Rocket Fuel Inc.
Rocket Fuel Inc. (Form: 10-Q, Received: 11/13/2013 10:44:54)

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

Form 10-Q

 


 

(Mark One)

 

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

 

For the quarterly period ended September 30, 2013

 

OR

 

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

 

For the transition period from              to             

 

Commission file number 001-36071

 


 

Rocket Fuel Inc.

(Exact name of registrant as specified in its charter)

 


 

Delaware

 

30-0472319

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

 

350 Marine Parkway

Marina Park Center

Redwood City, CA 94065

(Address of principal executive offices, including zip code)

 

Registrant’s telephone number, including area code:

(650) 595-1300

 


 

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   o   No   x

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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   x   No   o

 

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

 

 

 

 

 

 

Large accelerated filer

o

 

Accelerated filer

o

 

 

 

 

 

Non-accelerated filer

x

(Do not check if a smaller reporting company)

Smaller reporting company

o

 

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

 

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

 

Class

 

Outstanding as of October 31, 2013

Common Stock

 

32,821,242

 

 

 



Table of Contents

 

Rocket Fuel Inc.

Quarterly Report on Form 10-Q

 

INDEX

 

 

 

Page No.

PART I. — FINANCIAL INFORMATION

 

 

 

Item 1.

Financial Statements (Unaudited)

3

 

Condensed Consolidated Balance Sheet as of September 30, 2013 and December 31, 2012

3

 

Condensed Consolidated Statements of Operations for the Three and Nine Month Periods Ended September 30, 2013 and September 30, 2012

4

 

Condensed Consolidated Statements of Comprehensive Loss for the Three and Nine Month Periods Ended September 30, 2013 and September 30, 2012

5

 

Condensed Consolidated Statements Statement of Changes in Stockholders’ Equity for the Nine Months Ended September 30, 2013

6

 

Condensed Consolidated Statements of Cash Flows for the Nine Month Periods Ended September 30, 2013 and September 30, 2012

7

 

Notes to Condensed Consolidated Financial Statements

8

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

23

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

36

Item 4.

Controls and Procedures

37

 

 

 

PART II. — OTHER INFORMATION

 

 

 

Item 1.

Legal Proceedings

37

Item 1A.

Risk Factors

37

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

55

Item 3.

Defaults upon Senior Securities

56

Item 4.

Mine Safety Disclosures

56

Item 5.

Other Information

56

Item 6.

Exhibits

56

Signatures

 

57

 

TRADEMARKS

 

© Copyright 2013 Rocket Fuel Inc. All rights reserved. No portions of this document may be reproduced without the prior written consent of Rocket Fuel Inc. “Rocket Fuel,”  the Rocket Fuel logo, “Advertising that Learns,” and other trademarks or service marks of Rocket Fuel appearing in this Quarterly Report on Form 10-Q are the property of Rocket Fuel Inc. Trade names, trademarks and service marks of other companies appearing in this Quarterly Report on Form 10-Q are the property of their respective holders and should be treated as such.

 

2



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

Item 1.                              Financial Statements

 

Rocket Fuel Inc.

Condensed Consolidated Balance Sheet

(in thousands, except par values, share and per share data)

(unaudited)

 

 

 

September 30,

 

December 31,

 

 

 

2013

 

2012

 

Assets

 

 

 

 

 

Current Assets:

 

 

 

 

 

Cash and cash equivalents

 

$

125,282

 

$

14,896

 

Accounts receivable, net

 

67,984

 

47,333

 

Deferred tax assets

 

334

 

334

 

Prepaid expenses and other current assets

 

2,159

 

1,215

 

Total current assets

 

195,759

 

63,778

 

Property, equipment and software, net

 

20,941

 

10,939

 

Other assets

 

1,165

 

472

 

Total assets

 

$

217,865

 

$

75,189

 

 

 

 

 

 

 

Liabilities and Stockholder’s Equity

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

Accounts payable

 

$

34,088

 

$

17,482

 

Accrued and other current liabilities

 

15,707

 

6,186

 

Deferred revenue

 

451

 

187

 

Current portion of line of credit

 

11,853

 

 

Current portion of long-term debt

 

4,375

 

1,988

 

Total current liabilities

 

66,474

 

25,843

 

Line of credit - Less current portion

 

 

1,853

 

Long-term debt - Less current portion

 

10,625

 

3,125

 

Deferred rent - Less current portion

 

482

 

430

 

Deferred tax liabilities

 

334

 

334

 

Convertible preferred stock warrant liability

 

 

2,741

 

Total liabilities

 

77,915

 

34,326

 

 

 

 

 

 

 

Commitments and contingencies (Note 11)

 

 

 

 

 

Stockholders’ Equity (Note 8)

 

 

 

 

 

Convertible preferred stock, Series A, $0.001 par value - 10,884,902 authorized as of December 31, 2012; 0 and 10,618,372 issued and outstanding as of September 30, 2013 and December 30, 2012, respectively

 

 

9,788

 

Convertible preferred stock, Series B, $0.001 par value - 4,811,855 authorized as of December 31, 2012; 0 and 4,811,855 issued and outstanding as of September 30, 2013 and December 31, 2012, respectively

 

 

9,935

 

Convertible preferred stock, Series C, $0.001 par value - 1,116,030 authorized as of December 31, 2012; 0 and 1,116,030 issued and outstanding as of September 30, 2013 and December 31, 2012, respectively

 

 

6,501

 

Convertible preferred stock, Series C-1, $0.001 par value - 2,975,228 authorized as of December 31, 2012; 0 and 2,932,675 issued and outstanding as of September 30, 2013 and December 31, 2012, respectively

 

 

34,393

 

Common stock, $0.001 par value - 1,000,000,000 and 35,850,100 authorized as of September 30, 2013 and December 31, 2012, respectively; 32,807,784 and 8,680,041 issued and outstanding as of September 30, 2013 and December 31, 2012, respectively

 

33

 

8

 

Additional paid-in capital

 

182,332

 

3,865

 

Accumulated other comprehensive loss

 

(101

)

(84

)

Accumulated deficit

 

(42,314

)

(23,543

)

Total stockholders’ equity

 

139,950

 

40,863

 

Total liabilities and stockholders’ equity

 

$

217,865

 

$

75,189

 

 

See Notes to Condensed Consolidated Financial Statements

 

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Table of Contents

 

Rocket Fuel Inc.

Condensed Consolidated Statements of Operations

(in thousands)

(unaudited)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

62,458

 

$

26,902

 

$

155,039

 

$

66,494

 

Cost of revenue

 

31,877

 

14,955

 

81,529

 

36,988

 

Gross Profit

 

30,581

 

11,947

 

73,510

 

29,506

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

4,464

 

1,066

 

10,587

 

2,604

 

Sales and marketing

 

21,644

 

10,351

 

56,293

 

25,893

 

General and administrative

 

8,719

 

1,675

 

19,671

 

4,245

 

Total operating expenses

 

34,827

 

13,092

 

86,551

 

32,742

 

Loss from operations

 

(4,246

)

(1,145

)

(13,041

)

(3,236

)

Other expense, net:

 

 

 

 

 

 

 

 

 

Interest expense

 

(251

)

(63

)

(604

)

(233

)

Other income (expense) - net

 

155

 

65

 

(213

)

157

 

Change in fair value of convertible preferred stock warrant liability

 

(2,385

)

(831

)

(4,740

)

(1,093

)

Other expense, net

 

(2,481

)

(829

)

(5,557

)

(1,169

)

Loss before income taxes

 

(6,727

)

(1,974

)

(18,598

)

(4,405

)

Provision for income taxes

 

(133

)

(28

)

(173

)

(67

)

Net loss

 

$

(6,860

)

$

(2,002

)

$

(18,771

)

$

(4,472

)

Basic and diluted net loss per share attributable to common stockholders

 

$

(0.61

)

$

(0.25

)

$

(2.01

)

$

(0.56

)

Basic and diluted weighted-average shares used to compute net loss per share attributable to common stockholders

 

11,315

 

8,067

 

9,346

 

7,971

 

 

See Notes to Condensed Consolidated Financial Statements

 

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Table of Contents

 

Rocket Fuel Inc.

Condensed Consolidated Statements of Comprehensive Loss

(in thousands)

(unaudited)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(6,860

)

$

(2,002

)

$

(18,771

)

$

(4,472

)

Other comprehensive loss:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

24

 

(38

)

(17

)

(36

)

Comprehensive loss

 

$

(6,836

)

$

(2,040

)

$

(18,788

)

$

(4,508

)

 

See Notes to Condensed Consolidated Financial Statements

 

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Table of Contents

 

Rocket Fuel Inc.

Statement of Changes in Stockholders’ Equity

(in thousands, except share data)

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

Convertible

 

 

 

 

 

Additional

 

Other

 

 

 

Total

 

 

 

Preferred Stock

 

Common Stock

 

Paid-In

 

Comprehensive

 

Accumulated

 

Stockholders’

 

 

 

Shares

 

Amount

 

Shares

 

Amount

 

Capital

 

Loss

 

Deficit

 

Equity

 

Balance - December 31, 2012

 

19,478,932

 

60,617

 

8,680,041

 

8

 

3,865

 

(84

)

(23,543

)

40,863

 

Issuance of common stock upon exercises of employee stock options, net of repurchases

 

 

 

382,281

 

1

 

437

 

 

 

438

 

Conversion of convertible preferred stock to common stock

 

(19,478,932

)

(60,617

)

19,478,932

 

19

 

60,598

 

 

 

 

Conversion of convertible preferred stock warrants to common stock

 

 

 

266,530

 

1

 

7,579

 

 

 

7,580

 

Issuance of common stock from initial public offering, net of issuance costs

 

 

 

4,000,000

 

4

 

103,140

 

 

 

 

103,144

 

Stock-based compensation

 

 

 

 

 

6,713

 

 

 

6,713

 

Foreign currency translation adjustment

 

 

 

 

 

 

(17

)

 

(17

)

Net loss

 

 

 

 

 

 

 

(18,771

)

(18,771

)

Balance - September 30, 2013

 

 

$

 

32,807,784

 

$

33

 

$

182,332

 

$

(101

)

$

(42,314

)

$

139,950

 

 

See Notes to Condensed Consolidated Financial Statements

 

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Table of Contents

 

Rocket Fuel Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

 

 

 

Nine Months Ended
September 30,

 

 

 

2013

 

2012

 

OPERATING ACTIVITIES:

 

 

 

 

 

Net loss

 

$

(18,771

)

$

(4,472

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

Depreciation and amortization

 

4,583

 

2,461

 

Provision for doubtful accounts

 

521

 

63

 

Stock-based compensation

 

6,277

 

507

 

Issuance of restricted stock for services provided

 

 

20

 

Amortization of debt discount

 

1

 

6

 

Loss on disposal of property, equipment and software

 

(26

)

 

Change in fair value of preferred stock warrant liability

 

4,740

 

1,093

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(21,236

)

(15,586

)

Prepaid expenses and other current assets

 

(941

)

(679

)

Other assets

 

(700

)

(251

)

Accounts payable

 

12,532

 

3,951

 

Accrued and other liabilities

 

5,496

 

2,235

 

Deferred rent

 

100

 

315

 

Deferred revenue

 

264

 

18

 

Net cash used in operating activities

 

(7,160

)

(10,319

)

 

 

 

 

 

 

INVESTING ACTIVITIES:

 

 

 

 

 

Purchases of property, equipment and software

 

(5,564

)

(2,513

)

Capitalized internal use software development costs

 

(4,486

)

(3,294

)

Net cash used in investing activities

 

(10,050

)

(5,807

)

 

 

 

 

 

 

FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from issuance of common stock in initial public offering, net of underwriting discounts and commission

 

107,880

 

 

Payments of costs related to initial public offering

 

(1,534

)

 

Proceeds from the issuance of convertible preferred stock

 

 

34,500

 

Proceeds from the exercise of common stock warrants

 

97

 

 

Issuance costs related to convertible preferred stock

 

 

(105

)

Proceeds from exercise of vested common stock options

 

208

 

46

 

Proceeds from early exercise of unvested common stock options

 

1,058

 

378

 

Repurchases of common stock options early exercised

 

(11

)

(3

)

Borrowings from line of credit

 

10,000

 

4,000

 

Repayment of line of credit

 

 

(6,000

)

Proceeds from issuance of long-term debt

 

10,000

 

3,000

 

Repayment of long-term debt

 

(114

)

(311

)

Net cash provided by financing activities

 

127,584

 

35,505

 

 

 

 

 

 

 

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS

 

12

 

(51

)

CHANGE IN CASH AND CASH EQUIVALENTS

 

110,386

 

19,328

 

CASH AND CASH EQUIVALENTS-Beginning of period

 

14,896

 

5,071

 

CASH AND CASH EQUIVALENTS-End of period

 

$

125,282

 

$

24,399

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURES OF OTHER CASH FLOW INFORMATION:

 

 

 

 

 

Cash paid for income taxes

 

$

348

 

$

 

Cash paid for interest

 

$

543

 

$

233

 

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:

 

 

 

 

 

Purchases of property and equipment recorded in accounts payable and accruals

 

$

4,952

 

$

232

 

Deferred offering costs recorded in accrued liabilities

 

$

3,194

 

$

 

Vesting of early exercised options

 

$

229

 

$

91

 

Stock-based compensation capitalized in internally developed software costs

 

$

437

 

$

 

Conversion of convertible preferred stock to common stock

 

$

60,617

 

$

 

Conversion of preferred stock warrants to common stock

 

$

7,481

 

$

 

 

See Notes to Condensed Consolidated Financial Statements

 

7



Table of Contents

 

Rocket Fuel Inc.

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

1.                                       NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Rocket Fuel Inc. (the “Company”) was incorporated as a Delaware corporation on March 25, 2008. The Company is a provider of an artificial-intelligence digital advertising solution. The Company is headquartered in Redwood City, California, and has offices throughout the United States. The Company established a wholly-owned subsidiary in the United Kingdom in 2011, with branches in various countries through Europe, and a wholly-owned subsidiary in Germany in 2013.

 

In September 2013, the Company completed the initial public offering of its common stock (the “IPO”) whereby 4,000,000 shares of common stock were sold by the Company and 600,000 shares of common stock were sold by selling stockholders. The public offering price of the shares sold in the offering was $29.00 per share. The Company did not receive any proceeds from the sale of shares by the selling stockholders. The total gross proceeds from the offering to the Company were $116.0 million. After deducting underwriters’ discounts and commissions, the aggregate net proceeds received by the Company totaled approximately $107.9 million.

 

Basis of Presentation —The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“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. Therefore, these condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes presented in the Company’s prospectus filed with the SEC on September 20, 2013 pursuant to Rule 424(b) under the Securities Act of 1933.

 

The condensed consolidated balance sheet as of December 31, 2012 included herein was derived from the audited financial statements as of that date, but does not include all notes and other disclosures required by GAAP.

 

In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all normal recurring adjustments necessary to present fairly the financial position, results of operations, and cash flows for the interim periods, but are not necessarily indicative of the results of operations to be anticipated for the full year 2013 or any future period.

 

Principles of Consolidation —The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, which are engaged in marketing and selling advertising campaigns. All intercompany transactions and balances have been eliminated in consolidation.

 

Use of Estimates —The preparation of unaudited condensed consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosures of contingent assets and liabilities at the date of the unaudited condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Such estimates include, but are not limited to, provisions for doubtful accounts, the amount of software development costs which should be capitalized, future taxable income, the useful lives of long-lived assets and the assumptions used for purposes of determining stock-based compensation. Actual results could differ from those estimates.

 

Foreign Currency Translation —Each of the Company’s foreign subsidiaries records its assets, liabilities and results of operations in its local currency, which is its functional currency. The Company translates these subsidiary consolidated financial statements into U.S. dollars each reporting period for purposes of consolidation.

 

Assets and liabilities of the Company’s foreign subsidiaries are translated at the period-end currency exchange rates, certain equity accounts are translated at historical exchange rates while revenue, expenses, gains and losses are translated at the average currency exchange rates in effect for the period. The effects of these translation adjustments are reported in a separate component of stockholders’ equity titled accumulated other comprehensive loss.

 

Fair Value of Financial Instruments —The Company’s financial instruments consist principally of cash equivalents, accounts receivable, accounts payable, accrued liabilities, term debt and line of credit. The fair value of the Company’s cash equivalents is determined based on quoted prices in active markets for identical assets for its money market funds. The recorded values of the Company’s accounts receivable, accounts payable, accrued liabilities approximate their current fair values due to the relatively short-term nature of these accounts. The Company believes that the fair value of the term debt and line of credit approximates its recorded amount at September 30, 2013 as the interest rate on the term debt and line of credit is variable and is based on market interest rates after consideration of default and credit risk.

 

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Cash and Cash Equivalents —Cash consists of cash maintained in checking and savings accounts. All highly liquid investments purchased with an original maturity date of three months or less at the date of purchase are considered to be cash equivalents. Cash equivalents consist of money market funds.

 

Concentration of Credit Risk —Financial instruments, which potentially subject the Company to significant concentrations of credit risk, consist primarily of cash and accounts receivable. A significant portion of the Company’s cash is held at one major financial institution, which management assesses to be of high credit quality. The Company has not experienced any losses in such accounts.

 

The Company mitigates its credit risk with respect to accounts receivable by performing credit evaluations and monitoring its customers’ accounts receivable balances. As of September 30, 2013, no customer accounted for 10% or more of accounts receivable.  As of December 31, 2012, one customer accounted for 10% of accounts receivable.

 

During the three and nine months ended September 30, 2013 and 2012, no single customer represented more than 10% of revenue.

 

Provision for Doubtful Accounts —The Company records a provision for doubtful accounts based on historical experience and a detailed assessment of the collectability of its accounts receivable. In estimating the allowance for doubtful accounts, management considers, among other factors, the aging of the accounts receivable, historical write-offs and the credit-worthiness of each customer. If circumstances change, such as higher-than-expected defaults or an unexpected material adverse change in a major customer’s ability to meet its financial obligations, the Company’s estimate of the recoverability of the amounts due could be reduced by a material amount.

 

The following table presents the changes in the allowance for doubtful accounts (in thousands):

 

 

 

Nine Months

 

 

 

 

 

Ended

 

Year Ended

 

 

 

September 30,

 

December 31,

 

 

 

2013

 

2012

 

 

 

 

 

 

 

Allowance for doubtful accounts:

 

 

 

 

 

Balance, beginning of period

 

$

468

 

$

203

 

Bad debt expense

 

521

 

285

 

Recoveries (write-offs), net

 

19

 

(20

)

Balance, end of the period

 

$

1,008

 

$

468

 

 

Property and Equipment —Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the related assets. Maintenance and repairs are charged to expense as incurred, and improvements and betterments are capitalized. When assets are retired or otherwise disposed of, the cost and accumulated depreciation and amortization are removed from the balance sheet and any resulting gain or loss is reflected in operations in the period realized.

 

Property and equipment are initially recorded at cost and depreciated using the straight-line method over the estimated useful lives of the assets. Depreciation and amortization periods for the Company’s property and equipment are as follows:

 

Asset
Classification

 

Estimated
Useful Life

 

Computer hardware and purchased software

 

2—3 years

 

Capitalized internal use software costs

 

2—3 years

 

Office equipment, furniture and fixtures

 

5 years

 

Leasehold improvements

 

Shorter of the lease term or estimated useful life

 

 

Internal Use Software Development Costs —The Company incurs costs to develop software for internal use. The Company expenses all costs that relate to the planning and post implementation phases of development as research and development expense. The Company capitalizes costs when preliminary efforts are successfully completed, management has authorized and committed project funding, and it is probable that the project will be completed and will be used as intended. Costs incurred for enhancements that are expected to result in additional material functionality are capitalized. The Company capitalized $4.9 million and $3.3 million in internal-use software costs during the nine months ended September 30, 2013 and 2012, respectively, which are included in property, equipment and software, net on the consolidated balance sheets.

 

Amortization commences when the website or software for internal use is ready for its intended use and the amortization period is the estimated useful life of the related asset, which is generally two to three years. Amortization expense totaled $0.9 million and

 

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$0.6 million for the three months ended September 30, 2013 and 2012, respectively, and $2.5 million and $1.6 million for the nine months ended September 30, 2013 and 2012, respectively.

 

Impairment of Long-lived Assets —The Company periodically reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset is impaired or its estimated useful life is no longer appropriate. If indicators of impairment exist and the undiscounted projected cash flows associated with such asset is less than the carrying amount of the asset, an impairment loss is recorded to write the asset down to its estimated fair value. Fair value is estimated based on discounted future cash flows. No impairment charges were recorded during the three and nine months ended September 30, 2013 and 2012.

 

Revenue Recognition —We generate revenue by delivering digital advertisements to Internet users through various channels, including display, mobile, social and video.

 

The Company recognizes revenue when all four of the following criteria are met:

 

·                   Persuasive evidence of an arrangement exists;

 

·                   Delivery has occurred or a service has been provided;

 

·                   Customer fees are fixed or determinable; and

 

·                   Collection is reasonably assured.

 

Revenue arrangements are evidenced by a fully executed insertion order (“IO”). Generally, IOs state the number and type of advertising impressions to be delivered, the agreed upon rate and a fixed period of time for delivery.

 

The Company determines collectability by performing ongoing credit evaluations and monitoring its customers’ accounts receivable balances. For new customers and their agents, which may be advertising agencies or other third parties, the Company performs a credit check with an independent credit agency and may check credit references to determine creditworthiness. The Company only recognizes revenue when collection is reasonably assured.

 

In the normal course of business, the Company frequently contracts with advertising agencies on behalf of their advertiser clients. The determination of whether revenue should be reported on a gross or net basis is based on an assessment of whether the Company is acting as the principal or an agent in the transaction. In determining whether the Company acts as the principal or an agent, the Company follows the accounting guidance for principal-agent considerations. While none of the factors identified in this guidance is individually considered presumptive or determinative, because the Company is the primary obligor and is responsible for (i) fulfilling the advertisement delivery, (ii) establishing the selling prices for delivery of the advertisements, and (iii) performing all billing and collection activities including retaining credit risk, the Company acts as the principal in these arrangements and therefore reports revenue earned and costs incurred on a gross basis.

 

On occasion, the Company has offered customer incentive programs which provide rebates after achieving a specified level of advertising spending. The Company records reductions to revenue for estimated commitments related to these customer incentive programs. For transactions involving incentives, the Company recognizes revenue net of the estimated amount to be paid by rebate, provided that the rebate amount can be reasonably and reliably estimated and the other conditions for revenue recognition have been met. The Company’s policy requires that, if rebates cannot be reliably estimated, revenue is not recognized until reliable estimates can be made or the program lapses.

 

Multiple-Element Arrangements —The Company enters into arrangements to sell advertising that includes different media placements or ad services that are delivered at the same time, or within close proximity of one another. Beginning on January 1, 2011, the Company adopted authoritative guidance on multiple element arrangements, using the prospective method for all arrangements entered into or materially modified from the date of adoption. Under this new guidance, the Company allocates arrangement consideration in multiple-deliverable revenue arrangements at the inception of an arrangement to all deliverables or those packages in which all components of the package are delivered at the same time, based on the relative selling price method in accordance with the selling price hierarchy, which includes: (1) vendor-specific objective evidence (“VSOE”), if available; (2) third-party evidence (“TPE”), if VSOE is not available; and (3) best estimate of selling price (“BESP”), if neither VSOE nor TPE is available.

 

VSOE —The Company determines VSOE based on its historical pricing and discounting practices for the specific product or service when sold separately. In determining VSOE, the Company requires that a substantial majority of the stand-alone selling prices for these services fall within a reasonably narrow pricing range. The Company has not been able to establish VSOE for any of its advertising offerings.

 

TPE —When VSOE cannot be established for deliverables in multiple element arrangements, the Company applies judgment with respect to whether it can establish a selling price based on TPE. TPE is determined based on competitor prices for similar deliverables when sold separately. Generally, the Company’s go-to-market strategy differs from that of its peers, and its offerings contain a significant level of differentiation such that the comparable pricing of services cannot be obtained. Furthermore, the

 

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Company is unable to reliably determine the selling prices of similar competitor services on a stand-alone basis. As a result, the Company has not been able to establish selling price based on TPE.

 

BESP —When it is unable to establish selling price using VSOE or TPE, the Company uses BESP in its allocation of arrangement consideration. The objective of BESP is to determine the price at which the Company would transact a sale if the service were sold on a stand-alone basis. BESP is generally used to allocate the selling price to deliverables in the Company’s multiple element arrangements. The Company determines BESP for deliverables by considering multiple factors, including, but not limited to, prices it charges for similar offerings, market conditions, competitive landscape and pricing practices. In particular, the Company reviews multiple data points to determine BESP, including price lists used by the Company’s sales team in pricing negotiations, historical average and median pricing achieved in prior contractual customer arrangements and input from the Company’s sales operation department regarding what it believes the deliverables could be sold for on a stand-alone basis. BESP is determined at an advertising unit level that is consistent with the Company’s underlying market strategy and stratified based on specific consideration of geography, industry and size, as deemed necessary.

 

The Company limits the amount of allocable arrangement consideration to amounts that are fixed or determinable and that are not contingent on future performance or future deliverables. The Company regularly reviews BESP. Changes in assumptions or judgments or changes to the elements in the arrangement could cause a material increase or decrease in the amount of revenue that the Company reports in a particular period.

 

The Company recognizes the relative fair value of advertising services as they are delivered, assuming all other revenue recognition criteria are met. Deferred revenue is comprised of contractual billings in excess of recognized revenue and payments received in advance of revenue recognition, and is typically recognized within twelve months.

 

Cost of Revenue —Cost of revenue consists primarily of media cost for advertising impressions purchased from real-time advertising exchanges and other third parties. Cost of revenue also includes third-party data center costs and the salaries and related costs of the Company’s operations group. This group sets up, initiates and monitors the Company’s advertising campaigns. In addition, depreciation of the data center equipment, rental payments to third-party vendors for data centers and amortization of capitalized internal use software are included in cost of revenue.

 

Research and Development —Research and development expenses include costs associated with the maintenance and ongoing development of the Company’s technology, including compensation and employee benefits and allocated costs, such as facility-related expenses, insurance, supplies and other fixed costs, associated with the Company’s engineering and research and development departments, as well as costs for contracted services and supplies. The Company reviews costs incurred in the application development stage and assesses such costs for capitalization.

 

Sales and Marketing —Sales and marketing expenses consist primarily of compensation (including commissions) and employee benefits of sales and marketing personnel and related support teams, allocated costs, such as facility-related expenses, insurance, supplies and other fixed costs, certain advertising costs, travel, trade shows and marketing materials. The Company incurred advertising costs of $1.6 million and $0.1 million for the three months ended September 30, 2013 and 2012, respectively, and $3.3 million and $0.1 million for the nine months ended September 30, 2013 and 2012, respectively.

 

General and Administrative —General and administrative expenses include facilities costs, executive and administrative compensation and employee benefits, depreciation, professional services fees, insurance costs, bad debt and other allocated costs, such as facility-related expenses, supplies and other fixed costs.

 

Stock-Based Compensation —The Company measures compensation expense for all stock-based payment awards, including stock options and restricted stock units granted to employees, based on the estimated fair values on the date of the grant. The fair value of each stock-based payment award granted is estimated using the Black-Scholes option pricing model. Stock-based compensation is recognized on a straight-line basis over the requisite service period, net of estimated forfeitures. The forfeiture rate is based on an analysis of the Company’s actual historical forfeitures.

 

The Company accounts for stock options issued to nonemployees based on the fair value of the awards determined using the Black-Scholes option pricing model. The fair value of stock options granted to nonemployees is re-measured as the stock options vest, and the resulting change in fair value, if any, is recognized in the Company’s consolidated statement of operations during the period the related services are rendered, generally between one and four years.

 

Preferred Stock Warrant Liability —Freestanding warrants related to shares that are redeemable or contingently redeemable are classified as a liability on the Company’s consolidated balance sheet as of December 31, 2012. The fully vested convertible preferred stock warrants are subject to re-measurement at each balance sheet date, and any change in fair value is recognized as a component of other expense, net. As completion of the Company’s initial public offering constituted a liquidation event, the convertible preferred stock warrants were converted into common stock or warrants to purchase common stock, and the liability was reclassified to additional paid-in capital as of September 30, 2013.

 

Income Taxes —The Company accounts for income taxes using an asset and liability approach. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Operating loss and tax credit carryforwards are measured by applying currently enacted tax laws. Valuation allowances are provided when necessary to reduce net deferred tax assets to an amount that is more likely than not to be realized. Due to uncertainty as to the realization of benefits from deferred tax assets, including net operating loss carryforwards, research and development and other tax credits, the Company has provided a full valuation allowance reserved against such assets as of September 30, 2013 and December 31, 2012.

 

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The Company recognizes the tax effects of an uncertain tax position only if it is more likely than not to be sustained based solely on its technical merits as of the reporting date, and then, only in an amount more likely than not to be sustained upon review by the tax authorities. The Company considers many factors when evaluating and estimating its tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes.

 

Deferred Offering Costs —Deferred offering costs consisted primarily of direct incremental costs related to the Company’s IPO of its common stock. Approximately $0.1 million of deferred offering costs are included in other assets on the Company’s consolidated balance sheets as of December 31, 2012.  Upon the completion of the IPO, these amounts were offset against the proceeds of the IPO.

 

Comprehensive Loss —In June 2011, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update that requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance eliminates the option to present the components of other comprehensive income as part of the statement of equity. The Company retrospectively adopted these new standards in the first quarter of 2012 and has presented a separate consolidated statement of comprehensive loss for the three and nine months ended September 30, 2013 and 2012.

 

Recently Issued Accounting Pronouncements

 

In July 2013, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) No. 2013-11,  Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (ASU 2013-11). The guidance requires an entity to present its unrecognized tax benefits net of its deferred tax assets when settlement in this manner is available under the tax law, which would be based on facts and circumstances as of the balance sheet reporting date and would not consider future events. Gross presentation in the notes to the financial statements will still be required. ASU 2013-11 will apply on a prospective basis to all unrecognized tax benefits that exist at the effective date. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of ASU 2013-11 is not expected to have a material impact on our consolidated condensed financial statements.

 

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2.                                       FAIR VALUE MEASUREMENTS

 

Fair value is defined as the price that would be received on sale of an asset or paid to transfer a liability (exit price) in an orderly transaction between market participants at the measurement date. The FASB has established a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3).

 

The three levels of the fair value hierarchy under the guidance for fair value measurement are described below:

 

Level 1

 

Inputs are unadjusted quoted prices in active markets for identical assets or liabilities. Pricing inputs are based upon quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. The valuations are based on quoted prices of the underlying security that are readily and regularly available in an active market, and accordingly, a significant degree of judgment is not required. As of September 30, 2013 and December 31, 2012, the Company used Level 1 assumptions for its money market funds.

 

 

 

Level 2

 

Pricing inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities. As of September 30, 2013 and December 31, 2012, the Company did not have any Level 2 financial assets or liabilities.

 

 

 

Level 3

 

Pricing inputs are generally unobservable for the assets or liabilities and include situations where there is little, if any, market activity for the investment. The inputs into the determination of fair value require management’s judgment or estimation of assumptions that market participants would use in pricing the assets or liabilities. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques. As of September 30, 2013, the Company did not have any Level 3 financial assets or liabilities. As of December 31, 2012, the Company used Level 3 assumptions for its convertible preferred stock warrant liability.

 

The carrying amounts of cash equivalents, accounts receivable, prepaid expenses, accounts payable and accrued liabilities approximate fair value due to the short-term nature of these items. Based on the borrowing rates currently available to the Company or debt with similar terms, the carrying value of the line of credit and term-debt approximate fair value (using Level 2 inputs).

 

Level 3 includes convertible preferred stock warrant liability, the value of which is determined based on an option-pricing model that takes into account the expected term as well as multiple inputs, such as the Company’s stock price, risk-free interest rates and expected volatility.

 

The following table sets forth the Company’s financial instruments that were measured at fair value on a recurring basis as of September 30, 2013 and December 31, 2012, by level within the fair value hierarchy. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability. The Company’s fair value hierarchy for its financial assets and financial liabilities that are carried at fair value are as follows (in thousands):

 

September 30, 2013

 

Fair Value

 

Level 1

 

Level 2

 

Level 3

 

Money market funds (included in cash and cash equivalents)

 

$

2,900

 

$

2,900

 

$

 

$

 

 

December 31, 2012

 

Fair Value

 

Level 1

 

Level 2

 

Level 3

 

Money market funds (included in cash and cash equivalents)

 

$

2,900

 

$

2,900

 

$

 

$

 

Convertible preferred stock warrant liability

 

$

(2,741

)

$

 

$

 

$

(2,741

)

 

Convertible Preferred Stock Warrant Liability —Warrants to purchase the Company’s convertible preferred stock are classified as liabilities in the consolidated balance sheet as of December 31, 2012. The warrants are subject to remeasurement at each balance sheet date, and any change in fair value is recognized as a component of other income (expense) in the consolidated statements of operations.

 

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A reconciliation of the convertible preferred stock warrants measured and recorded at fair value on a recurring basis, using significant unobservable inputs (Level 3) is as follows (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Balance at beginning of period

 

$

5,096

 

$

695

 

$

2,741

 

$

433

 

Changes in fair value of warrants

 

2,385

 

831

 

4,740

 

1,093

 

Conversion of warrants to common stock

 

(7,481

)

 

(7,481

)

 

Balance at end of period

 

$

 

$

1,526

 

$

 

$

1,526

 

 

3.                                      CASH AND CASH EQUIVALENTS

 

Cash and cash equivalents as of September 30, 2013 and December 31, 2012 consisted of the following (in thousands):

 

 

 

September 30,

 

December 31,

 

 

 

2013

 

2012

 

Cash and cash equivalents

 

 

 

 

 

Cash

 

$

122,382

 

$

11,996

 

Money market funds

 

2,900

 

2,900

 

Total cash and cash equivalents

 

$

125,282

 

$

14,896

 

 

4.                                       PROPERTY, EQUIPMENT AND SOFTWARE

 

Property, equipment and software as of September 30, 2013 and December 31, 2012 consisted of the following (in thousands):

 

 

 

September 30,

 

December 31,

 

 

 

2013

 

2012

 

Capitalized internal use software costs

 

$

15,364

 

$

10,441

 

Computer hardware and software

 

12,970

 

4,281

 

Furniture and fixtures

 

1,624

 

816

 

Leasehold improvements

 

807

 

656

 

Construction in progress

 

1,115

 

1,126

 

Total

 

31,880

 

17,320

 

Accumulated depreciation and amortization

 

(10,939

)

(6,381

)

Net property, equipment and software

 

$

20,941

 

$

10,939

 

 

Total depreciation and amortization expense, excluding amortization of internal use software costs, was $0.8 million and $0.4 million for the three months ended September 30, 2013 and 2012, respectively, and $2.1 million and $0.9 million for the nine months ended September 30, 2013 and 2012, respectively. Amortization expense of internal use software costs was $0.9 million and $0.6 million for the three months ended September 30, 2013 and 2012, respectively, and $2.5 million and $1.6 million for the nine months ended September 30, 2013 and 2012, respectively. The Company held no capital leases as of September 30, 2013 and December 31, 2012.

 

5.                                       ACCRUED AND OTHER CURRENT LIABILITIES

 

Accrued and other current liabilities as of September 30, 2013 and December 31, 2012 consisted of the following (in thousands):

 

 

 

September 30,

 

December 31,

 

 

 

2013

 

2012

 

Payroll and related expenses

 

$

7,765

 

$

3,357

 

Accrued vacation

 

1,791

 

991

 

Professional services

 

1,932

 

268

 

Accrued credit cards

 

751

 

122

 

Early exercise of unvested stock options

 

1,269

 

451

 

Other accrued expenses

 

2,199

 

997

 

Total

 

$

15,707

 

$

6,186

 

 

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6.                                       OTHER INCOME (EXPENSE), NET

 

Other income (expense), net for the three and nine months ended September 30, 2013 and 2012 consisted of the following (in thousands):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Gain (loss) on foreign translation

 

$

108

 

$

31

 

$

(352

)

$

31

 

Other non-operating income (loss), net

 

47

 

34

 

139

 

126

 

Total

 

$

155

 

$

65

 

$

(213

)

$

157

 

 

7.                                       DEBT

 

Line of Credit —In April 2010, the Company entered into a loan and security agreement (the “Comerica Agreement”), with Comerica Bank (“Comerica”), to establish a revolving line of credit for working capital purposes. The maximum amount available for borrowing under the revolving line of credit, as amended in June 2013, is not to exceed the lesser of $35.0 million or an amount equal to 85% of certain eligible accounts receivable. Eligible accounts exclude, among others, accounts that have aged over 120 days, and accounts in which 25% of the total account is aged over 120 days, and certain other accounts such as governmental, intercompany, employee and certain foreign accounts. The revolving line of credit has a maturity date of July 26, 2014 and may be repaid and redrawn at any time prior to the maturity date, at which time all advances and any accrued and unpaid interest are due and payable. Interest is charged at LIBOR, plus a 2.75% applicable margin, which equaled 2.93% and 2.99% as of September 30, 2013 and December 31, 2012, respectively. As of September 30, 2013 and December 31, 2012, the Company had $11.9 million and $1.9 million outstanding under the revolving line of credit, respectively.

 

The Company’s obligations under the Comerica Agreement are secured by substantially all of the Company’s assets.

 

Term Debt —In March 2012, the Company amended the Comerica Agreement to provide for growth capital advances of up to $3.0 million. The Comerica Agreement was further amended in February 2013 to increase the growth capital advances to up to $15.0 million. Growth capital advances may be drawn on before February 13, 2014 and are payable in equal monthly installments beginning on March 13, 2014 and continuing over a twenty-four month period ending on February 13, 2016 when the remaining principal and any accrued and unpaid interest will be due and payable. Interest on outstanding balances is charged at LIBOR, plus a 4.75% applicable margin, which equaled 4.93% and 4.99% as of September 30, 2013 and December 31, 2012, respectively. As of September 30, 2013 and December 31, 2012, the principal amount of $15.0 million and $5.0 million, respectively, was outstanding under the loan.

 

Venture Debt —In April 2010, the Company entered into a loan and security agreement (the “VLL Agreement”) to provide for a growth capital loan of up to $1.0 million, which the Company drew in full concurrently upon entering into the VLL Agreement. The funds borrowed were used for general corporate purposes of the Company. The loan was payable in monthly installments of interest only for the first six months, and thereafter interest and principal was payable in 30 equal monthly installments. Interest accrued at a fixed rate of 13%. All receivables, equipment, fixtures, deposit accounts, investment property, and all other goods and personal property of the Company, whether tangible or intangible, were collateral on the loan. The Agreement contains certain conditions of default. As of December 31, 2012, the principal amount of $0.1 million was outstanding under the agreement.

 

In March 2013, the Company repaid the VLL growth capital loan in full per the terms of the VLL Agreement, upon which VLL’s security interest in the Company’s collateral was released, and the agreement was terminated. As such, no amounts were outstanding under the VLL Agreement as of September 30, 2013.

 

Covenants

 

The Comerica Agreement includes, and the VLL Agreement included, customary affirmative and negative covenants, including, among others, covenants limiting the ability of the Company and its subsidiaries to dispose of assets, merge or consolidate, incur indebtedness, grant liens, make certain restricted payments, make investments, make acquisitions and enter into transactions with affiliates, in each case subject to customary exceptions.  In addition, the Comerica Agreement provides that the Company must maintain compliance with a minimum EBITDA covenant and a minimum liquidity, each as determined in accordance with the Comerica Agreement and described in more detail below.

 

Under the terms of the Comerica Agreement, the Company is required to comply with the following financial covenants:

 

1. EBITDA: The Company must maintain quarterly and annual EBITDA, which is defined with respect to any fiscal period as an amount equal to the sum of (i) consolidated net income (loss) in accordance with GAAP, after eliminating all extraordinary nonrecurring items of income, plus (ii) depreciation and amortization, income tax expense, total interest expense paid or accrued and non-cash stock-based compensation expense, less (iii) all extraordinary and non-recurring revenue and gains (including income tax benefits).

 

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2. Liquidity ratio: The ratio of (i) the sum of all cash on deposit with Comerica and 85% of eligible accounts receivable to (ii) all funded debt under the Comerica Agreement must be 1.15:1.00, measured on a monthly basis.

 

As of December 31, 2012, the Company was in non-compliance with respect to various financial and non-financial covenants under the Comerica Agreement.  However, the Company subsequently obtained a waiver for each of the covenant violations. As of September 30, 2013, the Company was in compliance with each of the financial and non-financial covenants, except for a covenant related to permitted indebtedness for a corporate credit card account balance, for which it obtained a waiver.

 

As of December 31, 2012, the Company was in breach of the covenant under the VLL Agreement requiring submission of monthly consolidated financial statements within 30 days of month end. As of March 31, 2013, the VLL Agreement had been terminated upon repayment. Hence, a waiver was not required.

 

Future Payments

 

Future principal payments of long-term debt as of September 30, 2013 were as follows (in thousands):

 

2013 (remaining 3 months)

 

$

 

2014

 

6,250

 

2015

 

7,500

 

2016

 

1,250

 

Total

 

15,000

 

Less current portion

 

(4,375

)

Noncurrent portion of debt

 

$

10,625

 

 

As of September 30, 2013, the $11.9 million balance outstanding under the revolving line of credit with Comerica had a maturity date of July 26, 2014, and as a result is shown as a current liability in the accompanying condensed consolidated balance sheet.

 

8.                                       STOCKHOLDERS’ EQUITY (DEFICIT)

 

Initial Public Offering

 

In September 2013, the Company completed its IPO whereby 4,000,000 shares of common stock were sold by the Company and 600,000 shares of common stock were sold by selling stockholders. The public offering price of the shares sold in the IPO was $29.00 per share. The Company did not receive any proceeds from the sales of shares by the selling stockholders. The total gross proceeds from the offering to the Company were $116.0 million. After deducting underwriters’ discounts and commissions and offering expenses, the aggregate net proceeds received by the Company totaled approximately $107.9 million. Immediately prior to the closing of the IPO, all shares of the Company’s outstanding convertible preferred stock automatically converted into 19,478,932 shares of common stock.

 

The following table presents the shares authorized and issued and outstanding as of the periods presented (in thousands, except share data):

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

 

 

Shares

 

 

 

Shares

 

 

 

 

 

Shares

 

Issued and

 

Shares

 

Issued and

 

Liquidation

 

 

 

Authorized

 

Outstanding

 

Authorized

 

Outstanding

 

Preference

 

 

 

 

 

 

 

 

 

 

 

 

 

Series A convertible preferred stock

 

 

 

10,884,902

 

10,618,372

 

$

9,860

 

Series B convertible preferred stock

 

 

 

4,811,855

 

4,811,855

 

12,500

 

Series C convertible preferred stock

 

 

 

1,116,030

 

1,116,030

 

8,187

 

Series C-1 convertible preferred stock

 

 

 

2,975,228

 

2,932,675

 

34,500

 

Common stock, $0.001 par value

 

1,000,000,000

 

32,807,784

 

35,850,100

 

8,680,041

 

 

Undesignated preferred stock

 

100,000,000

 

 

 

 

 

 

Warrants

 

In April 2010, the Company issued a fully vested warrant to purchase 161,533 shares of Series A preferred stock at an exercise price of $0.9286 per share. The warrant was issued in connection with the Company entering into a loan and security agreement. The warrant had an expiration of 10 years from the date of issuance. As of December 31, 2012, the warrant, with an estimated fair value of $1.7 million, was classified as a liability in the accompanying consolidated balance sheet.

 

On September 25, 2013, upon closing of the Company’s IPO, the warrant converted from a warrant to purchase Series A preferred stock to a warrant to purchase shares of common stock, and the liability at its then fair value of $4.5 million was reclassified to additional paid-in capital. Prior to this date, all changes in the fair value of the warrant were recorded in other income (expense) in the accompanying unaudited condensed consolidated statements of operations.

 

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In April 2010, the Company issued a fully vested warrant to purchase 104,997 shares of Series A convertible preferred stock at an exercise price of $0.9286 per share. The warrant was issued in connection with the Company obtaining a line of credit. The warrant was scheduled to expire seven years from the date of issuance. As of December 31, 2012, the warrant, with an estimated fair value of $1.1 million, was classified as a liability in the accompanying consolidated balance sheet.

 

On September 25, 2013, upon closing of the Company’s IPO, the warrant converted from a warrant to purchase Series A preferred stock to a warrant to purchase common stock and the liability at its then fair value of $2.9 million was reclassified to additional paid-in capital. Prior to this date, all changes in the fair value of the warrant were recorded in other income (expense) in the accompanying unaudited condensed consolidated statements of operations.

 

On September 25, 2013, following the closing of the IPO, the warrant to purchase common stock was exercised, resulting in the issuance of 104,997 shares of the Company’s common stock.

 

The Company recorded other expense of $2.4 million and $4.7 million for the three and nine months ended September 30, 2013, respectively, related to the fair value adjustment of the preferred stock warrant liability. The Company recorded other expense of $0.8 million and $1.1 million for the three and nine months ended September 30, 2012, respectively, related to the fair value adjustment of the warrant.

 

Equity Incentive Plans

 

2008 Equity Incentive Plan The Company granted awards under its 2008 Equity Incentive Plan (the “2008 Plan”) until August 2013. The terms of the 2008 Plan provide for the grant of incentive stock options within the meaning of Section 422 of the Code to the Company’s employees and any parent and subsidiary corporations’ employees, and for the grant of nonstatutory stock options, restricted stock, restricted stock units and stock appreciation rights to the Company’s employees, directors and consultants, and the Company’s parent and subsidiary corporations’ employees and consultants. The compensation committee of the board of directors had the authority to approve the employees and other service providers to whom equity awards were granted and had the authority to determine the terms of each award, subject to the terms of the 2008 Plan, including (i) the number of shares of common stock subject to the award; (ii) when the award becomes exercisable; (iii) the option or stock appreciation right exercise price, which must be at least 100% of the fair market value of the common stock as of the date of grant; and (iv) the duration of the option or stock appreciation right (which may not exceed 10 years). Options granted under the 2008 Plan generally are scheduled to vest over four years, subject to continued service, and subject to certain acceleration of vesting provisions, and expire no later than 10 years from the date of grant. Restricted stock units granted under the 2008 Plan generally are scheduled to vest over four years, subject to continued service, and subject to certain acceleration of vesting provisions.  As of December 31, 2012, 14,738 shares of common stock were available for future grant under the 2008 Plan.   The Company has terminated the 2008 Plan for future use and provided that no further equity awards are to be granted under the 2008 Plan. All outstanding awards under the 2008 Plan will continue to be governed by their existing terms.

 

Under the terms of the 2008 Plan, employees were granted rights to exercise unvested options.  Upon termination of service, an employee’s unvested shares may be repurchased by the Company at the original purchase price.  As of September 30, 2013 and December 31, 2012, 380,478 and 449,622 unvested shares, respectively, were subject to repurchase. During the nine months ended September 30, 2013 and year ended December 31, 2012, the Company repurchased 8,958 and 5,834 shares of unvested stock, respectively.

 

2013 Equity Incentive Plan The Company’s board of directors adopted and the Company’s stockholders approved a 2013 Equity Incentive Plan (the “2013 Plan”), and the 2013 Plan became effective September 18, 2013.  The 2013 Plan permits the grant of incentive stock options, within the meaning of Section 422 of the Code to the Company’s employees and any parent and subsidiary corporations’ employees, and for the grant of nonstatutory stock options, restricted stock, restricted stock units, stock appreciation rights, performance units and performance shares to the Company’s employees, directors and consultants and the Company’s parent and subsidiary corporations’ employees and consultants.

 

Under the 2013 Plan, a total of 5,000,000 shares of common stock have been reserved for issuance.  In addition, the shares to be reserved for issuance under the 2013 Plan will also include shares subject to stock options or similar awards granted under the 2008 Plan that expire or terminate without having been exercised in full and shares issued pursuant to awards granted under the 2008 Plan that are forfeited to or repurchased by the Company (provided that the maximum number of shares that may be added to the 2013 Plan pursuant to this sentence is 7,900,000 shares).

 

The number of shares available for issuance under the 2013 Plan will also include an annual increase on the first day of each fiscal year beginning in 2014, equal to the least of (i) 4,000,000 shares; (ii) 5% of the outstanding shares of common stock as of the last day of the immediately preceding fiscal year; or (iii) such other amount as the Company’s board of directors may determine.

 

The compensation committee of the board of directors has the authority to approve the employees and other service providers to whom equity awards are granted and to determine the terms of each award, subject to the terms of the 2013 Plan.  The compensation committee may determine the number of shares subject to an award, except that the 2013 Plan provides certain limits on the number of awards that may be granted to non-employee members of the board of directors under the 2013 Plan in any fiscal year.  Options and stock appreciation rights granted under the 2013 Plan must have a per share exercise price equal to at least 100% of the fair market value of a shares of the common stock as of the date of grant and may not expire later than 10 years from the date of grant.

 

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Stock Options

 

The following table summarizes option award activity for the nine months ended September 30, 2013:

 

 

 

Number of

 

Average

 

Contractual

 

 

 

 

 

Shares

 

Exercise

 

Life

 

Aggregate

 

 

 

Outstanding

 

Price

 

(Years)

 

Intrinsic Value

 

 

 

 

 

 

 

 

 

(in thousands)

 

Balance at December 31, 2012

 

5,832,705

 

$

3.65

 

9.1

 

$

44,073

 

Options granted (weighted average fair value of $9.99 per share)

 

2,198,848

 

13.51

 

 

 

 

 

Options exercised

 

(388,115

)

3.26

 

 

 

 

 

Options forfeited

 

(238,624

)

3.93

 

 

 

 

 

Balance at September 30, 2013

 

7,404,814

 

$

6.59

 

8.7

 

$

349,123

 

 

 

 

 

 

 

 

 

 

 

Options vested and expected to vest - September 30, 2013

 

6,747,026

 

$

6.41

 

8.7

 

$

319,308

 

 

 

 

 

 

 

 

 

 

 

Options vested and exercisable - September 30, 2013

 

2,372,008

 

$

2.72

 

7.9

 

$

121,010

 

 

Aggregate intrinsic value represents the difference between the Company’s estimated fair value of its common stock and the exercise price of outstanding in-the-money options. The total intrinsic value of options exercised was approximately$9.5 million and $0.5 million for the three months ended September 30, 2013 and 2012, respectively, and $10.9 million and $0.8 million for the nine months ended September 30, 2013 and 2012, respectively.  The weighted-average grant date fair value of options granted was $13.12 and $3.80 for the three months ended September 30, 2013 and 2012, respectively, and $9.99 and $2.19 for the nine months ended September 30, 2013 and 2012, respectively.

 

Employee Stock-Based Compensation —The fair value of options on the date of grant is estimated based on the Black-Scholes option-pricing model using the single-option award approach with the weighted-average assumptions set forth below. Expected term represents the period that the Company’s stock-based awards are expected to be outstanding and is determined based on the simplified method. Volatility is estimated using comparable public company volatility for similar option terms. The risk-free interest rate is determined using a U.S. Treasury rate for the period that coincides with the expected term.

 

As the Company has never paid cash dividends, and at present, has no intention to pay cash dividends in the future, expected dividends are zero. Expected forfeitures are based on the Company’s historical experience. The Company uses the straight-line method for expense recognition.

 

The assumptions used to value stock-based awards granted to employees were as follows:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Expected term (years)

 

5.3-6.1

 

6.0-6.1

 

5.3-6.6

 

5.9-6.1

 

Volatility

 

58.2%-59.1%

 

62.4%-62.6%

 

58.2%-64.9%

 

62.3%-62.9%

 

Risk-free interest rate

 

1.59%-1.73%

 

0.91%-0.93%

 

1.04%-1.88%

 

0.85%-1.21%

 

Dividend yield

 

 

 

 

 

 

The following table summarizes the allocation of stock-based compensation and restricted stock for employees and non-employees in the accompanying consolidated statements of operations (in thousands):

 

 

 

Three Months

 

Nine Months

 

 

 

Ended

 

Ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Cost of revenue

 

$

93

 

$

5

 

$

211

 

$

20

 

Research and development

 

506

 

46

 

1,266

 

111

 

Sales and marketing

 

1,152

 

100

 

2,471

 

196

 

General and administrative

 

902

 

61

 

2,305

 

200

 

Total(*)

 

$

2,653

 

$

212

 

$

6,253

 

$

527

 

 


(*)                                  The table above includes the impact of the issuance of restricted stock at fair value.

 

The Company capitalized stock-based compensation as internally developed software costs of $0.3 million and $0 for the three months ended September 30, 2013 and 2012, respectively, and $0.4 million and $0 for the nine months ended September 30, 2013 and 2012, respectively.

 

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As of September 30, 2013 and December 31, 2012, unamortized stock-based compensation expense related to unvested common stock options was $23.3 million and $12.5 million, respectively. The weighted-average period over which such stock-based compensation expense will be recognized is approximately 3.1 years.

 

Options to Nonemployees —For the three and nine months ended September 30, 2013, the Company granted options to purchase a total of 1,500 and 8,500 shares of common stock, respectively, to nonemployees. The Company did not grant any stock options to nonemployees for the year ended December 31, 2012. The definition of an employee includes a nonemployee director of the Company.  Stock options granted to non-employees are recorded at their fair value on the measurement date. The measurement of stock-based compensation is subject to periodic adjustment as the underlying equity instruments vest. The fair value of options granted to consultants is expensed when vested.

 

The Company recorded stock-based compensation expense for options issued to non-employees of $0 for the three months ended September 30, 2013 and 2012, respectively, and $0.1 million and $0 for the nine months ended September 30, 2013 and 2012, respectively. Options to nonemployees of 8,900 and 12,400 were outstanding as of September 30, 2013 and December 31, 2012, respectively.

 

Restricted Common Stock —Pursuant to restricted stock purchase agreements, the Company issued a total of 0 shares for the three months ended September 30, 2013 and 2012, respectively, 0 and 11,571 shares for the nine months ended September 30, 2013 and September 30, 2012, respectively.

 

Restricted Stock Units (RSUs) — During the three months ended September 30, 2013, the Company granted 51,382 RSUs. For the three and nine months ended September 30, 2013, the Company recognized stock-based compensation expense associated with the RSUs of $0.1 million. At September 30, 2013, unrecognized compensation expense related to the RSUs was $0.9 million. The unrecognized compensation expense will be amortized on a straight-line basis through 2017.

 

Employee Stock Purchase Plan

 

In August 2013, the Company’s board of directors adopted and the stockholders approved the Company’s 2013 Employee Stock Purchase Plan (the “ESPP”), which became effective upon adoption by the Company’s board of directors. The ESPP allows eligible employees to purchase shares of the Company’s common stock at a discount through payroll deductions of up to 15% of their eligible compensation, subject to any plan limitations. The offering periods generally start on the first trading day on or after June 1 and December 1 of each year and end on the first trading day on or before November 30 and May 31 approximately six months later. The administrator may, in its discretion, modify the terms of future offering periods. Due to the timing of the IPO, the first offering period started October 1, 2013 and will end on May 31, 2014.  At the end of each offering period, employees are able to purchase shares at 85% of the lower of the fair market value of the Company’s common stock on the first trading day of the offering period or on the last day of the offering period. There were no offerings of share purchase rights to employees under the Company’s ESPP for the nine months ended September 30, 2013.

 

9.                                       NET INCOME (LOSS) PER SHARE

 

The Company calculates its basic and diluted net loss per share attributable to common stockholders in conformity with the two-class method required for companies with participating securities. Under the two-class method, in periods when the Company has net income, net income attributable to common stockholders is determined by allocating undistributed earnings, calculated as net income less current period convertible preferred stock non-cumulative dividends, between common stock and convertible preferred stock. In computing diluted net income attributable to common stockholders, undistributed earnings are re-allocated to reflect the potential impact of dilutive securities. The Company’s basic net loss per share attributable to common stockholders is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding for the period. The diluted net loss per share attributable to common stockholders is computed by giving effect to all potential dilutive common stock equivalents outstanding for the period. For purposes of this calculation, convertible preferred stock, options to purchase common stock and preferred stock warrants are considered common stock equivalents but have been excluded from the calculation of diluted net loss per share attributable to common stockholders as their effect is antidilutive.

 

Basic loss per share is calculated by dividing net loss by the weighted-average number of shares of common stock outstanding during the period, less shares subject to repurchase, and excludes any dilutive effects of employee stock-based awards and warrants. Diluted net loss per common share is computed giving effect to all potential dilutive common shares, including common stock issuable upon exercise of stock options, and unvested restricted common stock. As the Company had net losses for the three months ended September 30, 2013 and 2012, and for the nine months ended September 30, 2013 and 2012, all potential common shares were determined to be anti-dilutive.

 

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

 

 

 

Three Months

 

Nine Months

 

 

 

Ended September 30,

 

Ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Net loss

 

$

(6,860

)

$

(2,002

)

$

(18,771

)

$

(4,472

)

Weighted-average shares used to compute basic and diluted net loss per share

 

11,315

 

8,067

 

9,346

 

7,971

 

Basic and diluted net loss per share

 

$

(0.61

)

$

(0.25

)

$

(2.01

)

$

(0.56

)

 

The following securities were excluded from the calculation of diluted net loss per share attributable to common stockholders because their effect would have been anti-dilutive for the periods presented (in thousands):

 

 

 

Three Months

 

Nine Months

 

 

 

Ended September 30,

 

Ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Convertible preferred stock

 

 

19,479

 

 

19,479

 

Employee stock options

 

7,405

 

3,261

 

7,405

 

3,261

 

Shares subject to repurchase

 

380

 

436

 

380

 

436

 

Restricted Stock Units (RSUs)

 

51

 

 

51

 

 

Convertible preferred stock warrants

 

 

267

 

 

267

 

 

 

7,836

 

23,443

 

7,836

 

23,443

 

 

10.                                INCOME TAXES

 

The Company is subject to income tax in the United States as well as other tax jurisdictions in which it conducts business.  Earnings from non-U.S. activities are subject to local country income tax. The Company does not provide for federal income taxes on the undistributed earnings of its foreign subsidiaries as such earnings are to be reinvested indefinitely.

 

The Company recorded an income tax provision of $0.1 million and $0.1 million for the three months ended September 30, 2013 and 2012, respectively, related to foreign income taxes and state minimum taxes and $0.2 million and $0.1 million for the nine months ended September 30, 2013 and 2012, respectively. The primary difference between the effective tax rate and the federal statutory tax rate in the United States relates to the valuation allowances on the Company’s net operating losses, foreign tax rate differences, and non-deductible stock-based compensation expense.

 

Valuation allowances are provided when necessary to reduce net deferred tax assets to an amount that is more likely than not to be realized. Due to uncertainty as to the realization of benefits from deferred tax assets, including net operating loss carryforwards, research and development and other tax credits, the Company has provided a full valuation allowance reserved against such assets as of September 30, 2013 and December 31, 2012.

 

11.                                COMMITMENTS AND CONTINGENCIES

 

Operating Leases —The Company has operating lease agreements for office, research and development and sales and marketing space in the United States that expire at various dates, with the latest expiration date being November 2024.

 

The Company recognizes rent expense on a straight-line basis over the lease term and records the difference between cash rent payments and the recognition of rent expense as a deferred rent liability. Rent expense was $1.0 million and $0.5 million for the three months ended September 30, 2013 and 2012, respectively, and $2.5 million and $1.1 million for the nine months ended September 30, 2013 and 2012, respectively.

 

Approximate remaining future minimum lease payments under these non-cancelable operating leases as of September 30, 2013 were as follows (in thousands): 

 

Year ending December 31,

 

Future
Payments

 

2013 (remaining 3 months)

 

$

862

 

2014

 

4,164

 

2015

 

8,869

 

2016

 

9,028

 

2017

 

8,555

 

Thereafter

 

29,661

 

 

 

$

61,139

 

 

The total approximate future minimum lease payments of $61.1 million is primarily comprised of lease payments due under two operating lease agreements. The first lease is for the Company’s new sales office in New York, New York, which expires in 2024 and has future operating lease obligations of $25.0 million. The second lease is for the Company’s new headquarters facility in Redwood City, California, which expires in 2019 and has future operating lease obligations of $25.6 million.

 

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Letter of Credit —As of September 30, 2013 and December 31, 2012, the Company had irrevocable letters of credit outstanding in the amount of $3.0 million and $0.2 million for the benefit of a landlord related to noncancelable facilities leases. The letters of credit expire at various dates, with the latest expiration date being February 2023.

 

Indemnification Agreements —In the ordinary course of business, the Company enters into agreements of varying scope and terms pursuant to which it is obligated to indemnify customers, vendors, lessors, business partners, and other parties with respect to certain matters, including, but not limited to, losses arising out of breach of such agreements, services to be provided by the Company or from intellectual property infringement claims made by third parties. In addition, the Company has entered into indemnification agreements with directors and certain officers and employees that will require the Company, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors, officers or employees. No demands have been made upon the Company to provide indemnification under such agreements, and thus there are no claims that the Company is aware of that could have a material effect on the Company’s consolidated balance sheet, consolidated statement of operations, consolidated statements of comprehensive loss, or consolidated statements of cash flows.

 

Legal Proceedings —From time to time, the Company is subject to various legal proceedings and claims, either asserted or unasserted, that arise in the ordinary course of business. Although the outcome of the various legal proceedings and claims cannot be predicted with certainty, the Company has not had a history of outcomes to date that have been material to the statement of operations and does not currently believe that any of these proceedings or other claims will have a material adverse effect on the Company’s business, consolidated financial condition, results of operations or cash flows.

 

12.                                RETIREMENT PLANS

 

The Company has established a 401(k) plan to provide tax deferred salary deductions for all eligible employees. Participants may make voluntary contributions to the 401(k) plan, limited by certain Internal Revenue Service restrictions. The Company is responsible for the administrative costs of the 401(k) plan. The Company does not match employee contributions.

 

13.                                SEGMENTS

 

The Company considers operating segments to be components of the Company in which separate financial information is available that is evaluated regularly by the Company’s chief operating decision maker in deciding how to allocate resources and in assessing performance. The chief operating decision maker for the Company is the Chief Executive Officer. The Chief Executive Officer reviews financial information presented on a consolidated basis for purposes of allocating resources and evaluating financial performance. The Company has one business activity, and there are no segment managers who are held accountable for operations, operating results or plans for levels or components below the consolidated unit level. Accordingly, the Company has determined that it has a single operating and reportable segment. The following table summarizes total revenue generated through sales personnel located in the respective locations (in thousands):

 

 

 

Three Months

 

Nine Months

 

 

 

Ended September 30,

 

Ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

North America

 

$

56,578

 

$

24,062

 

$

137,824

 

$

60,580

 

All Other Countries

 

5,880

 

2,840

 

17,215

 

5,914

 

Total revenue

 

$

62,458

 

$

26,902

 

$

155,039

 

$

66,494

 

 

The following table summarizes total long-lived assets in the respective locations (in thousands):

 

 

 

September 30,

 

December 31,

 

 

 

2013

 

2012

 

North America

 

$

19,888

 

$

9,959

 

All Other Countries

 

1,053

 

980

 

Total long-lived assets, net

 

$

20,941

 

$

10,939

 

 

During the three and nine months ended September 30, 2013 and 2012, no single customer represented more than 10% of revenue.

 

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14.                               SUBSEQUENT EVENTS

 

No subsequent events occured that would require adjustment to the financial statements or disclosures included in the financial statements.

 

******

 

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

 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The words “believe,” “may,” “will,” “potentially,” “estimate,” “continue,” “anticipate,” “intend,” “could,” “would,” “project,” “plan,” “expect” and similar expressions that convey uncertainty of future events or outcomes are intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements concerning the following:

 

· our future financial and operating results;

 

· our planned investments;

 

· our expectations regarding our operating expenses;

 

· our ability to maintain an adequate rate of revenue growth;

 

· our business plan and our ability to effectively manage our growth and associated investments;

 

· our ability to attract and retain advertisers and advertising agencies;

 

· our expectations concerning the market for digital advertising;

 

· our ability to further penetrate our existing customer base;

 

· our ability to maintain our competitive technological advantages against competitors in our industry;

 

· our ability to timely and effectively adapt our existing technology;

 

· our ability to introduce new offerings and bring them to market in a timely manner;

 

· our ability to maintain, protect and enhance our brand and intellectual property;

 

· our ability to continue to expand internationally;

 

· the effects of increased competition in our market and our ability to compete effectively;

 

· costs associated with defending intellectual property infringement and other claims;

 

· our expectations concerning relationships with third parties;

 

· the attraction and retention of qualified employees and key personnel;

 

· future acquisitions of or investments in complementary companies or technologies;

 

· the effects of changing interest rates, currency exchange rates and inflation rates;

 

· our expected capital expenditures, cash flows and liquidity;

 

· the effects of seasonal trends on our results of operations; and

 

· our ability to comply with evolving legal standards and regulations, particularly concerning data protection and consumer privacy.

 

These forward-looking statements speak only as of the date of this Form 10-Q and are subject to uncertainties, assumptions and business and economic risks. As such, our actual results could differ materially from those set forth in the forward-looking statements as a result of the factors set forth below in Part II, Item 1A, “Risk Factors,” and in our other reports filed with the Securities and Exchange Commission. Moreover, we operate in a very competitive and rapidly changing environment, and new risks emerge from time to time. It is not possible for us to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Form 10-Q may not occur, and actual results could differ materially and adversely from those anticipated or implied in our forward-looking statements.

 

You should not rely upon forward-looking statements as predictions of future events. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance or events and circumstances described in the forward-looking statements will be achieved or occur. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We undertake no obligation to update publicly any forward-looking statements for any reason after the date of this Form 10-Q to conform these statements to actual results or to changes in our expectations, except as required by law.

 

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The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q with the understanding that our actual future results, levels of activity, performance and events and circumstances may be materially different from what we expect.

 

Overview

 

Rocket Fuel is a technology company that has developed an Artificial Intelligence and Big Data-driven predictive modeling and automated decision-making platform. Our technology is designed to address the needs of markets in which the volume and speed of information render real-time human analysis infeasible. We are focused on the large and growing digital advertising market that faces these challenges.

 

There are tens of billions of daily trades across all digital advertising exchanges, thousands of times more than the number of daily trades executed by NASDAQ and the NYSE combined. Our Artificial Intelligence, or AI, system autonomously purchases ad spots, or impressions, one at a time, on these exchanges to create portfolios of impressions designed to optimize the goals of our advertisers, such as increased sales, heightened brand awareness and decreased cost per customer acquisition. We believe that our customers value our solution, as our revenue retention rate was 134% and 175% for the years ended December 31, 2011 and 2012, respectively. We define our “revenue retention rate” with respect to a given twelve-month period as (i) revenue recognized during such period from customers that contributed to revenue recognized in the prior twelve-month period divided by (ii) total revenue recognized in such prior twelve-month period.

 

Benefiting from our unique combination of technology and industry expertise, we have rapidly grown our business, building a diversified customer base that, as of September 30, 2013, was comprised of over 70 of the Advertising Age 100 Leading National Advertisers and over 40 of the Fortune 100 companies.

 

Our solution is designed to optimize both direct-response campaigns focused on generating specific consumer purchases or responses, generally defined as cost per action goals, as well as brand campaigns geared towards lifting brand metrics, generally defined as cost-per-click and brand survey goals. For the three and nine months ended September 30, 2013 and 2012, direct response campaigns contributed approximately two-thirds of our revenue, with the remaining one-third of our revenue generated through brand campaigns. We have successfully run advertising campaigns for products and brands ranging from consumer products to luxury automobiles to travel and have served well over 100 billion impressions as of September 30, 2013. We provide a differentiated solution that is simple, powerful, scalable and extensible across geographies, industry verticals and advertising channels. Our computational infrastructure supports over 12,000 CPU cores in six data centers and houses 12 petabytes of data.

 

We generate revenue by delivering digital advertisements to consumers through our solution across display, mobile, social and video channels. Historically, our revenue has predominantly come from display advertising because display advertising inventory was the first to be made available for programmatic buying through real-time advertising exchanges. The digital advertising industry is rapidly adopting programmatic buying for mobile, social and video advertising, accelerating the amount of digital advertising inventory available through real-time advertising exchanges. We offer a single solution for advertisers across all of these channels to compete for a larger share of advertisers’ budgets. While a majority of our revenue currently comes from display advertising, we are focused on offering advertisers a comprehensive solution that addresses the display, mobile, social and video channels.

 

Our contracts typically have a term of less than a year, and we recognize revenue as we deliver advertising impressions, subject to satisfying all other revenue recognition criteria. Our revenue recognition policies are discussed in more detail under “Nature of Business and Summary of Significant Accounting Policies.”

 

We plan to invest for long-term growth. We anticipate that our operating expenses will increase significantly in the foreseeable future as we invest in research and development to enhance our solution and in sales and marketing to acquire new customers and reinforce our relationships with existing customers. We believe that these investments will contribute to our long-term growth, although they will reduce our profitability in the near term.

 

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Key Metrics

 

We monitor the key metrics set forth below to help us evaluate growth, establish budgets, measure the effectiveness of our research and development and sales and marketing and other investments, and assess our operational efficiencies. Revenue is discussed under the headings “—Components of Our Results of Operations” and “—Results of Operations.” Revenue less media costs and adjusted EBITDA are discussed under the heading “—Non-GAAP Financial Performance Metrics.” Number of active customers is discussed below.

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands, except number of active

 

 

 

customers)

 

Revenue

 

$

62,458

 

$

26,902

 

$

155,039

 

$

66,494

 

Revenue less media costs (non-GAAP)

 

$

36,035

 

$

14,448

 

$

87,327

 

$

35,874

 

Adjusted EBITDA (non-GAAP)

 

$

(657

)

$

(477

)

$

(4,941

)

$

(1,656

)

Number of active customers

 

938

 

406

 

938

 

406

 

 

Number of Active Customers

 

We define an active customer as a customer from whom we recognized revenue in the last three months. Each customer can be either an advertiser who purchases our solution from us directly or an advertiser who purchases our solution through an advertising agency or other third party. We count all advertisers within a single corporate structure as one customer even in cases where multiple brands, branches or divisions of an organization enter into separate contracts with us. We believe that our ability to increase the number of active customers using our solution is an important indicator of our ability to grow our business, although we expect this number to fluctuate based on the seasonality in our business.

 

Non-GAAP Financial Performance Metrics

 

To supplement our consolidated financial statements, which are prepared and presented in accordance with GAAP, we provide investors with the following financial measures that are not prepared in accordance with GAAP.

 

Revenue Less Media Costs

 

Revenue less media costs is a non-GAAP financial measure defined by us as generally accepted accounting principles, or GAAP, revenue less media costs. Media costs consist of costs for advertising impressions we purchase from real-time advertising exchanges or through other third parties. We believe that revenue less media costs is a meaningful measure of operating performance because it is frequently used for internal management purposes, indicates the performance of our solution in balancing the goals of delivering exceptional results to advertisers while meeting our margin objectives and facilitates a more complete period-to-period understanding of factors and trends affecting our underlying revenue performance.

 

A limitation of revenue less media costs is that it is a measure that we have defined for internal purposes that may be unique to us, and therefore it may not enhance the comparability of our results to other companies in our industry that have similar business arrangements but present the impact of media costs differently. Management compensates for these limitations by also relying on the comparable GAAP financial measures of revenue, cost of revenue and total operating expenses. The following table presents a reconciliation of revenue less media costs to revenue for each of the periods indicated:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Revenue

 

$

62,458

 

$

26,902

 

$

155,039

 

$

66,494

 

Less: Media costs

 

26,423

 

12,454

 

67,712

 

30,620

 

Revenue less media costs

 

$

36,035

 

$

14,448

 

$

87,327

 

$

35,874

 

 

Adjusted EBITDA

 

Adjusted EBITDA is a non-GAAP financial measure defined by us as net loss before income tax (expense) benefit, interest expense, net, depreciation and amortization (excluding amortization of internal use software), stock-based compensation expense and change in fair value of convertible preferred stock warrant liability. We have presented adjusted EBITDA because it is a key measure used by our management and board of directors to understand and evaluate our core operating performance and trends, to prepare and approve our annual budget, to develop short and long-term operating plans and to determine bonus payouts. In particular, we believe that the exclusion of the expenses eliminated in calculating adjusted EBITDA can provide a useful measure for period-to-period comparisons of our core business. Additionally, adjusted EBITDA is a key financial measure used by the compensation committee of our board of directors in connection with the determination of compensation for our executive officers. Accordingly, we believe that adjusted EBITDA provides useful information in understanding and evaluating our operating results.

 

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Our use of adjusted EBITDA has limitations as an analytical tool, and should not be considered in isolation or as a substitute for analysis of our financial results as reported under GAAP. Some of these limitations are as follows:

 

·                   although depreciation and amortization of property and equipment (excluding amortization of internal use software) are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements;

 

·                   adjusted EBITDA does not reflect: (1) changes in, or cash requirements for, our working capital needs; (2) the potentially dilutive impact of equity-based compensation; or (3) tax payments that may represent a reduction in cash available to us; and

 

·                   other companies, including companies in our industry, may calculate adjusted EBITDA or similarly titled measures differently, which reduces its usefulness as a comparative measure.

 

Because of these and other limitations, adjusted EBITDA should be considered along with other GAAP-based financial performance measures, including various cash flow metrics, net income or loss, and our other GAAP financial results. The following table presents a reconciliation of adjusted EBITDA to net loss for each of the periods indicated:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Net loss

 

$

(6,860

)

$

(2,002

)

$

(18,771

)

$

(4,472

)

Adjustments:

 

 

 

 

 

 

 

 

 

Interest expense, net

 

251

 

63

 

604

 

233

 

Income tax expense

 

133

 

28

 

173

 

67

 

Depreciation and amortization expense (excludes amortization of internal use software)

 

781

 

391

 

2,060

 

896

 

Stock-based compensation

 

2,653

 

212

 

6,253

 

527

 

Change in fair value of convertible preferred stock warrants

 

2,385

 

831

 

4,740

 

1,093

 

Total adjustments

 

6,203

 

1,525

 

13,830

 

2,816

 

Adjusted EBITDA

 

$

(657

)

$

(477

)

$

(4,941

)

$

(1,656

)

 

Adjusted Net Loss

 

Adjusted net loss and adjusted diluted net loss per share are non-GAAP financial measures that are useful to us and investors because they present an additional measurement of our financial performance, taking into account depreciation, which we believe is an ongoing cost of doing business, but excluding the impact of certain non-cash expenses (e.g. stock-based compensation). We believe that analysts and investors use adjusted net income and adjusted diluted net income per share as supplemental measures to evaluate the overall operating performance of companies in our industry.

 

A limitation of adjusted net income/(loss) is that it is a measure that may be unique to the Company and may not enhance the comparability of the Company’s results to other companies in the same industry that define adjusted net income/(loss) differently. This measure may also exclude expenses that may have a material impact on the Company’s reported financial results.  Our management compensates for these limitations by also considering the comparable GAAP financial measure of net income/(loss).

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Net loss

 

$

(6,860

)

$

(2,002

)

$

(18,771

)

$

(4,472

)

Stock-based compensation expense

 

2,653

 

212

 

6,253

 

527

 

Change in fair value of convertible preferred stock warrant liability

 

2,385

 

831

 

4,740

 

1,093

 

Tax impact of the above items

 

 

 

 

 

Adjusted net loss

 

$

(1,822

)

$

(959

)

$

(7,778

)

$

(2,852

)

 

 

 

 

 

 

 

 

 

 

Adjusted diluted net loss per share

 

$

(0.16

)

$

(0.12

)

$

(0.83

)

$

(0.36

)

 

 

 

 

 

 

 

 

 

 

Weighted average shares used in computing adjusted diluted net loss per share

 

11,315

 

8,067

 

9,346

 

7,971

 

 

Factors Affecting Our Performance

 

We believe that the growth of our business and our future success depend on various opportunities, challenges and other factors, including the following:

 

Investment in Growth

 

We plan to invest for long-term growth. We anticipate that our operating expenses will increase significantly in the foreseeable future as we invest in research and development to enhance our solution, in sales and marketing to acquire new customers and reinforce our relationships with existing customers and in our infrastructure, including our IT, financial and administrative systems and controls. We are also investing to further automate our business processes with the goal of enhancing our administrative and operational efficiency. We believe that these investments will contribute to our long-term growth, although they will reduce our profitability in the near term.

 

Technology Enhancements and Customer Satisfaction

 

                We will continue to make improvements to our technology platform that may have an impact on both our gross profit margin and our performance against advertiser objectives.  While our technology improvements in the third quarter enabled significant margin improvement, we do not currently expect the margin performance achieved in the third quarter to continue to improve or be maintained at this level. We expect that our margin will be impacted not only by technology improvements, but also by our commitment to satisfying advertiser objectives, the impact of seasonality in the advertising business, the supply and demand dynamics of real-time advertising exchange-traded media, by the number and types of campaigns that we run and customers that we serve as we scale our business.

 

Ability to Increase Penetration in All Channels

 

Historically, our revenue has predominantly come from display advertising. Our future performance is dependent on our continued ability to penetrate and grow our revenue in display, as well as mobile, social and video channels.

 

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Customer Growth and Revenue Retention

 

While we have a significant customer base, we must continue to attract new customers, and gain a larger amount of our current customers’ advertising budgets, to continue our growth. We believe our ability to attract new customers and retain and increase revenue from our existing customers is an important element of our business. Our number of active customers increased from 536 as of December 31, 2012 to 938 as of September 30, 2013, and our revenue retention rate was 178% for the twelve months ended September 30, 2013.

 

Growth of the Real-time Advertising Exchange Market and Digital Advertising

 

Our performance is significantly affected by growth rates in both real-time advertising exchanges and the digital advertising channels that we address. These markets have grown rapidly in the past several years, and any acceleration, or slowing, of this growth would affect our overall performance.

 

Seasonality

 

In the advertising industry, companies commonly experience seasonal fluctuations in revenue. For example, many advertisers allocate the largest portion of their budgets to the fourth quarter of the calendar year to coincide with increased holiday purchasing. Historically, the fourth quarter of the year reflects our highest level of advertising activity, and the first quarter reflects the lowest level of such activity. We expect our revenue to continue to fluctuate based on seasonal factors that affect the advertising industry as a whole.

 

Components of Our Results of Operations

 

Revenue

 

We generate revenue by delivering digital advertisements to consumers through the display channel and other channels. The display channel excludes advertising delivered to mobile devices and advertising delivered through social and video channels. For the three and nine months ended September 30, 2013 and 2012, direct-response campaigns, which are focused on generating specific consumer purchases or responses, contributed approximately two-thirds of our revenue, while brand campaigns, which are focused on lifting brand metrics, contributed the remaining one-third of our revenue. We predominantly contract with advertising agencies who purchase our solution on behalf of advertisers. When we contract with an agency, it acts as an agent for a disclosed principal, which is the advertiser. Our contracts usually also provide that if the advertiser does not pay the agency, the agency is not liable to us, and we must seek payment solely from the advertiser. Our contracts with advertisers, including advertising agencies representing advertisers, are generally in the form of an insertion order. An insertion order is a contract that outlines the terms and conditions of an advertising campaign and its objectives. Our contracts typically have a term of less than a year, and we recognize revenue as we deliver advertising impressions, subject to satisfying all other revenue recognition criteria.

 

Cost of Revenue

 

Cost of revenue consists primarily of media costs, and to a lesser extent, data center costs, personnel costs, depreciation expense, amortization of internal use software development costs on revenue-producing technologies and allocated costs. Media costs consist primarily of costs for advertising impressions we purchase from real-time advertising exchanges and other third parties, which are expensed when incurred. We typically pay these advertising exchanges on a per impression basis. Personnel costs include salaries, bonuses, stock-based compensation expense and employee benefit costs. These personnel costs are primarily attributable to individuals maintaining our servers and members of our network operations group, which initiates, sets up and launches advertising campaigns. We capitalize costs associated with software that is developed or obtained for internal use and amortize these costs in cost of revenue over the internal use software’s useful life. Cost of revenue also includes purchased data, third-party data center costs and depreciation of data center equipment. We anticipate that our cost of revenue will increase in absolute dollars as our revenue increases.

 

Operating Expenses

 

We classify our operating expenses into three categories: research and development, sales and marketing and general and administrative. Our operating expenses consist primarily of personnel costs, and, to a lesser extent, professional fees and allocated costs. Personnel costs for each category of operating expense generally include salaries, bonuses and commissions for sales personnel, stock-based compensation expense and employee benefit costs.

 

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Table of Contents

 

·                   Research and development.  Our research and development expenses consist primarily of personnel costs and professional services associated with the ongoing development and maintenance of our technology. We believe that continued investment in technology is critical to attaining our strategic objectives, and, as a result, we expect research and development expenses to increase in absolute dollars in future periods.

 

·                   Sales and marketing.  Our sales and marketing expenses consist primarily of personnel costs (including commissions) and, to a lesser extent, allocated costs, professional services, brand marketing, travel, trade shows and marketing materials. Our sales organization focuses on (1) marketing our solution to generate awareness; (2) increasing the adoption of our solution by existing and new advertisers; and (3) expanding our international business, primarily by growing our sales team in certain countries in which we currently operate and establishing a presence in additional countries. As a result, we expect sales and marketing expenses to increase in absolute dollars in future periods.

 

·                   General and administrative.  Our general and administrative expenses consist primarily of personnel costs associated with our executive, finance, legal, human resources, compliance and other administrative personnel, as well as accounting and legal professional services fees, allocated costs and other corporate expenses. We expect to continue to invest in corporate infrastructure and incur additional expenses associated with being a public company, including increased legal and accounting costs, investor relations costs, higher insurance premiums and compliance costs associated with Section 404 of the Sarbanes-Oxley Act of 2002. As a result, we expect general and administrative expenses to increase in absolute dollars in future periods.

 

Other Expense, Net

 

Interest expense.   Interest expense is related to our credit facilities and, in previous periods, our term debt.

 

Other income (expense)—net.   Other income (expense)—net consists primarily of interest income, gains and losses on the sale and disposal of property, equipment and software, as well as gains and losses on foreign currency translation. We have foreign currency exposure related to our accounts receivable that are denominated in currencies other than the U.S. dollar, principally the British pound sterling and euro.

 

Change in fair value of convertible preferred stock warrant liability.   As of December 31, 2012, we had two outstanding warrants to purchase shares of our capital stock. The convertible preferred stock warrants were subject to re-measurement at each balance sheet date, and any change in fair value was recognized as a component of other expense, net. In connection with the closing of our initial public offering, or IPO, one of the warrants was automatically converted into shares of common stock and the other warrant was converted into a warrant to purchase shares of common stock, which was exercised by the holder following the completion of the IPO. As such, we no longer are required to remeasure the value of the converted common stock warrant, and therefore, no further charges or credits related to such warrant will be made to other income and expense.

 

Provision for Income Taxes

 

Provision for income taxes consists primarily of federal and state income taxes in the United States and income taxes in foreign jurisdictions in which we conduct business. Due to uncertainty as to the realization of benefits from our deferred tax assets, including net operating loss carryforwards, research and development and other tax credits, we have a full valuation allowance reserved against such assets. We expect to maintain this full valuation allowance in the near term.

 

Critical Accounting Policies and Estimates

 

We prepare our consolidated financial statements in accordance with U.S. GAAP. The preparation of consolidated financial statements also requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ significantly from the estimates made by our management. To the extent that there are differences between our estimates and actual results, our future financial statements presentation, financial condition, results of operations, and cash flows will be affected. Please refer to Note 1 “Nature of Business and Summary of Significant Accounting Policies” for further discussion.

 

Recently Issued Accounting Pronouncements

 

In July 2013, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) No. 2013-11,  Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (ASU 2013-11). The guidance requires an entity to present its unrecognized tax benefits net of its deferred tax assets when settlement in this manner is available under the tax law, which would be based on facts and circumstances as of the balance sheet reporting date and would not consider future events. Gross presentation in the notes to the financial statements

 

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Table of Contents

 

will still be required. ASU 2013-11 will apply on a prospective basis to all unrecognized tax benefits that exist at the effective date. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of ASU 2013-11 is not expected to have a material impact on our consolidated condensed financial statements.

 

Results of Operations

 

The following tables set forth our results of operations for the periods presented as a percentage of revenue for those periods. The period-to-period comparison of financial results is not necessarily indicative of future results.

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Consolidated Statements of Operations Data:*

 

 

 

 

 

 

 

 

 

Revenue

 

100

%

100

%

100

%

100

%

Cost of revenue

 

51

%

56

%

53

%

56

%

Gross Profit

 

49

%

44

%

47

%

44

%

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

7

%

4

%

7

%

4

%

Sales and marketing

 

35

%

38

%

36

%

39

%

General and administrative

 

14

%

6

%

13

%

6

%

Total operating expenses

 

56

%

49

%

56

%

49

%

Loss from operations

 

(7

)%

(4

)%

(8

)%

(5

)%

Other expense, net:

 

 

 

 

 

 

 

 

 

Interest expense

 

%

%

%

%

Other income (expense) - net

 

%

%

%

%

Change in fair value of convertible preferred stock

 

%

%