Rosetta Stone 2009 Annual Report Download - page 48

Table of Contents
2009. Our institutional revenue is seasonally stronger in the second and third quarters of the calendar year due to education, home school and government
purchasing cycles. We expect these trends to continue.
Cost of 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, third-party royalty fees and inventory storage,
obsolescence and shrinkage. Cost of subscription and service revenue primarily represents costs associated with supporting our online language learning
service, which includes hosting costs and depreciation. We also include the cost of credit card processing and customer technical support in both cost of
product revenue and cost of subscription and service revenue. We expect our cost of revenue to increase in absolute dollars in future periods as our unit sales
continue to grow. We also expect cost of revenue will increase as a percentage of revenue in future periods with the planned launch of Rosetta Stone Version
4 TOTALe which includes services that have higher direct costs to deliver to customers than our existing software solutions.
Operating Expenses
We classify our operating expenses into three categories: sales and marketing, research and development and general and administrative.
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.
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, rental payments for our kiosks and commissions paid to our sales
personnel. Sales and marketing expenses also include amortization expense of intangible assets related to customer relationships associated with the 2006
acquisition of Fairfield & Sons, Ltd. These intangible assets were fully amortized by January 2009. In 2007, we began to make significant investments to
expand our sales and marketing operations in Europe and Japan. In 2009, we began to make significant investments to expand our sales and marketing
operations in South Korea. In each case we established local sales offices and call centers, added employees and launched marketing and public relations
campaigns within the region. We intend to continue to expand our sales activities within these regions as well as to expand our presence into new countries,
including Germany, in addition to expanding our media and advertising campaigns in the United States. As a result, we expect sales and marketing expenses
to increase in future periods.
Research and Development. Research and development expenses consist primarily of personnel costs and contract development fees associated with
the development of our solutions. Our development efforts are primarily based in the United States and are devoted to expanding our product portfolio
through the addition of new content and new complimentary products and services to our language learning solutions. We expect our investment in research
and development expenses to increase in future years but provide us with significant benefits in the future.
General and Administrative. General and administrative expenses consist primarily of personnel costs of our executive, finance, legal, human resources
and other administrative personnel, as well as accounting and legal professional services fees and other corporate expenses. We expect general and
administrative expenses to increase in future periods as we expect to continue to invest in corporate
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