Rocket Fuel Inc.
Rocket Fuel Inc. (Form: 10-Q, Received: 11/14/2014 16:34:57)





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, 2014
or
¨
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  
(State or other jurisdiction of incorporation or organization)
30-0472319  
(I.R.S. Employer Identification Number)

1900 Seaport Boulevard, Pacific Shores Center, Redwood City, CA 94063
(Address of principal executive offices and Zip Code)
(650) 595-1300
(Registrant's telephone number, including area code)
__________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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   x     No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   x     No   ¨

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 definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
¨
Accelerated filer
¨
Non-accelerated filer
  x  (Do not check if a smaller reporting company)
Smaller reporting company
¨

1




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

Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. On October 31, 2014, 41,295,064 shares of the registrant's common stock, par value $0.001 , were outstanding.

EMERGING GROWTH COMPANY
We are an ‘‘emerging growth company’’ as that term is defined in the Jumpstart Our Business Startups Act of 2012 and, as such, we have elected to comply with certain reduced public company reporting requirements.


2



ROCKET FUEL INC.
FORM 10-Q
TABLE OF CONTENTS

 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
TRADEMARKS
 
“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.





3




ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

Rocket Fuel Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)

 
September 30,
 
December 31,
 
2014
 
2013
Assets
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
111,632

 
$
113,873

Accounts receivable, net
116,229

 
90,502

Deferred tax assets
1,154

 
207

Prepaid expenses
3,974

 
2,164

Other current assets
15,331

 
3,962

Total current assets
248,320

 
210,708

Property, equipment and software, net
78,217

 
25,794

Restricted cash
3,010

 

Intangible assets
73,525

 

Goodwill
114,871

 

Other assets
1,198

 
1,006

Total assets
$
519,141

 
$
237,508

Liabilities and Stockholders’ Equity
 
 
 
Current Liabilities:
 
 
 
Accounts payable
$
65,284

 
$
39,910

Accrued and other current liabilities
33,268

 
21,584

Deferred revenue
1,251

 
918

    Current portion of capital leases
2,695

 
203

Current portion of debt
45,990

 
7,243

Total current liabilities
148,488

 
69,858

Long-term debt—Less current portion
15,965

 
19,568

Capital leases—Less current portion
5,024

 
412

Deferred rent—Less current portion
24,260

 
3,909

Deferred tax liabilities
2,231

 
207

Other liabilities
543

 
387

Total liabilities
196,511

 
94,341

Commitments and contingencies (Note 13)


 


Stockholders’ Equity
 
 
 
Common stock, $0.001 par value— 1,000,000,000 authorized as of September 30, 2014 and December 31, 2013, respectively; 41,234,242 and 32,825,992 issued and outstanding as of September 30, 2014 and December 31, 2013, respectively
41

 
33

Additional paid-in capital
410,923

 
187,624

Accumulated other comprehensive loss
(44
)
 
(15
)
Accumulated deficit
(88,290
)
 
(44,475
)
Total stockholders’ equity
322,630

 
143,167

Total liabilities and stockholders’ equity
$
519,141

 
$
237,508


See Accompanying Notes to Condensed Consolidated Financial Statements.

4



Rocket Fuel Inc.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except loss per share data)
(Unaudited)

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Revenue
$
102,098

 
$
62,458

 
$
269,137

 
$
155,039

Cost of revenue
54,952

 
31,877

 
139,410

 
81,529

Gross profit
47,146

 
30,581

 
129,727

 
73,510

Operating expenses:
 
 
 
 
 
 
 
Research and development
11,200

 
4,464

 
26,875

 
10,587

Sales and marketing
40,421

 
21,644

 
103,969

 
56,293

General and administrative
19,320

 
8,719

 
41,795

 
19,671

Total operating expenses
70,941

 
34,827

 
172,639

 
86,551

Loss from operations
(23,795
)
 
(4,246
)
 
(42,912
)
 
(13,041
)
Other expense, net:
 
 
 
 
 
 
 
Interest expense
(1,157
)
 
(251
)
 
(2,085
)
 
(604
)
Other income (expense)—net
(1,999
)
 
155

 
(2,443
)
 
(213
)
Change in fair value of convertible preferred stock warrant liability

 
(2,385
)
 

 
(4,740
)
Other expense, net
(3,156
)
 
(2,481
)
 
(4,528
)
 
(5,557
)
Loss before income taxes
(26,951
)
 
(6,727
)
 
(47,440
)
 
(18,598
)
Income tax benefit (provision)
4,120

 
(133
)
 
3,625

 
(173
)
Net loss
$
(22,831
)
 
$
(6,860
)
 
$
(43,815
)
 
$
(18,771
)
Basic and diluted net loss per share attributable to common stockholders
$
(0.61
)
 
$
(0.61
)
 
$
(1.23
)
 
$
(2.01
)
Basic and diluted weighted-average shares used to compute net loss per share attributable to common stockholders
37,230

 
11,315

 
35,490

 
9,346


See Accompanying Notes to Condensed Consolidated Financial Statements.


5



Rocket Fuel Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
(Unaudited)

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Net loss
$
(22,831
)
 
$
(6,860
)
 
$
(43,815
)
 
$
(18,771
)
Other comprehensive income (loss): (1)
 
 
 
 
 
 
 
Foreign currency translation adjustments
(54
)
 
24

 
(29
)
 
(17
)
Comprehensive loss
$
(22,885
)
 
$
(6,836
)
 
$
(43,844
)
 
$
(18,788
)

(1) Reclassifications out of Other comprehensive income (loss) into Net loss were not significant.


See Accompanying Notes to Condensed Consolidated Financial Statements.


6



Rocket Fuel Inc.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2014
(In thousands, except share data)
(Unaudited)

 
Common Stock
Additional
Paid-In
Accumulated
Other
Comprehensive
Accumulated
Total
Stockholders’
 
Shares
Amount
Capital
Income (Loss)
Deficit
Equity
Balance—January 1, 2014
32,825,992

$
33

$
187,624

$
(15
)
$
(44,475
)
$
143,167

Issuance of common stock upon exercises of employee stock options, net of repurchases
937,733

1

3,376



3,377

Issuance of common stock upon vesting of restricted stock units
54,334






Shares withheld related to net share settlement of restricted stock units
(15,351
)

(241
)


(241
)
Issuance of common stock in connection with acquisition
5,253,084

5

82,416



82,421

Issuance of common stock from follow-on offering, net of issuance costs
2,000,000

2

115,401



115,403

Issuance of common stock in connection with employee stock purchase plan
178,450


3,792



3,792

Stock-based compensation


18,376



18,376

Foreign currency translation adjustment



(29
)

(29
)
Tax benefit from stock-based award activity


179



179

Net loss




(43,815
)
(43,815
)
Balance—September 30, 2014
41,234,242

$
41

$
410,923

$
(44
)
$
(88,290
)
$
322,630


S ee Accompanying Notes to Condensed Consolidated Financial Statements.


7



Rocket Fuel Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Nine Months Ended
 
September 30,
 
2014
 
2013
OPERATING ACTIVITIES:
 
 
 
Net loss
$
(43,815
)
 
$
(18,771
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
12,525

 
4,583

Provision for doubtful accounts
62

 
521

Stock-based compensation
17,193

 
6,277

Amortization of debt discount
144

 
1

Excess tax benefit from stock-based activity
(179
)
 

Loss (gain) on disposal of property, equipment and software
216

 
(26
)
Change in fair value of preferred stock warrant liability

 
4,740

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(5,062
)
 
(21,236
)
Prepaid expenses
(783
)
 
(649
)
Other current assets
(11,368
)
 
(292
)
Other assets
(247
)
 
(700
)
Accounts payable
13,925

 
12,532

Accrued and other liabilities
(1,475
)
 
5,496

Deferred rent
20,471

 
100

Deferred revenue
323

 
264

Other liabilities
(3,894
)
 

Net cash used in operating activities
(1,964
)
 
(7,160
)
 
 
 
 
INVESTING ACTIVITIES:
 
 
 
Purchases of property, equipment and software
(40,286
)
 
(5,564
)
Business acquisition, net
(97,444
)
 

Capitalized internal-use software development costs
(5,459
)
 
(4,486
)
Restricted cash
(2,203
)
 

Net cash used in investing activities
(145,392
)
 
(10,050
)
 
 
 
 
FINANCING ACTIVITIES:
 
 
 
Proceeds from the issuance of common stock in initial and follow-on public offering, net of underwriting discounts and commission
116,510

 
107,880

Issuance costs related to initial and follow-on public offering
(1,107
)
 
(1,534
)
Proceeds from the exercise of common stock warrants

 
97

Proceeds from exercise of vested common stock options
2,682

 
208

Proceeds from early exercise of unvested common stock options
17

 
1,058

Repurchases of common stock options early exercised
(24
)
 
(11
)
Excess tax benefit from stock-based activity
179

 

Proceeds from issuance of common stock from employee stock purchase plan

3,792

 

Tax withholdings related to net share settlements of restricted stock units

(241
)
 

Repayment of capital lease obligations
(559
)
 


8



 
 
 
 
 
Nine Months Ended
 
September 30,
FINANCING ACTIVITIES (cont.):
2014
 
2013
Borrowings from line of credit
35,000

 
10,000

Proceeds from issuance of long-term debt

 
10,000

Repayment of long-term debt
(11,133
)
 
(114
)
Net cash provided by financing activities
145,116

 
127,584

 
 
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
(1
)
 
12

CHANGE IN CASH AND CASH EQUIVALENTS
(2,241
)
 
110,386

CASH AND CASH EQUIVALENTS—Beginning of period
113,873

 
14,896

CASH AND CASH EQUIVALENTS—End of period
$
111,632

 
$
125,282

 
 
 
 
SUPPLEMENTAL DISCLOSURES OF OTHER CASH FLOW INFORMATION:
 
 
 
Cash paid for income taxes, net of refunds
$
195

 
$
348

Cash paid for interest
1,598

 
543

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
Purchases of property and equipment recorded in accounts payable and accruals
$
7,523

 
$
4,952

Offering costs recorded in accrued liabilities

 
3,194

Property, plant and equipment acquired under capital lease obligations
7,855

 

Vesting of early exercised options
674

 
229

Stock-based compensation capitalized in internal-use software costs
1,183

 
437

Issuance of common stock in connection with acquisition
82,421

 

Conversion of convertible preferred stock to common stock

 
60,617

Conversion of preferred stock warrants to common stock

 
7,481



See Accompanying Notes to Condensed Consolidated Financial Statements.


9



ROCKET FUEL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 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 artificial-intelligence digital advertising solutions and is headquartered in Redwood City, California, and has offices in various cities across the United States. The Company established a wholly-owned subsidiary in the United Kingdom in 2011, in Canada in 2013, and in Brazil during the third quarter of 2014. The United Kingdom subsidiary has offices throughout Europe and in Australia and established 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 and offering expenses, the aggregate net proceeds received by the Company totaled approximately $103.3 million .
In February 2014, the Company completed an underwritten follow-on public offering (the “Follow-on Offering”) of its common stock in which 2,000,000 shares of common stock were sold by the Company and 3,000,000 shares of common stock were sold by selling stockholders. The public offering price of the shares sold in the offering was $61.00 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 $122.0 million . After deducting underwriters’ discounts and commissions and offering expenses, the aggregate net proceeds received by the Company totaled approximately $115.4 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 Company’s audited consolidated financial statements and the notes thereto for the year ended December 31, 2013 , included in its Annual Report on Form 10-K.
The condensed consolidated balance sheet as of December 31, 2013 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 2014 or any future period.
Principles of Consolidation —The consolidated financial statements include the Company and its wholly-owned subsidiaries. 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 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 —The Company’s foreign subsidiaries record their assets, liabilities and results of operations in their local currencies, which are their functional currencies. The Company translates its subsidiaries' 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 and revenue, expenses, gains and losses are translated at the

10



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 income (loss).
Fair Value of Financial Instruments —The Company’s financial instruments consist principally of cash equivalents, accounts receivable, accounts payable, accrued liabilities, capital leases, term debt and revolving credit facilities. 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 and 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 capital leases, term debt and revolving credit facilities approximates its recorded amount as of September 30, 2014 as the interest rates on the term debt and revolving credit facilities are variable and the rates for each are based on market interest rates after consideration of default and credit risk.
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 90 days or less at the date of purchase are considered to be cash equivalents. Cash equivalents consist of money market funds.
Restricted Cash —Restricted cash as of September 30, 2014 consists of cash required to be deposited with financial institutions for security deposits for some of the Company's office lease agreements.
Concentration of Credit Risk —Financial instruments that 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 three major financial institutions that the Company's management has assessed 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 agencies' and advertisers' accounts receivable balances. As of September 30, 2014 , three agency holding companies and no single advertiser accounted for 10% of more of accounts receivable. As of December 31, 2013 , no single agency holding company or advertiser accounted for 10% or more of accounts receivable.
With respect to revenue concentration, the Company defines a customer as an advertiser that is a distinct source of revenue and is legally bound to pay for the advertising services that the Company delivers on the advertiser’s behalf. The Company counts 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 the Company. During the three and nine months ended September 30, 2014 and 2013 , no single customer represented 10% or more of revenue.

The Company also monitors the percentage of revenue that flows through advertising agencies, even though advertising agencies that act on behalf of the Company’s advertisers are not considered customers based on the definition above. If all branches and divisions within each global advertising agency were considered to be a single agency for this purpose, three agency holding companies would have been associated with 10% or more of revenue during the three and nine months ended September 30, 2014 , and two agency holding companies would have been associated with 10% or more of revenue during the three and nine months ended September 30, 2013 .

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):

11



 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Allowance for doubtful accounts:
 
 
 
 
 
 
 
Balance, beginning of period
$
797

 
$
485

 
$
1,057

 
$
468

Add: bad debt expense
53

 
505

 
254

 
521

Less: write-offs, net of recoveries
271

 
18

 
(190
)
 
19

Balance, end of period
$
1,121

 
$
1,008

 
$
1,121

 
$
1,008

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 or amortization, as applicable, are removed from the balance sheet and any resulting gain or loss is reflected in operations in the period realized.
Construction in progress primarily includes costs related to the leasehold improvements and also includes network equipment infrastructure to support the Company's data centers around the world. Interest capitalized during the periods presented was not material.
Leasehold improvements are amortized on a straight-line basis over the term of the lease, or the useful life of the assets, whichever is shorter. 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
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 $2.3 million and $1.7 million in internal-use software costs during the three months ended September 30, 2014 and 2013 , respectively, and $6.6 million and $4.9 million for the nine months ended September 30, 2014 and 2013 , respectively. These capitalized amounts are included in property, equipment and software—net on the condensed 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. Amortization expense totaled $1.4 million and $0.9 million for the three months ended September 30, 2014 and 2013 , respectively, and $3.7 million and $2.5 million for the nine months ended September 30, 2014 and 2013 , 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 the estimated useful life is no longer appropriate. If indicators of impairment exist and the undiscounted projected cash flows associated with an asset are 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, 2014 and 2013 .
Business Combinations —The Company accounts for business combinations using the acquisition accounting method as required under the provisions of FASB ASC 805, Business Combinations, or ASC 805. The total purchase price is allocated to the assets acquired and liabilities assumed based on fair values at the date of acquisition. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the identifiable assets acquired and the liabilities assumed.

12



Best estimates and assumptions are used in the purchase price allocation process to accurately value assets acquired and liabilities assumed at the business combination date. These estimates and assumptions are inherently uncertain and subject to refinement. As a result, during the preliminary purchase price allocation period, which may be up to one year from the business combination date, the Company may record adjustments to the assets acquired and liabilities assumed, with the corresponding adjustment to goodwill. After the preliminary purchase price allocation period, adjustments are recorded in the operating results in the period in which the adjustments were determined.
The fair value assigned to identifiable intangible assets acquired is determined using the income approach which discounts expected future cash flows to present value using estimations and assumptions determined by management. The Company believes that these identified intangible assets will have no residual value after their estimated economic useful lives. The identifiable intangible assets are subject to amortization on a straight-line basis as this best approximates the benefit period related to these assets.
The excess of the purchase price over the identified tangible and intangible assets, less liabilities assumed, is recorded as goodwill and primarily reflects the value of the synergies expected to be generated from combining the Company's and the acquired entity’s technology and operations. Generally, the goodwill is not deductible for income tax purposes.
Goodwill, Intangibles and Impairment Assessments —Goodwill represents the excess of the aggregate purchase price paid over the fair value of the net tangible and intangible assets acquired. Intangible assets that are not considered to have an indefinite useful life are amortized over their useful lives. The Company evaluates the estimated remaining useful lives of purchased intangible assets and whether events or changes in circumstances warrant a revision to the remaining periods of amortization.
Goodwill is not amortized and is tested for impairment at least annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The Company has determined that it operates as one reporting unit and has selected December 1 as the date to perform its annual impairment test.
In the impairment assessment of its goodwill, the Company performs a qualitative assessment and then, if necessary, a two step impairment test, which involves assumptions regarding estimated future cash flows to be derived from the Company. If these estimates or their related assumptions change in the future, the Company may be required to record impairment for these assets. The first step of the impairment test involves comparing the fair value of the reporting unit to its net book value, including goodwill. If the net book value exceeds its fair value, then the Company would perform the second step of the goodwill impairment test to determine the amount of the impairment loss. The impairment loss would be calculated by comparing the implied fair value of the Company to its net book value. In calculating the implied fair value of the Company’s goodwill, the fair value of the Company would be allocated to all of the other assets and liabilities based on their fair values. The excess of the fair value of the Company over the amount assigned to its other assets and liabilities is the implied fair value of goodwill. An impairment loss would be recognized when the carrying amount of goodwill exceeds its implied fair value. There has been no impairment of goodwill during the periods presented.
Revenue Recognition —To date, the Company has generated most of its revenue by delivering digital advertisements to Internet users through various channels, including display, mobile, social and video. This aspect of its business is referred to as a demand side platform, or “DSP.”
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.
These revenue arrangements are generally evidenced by a fully-executed insertion order (“IO”). Generally, IOs state the number and type of advertising impressions (cost-per-thousand) to be delivered, the agreed upon rate for each delivered impression, 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 from DSP arrangements should be reported on a gross or net basis is based on an

13



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 (a) 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, (iii) selecting the media to fulfill the insertion order, and (iv) performing all billing and collection activities including retaining credit risk, and (b) the Company has the risk of fluctuating costs from its media vendors relative to fixed pricing negotiated with its customers and has discretion in selecting media vendors when fulfilling a customer’s campaign, the Company has concluded that it acts as the principal in the majority of these arrangements and therefore reports revenue earned and costs incurred on a gross basis.
On occasion, the Company has offered customer incentive programs that 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 rebate program lapses.
In addition to delivering internet advertising through its full-service DSP, the Company licenses a self-service version of its DSP technology platforms and its data management platform ("DMP") to agencies and advertisers for their own use. These arrangements do not provide the customer with the right to take possession of the software or platform. The Company also provides professional services to certain of its customers. Revenue from license agreements is recognized ratably over the license term. Professional services consist primarily of assisting these customers with on-site support, training and other consulting services. When professional services are not considered essential to the functionality of the software, revenue is recognized ratably over the service or related subscription term, whichever is longer, otherwise recognition is deferred until the services are completed.
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. 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 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 channel, 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

14



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.
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 associated with the Company’s engineering and research and development departments, as well as costs for contracted services and supplies. Allocated costs include charges for facilities, office expenses, telephones, and other miscellaneous expenses. The Company reviews costs incurred in the application development stage and assesses such costs for potential 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, certain advertising costs, travel, trade shows and marketing materials. Allocated costs include charges for facilities, office expenses, telephones, and other miscellaneous expenses. The Company incurred advertising costs of $1.5 million and $1.6 million for the three months ended September 30, 2014 and 2013 , respectively, and $4.5 million and $3.3 million for the nine months ended September 30, 2014 and 2013 , 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. Allocated costs include charges for facilities, office expenses, telephones, and other miscellaneous expenses.
Stock-based Compensation —The Company measures compensation expense for all stock-based payment awards, including stock options granted to employees, based on the estimated fair value of the awards on the date of the grant. The fair value of each stock option granted is estimated using the Black-Scholes option pricing model. Stock-based compensation is recognized on a straight-line basis over the requisite vesting 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 non-employees based on the fair value of the awards determined using the Black-Scholes option pricing model.
Preferred Stock Warrant Liability —Freestanding warrants related to shares that are redeemable or contingently redeemable were classified as a liability on the Company’s condensed consolidated balance sheet. The fully-vested convertible preferred stock warrants were 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 in the third quarter of 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 carry-forwards 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.
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.

15



Recently Issued and Adopted Accounting Pronouncements —Under the Jumpstart Our Business Startups Act (the "JOBS Act"), we qualify as an “emerging growth company.” We have irrevocably elected to opt out of the extended transition period for complying with new or revised accounting standards pursuant to Section 107(b) of the JOBS Act, and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not “emerging growth companies.”
In May 2014, the FASB issued new accounting guidance related to revenue recognition. This new standard will replace all current U.S. GAAP guidance on this topic and eliminate all industry-specific guidance. The new revenue recognition standard provides a unified model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. This guidance will be effective beginning January 1, 2017 and can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. We have not yet determined if we will apply this new accounting standard retrospectively or as a cumulative-effect adjustment and are in the process of evaluating the impact of adopting this standard on our financial statements.

In August 2014, the FASB issued new guidance related to management responsibility to assess and provide related disclosure of the Company’s ability to continue as a going concern. This ASU will be effective for annual periods ending after December 15, 2016. The adoption of this guidance will not have a material impact on the Company's consolidated financial statements.
NOTE 2.
FAIR VALUE MEASUREMENTS
Fair value is defined as the price that would be received on the 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. For securities, the valuations are based on quoted prices of the 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, 2014 and December 31, 2013, 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, 2014 and December 31, 2013, 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, 2014 and December 31, 2013, the Company did not have any Level 3 financial assets or liabilities.
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 for debt with similar terms, the carrying value of the capital lease, term debt and line of credit approximate fair value (using Level 2 inputs).
The following tables set forth the Company’s financial instruments that were measured at fair value on a recurring basis as of September 30, 2014 and December 31, 2013 , by level within the fair value hierarchy. The Company’s assessment of the significance of a particular input to the fair value measurement 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):

16



September 30, 2014
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Money market funds (included in cash and cash equivalents)
 
$
22,903

 
$
22,903

 
$

 
$


December 31, 2013
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Money market funds (included in cash and cash equivalents)
 
$
2,900

 
$
2,900

 
$

 
$


NOTE 3.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents as of September 30, 2014 and December 31, 2013 consisted of the following (in thousands):
 
September 30,
 
December 31,
 
2014
 
2013
Cash and cash equivalents:
 
 
 
Cash
$
88,729

 
$
110,973

Money market funds
22,903

 
2,900

Total cash and cash equivalents
$
111,632

 
$
113,873


NOTE 4.
PROPERTY, EQUIPMENT AND SOFTWARE, NET
Property, equipment and software, net as of September 30, 2014 and December 31, 2013 , consisted of the following (in thousands):
 
September 30,
 
December 31,
 
2014
 
2013
Capitalized internal-use software costs
$
20,672

 
$
14,030

Computer hardware and software
35,328

 
17,077

Furniture and fixtures
11,167

 
1,735

Leasehold improvements
33,126

 
815

Construction in progress

 
3,622

Total
100,293

 
37,279

Accumulated depreciation and amortization
(22,076
)
 
(11,485
)
Total property, equipment and software, net
$
78,217

 
$
25,794

Total depreciation and amortization expense, excluding amortization of internal-use software costs, was $3.2 million and $0.8 million for the three months ended September 30, 2014 and 2013 , respectively, and $7.7 million and $2.1 million for the nine months ended September 30, 2014 and 2013 , respectively. Amortization expense of internal-use software costs was $1.4 million and $0.9 million for the three months ended September 30, 2014 and 2013 , respectively, and $3.7 million and $2.5 million for the nine months ended September 30, 2014 and 2013 , respectively. Refer to Note 6 for details of the Company's capital leases as of September 30, 2014 and December 31, 2013 .
NOTE 5.
BUSINESS COMBINATIONS
On September 5, 2014, the Company acquired X Plus Two Solutions, Inc., a Delaware corporation (“X Plus Two”), which wholly owns X Plus One Solutions, Inc, known in the industry as [x+1] ("[x+1]"). The Company paid as consideration an aggregate of $98.0 million in cash and 5,253,084 shares of the Company’s common stock.

17



Purchase consideration:
 
Cash
$
98,045

Fair value of 5,253,084 shares common stock transferred
82,421

Total preliminary purchase price
$
180,466

 The acquisition of X Plus Two was accounted for in accordance with the acquisition method of accounting for business combinations with the Company as the accounting acquirer. The Company expensed the related acquisition costs in the amount of $ 4.7 million in general and administrative expenses. Under the acquisition method of accounting, the total purchase price as shown in the table above is allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values. The total purchase price was allocated using the information currently available. As a result, we may continue to adjust the preliminary estimated purchase price allocation after obtaining more information regarding asset valuations, liabilities assumed, and making any revisions of our preliminary estimates. The preliminary purchase price allocation of the estimated purchase consideration is as follows:
Current assets
$
32,005

Non-current assets
3,999

Current liabilities
(28,893
)
Non-current liabilities
(16,216
)
Net acquired tangible assets
(9,105
)
Identifiable intangible assets
74,700

Goodwill
114,871

Total preliminary purchase price
$
180,466

The $114.9 million of goodwill is primarily attributable to synergies expected to be generated from combining the Company's and [x+1]’s technology and operations. None of the goodwill recorded as part of the acquisition will be deductible for U.S. federal income tax purposes.
The preliminary estimated useful life and fair values of the identifiable intangible assets as of September 30, 2014 were as follows (in thousands):
 
 
 
 
 
As of September 30, 2014
 
Estimated Useful Life (in years)
 
Preliminary Fair Value
(in thousands)
 
Accumulated Amortization
 
Net Book Value
Developed technology
3-4
 
$
42,100

 
$
(805
)
 
$
41,295

Customer relationships
7-8
 
27,700

 
(241
)
 
27,459

Trademarks
5
 
2,000

 
(28
)
 
1,972

Non-compete agreements
2
 
2,900

 
(100
)
 
2,800

Total
 
 
$
74,700

 
(1,174
)
 
73,526

Amortization expense of intangible assets for the three and nine months ended September 30, 2014 was $1.2 million . The expected annual amortization expense of intangible assets as of September 30, 2014 is presented below (in thousands):

18



Year ending December 31,
 
Amortization
2014 (remaining 3 months)
 
$
4,227

2015
 
16,908

2016
 
16,445

2017
 
14,095

2018
 
8,851

2019 and thereafter
 
13,000

Total
 
$
73,526

The results of operations of X Plus Two have been included in the Company's consolidated statements of operations from the acquisition date. The following unaudited pro forma condensed combined financial information reflects the Company's condensed results of operations for the periods indicated and assumes that the business had been acquired at the beginning of fiscal year 2013 and includes pro forma adjustments. Direct and incremental transaction costs are excluded from the three and nine months ended September 30, 2014 pro forma condensed combined financial information presented below, and included in the three and nine months ended September 30, 2013 . The unaudited pro forma results also include amortization associated with preliminary estimates for the acquired intangible assets and the associated tax impact on these unaudited pro forma adjustments. The tax benefit of $4.1 million that resulted from the acquisition is recorded in the three and nine months ended September 30, 2013 . The pro forma condensed combined financial information is presented for informational purposes only and is not necessarily indicative of results that would have occurred had the acquisition taken place at the beginning of the earliest period presented, or of future results.
Supplemental information on an unaudited pro forma basis, as if the acquisition had been consummated on January 1, 2013, is presented as follows (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Pro forma revenue
$
118,193

 
$
75,566

 
$
327,398

 
$
198,749

Pro forma net loss
$
(28,970
)
 
$
(18,842
)
 
$
(63,578
)
 
$
(45,919
)
NOTE 6.
ACCRUED AND OTHER CURRENT LIABILITIES
Accrued and other current liabilities as of September 30, 2014 and December 31, 2013 consisted of the following (in thousands):
 
September 30,
 
December 31,
 
2014
 
2013
Payroll and related expenses
$
15,641

 
$
10,722

Accrued vacation
385

 
2,220

Professional services
645

 
650

Accrued credit cards
971

 
774

Early exercise of unvested stock options
404

 
1,107

Employee stock purchase plan
2,181

 
1,427

Acquisition-integration costs

1,475

 

Fixed assets received, but unbilled

3,653

 

Other accrued expenses
7,913

 
4,684

Total accrued and other current liabilities
$
33,268

 
$
21,584



19



NOTE 7.
CAPITAL LEASES
Property and equipment at September 30, 2014 and December 31, 2013 included $8.5 million and $0.6 million , respectively, acquired under capital lease agreements of which the majority consists of computer hardware. There was $0.8 million and $0 of accumulated depreciation of property and equipment acquired under these capital leases at September 30, 2014 and December 31, 2013 , respectively.
The remaining future minimum lease payments under these non-cancelable capital leases as of September 30, 2014 were as follows (in thousands):
Year ending December 31,
 
Future Payments
2014 (remaining 3 months)
 
$
772

2015
 
3,088

2016
 
3,088

2017
 
1,424

Thereafter
 

Total minimum lease payments
 
$
8,372

Less: amount representing interest and taxes
 
(653
)
Less: current portion of minimum lease payments
 
(2,695
)
Capital lease obligations, net of current portion
 
$
5,024


NOTE 8.
OTHER INCOME (EXPENSE)—NET
Other income (expense)—net for the three and nine months ended September 30, 2014 and 2013 , consisted of the following (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Gain (loss) on foreign translation
$
(2,015
)
 
$
108

 
$
(2,476
)
 
$
(351
)
Other non-operating income (loss), net
16

 
47

 
33

 
138

Total other income (expense)—net
$
(1,999
)
 
$
155

 
$
(2,443
)
 
$
(213
)

NOTE 9.
DEBT
Loan Facility —On December 20, 2013, the Company entered into an Amended and Restated Revolving Credit and Term Loan Agreement (the "Loan Facility") with certain lenders. Subsequently, the Company entered into a First Amendment to the Loan Facility on June 30, 2014 and a Second Amendment to the Loan Facility on October 31, 2014 to expand the credit facility and to adjust certain terms, definitions and covenants. The Loan Facility provides for an $80.0 million revolving credit facility, with a $12.0 million letter of credit subfacility, as amended from $5.0 million, and a $1.5 million swingline subfacility, and a $20.0 million secured term loan facility. The Loan Facility permits the Company, subject to certain requirements, to request an increase in the maximum revolving commitments under the Loan Facility by up to $25.0 million in additional revolving commitments. Revolving loans may be advanced under the Loan Facility in amounts up to the lesser of the $80.0 million maximum and a borrowing base equal to 85% of the value of eligible accounts receivable. The borrowing base is subject to certain reserves and eligibility criteria. Letters of credit can be issued under the subfacility up to $12.0 million , provided that the aggregate amount of advances outstanding under the revolving facility, the subfacility and the swingline facility do not exceed the lesser of the $80.0 million maximum and the borrowing base amount. If at any time the aggregate amounts outstanding under the revolving facility, the letter of credit subfacility and the swingline facility exceed the lesser of the $80.0 million maximum and the borrowing base then in effect, then the Company must make a prepayment in an amount sufficient to eliminate the excess. Loan proceeds may be

20



used for general corporate purposes. The Company may prepay revolving loans and term loans under the Loan Facility in whole or in part at any time without premium or penalty, subject to certain conditions.
In September 2014, the Company drew $35.0 million on the revolving credit facility for a total $42.4 million balance outstanding as of September 30, 2014 .
Revolving loans bear interest, at the Company's option, at (i) a base rate determined pursuant to the terms of the Loan Facility, plus a spread of 1.75% to 2.50% , or (ii) a LIBOR rate determined pursuant to the terms of the Loan Facility, plus a spread of 2.75% to 3.50% . Term loans bear interest, at the Company's option, at (i) a base rate determined pursuant to the terms of the Loan Facility, plus a spread of 2.75% to 3.50% , or (ii) a LIBOR rate determined pursuant to the terms of the Loan Facility, plus a spread of 3.75% to 4.50% . In each case, the spread is based on the cash reflected on the Company's balance sheet for the preceding fiscal quarter. The base rate is determined by taking the greatest of (i) the prime rate announced by Comerica, (ii) the federal funds rate plus 1.0% and (iii) the daily adjusting LIBOR rate plus 1.0% . Interest is due and payable quarterly in arrears for base rate loans. Interest is due and payable at the end of an interest period (or at each three months interval in the case of loans with interest periods greater than three months ) for LIBOR rate loans.
The Company is required to maintain certain financial covenants under the Loan Facility, including the following:
EBITDA. The Company is required to maintain specified EBITDA, which is defined for this purpose, with respect to any trailing twelve month 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; non-cash expenses or losses; stock-based compensation expense; costs and expenses from permitted acquisitions up to certain limits; costs and expenses in connection with the Loan Facility and any other expenses agreed with Comerica and the lenders; payroll-related expenses incurred in connection with the exercise of employee stock options up to certain limits; integration costs related to the [x+1] acquisition up to certain limits; less (iii) all extraordinary and non-recurring revenues and gains (including income tax benefits).
Liquidity ratio. Under the Loan Facility, the ratio of (i) the sum of all cash on deposit with Comerica and certain other domestic financial institutions and the aggregate amount of all eligible accounts receivable to (ii) all indebtedness owing to the lender of the Loan Facility must be at least 1.10 to 1.00 .
The terms of the Loan Facility also require the Company to comply with certain other financial and non-financial covenants. As of September 30, 2014 , the Company was out of compliance with one covenant, related to capital expenditure limits, for which a waiver was obtained. This limit was increased in the Second Amendment to the Loan Facility.
Future Payments
Future principal payments of long-term debt as of September 30, 2014 were as follows (in thousands):
Year ending December 31,
 
Future Payments
2014 (remaining 3 months)
 
$

2015
 
5,000

2016
 
5,000

2017
 
5,000

2018
 
5,000

Total
 
20,000

Less: current portion of long-term debt
 
(3,750
)
Long-term debt, net of current portion
 
$
16,250

As of September 30, 2014 , the $42.4 million balance outstanding under the revolving credit facility had a maturity date of December 20, 2016, and because the Company has the option to draw upon the facility or repay borrowed funds at any time, the balance is shown as a current liability in the accompanying consolidated balance sheet. Additionally, the debt liabilities on the condensed consolidated balance sheet are net of $0.5 million in debt discounts.

21



Additionally, $11.1 million of debt that was assumed with the acquisition of [x+1] was paid in full prior to September 30, 2014 .
NOTE 10.
STOCKHOLDERS’ EQUITY
In February 2014, the Company completed an underwritten follow-on public offering of its common stock in which 2,000,000 shares of common stock were sold by the Company and 3,000,000 shares of common stock were sold by selling stockholders. The public offering price of the shares sold in the offering was $61.00 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 $122.0 million . After deducting underwriters’ discounts and commissions and offering expenses, the aggregate net proceeds received by the Company totaled approximately $115.4 million .
On September 5, 2014, the Company acquired X Plus Two, which wholly owns [x+1], for 5,253,084 shares of the Company’s common stock and $98.0 million in cash.
Reserved Shares of Common Stock —The Company’s shares of capital stock reserved for issuance as of September 30, 2014 were as follows:
 
September 30, 2014
Options outstanding
6,716,267
Restricted stock awards and units outstanding
977,005
Available for future stock option and restricted stock unit grants
5,367,331
Available for future employee stock purchase plan purchases
1,478,069
Total shares reserved
14,538,672
2008 Equity Incentive Plan —The 2008 Equity Incentive Plan (the “2008 Plan”) provides for the grant of incentive stock options and nonqualified stock options. The compensation committee of the Company's board of directors has the authority to approve the employees and non-employees to whom options are granted and determine the terms of each option, including (i) the number of shares of common stock subject to the option; (ii) when the option becomes exercisable; (iii) the option exercise price, which, in the case of incentive stock options, 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 (which, in the case of incentive stock options, may not exceed 10 years ). Options granted under the 2008 Plan generally vest over four years and expire no later than 10 years from the date of grant. The Company has terminated the 2008 Plan for future use, and 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, certain employees received the right 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, 2014 and December 31, 2013 , 137,865 and 315,579 unvested shares, respectively, were subject to repurchase. During the nine months ended September 30, 2014 and year ended December 31, 2013 , the Company repurchased 21,855 and 5,834 shares of unvested stock, respectively.
2013 Equity Incentive Plan —Since its initial public offering in September 2013, the Company has made equity grants pursuant to its 2013 Equity Incentive Plan (the “2013 Plan”). 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 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.
A total of 5,000,000 shares of common stock were reserved for issuance upon initial adoption of the 2013 Plan. 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 provision is 7,900,000 shares).
The number of shares available for issuance under the 2013 Plan also includes an annual increase on the first day of each fiscal year 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

22



immediately preceding fiscal year; or (iii) such other amount as the Company’s board of directors may determine. Effective January 1, 2014, 1,641,299 shares were added to the shares reserved for issuance under the 2013 Plan according to the terms described above.
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 awards to non-employee members of the board of directors are determined under the Company's Outside Director Compensation Policy. 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 Company's common stock as of the date of grant and may not expire later than 10 years from the date of grant.

The following tables summarize option award activity:
 
Number of
Shares
Outstanding
 
Weighted-
Average
Exercise
Price
 
Weighted-
Average
Remaining
Contractual
Life
(Years)
 
Aggregate
Intrinsic Value (in thousands)
 
 
 
 
 
 
 
 
Balance at December 31, 2013
7,410,588
 
$
6.97

 
8.5
 
$
404,106

Options granted (weighted average fair value of $23.40 per share)
537,908
 
43.15

 
 
 
 
Options exercised
(959,588)
 
2.81

 
 
 
 
Options forfeited
(272,641)
 
12.25

 
 
 
 
Balance at September 30, 2014
6,716,267
 
$
10.24

 
7.9
 
$
54,427

Options vested and expected to vest—September 30, 2014
6,383,874
 
$
9.86

 
7.9
 
$
52,879

Options vested and exercisable—September 30, 2014
3,423,608
 
$
5.69

 
7.4
 
$
35,329

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 $1.7 million and $9.5 million for the three months ended September 30, 2014 and 2013 , respectively, and $29.7 million and $10.9 million for the nine months ended September 30, 2014 and 2013 , 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. Due to the lack of historical exercise activity for the Company, the simplified method calculates the expected term as the mid-point between the vesting date and the contractual expiration date of the award. Volatility is estimated using comparable public company volatility for similar option terms until a sufficient amount of historical information regarding the volatility of our own common stock share price becomes available. 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:

23



 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Expected term (years)
6.3
 
5.3–6.1
 
5.5–6.3
 
5.3–6.6
Volatility
56.7%–57.6%
 
58.2%–59.1%
 
55.6%–58.0%
 
58.2%–64.9%
Risk-free interest rate
1.84%
 
1.59%–1.73%
 
1.84%–1.97%
 
1.04%–1.88%
Dividend yield
 
 
 

As of September 30, 2014 and December 31, 2013 , unamortized stock-based compensation expense related to unvested common stock options was $27.2 million and $21.7 million , respectively. The weighted-average period over which such stock-based compensation expense will be recognized is approximately 2.2  years.
Restricted Stock Units ("RSUs") and Restricted Stock Awards ("RSAs") —A summary of RSU activity for the nine months ended September 30, 2014 is as follows:
 
Number of Shares
 
Weighted Average Grant Date Fair Value
Unvested at December 31, 2013
382,402

 
$
55.86

Granted
718,112

 
30.20

Vested and issued
(54,334
)
 
45.33

Canceled
(69,175
)
 
44.99

Unvested at September 30, 2014
977,005

 
$
38.35

During the nine months ended September 30, 2014 , the Company granted 4,000 RSAs with a weighted average grant date fair value of $16.67 .
The Company recognized stock-based compensation expense associated with RSUs and RSAs of $2.5 million and $0.1 million for the three months ended September 30, 2014 and 2013 , respectively, and $6.5 million and $0.1 million for the nine months ended September 30, 2014 and 2013 , respectively. At September 30, 2014 , unrecognized compensation expense related to the RSUs and RSAs was $26.8 million . The unrecognized compensation expense will be amortized on a straight-line basis through 2018. The total fair value of RSUs and RSAs vested and issued during the three and nine months ended September 30, 2014 was $0.5 million and $1.2 million , respectively.
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 Company's initial public offering, the first offering period started on October 1, 2013 and ended 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 trading day of the offering period. As of September 30, 2014 , total compensation costs related to rights to purchase shares of common stock under the ESPP offering period ending November 30, 2014, but not yet vested were approximately $1.7 million , which will be recognized over the offering period.


24



The assumptions used to calculate our stock-based compensation for each stock purchase right granted under the ESPP were as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2014
 
September 30, 2014
Expected term (years)
0.5
 
0.5–0.7
Volatility
77.4%
 
66.2%–77.4%
Risk-free interest rate
0.06%
 
0.06%–0.07%
Dividend yield
 

Equity compensation allocation
The following table summarizes the allocation of stock-based compensation in the accompanying condensed consolidated statements of operations (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Cost of revenue
$
282

 
$
93

 
$
810

 
$
211

Research and development
1,279

 
506

 
3,577

 
1,266

Sales and marketing
2,683

 
1,152

 
7,598

 
2,471

General and administrative
1,685

 
902

 
4,900

 
2,305

Total
$
5,929

 
$
2,653

 
$
16,885

 
$
6,253


NOTE 11.
NET INCOME (LOSS) PER SHARE
The Company calculates its basic and diluted net income (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. Because the Company had net losses for the three and nine months ended September 30, 2014 and 2013 , all potential shares of common stock were determined to be anti-dilutive.

25



The following table sets forth the computation of net loss per share of common stock (in thousands, except per share amounts):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Net loss
$
(22,831
)
 
$
(6,860
)
 
$
(43,815
)
 
$
(18,771
)
Weighted-average shares used to compute basic and diluted net loss per share
37,230

 
11,315

 
35,490

 
9,346

Basic and diluted net loss per share
$
(0.61
)
 
$
(0.61
)
 
$
(1.23
)
 
$
(2.01
)
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 Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Employee stock options
6,716

 
7,405

 
6,716

 
7,405

Shares subject to repurchase
138

 
380

 
138

 
380

Restricted stock units (RSUs) and restricted stock awards (RSAs)
977

 
51

 
977

 
51

Employee stock purchase plan
106

 

 
106

 

 
7,937

 
7,836

 
7,937

 
7,836


NOTE 12.
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 benefit of $4.1 million and income tax provision of $0.1 million for the three months ended September 30, 2014 and 2013 , respectively. The Company recorded an income tax benefit of $3.6 million and income tax provision of $0.2 million for the nine months ended September 30, 2014 and 2013 , respectively. The tax benefit for the three and nine months ended September 30, 2014 is primarily due to a partial release of valuation allowance against the Company’s deferred tax assets limited to the amount of the net deferred tax liabilities generated from intangibles acquired from the [x+1] acquisition, partially offset by provisions for foreign and state income taxes. The tax expense for the three and nine months ended September 30, 2013 is primarily due to foreign and state income tax expense.
The following table presents the components of the benefit (provision) for income taxes (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Federal
$
4,031

 
$

 
$
4,031

 
$

State
(2
)
 
5

 
(2
)
 
1

Foreign
91

 
(138
)
 
(404
)
 
(174
)
Total benefit (provision) for income taxes
$
4,120

 
$
(133
)
 
$
3,625

 
$
(173
)
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. In connection with the acquisition of [x+1], the Company recorded $5.1 million of net deferred tax liabilities related to the intangible assets less deferred tax assets from net operating losses and research and development tax credits of the acquired entity.

26



Due to uncertainty as to the realization of benefits from deferred tax assets, including net operating loss carry-forwards, research and development and other tax credits, the Company maintains a valuation allowance reserved against the balance of such assets as of September 30, 2014.
NOTE 13.
COMMITMENTS AND CONTINGENCIES
Operating Leases —The Company has operating lease agreements for office space for administration, research and development and sales and marketing activities in the United States that expire at various dates, with the latest expiration date in 2025.
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 $3.9 million and $1.0 million for the three months ended September 30, 2014 and 2013 , respectively, and $10.8 million and $2.5 million for the nine months ended September 30, 2014 and 2013 , respectively.
Approximate remaining future minimum lease payments under these non-cancelable operating leases as of September 30, 2014 were as follows (in thousands):
Year ending December 31,
 
Future Payments
2014 (remaining 3 months)
 
$
2,731

2015
 
17,087

2016
 
20,260

2017
 
19,770

2018
 
18,479

Thereafter
 
65,951

 
 
$
144,278

Please refer to Note 6 for details of the Company's capital lease commitments as of September 30, 2014 and December 31, 2013 .
Letters of Credit Bank Guarantees and Restricted Cash —As of September 30, 2014 and December 31, 2013 , the Company had irrevocable letters of credit outstanding in the amount of $6.2 million and $3.4 million , respectively, for facilities leases. The letters of credit have various expiration dates, with the latest being June 2025.
As of September 30, 2014 , the Company had $3.0 million reserved to support bank guarantees for certain office lease agreements. These amounts are classified as restricted cash on the Company's condensed consolidated balance sheets.
Indemnification Agreements —In the ordinary course of business, the Company enters into agreements providing for indemnification of varying scope and terms to 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 condensed consolidated balance sheets, condensed consolidated statements of operations, condensed consolidated statements of comprehensive loss, or condensed consolidated statements of cash flows.
Legal Proceedings —The Company is involved from time to time in claims, proceedings, and litigation, including the following:
On September 3, 2014 and September 10, 2014, respectively, two purported class actions were filed in the Northern District of California against the Company and certain of the Company’s officers and directors. The actions are Shah v. Rocket Fuel Inc., et al. , Case No. 4:14-cv-03998, and Mehrotra v. Rocket Fuel Inc., et al. , Case No. 4:14-cv-04114. The underwriters of the Company’s initial public offering on September 19, 2013 (the “IPO”) and its secondary offering on February 5, 2013 (the

27



“Secondary Offering”) are also named as defendants. The complaints allege that the defendants made false and misleading statements about the ability of the Company’s technology to detect and eliminate fraudulent web traffic, and about the Company's future prospects. The complaints also allege that the Company’s registration statements and prospectuses for the IPO and the Secondary Offering contained false and misleading statements on these topics. The complaints purport to assert claims for violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, and for violations of Sections 11 and 15 of the Securities Act of 1933, on behalf of those who purchased the Company’s common stock between September 20, 2013 and August 5, 2014, inclusive, as well as those who purchased stock in the Company’s initial public offering on September 19, 2013. The Mehrotra complaint also purports to assert a claim for violation of Section 12(a)(2) of the Securities Act of 1933. The complaints seek monetary damages in an unspecified amount.
The outcomes of the Company's legal proceedings are inherently unpredictable, subject to significant uncertainties, and could be material to its operating results and cash flows for a particular period. 
Legal fees are expensed in the period in which they are incurred.
NOTE 14.
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.
NOTE 15.
SEGMENTS
The Company considers operating segments to be components of the Company's business for 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 Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
North America
$
85,948

 
$
56,578

 
$
226,519

 
$
137,824

All Other Countries
16,150

 
5,880

 
42,618

 
17,215

Total revenue
$
102,098

 
$
62,458

 
$
269,137

 
$
155,039

The following table summarizes total long-lived assets in the respective locations (in thousands):
 
September 30,
 
December 31,
 
2014
 
2013
North America
$
73,263

 
$
23,956

All Other Countries
4,954

 
1,838

Total long-lived assets
$
78,217

 
$
25,794


As of September 30, 2014 , three agency holding companies and no single advertiser accounted for 10% of more of accounts receivable. As of December 31, 2013 , no single agency holding company or advertiser accounted for 10% or more of accounts receivable.

28



With respect to revenue concentration, the Company defines a customer as an advertiser that is a distinct source of revenue and is legally bound to pay for the advertising services that the Company delivers on the advertiser’s behalf. The Company counts 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 the Company. During the three and nine months ended September 30, 2014 and 2013 , no single customer represented 10% or more of revenue.
The Company also monitors the percentage of revenue that flows through advertising agencies, even though advertising agencies that act on behalf of the Company’s advertisers are not considered customers based on the definition above. If all branches and divisions within each global advertising agency were considered to be a single agency for this purpose, three agency holding companies would have been associated with 10% or more of revenue during the three and nine months ended September 30, 2014 , and two agency holding companies would have been associated with 10% or more of revenue during the three and nine months ended September 30, 2013 .
NOTE 16.
SUBSEQUENT EVENTS
No subsequent events have occurred that would require adjustment to the financial statements or disclosures included in the financial statements.


29



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, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended, (the "Exchange Act"). The words “believe,” “may,” “will,” “potentially,” “estimate,” “continue,” “anticipate,” “intend,” “could,” “would,” “project,” “plan,” “expect” and similar expressions that convey uncertain expectations 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;
the impact of our recent acquisition of [x+1] on our financial condition and results of operations, including but not limited to the impact of assumptions underlying the accounting treatment of the transaction;
our ability to effectively integrate the operations of [x+1] and realize anticipated synergies and new market opportunities from this combination;
our ability to maintain an adequate rate of revenue growth;
our capital investment plans and our ability to effectively manage those investments;
our growth strategies;
our ability to grow other channels and brand revenue and cross-sell our offerings;
our future operating expenses, including changes in research and development, sales and marketing and general and administrative expenses;
our ability to timely and effectively adapt our existing technology;
our ability to introduce new offerings that gain market acceptance, including the recently announced expansion of our self-service platform;
our ability to continue to expand internationally;
our ability to fulfill covenants and obligations under our existing business agreements;
our ability to manage our cash and undrawn balances under our loan facility to meet our liquidity needs for at least the next 12 months;
the effects of increased competition in our market and our ability to compete effectively;
our plans to use the proceeds from our initial and follow-on public offerings;
future acquisitions of or investments in complementary companies or technologies;
our expectations concerning relationships with third parties; and
the effects of seasonal trends on our results of operations and key metrics,
These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. 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 Quarterly Report on Form 10-Q may not occur and actual results could differ materially and adversely from those anticipated or implied in our forward-looking statements.

30



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 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 Quarterly Report on Form 10-Q to conform these statements to actual results or to changes in our expectations, except as required by law.
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 Artificial Intelligence, or AI, system autonomously purchases ad spots, or impressions, one at a time, on advertising 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. The ad purchasing solution we offer often is referred to as a Demand Side Platform, or “DSP.” We offer our DSP primarily as a full service platform for advertising agencies, advertisers and other parties. We have also provided a self-service version of the platform as a software-as-a-service ("SaaS") offering to a Japanese advertising agency since 2013, and in July 2014, we made the SaaS offering more widely available to agencies and other enterprise customers.
With our September 2014 acquisition of [x+1], a leading provider of programmatic marketing and data management solutions, we now have an Data Management Platform, or “DMP,” to offer to enterprise customers in conjunction with our DSP solution. [x+1] also offers customers a DSP solution, which we intend to integrate with our solution. [x+1]'s solutions allow enterprise customers to use their own customers' data to target relevant advertising messages across paid and owned media channels, including an advertiser's own website. The acquisition of [x+1] expands our market opportunity and accelerates our entry into the digital marketing enterprise SaaS market. Revenue from these SaaS offerings and related professional services was not material to the Company in the third quarter of 2014.
Our revenue retention rate was 135% and 149% for the twelve months ended September 30, 2014 and June 30, 2014 , 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 the prior twelve-month period. For the past twelve trailing months, as of September 30, 2014 , our active customer base included 90 of the Advertising Age 100 Leading National Advertisers and 61 of the Fortune 100 companies. Additionally, as of September 30, 2014 , we had 111 customers with more than $1 million in lifetime spend with us, with 55 of these 111 trusting us with over $2 million in lifetime spend and 17 of these 55 trusting us with over $5 million in lifetime spend.
Our solutions are 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, 2014 and 2013 , 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 had served well over 333 billion impressions as of September 30, 2014 . As of September 30, 2014 , our computational infrastructure supported over 41,000 CPU cores in eight data centers and housed 20 petabytes of compressed data.
We generate revenue primarily by delivering digital advertisements to consumers through our platform 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. Our technology works 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 comprehensive solutions that address the display, mobile, social and video channels, as well meeting the demand for data management solutions.
Our DSP contracts typically have a term of less than one 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

31



detail under “Note 1—Nature of Business and Summary of Significant Accounting Policies” in the notes to our condensed consolidated financial statements included in Part I, Item 1.
We plan to invest for long-term growth. We anticipate that our operating expenses will increase significantly in the foreseeable future as we continue to grow our business. We expect to invest in research and development to enhance our solutions and integrate [x+1]'s technology with ours. In addition, we expect to invest in sales and marketing to integrate the two companies’ sales organizations, to provide more training in enterprise offerings, to acquire new customers and to reinforce our relationships with existing customers. We also expect to invest in our infrastructure, including our IT, financial and administrative systems and controls, to support our growth.
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 ex-TAC (previously referred to as "Revenue less media costs") and adjusted EBITDA are discussed under the heading “—Non-GAAP Financial Performance Metrics.” Number of active customers is discussed below (in thousands, except number of active customers):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Revenue
$
102,098

 
$
62,458

 
$
269,137

 
$
155,039

Revenue ex-TAC (non-GAAP)
59,092

 
36,035

 
158,494

 
87,327

Adjusted EBITDA (non-GAAP)
(4,309
)
 
(676
)
 
(7,504
)
 
(4,578
)
Number of active customers
1,446

 
938

 
1,446

 
938

Number of Active Customers
We define an active customer as a customer from whom we recognized revenue in the last three months. A 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. For example, the number of active customers, excluding active customers originating through our licensing agreement with a Japanese advertising agency, was flat from December 31, 2013, to March 31, 2014, but increased by 18% from March 31, 2014 to June 30, 2014, and was flat again from June 30, 2014 to September 30, 2014.
Non-GAAP Financial Performance Metrics
To supplement our condensed consolidated financial statements, which are prepared and presented in accordance with generally accepted accounting principles, or GAAP, we provide investors with the following financial measures that are not prepared in accordance with GAAP.
Revenue ex-TAC (previously referred to as "Revenue Less Media Costs")
Revenue ex-TAC (previously referred to as "revenue less media costs," but with no changes to the definition) is a non-GAAP financial measure defined by us as 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 ex-TAC 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 ex-TAC 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 considering

32



the comparable GAAP financial measures of revenue, cost of revenue and total operating expenses. The following table presents a reconciliation of revenue ex-TAC to revenue for each of the periods indicated (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Revenue
$
102,098

 
$
62,458

 
$
269,137

 
$
155,039

Less: Media costs
43,006

 
26,423

 
110,643

 
67,712

Revenue ex-TAC
$
59,092

 
$
36,035

 
$
158,494

 
$
87,327

Adjusted EBITDA
Adjusted EBITDA is a non-GAAP financial measure defined by us as net loss before income tax benefit (provision), interest expense, net, depreciation and amortization expense (excluding amortization of internal use software), stock-based compensation expense and related payroll tax, change in fair value of convertible preferred stock warrant liability, other income (expense), net and acquisition related and other expenses. We have presented adjusted EBITDA in this Quarterly Report on Form 10-Q 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.
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) interest and 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.

33



The following table presents a reconciliation of adjusted EBITDA to net loss for each of the periods indicated (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Net loss
$
(22,831
)
 
$
(6,860
)
 
$
(43,815
)
 
$
(18,771
)
Adjustments:
 
 
 
 
 
 
 
Interest expense, net
1,157

 
251

 
2,085

 
604

Income tax benefit (provision)
(4,120
)
 
133

 
(3,625
)
 
173

Depreciation and amortization expense (excluding amortization of internal-use software)
4,394

 
781

 
8,865

 
2,061

Stock-based compensation expense
5,929

 
2,653

 
16,885

 
6,253

Change in fair value of convertible preferred stock warrant liability

 
2,385

 

 
4,740

Other income (expense) - net
1,999

 
(155
)
 
2,443

 
213

Acquisition related and other expenses
9,136

 

 
9,236

 

Payroll tax expense related to stock-based compensation
27

 
136

 
422

 
149

Total adjustments
18,522

 
6,184

 
36,311

 
14,193

Adjusted EBITDA
$
(4,309
)
 
$
(676
)
 
$
(7,504
)
 
$
(4,578
)
Prior to the third quarter of 2014, we defined Adjusted EBITDA as net loss before income tax benefit (provision), 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. This definition was revised, beginning in the third quarter of 2014, to exclude payroll tax expense related to stock-based compensation, other income (expense), net and acquisition related and other expenses.
Acquisition related and other expenses: We exclude the effect of acquisition related and other expenses and the effect of restructuring expenses from our non-GAAP operating expenses and net income/ (loss) measures. We have incurred and will incur significant expenses in connection with our acquisition of [x+1] and have also incurred certain other operating expenses or income, which we generally would not have otherwise incurred as a part of our continuing operations. Acquisition related and other expenses consist of personnel related costs for transitional employees, other acquired employee related costs, stock-based compensation expenses (in addition to the stock-based compensation expenses described above), integration related professional services, certain business combination adjustments including adjustments after the measurement period has ended and certain other operating items, net. Substantially all of the stock-based compensation expenses included in acquisition related and other expenses resulted from unvested options assumed in acquisitions whose vesting was fully accelerated upon termination of the employees pursuant to the original terms of those options. We believe it is useful for investors to understand the effects of these items on our total operating expenses. Acquisition related expenses generally diminish over time with respect to acquisitions, we generally will incur these expenses in connection with any future acquisitions.
Payroll tax expense related to stock-based compensation. We exclude payroll tax expense related to stock-based compensation expense because, without excluding these tax expenses, investors would not see the full effect that excluding stock-based compensation expense had on our operating results. These expenses are tied to the exercise or vesting of underlying equity awards and the price of our common stock at the time of vesting or exercise, which factors may vary from period to period independent of the operating performance of our business. Similar to stock-based compensation expense, we believe that excluding this payroll tax expense provides investors and management with greater visibility to the underlying performance of our business operations and facilitates comparison with other periods as well as the results of other companies.
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 such as amortization of intangible assets and 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.

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A limitation of adjusted net loss is that it is a measure that may be unique to us and may not enhance the comparability of our results to other companies in the same industry that define adjusted net loss differently. This measure may also exclude expenses that may have a material impact on our reported financial results. Our management compensates for these limitations by also considering the comparable GAAP financial measure of net loss.
The following table presents a reconciliation of adjusted net loss to net loss for each of the periods indicated (in thousands):


Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
Net loss
$
(22,831
)
 
$
(6,860
)
 
$
(43,815
)
 
$
(18,771
)
Adjustments:
 
 
 
 
 
 
 
Stock-based compensation expense
5,929

 
2,653

 
16,885

 
6,253

Change in fair value of convertible preferred stock warrant liability

 
2,385

 

 
4,740

Amortization of intangible assets
1,175

 

 
1,175

 

Acquisition related and other expenses
9,136

 

 
9,236

 

Tax impact of the above items

 

 

 

Adjusted net loss
$
(6,591
)
 
$
(1,822
)
 
$
(16,519
)
 
$
(7,778
)
Adjusted diluted net loss per share
$
(0.18
)
 
$
(0.16
)
 
$
(0.47
)
 
$
(0.83
)
Weighted average shares used in computing adjusted diluted net loss per share
37,230

 
11,315

 
35,490

 
9,346

Prior to the third quarter of 2014, we defined adjusted net loss as net loss before stock-based compensation expense and the change in fair value of convertible preferred stock warrant liability. This definition was revised, beginning in the third quarter of 2014, as net loss excluding stock-based compensation expense, changes in fair value of convertible preferred stock warrant liability, amortization of intangible assets, acquisition related and other expenses and the estimated tax impact of the foregoing items. The change in this definition did not result in a change to prior periods previously disclosed, except for the quarter ending June 30, 2014 which would be adjusted by $0.1 million for acquisition related and other expenses.
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 have invested and will continue to invest in research and development to enhance our solution and create additional offerings, 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, data centers and leasehold improvements. We expect our capital expenditures to increase significantly in 2014 compared to 2013. We are also investing to further automate our business processes with the goals of scaling our business while maintaining customer satisfaction and enhancing our profitability. Our acquisition of [x+1] represents a significant investment. We believe that these investments will contribute to our long-term growth, although they will reduce our profitability in the near term. Beginning in the second quarter of 2014, we saw operating expenses increase as a percent of revenue, and we anticipate this trend to continue at least through 2014. However, we expect that over the long term, our sales and marketing expenses will grow more slowly than revenue due to growth in our enterprise business as well as enhanced productivity within our sales team as their tenure increases. In addition, we expect research and development and general and administrative expenses to grow more slowly than revenue over the long term as we continue to scale our business.
Technology Enhancements and Customer Satisfaction

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      We will continue to make improvements to our technology platforms that may have an impact on both our gross profit margin and our performance against advertiser objectives. We expect that our margin may be impacted not only by technology improvements, but also by competitive pressures, 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, our product mix (particularly going forward the mix of DSP and DMP business), our pricing strategies and 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, which has constituted the majority of online 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. These latter channels are now growing faster than display. Our technology platform is scalable and extensible across all channels, so technology will not be a barrier to penetration of mobile, social and video channels; however, we have experienced and may continue to experience sales and marketing challenges as we expand into these channels and increase our offerings. We believe that our future success depends in part on the successful introduction of new offerings that expand our capabilities in video, mobile and brand advertising, and our ability to market and cross-sell the full suite of Rocket Fuel offerings to our customers.
Customer Growth and Retention; Competition
We must continue to attract new customers, and/or gain a larger amount of our current customers’ advertising budgets, to continue our growth. Over the long term we aim to do both, but the relative focus on onboarding new customers or developing existing customers will vary over time with our product offerings and sales and service efficiencies.
Our number of active customers increased from 938 as of September 30, 2013 to 1,446 as of September 30, 2014 , contributing to revenue growth from $62.5 million for three months ended September 30, 2013 , to $102.1 million for the three months ended September 30, 2014 . However, the number of active customers was flat from June 30, 2014 to September 30, 2014, increased by 15% from March 31, 2014 to June 30, 2014, and was flat again from December 31, 2013, to March 31, 2014.
New customers generally spend less than customers that have used our solution for longer periods of time. We also experienced decreased spending in 2014 by larger customers (measured by the amount of spend) who also spent with us in the same period in 2013. Adding new customers that tend to spend less and declining spend from larger and longer tenured customers contributed to the slowing rate of year-over-year revenue growth on a percentage basis since the third quarter of 2013, which we expect will continue for the remainder of 2014.
Our revenue retention rate was 135% for the twelve months ended September 30, 2014 and 149%, 161% and 168% for each of the twelve months ended June 30, 2014 , March 31, 2014 and December 31, 2013 , respectively.
We compete for advertising budget with a variety of companies, including agency trading desks and companies that offer self-service platforms that allow advertisers to purchase inventory directly from advertising exchanges or other third parties, and to manage and analyze their own and third-party data. In our experience, it is our larger and longer tenured customers who are more likely to reduce their spend with us in favor of self-service platforms, agency trading desks, or other media strategies. In 2014, we have experienced a decline in revenue from some customers when they utilized agency trading desks to a greater extent or adopted self-serve platforms. Furthermore, agencies are effective at promoting the use of agency trading desks and are increasingly involved in helping to select self-service platform providers for the advertisers they represent. This trend has impacted, and may continue to impact, our ability to grow revenue from those advertisers. In July 2014, we announced an expansion of our self-service platform to the United States and Europe, which we believe will allow us to compete more directly with companies that offer self-service platform solutions to agencies (as their trading desk solution) and to advertisers. With our September 2014 acquisition of [x+1], we now have an enterprise DMP to offer to enterprise customers in conjunction with our DSP solution.
Our ability to continue growing revenue will also depend in part upon the successful introduction of new offerings for mobile, video and brand advertising campaigns that continue to differentiate us from our competitors; our ability to improve our relationships with and identify opportunities to work collaboratively with agencies and agency trading desks; our ability to market and cross-sell our full suite of offerings and increase our larger customers' spend with us; and the rate at which new sales personnel become productive and we add new customers. While we have experienced a decline in sales productivity since the second quarter of 2014 in North America, we continue to believe that as our sales team becomes more seasoned, we will experience an increase in sales productivity over the long term.

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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. Over the past two quarters we have noted an expanding trend of customer concerns about inventory quality on real-time advertising exchanges that impacts the entire industry. 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 primarily by delivering digital advertisements to consumers through the display channel and other channels such as mobile devices and through social and video channels. For the three and nine months ended September 30, 2014 and 2013 , 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 typically 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 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. Any revenue from subscriptions and related professional services, which is generally recognized over the term of the subscription period, was not material. Our revenue recognition policies are discussed in more detail under “—Nature of Business and Summary of Significant Accounting Policies” in the notes to our Condensed Consolidated Financial Statements included in Part I, Item 1.
Cost of Revenue
Cost of revenue consists primarily of media costs, and to a lesser extent, personnel costs, depreciation and amortization expense, amortization of internal-use software development costs on revenue-producing technologies, third-party inventory validation and data vendor costs, hosting costs 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. Third-party inventory validation and data vendor costs consist primarily of costs to augment campaign performance and monitor our brand safety efforts. Cost of revenue also includes third-party data center costs and depreciation of data center equipment. Allocated costs include charges for facilities, office expenses, telephones, and other miscellaneous expenses. 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. Allocated costs include charges for facilities, office expenses, telephones and other miscellaneous expenses.
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

37



continued investment in technology is critical to pursuing 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 (i) marketing our solution to generate awareness; (ii) increasing the adoption of our solution by existing and new advertisers; and (iii) 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. We expect sales and marketing expenses to increase in absolute dollars in future periods. In particular, we expect to incur additional marketing costs to support the launch of new offerings.
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 functions, 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 term debt.
Other income (expense)—net. Other income (expense)—net consists primarily of gains and losses on foreign currency translation and, to a lesser extent, interest income. We have foreign currency exposure related to our cash and accounts receivable that are denominated in currencies other than the U.S. dollar, principally the British pound and the Euro.
Change in fair value of convertible preferred stock warrant liability.   During 2013, 2012 and 2011, 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, in September 2013, 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, beginning with the fourth quarter of 2013, we were no longer 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 carry-forwards, research and development and other tax credits, we evaluate the need to have a valuation allowance against such tax assets. We expect to maintain this valuation allowance at least in the near term.

38



Results of Operations
The following tables set forth our consolidated results of operations and our consolidated results of operations as a percentage of revenue for the periods presented (in thousands):
 
Three Months Ended
 
Nine Months Ended