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YUME > SEC Filings for YUME > Form 10-K on 27-Mar-2014All Recent SEC Filings

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Form 10-K for YUME INC


27-Mar-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 consolidated 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 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 Form 10-K, particularly in Part I, Item 1A: "Risk Factors."

Overview

We are a leading independent provider of digital video advertising solutions that are purpose-built for large brand advertisers, advertising agencies, and digital media properties. Through a sophisticated platform of proprietary embedded software, data science and machine learning algorithms, we deliver TV-scale video advertising campaigns to relevant, brand-receptive digital audiences. We aggregate these audiences across a wide range of Internet-connected devices by providing global digital media properties with software that monetizes their professionally produced content and applications with our advertising campaigns. Our industry leadership is reflected in our wide audience reach, large customer base, and scale in data derived from our large embedded software base.

For our advertising customers, we overcome the complexities of delivering digital video advertising campaigns in a highly fragmented environment where audiences use an increasing variety of Internet-connected devices to access thousands of online and mobile websites and applications. Our solutions deliver video advertising campaigns seamlessly across personal computers, smartphones, tablets, set-top boxes, game consoles, Internet-connected TVs and other devices. In addition, our platform optimizes campaign results to metrics that are relevant to brand advertisers, such as brand awareness, message recall, brand favorability and purchase intent.

For our global digital media property owners, we offer software that delivers digital video advertisements to their audiences. We access data from this software and we apply our data science capabilities to target those audiences that will be relevant to particular advertisers. In combination, these capabilities allow us to deliver ads to audiences that we expect to be receptive to specific brand messages, while driving better monetization for the digital media property owner.

We generate revenue by delivering digital video advertisements on Internet-connected devices. Our ads run when users choose to view video content on their devices. Advertising customers submit ad insertion orders to us and we fulfill those orders by delivering their digital video advertisements to audiences available through digital media properties, a process that we refer to as an advertising campaign. We are typically paid on a cost per thousand basis ("CPM"), of which we generally pay digital media properties a negotiated percentage. Our customers primarily consist of large global brands and their advertising agencies. In the twelve months ended December 31, 2013, our customers included 73 of the top 100 U.S. advertisers as ranked by Advertising Age magazine in 2012 ("the AdAge 100"), such as American Express, AT&T, GlaxoSmithKline, Home Depot and McDonald's.

The core of our business relies on our sophisticated platform that encompasses customized embedded software, advertising management, and data science capabilities. Our YuMe SDKs are embedded by our digital media property owners and collects dozens of data elements that we use for our advanced audience modeling algorithms that continuously improve our ability to optimize campaigns around key brand metrics. Our Placement Quality Index ("PQI"), inventory scoring system leverages YuMe SDK and other data sources through algorithms to assess the quality of ad placements and optimize placements to maximize brand advertising results. In addition, our Audience Amplifier machine-learning tool uses those brand results in its correlative data models to find audiences that we expect to be receptive to specific brand messages.

Over our nine-year operating history we have amassed a vast amount of data derived from our large software installed base of YuMe SDKs that are embedded in online and mobile websites and entertainment applications residing on millions of personal computers, smartphones, tablets, Internet-connected TVs and other devices. This allows us to deliver television-like ads, enhanced and customized for each specific device type, and collect valuable advertisement viewership data. We collect billions of data points each year from ad impressions we deliver. As we grow our audience and advertiser footprint, we are able to collect even more data, which in turn enables us to improve the efficacy of our targeting models, further improving the utility of our solutions and driving additional adoption.


In July 2013, our board of directors and stockholders approved an amendment to our then current amended and restated certificate of incorporation. The amendment provided for a 1-for-6 reverse stock split of the outstanding common stock, effective July 24, 2013. Accordingly, (i) every six shares of common stock have been combined into one share of common stock, (ii) the number of shares of common stock into which each outstanding option or warrant to purchase common stock is exercisable, as the case may be, have been proportionately decreased on a 1-for-6 basis, (iii) the exercise price for each such outstanding option or warrant to purchase common stock has been proportionately increased on a 6-for-1 basis, and (iv) the conversion ratio for each share of preferred stock outstanding was proportionately reduced on a 1-for-6 basis. All of the share numbers, share prices, and exercise prices have been adjusted within our consolidated financial statements, on a retroactive basis, to reflect this 1-for-6 reverse stock split. We paid cash in lieu of any fractional shares to which a holder of common stock would otherwise be entitled as a result of the reverse stock split.

On August 12, 2013, we closed the IPO of our common stock. In the IPO, we sold 5,125,000 shares of our common stock at a public offering price of $9.00 per share. Net proceeds were approximately $40.0 million, after deducting underwriting discounts and commissions of $3.2 million and offering expenses of $2.9 million. Upon the closing of the IPO, all outstanding shares of our convertible preferred stock automatically converted into 21,840,537 shares of common stock and all outstanding warrants to purchase convertible preferred stock converted into warrants to purchase 53,983 shares of our common stock.

Acquisition Activity

In June 2011, we acquired Appealing Media, Limited, a U.K.-based mobile advertising technology and services company, for an aggregate purchase price of $1.3 million in cash, excluding performance-related earn-outs. In December 2012, we acquired Crowd Science, Inc., a U.S.-based audience targeting technology company, for approximately $1.1 million in cash and 2,000,000 shares of our Series D-1 preferred stock. We held back $49,000 in cash and 400,000 shares of our Series D-1 convertible preferred stock until the second anniversary of the closing date, for general representations and subject to the satisfaction of certain performance conditions. The performance conditions were not met in 2013. As such, we permanently withheld the contingent consideration. Our 1-for-6 reverse stock split in July 2013 and the conversion of preferred stock to common stock associated with the Company's IPO in August 2013 resulted in the number of shares permanently held back by the Company to become 66,666 common stock shares. We account for the withheld shares as 66,666 shares of treasury stock.

Results of Operations

The following tables set forth our results of operations for the years ended December 31, 2013, 2012 and 2011. The period-to-period comparison of financial results is not necessarily indicative of future results.

                                                    Year Ended December 31,
                                 2013                        2012                        2011
Consolidated                                        (dollars in thousands)
Statement of
Operations Data:
Revenue                 $ 151,128         100.0 %   $ 116,744         100.0 %   $  68,565         100.0 %
Cost of revenue(1)         80,242          53.1        62,985          54.0        42,787          62.4
Gross profit               70,886          46.9        53,759          46.0        25,778          37.6
Operating expenses:
Sales and
marketing(1)               47,118          31.2        31,385          26.9        23,416          34.2
Research and
development(1)              4,499           3.0         2,766           2.4         2,734           4.0
General and
administrative(1)          17,992          11.9        12,466          10.7        10,596          15.5
Total operating
expenses                   69,609          46.1        46,617          40.0        36,746          53.7
Income (loss) from
operations                  1,277           0.8         7,142           6.0       (10,968 )       (16.1 )
Interest and other
income (expense),
net:
Interest expense              (47 )        (0.0 )        (117 )        (0.1 )        (164 )        (0.2 )
Other income
(expense), net               (239 )        (0.2 )        (147 )        (0.1 )         (19 )        (0.0 )
Total interest and
other income
(expense), net               (286 )        (0.2 )        (264 )        (0.2 )        (183 )        (0.2 )
Income (loss) before
income taxes                  991           0.6         6,878           5.8       (11,151 )       (16.3 )
Income tax (expense)
benefit                      (670 )        (0.4 )        (612 )        (0.5 )          62           0.1
Net income (loss)       $     321           0.2 %   $   6,266           5.3 %   $ (11,089 )       (16.2 )%

(1) Stock-based compensation expense included in the consolidated statement of operations data above is as follows:


                                             Year Ended December 31,
                                           2013        2012        2011
                                                  (in thousands)
Cost of revenue                          $    185     $   128     $    68
Sales and marketing                         1,806       1,215         981
Research and development(2)                   346         184          65
General and administrative                  1,497         515         354
Total stock-based compensation expense   $  3,834     $ 2,042     $ 1,468

(2) Excludes $226,000, $79,000 and $74,000 of stock-based compensation expense that was capitalized as part of internal-use software development costs for the years ended December 31, 2013, 2012 and 2011, respectively.

Revenue

We principally derive revenue from advertising solutions priced on a CPM basis and measured by the number of advertising impressions delivered on digital media properties. A substantial majority of our contracts with customers take the form of ad insertion orders placed by advertising agencies on behalf of their brand advertiser clients, which are typically one to three months in duration. Occasionally, we enter into longer term contracts with customers.

We count direct advertising customers in accordance with the following principles: we count (i) each advertiser, not the advertising agencies through which its ad insertion orders may be placed, as the customer; and (ii) entities that are part of the same corporate structure are counted as a single customer. We also have other revenue (i) that is paid by digital media property owners, including platform fees, professional service fees and ad serving fees and
(ii) from intermediaries that have relationships with advertising agencies and advertisers. In calculating revenue per direct advertising customer, we exclude this other revenue.

Our revenue tends to fluctuate based on seasonal factors that affect the advertising industry. For example, many advertisers devote the largest portion of their budgets to the fourth quarter of the calendar year, to coincide with increased holiday and year-end purchasing activities. Historically, the fourth quarter of the year reflects the highest advertising activity and the first quarter reflects the lowest level of such activity.

                     Year Ended                                Year Ended                                Year Ended
                      December                                  December                                  December
                         31,                Change                 31,                Change                 31,
                        2013            $            %            2012            $            %              2011
                                                         (dollars in thousands)
Revenue              $   151,128     $ 34,384         29.5 %   $   116,744     $ 48,179         70.3 %   $    68,565

For 2013, revenue increased $34.4 million, or 29.5%, compared to 2012. The increase was primarily due to an increase of $32.7 million in net advertising sales and $1.8 million in platform sales. The increase in net advertising sales was primarily driven by an increase in the number of advertising customers, including those located in international markets we operate in and others we have recently entered. We had 580 advertising customers with average revenue of $255,000 per advertising customer in 2013 compared to 449 advertising customers with average revenue of $257,000 per advertising customer in 2012. The decrease in average revenue per advertising customer was primarily the result of the increase in number of new advertising customers, particularly new international customers, which tend to start out deploying smaller digital video advertising budgets through our solutions. Our top 20 advertising customers for 2013 accounted for $61.9 million, or 41.0%, of our revenue, compared to $58.6 million or 50.2% of our revenue for 2012.

For 2012, revenue increased $48.2 million, or 70.3%, compared to 2011. The increase was primarily due to an increase in net advertising sales as a result of an increase in the number of advertising customers, and an increase in the average revenue per advertising customer. We had 449 advertising customers with average revenue of $257,000 per advertising customer in 2012 compared to 261 advertising customers with average revenue of $241,000 per advertising customer in 2011. The increase in average revenue per advertising customer was primarily the result of advertisers directing an increasing amount of their budgets to digital video advertising. Our top 20 advertising customers accounted for $58.6 million or 50.2% of our revenue in 2012, compared to $37.2 million or 54.2% of our revenue in 2011.

Cost of Revenue and Gross Profit

Our cost of revenue primarily consists of amounts incurred with digital media property owners, typically under revenue-sharing arrangements. We refer to these costs as traffic acquisition costs. Generally, we incur traffic acquisition costs in the period the advertising impressions are delivered. In limited circumstances, we incur costs based on minimum guaranteed impressions. Cost of revenue also includes ad delivery costs, such as labor and related costs, depreciation and amortization related to acquired technologies, internally developed software and data center assets, and Internet access costs. These expenses are classified as cost of revenue in the corresponding period in which the revenue is recognized. We expect cost of revenues, including our traffic acquisition costs, to increase, but to remain relatively constant as a percentage of revenue in the near term.


                          Year Ended                                Year Ended                                Year Ended
                           December                                  December                                  December
                              31,                Change                 31,                Change                 31,
                             2013            $            %            2012            $            %            2011
                                                              (dollars in thousands)
Cost of revenue           $    80,242     $ 17,257         27.4 %   $    62,985     $ 20,198         47.2 %   $    42,787
Gross profit amount       $    70,886     $ 17,127         31.9 %   $    53,759     $ 27,981        108.5 %   $    25,778
Gross profit percentage          46.9 %                                    46.0 %                                    37.6 %

For 2013, cost of revenue increased $17.3 million, or 27.4%, compared to 2012. The increase was primarily attributable to an increase of $12.9 million in traffic acquisition costs due primarily to an increase in ad impressions delivered, as well as a $3.4 million increase in ad delivery costs. In addition, depreciation and amortization increased $1.0 million related to amortization of acquired intangible assets in connection with our acquisition of Crowd Science in December 2012. Partially offsetting these increases was a decrease in other operating costs of $0.6 million primarily from lower equipment support and maintenance expenses. For 2013, cost of revenue, as a percentage of revenue, decreased by 0.9% to 53.1% compared to 2012, primarily as a result of improved management of traffic acquisition costs.

For 2012, cost of revenue increased $20.2 million, or 47.2%, compared to 2011. The increase was primarily attributable to an increase of $17.0 million in traffic acquisition costs due primarily to an increase in ad impressions delivered, as well as a $1.3 million increase in ad delivery costs. As a result of the growth in our business, we hired additional employees to support our ad operations department (including hires in India) and experienced an increase in salaries and related costs, including stock-based compensation, of $1.1 million and depreciation and amortization of $0.7 million. Traffic acquisition costs decreased as a percentage of revenue in 2012 compared to 2011. The decrease in traffic acquisition costs as a percentage of revenue was related to the implementation of a new system of inventory quality scoring, fewer ad hoc media buys during 2012 and the impact of an increase in other revenue for which there was no associated traffic acquisition cost.

Sales and Marketing

We sell to our customers primarily through our direct sales force personnel, who have established relationships with major ad agencies and direct relationships with advertisers. Our sales and marketing expenses primarily consist of salaries, benefits, stock-based compensation, travel and entertainment expenses, and incentive compensation for our sales and marketing employees. Sales and marketing expenses also include promotional, advertising and public relations costs, as well as depreciation, facilities and other supporting overhead costs. We expect sales and marketing expenses to increase as we hire additional employees to expand our sales force and to support our marketing initiatives, and to decline as a percentage of revenue over time.

                        Year Ended                                Year Ended                                Year Ended
                         December                                  December                                  December
                            31,                Change                 31,                Change                 31,
                           2013            $            %            2012            $            %            2011
                                                            (dollars in thousands)
Sales and marketing     $    47,118     $ 15,733         50.1 %   $    31,385     $  7,969         34.0 %   $    23,416
Percentage of revenue          31.2 %                                    26.9 %                                    34.2 %

For 2013, sales and marketing expenses increased $15.7 million, or 50.1%, compared to 2012. The increase was primarily attributable to an increase of $11.5 million in employee compensation, benefits and other employee-related expenses, including stock-based compensation, associated with a 71.5% increase in sales and marketing employees as we expanded our sales organization, both domestically and internationally. Advertising-related and other sales and marketing expenses increased $3.7 million associated with the increase in revenue for 2013 compared to 2012. Additionally, depreciation and amortization increased by $0.5 million as a result of capital expenditures. For 2013, sales and marketing expenses, as a percentage of revenue, increased to 31.2% from 26.9% in 2012, primarily as a result of the increase in sales and marketing employees and related expenses as we continue to expand our domestic and international sales force and increase market awareness of our solutions.

For 2012, sales and marketing expenses increased $8.0 million, or 34.0%, compared to 2012. The increase was primarily attributable to an increase in employee-related expenses of $3.1 million, including stock-based compensation, as we expanded our sales organization, both domestically and internationally. As a result of our increase in revenue and increase in sales and marketing headcount, our commission expenses also increased $3.8 million. Additionally, general marketing expenditures increased $0.2 million and travel and entertainment expense increased $0.4 million, to expand market awareness of our solutions. Facilities expenses increased $0.5 million, reflecting our increased investment in infrastructure.


Research and Development

We engage in research and development efforts to create new, and enhance our existing, data-science capabilities and proprietary technologies. Our research and development expenses primarily consist of salaries, benefits and stock-based compensation for our engineers, product development and information technology personnel. Research and development expenses also include outside services and consulting, depreciation, facilities and other overhead costs. We capitalize a portion of our research and development costs attributable to internally developed software.

As of December 31, 2013, 2012 and 2011, we had 89, 82 and 63 research and development employees, respectively. As of December 31, 2013, 78 of our research and development employees were located in our Chennai, India office. We expect our research and development expenses to increase as we continue to invest in the research and development of our products, and to increase as a percentage of revenue in the short term. We believe that our nine-year operating history and our ability to attract and retain the large pool of engineering talent available in Chennai will help us expand our engineering resources and capabilities cost-effectively.

                      Year Ended                                 Year Ended                                 Year Ended
                     December 31,            Change             December 31,            Change             December 31,
                         2013            $            %             2012            $            %             2011
                                                           (dollars in thousands)
Research and
development          $      4,499     $  1,733         62.7 %   $      2,766     $     32          1.2 %   $      2,734
Percentage of
revenue                       3.0 %                                      2.4 %                                      4.0 %

For 2013, research and development expenses increased $1.7 million, or 62.7%, compared to 2012. The increase was primarily attributable to an increase of $2.8 million in employee compensation, benefits and other employee-related expenses, including stock-based compensation, associated with a 9% increase in research and development employees. Partially offsetting this increase was a decrease of $1.1 million in other research and development costs, primarily related to capitalized software development costs. For 2013, research and development expenses, as a percentage of revenue, increased to 3.0% in 2013 from 2.4% in 2012, primarily as a result of the increase in research and development employee compensation, benefits and other employee-related expenses, including stock-based compensation.

For 2012, research and development expenses increased slightly compared 2011. The increase was attributable to an increase in employee-related expenses of $0.1 million, as we further invested in our research and development capabilities in Chennai, India. In addition, we benefited from a favorable fluctuation in the Indian rupee exchange rate.

General and Administrative

Our general and administrative expenses primarily consist of salaries, benefits and stock-based compensation for our executive, finance, legal, human resources and other administrative employees. General and administrative expenses also include outside consulting, legal and accounting services, and facilities and other supporting overhead costs. We expect our general and administrative expenses to increase as we expand our financial, accounting, human resources, information systems and legal personnel and resources to support our public reporting requirements, and to decrease as a percentage of revenue over time.

                     Year Ended                                Year Ended                                Year Ended
                      December                                  December                                  December
                         31,                Change                 31,                Change                31,
                        2013            $            %            2012            $            %            2011
                                                         (dollars in thousands)
General and
administrative       $    17,992     $  5,526         44.3 %   $    12,466     $  1,870         17.6 %   $    10,596
Percentage of
revenue                     11.9 %                                    10.7 %                                    15.5 %

For 2013, general and administrative expenses increased $5.5 million, or 44.3%, compared to 2012. The increase was primarily attributable to an increase of $3.5 million in employee compensation, benefits and other employee-related expenses, including stock-based compensation, associated with a 54% increase in general and administrative employees hired in association with the growth in our business and operating as a public company. Additionally, other general and administrative expenses, primarily audit, tax and other expenses, increased $2.1 million as we invested in infrastructure to prepare for the growth of the business, and our August 2013 IPO. For 2013, general and administrative expenses as a percentage of revenue increased to 11.9% from 10.7% in 2012, primarily as a result of the increase in general and administrative employees and professional services, and due to costs associated in preparing for our IPO in August 2013.


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