Rocket Fuel Inc.
Rocket Fuel Inc. (Form: 10-Q, Received: 08/14/2014 12:05:32)





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 June 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. O n July 31, 2014, 35,854,036 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)

 
June 30,
 
December 31,
 
2014
 
2013
Assets
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
203,540

 
$
113,873

Accounts receivable, net
93,941

 
90,502

Deferred tax assets
207

 
207

Prepaid expenses
2,526

 
2,164

Other current assets
17,797

 
3,962

Total current assets
318,011

 
210,708

Property, equipment and software, net
56,234

 
25,794

Restricted cash
2,227

 

Other assets
1,315

 
1,006

Total assets
$
377,787

 
$
237,508

Liabilities and Stockholders’ Equity
 
 
 
Current Liabilities:
 
 
 
Accounts payable
$
42,976

 
$
39,910

Accrued and other current liabilities
22,891

 
21,584

Deferred revenue
1,375

 
918

    Current portion of capital leases
2,566

 
203

Current portion of debt
9,743

 
7,243

Total current liabilities
79,551

 
69,858

Long-term debt—Less current portion
17,168

 
19,568

Capital leases—Less current portion
4,744

 
412

Deferred rent—Less current portion
19,629

 
3,909

Deferred tax liabilities
207

 
207

Other liabilities
499

 
387

Total liabilities
121,798

 
94,341

Commitments and contingencies (Note 12)


 


Stockholders’ Equity
 
 
 
Common stock, $0.001 par value— 1,000,000,000 authorized as of June 30, 2014 and December 31, 2013, respectively; 35,825,272 and 32,825,992 issued and outstanding as of June 30, 2014 and December 31, 2013, respectively
36

 
33

Additional paid-in capital
321,403

 
187,624

Accumulated other comprehensive loss
10

 
(15
)
Accumulated deficit
(65,460
)
 
(44,475
)
Total stockholders’ equity
255,989

 
143,167

Total liabilities and stockholders’ equity
$
377,787

 
$
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
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Revenue
$
92,642

 
$
54,369

 
$
167,039

 
$
92,581

Cost of revenue
46,923

 
28,981

 
84,458

 
49,652

Gross profit
45,719

 
25,388

 
82,581

 
42,929

Operating expenses:
 
 
 
 
 
 
 
Research and development
8,434

 
3,711

 
15,675

 
6,123

Sales and marketing
33,789

 
18,419

 
63,548

 
34,649

General and administrative
12,135

 
5,775

 
22,475

 
10,952

Total operating expenses
54,358

 
27,905

 
101,698

 
51,724

Loss from operations
(8,639
)
 
(2,517
)
 
(19,117
)
 
(8,795
)
Other expense, net:
 
 
 
 
 
 
 
Interest expense
(514
)
 
(229
)
 
(928
)
 
(353
)
Other income (expense)—net
(425
)
 
151

 
(444
)
 
(368
)
Change in fair value of convertible preferred stock warrant liability

 
(1,258
)
 

 
(2,355
)
Other expense, net
(939
)
 
(1,336
)
 
(1,372
)
 
(3,076
)
Loss before income taxes
(9,578
)
 
(3,853
)
 
(20,489
)
 
(11,871
)
Provision for income taxes
(181
)
 
14

 
(496
)
 
(40
)
Net loss
$
(9,759
)
 
$
(3,839
)
 
$
(20,985
)
 
$
(11,911
)
Basic and diluted net loss per share attributable to common stockholders
$
(0.28
)
 
$
(0.46
)
 
$
(0.61
)
 
$
(1.43
)
Basic and diluted weighted-average shares used to compute net loss per share attributable to common stockholders
35,172

 
8,396

 
34,606

 
8,347


See Accompanying Notes to Condensed Consolidated Financial Statements.


5



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

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Net loss
$
(9,759
)
 
$
(3,839
)
 
$
(20,985
)
 
$
(11,911
)
Other comprehensive income (loss): (1)
 
 
 
 
 
 
 
Foreign currency translation adjustments
(7
)
 
(10
)
 
25

 
(41
)
Comprehensive loss
$
(9,766
)
 
$
(3,849
)
 
$
(20,960
)
 
$
(11,952
)

(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 SIX MONTHS ENDED JUNE 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—December 31, 2013    
32,825,992

$
33

$
187,624

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

Issuance of common stock upon exercises of employee stock options, net of repurchases
797,822

1

2,473



2,474

Issuance of common stock upon vesting of restricted stock units
26,606






Shares withheld related to net share settlement of restricted stock units
(3,598
)

(53
)


(53
)
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


12,003



12,003

Foreign currency translation adjustment



25


25

Tax benefit from stock-based award activity


163



163

Net loss




(20,985
)
(20,985
)
Balance—June 30, 2014
35,825,272

$
36

$
321,403

$
10

$
(65,460
)
$
255,989


S ee Accompanying Notes to Condensed Consolidated Financial Statements.


7



Rocket Fuel Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Six Months Ended
 
June 30,
 
2014
 
2013
OPERATING ACTIVITIES:
 
 
 
Net loss
$
(20,985
)
 
$
(11,911
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
6,940

 
2,882

Provision for doubtful accounts
(260
)
 
16

Stock-based compensation
11,241

 
3,600

Amortization of debt discount
101

 
1

Excess tax benefit from stock-based activity
(163
)
 

Loss (gain) on disposal of property, equipment and software
228

 
(5
)
Change in fair value of preferred stock warrant liability

 
2,355

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(3,179
)
 
(12,464
)
Prepaid expenses
(362
)
 
123

Other current assets
(13,835
)
 
30

Other assets
(417
)
 
(137
)
Accounts payable
(248
)
 
8,181

Accrued and other liabilities
(1,301
)
 
4,094

Deferred rent
15,749

 
10

Deferred revenue
457

 
603

Other liabilities
112

 

Net cash used in operating activities
(5,922
)
 
(2,622
)
INVESTING ACTIVITIES:
 
 
 
Purchases of property, equipment and software
(19,141
)
 
(2,603
)
Capitalized internal-use software development costs
(3,555
)
 
(3,020
)
Restricted cash
(2,203
)
 

Net cash used in investing activities
(24,899
)
 
(5,623
)
FINANCING ACTIVITIES:
 
 
 
Proceeds from the issuance of common stock in follow-on public offering, net of underwriting discounts and commission
116,510

 

Issuance costs related to initial and follow-on public offering
(1,380
)
 
(298
)
Proceeds from exercise of vested common stock options
1,875

 
51

Proceeds from early exercise of unvested common stock options
17

 
770

Repurchases of common stock options early exercised
(13
)
 
(1
)
Excess tax benefit from stock-based activity
163

 

Proceeds from issuance of common stock from employee stock purchase plan

3,792

 

Tax withholdings related to net share settlements of restricted stock units

(53
)
 

Repayment of capital lease obligations
(430
)
 

Borrowings from line of credit

 
5,000

Proceeds from issuance of long-term debt

 
10,000

Repayment of long-term debt

 
(113
)
Net cash provided by financing activities
120,481

 
15,409


8



 
Six Months Ended
 
June 30,
 
2014
 
2013
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
7

 
(75
)
CHANGE IN CASH AND CASH EQUIVALENTS
89,667

 
7,089

CASH AND CASH EQUIVALENTS—Beginning of period
113,873

 
14,896

CASH AND CASH EQUIVALENTS—End of period
$
203,540

 
$
21,985

SUPPLEMENTAL DISCLOSURES OF OTHER CASH FLOW INFORMATION:
 
 
 
Cash paid for income taxes
$
205

 
$
123

Cash paid for interest
791

 
302

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
Purchases of property and equipment recorded in accounts payable and accruals
$
9,079

 
$
828

Offering costs recorded in accrued liabilities
32

 
1,933

Property, plant and equipment acquired under capital lease obligations
7,350

 

Vesting of early exercised options
576

 
140

Stock-based compensation capitalized in internal-use software costs
762

 



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 an artificial-intelligence digital advertising solution. The Company 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 and in Canada in 2013. 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 in the United Kingdom and Canada, which are currently engaged in marketing and selling advertising campaigns. All intercompany transactions and balances have been eliminated in consolidation.
Use of Estimates —The preparation of unaudited condensed consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and disclosures of contingent assets and liabilities at the date of the 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 June 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 June 30, 2014 consists of cash required to be deposited with financial institutions for security deposits for the Company's London, United Kingdom and Paris, France 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 four major financial institutions, which management assesses to be of high credit quality. The Company has not experienced any losses in such accounts.
The Company mitigates its credit risk with respect to accounts receivable by performing credit evaluations and monitoring agencies' and advertisers' accounts receivable balances. As of June 30, 2014 , two agencies and no single advertiser accounted for 10% of more of accounts receivable. As of December 31, 2013 , no single agency or advertiser accounted for 10% or more of accounts receivable.
With respect to revenue concentration, the Company define 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 six months ended June 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, two and three agencies would have been associated with 10% or more of revenue during the three and six months ended June 30, 2014 , respectively, and two agencies would have been associated with 10% or more of revenue during the three and six months ended June 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
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Allowance for doubtful accounts:
 
 
 
 
 
 
 
Balance, beginning of period
$
1,090

 
$
468

 
$
1,057

 
$
468

Add: bad debt expense
167

 
16

 
201

 
16

Less: write-offs, net of recoveries
(460
)
 
1

 
(461
)
 
1

Balance, end of period
$
797

 
$
485

 
$
797

 
$
485


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 $2.2 million and $1.5 million in internal-use software costs during the three months ended June 30, 2014 and 2013 , respectively, and $4.3 million and $3.2 million for the six months ended June 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, which is generally three years. Amortization expense totaled $1.2 million and $0.8 million for the three months ended June 30, 2014 and 2013 , respectively, and $2.3 million and $1.6 million for the six months ended June 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 six months ended June 30, 2014 and 2013 .
Revenue Recognition —The Company generates revenue by delivering digital advertisements to Internet users through various channels, including display, mobile, social and video.
The Company recognizes revenue when all four of the following criteria are met:

12



•    Persuasive evidence of an arrangement exists
•    Delivery has occurred or a service has been provided
•    Customer fees are fixed or determinable
•    Collection is reasonably assured
Revenue arrangements are evidenced by a fully-executed insertion order (“IO”). Generally, IOs state the number and type of advertising impressions (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 should be reported on a gross or net basis is based on an assessment of whether the Company is acting as the principal or an agent in the transaction. In determining whether the Company acts as the principal or an agent, the Company follows the accounting guidance for principal-agent considerations. While none of the factors identified in this guidance is individually considered presumptive or determinative, because (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, the Company has licensed a self-service version of its technology platform to a Japanese advertising agency, for use by the agency's customers.  Under this licensing agreement, the agency is responsible for the media costs. In this type of arrangement, the Company recognizes its licensing fee revenue on a net basis.
Multiple-Element Arrangements —The Company enters into arrangements to sell advertising that includes different media placements or ad services that are delivered at the same time, or within close proximity of one another. Beginning on January 1, 2011, the Company adopted new authoritative guidance on multiple element arrangements, using the prospective method for all arrangements entered into or materially modified from the date of adoption. Under this new guidance, the Company allocates arrangement consideration in multiple-deliverable revenue arrangements at the inception of an arrangement to all deliverables or those packages in which all components of the package are delivered at the same time, based on the relative selling price method in accordance with the selling price hierarchy, which includes: (1) vendor-specific objective evidence (“VSOE”), if available; (2) third-party evidence (“TPE”), if VSOE is not available; and (3) best estimate of selling price (“BESP”), if neither VSOE nor TPE is available.
VSOE —The Company determines VSOE based on its historical pricing and discounting practices for the specific product or service when sold separately. In determining VSOE, the Company requires that a substantial majority of the stand-alone selling prices for these services fall within a reasonably narrow pricing range. The Company has not been able to establish VSOE for any of its advertising offerings.
TPE —When VSOE cannot be established for deliverables in multiple element arrangements, the Company applies judgment with respect to whether it can establish a selling price based on TPE. TPE is determined based on competitor prices for similar deliverables when sold separately. Generally, the Company’s go-to-market strategy differs from that of its peers and its offerings contain a significant level of differentiation such that the comparable pricing of services cannot be obtained. Furthermore, the 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.

13



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 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 $1.8 million and less than $0.1 million for the three months ended June 30, 2014 and 2013 , respectively, and $3.0 million and $0.1 million for the six months ended June 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. The fair value of stock options granted to non-employees is re-measured as the stock options vest, and the resulting change in fair value, if any, is recognized in the Company’s condensed consolidated statement of operations during the period the related services are rendered, generally between one and four years.
Preferred Stock Warrant Liability —Freestanding warrants related to shares that are redeemable or contingently redeemable 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

14



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. 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 has provided a full valuation allowance reserved against such assets as of June 30, 2014 and December 31, 2013 .
The Company recognizes the tax effects of an uncertain tax position only if it is more likely than not to be sustained based solely on its technical merits as of the reporting date, and then, only in an amount more likely than not to be sustained upon review by the tax authorities. The Company considers many factors when evaluating and estimating its tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes.
Deferred Offering Costs —Deferred offering costs consisted primarily of direct incremental costs related to the Company’s public offerings of its common stock. Approximately $0.1 million of deferred offering costs were included in other assets on the Company’s condensed consolidated balance sheet as of December 31, 2013 . No deferred offering costs are included as of June 30, 2014 . Upon completion of the offerings, these amounts were offset against the proceeds of the offerings.
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 July 2013, the FASB issued new guidance related to income tax presentation. The guidance requires an entity to present its unrecognized tax benefits net of its deferred tax assets when settlement in this manner is available under the tax law, which would be based on facts and circumstances as of the balance sheet reporting date and would not consider future events. Gross presentation of unrecognized tax benefit will still be required in the notes to the financial statements. ASU 2013-11 will apply on a prospective basis to all unrecognized tax benefits that exist at the effective date. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of ASU 2013-11 did not have a material impact on our consolidated financial statements.
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.

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:

15



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 June 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 June 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 June 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 June 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 in its entirety requires management to make judgments and consider factors specific to the asset or liability. The Company’s fair value hierarchy for its financial assets and financial liabilities that are carried at fair value are as follows (in thousands):
June 30, 2014
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Money market funds (included in cash and cash equivalents)
 
$
127,902

 
$
127,902

 
$

 
$


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 June 30, 2014 and December 31, 2013 , consisted of the following (in thousands):
 
June 30,
 
December 31,
 
2014
 
2013
Cash and cash equivalents:
 
 
 
Cash
$
75,638

 
$
110,973

Money market funds
127,902

 
2,900

Total cash and cash equivalents
$
203,540

 
$
113,873


NOTE 4.
PROPERTY, EQUIPMENT AND SOFTWARE, NET
Property, equipment and software, net as of June 30, 2014 and December 31, 2013 , consisted of the following (in thousands):

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June 30,
 
December 31,
 
2014
 
2013
Capitalized internal-use software costs
$
18,347

 
$
14,030

Computer hardware and software
26,799

 
17,077

Furniture and fixtures
5,627

 
1,735

Leasehold improvements
23,352

 
815

Construction in progress

 
3,622

Total
74,125

 
37,279

Accumulated depreciation and amortization
(17,891
)
 
(11,485
)
Total property, equipment and software, net
$
56,234

 
$
25,794

Total depreciation and amortization expense, excluding amortization of internal-use software costs, was $2.7 million and $0.7 million for the three months ended June 30, 2014 and 2013 , respectively, and $4.5 million and $1.3 million for the six months ended June 30, 2014 and 2013 , respectively. Amortization expense of internal-use software costs was $1.2 million and $0.8 million for the three months ended June 30, 2014 and 2013 , respectively, and $2.3 million and $1.6 million for the six months ended June 30, 2014 and 2013 , respectively. Refer to Note 6 for details of the Company's capital leases as of June 30, 2014 and December 31, 2013 .
NOTE 5.
ACCRUED AND OTHER CURRENT LIABILITIES
Accrued and other current liabilities as of June 30, 2014 and December 31, 2013 , consisted of the following (in thousands):
 
June 30,
 
December 31,
 
2014
 
2013
Payroll and related expenses
$
8,075

 
$
10,722

Accrued vacation
455

 
2,220

Professional services
492

 
650

Accrued credit cards
261

 
774

Early exercise of unvested stock options
513

 
1,107

Employee stock purchase plan
864

 
1,427

Other accrued expenses
12,231

 
4,684

Total accrued and other current liabilities
$
22,891

 
$
21,584


NOTE 6.
CAPITAL LEASES
Property and equipment at June 30, 2014 and December 31, 2013 include d $8.0 million and $0.6 million , respectively, acquired under capital lease agreements of which the majority consists of computer hardware and software. There was $0.4 million and $0 of accumulated depreciation of property and equipment acquired under these capital leases at June 30, 2014 and December 31, 2013 , respectively. The related depreciation is included in depreciation expense.

Approximate remaining future minimum lease payments under these non-cancelable capital leases as of June 30, 2014 were as follows (in thousands):

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Year ending December 31,
 
Future Payments
2014 (remaining 6 months)
 
$
1,451

2015
 
2,902

2016
 
2,892

2017
 
648

Thereafter
 

Total minimum lease payments
 
$
7,893

Less: amount representing interest and taxes
 
(583
)
Less: current portion of minimum lease payments
 
(2,566
)
Capital lease obligations, net of current portion
 
$
4,744


NOTE 7.
OTHER INCOME (EXPENSE)—NET
Other income (expense)—net for the three and six months ended June 30, 2014 and 2013 , consisted of the following (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Gain (loss) on foreign translation
$
(432
)
 
$
97

 
$
(461
)
 
$
(459
)
Other non-operating income (loss), net
7

 
54

 
17

 
91

Total other income (expense)—net
$
(425
)
 
$
151

 
$
(444
)
 
$
(368
)

NOTE 8.
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, including Comerica Bank, as administrative agent for the lenders. The Company then entered into a First Amendment of the Loan Facility on June 30, 2014. 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. Comerica may also issue letters of credit under the subfacility, as amended, 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. Term loans equal to $20.0 million were advanced to the Company under the term loan facility during December 2013. Loan proceeds may be 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.

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

18



periods greater than three months ) for LIBOR rate loans. Term loans will be repaid in quarterly principal installments of approximately $1.3 million commencing in January 2015, with any remaining principal, together with all accrued and unpaid interest, due and payable on December 20, 2018. Principal, together with all accrued and unpaid interest, on the revolving loans are due and payable on December 20, 2016.
The Company is required to maintain certain financial covenants under the Loan Facility, including the following:
EBITDA. The Company is required to maintain specified quarterly EBITDA, which is defined for this purpose, with respect to any fiscal period as an amount equal to the sum of (i) consolidated net income (loss) in accordance with GAAP, after eliminating all extraordinary nonrecurring items of income, plus (ii) depreciation and amortization, income tax expense, total interest expense paid or accrued, non-cash 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, 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 non-financial covenants. As of June 30, 2014 , the Company was in compliance with each of the financial and non-financial covenants.
Future Payments
Future principal payments of long-term debt as of June 30, 2014 were as follows (in thousands):
Year ending December 31,
 
Future Payments
2014 (remaining 6 months)
 
$

2015
 
5,000

2016
 
5,000

2017
 
5,000

2018
 
5,000

Total
 
20,000

Less: current portion of long-term debt
 
(2,500
)
Long-term debt, net of current portion
 
$
17,500

As of June 30, 2014 , the $7.4 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.
NOTE 9.
STOCKHOLDERS’ EQUITY
Follow-on Offering

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 .
Reserved Shares of Common Stock —The Company’s shares of capital stock reserved for issuance as of June 30, 2014 were as follows:

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June 30, 2014
Options outstanding
6,926,466
Restricted stock units outstanding
845,009
Available for future stock option and restricted stock unit grants
5,450,545
Available for future employee stock purchase plan purchases
1,478,069
Total shares reserved
14,700,089
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 June 30, 2014 and December 31, 2013 , 180,142 and 315,579 unvested shares, respectively, were subject to repurchase. During the six months ended June 30, 2014 and year ended December 31, 2013 , the Company repurchased 19,876 and 5,834 shares of unvested stock, respectively.
2013 Equity Incentive Plan —The Company’s board of directors adopted and the Company’s stockholders approved a 2013 Equity Incentive Plan (the “2013 Plan”), which became effective September 18, 2013.  The 2013 Plan permits the grant of incentive stock options, within the meaning of Section 422 of the Code, to the Company’s employees and any parent and subsidiary corporations’ employees, and for the grant of nonstatutory stock options, restricted stock, restricted stock units, stock appreciation rights, performance units and performance shares to the Company’s employees, directors and consultants and the Company’s parent and subsidiary corporations’ employees and consultants.
 
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 beginning in 2014, equal to the least of (i)  4,000,000 shares; (ii)  5% of the outstanding shares of common stock as of the last day of the immediately preceding fiscal year; or (iii) such other amount as the Company’s board of directors may determine. 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.


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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 $24.89 per share)
487,408
 
45.90

 
 
 
 
Options exercised
(817,698)
 
2.31

 
 
 
 
Options forfeited
(153,832)
 
14.58

 
 
 
 
Balance at June 30, 2014
6,926,466
 
$
10.09

 
8.2
 
$
153,917

Options vested and expected to vest—June 30, 2014
6,534,456
 
$
9.68

 
8.2
 
$
147,117

Options vested and exercisable—June 30, 2014
3,127,695
 
$
5.32

 
7.7
 
$
80,606


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 $12.7 million and $0.2 million for the three months ended June 30, 2014 and 2013 , respectively, and $28.0 million and $1.4 million for the six months ended June 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:
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
Expected term (years)
5.5–6.3
 
5.9–6.1
 
5.5–6.3
 
5.9–6.6
Volatility
57.8%–58.0%
 
61.7%
 
55.6%–58.0%
 
61.7%–64.9%
Risk-free interest rate
1.96%–1.97%
 
1.04%–1.08%
 
1.85%–1.97%
 
1.04%–1.26%
Dividend yield
 
 
 

As of June 30, 2014 and December 31, 2013 , unamortized stock-based compensation expense related to unvested common stock options was $30.4 million and $21.7 million , respectively. The weighted-average period over which such stock-based compensation expense will be recognized is approximately 2.4  years.

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Options to Non-employees —The Company granted 2,000 and 2,000 stock options to non-employees (other than non-employee directors, who are considered "employees" for purposes of the 2013 Plan) for the three months ended June 30, 2014 and 2013 , respectively, and 2,000 and 7,000 stock options to non-employees for the six months ended June 30, 2014 and 2013 , respectively. Stock options granted to non-employees are recorded at their fair value on the measurement date. The measurement of stock-based compensation is subject to periodic adjustment as the underlying equity instruments vest. The fair value of options granted to non-employees is expensed when vested.
The Company recorded stock-based compensation expense for options issued to non-employees of less than $0.1 million and $0.1 million of for three months ended June 30, 2014 and 2013 , respectively, and $0.1 million and $0.1 million for the six months ended June 30, 2014 and 2013 , respectively. Options to non-employees of 5,900 and 8,900 were outstanding as of June 30, 2014 and December 31, 2013 , respectively.
Restricted Stock —The Company issued no shares pursuant to restricted stock purchase agreements during the three and six months ended June 30, 2014 and 2013 .
Restricted Stock Units (RSUs) —A summary of RSU activity for the six months ended June 30, 2014 is as follows:
 
Number of Shares
 
Weighted Average Grant Date Fair Value
Unvested at December 31, 2013
382,402

 
55.86

Granted
520,358

 
35.34

Vested and issued
(26,606
)
 
32.07

Canceled
(31,145
)
 
51.15

Unvested at June 30, 2014
845,009

 
44.15


The Company recognized stock-based compensation expense associated with the RSUs of $2.5 million and $0 for the three months ended June 30, 2014 and 2013 , respectively, and $4.3 million and $0 for the six months ended June 30, 2014 and 2013 , respectively. At June 30, 2014 , unrecognized compensation expense related to the RSUs was $27.2 million . The unrecognized compensation expense will be amortized on a straight-line basis through 2018. The total fair value of RSUs vested and issued during the three and six months ended June 30, 2014 was $0.6 million and $0.8 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 June 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.


22



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

Equity compensation allocation
The following table summarizes the allocation of stock-based compensation and restricted stock expense for employees and non-employees in the accompanying consolidated statements of operations (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Cost of revenue
$
276

 
$
91

 
$
528

 
$
118

Research and development
1,311

 
368

 
2,298

 
759

Sales and marketing
2,748

 
808

 
4,915

 
1,320

General and administrative
1,664

 
768

 
3,215

 
1,403

Total *
$
5,999

 
$
2,035

 
$
10,956

 
$
3,600


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

NOTE 10.
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 six months ended June 30, 2014 and 2013 , all potential shares of common stock were determined to be anti-dilutive.

23



The following table sets forth the computation of net loss per share of common stock (in thousands, except per share amounts):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Net loss
$
(9,759
)
 
$
(3,839
)
 
$
(20,985
)
 
$
(11,911
)
Weighted-average shares used to compute basic and diluted net loss per share
35,172

 
8,396

 
34,606

 
8,347

Basic and diluted net loss per share
$
(0.28
)
 
$
(0.46
)
 
$
(0.61
)
 
$
(1.43
)
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
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Convertible preferred stock

 
19,479

 

 
19,479

Employee stock options
6,926

 
7,607

 
6,926

 
7,607

Shares subject to repurchase
180

 

 
180

 

Restricted stock units (RSUs)
845

 

 
845

 

Employee stock purchase plan
42

 

 
42

 

Convertible preferred stock warrants

 
267

 

 
267

 
7,993

 
27,353

 
7,993

 
27,353


NOTE 11.
INCOME TAXES
The Company is subject to income tax in the United States as well as other tax jurisdictions in which it conducts business.  Earnings from non-U.S. activities are subject to local country income tax. The Company does not provide for federal income taxes on the undistributed earnings of its foreign subsidiaries as such earnings are to be reinvested indefinitely.
The Company recorded an income tax provision of $0.2 million and $0.0 million for the three months ended June 30, 2014 and 2013 , respectively, related to foreign income taxes and state minimum taxes and $0.5 million and $0.0 million for the six months ended June 30, 2014 and 2013 , respectively. The primary difference between the effective tax rate and the federal statutory tax rate in the United States relates to the valuation allowances on the Company’s net operating losses, foreign tax rate differences, and non-deductible stock-based compensation expense.
 
Valuation allowances are provided when necessary to reduce net deferred tax assets to an amount that is more likely than not to be realized. Due to uncertainty as to the realization of benefits from deferred tax assets, including net operating loss carry-forwards, research and development and other tax credits, the Company has provided a full valuation allowance reserved against such assets as of June 30, 2014 and December 31, 2013 .

NOTE 12.
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 2024.
The Company recognizes rent expense on a straight-line basis over the lease term and records the difference between cash rent payments and the recognition of rent expense as a deferred rent liability. Rent expense was $3.6 million and $0.7 million for the three months ended June 30, 2014 and 2013 , respectively, and $6.8 million and $1.4 million for the six months ended June 30, 2014 and 2013 , respectively.

24



Approximate remaining future minimum lease payments under these non-cancelable operating leases as of June 30, 2014 were as follows (in thousands):
Year ending December 31,
 
Future Payments
2014 (remaining 6 months)
 
$
4,085

2015
 
15,765

2016
 
19,363

2017
 
19,495

2018
 
18,270

Thereafter
 
65,417

 
 
$
142,395

Please refer to Note 6 for details of the Company's capital lease commitments as of June 30, 2014 and December 31, 2013 .
Letters of Credit and Bank Guarantees —As of June 30, 2014 and December 31, 2013 , the Company had irrevocable letters of credit outstanding in the amount of $5.4 million and $3.4 million , respectively, for the benefit of a landlord related to non-cancelable facilities leases. The letters of credit have various expiration dates, with the latest being June 2025.
As of June 30, 2014 , the Company had $2.2 million in bank guarantees for security deposits for the Company's London, United Kingdom and Paris, France 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 not currently a party to any legal proceedings, litigation, or claims that could materially affect its business, results of operations, cash flows, or financial position. The Company may, from time to time, be party to litigation and subject to claims incident to the ordinary course of business. As its growth continues, the Company may become party to an increasing number of litigation matters and claims. The outcome of litigation and claims cannot be predicted with certainty, and the resolution of any future matters could materially affect the Company's future financial position, results of operations or cash flows.
NOTE 13.
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 14.
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

25



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
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
North America
$
77,924

 
$
48,397

 
$
140,571

 
$
81,246

All Other Countries
14,718

 
5,972

 
26,468

 
11,335

Total revenue
$
92,642

 
$
54,369

 
$
167,039

 
$
92,581

The following table summarizes total long-lived assets in the respective locations (in thousands):
 
June 30,
 
December 31,
 
2014
 
2013
North America
$
52,695

 
$
23,956

All Other Countries
3,539

 
1,838

Total long-lived assets
$
56,234

 
$
25,794


As of June 30, 2014 , two agencies and no single advertiser accounted for 10% of more of accounts receivable. As of December 31, 2013 , no single agency or advertiser accounted for 10% or more of accounts receivable.

With respect to revenue concentration, the Company define 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 six months ended June 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, two and three agencies would have been associated with 10% or more of revenue during the three and six months ended June 30, 2014 , respectively, and two agencies would have been associated with 10% or more of revenue during the three and six months ended June 30, 2013 .

NOTE 15.
SUBSEQUENT EVENTS
On August 4, 2014, the Company and [x+1], Inc., a Delaware corporation (“[x+1]”) entered into a definitive agreement under which the Company will acquire [x+1] in a cash and stock transaction, with an enterprise value of approximately $230 million . The transaction will be accomplished through the Company’s acquisition of X Plus Two Solutions, Inc., a Delaware corporation of which [x+1] is the sole asset (the “Parent”) pursuant to an Agreement and Plan of Merger, dated as of August 4, 2014 (the “Merger Agreement”). Under the terms of the agreement, if the transaction closes, all outstanding shares of the Parent’s capital stock and options to purchase the Parent’s capital stock will be cancelled in exchange for an aggregate of 5,367,797 shares of the Company’s common stock valued at $130.0 million (based on the average closing price of the twenty trading days preceding August 4, 2014, of $24.22 per share) and $100.0 million in cash, subject to certain adjustments as set forth in the Merger Agreement. The Closing of the Merger is subject to customary closing conditions, including regulatory approvals. The Merger is anticipated to close by early in the fourth quarter of 2014.


26



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 anticipated closing of the acquisition of [x+1] (including the expectation that the acquisition will close by early in the fourth quarter of 2014) and the expected impact of the acquisition on our financial condition and results of operations;
our ability to maintain an adequate rate of revenue growth;
our capital investment plans and our ability to effectively manage those investments;
our growth strategy;
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 to meet our liquidity needs;
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.
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.
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.

27



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. As our revenue retention rate was 149% and 168% for the twelve months ended June 30, 2014 and December 31, 2013 , 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 June 30, 2014 , our active customer base included 84 of the Advertising Age 100 Leading National Advertisers and 60 of the Fortune 100 companies. Additionally, as of June 30, 2014 , we had 100 customers with more than $1 million in lifetime spend with us, with 51 of these 100 trusting us with over $2 million in lifetime spend and 14 of these 100 trusting us with over $5 million in lifetime spend.
Our solution is designed to optimize both direct-response campaigns focused on generating specific consumer purchases or responses, generally defined as cost per action goals, as well as brand campaigns geared towards lifting brand metrics, generally defined as cost-per-click and brand survey goals. For the three and six months ended June 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 280 billion impressions as of June 30, 2014 . As of June 30, 2014 , our computational infrastructure supported over 34,000 CPU cores in eight data centers and housed 17 petabytes of compressed data.
 
We generate revenue 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. We offer a single solution for advertisers across all of these channels to compete for a larger share of advertisers’ budgets. While a majority of our revenue currently comes from display advertising, we are focused on offering advertisers a comprehensive solution that addresses the display, mobile, social and video channels.
 
Our contracts typically have a term of less than 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 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.

In August 2014, we signed a definitive agreement to acquire [x+1], Inc., a provider of programmatic marketing and data management solutions. Under the terms of the agreement, we expect to pay $100 million in cash and approximately 5.4 million shares of our common stock as consideration, which, based on the average of the observed closing prices of our common stock for the 20 trading days prior to the signing of the definitive agreement, represents an enterprise value of $230 million. The transaction is subject to regulatory approvals and satisfaction of customary closing conditions, including Hart-Scott-Rodino clearance in the U.S., and is expected to close by early in the fourth quarter of 2014. See “Note 15 - Subsequent Events” in the notes to our condensed consolidated financial statements included in Part I, Item 1 for additional information regarding our proposed acquisition of [x+1].
 
We plan to invest for long-term growth. We anticipate that our operating expenses will increase significantly in the foreseeable future as we invest in research and development to enhance our solution, in sales and marketing to acquire new customers and reinforce our relationships with existing customers and in our infrastructure, including our IT, financial and administrative systems and controls. On August 5, 2014, we entered into an agreement to acquire [x+1]. See “Note 15 - Subsequent Events” in the notes to our condensed consolidated financial statements included in Part I, Item 1. If the transaction closes as anticipated by early in the fourth quarter of 2014, it will result in an increase in our operating expenses on the date we close the transaction. We believe that these investments will contribute to our long-term growth, although they will reduce our profitability in the near term.


28



Key Metrics
We monitor the key metrics set forth below to help us evaluate growth, establish budgets, measure the effectiveness of our research and development and sales and marketing and other investments, and assess our operational efficiencies. Revenue is discussed under the headings “—Components of Our Results of Operations” and “—Results of Operations.” Revenue less media costs (to be renamed revenue ex-TAC beginning in the third quarter of 2014) 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
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Revenue
$
92,642

 
$
54,369

 
$
167,039

 
$
92,581

Revenue less media costs (non-GAAP)
54,712

 
29,726

 
99,402

 
51,292

Adjusted EBITDA (non-GAAP)
(398
)
 
343

 
(4,134
)
 
(4,284
)
Number of active customers
1,444

 
784

 
1,444

 
784

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.
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 Less Media Costs (to be renamed Revenue ex-TAC)
Revenue less media costs (to be renamed revenue ex-TAC, but with no changes to the definition, beginning in the third quarter of 2014) 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 less media costs is a meaningful measure of operating performance because it is frequently used for internal management purposes, indicates the performance of our solution in balancing the goals of delivering exceptional results to advertisers while meeting our margin objectives and facilitates a more complete period-to-period understanding of factors and trends affecting our underlying revenue performance.
A limitation of revenue less media costs is that it is a measure that we have defined for internal purposes that may be unique to us, and therefore it may not enhance the comparability of our results to other companies in our industry that have similar business arrangements but present the impact of media costs differently. Management compensates for these limitations by also relying on the comparable GAAP financial measures of revenue, cost of revenue and total operating expenses. The following table presents a reconciliation of revenue less media costs to revenue for each of the periods indicated (in thousands):

29



 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Revenue
$
92,642

 
$
54,369

 
$
167,039

 
$
92,581

Less: Media costs
37,930

 
24,643

 
67,637

 
41,289

Revenue less media costs
$
54,712

 
$
29,726

 
$
99,402

 
$
51,292


Adjusted EBITDA
Adjusted EBITDA is a non-GAAP financial measure defined by us as net loss before income tax (expense) benefit, interest expense, net, depreciation and amortization (excluding amortization of internal-use software), stock-based compensation expense and change in fair value of convertible preferred stock warrant liability. We have presented adjusted EBITDA 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) tax payments that may represent a reduction in cash available to us; and
other companies, including companies in our industry, may calculate adjusted EBITDA or similarly titled measures differently, which reduces its usefulness as a comparative measure.
Because of these and other limitations, adjusted EBITDA should be considered along with other GAAP-based financial performance measures, including various cash flow metrics, net income or loss, and our other GAAP financial results.
The following table presents a reconciliation of adjusted EBITDA to net loss for each of the periods indicated (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Net loss
$
(9,759
)
 
$
(3,839
)
 
$
(20,985
)
 
$
(11,911
)
Adjustments:
 
 
 
 
 
 
 
Interest expense, net
514

 
229

 
928

 
353

Income tax expense
181

 
(14
)
 
496

 
40

Depreciation and amortization expense (excluding amortization of internal-use software)
2,667

 
673

 
4,471

 
1,279

Stock-based compensation expense
5,999

 
2,035

 
10,956

 
3,600

Change in fair value of convertible preferred stock warrant liability

 
1,258

 

 
2,355

Total adjustments
9,361

 
4,181

 
16,851

 
7,627

Adjusted EBITDA
$
(398
)
 
$
343

 
$
(4,134
)
 
$
(4,284
)

30



Beginning in the third quarter of 2014, we will be define its Adjusted EBITDA as net loss before income tax (expense) benefit, interest and other expenses, depreciation and amortization expense (excluding amortization of internal use software), stock-based compensation expense, acquisition related and other expenses; payroll tax expense related to stock-based compensation expense and changes in the fair value of convertible preferred stock warrant liability.
Acquisition related and other expenses: We will be excluding 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 will incur significant expenses in connection with our pending acquisition and 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 will 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 share-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 share-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.

The following tables present a reconciliation of adjusted EBITDA to net loss for each of the periods indicated (in thousands) using the current definition and the definition which will be used beginning in the third quarter of 2014:
Adjusted EBITDA as previously disclosed
 
Three Months Ended
 
Mar 31,
2013
 
Jun 30,
2013
 
Sep 30,
2013
 
Dec 31,
2013
 
Mar 31,
2014
 
Jun 30,
2014
Net income (loss)
$
(8,072
)
 
$
(3,839
)
 
$
(6,860
)
 
$
(2,161
)
 
$
(11,225
)
 
$
(9,759
)
Adjustments:
 
 
 
 
 
 
 
 
 
 
 
Interest expense
124

 
229

 
251

 
313

 
414

 
514

Income tax expense
54

 
(14
)
 
133

 
112

 
314

 
181

Depreciation and amortization (excluding amortization of internal use software)
607

 
673

 
781

 
2,407

 
1,804

 
2,667

Stock-based compensation
1,565

 
2,035

 
2,653

 
4,589

 
4,957

 
5,999

Change in fair value of preferred stock warrants
1,097

 
1,258

 
2,385

 

 

 

Total adjustments
3,447

 
4,181

 
6,203

 
7,421

 
7,489

 
9,361

Adjusted EBITDA
$
(4,625
)
 
$
343

 
$
(657
)
 
$
5,260

 
$
(3,736
)
 
$
(398
)


31



Adjusted EBITDA with revised definition
 
Three Months Ended
 
Mar 31,
2013
 
Jun 30,
2013
 
Sep 30,
2013
 
Dec 31,
2013
 
Mar 31,
2014
 
Jun 30,
2014
Net income (loss)
$
(8,072
)
 
$
(3,839
)
 
$
(6,860
)
 
$
(2,161
)
 
$
(11,225
)
 
$
(9,759
)
Adjustments:
 
 
 
 
 
 
 
 
 
 
 
Interest expense
124

 
229

 
251

 
313

 
414

 
514

Income tax expense
54

 
(14
)
 
133

 
112

 
314

 
181

Depreciation and amortization (excluding amortization of internal use software)
607

 
673

 
781

 
2,407

 
1,804

 
2,667

Stock-based compensation
1,565

 
2,035

 
2,653

 
4,589

 
4,957

 
5,999

Change in fair value of preferred stock warrants
1,097

 
1,258

 
2,385

 

 

 

Other income (expense) - net
519

 
(151
)
 
(155
)
 
95

 
19

 
425

Acquisition related and other expenses

 

 

 

 

 
100

Payroll tax expense related to stock-based compensation
10

 
3

 
136

 
14

 
210

 
185

Total adjustments
3,976

 
4,033

 
6,184

 
7,530

 
7,718

 
10,071

Adjusted EBITDA
$
(4,096
)
 
$
194

 
$
(676
)
 
$
5,369

 
$
(3,507
)
 
$
312


Adjusted Net Loss
Adjusted net loss and adjusted diluted net loss per share are non-GAAP financial measures that are useful to us and investors because they present an additional measurement of our financial performance, taking into account depreciation, which we believe is an ongoing cost of doing business, but excluding the impact of certain non-cash expenses (e.g. stock-based compensation). We believe that analysts and investors use adjusted net income and adjusted diluted net income per share as supplemental measures to evaluate the overall operating performance of companies in our industry.
A limitation of adjusted net 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
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Net loss
$
(9,759
)
 
$
(3,839
)
 
$
(20,985
)
 
$
(11,911
)
Adjustments:
 
 
 
 
 
 
 
Stock-based compensation expense
5,999

 
2,035

 
10,956

 
3,600

Change in fair value of convertible preferred stock warrant liability

 
1,258

 

 
2,355

Tax impact of the above items

 

 

 

Adjusted net loss
$
(3,760
)
 
$
(546
)
 
$
(10,029
)
 
$
(5,956
)
Adjusted diluted net loss per share
$
(0.11
)
 
$
(0.07
)
 
$
(0.29
)
 
$
(0.71
)
Weighted average shares used in computing adjusted diluted net loss per share
35,172

 
8,396

 
34,606

 
8,347



32



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. We believe that these investments will contribute to our long-term growth, although they will reduce our profitability in the near term. 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 the second half of 2014.
If we complete our proposed acquisition of [x+1], it will represent a significant investment in long-term growth. However, there are a number of risks associated with the proposed acquisition as well. See “Risk Factors - We may invest in or acquire other businesses, such as our proposed acquisition of [x+1]. These activities require significant management attention and could disrupt our business, dilute stockholder value and adversely affect our financial condition and results of operations .”
Technology Enhancements and Customer Satisfaction
 
We will continue to make improvements to our technology platform that may have an impact on both our gross profit margin and our performance against advertiser objectives. While our technology improvements have enabled strong margins, we do not currently expect the margins achieved in recent quarters to improve. 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, 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 gain a larger amount of our current customers’ advertising budgets, to continue our growth. Our number of active customers increased from 784 as of June 30, 2013 to 1,444 as of June 30, 2014 , contributing to revenue growth from $54.4 million for three months ended June 30, 2013 , to $92.6 million for the three months ended June 30, 2014 . New customers generally spend less than customers that have used our solution for longer periods of time. We also experienced decreased spending in the first half of 2014 by larger customers (measured by the amount of spend) who also spent with us in the same period ended June 30, 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 149% for the twelve months ended June 30, 2014 , 168% for the twelve months ended December 31, 2013 , and 175% for the twelve months ended December 2012.
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 the first

33



half of 2014, we 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.
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 experienced a decline in sales productivity in 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.
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 last quarter 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 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 six months ended June 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. An insertion order is a contract that outlines the terms and conditions of an advertising campaign and its objectives. Our contracts typically have a term of less than a year, and we recognize revenue as we deliver advertising impressions, subject to satisfying all other revenue recognition criteria. 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 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

34



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 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 our previous term debt.
Other income (expense)—net. Other income (expense)—net consists primarily of interest income, gains and losses on the sale and disposal of property, equipment and software, as well as gains and losses on foreign currency translation. We have foreign currency exposure related to our accounts receivable that are denominated in currencies other than the U.S. dollar, principally the British pound sterling and 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 have a full valuation allowance reserved against such assets. We expect to maintain this full valuation allowance at least in the near term.

35



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
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Consolidated Statements of Operations Data:
 
 
 
 
 
 
 
Revenue
$
92,642

 
$
54,369