Chegg 2014 Annual Report Download - page 79

Table of Contents
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costs, the cost of textbooks sold, payment processing costs, write-offs and allowances related to the textbook library and all
expenses associated with our distribution and customer service centers, including personnel and warehousing costs. The cost of
textbooks sold, shipping and other fulfillment costs and payment processing expenses are recognized upon shipment, while
textbook depreciation is recognized under an accelerated method over the life of the textbook. We believe this method most
accurately reflects the actual pattern of decline in the economic value of the assets, resulting in higher costs earlier in the
textbook lifecycle. Changes in our cost of revenues may be disproportionate to changes in our revenue because unrecoverable
costs, such as outbound shipping and other fulfillment and payment processing fees, are expensed in the period they are
incurred while revenue is recognized ratably over the rental term. This effect is particularly pronounced in the first and third
quarters at the beginning of academic terms. As a result, we could experience quarters in which our cost of revenues exceeds
our revenue for the period. In addition, print cost of revenues include allocated information technology and facilities costs.
Cost of revenues related to digital offerings, in which we also group eTextbooks, consist primarily of the depreciation
of our eTextbook Reader software, publisher content fees for eTextbooks, content amortization expense related to content that
we develop or license, including publisher agreements for which we pay one-time license fees for published content,
enrollment marketing services leads purchased from third-party suppliers to fulfill leads that we are unable to fulfill through
our internal database, personnel costs and other direct costs related to providing content or services. In addition, digital cost of
revenues include allocated information technology and facilities costs.
Margins on digital offerings are generally higher than margins on the rental or sale of print textbooks. However, we
experience substantially lower margins with eTextbook transactions than we do with other digital offerings. Overall, we
anticipate that to the extent digital offerings revenue grows, our gross margins will generally improve over time.
Operating Expenses
We classify our operating expenses into four categories: technology and development, sales and marketing, general
and administrative and loss (gain) on liquidation of textbooks. One of the most significant components of our operating
expenses is employee-related costs, which include share-based compensation expenses. We expect to continue to hire new
employees in order to support our anticipated growth. In any particular period, the timing of additional hires could materially
affect our operating expenses, both in absolute dollars and as a percentage of revenue. Our costs and expenses contain
information technology expenses and facilities expenses such as webhosting, depreciation on our infrastructure systems, our
headquarters lease expense and the employee-related costs for information technology support staff. We allocate these costs to
each expense category, including cost of revenues, technology and development, sales and marketing and general and
administrative. The allocation is primarily based on the headcount in each group at the end of a period. As our business grows,
we expect our operating expenses will increase over time to expand capacity and sustain our workforce.
Technology and Development
Our technology and development expenses consist of salaries, benefits and share-based compensation expense for
employees in our product and web design, engineering and technical teams who are responsible for maintaining our website,
developing new products and improving existing products. Technology and development costs also include amortization of
acquired intangible assets, webhosting costs, third-party development costs and allocated information technology and facilities
expenses. We expense substantially all of our technology and development expenses as they are incurred. In the past three
years, our expenses have increased to support new products and services as well as to expand our infrastructure capabilities to
support back-end processes associated with our revenue transactions and internal systems used to manage our textbook library.
We intend to continue making significant investments in developing new products and services and enhancing the functionality
of existing products and services.
Sales and Marketing
Our sales and marketing expenses consist of user and advertiser-facing marketing and promotional expenditures
through a number of targeted online marketing channels, sponsored search, display advertising, email marketing campaigns and
other initiatives. We incur salaries, benefits and share-based compensation expenses for our employees engaged in marketing,
business development and sales and sales support functions required for enrollment marketing services and amortization of
acquired intangible assets and allocated information technology and facilities costs. Our marketing expenses are largely
variable; and we tend to incur these in the first and third quarters of the year due to our efforts to target students at the
beginning of academic terms. To the extent there is increased or decreased competition for these traffic sources, or to the extent
our mix of these channels shifts, we would expect to see a corresponding change in our marketing expense. Sales and