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FUEL > SEC Filings for FUEL > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for ROCKET FUEL INC.

Form 10-K for ROCKET FUEL INC.


28-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the consolidated financial statements and the related notes to the consolidated financial statements included later in this Annual Report on Form 10-K. In addition to historical financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, beliefs and expectations that involve risks and uncertainties. Our actual results and the timing of events could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in "Risk Factors" and "Special Note Regarding Forward-Looking Statements."

Overview

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

There are tens of billions of daily trades across all digital advertising exchanges, thousands of times more than the number of daily trades executed by NASDAQ and the NYSE combined. Our Artificial Intelligence, or AI, system autonomously purchases ad spots, or impressions, one at a time, on these exchanges to create portfolios of impressions designed to optimize the goals of our advertisers, such as increased sales, heightened brand awareness and decreased cost per customer acquisition. We believe that our customers value our solution, as our revenue retention rate was 168%, 175% and 134% for the twelve months ended December 31, 2013, 2012 and 2011, respectively. We define our "revenue retention rate" with respect to a given twelve-month period as
(i) revenue recognized during such period from customers that contributed to revenue recognized in the prior twelve-month period divided by (ii) total revenue recognized in the prior twelve-month period.

Benefiting from our unique combination of technology and industry expertise, we have rapidly grown our business, building a diversified customer base that, as of December 31, 2013, included over 70 of the Advertising Age 100 Leading National Advertisers and over 50 of the Fortune 100 companies.

Our solution is designed to optimize both direct-response campaigns focused on generating specific consumer purchases or responses, generally defined as cost per action goals, as well as brand campaigns geared towards lifting brand metrics, generally defined as cost-per-click and brand survey goals. For the years ended December 31, 2013 and 2012, direct response campaigns contributed approximately two-thirds of our revenue, with the remaining one-third of our revenue generated through brand campaigns. We have successfully run advertising campaigns for products and brands ranging from consumer products to luxury automobiles to travel and had served well over 180 billion impressions as of December 31, 2013. We provide a differentiated solution that is simple, powerful, scalable and extensible across geographies, industry verticals and advertising channels. Our computational infrastructure supports over 25,000 CPU cores in eight data centers and houses 15 petabytes of data.

We generate revenue by delivering digital advertisements to consumers through our platform across display, mobile, social and video channels. Historically, our revenue has predominantly come from display advertising because display advertising inventory was the first to be made available for programmatic buying through real-time advertising exchanges. The digital advertising industry is rapidly adopting programmatic buying for mobile, social and video advertising, accelerating the amount of digital advertising inventory available through real-time advertising exchanges. We offer a single solution for advertisers across all of these channels to compete for a larger share of advertisers'


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budgets. While a majority of our revenue currently comes from display advertising, we are focused on offering advertisers a comprehensive solution that addresses the display, mobile, social and video channels.

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

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

Since our incorporation in March 2008, we have achieved significant growth as we have scaled our platform and expanded our offerings. For the years ended December 31, 2013, 2012 and 2011, our revenue was $240.6 million, $106.6 million and $44.7 million, respectively, representing a compound annual growth rate, or CAGR, of 126%. For the years ended December 31, 2013, 2012 and 2011, our net loss was $(20.9) million, $(10.3) million and $(4.3) million, respectively. For the years ended December 31, 2013, 2012 and 2011, our adjusted EBITDA was $0.3 million, $(3.0) million and $(3.1) million, respectively. Adjusted EBITDA is a non-GAAP financial measure. For a definition of adjusted EBITDA, an explanation of our management's use of this measure and a reconciliation of adjusted EBITDA to our net loss, see "Selected Financial Data-Non-GAAP Financial Measures."

Key Operating and Financial Performance Metrics

    We monitor the key operating and financial performance metrics set forth
below to help us evaluate growth, establish budgets, measure the effectiveness
of our research and development and sales and marketing and other investments,
and assess our operational efficiencies. Revenue less media costs, adjusted
EBITDA, and number of active customers are discussed immediately following the
table below. Revenue is discussed under the headings "-Components of Our Results
of Operations" and "-Results of Operations."

                                                  Years Ended December 31,
                                               2013            2012         2011
                                               (in thousands, except number of
                                                      active customers)
     Revenue                                $   240,605     $   106,589   $ 44,652
     Revenue less media costs (non-GAAP)        136,968          55,920     22,003
     Adjusted EBITDA (non-GAAP)                     319          (2,981 )   (3,125 )
     Number of active customers                   1,224             536        266

Revenue Less Media Costs

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


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to the limitations of using revenue less media costs and for a reconciliation of revenue less media costs to revenue, the most directly comparable financial measure calculated in accordance with GAAP.

Adjusted EBITDA

Adjusted EBITDA is a non-GAAP financial measure defined by us as net loss before income tax (expense) benefit, interest expense, net, depreciation and amortization (excluding amortization of internal-use software), stock-based compensation expense and change in fair value of convertible preferred stock warrant liability. We have presented adjusted EBITDA in this Annual Report on Form 10-K because it is a key measure used by our management and board of directors to understand and evaluate our core operating performance and trends, to prepare and approve our annual budget, to develop short and long-term operating plans and to determine bonus payouts. In particular, we believe that the exclusion of the expenses eliminated in calculating adjusted EBITDA can provide a useful measure for period-to-period comparisons of our core business. Additionally, adjusted EBITDA is a key financial measure used by the compensation committee of our board of directors in connection with the determination of compensation for our executive officers. Accordingly, we believe that adjusted EBITDA provides useful information in understanding and evaluating our operating results. Please see "Selected Financial Data-Non-GAAP Financial Measures" for information regarding the limitations of using adjusted EBITDA as a financial measure and for a reconciliation of adjusted EBITDA to net loss, the most directly comparable financial measure calculated in accordance with GAAP.

Number of Active Customers

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

Factors Affecting Our Performance

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

Investment in Growth

We plan to invest for long-term growth. We have invested and will continue to invest in research and development to enhance our solution and create additional offerings, in sales and marketing to acquire new customers and reinforce our relationships with existing customers and in our infrastructure, including our IT, financial and administrative systems and controls, data centers and leasehold improvements. We expect our capital expenditures to increase significantly in 2014 as compared to 2013. We are also investing to further automate our business processes with the goal of enhancing our profitability. We believe that these investments will contribute to our long-term growth, although they will reduce our profitability in the near term. We also believe that as our sales team becomes more seasoned, we will experience an increase in sales productivity.


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Technology Enhancements and Customer Satisfaction

We will continue to make improvements to our technology platform that may have an impact on both our gross profit margin and our performance against advertiser objectives. While our technology improvements in the third and fourth quarters of 2013 enabled significant margin improvement, we do not currently expect the margin performance achieved in those quarters to continue to improve or be maintained at this level. We expect that our margin may be impacted not only by technology improvements, but also by our commitment to satisfying advertiser objectives, the impact of seasonality in the advertising business, the supply and demand dynamics of real-time advertising exchange-traded media, and the number and types of campaigns that we run and customers that we serve as we scale our business.

Ability to Increase Penetration in All Channels

Historically, our revenue has predominantly come from display advertising, which has constituted the majority of online advertising. Our future performance is dependent on our continued ability to penetrate and grow our revenue in display, as well as mobile, social and video channels. These latter channels are now growing faster than display. Our technology platform is scalable and extensible across all channels, so technology will not be a barrier to penetration of mobile, social and video channels.

Customer Growth and Retention

While we have a significant customer base, we must continue to attract new customers, and gain a larger amount of our current customers' advertising budgets, to continue our growth. Our number of active customers increased from 266 as of December 31, 2011 to 536 as of December 31, 2012 and 1,224 as of December 31, 2013, and our revenue retention rate was 175% and 168% for the years ended December 31, 2012 and December 31, 2013, respectively. As customers that use our platform continue to increase their spend in absolute dollars, the year-over-year percentage increases in spend are on average smaller, which affects our revenue retention rate. Of the $106.6 million of revenue for the year ended December 31, 2012, $78.2 million, or 73%, was from customers that contributed to revenue recognized in the prior year. For the year ended December 31, 2013, the amount was $180.0 million, or 74%.

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

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

Seasonality

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

Components of Our Results of Operations

Revenue

We generate revenue by delivering digital advertisements to consumers through the display channel and other channels such as mobile devices and advertising delivered through social and video channels.


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For the years ended December 31, 2013 and 2012, direct-response campaigns, which are focused on generating specific consumer purchases or responses, contributed approximately two-thirds of our revenue, while brand campaigns, which are focused on lifting brand metrics, contributed the remaining one-third of our revenue. We predominantly contract with advertising agencies who purchase our solution on behalf of advertisers. When we contract with an agency, it acts as an agent for a disclosed principal, which is the advertiser. Our contracts usually provide that if the advertiser does not pay the agency, the agency is not liable to us, and we must seek payment solely from the advertiser. Our contracts with advertisers, including advertising agencies representing advertisers, are generally in the form of an insertion order. An insertion order is a contract that outlines the terms and conditions of an advertising campaign and its objectives. Our contracts typically have a term of less than a year, and we recognize revenue as we deliver advertising impressions, subject to satisfying all other revenue recognition criteria. Our revenue recognition policies are discussed in more detail under "-Critical Accounting Policies and Estimates."

Cost of Revenue

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

Operating Expenses

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


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


Sales and marketing. Our sales and marketing expenses consist primarily of personnel costs (including commissions) and, to a lesser extent, allocated costs, professional services, brand marketing, travel, trade shows and marketing materials. Our sales organization focuses on (i) marketing our solution to generate awareness;
(ii) increasing the adoption of our solution by existing and new advertisers; and (iii) expanding our international business, primarily by growing our sales team in certain countries in which we currently operate and establishing a presence in


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additional countries. We expect sales and marketing expenses to increase in absolute dollars in future periods.


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

Other Expense, Net

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

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

Change in fair value of convertible preferred stock warrant liability. During 2013, 2012 and 2011, we had two outstanding warrants to purchase shares of our capital stock. The convertible preferred stock warrants were subject to re-measurement at each balance sheet date, and any change in fair value was recognized as a component of other expense, net. In connection with the closing of our initial public offering, or IPO, in September 2013, one of the warrants was automatically converted into shares of common stock and the other warrant was converted into a warrant to purchase shares of common stock, which was exercised by the holder following the completion of the IPO. As such, beginning with the fourth quarter of 2013, we no longer are required to remeasure the value of the converted common stock warrant, and therefore, no further charges or credits related to such warrant will be made to other income and expense.

Provision for Income Taxes

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


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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.

                                                            Years Ended December 31,
                                                          2013        2012        2011
                                                                 (in thousands)
Consolidated Statements of Operations Data:
Revenue                                                 $ 240,605   $ 106,589   $ 44,652
Cost of revenue(1)                                        125,520      60,011     27,300


Gross profit                                              115,085      46,578     17,352


Operating expenses:
Research and development(1)                                17,714       4,876      1,545
Sales and marketing(1)                                     83,345      41,069     17,256
General and administrative(1)                              28,708       8,403      2,336


Total operating expenses                                  129,767      54,348     21,137


Loss from operations                                      (14,682 )    (7,770 )   (3,785 )
Other expense, net:
Interest expense                                             (917 )      (316 )     (250 )
Other income (expense)-net                                   (308 )       135         33
Change in fair value of convertible preferred stock
warrant liability                                          (4,740 )    (2,308 )     (295 )


Other expense, net                                         (5,965 )    (2,489 )     (512 )


Loss before income taxes                                  (20,647 )   (10,259 )   (4,297 )
Provision for income taxes                                   (285 )       (84 )      (28 )


Net loss                                                $ (20,932 ) $ (10,343 ) $ (4,325 )

Loss per share:
Net loss per share, basic and diluted $ (1.38 ) $ (1.29 ) $ (0.57 )


(1)
Includes stock-based compensation expense as follows:

                                              Years Ended December 31,
                                              2013          2012     2011
                                                   (in thousands)
              Cost of revenue               $      471     $    37   $   7
              Research and development           2,308         734       8
              Sales and marketing                4,482       1,100      66
              General and administrative         3,581       1,450      83


                                            $   10,842     $ 3,321   $ 164


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                                                                      Years Ended
                                                                     December 31,
                                                                2013     2012     2011
Consolidated Statements of Operations Data:*
Revenue                                                           100 %    100 %    100 %
Cost of revenue                                                    52       56       61


Gross profit                                                       48       44       39


Operating expenses:
Research and development                                            7        5        3
Sales and marketing                                                35       39       39
General and administrative                                         12        8        5


Total operating expenses                                           54       51       47


Loss from operations                                               (6 )     (7 )     (8 )
Other expense, net:
Interest expense                                                    -        -       (1 )
Other expense-net                                                   -        -        -
Change in fair value of convertible preferred stock warrant
liability                                                          (2 )     (2 )     (1 )


Other expense, net                                                 (2 )     (2 )     (1 )


Loss before income taxes                                           (9 )    (10 )    (10 )
Provision for income taxes                                          -        -        -


Net loss                                                           (9 )%   (10 )%   (10 )%

. . .

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