Rocket Fuel Inc.
Rocket Fuel Inc. (Form: 10-Q, Received: 08/08/2016 16:10:13)





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, 2016
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 Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   ¨

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

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
  x  
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
Smaller reporting company
¨

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 on common stock as of the latest practicable date. On July 31, 2016, there were 44,452,886 shares of the registrant's common stock, par value $0.001 , outstanding.


1




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,” “Marketing 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



PART I
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
Rocket Fuel Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)

 
June 30,
 
December 31,
 
2016
 
2015
Assets
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
66,664

 
$
78,560

Accounts receivable, net
114,038

 
124,998

Prepaid expenses
3,071

 
3,803

Other current assets
3,895

 
2,081

Total current assets
187,668

 
209,442

Property, equipment and software, net
68,524

 
82,781

Restricted cash
1,876

 
2,141

Intangible assets, net
42,665

 
50,919

Deferred tax assets, net
525

 
718

Other assets
1,243

 
1,053

Total assets
$
302,501

 
$
347,054

Liabilities and Stockholders’ Equity
 
 
 
Current Liabilities:
 
 
 
Accounts payable
$
64,059

 
$
71,292

Accrued and other current liabilities
33,745

 
40,734

Deferred revenue
1,988

 
2,116

Current portion of capital leases
8,737

 
8,602

Current portion of debt
62,035

 
45,720

Total current liabilities
170,564

 
168,464

Debt —Less current portion

 
17,617

Capital leases—Less current portion
8,148

 
11,855

Deferred rent—Less current portion
15,897

 
14,042

Other liabilities
1,311

 
1,176

Total liabilities
195,920

 
213,154

Commitments and contingencies (Note 10)


 


Stockholders’ Equity:
 
 
 
Common stock, $0.001 par value— 1,000,000,000 authorized as of June 30, 2016 and December 31, 2015; 44,438,214 and 43,567,016 issued and outstanding as of June 30, 2016 and December 31, 2015, respectively
44

 
44

Additional paid-in capital
463,959

 
453,338

Accumulated other comprehensive loss
(625
)
 
(151
)
Accumulated deficit
(356,797
)
 
(319,331
)
Total stockholders’ equity
106,581

 
133,900

Total liabilities and stockholders’ equity
$
302,501

 
$
347,054

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,
 
2016
 
2015
 
2016
 
2015
Revenue
$
116,968

 
$
120,065

 
$
221,713

 
$
224,399

Costs and expenses:
 
 
 
 
 
 
 
Media costs
50,922

 
49,155

 
93,481

 
94,716

Other cost of revenue
20,397

 
19,826

 
40,482

 
39,782

Research and development
9,438

 
11,791

 
20,077

 
23,114

Sales and marketing
36,190

 
41,750

 
73,030

 
84,628

General and administrative
12,765

 
14,761

 
27,086

 
32,335

Restructuring
1,766

 
6,471

 
1,567

 
6,471

Total costs and expenses
131,478

 
143,754

 
255,723

 
281,046

Operating loss
(14,510
)
 
(23,689
)
 
(34,010
)
 
(56,647
)
Interest expense
1,032

 
1,045

 
2,269

 
2,385

Other (income) expense, net
866

 
(696
)
 
672

 
1,512

Loss before income taxes
(16,408
)
 
(24,038
)
 
(36,951
)
 
(60,544
)
Income tax provision
285

 
372

 
515

 
729

Net loss
$
(16,693
)
 
$
(24,410
)
 
$
(37,466
)
 
$
(61,273
)
Basic and diluted net loss per share attributable to common stockholders
$
(0.38
)
 
$
(0.58
)
 
$
(0.85
)
 
$
(1.45
)
Basic and diluted weighted-average shares used to compute net loss per share attributable to common stockholders
44,056

 
42,296

 
43,828

 
42,140


See Accompanying Notes to Condensed Consolidated Financial Statements.


5



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

 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2016
 
2015
 
2016
 
2015
Net loss
$
(16,693
)
 
$
(24,410
)
 
$
(37,466
)
 
$
(61,273
)
Other comprehensive income (loss): (1)
 
 
 
 
 
 
 
Foreign currency translation adjustments
(301
)
 
116

 
(474
)
 
7

Comprehensive loss
$
(16,994
)
 
$
(24,294
)
 
$
(37,940
)
 
$
(61,266
)
(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 CASH FLOWS
(In thousands)
(Unaudited)

 
Six Months Ended
 
June 30,
 
2016
 
2015
Operating Activities:
 
 
 
Net loss
$
(37,466
)
 
$
(61,273
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization
25,145

 
24,023

Impairment of long-lived assets
1,225

 
2,704

Accelerated amortization of leasehold improvements
7,059

 

Stock-based compensation expense
8,892

 
13,881

Deferred taxes
193

 
(20
)
Other non-cash adjustments, net
1,607

 
1,044

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
10,102

 
15,362

Prepaid expenses and other assets
(2,209
)
 
6,318

Accounts payable
(7,792
)
 
(11,538
)
Accrued and other liabilities
1,876

 
182

Deferred rent
(6,103
)
 
890

Deferred revenue
(128
)
 
1,338

Net cash provided by (used in) operating activities
2,401

 
(7,089
)
Investing Activities:
 
 
 
Purchases of property, equipment and software
(3,055
)
 
(10,085
)
Capitalized internal-use software development costs
(5,924
)
 
(6,048
)
Proceeds from sale of property
293

 

Changes in restricted cash
39

 
636

Net cash used in investing activities
(8,647
)
 
(15,497
)
Financing Activities:
 
 
 
Proceeds from employee stock plans, net
1,080

 
3,139

Tax withholdings related to net share settlements of restricted stock units
(609
)
 
(533
)
Repayment of capital lease obligations
(4,218
)
 
(2,755
)
Proceeds from debt facilities, net of issuance costs
22,350

 
(242
)
Repayment of debt
(24,000
)
 
(3,000
)
Net cash used in financing activities
(5,397
)
 
(3,391
)
 
 
 
 
Effect of Exchange Rate Changes on Cash and Cash Equivalents
(253
)
 
(14
)
Change in Cash and Cash Equivalents
(11,896
)
 
(25,991
)
Cash and Cash Equivalents—Beginning of period
78,560

 
107,056

Cash and Cash Equivalents—End of period
$
66,664

 
$
81,065


7



 
Six Months Ended
 
June 30,
 
2016
 
2015
SUPPLEMENTAL DISCLOSURES OF OTHER CASH FLOW INFORMATION:
 
 
 
Cash paid for income taxes, net of refunds
$
384

 
$
454

Cash paid for interest
1,937

 
1,921

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
Purchases of property, equipment and software recorded in accounts payable and accruals
$
2,371

 
$
428

Property, equipment and software acquired under capital lease obligations
646

 
1,786

Vesting of early exercised options
25

 
97

Stock-based compensation capitalized in internal-use software costs
1,308

 
1,286

See Accompanying Notes to Condensed Consolidated Financial Statements.

8



ROCKET FUEL INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Rocket Fuel Inc. (the “Company”) was incorporated as a Delaware corporation on March 25, 2008. The Company is a provider of artificial-intelligence digital advertising solutions headquartered in Redwood City, California.
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and the applicable rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in Consolidated Financial Statements prepared in accordance with GAAP have been condensed or omitted in accordance with such rules and regulations. The Condensed Consolidated Balance Sheet data as of December 31, 2015 was derived from audited financial statements, but does not include all disclosures required by GAAP. In the opinion of management, the accompanying unaudited Condensed Consolidated Financial Statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of our financial position and our results of operations and cash flows.

These Condensed Consolidated Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015.

The significant accounting policies and recent accounting pronouncements were described in Note 1 to the Consolidated Financial Statements included in the 2015 Annual Report on Form 10-K for the fiscal year ended December 31, 2015. There have been no significant changes in or updates to the accounting policies since December 31, 2015.

Recently Issued and Adopted Accounting Pronouncements
In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC”) 842 (“ASC 842”), “Leases” which replaces the existing guidance in ASC 840, Leases. The amendment is effective for the Company for fiscal years, and interim periods within those years, beginning after December 15, 2018. ASC 842 requires a dual approach for lessee accounting under which a lessee would account for leases as finance leases or operating leases. Both finance leases and operating leases will result in the lessee recognizing a right-of-use ("ROU") asset and a corresponding lease liability. For finance leases the lessee would recognize interest expense and amortization of the ROU asset and for operating leases the lessee would recognize a straight-line total lease expense. The Company is evaluating the impact of the adoption on the consolidated financial statements and related disclosures.

In March 2016, the FASB issued Accounting Standards Update ("ASU") 2016-09 ("ASU 2016-09"), which simplifies several aspects of the accounting for employee share-based payment transactions for both public and nonpublic entities, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. ASU 2016-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within those annual reporting periods. The Company is currently evaluating the impact of this ASU and expects no material modifications to its consolidated financial statements and related disclosures.

In April 2016, the FASB issued ASU 2016-10 ("ASU 2016-10"), which provides more detailed guidance on identifying performance obligations and licenses of intellectual property. ASU 2016-10 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within those annual reporting periods. The Company is currently evaluating the impact of this ASU to its consolidated financial statements and related disclosures.

In May 2016, the FASB issued ASU 2016-12 ("ASU 2016-12"), which provides clarification on some topics of the new revenue recognition guidance under ASC 606 . ASU 2016-12 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within those annual reporting periods. The Company is currently evaluating the impact of this ASU and the adoption of ASC 606 to its consolidated financial statements and related disclosures.

With the exception of the new standards discussed above, there have been no other recent accounting pronouncements or changes in accounting pronouncements during the  six months ended June 30, 2016 that are of significance or potential significance to the Company, as compared to the recent accounting pronouncements described in Note 1 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.



9



NOTE 2.
PROPERTY, EQUIPMENT AND SOFTWARE, NET
Property, equipment and software, net as of June 30, 2016 and December 31, 2015 , consisted of the following (in thousands):
 
June 30,
 
December 31,
 
2016
 
2015
Capitalized internal-use software costs
$
45,875

 
$
38,879

Computer hardware and software
58,821

 
57,827

Furniture and fixtures
12,570

 
13,619

Leasehold improvements
30,012

 
39,956

Total
147,278

 
150,281

Accumulated depreciation and amortization
(78,754
)
 
(67,500
)
Total property, equipment and software, net
$
68,524

 
$
82,781

Refer to Note 4 for details of the Company's capital leases.
The Company capitalized internal-use software development costs of $3.4 million and $3.9 million for the three months ended June 30, 2016 and 2015 , respectively, and $7.0 million and $7.6 million for the six months ended June 30, 2016 and 2015 , respectively. Amortization expense of internal-use software costs was $2.7 million and $1.8 million for the three months ended June 30, 2016 and 2015 , respectively, and $5.0 million and $3.4 million for the six months ended June 30, 2016 and 2015 , respectively.
Total depreciation and amortization expense related to property, equipment and software, exclusive of the amortization of capitalized internal-use software costs, was $6.0 million and $6.1 million for the three months ended June 30, 2016 and 2015 , respectively, and $11.9 million and $12.1 million for the six months ended June 30, 2016 and 2015 , respectively.
In addition, in the three and six months ended June 30, 2016 , the Company recorded impairment and accelerated amortization of leasehold improvements and furniture and fixtures of $ 4.8 million and $8.3 million , respectively, primarily related to its terminated office lease in New York in connection with its restructuring activities. Refer to Note 5 for details of the Company's restructuring costs.

NOTE 3.
BUSINESS COMBINATIONS
Acquisitions in Fiscal Year 2014

On September 5, 2014, the Company acquired X Plus Two Solutions, Inc., a Delaware corporation (“X Plus Two”), which wholly owns X Plus One Solutions, Inc. known in the industry as [x+1] ("[x+1]"). Management believed the acquisition of [x+1] would significantly expand the market opportunity and help accelerate the Company’s entry into the digital marketing enterprise software-as-a-service ("SaaS") market. The total purchase consideration was as follows (in thousands):
Purchase consideration:
 
Cash
$
98,045

Fair value of 5.3 million shares common stock transferred
82,421

Total purchase price
$
180,466


10



The acquisition of [x+1] was accounted for in accordance with the acquisition method of accounting for business combinations with the Company as the accounting acquiror. The Company expensed the acquisition-related transaction costs in the amount of $4.9 million in general and administrative expenses. The total purchase price as shown in the table above was allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values as of September 5, 2014, as set forth below. The Company finalized its estimates of fair value for certain of the acquired current assets and liabilities resulting in an adjustment of $2.1 million which was recorded during the three months ended September 30, 2015. The total purchase price was allocated as follows (in thousands):
Current assets
$
29,853

Non-current assets
3,999

Current liabilities
(29,354
)
Non-current liabilities
(16,253
)
Net acquired tangible assets
(11,755
)
Identifiable intangible assets
74,700

Goodwill
117,521

Total purchase price
$
180,466

Due to a stock price decline during the third quarter of 2015, the Company’s market capitalization declined to a value below the net book value of the Company’s equity, triggering the Company to conduct a goodwill impairment test. The outcome of the goodwill impairment test resulted in a non-cash impairment of goodwill of $117.5 million , which was recorded in the third quarter of 2015. Identifiable intangible assets acquired are as follows:    
 
 
 
 
 
June 30, 2016
 
 
 
December 31, 2015
 
Estimated Useful Life (in years)
 
Gross
 
Accumulated Amortization
 
Net Book Value
 
Gross
 
Accumulated Amortization
 
Net Book Value
Developed technology
3-4
 
$
42,100

 
$
(21,091
)
 
$
21,009

 
$
42,100

 
$
(15,295
)
 
$
26,805

Customer relationships
7-8
 
27,700

 
(6,306
)
 
21,394

 
27,700

 
(4,573
)
 
23,127

Trademarks
5
 
2,000

 
(2,000
)
 

 
2,000

 
(2,000
)
 

Non-compete agreements
2
 
2,900

 
(2,638
)
 
262

 
2,900

 
(1,913
)
 
987

Total
 
 
$
74,700

 
(32,035
)
 
42,665

 
$
74,700

 
$
(23,781
)
 
$
50,919

Total amortization expense related to intangible assets acquired in the business combination with [x+1] was $4.1 million and $4.2 million for the three months ended June 30, 2016 and 2015, respectively, and $8.3 million and $8.4 million for the six months ended June 30, 2016 and 2015 , respectively. During the third quarter of 2015, the Company accelerated the amortization of the trademark assets, recording $1.6 million in additional amortization expense due to a change of its useful life.

    
NOTE 4.
CAPITAL LEASES
Property, equipment and software includes hardware and software related to our data centers, which are typically acquired under capital lease agreements. The remaining future minimum lease payments under these non-cancelable capital leases as of June 30, 2016 were as follows (in thousands):

11



Year ending December 31,
 
Future Payments
2016 (remaining 6 months)
 
$
4,902

2017
 
8,006

2018
 
4,510

2019
 
558

2020
 
84

Total minimum lease payments
 
$
18,060

Less: amount representing interest and taxes
 
(1,175
)
Less: current portion of minimum lease payments
 
(8,737
)
Capital lease obligations, net of current portion
 
$
8,148


NOTE 5.
RESTRUCTURING COSTS
During the three months ended June 30, 2016 , the Company recorded $1.8 million in restructuring expenses, net of credits, consisting of accelerated amortization and impairment of leasehold and other assets of $4.8 million , $0.4 million of moving costs, primarily related to the termination and sublease of certain office spaces, and severance costs of $0.8 million . These expenses were partially offset by the release of deferred rent liabilities of $4.2 million related to the aforementioned office spaces. As of June 30, 2016, $0.4 million of severance costs remained unpaid.
During the six months ended June 30, 2016 , the Company recorded $1.6 million of restructuring expenses, net of credits, consisting of accelerated amortization and impairment of leasehold and other assets of $ 8.3 million and $0.4 million of moving costs, primarily related to the termination and sublease of certain office spaces, and severance costs of $1.2 million ; partially offset by the release of deferred rent liabilities of $8.3 million related to the aforementioned office spaces.
During the three months ended June 30, 2015, the Company incurred approximately  $3.4 million  in employee severance costs and  $0.3 million  in broker costs associated with subleasing excess office space. The Company also incurred a $ 2.7 million  impairment of leasehold and other assets related to the subleased facility.


NOTE 6.
DEBT
Loan Facility
On December 31, 2014, the Company entered into a Second Amended and Restated Revolving Credit and Term Loan Agreement with certain lenders (the "2014 Loan Facility"). The 2014 Loan Facility amended and restated the Company's then-existing Amended and Restated Revolving Credit and Term Loan Agreement, dated as of December 20, 2013. Through March 10, 2016, the 2014 Loan Facility provided for an $80.0 million revolving credit facility which matures on December 31, 2017, with a $12.0 million letter of credit sub-facility, a $2.5 million swing-line sub-facility, and a $30.0 million secured term loan that matures on December 31, 2019. Revolving loans could be advanced under the revolving credit facility in amounts up to the lesser of (i) 85% of eligible accounts receivable and (ii) $80.0 million , less the then outstanding principal amount of the term loan. If at any time the aggregate amounts outstanding exceeded the allowable maximum advance, then the Company was required to make a repayment in an amount sufficient to eliminate the excess.
On March 10, 2016, the Company amended the 2014 Loan Facility and terminated the term loan. The then-remaining balance of the term loan was repaid and refinanced by an additional draw down on the revolving credit facility of $22.5 million . In the amendment, the minimum bank-defined EBITDA covenant and the liquidity ratio covenant were changed. Subsequently, on June 21, 2016, the Company further amended its credit agreement to increase the sublimit of eligible foreign account receivables to $12 million . The credit agreement, as so amended, is referred to in the report as the "2016 Loan Facility". The Company paid customary closing fees in connection with establishing and amending its credit agreement, and pays customary commitment fees and letter of credit fees.    
Under the 2016 Loan Facility, the lenders have the right to use future cash collections from accounts receivable directly to reduce the outstanding balance of the revolving credit facility if the aggregate cash balances on deposit with the lenders and

12



certain other domestic financial institutions fall below $40.0 million . The Company may repay revolving loans and term loans under the 2016 Loan Facility in whole or in part at any time without premium or penalty, subject to certain conditions.
As of June 30, 2016 , $62.5 million under the revolving credit facility and letters of credit in the amount of $7.5 million were outstanding. In July and August 2016, the Company drew additional funds which increased its borrowing to $71.5 million fully utilizing the available borrowing capacity under the 2016 Loan Facility.
Revolving loans bear interest, at the Company's option, at (i) a base rate determined pursuant to the terms of the 2016 Loan Facility, plus a spread of 1.625% to 2.125% , or (ii) a LIBOR rate determined pursuant to the terms of the 2016 Loan Facility, plus a spread of 2.625% to 3.125% . Term loans bear interest, at the Company's option, at (i) a base rate determined pursuant to the terms of the 2016 Loan Facility, plus a spread of 2.50% to 3.00% , or (ii) a LIBOR rate determined pursuant to the terms of the 2016 Loan Facility, plus a spread of 3.50% to 4.00% . In each case, the spread is based on the cash reflected on the Company’s balance sheet for the preceding fiscal quarter, plus an amount equal to the average unused portion of the revolving credit commitments during such fiscal quarter. The base rate is determined as the highest of (i) the prime rate announced by Comerica Bank, (ii) the federal funds rate plus a margin equal to 1.00% and (iii) the daily adjusted LIBOR rate plus a margin equal to 1.00% . Under certain circumstances, a default interest rate of  2.00%  above the applicable interest rate will apply on all obligations during the existence of an event of default under the 2016 Loan Facility.
The Company is required to maintain a minimum of $30.0 million of cash on deposit with the lenders and comply with certain financial covenants under the 2016 Loan Facility, including the following:
Bank-defined EBITDA. The Company is required to maintain specified bank-defined EBITDA, which is defined for this purpose, with respect to any trailing twelve-month period, as an amount equal to the sum of (i) consolidated net income (loss) in accordance with GAAP, after eliminating all extraordinary non-recurring items of income, plus (ii) depreciation and amortization, income tax expense, total interest expense, non-cash expenses or losses, stock-based compensation expense, costs and expenses from permitted acquisitions up to certain limits, costs and expenses in connection with the 2016 Loan Facility up to certain limits; certain legal fees up to certain limits incurred through December 2015, integration costs related to the [x+1] acquisition up to certain limits incurred through December 31, 2014 and any other expenses agreed with Comerica and the lenders, less (iii) all extraordinary and non-recurring revenues and gains (including income tax benefits).
Liquidity ratio. Under the 2016 Loan Facility, the ratio of (i) the sum of all cash and accounts receivable to (ii) the sum of all accounts payable and all indebtedness owing to the lenders under the 2016 Loan Facility must be at least 1.00 to 1.00.
The terms of the 2016 Loan Facility also require the Company to comply with certain other financial and non-financial covenants. As of June 30, 2016 , the Company was in compliance with all financial and non-financial covenants.
As of June 30, 2016 , the $62.5 million balance outstanding under the 2016 Loan Facility had a maturity date of December 31, 2017, 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 condensed consolidated balance sheets. The debt on the condensed consolidated balance sheets is shown net of $0.5 million in debt issuance costs.


13



NOTE 7.
STOCKHOLDERS’ EQUITY
Registration Statement
On May 10, 2016, the Company filed a shelf registration statement on Form S-3 with the SEC (the “Registration Statement”). The Registration Statement contains (i) a base prospectus that covers the offering, issuance and sale by the Company of up to a maximum aggregate offering price of $50.0 million of the Company’s common stock, preferred stock, warrants, debt securities, subscription rights and units and (ii) a sales agreement prospectus supplement along with an accompanying base prospectus covering the offering, issuance and sale by the Company of up to a maximum aggregate offering price of $30.0 million of the Company’s common stock that may be issued and sold from time to time under a sales agreement with Cantor Fitzgerald & Co. The up to $30.0 million of common stock that may be issued and sold under the sales agreement prospectus supplement is included in the $50.0 million of securities that may be offered and sold under the base prospectus. As disclosed in a press release issued August 2, 2016, the Company does not expect to issue shares under the sales agreement in an amount greater than $5.0 million , if any, during the quarter ending September 30, 2016.
The Registration Statement had not yet been declared effective by the SEC as of the date of this report.

Stock Options and Stock Awards
The following table summarizes information pertaining to our stock-based compensation expense from stock options and stock awards, which are comprised of restricted stock awards and restricted stock units (in thousands, except grant-date fair value and recognition period):
 
Six Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
Stock options:
 
 
 
Outstanding at the beginning of the period
5,387

 
6,291

Options granted (1)
5,817

 
375

Options exercised
(112
)
 
(217
)
Options canceled and forfeited (1)
(3,514
)
 
(364
)
Outstanding at the end of the period
7,578

 
6,085

Total intrinsic value of options exercised
$
267

 
$
1,426

Total unrecognized compensation expense at period-end
$
9,958

 
$
18,569

Weighted-average remaining recognition period at period-end (in years)
2.4

 
2.0

 
 
 
 
Stock awards:
 
 
 
Outstanding at the beginning of the period
3,612

 
2,515

Stock awards granted
517

 
1,628

Stock awards vested
(485
)
 
(172
)
Stock awards canceled
(610
)
 
(561
)
Outstanding at the end of the period
3,034

 
3,410

Weighted-average grant-date fair value
$
9.77

 
$
12.76

Total unrecognized compensation expense at period-end
$
20,133

 
$
39,102

Weighted-average remaining recognition period at period-end (in years)
2.4

 
3.2

(1) Includes options canceled and issued in connection with the Company's tender offer to its employees during the three months ended June 30, 2016.
2016 Inducement Equity Incentive Plan
Effective March 4, 2016, the Company's board of directors adopted the 2016 Inducement Equity Incentive Plan (the “2016 Plan”) pursuant to Nasdaq Listing Rule 5635(c)(4) (the "Listing Rule"). The Listing Rule permits a company to adopt a

14



plan without stockholder approval if each grant is made to a new employee of the Company, or an employee returning to the Company after a bona fide period of non-employment, and in each case was offered the grant as a material inducement for the employee to join the Company. The 2016 Plan permits the grant of non-statutory stock options, restricted stock, restricted stock units, stock appreciation rights, performance units and performance shares to eligible participants.
A total of 2,200,000 shares of common stock were reserved for issuance upon initial adoption of the 2016 Plan. The 2016 Plan has a term of one year from its effective date. The compensation committee of the board of directors has the authority to approve the employees to whom equity awards are granted and to determine the terms of each award, subject to the terms of the 2016 Plan. The compensation committee may determine the number of shares subject to an award. Options and stock appreciation rights granted under the 2016 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.
As of June 30, 2016 , 1.4 million shares have been granted under the 2016 Plan.
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. 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, 2016 , total compensation costs, representing the fair value related to outstanding rights to purchase shares of common stock under the ESPP offering period ending on the first trading day on or before November 30, 2016, were approximately $0.7 million , which will be recognized over the offering period.
Effective January 15, 2016, the compensation committee of the Company's board of directors adopted an amendment and restatement of the ESPP that will apply to offering periods beginning on and after June 1, 2016. Pursuant to the amendment, future offering periods will start on the first trading day on or after June 1 and December 1 of each year and terminate on the first trading day or before the May 31 and November 30 that occurs approximately 24 months later. Each twenty-four month offering period will generally have four purchase periods of approximately six months in length, with the first purchase period of an offering period commencing on the date the offering period commences. At the end of each purchase period, employees are able to purchase shares, subject to any plan limitations, 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 purchase period. Offering periods may overlap. However, if the fair market value of the Company's stock has declined between the first date of an offering period and the end of a purchase period, the offering period will terminate on the purchase date that is at the end of that purchase period immediately after the purchase and participants in that offering period will automatically be re-enrolled in the immediately following offering period.
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 the Company's 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 fair value of restricted stock unit awards is the grant date closing price of the Company's common stock.
The Company uses the straight-line method for expense recognition over the vesting period of the award or option.
The assumptions used to value options granted to employees were as follows:

15



 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2016
 
2015
 
2016
 
2015
Expected term (years)
5.5 - 6.25
 
6.3
 
5.5 - 6.25
 
6.3
Volatility
55.0%
 
50.7% - 58.0%
 
55.0%
 
50.7% - 58.0%
Risk-free interest rate
1.29% - 1.55%
 
1.57% - 1.85%
 
1.29% - 1.93%
 
1.57% - 1.85%
Dividend yield
 
 
 
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,
 
June 30,
 
2016
 
2015
 
2016
 
2015
Expected term (years)
0.5
 
0.5
 
0.5
 
0.5
Volatility
63.0%
 
73.3% - 77.2%
 
63.0% - 65.0%
 
73.3% - 77.2%
Risk-free interest rate
0.49%
 
0.07% - 0.08%
 
0.42% - 0.49%
 
0.07% - 0.08%
Dividend yield
 
 
 
Stock-based Compensation Allocation
The following table summarizes the allocation of stock-based compensation, net of amounts capitalized for internal-use software development, in the accompanying condensed consolidated statements of operations (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2016
 
2015
 
2016
 
2015
Other cost of revenue
$
493

 
$
477

 
$
1,023

 
$
1,102

Research and development
981

 
1,834

 
2,346

 
4,081

Sales and marketing
1,357

 
2,325

 
2,846

 
5,156

General and administrative
1,251

 
1,798

 
2,677

 
3,542

Total
$
4,082

 
$
6,434

 
$
8,892

 
$
13,881



NOTE 8.
NET LOSS PER SHARE
Basic net 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. Because the Company had net losses for the three and six months ended June 30, 2016 and 2015 , all these potentially dilutive shares of common stock were determined to be anti-dilutive and accordingly were not included in the calculation of diluted net loss per share.

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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,
 
2016
 
2015
 
2016
 
2015
Net loss
$
(16,693
)
 
$
(24,410
)
 
$
(37,466
)
 
$
(61,273
)
Weighted-average shares used to compute basic and diluted net loss per share
44,056

 
42,296

 
43,828

 
42,140

Basic and diluted net loss per share
$
(0.38
)
 
$
(0.58
)
 
$
(0.85
)
 
$
(1.45
)
Common stock equivalents excluded from net loss per diluted share because their effect would have been anti-dilutive
10,833

 
9,606

 
10,833

 
9,606


NOTE 9.
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 intended to be reinvested indefinitely.

The Company recorded income tax provisions of $0.3 million and $ 0.4 million for the three months ended June 30, 2016 and 2015 , respectively, and $0.5 million and $ 0.7 million for the six months ended June 30, 2016 and 2015 , respectively, primarily due to foreign and state income taxes.
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 valuation allowances against such domestic assets as of  June 30, 2016  and  December 31, 2015 .

NOTE 10.
COMMITMENTS AND CONTINGENCIES
Operating Leases —The Company has operating lease agreements for office space for administrative, research and development and sales and marketing activities in the United States that expire at various dates through 2026.
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 $4.3 million and $4.0 million for the three months ended June 30, 2016 and 2015 , respectively, and $8.6 million and $8.0 million for the six months ended June 30, 2016 and 2015 , respectively.
The approximate remaining future minimum cash lease payments under these non-cancelable operating leases as of June 30, 2016 were as follows (in thousands):
Year ending December 31,
 
Future Payments
2016 (remaining 6 months)
 
$
7,978

2017
 
16,846

2018
 
15,427

2019
 
16,363

2020
 
7,137

Thereafter
 
20,971

 
 
$
84,722


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Please refer to Note 4 for details of the Company's capital lease commitments as of June 30, 2016 .
Letters of Credit Bank Guarantees and Restricted Cash —As of June 30, 2016 and December 31, 2015 , the Company had irrevocable letters of credit for facilities leases of $7.7 million and $6.3 million , respectively. The letters of credit have various expiration dates, with the latest being June 2025.
As of June 30, 2016 and December 31, 2015, the Company had $1.9 million and $2.1 million , respectively, in cash reserved to support bank guarantees for certain office lease agreements. These amounts are classified as restricted cash on the Company's condensed consolidated balance sheets.
Indemnification Agreements —In the ordinary course of business, the Company enters into agreements providing for indemnification of varying scope and terms to customers, vendors, lessors, business partners, and other parties with respect to certain matters, including, but not limited to, losses arising out of breach of such agreements, services to be provided by the Company or from intellectual property infringement claims made by third parties. In addition, the Company has entered into indemnification agreements with directors and certain officers and employees that will require the Company, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors, officers or employees. No demands have been made upon the Company to provide indemnification under such agreements, and thus there are no claims that the Company is aware of that could have a material effect on the Company’s condensed consolidated balance sheets, condensed consolidated statements of operations, condensed consolidated statements of comprehensive loss, or condensed consolidated statements of cash flows.
Legal Proceedings —The Company is involved from time to time in claims, proceedings, and litigation, including the following:
On September 3, 2014 and September 10, 2014, respectively, two purported class actions were filed in the Northern District of California against the Company and certain of its officers and directors at the time. The actions are Shah v. Rocket Fuel Inc., et al. , Case No. 4:14-cv-03998, and Mehrotra v. Rocket Fuel Inc., et al. , Case No. 4:14-cv-04114. The underwriters in the initial public offering on September 19, 2013 (the "IPO") and the secondary offering on February 5, 2014 (the "Secondary Offering") were also named as defendants. These actions were consolidated and a consolidated complaint, In re Rocket Fuel Securities Litigation , was filed on February 27, 2015. The consolidated complaint alleged that the defendants made false and misleading statements about the ability of the Company's technology to detect and eliminate fraudulent web traffic, and about Rocket Fuel’s future prospects. The consolidated complaint also alleged that the Company’s registration statements and prospectuses for the IPO and the Secondary Offering contained false and misleading statements on these topics. The consolidated complaint purported to assert claims for violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and SEC Rule 10b-5 (the "Exchange Act" claims), and for violations of Sections 11 and 15 of the Securities Act of 1933, as amended (the "Securities Act" claims), on behalf of those who purchased the Company’s common stock between September 20, 2013 and August 5, 2014, inclusive, as well as those who purchased stock in the IPO, and a claim for violation of Section 12(a)(2) of the Securities Act in connection with the Secondary Offering. The consolidated complaint sought monetary damages in an unspecified amount. All defendants moved to dismiss the consolidated complaint and on December 23, 2015, the court granted in part and denied in part the defendants’ motions to dismiss. The court dismissed the Securities Act claims and all but one of the statements on which the Exchange Act claims were based. The court also dismissed all claims against the outside directors and the underwriters of the Company’s public offerings.
On March 23, 2015, a purported shareholder derivative complaint for breach of fiduciary duty, waste of corporate assets, and unjust enrichment was filed in San Mateo, California Superior Court against certain of the then-current and former officers and the Company’s board of directors at that time. The action is Davydov v. George H. John , et.al, Case No. CIV 53304. The complaint seeks monetary damages in an unspecified amount, restitution, and reform of internal controls. This state court action has been stayed pending the resolution of the In re Rocket Fuel, Inc. Derivative Litigation action described below.
On January 27, 2016, a purported shareholder derivative complaint was filed in the Delaware Court of Chancery. The action was Gee v. Wootton et al. , Case No. 11940-VCL. The plaintiff voluntarily dismissed this action on February 9, 2016.
On October 6, 2015, a purported verified shareholder derivative complaint was filed in the Northern District of California. The action is Victor Veloso v. George H. John et al. , Case No. 4:15-cv-04625-PJH. Beginning in January 2016, three substantially similar related cases, Gervat v. Wootton et al. , 4:16-cv-00332-PJH, Pack v. John et al. , 4:16-cv-00608-EDL, and McCawley v. Wootton et al ., Case No. 4:16-cv-00812, also were filed in the Northern District of California on January 21, 2016, February 4, 2016 and February 18, 2016, respectively. The complaints in these related actions are based on substantially the same facts as the In re Rocket Fuel Securities Litigation, and name as defendants the Company’s board of directors at the time of filing and certain then-current and former executives. The Veloso action has been related to the In re Rocket Fuel Securities Litigation and motions

18



to relate the other actions are pending. The four purported verified shareholder derivative complaints were consolidated by the Court in March 2016, and a complaint in the consolidated action, titled In re Rocket Fuel, Inc. Derivative Litigation , Case No. 4:15-cv-4625-PJH, was filed on April 14, 2016. The complaint seeks monetary damages in an unspecified amount and reform of internal controls. All defendants moved to dismiss the consolidated complaint on May 19, 2016.
On March 29, 2016, a purported shareholder derivative complaint for breach of fiduciary duty and violation of California corporations code section 25402 was filed in San Francisco, California Superior Court against certain of the Company's current and former officers and certain of the Company's current and former directors. The action is Lunam v. William Ericson, et. al., Case No. CGC-16-551209. The complaint seeks monetary damages in an unspecified amount and reform of internal controls. This state court action has been stayed pending the resolution of the In re Rocket Fuel, Inc. Derivative Litigation action described above.

The Company intends to vigorously defend itself against these actions. We cannot currently estimate a reasonably possible range of loss for these actions. The outcomes of the legal proceedings are inherently unpredictable, subject to significant uncertainties, and could be material to the Company's operating results and cash flows for a particular period.
Legal fees are expensed in the period in which they are incurred.

NOTE 11.
SEGMENTS
The Company considers operating segments to be components of the Company's business for which separate financial information is available that is evaluated regularly by the Company’s chief operating decision maker in deciding how to allocate resources and in assessing performance. The chief operating decision maker for the Company is the Chief Executive Officer. The Chief Executive Officer reviews financial information presented on a consolidated basis for purposes of allocating resources and evaluating financial performance. The Company has one business activity, and there are no segment managers who are held accountable for operations, operating results or plans for levels or components below the consolidated unit level. Accordingly, the Company has determined that it has a single operating and reportable segment.
The following table summarizes total revenue generated through sales personnel located in the respective locations (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2016
 
2015
 
2016
 
2015
United States
$
89,973

 
$
99,013

 
$
171,370

 
$
185,164

All Other Countries (1)
26,995

 
21,052

 
50,343

 
39,235

Total revenue
$
116,968

 
$
120,065

 
$
221,713

 
$
224,399


(1) No individual country, other than the United States exceeded 10% of our total revenue for any period presented.

The following table summarizes total carrying values of property, equipment and software, in the respective locations (in thousands):
 
June 30,
 
December 31,
 
2016
 
2015
North America
$
64,133

 
$
77,038

All Other Countries
4,391

 
5,743

Total property, equipment and software
$
68,524

 
$
82,781



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NOTE 12.
GOODWILL
Due to a stock price decline during fiscal year 2015, the Company’s market capitalization declined to a value below the net book value of the Company’s equity, triggering the Company to test its goodwill for impairment.

The Company first tested its intangible assets (other than goodwill) and determined that these assets were not impaired.

Goodwill is tested for impairment in a two-step process. The first step is to determine if there is an indication of impairment by comparing the estimated fair value of the reporting unit to its carrying value including goodwill. Goodwill is considered impaired if the reporting unit’s carrying value exceeds its estimated fair value. Upon indication of impairment, a second step is performed to determine the amount of the impairment by comparing the implied fair value of the reporting unit’s goodwill with the carrying value of the goodwill. Since the Company operates its business in one reporting unit, goodwill is tested for impairment at the enterprise level.

In the first step of the goodwill impairment test, the Company estimated the fair value of its reporting unit using the market approach. Under the market approach, the Company utilized the market capitalization of its publicly-traded shares and comparable company information to determine revenue multiples which were used to determine the fair value of the reporting unit. Based on this approach, the Company determined that there is an indication of impairment as the carrying value including goodwill exceeded the estimated fair value of the reporting unit.

In the second step of the goodwill impairment test the Company estimated the fair value of its assets and liabilities to determine the implied fair value of goodwill, and then compared the implied fair value of the goodwill to its carrying value. The outcome of this second step resulted in a non-cash impairment of goodwill of $117.5 million , which was recorded during the third quarter of fiscal year 2015.

The inputs used to measure the estimated fair value of goodwill are classified as a Level 3 fair value measurement due to the significance of unobservable inputs based on company specific information.
    

NOTE 13. RELATED PARTY TRANSACTIONS
John J. Lewis served as Global President of Nielsen Holding Plc ("Nielsen") from July 2014 to June 2016 and joined the Board of Directors of Rocket Fuel Inc. on January 19, 2016. Mr. Lewis was also appointed to the Audit Committee of the Board.

Nielsen is one of the Company's data vendors. Total expense recognized for services delivered by Nielsen and its affiliates during the six months ended June 30, 2016 was $0.5 million . Total accounts payable as of June 30, 2016 were $0.6 million .


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, or the Exchange Act. The words "believe," "may," "will," "potentially," "estimate," "continue," "anticipate," "predict," "intend," "could," "should," "would," "project," "plan," "expect," "seek," "foresee," "forecast," or the negative of these words, and similar expressions that convey uncertainty of future events or outcomes are intended to identify forward-looking statements. These forward-looking statements include, but are not limited to, statements concerning the following:
expectations for financial performance in 2016, including revenue and the levels of operating expenses in the areas of research and development, sales and marketing and general and administrative;

our expectation that, subject to achieving our operating plan for 2016, existing cash and cash equivalents and financing from the 2016 Loan Facility and any capital raises will be sufficient to meet our business requirements for at least the next 12 months;
expected restructuring costs in 2016;

20




the anticipated impact of the growth rates in the real-time advertising exchange market and digital advertising on our future performance;
our belief that our programmatic marketing platform can enhance digital media buying across any programmatic inventory;
our goal of gaining a larger share of current customers' budgets and attracting new high-value customers;
the expected impact on our growth and profitability of focusing on our top 50 and top 250 customers;
the expected increase in demand for programmatic brand advertising;
our plans to reduce capital expenditures for property and equipment in 2016 compared to 2015, including our intention to finance data center hardware through capital leasing facilities;
the impact that our sales strategies and our product mix between our Media Services and Platform Solutions will have on margins, media and other costs of revenue;
the impact of working capital requirements on our goal of growing our business;
the expected impact of seasonality on our operating results;
our expectation that, as our foreign revenues and expenses increase, our operating results may be more affected by fluctuations in the exchange rates of the currencies in which we do business; and
our intention to vigorously defend against pending securities lawsuits.
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 will occur. Moreover, we assume no responsibility for the accuracy and completeness of the forward-looking statements. We undertake no obligation to revise or update any forward-looking statements for any reason, except as required by law.
The following discussion should be read in conjunction with (i) our unaudited condensed consolidated financial statements and notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q, (ii) the audited Consolidated Financial Statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015, and (iii) the understanding that our actual results and circumstances may be materially different from our forward-looking statements and/or expectations.
Overview
Rocket Fuel brings the power of machine learning to the world of digital marketing, offering a technology and services
designed to help advertising agencies and their clients connect with consumers through digital media at moments when that connection is most likely to be influential and most likely to achieve the advertiser’s objectives. Our platform autonomously purchases ad spots, or impressions, one at a time, on real-time 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.


21





Core to our ability to connect advertisers and consumers is our artificial intelligence (AI) engine, which consists of big data-driven predictive modeling and automated decision-making components. Our programmatic marketing platform uses a technology enabled by our AI that we call Moment Scoring™, which is designed to consider in a fraction of a second whether a particular advertising opportunity, or impression, is the right time to influence a consumer, based on our platform’s real-time scoring - positive or negative - of the likelihood of consumer engagement with the advertising based on relevant attributes.  

Our programmatic marketing platform is designed to learn from each message it delivers and apply that learning to future decisions as the advertising campaign is being delivered - a feature we call Marketing that Learns™.

In September 2014, we acquired X Plus Two Solutions, Inc., the parent company of [x+1], a privately held programmatic marketing technology company. Our acquisition of [x+1] allowed us to add important assets to our technology solutions, including our DMP.

Factors Affecting Our Performance
We believe the growth and any future profitability of our business and our future success depend on various opportunities, challenges and other factors, including the following:
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 we address. These markets have grown rapidly in the past several years but are highly dynamic; any acceleration, or slowing, of this growth would affect our overall performance.
A significant shift in the channel mix of digital advertising, or limitations on our ability to access inventory, could also impact our performance as we must optimize our solutions across the display (fundamentally desktop and laptop), mobile, social and video channels. We face different competitive landscapes in mobile, social and video channels. For example, at the beginning of 2015 Facebook eliminated access to the Facebook exchange platform, or "FBX," for some of their partners including us, requiring us to adapt our offering in order to continue to access some of the advertising inventory from Facebook. We adapted our technology offerings to address this change, but our sales efforts were impacted and our Facebook campaigns declined since we have shifted to buying Facebook inventory through their APIs. Facebook has continued to allow some other companies in our industry to purchase inventory through the FBX platform, which has likely put us at a competitive disadvantage. Another potential emerging trend that could impact our future performance is our ability to access inventory, particularly premium inventory through real-time bidding, or "RTB." Our DSP offering primarily relies on having access to RTB exchanges; however, some publishers have begun to remove their advertising inventory from RTB exchanges, notably the FBX restrictions noted above and changes to Google’s YouTube video inventory availability beginning in 2016.
Ability to Compete Effectively to Sell our Media Services and Platform Solutions
We are focused on developing direct response and brand advertising solutions for agencies, advertisers and publishers, available through our Media Services and our Platform Solutions. We believe we can offer a programmatic marketing platform that combines the functionality of our DSP with features of our DMP to enhance digital media buys across any programmatic inventory.

Our programmatic marketing platform offerings compete for digital advertising budgets with a variety of companies, including other companies with DSP offerings, agency trading desks, publishers that sell their inventory directly to agencies and advertisers, 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 data and third-party data. Furthermore, agencies have been 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. In July 2014, we announced our Platform Solutions in the United States and Europe, which allow us to compete more directly with companies that offer self-service platform solutions to agencies (as their trading desk solution) and to advertisers. To succeed, we must attract customers to our programmatic marketing platform, and establish relationships with systems integrators and other partners to integrate our functionality into their customers' marketing technology

22



platforms. As we offer Platform Solutions to more customers across the globe, our costs of compliance with policies set by real time advertising exchanges for the use of their exchanges increases as these customers use our programmatic marketing platform to purchase inventory. We also take on risk that customers on our platform violate these policies through the distribution of malware or other policy violations, and those policy violations jeopardize our access to real time advertising exchanges on behalf of our Media Services customers and other Platform Solutions customers. We have terminated relationships with customers whose policy violations have jeopardized our access to real time advertising exchanges.
In addition to challenges created by the emergence of agency trading desks and competing self-service platforms, our insertion order, or "IO,"-based Media Services business has faced increased challenges within some of the major agency holding companies. These challenges include overcoming questions and objections regarding our pricing and related media cost margins, impression placements and the transparency of our results, and how our technology achieved them. Our strategic agency team is focused on addressing these concerns with the major agency holding companies, their agencies and trading desks.
To expand our reach with advertisers we have a number of sales representatives dedicated to enterprise sales. We are also developing partnerships with marketing software companies, system integrators and direct response agency partners to enhance our ability to gain access to senior level marketing decision makers.
Our customers have many DSP and DMP solutions and technology partners to choose from. In order to increase the adoption of our programmatic marketing platform, we are enhancing its ease of use and working on proving the value of our solutions to agency holding companies, their affiliated operating agencies and advertisers.
Expanding our Business with Higher Value Customers
In order to achieve sustainable revenue growth, we must retain spend and gain a larger amount of our current customers’ advertising budgets, and attract new, high-value customers. Our strategy is to focus on expanding our business with a smaller set of larger, higher value customers rather than expanding our customer count. Accordingly, a key measure for us is revenue from our top 50 and 250 customers. During the three months ended June 30, 2016 , revenue from our top 50 customers was 53% of total revenue, compared to 47% in the second quarter of fiscal year 2015. During the three months ended June 30, 2016 , revenue from our top 250 customers was 82% of total revenue, compared to 78% in the second quarter of fiscal year 2015.
We believe that expanding our business with higher value customers is an important indicator of our ability to grow our business and achieve profitability through scale. Our goal is to increase our revenue period-over-period, and to increase the percentage of that revenue represented by these two customer sets.
Ability to Improve the Productivity and Efficiency of our Resources and Infrastructure
We have invested for long-term growth through the expansion of our offerings and infrastructure to address the needs of our target markets, including offering our DMP and DSP as Media Services or Platform Solutions.
As part of this growth strategy, during 2014, we added sales, marketing, operations and customer support personnel. Our growth strategy also included continuing to invest in research and development to enhance our solutions, integrate our and [x+1]'s technology platforms, improve the self-service capabilities of our platform, and create additional offerings. As a result, as part of these investments in resources and growth, we saw operating expenses increase significantly in absolute dollars and increase as a percent of revenue. In 2015, we focused on streamlining our customer services, research and development, sales and marketing, and general and administrative areas with a goal of reducing the cost of those functions as a percentage of revenue in future periods, while maintaining our ability to service customers. As part of this effort, we reduced our workforce approximately 11% and implemented other cost reduction measures, recording $7.4 million in restructuring charges in fiscal year 2015. We have continued to streamline our operations in 2016, recording $1.6 million in net restructuring charges in the six months ended June 30, 2016, further reducing our overall cost base. However, employee attrition and the resulting influx of new leaders and other employees in 2015 and 2016 have impacted our efficiency across the company as we expend the time and resources necessary to recruit and retain our talent, restructure our organizations, and train new employees.
We have experienced a continuing decline in our revenue growth rate in North America since the third quarter of 2013. In the short term, we expect our revenue to continue to be impacted as we refine our agency and enterprise sales capabilities. Looking ahead, we will focus on achieving revenue growth by focusing our sales efforts on fewer, higher value customers, and by increasing the adoption of our Platform Solutions by agencies and direct customers.    
Our capital expenditures for property, equipment and software were $11.5 million during fiscal year 2015 as we completed the majority of our facilities. In the first six months of fiscal year 2016, we invested $3.1 million into property, equipment and

23



software, and we expect these expenditures to remain below prior year's. To minimize the upfront cash investment required to scale our data centers, we utilize capital leasing facilities, as available, to finance our data center hardware and software needs.
Mix
Our strategy to offer our programmatic marketing platform has had, and we expect will continue to have, an impact on our revenue mix, margins and profitability. Media Services agreements, in the form of insertion orders, typically have a term of a few weeks to months, and are most often priced on a cost-per-thousand impressions basis with the media spend optimized through our AI technology and big data management systems. Platform Solutions agreements, on the other hand, have longer terms to use the technology at a predetermined percentage of media spend, which may vary based on volume. The media margin in these arrangements is typically materially lower than for Media Services. Our customers can acquire and operate the technology themselves or obtain supporting services from us. Our operating costs are typically higher up front as we train and assist our customers adopting our programmatic marketing platform and as they increase the number of campaigns run on it, but we expect such costs to decline over time as our customers learn to self-serve or agree to pay us additional services fees for assistance we provide on a longer term basis. Our success in our Platform Solutions strategy depends upon our ability to train our platform customers quickly and efficiently, to charge for services required over time, and to drive the volume of campaigns these customers run through our systems.
Working Capital
In all of our Media Services business and substantially all of our Platform Solutions business, we make media purchases to run our customers' advertising campaigns. In our industry, agencies and advertisers typically pay more slowly than we are required to make payments to media providers, resulting in payment terms that are approximately one-half of collection times. Our goal is to grow our business, but to do so will require either that we better align our collection and payment terms, obtain additional capital to support this working capital requirement, or develop alternatives to enable our customers to purchase media directly.
Ability to Grow Programmatic Advertising for Video Brand Campaigns
Our DSP solutions are designed to optimize campaigns for direct response and brand advertisers by generating specific consumer responses, and to drive brand awareness.
The digital advertising industry is rapidly adopting programmatic buying for video advertising and programmatic TV, or "pTV," which is dominated by brand campaigns. To measure our success in brand, we categorize and report video and pTV campaigns as brand, and report all non-video or non-pTV campaigns as direct-response. In the second quarter of fiscal year 2016, the revenue split between direct-response and video brand was approximately 93% to 7%, compared to 94% to 6% in the second quarter of fiscal year 2015. We expect the demand for programmatic brand advertising to expand quickly in the future, and thus we will continue our strategic focus on this opportunity. Our success in our brand strategy will depend in part upon our ability to further develop models to validate our video campaigns' performance to our customers.
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. Despite the seasonal nature of our revenue, many of our costs, such as headcount-related expenses, depreciation and amortization, and facilities costs, are relatively fixed in the short term and do not follow these same seasonal trends.
Components of Our Results of Operations
Revenue
We generate revenue primarily by delivering digital advertisements to consumers through the display channel and other channels such as mobile devices and through video and social channels. We predominantly contract with advertising agencies who purchase our solution on behalf of advertisers. When we contract with an agency, it acts as an agent for a disclosed principal, which is the advertiser. Our contracts typically provide that if the advertiser does not pay the agency, the agency is not liable to us, and we must seek payment solely from the advertiser. Our contracts with advertisers, including advertising agencies representing advertisers, are generally in the form of an insertion order that outlines the terms and conditions of an advertising campaign and its objectives. Our contracts typically have a term of less than a year, and we recognize revenue as we deliver advertising impressions,

24



subject to satisfying all other revenue recognition criteria. To a lesser extent, we generate revenue from license fees to access our DMP and DSP offerings and related professional services, which are generally recognized over the term of the performance period.
Costs and Expenses
We classify our expenses into these categories: media costs, other cost of revenue, research and development, sales and marketing, general and administrative, and restructuring expense. Personnel costs for each category of expense generally include salaries, bonuses and sales commissions (for sales and marketing only), stock-based compensation expense and employee benefit costs. Allocated costs include charges for facilities, office expenses, utilities, telephones and other miscellaneous expenses.
Media costs. These costs consist primarily of costs for advertising impressions we purchase from advertising exchanges, publishers and other third parties, which are expensed when incurred. We typically pay for these media costs on a per impression basis. We anticipate that our media costs will continue to vary with the related seasonal changes in revenue and overall growth in revenue. Through the third quarter of fiscal year 2015, we reported a sequential decline in media costs as a percentage of revenue as we continued to see the benefits of improvements in our AI-based targeting overall and migrated some former [x+1] DSP customers to the Rocket Fuel DSP with its higher performance targeting. Over the longer term, if we are successful with our efforts to sell Platform Solutions offerings, including our DMP and DSP, and also are successful in structuring large agency trading desk deals, we expect the resulting changes in revenue mix to increase our media costs as a percentage of total revenue.
Other cost of revenue. These costs include personnel costs, depreciation and amortization expense, amortization of internal-use software development costs, third-party inventory validation and data vendor costs, data center hosting costs and allocated costs. The personnel costs are primarily attributable to individuals maintaining our servers and members of our operations and analytics groups, which initiates, sets up, launches and monitors our advertising campaigns or implements and supports our platform. We capitalize costs associated with our platform software that is developed or obtained for internal-use, and amortize these costs in other cost of revenue over the internal-use software’s useful life. Third-party inventory validation and data vendor costs consist primarily of costs to augment campaign performance and monitor our brand safety efforts. Other cost of revenue also includes third-party data center costs and depreciation of data center equipment. We anticipate that our other cost of revenue will remain at a similar percentage of total revenue in fiscal 2016 as in fiscal year 2015.
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 we will prioritize resources on the most critical projects. Consistent with GAAP, we capitalize a portion of our software development costs, and amortize such costs to Other Costs of Revenue over the useful periods of the projects' lives. In fiscal 2016, we expect research and development expenses (net of amounts capitalized in software development costs) to decrease as a percentage of total revenue from fiscal year 2015 levels.
Sales and marketing. Our sales and marketing expenses consist primarily of personnel costs (including sales commissions) and allocated costs, professional services, brand marketing, travel, trade shows and marketing materials. Our sales and marketing organization focuses on (i) marketing our solutions to generate awareness; (ii) increasing the adoption of our solutions by existing and new advertisers and agencies. In fiscal year 2016, we expect overall sales and marketing expenses to decrease from fiscal year 2015 levels.
General and administrative. Our general and administrative expenses consist primarily of personnel costs associated with our executive, IT, finance, legal, human resources, compliance and other administrative functions, as well as accounting, audit and legal professional services fees, allocated costs and other corporate expenses. Other miscellaneous expenses primarily include local taxes and fees. In fiscal year 2016, we expect general and administrative expenses to decrease from fiscal year 2015 levels.
Restructuring expense. Restructuring expense is related to severance payments to employees, exit costs for excess facilities, depreciation or impairments of lease-related assets and the release of deferred rent liabilities related to terminated leases. We expect to incur additional restructuring related expenses (net of gains) as we continue to restructure our facilities in fiscal year 2016.
Other Expense, Net
Interest expense. Interest expense is primarily related to our credit facility and capital leases.

25



Other (income) expense, net. Other (income) expense—net consists primarily of gains and losses on foreign currency transactions. We have foreign currency exposure related to our cash and accounts receivable that are denominated in currencies other than the U.S. dollar, primarily the Canadian dollar, British pound and the Euro. As our foreign sales and expenses increase, our operating results may be more affected by fluctuations in the exchange rates of the currencies in which we do business.
Income Tax Provision (Benefit)
Income tax provision (benefit) consists primarily of 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 maintain a full valuation allowance against most of our deferred tax assets. We expect to maintain this valuation allowance at least in the near term.
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, except loss per share):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2016
 
2015
 
2016
 
2015
Consolidated Statements of Operations Data:
 
 
 
 
 
 
 
Revenue
$
116,968

 
$
120,065

 
$
221,713

 
$
224,399

Costs and expenses:
 
 
 
 
 
 
 
Media cost
50,922

 
49,155

 
93,481

 
94,716

Other cost of revenue (1)
20,397

 
19,826

 
40,482

 
39,782

Research and development (1)
9,438

 
11,791

 
20,077

 
23,114

Sales and marketing (1)
36,190

 
41,750

 
73,030

 
84,628

General and administrative (1)
12,765

 
14,761

 
27,086

 
32,335

Restructuring
1,766

 
6,471

 
1,567

 
6,471

Total costs and expenses
131,478

 
143,754

 
255,723

 
281,046

Operating loss
(14,510
)
 
(23,689
)
 
(34,010
)
 
(56,647
)
Interest expense
1,032

 
1,045

 
2,269

 
2,385

Other (income) expense, net
866

 
(696
)
 
672

 
1,512

Loss before income taxes
(16,408
)
 
(24,038
)
 
(36,951
)
 
(60,544
)
Income tax (benefit) provision
285

 
372

 
515

 
729

Net loss
$
(16,693
)
 
$
(24,410
)
 
$
(37,466
)
 
$
(61,273
)
 
 
 
 
 
 
 
 
Net loss per share, basic and diluted
$
(0.38
)
 
$
(0.58
)
 
$
(0.85
)
 
$
(1.45
)
(1)
Includes stock-based compensation expense as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2016
 
2015
 
2016
 
2015
Other cost of revenue
$
493

 
$
477

 
$
1,023

 
$
1,102

Research and development
981

 
1,834

 
2,346

 
4,081

Sales and marketing
1,357

 
2,325

 
2,846

 
5,156

General and administrative
1,251

 
1,798

 
2,677

 
3,542

Total
$
4,082

 
$
6,434

 
$
8,892

 
$
13,881


26



 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2016
 
2015
 
2016
 
2015
Consolidated Statements of Operations Data Percentage of Revenue: *
 
 
 
 
 
 
 
Revenue
100
 %
 
100
 %
 
100
 %
 
100
 %
Costs and expenses:
 
 
 
 
 
 
 
Media cost
44

 
41

 
42

 
42

Other cost of revenue
17

 
17

 
18

 
18

Research and development
8

 
10

 
9

 
10

Sales and marketing
31

 
35

 
33

 
38

General and administrative
11

 
12

 
12

 
14

Restructuring
2

 
5

 
1

 
3

Total costs and expenses
112

 
120

 
115

 
125

Operating loss
(12
)
 
(20
)
 
(15
)
 
(25
)
Interest expense
1

 
1

 
1

 
1

Other (income) expense, net
1

 
(1
)
 

 
1

Loss before income taxes
(14
)
 
(20
)
 
(17
)
 
(27
)
Income tax (benefit) provision

 

 

 

Net loss
(14
)%
 
(20
)%
 
(17
)%
 
(27
)%
*
Certain figures may not sum due to rounding.
Comparison of the Three and Six Months Ended June 30, 2016 and 2015
Revenue
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
 
(in thousands, except percentages)
Revenue
$
116,968

 
$
120,065

 
(3
%)
 
$
221,713

 
$
224,399

 
(1
%)
Revenue decreased 3% during the three months ended June 30, 2016 compared to the three months ended June 30, 2015 , due primarily to lower North American agency business, partially offset by higher revenue from our Platform Solutions offerings and International (outside of North America) operations. Media Services represented 82% and 94% of revenue and Platform Solutions was 18% and 6% of revenue for the three months ended June 30, 2016 and 2015 , respectively. Revenue from International operations increased by 31% for the three months ended June 30, 2016 compared to the three months ended June 30, 2015 , from 15% to 21% of revenue.
Revenue slightly decreased during the six months ended June 30, 2016 compared to the six months ended June 30, 2015 , due to the same factors mentioned above. Media Services represented 83% and 94% of revenue and Platform Solutions was 17% and 6% of revenue for the six months ended June 30, 2016 and 2015 , respectively. International revenue increased by 27% for the six months ended June 30, 2016 compared to the six months ended June 30, 2015 , from 15% to 20% of revenue.
Media Costs and Other Cost of Revenue
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
 
(in thousands, except percentages)
Media costs
$
50,922

 
$
49,155

 
4
%
 
$
93,481

 
$
94,716

 
(1
)%
Other cost of revenue
$
20,397

 
$
19,826

 
3
%
 
$
40,482

 
$
39,782

 
2
 %
Headcount (at period end)
163

 
143

 
14
%
 
 
 
 
 
 

27



Media costs increased by $1.8 million , or 4% , during the three months ended June 30, 2016 compared to the three months ended June 30, 2015 to approximately 44% as a percentage of revenue from 41% of revenue for the three months ended June 30, 2016 and 2015 , respectively, partially due to the mix shift from Media Services to Platform Solutions. Our media margin (revenue minus media costs) is substantially lower for our Platform Solutions offerings.
Other cost of revenue increased slightly by $0.6 million , or 3% , during the three months ended June 30, 2016 compared to the three months ended June 30, 2015 . This increase was primarily due to an increase in depreciation and amortization of $1.0 million, which includes capitalized internal-use software, acquired technology intangible assets and other fixed assets. Amortization of capitalized internal-use software was $2.7 million and $1.8 million for the three months ended June 30, 2016 and 2015 , respectively.
Media costs decreased by $1.2 million , or 1% , during the six months ended June 30, 2016 compared to the six months ended June 30, 2015 and stayed flat at 42% of revenue for the six months ended June 30, 2016 and 2015 .
Other cost of revenue increased slightly by $0.7 million , or 2% , during the six months ended June 30, 2016 compared to the six months ended June 30, 2015 , primarily due to an increase in depreciation and amortization of $1.7 million, which includes capitalized internal-use software, acquired technology intangible assets, and other fixed assets, and to a lesser extent, an increase in personnel expense, partially offset by a decrease in data and inventory validation costs of $1.5 million resulting from optimized data usage. Amortization of capitalized internal-use software was $5.0 million and $3.4 million for the six months ended June 30, 2016 and 2015 , respectively.
Research and Development
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
 
(in thousands, except percentages)
Research and development
$
9,438

 
$
11,791

 
(20
)%
 
$
20,077

 
$
23,114

 
(13
)%
Percent of revenue
8
%
 
10
%
 
 
 
9
%
 
10
%
 
 
Headcount (at period end)
138

 
189

 
(27
)%
 
 
 
 
 
 
Research and development expense decreased by $2.4 million , or 20% , during the three months ended June 30, 2016 compared to the three months ended June 30, 2015 . This decrease was due to a decrease in personnel expense from a reduction in average headcount as we continue to optimize our cost structure to support our business and provide operating leverage.
Research and development expense decreased by $3.0 million , or 13% , during the six months ended June 30, 2016 compared to the six months ended June 30, 2015 . This change was due to a decrease in personnel expense from a reduction in average headcount as described above.
We capitalized internal-use software development costs of $3.4 million and $3.9 million for the three months ended June 30, 2016 and 2015 , respectively, and $7.0 million and $7.6 million for the six months ended June 30, 2016 and 2015 , respectively. The change was due to decreased headcount devoted to internal-use software development.
Sales and Marketing
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
 
(in thousands, except percentages)
Sales and marketing
$
36,190

 
$
41,750

 
(13
)%
 
$
73,030

 
$
84,628

 
(14
)%
Percent of revenue
31
%
 
35
%
 
 
 
33
%
 
38
%
 
 
Headcount (at period end)
449

 
531

 
(15
)%
 
 
 
 
 
 
Sales and marketing expense decreased by $5.6 million , or 13% , during the three months ended June 30, 2016 compared to the three months ended June 30, 2015 . This decrease was primarily due to a decline in average headcount, which decreased

28



personnel expense by $3.2 million and travel and related expense by $0.8 million as we continue to optimize our cost structure to support our business and provide operating leverage.
Sales and marketing expense decreased by $11.6 million , or 14% , during the six months ended June 30, 2016 compared to the six months ended June 30, 2015 . This decrease was primarily due to a decline in average headcount, which decreased personnel expense by $7.2 million and travel and related expense by $1.9 million .
General and Administrative
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
 
(in thousands, except percentages)
General and administrative
$
12,765

 
$
14,761

 
(14
)%
 
$
27,086

 
$
32,335

 
(16
)%
Percent of revenue
11
%
 
12
%
 
 
 
12
%
 
14
%
 
 
Headcount (at period end)
149

 
145

 
3
 %
 
 
 
 
 
 
General and administrative expense decreased by $2.0 million , or 14% , during the three months ended June 30, 2016 compared to the three months ended June 30, 2015 . This decrease was primarily due to lower personnel expenses of $1.7 million , because of lower stock-based compensation and contractor costs, as we continue to optimize our cost structure to support our business and provide operating leverage.
General and administrative expense decreased by $5.2 million , or 16% , during the six months ended June 30, 2016 compared to the six months ended June 30, 2015 . This decrease was primarily due to decreased personnel expenses by $3.8 million and professional services by $1.3 million .
Restructuring
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
 
(in thousands, except percentages)
Restructuring charges
$
1,766

 
$
6,471

 
(73
%)
 
$
1,567

 
$
6,471

 
(76
%)
Percent of revenue
2
%
 
5
%
 
 
 
1
%
 
3
%
 
 
During the three months ended June 30, 2016 , we recorded $1.8 million in restructuring expenses as the accelerated amortization and impairment of leasehold assets of $4.8 million, $0.4 million of moving costs, primarily related to the termination and sublease of certain office spaces, and severance costs of $0.8 million. These expenses were partially offset by the release of deferred rent liabilities of $4.2 million related to the aforementioned office spaces.
During the six months ended June 30, 2016 , we recorded $1.6 million of restructuring expenses, net of credits, consisting of accelerated amortization and impairment of leasehold assets of $8.3 million and $0.4 million of moving costs, primarily related to the termination and sublease of certain office spaces, and severance costs of $1.2 million; partially offset by the release of deferred rent liabilities of $8.3 million related to the aforementioned office spaces.
    Total workforce declined from 1,008 at June 30, 2015 to 899 at June 30, 2016 , as we continue to manage our workforce with a goal of better operating leverage.


29



Interest and Other Expense
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
 
(in thousands, except percentages)
Interest expense
$
1,032

 
$
1,045

 
(1
)%
 
$
2,269

 
$
2,385

 
(5
)%
Other (income) expense, net
866

 
(696
)
 
(224
)%
 
672

 
1,512

 
(56
)%
Total
$
1,898

 
$
349

 
444
 %
 
$
2,941

 
$
3,897

 
(25
)%
The increase in interest and other expense during the three months ended June 30, 2016 compared to the three months ended June 30, 2015 , was primarily due to foreign currency losses from unfavorable exchange rate fluctuations during the three months ended June 30, 2016 versus a gain in the same period in 2015.
Interest and other expense decreased during the  six months ended June 30, 2016  compared to the  six months ended June 30, 2015 , primarily due to foreign currency losses resulting from unfavorable exchange rate fluctuations in fiscal year 2016.
Income Tax (Benefit) Provision
We recorded an income tax expense of $0.3 million and $0.4 million for the three months ended June 30, 2016 and 2015 , respectively, and $0.5 million and $0.7 million for the six months ended June 30, 2016 and 2015 , respectively, primarily due to foreign income taxes.
Liquidity and Capital Resources
As of June 30, 2016 , we had cash and cash equivalents of $66.7 million (of which $1.9 million was held by our foreign subsidiaries), $62.0 million in debt obligations (net of $0.5 million in debt issuance costs, under the 2016 Loan Facility) and $16.9 million in capital lease obligations. Cash and cash equivalents consist of cash and money market funds. We did not have any short-term or long-term investments as of June 30, 2016 .
On December 31, 2014, we entered into the Second Amended and Restated Revolving Credit and Term Loan Agreement with certain lenders, including Comerica Bank, or "Comerica," as administrative agent for the lenders (the "2014 Loan Facility"). The 2014 Loan Facility amended and restated our then-existing Amended and Restated Revolving Credit and Term Loan Agreement, dated December 20, 2013, between us, certain lenders, and Comerica as administrative agent for the lenders. The 2014 Loan Facility provided for a secured $80.0 million three year revolving credit facility, and a secured $30.0 million five-year term loan. Revolving loans may be advanced under the 2014 Loan Facility in amounts up to the lesser of (i) 85% of eligible accounts receivable and (ii) $80.0 million . If the borrowing base falls below our outstanding balance under the revolving credit facility, we may not have access to additional borrowing capacity and may have to repay some of the outstanding balance.
In March 2016, we amended the 2014 Loan Facility (the "2016 Loan Facility") and terminated the term loan. On March 11, 2016, the then remaining balance of the term loan was repaid and refinanced by an additional draw down on the revolving credit facility.
The 2016 Loan Facility contains customary affirmative and negative covenants, that limit our ability to, among other things, incur additional debt, make acquisitions, make certain restricted payments, make investments or make capital expenditures. If the aggregated cash balances on deposit with the lenders and certain other domestic financial institutions fall below $40.0 million, the lenders have the right to use future cash collections from accounts receivable directly to reduce the outstanding balance of the revolving credit facility. We must comply with a minimum bank-defined EBITDA covenant (Refer to Note 6 to our Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for details), maintain at least $30.0 million of cash on deposit with the lenders and maintain a minimum liquidity ratio. As of June 30, 2016 , we were in compliance with all covenants under the 2016 Loan Facility. However, if future operating results are less favorable than currently anticipated, we may need to seek waivers or amendments to modify our debt covenants.
As of June 30, 2016 , we had $62.5 million of outstanding revolving loans and letters of credit had been issued amounting to $7.5 million under the 2016 Loan Facility. In July and August 2016, we drew additional funds which increased our borrowing to $71.5 million fully utilizing the available borrowing capacity of the 2016 Loan Facility. Our intra-quarter cash flows are highly cyclical, and therefore, our intra-quarter cash balances fluctuate and can present significant cash management challenges for us,

30



and potentially trigger our lenders’ rights to use future cash collections from accounts receivable directly to reduce our outstanding balance under the revolving credit facility.
    We believe that, subject to achieving our operating plan for 2016, our existing cash and cash equivalents balance, 2016 Loan Facility and any potential capital we may raise will enable us to meet our business requirements for at least the next twelve months. In May 2016 we filed a registration statement on Form S-3 covering up to $50.0 million of our common stock and other types of securities. The Registration Statement had not yet been declared effective by the SEC as of the date of this report. We concurrently entered into a sales agreement for an at-the-market offering under which we may offer and sell shares of common stock into the market over time. This sales agreement gives us the flexibility to issue shares in the amount of up to $30.0 million; however, as disclosed in a press release issued August 2, 2016, we do not expect to issue shares under the sales agreement in an amount greater than $5.0 million, if any, during the quarter ending September 30, 2016. If we raise additional funds by issuing equity or equity-linked securities, the ownership of our existing stockholders will be diluted. If we raise additional financing by the incurrence of indebtedness, we will be subject to increased debt service obligations and could also be subject to more restrictive covenants, such as limitations on our ability to incur additional debt, and other operating restrictions that could adversely impact our ability to conduct our business. If we are unable to raise additional funds, we may be forced to take additional measures to reduce expenses to offset any shortfall.
There can be no assurances that we will be able to raise additional capital through sales of equity, or through debt financing arrangements, or obtain any desired waivers or amendments of the 2016 Loan Facility on acceptable terms or at all, and the failure to do so would adversely affect our ability to achieve our business objectives. In addition, if our future operating performance is below our expectations, our liquidity and ability to operate our business could be adversely affected. See "Risk Factors - Our credit agreement contains operating and financial covenants that restrict our business and financing activities and, in some cases, could result in an immediate requirement to repay our outstanding loans. "
Cash Flows
The following table summarizes our cash flows for the periods presented (in thousands):
 
Six Months Ended
 
June 30,
 
2016
 
2015
Consolidated Statements of Cash Flows Data:
 
 
 
Cash flows provided by (used in) operating activities
$
2,401

 
$
(7,089
)
Cash flows used in investing activities
(8,647
)
 
(15,497
)
Cash flows used in financing activities
(5,397
)
 
(3,391
)
Effects of exchange rate changes on cash and cash equivalents
(253
)
 
(14
)
Decrease in cash and cash equivalents
$
(11,896
)
 
$
(25,991
)
Operating Activities
Our primary source of cash from operating activities is from the collection of receivables from customer billings. Our primary use of cash in operating activities is for media costs. Cash used in operating activities is primarily influenced by the volume of sales to advertising agencies representing advertisers and directly to advertisers, as well as by the amount of cash we invest in personnel and infrastructure. Cash used in operating activities has typically been due to net losses, adjusted for non-cash expense items such as depreciation, amortization and stock-based compensation expense, and by changes in our operating assets and liabilities, particularly in the areas of accounts receivable and accounts payable.
Our collection cycles can vary from period to period based on common payment practices employed by advertising agencies. Our contracts with advertising inventory suppliers and exchanges typically are based on industry standard payment terms which are typically shorter than our corresponding payment terms with customers. Typically, we expect that during the second and the fourth quarter of each year, our working capital needs may increase due to the seasonality of our business. This increase is driven by the fact that we have to make timely payments to publishers and exchanges, while our customer payments may be delayed beyond the contractual terms of the customers’ invoices. As a result, the timing of cash receipts and vendor payments can significantly impact our cash used in operations for any period presented.

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For the six months ended June 30, 2016 , cash provided by operating activities was $2.4 million , resulting from a net loss of $37.5 million , offset by the other non-cash expenses of $44.1 million , which mainly included depreciation, amortization, stock-based compensation expense and accelerated amortization charges related to our terminated office lease in New York. Cash used in operating activities was further affected by the $4.3 million increase in net working capital items, most notably a decrease in accounts receivable of $10.1 million due to the seasonality of advertising campaigns as well as timing of payments from customers and agencies which was more than offset by a decrease in accounts payable of $7.8 million , due to the seasonality of advertising campaigns as well as the timing of our payments to our vendors, a decrease in deferred rent of $6.1 million , and other items.
For the six months ended June 30, 2015 , cash used in operating activities was $7.1 million , resulting from a net loss of $61.3 million , offset by non-cash expenses of $41.6 million , which mainly included depreciation, amortization and stock-based compensation expense and deferred taxes. The net loss was further offset by $12.6 million  from the positive net change in working capital items, most notably a decrease in accounts receivable of $15.4 million  due to the seasonality of advertising campaigns as well as timing of payments from customers and agencies, a decrease in prepaid and other assets of  $6.3 million  due to the collection of certain leasehold reimbursements from landlords, partially offset by a decrease in accounts payable of  $11.5 million , due to the seasonality of advertising campaigns as well as the timing of our payments to our vendors.
Investing Activities
During the six months ended June 30, 2016 , investing activities primarily consisted of $3.1 million of capital expenditures for facilities, equipment and software and $5.9 million of capitalized internal-use software. We expect facilities-related cash outflows for the remainder of the year mainly due to our new office space in New York City, which we occupied in June 2016.
During the six months ended June 30, 2015 , investing activities primarily consisted of $10.1 million of capital expenditures for facilities, equipment and software and $6.0 million of capitalized internal-use software.
Financing Activities
During the six months ended June 30, 2016 , cash used in financing activities was $5.4 million , consisting primarily of $4.2 million in payments, inclusive of debt issuance costs, towards our capital lease obligations as well as the net payments towards the term loan under our Loan Facility of $1.7 million .
During the six months ended June 30, 2015 , cash used in financing activities was $3.4 million , consisting primarily of $3.0 million in payments towards our Loan Facility, as well as $2.8 million in payments towards our capital lease obligations, partially offset by $3.1 million in net cash proceeds from the issuance of common stock, primarily under the employee stock purchase plan.
Off Balance Sheet Arrangements
We did not have any off balance sheet arrangements as of June 30, 2016 or December 31, 2015 as defined in Item 303(a)(4) of Regulation S-K.
Contractual Obligations and Known Future Cash Requirements
Commitments
As of June 30, 2016 , our principal commitments consisted of obligations under the 2016 Loan Facility, our operating leases for our offices, and capital lease agreements for computer hardware and software.

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The following table summarizes our future minimum payments under these arrangements as of June 30, 2016 (in thousands):
 
Payments Due by Period
 
Total
 
Less Than
1 Year
 
1–3 Years
 
3–5 Years
 
More Than
5 Years
Operating lease obligations
$
84,722

 
$
16,926

 
$
31,542

 
$
18,820

 
$
17,434

Capital lease obligations
16,885

 
8,738

 
7,835

 
312

 

Revolving credit facility (1)
62,500

 

 
62,500

 

 

Total minimum payments
$
164,107

 
$
25,664

 
$
101,877

 
$
19,132

 
$
17,434

(1)
Accrues interest, at our option, at (i) a base rate determined in accordance with the 2016 Loan Facility, plus a spread of 1.625% to 2.125%, or (ii) a LIBOR rate determined in accordance with the credit agreement, plus a spread of 2.625% to 3.125%, which was equal to 3.33%, as of June 30, 2016 , and has a final maturity date in December 2017.
The contractual commitment amounts in the table above are associated with agreements that are enforceable and legally binding. Obligations under contracts that we can cancel without a significant penalty are not included in the table above.
Critical Accounting Policies, Estimates and Judgments
Our condensed consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States, or "GAAP." The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates.
We believe that the assumptions, estimates and judgments associated with revenue recognition, allowances for doubtful accounts and returns, internal-use software development costs, income taxes, stock-based compensation expense and impairment of goodwill and intangible assets have the greatest potential impact on our condensed consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, see the notes to our condensed consolidated financial statements. The critical accounting policies, estimates and judgments are described in Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our 2015 Annual Report on Form 10-K for the fiscal year ended December 31, 2015. There have been no changes or updates to our critical accounting policies since the end of fiscal year 2015.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We have operations both within the United States and internationally, and we are exposed to market risks in the ordinary course of our business, primarily interest rate and foreign currency exchange risks.
Interest Rate Fluctuation Risk
The primary objective of our investment activities is to preserve principal while maximizing income without significantly increasing risk. Our cash and cash equivalents consist of cash, deposits and money market funds which, due to their relatively short maturity, are relatively insensitive to interest rate changes.
Our borrowings under our credit facility are subject to variable interest rates and thus expose us to interest rate fluctuations depending on the extent to which we utilize the credit facility. If market interest rates materially increase, our results of operations could be adversely affected. A hypothetical increase in market interest rates of 100 basis points would result in an increase in our interest expense of $0.1 million per year for every $10.0 million of outstanding debt under the credit facility.
Our borrowings under capital lease obligations are at fixed interest rates, and therefore do not expose us to additional interest rate fluctuation risk.

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Foreign Currency Exchange Risk
We have foreign currency risks related to our revenue and operating expenses denominated in currencies other than the U.S. dollar, primarily the Canadian dollar, the British Pound and the Euro. While a portion of our sales are denominated in these foreign currencies and then translated into the U.S. dollar, the vast majority of our media costs are billed in the U.S. dollar, causing both our revenue and, disproportionately, our operating loss and net loss to be impacted by fluctuations in the exchange rates.
In addition, gains or losses from the translation of certain cash balances, trade accounts receivable balances and intercompany balances that are denominated in these currencies impact our net income (loss). A hypothetical decrease in all foreign currencies against the US dollar of 10 percent, would result in a foreign currency loss of approximately $3.0 million on foreign-denominated balances, excluding our intercompany loans with our subsidiaries, at  June 30, 2016 . As our foreign operations expand, our results may be more impacted by fluctuations in the exchange rates of the currencies in which we do business.
At this time we do not, but we may in the future, enter into financial instruments to hedge our foreign currency exchange risk.

ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
The phrase "disclosure controls and procedures" (as defined in Rules 13a- 15(e) and 15d- 15(e) under the Exchange Act)refers to controls and procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934, as amended, or the Exchange Act, such as this Quarterly Report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Disclosure controls and procedures are also designed to ensure that such information is accumulated and communicated to our management, including our chief executive officer, or CEO, and chief financial officer, or CFO, as appropriate to allow timely decision regarding required disclosure.
Our management, with the participation of our CEO and CFO, has evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2016 , the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our CEO and CFO have concluded that as of June 30, 2016 , our disclosure controls and procedures were designed at a reasonable assurance level and were effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control
There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the second quarter of 2016 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Limitations on Effectiveness of Controls and Procedures
In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs.

PART II
ITEM 1. LEGAL PROCEEDINGS
We are involved from time to time in claims, proceedings, and litigation, including the following:

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On September 3, 2014 and September 10, 2014, respectively, two purported class actions were filed in the Northern District of California against us and certain of our officers and directors at the time. The actions are Shah v. Rocket Fuel Inc., et al. , Case No. 4:14-cv-03998, and Mehrotra v. Rocket Fuel Inc., et al. , Case No. 4:14-cv-04114. The underwriters in the initial public offering on September 19, 2013, or the "IPO," and the secondary offering on February 5, 2014, or the "Secondary Offering," were also named as defendants. These actions were consolidated and a consolidated complaint, In re Rocket Fuel Securities Litigation , was filed on February 27, 2015. The consolidated complaint alleged that the defendants made false and misleading statements about the ability of our technology to detect and eliminate fraudulent web traffic, and about our future prospects. The consolidated complaint also alleged that our registration statements and prospectuses for the IPO and the Secondary Offering contained false and misleading statements on these topics. The consolidated complaint purported to assert claims for violations of Sections 10(b) and 20(a) of the Exchange Act and SEC Rule 10b-5 (the "Exchange Act claims"), and for violations of Sections 11 and 15 of the Securities Act (the "Securities Act claims"), on behalf of those who purchased the our common stock between September 20, 2013 and August 5, 2014, inclusive, as well as those who purchased common stock in the IPO, and a claim for violation of Section 12(a)(2) of the Securities Act in connection with the Secondary Offering. The consolidated complaint sought monetary damages in an unspecified amount. All defendants moved to dismiss the consolidated complaint and on December 23, 2015, the court granted in part and denied in part the defendants’ motions to dismiss. The court dismissed the Securities Act claims and all but one of the statements on which the Exchange Act claims were based. The court also dismissed all claims against the outside directors and the underwriters of the public offerings.
On March 23, 2015, a purported shareholder derivative complaint for breach of fiduciary duty, waste of corporate assets, and unjust enrichment was filed in San Mateo, California Superior Court against certain of our then-current and former officers and our board of directors at that time. The action is Davydov v. George H. John , et.al, Case No. CIV 53304. The complaint seeks monetary damages in an unspecified amount, restitution, and reform of internal controls. This state court action has been stayed pending the resolution of the In re Rocket Fuel, Inc. Derivative Litigation action described below.
On October 6, 2015, a purported verified shareholder derivative complaint was filed in the Northern District of California. The action is Victor Veloso v. George H. John et al. , Case No. 4:15-cv-04625-PJH. Beginning in January 2016, three substantially similar related cases, Gervat v. Wootton et al. , 4:16-cv-00332-PJH, Pack v. John et al. , 4:16-cv-00608-EDL, and McCawley v. Wootton et al ., Case No. 4:16-cv-00812, also were filed in the Northern District of California on January 21, 2016, February 4, 2016 and February 18, 2016, respectively. The complaints in these related actions are based on substantially the same facts as the In re Rocket Fuel Securities Litigation, and name as defendants our board of directors at the time of filings and certain then-current and former executives. The Veloso action has been related to the In re Rocket Fuel Securities Litigation and motions to relate the other actions are pending. The four purported verified shareholder derivative complaints were consolidated by the court in March 2016, and a complaint in the consolidated action, titled In re Rocket Fuel, Inc. Derivative Litigation, Case No. 4:15-cv-4625-PJH, was filed on April 14, 2016. The complaint seeks monetary damages in an unspecified amount and reform of internal controls. All defendants moved to dismiss the consolidated complaint on May 19, 2016.
On March 29, 2016, a purported shareholder derivative complaint for breach of fiduciary duty and violation of California corporations code section 25402 was filed in San Francisco, California Superior Court against certain of the Company's current and former officers and certain of the Company's current and former directors. The action is Lunam v. William Ericson, et. al., Case No. CGC-16-551209. The complaint seeks monetary damages in an unspecified amount and reform of internal controls. This state court action has been stayed pending the resolution of the In re Rocket Fuel, Inc. Derivative Litigation action described above.

On January 27, 2016, a purported shareholder derivative complaint was filed in the Delaware Court of Chancery. The action was Gee v. Wootton et al. , Case No. 11940-VCL. The plaintiff voluntarily dismissed this action on February 9, 2016.

We intend to vigorously defend ourselves against these actions. The outcomes of the legal proceedings are inherently unpredictable, subject to significant uncertainties, and could be material to our operating results and cash flows for a particular period.

Legal fees are expensed in the period in which they are incurred.

ITEM 1A. RISK FACTORS
The following risk factors and other information included in this Quarterly Report on Form 10-Q should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we presently deem less significant may also impair our business operations. Please see the first two pages in Part I, Item 2 of this Quarterly Report on Form 10-Q for a discussion of the forward-looking statements that are qualified

35



by these risk factors. If any of the events or circumstances described in the following risk factors actually occurs, our business, operating results and financial condition could be materially adversely affected.
Risks Related to Our Business and Our Industry
Our limited operating history makes it difficult to evaluate our business and prospects.
We were incorporated in 2008 and, as a result, have only a limited operating history upon which our business and future prospects may be evaluated. Although we have experienced substantial revenue growth in our limited history, our rate of revenue growth has been declining since the third quarter of 2013. We may not be able to slow or reverse this decline in revenue growth rate, and we may not be able to maintain our current revenue levels. We have encountered and will continue to encounter risks and difficulties frequently experienced by companies in rapidly developing and changing industries, including challenges related to recruiting, integrating and retaining qualified employees; making effective use of our limited resources; achieving market acceptance of our existing and future offerings; competing against companies with greater financial and technical resources; acquiring and retaining advertisers and advertising agency customers; and developing new offerings, either internally or through acquisitions.
As a company in a rapidly evolving industry, our business prospects depend in large part on our ability to:
develop, offer, sell and provide effective service and support for competitive technology platforms and offerings that meet our advertisers’ and their agencies' needs as they change;
build a reputation for superior solutions and create trust and long-term relationships with advertisers and advertising agencies;
partner with advertising agencies to offer solutions to their customers;
attract, hire, integrate and retain qualified and motivated employees;
expand our expertise in technologies required for our offerings, such as our self-service DSP and DMP enterprise solutions, that involve developing solutions for use directly by customers, including user interface development, user documentation and ongoing customer support and maintenance;
effectively execute on cost-cutting and other operating efficiency initiatives in order to create more leverage in our business;
distinguish ourselves from competitors in our industry while at the same time working with those competitors that also offer advertising inventory for our acquisition and placement;
maintain and expand our relationships with the sources of quality inventory through which we execute our customers’ advertising campaigns, including but not limited to Facebook inventory;
respond to evolving industry standards, government regulations and customer requirements that impact our business, particularly in the areas of data collection and consumer privacy;
prevent or otherwise mitigate failures or breaches of security or privacy; and
expand our business internationally.
If we are unable to meet one or more of these objectives or otherwise adequately address the risks and difficulties that we face, our business may suffer, our revenue may decline and we may not be able to achieve further growth or long-term positive profitability or cash flow.
We may experience fluctuations in our operating results, which make our future results difficult to predict and could cause our operating results or future guidance that we issue to fall below our expectations or those of investors or analysts.
Our quarterly and annual operating results have fluctuated in the past. Similarly, we expect our future operating results to fluctuate for the foreseeable future due to a variety of factors, many of which are beyond our control. We have only a few longer term contracts, and we book, bill and recognize a substantial portion of our revenue on a month-to-month basis; both factors make

36



our business less predictable. Our fluctuating results have in the past and could in the future cause our performance to fall below the expectations of investors and securities analysts, and adversely affect the price of our common stock. Because our business is changing and evolving rapidly, our historical operating results may not be useful for predicting our future operating results. Factors that may increase the volatility of our operating results include the following:
the addition or loss of customers;
changes in demand and pricing for our solutions;
changes in our revenue mix and margins related to changes in our sales strategies or product mix;
the unpredictable nature of agency relationships;
the seasonal nature of our customers’ spending on digital advertising campaigns;
changes in our pricing policies or the pricing policies of our competitors;
the pricing of advertising inventory or of other third-party services that we require;
the introduction of new technologies, product or service offerings by our competitors;
changes in our customers’ advertising budget allocations, agency affiliations, or marketing strategies, which could affect their interest in our solutions;
changes and uncertainty in the regulatory environment for us or our customers;
changes in the economic prospects of our customers or the economy generally, which could alter current or prospective customers’ spending priorities, or could increase the time or costs required to complete sales to customers;
changes in the availability of advertising inventory through real-time advertising exchanges, or in the cost to reach end consumers through digital advertising;
the rate of our investment in people and related infrastructure;
the extent to which we expand operations outside of North America;
changes in our capital expenditures and/or lease obligations as we acquire the computer hardware, equipment, facilities and other assets required to support our business; and
the cost and potential outcomes of existing and future litigation, including, without limitation, the purported stockholder class action and stockholder derivative lawsuits described below under “Risks Related to the Securities Markets and Ownership of our Common Stock— The price of our common stock has been volatile and the value of our common stock has declined substantially since our IPO."
Based upon all of the factors described above and others that we may not anticipate, including those beyond our control, we have a limited ability to forecast our future revenue, costs and expenses and the resulting profit or loss and cash flows. As a result, our actual operating results may from time to time fall below our own estimates or the expectations of investors and analysts. Furthermore, our projected results may from time to time fall below our initial estimates or the expectations of investors and analysts. These situations have occurred several times since we became a public company and resulted in substantial declines in our stock price. See “Risks Related to the Securities Markets and Ownership of our Common Stock— We have failed in the past, and may fail in the future, to meet our publicly announced guidance or other expectations about our business and future operating results. Such past failures have caused, and future failures would likely cause, our stock price to decline, ” below.
Our credit agreement contains operating and financial covenants that restrict our business and financing activities and, in some cases, could result in an immediate requirement to repay our outstanding loans.
Borrowings under our credit agreement with certain lenders and Comerica Bank, or "Comerica," as agent for the lenders, are secured by substantially all of our assets, including our intellectual property. (See Note 6 of the unaudited Condensed Consolidated Financial Statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for a detailed description of this

37



agreement.) Our credit agreement also restricts our ability to, among other things:
dispose of or sell our assets;
make material changes in our business or management;
consolidate or merge with other entities;
incur additional indebtedness;
create liens on our assets;
pay dividends;
make investments, including capital expenditures;
enter into transactions with affiliates; and
pay off or redeem subordinated indebtedness.
These restrictions are subject to certain exceptions. In addition, our credit agreement requires us to comply with minimum bank-defined EBITDA (as defined in Note 6 of our unaudited Condensed Consolidated Financial Statements in Part I, Section 1 of this Quarterly Report on Form 10-Q) covenants, maintain minimum cash balances with the lenders and maintain minimum liquidity ratios, among other requirements, and gives the lenders the right to use future cash collections from accounts receivable directly to reduce the outstanding balance of the revolving credit facility, if the aggregated cash balances on deposit with the lenders and certain other domestic financial institutions fall below $40.0 million.
If the lenders were to exercise this right, our ability to pay the costs of our operations, including payroll and vendor costs, would be adversely impacted, and could lead to insolvency or bankruptcy.

The operating and financial restrictions and covenants in the credit agreement, as well as any future financing agreements that we may enter into, could restrict our ability to finance our operations and to engage in, expand or otherwise pursue business activities and strategies that we or our stockholders may consider beneficial. We have failed to comply with similar covenants in the past. For example, as of December 31, 2012, September 30, 2013, and September 30, 2014, we were not in compliance with certain financial and non-financial covenants in applicable secured loan and security agreements, including covenants related to permitted indebtedness for a corporate credit card account balance and limitations on our capital expenditures. Although we have been able to obtain a waiver for each such covenant violation in the past, there is no guarantee that our lender will waive such violations in the future. Our ability to comply with these covenants may be affected by events beyond our control, and future breaches of any of these covenants could result in a default under the credit agreement. Future defaults, if not waived, could cause all of the outstanding indebtedness under our credit agreement to become immediately due and payable and would permit the lenders to terminate all commitments to extend further credit and permit Comerica, on behalf of the lenders, to proceed against the collateral in which we granted Comerica a security interest.
If we do not have or are unable to generate sufficient cash available to repay our debt obligations when they become due and payable, either upon maturity or in the event of a default, we may not be able to obtain additional debt or equity financing on favorable terms, if at all. This could materially and adversely affect our liquidity and financial condition and our ability to operate and continue our business as a going concern.
We may require additional capital to support growth, and such capital might not be available on terms acceptable to us, if at all. This could hamper our growth and adversely affect our business.
We intend to continue to make investments to support business growth and may require additional funds to respond to business challenges, including the management of intra-quarter cash flow cyclicality, the need to develop new features or enhance our platform, improve our operating infrastructure or acquire complementary businesses and technologies. In implementing our business strategy, we may decide to, or need to, engage in public or private equity, equity-linked or debt financings to secure additional funds to strengthen our balance sheet, and support our business plans through the end of this year and into 2017. On May 10, 2016, we filed an S-3 registration statement, supplemental prospectus, and entered into a sales agreement for an at-the-market offering enabling us to sell common shares into the market over time. If we raise additional funds through future issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities

38



we issue could have rights, preferences and privileges superior to those of holders of our common stock. Any debt financing that we secure in the future could involve restrictive covenants relating to our capital raising activities and other financial and operational matters, including the ability to pay dividends. This may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. We may not be able to complete equity offerings or obtain additional financing on terms favorable to us, if at all. If we are unable to obtain capital on terms satisfactory to us when we require it, our ability to support business growth and respond to business challenges could be significantly impaired, and our business could be adversely affected.
We have a history of losses and may not achieve or sustain profitability in the future.
We incurred net losses of $210.5 million, $64.3 million and $20.9 million for the years ended December 31, 2015, 2014 and 2013 , respectively and a net loss of $(16.7) million for the three months ended June 30, 2016 . As of June 30, 2016 , we had an accumulated deficit of $356.8 million . We may not achieve profitability in the foreseeable future, if at all. For example, in 2015 our operating expenses increased more rapidly than our revenue primarily due to non-cash goodwill impairment and amortization and depreciation charges, as well as restructuring expenses related to our reduction in force in April 2015 and corresponding adjustments to physical facilities. Our operating expenses are largely based on personnel and facilities, and are relatively fixed in the short term. Hence, our operating expenses increased more rapidly than our revenue in 2014, primarily due to a shortfall in our revenue compared to our forecasts combined with substantial continued investments we were making in our business, including an 81% increase in our headcount during 2014, and due to leases and tenant improvements at our growing number of office locations.
We now sell Platform Solutions in addition to Media Services. Some of these sales may result in the deferral of platform revenues over the term of the subscription. However, our sales costs, including commissions on such sales, will generally be incurred up front, which could result in additional losses as we ramp this business, even though the aggregate revenues from such activities exceed the associated aggregate costs of acquiring and providing such services over the full course of the term. In addition, Platform Solutions typically have lower margins related to comparable Media Services.
In order to achieve sustained profitability and positive cash flow, we must change our operational infrastructure and practices. For example, we must manage our expenses to create operating leverage and manage our financial and capital resources more effectively. If we fail to implement the necessary changes to our operations on a timely basis, or if we are unable to implement them effectively or at all, our business may suffer. Our bank covenants require us to improve our bank-defined EBITDA (as defined in Note 6 of our unaudited Condensed Consolidated Financial Statements in Part I, Section 1 of this Quarterly Report on Form 10-Q) results materially over the course of fiscal year 2016. If we fail to achieve such improvements, the banks could revoke our loans. Any future losses will continue to impair our liquidity, which could ultimately cause us to become insolvent. Furthermore, our goal to grow our business will require either that we improve our working capital management, by better aligning the time it takes to collect on customer invoices with our vendor payment terms, which are typically shorter, or obtain additional capital to support this working capital requirement. In July and August 2016, we increased our borrowing under the 2016 Loan Facility to $71.5 million fully utilizing the borrowing capacity available to us under the 2016 Loan Facility. Our intra-quarter cash flows are highly cyclical, and therefore, our intra-quarter cash balances fluctuate and can present significant cash management challenges for us. We cannot provide assurance that we will be successful in addressing these and other challenges we may face in the future.
We have experienced a slowing rate of revenue growth since the third quarter of 2013. During the third quarter of 2015, revenue declined compared to the second quarter of 2015; during the fourth quarter of 2015, revenue declined compared to the fourth quarter of 2014; and during the second quarter of 2016, revenue was declined compared to the second quarter of 2015. Our revenue growth will continue to suffer if we do not improve our capabilities to attract key former and potential customers, retain our customers and sell more solutions to these customers.
In the short term, we expect our revenue growth to continue to be impacted as we continue building our enterprise sales capabilities and as we continue to hire new sales personnel, including senior sales leaders, who require time to become productive. To sustain or increase our revenue longer-term, we must add and retain new customers and encourage longer-term customers to purchase additional offerings from us, including our newer enterprise solutions. In 2016, we focused our sales and customer service personnel on attracting new high-value customers and on expanding our relationships with our largest existing customers, with a focus on increasing revenue from our top 50 and 250 customers. As the digital advertising industry matures and as competitors introduce lower cost or differentiated products or services that compete with or are perceived to compete with ours, our ability to sell our solutions to new and existing advertisers based on our offerings, pricing, technology platform and functionality has been and could continue to be challenged. Some advertisers that are repeat users of our Media Services have increased their spending over time. Conversely, some advertisers that are newer to our solution tend to spend less than, and may not return at all, or as frequently as, advertisers that have used our solution for longer periods of time. With long-time advertisers, we may reach or have already reached a point of saturation at which it is challenging to continue to grow our revenue from those advertisers because of

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their unfamiliarity with the breadth of our product suite, as well as factors beyond our control such as internal limits that advertisers or their agencies may place on the allocation of their advertising budgets to digital media, to particular campaigns, to a particular provider, or for other reasons not known to us. Since 2014, we have been experiencing fluctuations in average customer spend, as well as the loss of, or decline in spend by, some of our larger customers. If we are unable to reverse this trend, continue to attract more new high value customers and obtain additional business from existing customers, our revenue and operating results will continue to be adversely affected.
Our ability to slow or reverse this declining rate of revenue growth will depend in part upon the successful introduction of new offerings (including our ability to cross-sell our full suite of offerings). We operate in a highly competitive market, and there can be no assurance that these new offerings will gain significant levels of market acceptance. In particular, the market for our enterprise solutions is relatively new. Advertisers may be reluctant to make significant investments in these solutions. The sales cycle for enterprise solutions can be long and unpredictable and require considerable time and expense. Even if we generate a sale, we incur upfront costs associated with onboarding advertisers to our enterprise platforms, which can be a complex process as we must support a wide range of customer data formats and capabilities, and integrate with a wide range of applications and technology and process infrastructures. We may not recoup our investment if we do not maintain the advertiser relationship over time.
We compete for allocation of advertising budgets with agencies that may prefer to allocate their clients' advertising spend to their own internal agency trading desks or other solutions, reducing our ability to grow or retain revenue from customers represented by agencies even if our solutions are more effective.
Among our principal competitors for our solutions are advertising agencies that operate agency trading desks, either directly or through affiliates. Customers often rely on agencies to direct and allocate their advertising spend for advertising in digital media among various providers. We rely predominately on advertising agencies to purchase our solution on behalf of advertisers, and certain of those agencies or agency holding companies have, or are creating competitive solutions, referred to as agency trading desks. If these agency trading desks are successful in leveraging their relationships with the advertisers, we may be unable to compete for advertisers’ budgets even if our solution is more effective. Many agencies that we work with are also owned by large agency holding companies. For various reasons related to the agencies’ own priorities or those of their holding companies, they may not recommend our solution, even though it may be more effective, and we may not have the opportunity to demonstrate our value to advertisers. Furthermore, agencies 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. Since 2014, we have been experiencing declines in revenue from some customers that directed more spend through agency trading desks that did not use our Media Services. Our ability to compete successfully and return to consistent revenue growth will depend in part on our ability to identify opportunities to work collaboratively with agencies and agency trading desks.
We may not be able to compete successfully against current and future competitors because competition in our industry is intense, and our competitors may offer solutions that are perceived by our customers to be more attractive than ours or leverage captive inventory or data to their advantage. These factors could result in declining revenue or the inability to grow our business.
Competition for our advertisers’ advertising budgets is intense, as is competition for broader advertising solutions such as data management platforms. We operate in a market that is subject to rapid development and introduction of product and service offerings, changing branding objectives and evolving customer demands, all of which affect our ability to remain competitive. For example, in the past, we experienced a decline in revenue from some customers that adopted competitors' DSP and/or DMP solutions rather than our own similar solutions. We expect competition to increase as the barriers to enter our market are low and consolidation is increasing. Increased competition may force us to charge less for our solutions, or offer pricing models that are less attractive to us and decrease our margins. Our principal competitors for our media buying solutions include traditional advertising networks, and advertising agencies that operate an agency trading desk, either directly or through an affiliate. Competitors for our self-service solutions include other companies that offer self-service DSP and/or DMP solutions, such as Salesforce, Adobe and Oracle (BlueKai), that allow advertisers to purchase inventory directly from advertising exchanges or other third parties and manage and analyze their own consumer data and third party data. Other competitors for our solutions include in-house tools and custom solutions currently used by brand advertisers to manage their customer data and advertising and marketing activities. As our platforms evolve and we introduce new technologies, features and functionality, we may face competition from new sources.
We also compete with services offered through large online portals that have significant brand recognition, such as Yahoo!, Google, AOL, MSN and The Rubicon Project. These large portals have substantial proprietary digital advertising inventory that may provide them with competitive advantages, including far greater access to Internet user data, and the ability to significantly influence pricing for digital advertising inventory. Furthermore, these por