

 

(1,715

)

 

 

(12,505

)

 

 

(21,380

)

 

 

(305

)

 

 

(35,905

)

Balance as of January 1, 2019

 

$

10,607

 

 

$

927

 

 

$

4,309

 

 

$

7

 

 

$

15,850

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross Carrying Amount

 

$

12,313

 

 

$

13,367

 

 

$

25,621

 

 

$

312

 

 

$

51,613

 

Accumulated Amortization/Impairment

 

 

(1,706

)

 

 

(12,586

)

 

 

(21,547

)

 

 

(312

)

 

 

(36,151

)

Balance as of March 31, 2019

 

$

10,607

 

 

$

781

 

 

$

4,074

 

 

$

 

 

$

15,462

 

 

* 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, 2019 and March 31, 2019, 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,

 

 

 

2019

 

 

2018

 

Cost of revenue

 

$

146

 

 

$

146

 

Sales and marketing

 

 

235

 

 

 

481

 

Research and development

 

 

7

 

 

 

364

 

General and administrative

 

 

 

 

 

 

Total

 

$

388

 

 

$

991

 

 

The following table summarizes the estimated future amortization expense related to intangible assets for the remaining months of 2019 and years thereafter (in thousands):

 

 

 

As of March 31, 2019

 

2019 - remaining

 

$

1,145

 

2020

 

 

1,282

 

2021

 

 

940

 

2022

 

 

940

 

2023

 

 

548

 

Thereafter

 

 

 

Total

 

$

4,855

 

 

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ROSETTA STONE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 

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, 2019 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.

 

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 three months ended March 31, 2019 (in thousands):

 

 

 

Literacy

 

 

E&E

Language

 

 

Consumer

Language

 

 

Total

 

Balance as of January 1, 2019

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross Goodwill

 

$

9,962

 

 

$

39,277

 

 

$

27,514

 

 

$

76,753

 

Accumulated Impairment

 

 

 

 

 

 

 

 

(27,514

)

 

 

(27,514

)

Goodwill as of January 1, 2019

 

$

9,962

 

 

$

39,277

 

 

$

 

 

$

49,239

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of change in foreign currency rate

 

 

 

 

 

(239

)

 

 

 

 

 

(239

)