UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

 

For the quarterly period ended June 30, 2014

OR

 

For the transition period from              to              

Commission File: Number 001‑36262

 

Rightside Group, Ltd.

(Exact name of registrant as specified in its charter)

 

 

(425) 298-2500

(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  ◻     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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ◻ 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

The number of shares of registrant’s common stock outstanding as of August 21, 2014 was 18,414,101.

 

 

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RIGHTSIDE GROUP, LTD.

QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2014

TABLE OF CONTENTS

 

 

 

 

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PART 1.  FINANCIAL INFORMATION

Item 1.  Condensed Combined Financial Statements (Unaudited)

Rightside Group, Ltd.

Condensed Combined Balance Sheets

(In thousands)

(unaudited)

 

 

 

 

 

The accompanying notes are an integral part of these condensed combined financial statements.

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Rightside Group, Ltd.

Condensed Combined Statements of Operations

(In thousands, except per share amounts)

(unaudited)

 

 

 

 

 

 

 

The accompanying notes are an integral part of these condensed combined financial statements.

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Rightside Group, Ltd.

Condensed Combined Statements of Comprehensive Loss

(In thousands)

(unaudited)

 

 

 

 

The accompanying notes are an integral part of these condensed combined financial statements.

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Rightside Group, Ltd.

Condensed Combined Statement of Equity

(In thousands)

(unaudited)

 

 

 

 

The accompanying notes are an integral part of these condensed combined financial statements.

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Rightside Group, Ltd.

Condensed Combined Statements of Cash Flows

(In thousands)

(unaudited)

 

 

 

 

The accompanying notes are an integral part of these condensed combined financial statements.

 

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Rightside Group, Ltd.

Notes to Condensed Combined Financial Statements (Unaudited)

1.  Company Background and Basis of Presentation

In February 2013, Demand Media, Inc. (“Demand Media”) announced that its board of directors authorized Demand Media to pursue the separation of its business into two distinct publicly traded entities: a new company named Rightside Group, Ltd. (“Rightside,” the “Company,” “our,” “we,” or “us”) focused on domain name services, and Demand Media, a digital media company. On August 1, 2014, Demand Media consummated a tax free distribution of all of the outstanding shares of our common stock on a pro rata basis to Demand Media stockholders (the “separation” or the “spin‑off”) as of the record date. After the spin‑off, we began operating as an independent, publicly traded company.

We were incorporated on July 11, 2013 as a direct, wholly owned subsidiary of Demand Media, a New York Stock Exchange (“NYSE”) listed company that, prior to the spin-off, was a diversified digital media and domain name services company. During the periods presented, Demand Media owned all of the outstanding shares of our capital stock. We have one class of common stock issued and outstanding, and no preferred stock is outstanding. During the periods presented, we did not have any material assets or liabilities, nor did we engage in any business or other activities, other than in connection with the spin‑off. In connection with the spin‑off, Demand Media contributed or transferred certain of the subsidiaries and assets relating to Demand Media’s domain name services business to us, and we or our subsidiaries assumed all of the liabilities relating to Demand Media’s domain name services business.

 We provide domain name registration and related value‑added service subscriptions to third parties through our wholly owned subsidiaries, eNom, Incorporated (“eNom”) and Name.com. We are also a significant participant in the Internet Corporation for Assigned Names and Numbers’ (“ICANN”) substantial expansion of the number of available generic Top Level Domain (“gTLDs”), with the first gTLDs delegated in October 2013 (“New gTLD Program”). As part of the New gTLD Program, our domain name services business entered into its first registry operator agreements with ICANN becoming an accredited registry for new gTLDs, and eNom and Name.com also entered into contracts necessary to participate in the New gTLD Program. We began to provide back‑end domain name registry and related services for gTLDs owned by a third‑party domain name registry and we have operations for our own gTLDs.

Basis of Presentation

These condensed combined financial statements have been prepared on a stand‑alone basis and are derived from the condensed consolidated financial statements and accounting records of Demand Media. The condensed combined financial statements reflect our financial position, results of operations, equity and cash flows as a separate company and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). We reclassified our Statement of Operations to reflect a single‑step presentation. This reclassification was applied to all periods presented on a consistent basis.

On August 1, 2014, the 1,000 shares of the Company’s common stock, par value $0.0001 per share, issued and outstanding immediately prior to the separation from Demand Media, Inc. were automatically reclassified as and became 18,412,985 shares of common stock, par value $0.0001 per share. Basic and diluted earnings per share and the weighted average number of shares outstanding were retrospectively restated adjusting for such reclassification.

The accompanying condensed combined financial statements include eNom, Hot Media, Inc. and their respective subsidiaries as well as six international Demand Media subsidiaries. Rightside represented the domestic and international operations associated with Demand Media’s domain name services business.

 

Our condensed combined financial statements assume the allocation to us of certain Demand Media corporate expenses relating to Rightside (refer to Note 12—Transactions with Related Parties and Parent Company Investment for further information). The accounting for income taxes is computed for our company on a separate tax return basis (refer to Note 8—Income Taxes for further information).

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All significant intercompany accounts and transactions, other than those with Demand Media, have been eliminated in preparing the combined financial statements. All transactions between us and Demand Media have been included in these combined financial statements and are deemed to be settled. The total net effect of the settlement of these transactions is reflected in the combined statements of cash flow as a financing activity and in the combined balance sheets as “Parent company investment.” Parent company investment in the condensed combined balance sheets represents Demand Media’s historical investment in our company, the net effect of cost allocations from transactions with Demand Media and our accumulated earnings.

The condensed financial statements include expense allocations for certain:

These expenses have been allocated to us on a direct basis when identifiable, with the remainder allocated on a pro rata basis calculated as a percentage of our revenue, headcount or expenses to Demand Media’s consolidated results. We consider the basis on which these expenses were allocated to be a reasonable reflection of the utilization of services provided to or the benefit received by us during the periods presented. The allocations do not, however, reflect the expense that we would have incurred as an independent company for the periods presented. Actual costs that may have been incurred if we had been a stand‑alone company would depend on a number of factors, including, but not limited to, the chosen organizational structure, the costs of being a stand‑alone publicly traded company, what functions were outsourced or performed by employees and strategic decisions made in areas such as information technology and infrastructure. Following our separation from Demand Media, we will perform these functions using our own resources and purchased services. For an interim period, however, some of these functions will continue to be provided by Demand Media under a transition services agreement, which are planned to extend for a period up to 18 months. Costs incurred by Demand Media to complete the spin‑off were not allocated to us.

The condensed combined financial statements include certain assets and liabilities that have historically been held at the Demand Media corporate level but are specifically identifiable or otherwise allocable to us.

The accompanying interim condensed combined balance sheet at June 30, 2014, the condensed combined statements of operations and condensed combined statements of comprehensive income (loss) for the three and six month periods ended June 30, 2014 and 2013, the condensed combined statements of cash flows for the six month periods ended June 30, 2014 and 2013 and the condensed combined statement of stockholders’ equity for the six month period ended June 30, 2014 are unaudited.

In the opinion of management, the unaudited interim condensed combined financial statements have been prepared on the same basis as the audited combined financial statements and include all adjustments, which include only normal recurring adjustments, necessary for the fair statement of our statement of financial position as of June 30, 2014 and our results of operations for the three and six month periods ended June 30, 2014 and 2013 and our cash flows for the six month periods ended June 30, 2014 and 2013. The results for the three and six month period ended June 30, 2014 are not necessarily indicative of the results expected for the full year. The condensed combined balance sheet as of December 31, 2013 has been derived from our audited combined financial statements for the year ended December 31, 2013 included in our Form 10 as filed with the SEC on July 14, 2014.

The interim unaudited condensed combined financial statements have been prepared in accordance with GAAP, for interim financial information. They do not include all of the information and footnotes required by GAAP for complete financial statements. Therefore, these financial statements should be read in conjunction with our audited combined financial statements and notes thereto included elsewhere in our Form 10 as filed with the SEC on July 14, 2014.

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2.  Summary of Significant Accounting Policies

Refer to our audited combined financial statements included in our Form 10 as filed with the SEC on July 14, 2014 for a complete discussion of all significant accounting policies.

Recent Accounting Pronouncements

In February 2013, the FASB issued ASU 2013-2, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income (ASU 2013-2), to improve the reporting of reclassifications out of accumulated other comprehensive income. ASU 2013-2 requires presentation, either on the face of the financial statements or in the notes, of amounts reclassified out of accumulated other comprehensive income by component and by net income line item. ASU 2013-2 is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2012. We adopted ASU 2013-2 in the first quarter of fiscal 2014. The adoption of ASU 2013-2 did not have a significant impact on our condensed combined financial statements, but did require additional disclosures.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (ASU 2014-09). ASU 2014-09 outlines a new, single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. The new model will require revenue recognition to depict the transfer of promised goods or services to customers in an amount that reflects the consideration a company expects to receive in exchange for those goods or services. The amendments in ASU 2014-09 are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period and early adoption is not permitted. The standard can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. We are currently assessing the impact that this updated standard will have on our condensed combined financial statements and footnote disclosures.

In June 2014, the FASB issued ASU 2014-12, Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide that a Performance Target Could be Achieved after the Requisite Service Period (ASU 2014-12), which requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award. This update further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted. We do not anticipate that the adoption of this standard will have a material impact on our condensed combined financial statements.

3.  Property and Equipment

Property and equipment consisted of the following (in thousands):

 

 

 

 

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Depreciation and software amortization expense, which includes acceleration of depreciation, as a result of the shortening of the estimated useful lives for certain assets, which was immaterial for the three months ended June 30, 2014 and 2013, and $0.8 million for the six months ended June 30, 2014 and 2013, respectively, and is shown by classification below (in thousands):

 

 

 

 

 

 

 

 

 

 

 

4.  Intangible Assets

Intangible assets consisted of the following (in thousands):

 

 

 

 

 

 

Identifiable finite‑lived intangible assets are amortized on a straight‑line basis over their estimated useful lives commencing on the date that the asset is available for its intended use.

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Amortization expense by classification is shown below (in thousands):

 

 

 

 

 

 

 

 

 

5.  Other Assets

Other long‑term assets and gTLD deposits consisted of the following (in thousands):

 

 

 

 

 

We paid $11.5 million during the six months ended June 30, 2014 and $3.9 million during the year ended December 31, 2013 for certain gTLD applications under the New gTLD Program. Payments for gTLD applications represent amounts paid directly to ICANN or third parties in the pursuit of gTLD operator rights, the majority of which was paid to Donuts Inc. as described in Note 7— Commitments and Contingencies.

 

The net gain related to the withdrawals of our interest in certain gTLD applications was $0.9 million for the three months ended June 30, 2014, and $5.7 million for the six months ended June 30, 2014. For the three and six month periods ended June 30, 2013, the net gain related to the withdrawals of our interest in certain gTLD applications was $1.2 million. We recorded these gains in gain on other assets, net on the condensed combined statements of operations

 

Other assets include $1.2 million as of June 30, 2014 and $0.9 million as of December 31, 2013, of restricted cash comprising a collateralized letter of credit connected with our applications under the New gTLD Program. The restrictions require the cash to be maintained in a bank account for a minimum of five years from the delegation of the gTLDs.

6.  Other Balance Sheet Items

Accounts receivable consisted of the following (in thousands):

 

 

 

 

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Accrued expenses and other liabilities consisted of the following (in thousands):

 

 

 

 

 

 

 

 

7.  Commitments and Contingencies

Leases

We conduct our operations utilizing leased office facilities in various locations and lease certain equipment under non‑cancelable operating and capital leases. Our leases expire between August 2015 and April 2019. In February 2014, we executed the First Amendment to Lease to obtain additional space for our headquarters in Kirkland, Washington and to extend the lease to April 2019. 

Letters of Credit

Demand Media issued letters of credit under its Revolving Loan Facility on our behalf and as of June 30, 2014, the total letters of credit outstanding under this facility for us was $9.8 million.

Credit Facilities

On August 6, 2014, we entered into a $30.0 million term loan credit facility with certain funds managed by Tennenbaum Capital Partners, LLC, which matures in August 2019. The principal amount of the term loans is scheduled to be repaid in quarterly installments of $375,000, beginning March 31, 2015. Once repaid, term loans may not be reborrowed. All amounts outstanding under the facility are due and payable in full on the maturity date in August 2019.

Litigation

From time to time, we are party to various litigation matters incidental to the conduct of our business. There is no pending or threatened legal proceeding to which we are a party that, in our belief, is likely to have a material adverse effect on our future financial results.

Taxes

From time to time, various federal, state and other jurisdictional tax authorities undertake review of us and our filings. In evaluating the exposure associated with various tax filing positions, we accrue charges for possible exposures. We believe any adjustments that may ultimately be required as a result of any of these reviews will not be material to our condensed combined financial statements.

Domain Name Agreement

On April 1, 2011, we entered into an agreement with a customer to provide domain name registration services and manage certain domain names owned and operated by the customer (the “Domain Agreement”). In December 2013, we amended the Domain Agreement (as amended, the “Amended Domain Agreement”). The term of the Amended Domain Agreement expires on December 31, 2014, but will automatically renew for an additional one‑year period unless

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terminated by either party. Pursuant to the Amended Domain Agreement, we are committed to purchase approximately $0.2 million of expired domain names every calendar quarter over the remaining term of the agreement.

Donuts Agreement

As part of our initiative to pursue the acquisition of gTLD operator rights, we have entered into a gTLD acquisition agreement (“gTLD Agreement”) with Donuts Inc. (“Donuts”). The gTLD Agreement provides us with rights to acquire the operating and economic rights to certain gTLDs. These rights are shared equally with Donuts and are associated with specific gTLDs (“Covered gTLDs”) for which Donuts is the applicant under the New gTLD Program. We have the right, but not the obligation, to make further deposits with Donuts in the pursuit of acquisitions of Covered gTLDs, for example as part of the ICANN auction process. The operating and economic rights for each Covered gTLD will be determined through a process whereby we and Donuts each select gTLDs from the pool of Covered gTLDs, with the number of selections available to each party based upon the proportion of the total acquisition price of all Covered gTLDs that they funded. Gains on sale of our interest in Covered gTLDs will be recognized when realized, while losses will be recognized when deemed probable. Separately, we entered into an agreement to provide certain back‑end registry services for gTLD operator rights owned by Donuts for a period of five years commencing from the launch of Donut’s first gTLD. Outside of the collaboration, we are not an investor in Donuts nor involved in any joint venture with Donuts or its affiliates.

Indemnifications

 

In the normal course of business, we have made certain indemnities, commitments and guarantees under which we may be required to make payments in relation to certain transactions. Those indemnities include intellectual property indemnities to our customers, indemnities to our directors and officers to the maximum extent permitted under the laws of the State of Delaware and indemnifications related to our lease agreements. In addition, our advertiser and distribution partner agreements contain certain indemnification provisions, which are generally consistent with those prevalent in our industry. We have not incurred significant obligations under indemnification provisions historically and do not expect to incur significant obligations in the future. Accordingly, we have not recorded any liability for these indemnities, commitments and guarantees in the accompanying condensed combined balance sheets.

8.  Income Taxes

Our effective tax rate differs from the statutory rate primarily as a result of state taxes and nondeductible stock option expenses. The effective tax rate was 28.7% for the three months ended June 30, 2014 and (0.6)% for the six months ended June 30, 2014, compared to 6.2% for the three months ended June 30, 2013 and 18.9% for the six months ended June 30, 2013.

During the three months ended June 30, 2014, we recorded an income tax benefit of $1.4 million and the income tax expense was immaterial during the same period in 2013, representing an increase of $1.4 million. The increase was primarily due to increased book losses during the period. During the six months ended June 30, 2014, we recorded an immaterial income tax benefit compared to an income tax benefit of $0.6 million during the same period in 2013, representing a decreased benefit of $0.6 million. The decreased benefit was primarily due to the reversal of deferred tax assets as a result of cancelled stock options in the 2014 periods as compared to the 2013 periods.

We are subject to the accounting guidance for uncertain income tax positions. We believe that our income tax positions and deductions will be sustained on audit and do not anticipate any adjustments that will result in a material adverse effect on our financial condition, results of operations, or cash flow.

 

Our policy for recording interest and penalties associated with audits and uncertain tax positions is to record such items as a component of income tax expense, and amounts recognized to date are insignificant. No uncertain income tax positions were recorded during the three or six months ended June 30, 2014 or 2013, and we do not expect our uncertain tax position to change materially during the next 12 months. We file a U.S. federal and many state tax returns as well as tax returns in multiple foreign jurisdictions. All tax years since our incorporation remain subject to examination by the Internal Revenue Service and various state authorities.

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9.  Employee Benefit Plan

Demand Media has a defined contribution plan under Section 401(k) of the Internal Revenue Code (“401(k) Plan”) covering all our full‑time employees who meet certain eligibility requirements. Eligible employees may defer up to 90% of their pre‑tax eligible compensation, up to the annual maximum allowed by the Internal Revenue Service. Effective January 1, 2013, we began matching a portion of the employee contributions under the 401(k) Plan up to a defined maximum. During the six months ended June 30, 2014 and 2013, our contributions to our employees under the Demand Media 401(k) Plan were $0.4 million, and $0.3 million, respectively.

10.  Stock‑based Compensation Expense

The following table summarizes the stock‑based compensation expense related to all employee and non‑employee stock‑based awards that has been included in the following line items within the condensed combined statements of operations for each of the periods presented (in thousands):

 

 

 

 

On August 1, 2014, as part of the spin and the resulting conversion of equity awards, 1.2 million restricted stock units and options were outstanding. In addition in August 2014, we granted 0.4 million restricted stock units related to new employee, executive and board of director grants.

11.  Business Segments

We operate in one operating segment. Our chief operating decision maker (“CODM”) manages our operations on a combined basis for purposes of evaluating financial performance and allocating resources. The CODM reviews separate revenue information for our domain name services and aftermarket services. All other financial information is reviewed by the CODM on a combined basis. Our operations are located in the United States, Ireland, Canada, Australia and Cayman Islands. Revenue generated outside of the United States is not material for any of the periods presented.

Revenue derived from our Domain name services and Aftermarket and other service offering is as follows (in thousands):

 

 

 

 

 

 

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12.  Transactions with Related Parties and Parent Company Investment

The condensed combined financial statements include direct costs of Rightside incurred by Demand Media on our behalf and an allocation of certain general corporate costs incurred by Demand Media. Direct costs include finance, legal, human resources, technology development, and other services and have been determined based on a direct basis when identifiable, with the remainder allocated on a pro rata basis calculated as a percentage of our revenue, headcount or expenses to Demand Media’s consolidated results. General corporate costs include, but are not limited to, executive oversight, accounting, internal audit, treasury, tax, and legal. The allocations of general corporate costs are based primarily on estimated time incurred and/or activities associated with us. Management believes the allocations of corporate costs from Demand Media are reasonable. Costs incurred by Demand Media to complete the spin‑off have not been allocated to us. However, the condensed combined financial statements may not include all of the costs that would have been incurred had we been a stand‑alone company during the periods presented and may not reflect our financial position, results of operations and cash flows had we been a stand‑alone company during the periods presented. Costs incurred and allocated by Demand Media were included in the condensed combined statements of operations as follows (in thousands):

 

 

 

 

The table above includes allocated stock‑based compensation of $0.2 million and $1.5 million for the three months ended June 30, 2014 and 2013 and $0.7 million, respectively, and $3.0 million for the six months ended June 30, 2014 and 2013, respectively, for the employees of Demand Media whose cost of services was partially allocated to us.

13.  Fair Value of Financial Instruments

Fair value represents the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. We measure our financial assets and liabilities in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

In determining fair value, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible and consider counterparty credit risk in our assessment of fair value.

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We chose not to elect the fair value option for our financial assets and liabilities that had not been previously carried at fair value. Therefore, material financial assets and liabilities not carried at fair value, such as trade accounts receivable and payables, are reported at their carrying values.

 

The carrying amounts of our financial instruments, including cash and cash equivalents, accounts receivable, receivables from domain name registries, registry deposits, restricted cash, accounts payable, term loan, revolving credit facility, accrued liabilities and customer deposits approximate fair value because of their short maturities. Our investments in marketable securities are recorded at fair value. Certain assets, including equity investments, investments held at cost, goodwill and intangible assets are also subject to measurement at fair value on a nonrecurring basis, if they are deemed to be impaired as the result of an impairment review.

 

The cost of marketable securities sold is based upon the specific identification method and any realized gains or losses on the sale of investments are reflected as a component of other income or expense. For the year ended December 31, 2013, unrealized gain on marketable securities was $0.9 million. During the first quarter 2013, we sold all of our marketable securities, resulting in a reclassification of $0.9 million of unrealized gain on marketable securities from accumulated other comprehensive income to other income (expense), net. The sale of our marketable securities resulted in total realized gains of $1.4 million, which are included in other income (expense), net.

 

14. Earnings per share

 Basic and diluted earnings per share were calculated using the following (in thousands, except per share amounts):

 

 

 

 

 

 

15. Subsequent Events 

Separation from Demand Media

Immediately prior to the separation, the authorized shares of Rightside capital stock were increased from 1,000 shares to 120,000,000 shares, divided into the following classes: 100,000,000 shares of common stock, par value $0.0001 per share, and 20,000,000 shares of preferred stock, par value $0.0001 per share. The 1,000 shares of Rightside common stock, par value $0.0001 per share, that were previously issued and outstanding were automatically reclassified as and became 18,412,985 shares of common stock, par value $0.0001 per share. The separation was effected by Demand Media through a tax-free dividend involving the distribution of all Rightside Group, Ltd. common stock held by Demand Media to Demand Media’s stockholders on August 1, 2014. Upon effectiveness of the separation, holders of Demand Media common stock received one share of Rightside common stock for every five shares of Demand Media common stock they held on the record date. Following completion of the separation, Rightside Group, Ltd. became an independent, publicly traded company on the NASDAQ Global Select Market using the symbol: “NAME.”

As part of the separation, we entered into various agreements with Demand Media which provide for the allocation between Rightside and Demand Media of certain assets, liabilities, and obligations, and govern the relationship between Rightside and Demand Media after the separation. The agreements became effective as of August 1, 2014 and include the following: Separation and Distribution Agreement, Transition Services Agreement, Employee Matters Agreement and Tax Matters Agreement.

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As of June 30, 2014 our principal sources of liquidity were our cash and cash equivalents in the amount of $51.9 million. As part of our separation from Demand Media, cash and cash equivalents were allocated between the two companies, resulting in Rightside having cash of $26.1 million as of August 1, 2014 and Demand Media assuming all of the outstanding debt.

Credit Facilities

On August 1, 2014, we entered into a $30.0 million senior secured revolving credit facility with Silicon Valley Bank, including a subfacility of $15.0 million available for the issuance of letters of credit, which was amended on August 12, 2014 and which matures in August 2017. 

On August 6, 2014, we entered into a $30.0 million term loan credit facility with certain funds managed by Tennenbaum Capital Partners, LLC, which matures in August 2019. In connection with this agreement, we also issued 997,710 common stock warrants which will be recorded as debt discount and amortized to interest expense over the term of the agreement. 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

As used herein, “Rightside,” the “Company,” “our,” “we,” or “us” and similar terms include Rightside Group, Ltd. and its subsidiaries, unless the context indicates otherwise. “Rightside” and other trademarks of ours appearing in this report are our property. This report contains additional trade names and trademarks of other companies. We do not intend our use or display of other companies’ trade names or trademarks to imply an endorsement or sponsorship of us by such companies, or any relationship with any of these companies.

We were incorporated as a Delaware corporation on July 11, 2013. Prior to our spin off from Demand Media, Inc. on August 1, 2014 we did not have any material assets or liabilities, nor did we engage in any business or other activities. Our domestic operations have historically been conducted primarily through eNom, Incorporated and its subsidiaries. The following discussion describes our financial condition and results of operations as though we were a separate company as of the dates and for the periods presented, and includes the businesses, assets, and liabilities that comprise Rightside following the spin‑off. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited interim condensed combined financial statements and related notes included elsewhere in this report.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical facts contained in this Quarterly Report on Form 10-Q, including statements regarding our future results of operations and financial position, business strategy and plans, in particular with regard to gTLDs, our objectives for future operations, the effect of the spin-off, and competition and changes to the governing rules in the domain name services industry are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” “predict,” “plan” and similar expressions are intended to identify forward-looking statements. You should not rely upon forward-looking statements as guarantees of future performance. We have based these forward-looking statements largely on our estimates of our financial results and our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in the section entitled “Risk Factors” in Part II. Item 1A of this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management 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

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the forward-looking statements. We undertake no obligation to revise or update any forward-looking statements for any reason after the date of this Quarterly Report on Form 10-Q, except as required by law.

Separation from Demand Media

Prior to August 1, 2014, Rightside was a wholly owned subsidiary of Demand Media. In February 2013, Demand Media announced that its board of directors authorized Demand Media to pursue the separation of its business into two distinct publicly traded companies: Rightside Group, Ltd., focused on domain name services, and Demand Media, Inc., a digital media company. In January 2014, we received a private letter ruling from the Internal Revenue Service (“IRS”) confirming that the separation and the distribution of shares of Rightside Group, Ltd. common stock qualifies as a transaction that is tax-free for U.S. federal income tax purposes. On July 15, 2014, Demand Media announced that the SEC had declared the Rightside Group, Ltd. Registration Statement on Form 10 effective and that the board of directors of Demand Media had approved the separation of Rightside from Demand Media in the form of a tax-free dividend involving the distribution of all outstanding shares of Rightside common stock to holders of Demand Media common stock on August 1, 2014. Immediately prior to the separation, the authorized shares of Rightside capital stock were increased from 1,000 shares to 120,000,000 shares, divided into the following classes: 100,000,000 shares of common stock, par value $0.0001 per share, and 20,000,000 shares of preferred stock, par value $0.0001 per share. The 1,000 shares of Rightside common stock, par value $0.0001 per share, that were previously issued and outstanding were automatically reclassified as and became 18,412,985 shares of common stock, par value $0.0001 per share. Upon the separation, holders of Demand Media common stock received one share of Rightside common stock for every five shares of Demand Media common stock held on the record date. Following completion of the separation, Rightside Group, Ltd. became an independent, publicly traded company on the NASDAQ Global Select Market using the symbol: “NAME.”

In connection with the separation and effective as of July 31, 2014, the following individuals were appointed as officers of Rightside: Taryn J. Naidu as Chief Executive Officer; Tracy Knox as Chief Financial Officer; Wayne M. MacLaurin as Chief Technology Officer; and Rick Danis as General Counsel. Effective on August 1, 2014, David E. Panos, Richard C. Spalding and Robert J. Majteles joined Taryn J. Naidu and James R. Quandt on our board of directors.  Effective on August 25, 2014, Shawn J. Colo and Diane M. Irvine were appointed to our board of directors.

Credit Facilities

On August 1, 2014, we entered into a $30.0 million senior secured revolving credit facility with Silicon Valley Bank, including a subfacility of $15.0 million available for the issuance of letters of credit, which was amended on August 12, 2014 and which matures in August 2017 (see “Liquidity and Capital Resources – Credit Facilities” for further discussion).   

On August 6, 2014, we entered into a $30.0 million term loan credit facility with certain funds managed by Tennenbaum Capital Partners LLC, which matures in August 2019 (see “Liquidity and Capital Resources – Credit Facilities” for further discussion).

Overview

We are a leading provider of domain name services that enable businesses and consumers to find, establish, and maintain their digital address—the starting point for connecting with their online audience. Millions of digital destinations and thousands of resellers rely upon our comprehensive platform for the discovery, registration, usage, development, and monetization of domain names. As a result, we are a leader in the multi‑billion dollar domain name services industry, with a complete suite of services that our customers use as the foundation to build their entire online presence.

We are the world’s largest wholesale Internet domain name registrar, and the second largest registrar overall, offering domain name registration and other related services to resellers and directly to domain name registrants. Through our eNom brand, we provide infrastructure services that enable a network of more than 20,000 active resellers to offer domain name registration services to their customers. Further, through our retail brands, including Name.com, we directly offer domain name registration services to more than 250,000 customers. As of June 30, 2014, we had more

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than 16 million domain names under management. In addition to domain name registration and related services, we have developed proprietary tools and services that identify and acquire, as well as monetize and sell, domain names, both for our own portfolio of names as well as for our customers.

We are also positioned to become a leading domain name registry through our participation in the New gTLD Program. To capitalize on this opportunity, we have made significant organizational and technical investments required to operate a domain name registry. To date, we have launched into the marketplace our first 23 gTLDs, including,  .Rocks, .Immobilien, .Attorney and .Ninja. In total, we have secured an interest in active applications or registry operator agreements for approximately 100 new gTLDs. The combination of our existing registrar business and our new registry business will make us one of the largest providers of end‑to‑end domain name services in the world and uniquely positions us to capitalize on the New gTLD Program.

We are a Delaware corporation headquartered in Kirkland, Washington. We generate the substantial majority of our revenue through domain name registration subscriptions and related value‑added services. We also generate revenue from advertising on, and from the sale of domain names that are registered to our customers or ourselves.

For the six months ended June 30, 2014 and 2013, we reported revenue of $91.2 million and $94.1 million, respectively. 

Key Business Metrics

We review a number of business metrics, including the following key metrics, to evaluate our business, measure the performance of our business model, identify trends impacting our business, determine resource allocations, formulate financial projections and make strategic business decisions. We believe the following measures are the primary indicators of our performance:

Domain Name Services

The following table sets forth performance highlights of key business metrics for the periods presented:

 

 

 

 

Opportunities, Challenges and Risks

Substantially all of our revenue is derived from domain name registrations and related value‑added service subscriptions from our wholesale and retail customers to our registrar platform. Growth in our revenue is dependent upon our ability to attract wholesale and retail customers to our registrar platform, to sustain those recurring revenue relationships by maintaining consistent domain name registration and value‑added service renewal rates and to grow

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those relationships through competitive pricing on domain name registrations, differentiated value‑added service and customer service offerings, and best‑in‑class reseller integration tools. Over the past few years our revenue growth has been driven by the addition of reseller customers with large volumes of domain names as well as the acquisition of Name.com, a leading retail registrar. Certain of these large customers account for a significant portion of our revenue, and from time to time, we enter into multi‑year agreements with those customers. For example, our top three customers account for 25% of our combined revenue for the six months ended June 30, 2014. We also generate advertising revenue through our monetization platform for websites or domain names that we or our customers own. The revenue associated with these websites has recently experienced flat to declining trends due to lower traffic and advertising yields in the marketplace, which we expect to continue.

Going forward, we are diversifying our service offerings and expect to be a leading platform for offering new gTLDs, which we believe will help us attract new wholesale and retail customers as well as grow domain name registration volumes with existing customers.

ICANN has approved a framework for the significant expansion of the number of gTLDs, which ICANN began delegating in the fourth quarter of 2013. We believe that such expansion could result in an increase in the number of domain names registered on our platform. In addition to wholesale and retail customer growth opportunities in our existing registrar business, the New gTLD Program provides us with new revenue opportunities, such as the opportunity to provide the technical infrastructure for new gTLD registries operated by third parties. We also began generating revenue as the exclusive registry operator for our portfolio of new gTLDs in the first quarter of 2014.

We incurred approximately $8.4 million and $4.5 million of expenses related to the New gTLD Program for the year ended December 31, 2013 and for the six months ended June 30, 2014, respectively. We paid $3.9 million during the year ended December 31, 2013 and $18.2 million during the year ended December 31, 2012, for certain gTLD applications under the New gTLD Program. Payments for gTLD applications represent amounts paid directly to ICANN and third parties in the pursuit of certain exclusive gTLD operator rights. We capitalized payments made for gTLD applications that are determined to embody a probable economic benefit, and such capitalized payments are included in other long‑term assets and intangible assets. As part of the New gTLD Program, we have received partial cash refunds for certain gTLD applications and to the extent we elect to sell or dispose of certain gTLD applications throughout the process, we will continue to incur gains or losses on amounts invested. Gains on the sale of our interest in gTLDs are recognized when realized, while losses are recognized when deemed probable. Upon the delegation of operator rights for each gTLD by ICANN, which commenced in December 2013, gTLD application fees are reclassified as finite‑lived intangible assets and amortized on a straight‑line basis over their estimated useful life. We expense as incurred other costs incurred as part of this gTLD initiative and not directly attributable to the acquisition of gTLD operator rights.

Our service costs, the largest component of our operating expenses, can vary from period to period, particularly as a percentage of revenue. As a result of our recent growth having largely been driven by reseller customers with large volumes of domain names but from which we realize lower margins, service costs as a percentage of revenue increased in 2014 compared to 2013.

Historically, our marketing expense has reflected our wholesale registrar’s ability to leverage the existing marketing and customer relationships of its reseller base. We expect marketing investments to grow as we promote our Name.com retail registrar and New gTLD Program. Marketing activity will primarily flow through our sales and marketing expense line item, although to the extent that our registry offers performance incentive rebates or other business incentives to our partners, those incentives will be recognized as a reduction to revenue.

We believe that these factors, together with costs associated with our preparation for new gTLDs, which became available for registration in the fourth quarter of 2013, will compress our operating margin in the short term as we increase our investment in new business initiatives to support future growth. However, over the long term, we expect our overall operating margins to increase as the registry business becomes a larger contributor to our overall revenue

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mix, as registry‑related revenue streams are expected to have higher margins over the long term than our existing registrar business.

Basis of Presentation

The businesses included within Rightside have historically operated as part of Demand Media and not as a separate stand‑alone entity. Our condensed combined financial statements have been prepared on a “carve‑out” basis from the condensed consolidated financial statements of Demand Media to represent our financial position and operating results as if we had existed on a stand‑alone basis during the periods presented. Our condensed combined financial statements have been derived from the condensed consolidated financial statements and accounting records of Demand Media using the historical results of operations and historical basis of attributed assets and liabilities of Rightside’s business. These historical condensed combined financial statements reflect our financial position, results of operations and cash flows in conformity with generally accepted accounting principles (“GAAP”). Our financial statements include certain assets, liabilities, revenue and expenses of Demand Media, which were allocated for certain functions, including general corporate expenses related to finance, legal, information technology, human resources, shared services, insurance, employee benefits and incentives, and stock‑based compensation. These attributed assets, liabilities, revenue and expenses have been allocated to us on the basis of direct usage when identifiable, and for resources indirectly used by us, allocations were based on relative headcount, revenue, or other methodology, to reflect estimated usage by the Rightside business. Management considers the allocation methodology and results to be reasonable for all periods presented. However, these allocations may not be indicative of the actual results that we would have incurred as an independent public company or of the results expected to occur in the future. As such, the condensed combined financial statements included herein may not necessarily reflect our results of operations, financial position or cash flows in the future or what its results of operations, financial position or cash flows would have been had we been an independent company during the periods presented.

Revenue

Our revenue is principally comprised of registration fees charged to businesses and consumers in connection with new, renewed and transferred domain name registrations. In addition, our registrar also generates revenue from the sale of other value‑added services that are designed to help our customers easily build, enhance and protect their domain names, including security services, email accounts and web hosting, and the performance of services for registries. Finally, we generate advertising and domain name sales revenue as part of our aftermarket service offering. We generate this aftermarket revenue on domain names that we own, as well as by providing these services to third parties. Our revenue varies based upon the number of domain names registered or utilizing our aftermarket service offerings, the rates we charge our customers, our ability to sell value‑added services, our ability to sell domain names from our portfolio, and the monetization we are able to achieve through our aftermarket service offerings. Performance incentive rebates and certain other business incentives are recognized as a reduction in revenue. We primarily market our wholesale registration services under our eNom brand, and our retail registration services under our Name.com brand.

We began recognizing insignificant revenue from our gTLD Initiative in the fourth quarter of 2013 and began generating revenue from the portfolio of new gTLDs we exclusively operate in the first quarter of 2014. The amount as well as the timing of revenue is uncertain and is dependent upon the timing and number of our back‑end registry customers’ launches of gTLDs, the outcome of our negotiations or auctions to acquire the operating rights for gTLD applications contested with other participants, the demand and level of user adoption of new gTLDs and the continued progress of the overall ICANN New gTLD Program. To the extent that our registry will offer performance incentive rebates or certain other business incentives to our partners, those incentives will be recognized as a reduction to revenue.

Costs and Expenses

Costs and expenses consist of service costs, sales and marketing, product development, general and administrative, amortization of intangible assets, gain on other assets, net and other income. Included in our costs and expenses are stock‑based compensation and depreciation expenses associated with our capital expenditures.

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Service Costs

Service costs primarily consist of fees paid to registries and ICANN associated with domain name registrations, revenue‑sharing expenses, Internet connection and co‑location charges and other platform expenses including depreciation of the systems and hardware used to build and operate our services, and personnel costs related to customer service and information technology. Our service costs are dependent on a number of factors, including the volume of domain name registrations, value‑added services supported by our registrar service and the revenue share agreements we have with our domain name customers utilizing our monetization platform. In the near term, we expect higher overall registration costs as a percentage of revenue due to the recent growth in higher‑volume, lower‑margin customers as well as a mix shift of revenue toward lower‑margin domain name services revenue relative to aftermarket service revenue.

Sales and Marketing

Sales and marketing expenses consist primarily of sales and marketing personnel costs, sales support, advertising, marketing and general promotional expenditures. We currently anticipate that our sales and marketing expenses will continue to increase in the near term as a percent of revenue as we continue to support our sales efforts and invest in the growth of our business including our gTLD Initiative.

Product Development

Product development expenses consist primarily of expenses incurred in our software engineering and product development and related personnel costs. Fluctuations in our product development expenses are generally the result of hiring personnel to support and develop our platform, including the costs to develop our future service offerings. We currently anticipate that our product development expenses will increase, but remain relatively flat as a percentage of revenue as we continue to hire more product development personnel and further develop our products and offerings to support the growth of our business, including our gTLD Initiative.

General and Administrative

General and administrative expenses consist primarily of personnel costs from our executive, legal, finance, human resources and information technology organizations and facilities‑related expenditures, as well as third party professional fees, insurance and bad debt expenses. Professional fees are largely comprised of outside legal, audit and information technology consulting. In the near term, we expect our general and administrative expenses to remain relatively flat as a percentage of revenue as we start generating revenue from our registry operations.

Amortization of Intangibles

We capitalize certain costs allocated to the purchase price of certain identifiable intangible assets acquired in connection with business combinations and to acquire domain names, including initial registration costs. We amortize these costs on a straight‑line basis over the related expected useful lives of these assets, which have a useful life of 3‑20 years on a combined basis as of June 30, 2013. We determine the appropriate useful life of intangible assets by performing an analysis of expected cash flows based on its historical experience of intangible assets of similar quality and value. We capitalize gTLD assets once they become available for their intended use and amortize them on a straight‑line basis over the remaining contractual period of the registry operator agreement, which is approximately 10 years. We expect intangible amortization expense to increase in the near term as we recognize expenses related to the gTLDs as they are launched into the market.

Stock‑based Compensation

Included in our costs and expenses are expenses associated with stock‑based compensation, which are allocated and included in service costs, sales and marketing, product development and general and administrative expenses. Stock‑based compensation expense is largely comprised of costs associated with stock options and restricted stock units granted to employees, restricted stock issued to employees and expenses relating to Demand Media’s Employee Stock

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Purchase Plan. We record the fair value of these equity‑based awards and expense their cost ratably over related vesting periods.

Gain on Other Assets, Net

Gain on other assets, net represents the gains on withdrawals of our interest in certain gTLD applications.

Other Income (Expense), Net

Other income (expense), net, consists primarily of realized gains related to the sale of marketable securities, transaction gains and losses on foreign currency‑denominated assets and liabilities and interest income and expense.

We expect our gains and losses will vary depending upon potential gains or losses resulting from our gTLD applications as well as movements in underlying currency exchange rates, which could become more significant as we continue to expand internationally.

Provision for Income Taxes

We are subject to income taxes principally in the United States, and certain other countries where we have a legal presence, including Ireland, Canada, Cayman Islands and Australia. We anticipate that as we expand our operations outside the United States, we will become subject to taxation based on the foreign statutory rates, and our effective tax rate could fluctuate accordingly.

Income taxes are computed using the asset and liability method, under which deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. We recognize the effect on deferred taxes of a change in tax rates on income in the period that includes the enactment date.

Results of Operations

The following tables set forth our results of operations for the periods presented (in thousands). The period‑to‑period comparison of financial results is not necessarily indicative of future results.

 

 

 

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Depreciation expense included in the above line items:

 

 

 

Stock‑based compensation expense included in the above line items:

 

 

 

As a percentage of revenue:

 

 

 

Revenue

Revenue by service line was as follows (in thousands):