UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

 

For the quarterly period ended March 31, 2015

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 May 7, 2015 was 18,758,158.

 

 

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RIGHTSIDE GROUP, LTD.

QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED MARCH  31, 2015

TABLE OF CONTENTS

 

 

 

 

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PART 1.  FINANCIAL INFORMATION

Item 1.  Financial Statements (Unaudited)

Rightside Group, Ltd.

Balance Sheets

(In thousands, except per share amounts)

(Unaudited)

 

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

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Rightside Group, Ltd.

Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

 

 

 

 

 

 

 

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

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Rightside Group, Ltd.

Statements of Comprehensive Income (Loss)

(In thousands)

(Unaudited)

 

 

 

 

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

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Rightside Group, Ltd.

Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

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

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Rightside Group, Ltd.

Notes to Financial Statements (Unaudited)

1.  Company Background, Separation from Demand Media and Basis of Presentation

In February 2013, Demand Media, Inc. (“Demand Media”), a New York Stock Exchange listed company, announced that it would pursue the separation of its business into two distinct publicly-traded companies: a new company named Rightside Group, Ltd. (together with its subsidiaries, “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 completed 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”) as of the record date. After the Separation, 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. Prior to the Separation, 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 outstanding. In connection with the Separation, Demand Media contributed or transferred certain of the subsidiaries and assets relating to its 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. We are also a participant in the expansion of generic Top Level Domains (“gTLDs”) by the Internet Corporation for Assigned Names and Numbers (“ICANN”), with the first gTLDs delegated in October 2013 (the “New gTLD Program”). We became an accredited registry for new gTLDs as part of the New gTLD Program.

Separation from Demand Media

Immediately prior to the Separation, the authorized shares of Rightside capital stock were increased from 1,000 shares to 120.0 million shares, divided into the following classes: 100.0 million shares of common stock, par value $0.0001 per share, and 20.0 million 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 18.4 million shares of common stock, par value $0.0001 per share. The Separation was consummated through a tax-free transaction involving the distribution of all Rightside 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. Upon completion of the Separation, Rightside 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.

After the Separation on August 1, 2014

Our financial statements are presented on a consolidated basis, as we became a separate consolidated group. Our balance sheet, statement of operations, and statement of cash flows include the accounts of Rightside and our wholly-owned subsidiaries.  These financial statements reflect our financial position, results of operations, statement of comprehensive income (loss), equity and cash flows as a separate company and have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”).

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Prior to the Separation on August 1, 2014

Our financial statements were presented on a combined basis as carve-out financial statements, as we were not a separate consolidated company.  Our financial statements were derived from the financial statements and accounting records of Demand Media. Our financial statements assume the allocation to us of certain Demand Media corporate expenses relating to Rightside (refer to Note 8—Transactions with Related Parties for further information). The accounting for income taxes was computed for our company on a separate tax return basis.

All significant intercompany accounts and transactions, other than those with Demand Media, have been eliminated in preparing the financial statements. All transactions between us and Demand Media have been included in these financial statements and are deemed to be settled as of August 1, 2014. The total net effect of the settlement of these transactions was reflected in the statements of cash flow as a financing activity.

These financial statements included expense allocations for certain: (1) corporate functions historically provided by Demand Media, including, but not limited to, finance, legal, information technology, human resources, communications, compliance, and other shared services; (2) employee benefits and incentives; and (3) stock-based compensation expense. These expenses were 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 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 the Separation, we are performing a majority of these functions using our own resources and purchased services. For an interim period, some of these functions 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 Separation were not allocated to us.

Interim Financial Statements

We have prepared the unaudited interim financial statements on the same basis as the audited financial statements and have included all adjustments, which include only normal recurring adjustments, necessary for the fair statement of our statement of financial position, results of operations, and cash flows. The results for the three months ended March 31, 2015 and 2014, are not necessarily indicative of the results expected for the full year.

The interim unaudited financial statements have been prepared in accordance with GAAP. They do not include all of the information and footnotes required by GAAP for complete financial statements. The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. Therefore, these financial statements should be read in conjunction with our audited financial statements and notes thereto included in our Form 10-K as filed with the Securities and Exchange Commission (“SEC”) on March 23, 2015.

2.  Summary of Significant Accounting Policies

Refer to our audited financial statements included in our Form 10-K as filed with the SEC on March 23, 2015, for a complete discussion of all significant accounting policies.

Recently Adopted Accounting Guidance

In April 2014, the Financial Accounting Standards Board (“FASB”) issued ASU 2014‑08, “Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” The new standard changes the requirements and disclosures for reporting discontinued operations. We are required to adopt this standard effective

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January 1, 2015, although early adoption is permitted. The adoption of this standard did not have an impact on our financial position or results of operations.

Recent Accounting Guidance Not Yet Adopted

In April 2015, the FASB issued ASU No. 2015-05, “Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement.” The new standard provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The new standard does not change the accounting for a customer’s accounting for service contracts. The new standard is effective for interim and annual reporting periods beginning after December 15, 2015. We are assessing the provisions of the new standard and have not determined the impact of the adoption of this standard on our financial statements.

In April 2015, the FASB issued ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs.” The new guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability instead of being presented as an asset, consistent with debt discounts. Debt disclosures will include the face amount of the debt liability and the effective interest rate. The update is effective for fiscal years beginning after December 15, 2015, and required retrospective application. Early adoption is permitted for financial statements that have not been previously issued. As of March 31, 2015, and December 31, 2014, we had $2.4 million and $2.6 million of debt issuance costs that are classified as an Other Asset on our balance sheets.  Under this new standard we would recognize these costs as a reduction of Debt when we adopt the new guidance on January 1, 2016.

In February 2015, the FASB issued ASU 2015-02, “Consolidation (Topic 810) - Amendments to the Consolidation Analysis.” The new standard modifies existing consolidation guidance related to (i) limited partnerships and similar legal entities, (ii) the evaluation of  variable interests for fees paid to decision makers or service providers, (iii) the effect of fee arrangements and related parties on the primary  beneficiary determination, and (iv) certain investment funds. These changes reduce the number of consolidation models from four to two and place more emphasis on the risk of loss when determining a controlling financial interest. The new standard is effective for fiscal years beginning after December 15, 2015. We are in the process of evaluating the adoption of the new standard, but we do not expect it to have a material effect on our results of operations and financial condition.

In January 2015, the FASB issued ASU 2015-01, “Income Statement - Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.” The new standard eliminates the separate presentation of extraordinary items but does not change the requirement to disclose material items that are unusual or infrequent in nature. The new standard is effective for fiscal years beginning after December 15, 2015, as well as interim periods within those fiscal years. The new standard may be applied retrospectively to all prior periods presented in the financial statements, and early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. We do not expect the adoption of the new standard will have a material impact on our financial statements.

In May 2014, the FASB issued ASU 2014‑09, “Revenue from Contracts with Customers (Topic 606).” The new standard provides new criteria for recognizing revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration to which the company expects to be entitled in exchange for those goods or services. The new standard requires expanded disclosures to provide greater insight into both revenue that has been recognized and revenue that is expected to be recognized in the future from existing contracts. Quantitative and qualitative information will be provided about the significant judgments and changes in those judgments that management made to determine the revenue that is recorded. The new standard will be effective for the first interim period within annual reporting periods beginning after December 15, 2016. Early adoption is not permitted. We are assessing the provisions of the new standard and have not determined the impact of the adoption of this standard guidance on our financial statements.

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Reclassifications

Certain amounts previously presented for prior periods have been reclassified to conform to current presentation. We reclassified $1.0 million of current deferred revenue to accrued expenses and other current liabilities on our balance sheet as of December 31, 2014. This balance was settled in March 2015.

3.  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.

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

 

 

 

 

 

Estimated future amortization expense related to intangible assets held as of March 31, 2015 (in thousands):

 

 

 

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4.  gTLD Deposits

gTLD deposits consisted of the following (in thousands):

 

 

 

 

 

We paid $8.1 million during the three months ended March 31, 2015, and $32.0 million during the year ended December 31, 2014, 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. These deposits would be applied to the purchase of the gTLD if we are awarded the gTLD operator rights or these deposits may be returned to us if we withdraw our interest in the gTLD application.

 

The net gain related to the withdrawals of our interest in certain gTLD applications was $7.2 million and $4.9 million for the three months ended March 31, 2015 and 2014. We recorded these gains in gain on other assets, net on the statements of operations.

5.  Other Balance Sheet Items

Accounts receivable consisted of the following (in thousands):

 

 

 

Prepaid expenses and other current assets consisted of the following (in thousands):

 

In October 2014, we entered into an agreement with Namecheap, Inc. (“Namecheap”), whereby Namecheap issued a Senior Unsecured Promissory Note (“Note receivable”) to us for $2.5 million. As of December 31, 2014, the outstanding balance on the Note receivable was $2.5 million.  During the three months ended March 31, 2015, Namecheap made two principal payments totaling $1.5 million reducing the outstanding balance of the Note receivable to $1.0 million.

 

 

6.  Income Taxes

Our effective tax rate differs from the statutory rate primarily as a result of state taxes, nondeductible stock option expenses and international operations. The effective tax rate was (101%) for the three months ended March 31, 2015, compared to (53.4%) for the three months ended March 31, 2014.

We recorded an income tax benefit of $0.9 million during the three months ended March 31, 2015, compared to an income tax expense of $1.4 million during the same period in 2014. The increase was primarily due to increased book losses and decreased expired stock options during the period.

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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 months ended March 31, 2015 or 2014, 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.

7.  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 registrar services, registry services, and aftermarket and other 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 derived from our registrar services, registry services, and aftermarket and other service offerings are as follows (in thousands):

 

 

Beginning January 1, 2015, we started presenting our Registrar and Registry services revenue separately. These amounts were previously presented on a combined basis as Domain name services revenue. Amounts in the prior periods have been updated to reflect this presentation. The amounts in the eliminations line reflect the elimination of intercompany transactions between our registry and registrar businesses.

Revenue by geographic location is as follows (in thousands):

 

 

No international country represented more than 10% of total revenue in any period presented.

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8.  Transactions with Related Parties

Prior to the Separation, our financial statements included 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 Separation have not been allocated to us. However, the 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.

Prior to the Separation, we recorded the following costs incurred and allocated by Demand Media in our statements of operations as follows (in thousands):

 

The table above includes allocated stock‑based compensation of $0.5 million for the three months ended March 31, 2014, for the employees of Demand Media whose cost of services was partially allocated to us.

 

 

9.  Fair Value of Financial Instruments

Our financial assets and liabilities measured at fair value as of March 31, 2015, and December 31, 2014, are summarized below (in thousands):

 

 

 

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The following table presents a reconciliation of our note receivable at fair value using unobservable inputs (Level 3) as of March 31, 2015 (in thousands):

 

The following table presents a reconciliation of our debt measured at fair value using unobservable inputs (Level 3) as of March 31, 2015 (in thousands):

 

 

 

 

10. Earnings (loss) per share

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

 

On August 1, 2014, the 1,000 shares of Rightside common stock, par value $0.0001 per share, issued and outstanding immediately prior to the Separation were automatically reclassified as and became 18.4 million 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 updated to reflect these transactions.

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

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, are forward-looking statements. Forward-looking statements are identified by words such as “believe,” “anticipate,” “expect,” “intend,” “plan,” “will,” “may,” and other similar expressions. These forward-looking statements include, but are not limited to:

 

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 “Item 1A. Risk Factors.” 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 Annual Report on Form 10-K may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. We undertake no obligation to revise or update any forward-looking statements for any reason after the date of this Annual Report on Form 10-K, except as required by law. 

  

You should read this Quarterly Report on Form 10-Q and the documents that we reference in this Quarterly Report on Form 10-Q and have filed with the SEC with the understanding that our actual future results, levels of activity, performance and events and circumstances may be materially different from what we expect. 

Prior to our Separation from Demand Media on August 1, 2014, we were a wholly-owned subsidiary of Demand Media and did not have any material assets or liabilities, nor did we engage in any business or other activities. 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 separation. 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. Throughout this discussion and analysis, where we provide discussion of the three months ended March 31, 2015, compared to the same period in 2014, we refer to the prior period as “2014.”

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 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 one of the world’s largest registrars, 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 28,000 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 300,000 customers. As of March 31, 2015, we had over 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 domain names as well as for our customers’ domain names.

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We are a leading domain name registry through our participation in the expansion of generic Top Level Domains (“gTLDs”) by the Internet Corporation for Assigned Names and Numbers (“ICANN”), with the first gTLDs delegated in October 2013 (the “New gTLD Program”). Since the launch of the New gTLD Program, we have amassed a portfolio of 39 gTLDs.  In May 2014, we began releasing our gTLDs into general availability in the marketplace and to date, we have launched 36 gTLDs in our portfolio including .NINJA, .ROCKS and .VIDEO.  Through the establishment of our registry services business, we have also built a distribution network of over 100 ICANN accredited registrars, including GoDaddy, eNom and Name.com, that currently offer our gTLD domain names to businesses and consumers. In addition to operating our own gTLD registries, a subsidiary of ours provides technical back‑end infrastructure services for new gTLD operator rights acquired by Donuts (collectively, our “gTLD Initiative”).

The combination of our registrar and registry services businesses makes us one of the largest providers of end-to-end domain name services in the world. This uniquely positions us to capitalize on the New gTLD Program because we can distribute owned and third party gTLDs through our retail registrar brands, our eNom reseller network and our third party registrar distribution channel.

We generate the majority of our revenue through domain name registration subscriptions, including registrations of domain names for our owned gTLDs, 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. Our business model is characterized by non-refundable, up-front payments, which lead to recurring revenue and positive operating cash flow.  We had revenue of $50.5 million, net income of $1.9 million and adjusted earnings before interest, income taxes, depreciation and amortization (“Adjusted EBITDA”) of $0.6 million for the three months ended March 31, 2015; compared to revenue of $44.6 million, net loss of $3.9 million and Adjusted EBITDA of $(2.3) million for 2014.

Separation from Demand Media

Prior to August 1, 2014, Rightside was a wholly owned subsidiary of Demand Media. On August 1, 2014, Demand Media completed a tax-free transaction involving the distribution of all outstanding shares of Rightside common stock to holders of Demand Media common stock (the “Separation”) as of the record date.

Immediately prior to the Separation, the authorized shares of Rightside capital stock were increased from 1,000 shares to 120.0 million shares, divided into the following classes: 20.0 million shares of preferred stock, par value $0.0001 per share, and 100.0 million shares of common 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 18.4 million 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 became an independent, publicly-traded company on the NASDAQ Global Select Market using the symbol: “NAME.”

We have agreements with Demand Media that have an impact on our results of operations and financial condition. This includes a Transition Services Agreement (the “TSA”) and Tax Matters Agreement. For more information regarding these and other agreements with Demand Media, see the section entitled “Item 1. Business—Agreements with Demand Media” in our Annual Report on Form 10-K which was filed with the SEC on March 23, 2015.

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 of 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 those relationships through competitive pricing on domain name registrations, differentiated value‑added services, 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

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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 27% of our consolidated revenue for the three months ended March 31, 2015. 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.

We began generating cash sales as the exclusive registry operator for our portfolio of new gTLDs in the first quarter of 2014. We have had steady growth in our registry revenue over the past 12 months. For the three months ended March 31, 2015, our revenue from our registry services was $1.6 million, compared to $42,000 for 2014.

For the three months ended March 31, 2015 and 2014, we made payments and deposits of $8.1 million and $0.4 million for 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 capitalize payments made for gTLD applications and other acquisition related costs, and include them 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 applications 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 and other acquisition-related costs 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 cost of revenue, which is the largest component of our operating expenses, can vary from period to period, particularly as a percentage of revenue. With the recent revenue growth coming from the sales of our higher margin registry business our cost of revenue as a percentage of revenue has decreased.

Historically, our marketing expense has reflected our wholesale registrar’s ability to leverage the existing marketing and customer relationships from its reseller base. We expect marketing investments to grow as we promote our Name.com retail registrar and the New gTLD Program. Marketing activity primarily flows 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 are recognized as a reduction to revenue.

We believe that these factors 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 services business becomes a larger contributor to our overall revenue mix.

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:

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The following table sets forth performance highlights of key business metrics for our registrar services for the periods presented (in millions, except for per domain and percentage data):

 

 

 

Cash sales from the portfolio of new gTLDs we exclusively operate started in the first quarter of 2014. As of March 31, 2015, our registry services end of period domains increased to 0.2 million from zero in 2014.

 

Components of Results of Operations

Revenue

Our revenue is principally comprised of registration fees charged to businesses and consumers in connection with new, renewed and transferred domain name registrations, including registrations of domain names for our own gTLDs. 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 cash sales 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 New gTLD Program. To the extent that our registry offers performance incentive rebates or certain other business incentives to our partners, those incentives are recognized as a reduction to revenue.

Costs and Expenses

Cost of Revenue

Cost of revenue consists primarily of direct costs we incur with selling an incremental product to our customers. Substantially all cost of revenue relates to domain name registration costs, payment processing fees, third-party commissions and customer care. Similar to our billing practices, we pay domain costs at the time of purchase, but recognize the costs of service ratably over the life of the registration. Customer care expense represents the costs to consult, advise and service our customers’ needs. Customer care expenses primarily consist of personnel costs (including stock-based compensation expense). We expect cost of revenue to increase in absolute dollars in future periods as we expand our domain names services business and our total customers. Domain name costs include fees paid to the various domain registries and ICANN. We prepay these costs in advance for the life of the registration. The terms of registry pricing are established by an agreement between registries and registrars. Cost of revenue may increase or decrease as a percentage of total revenue, depending on the mix of products sold in a particular period and the sales and marketing channels used.

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Sales and Marketing

Sales and marketing consists primarily of sales and marketing personnel costs (including stock-based compensation expense), sales support, advertising, marketing and general promotional expenditures. We anticipate that our sales and marketing expenses will 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.

Technology and Development

Technology and development consists primarily of costs associated with creation, development and distribution of our products and websites. These expenses primarily consist of headcount-related costs (including stock-based compensation expense) associated with the design, development, deployment, testing, operation and enhancement of our products, as well as costs associated with the data centers and systems infrastructure supporting those products. Technology and development expenses may increase or decrease as a percentage of total revenue depending on our level of investment in future headcount and global infrastructure footprint. We anticipate that our product development expenses will increase, but remain relatively flat as a percentage of revenue as we continue to hire more technology and 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 consists primarily of personnel costs (including stock-based compensation expense) from our executive, legal, finance, human resources and information technology organizations and facilities‑related expenditures, as well as third party professional fees, and insurance 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 level as a percentage of revenue as we support the growth of our business.

Depreciation and Amortization

Depreciation expense consists of charges relating to the depreciation of the property and equipment used in our business. Depreciation expense may increase or decrease in absolute dollars in future periods depending on the future level of capital investments in hardware and other equipment.

Amortization expense consists of the amortization of capitalized identifiable intangible assets acquired in connection with business combinations and to acquire domain names, including initial registration costs, as well as costs to acquire gTLDs. We amortize these costs on a straight‑line basis over the related expected useful lives of these assets. 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 the amortization of intangible assets to increase in the near term as we recognize expenses related to the gTLDs as they are launched into the market.

Gain on Other Assets, Net

Gain on other assets, net consists of gains on withdrawals of our interest in certain gTLD applications. We expect our gains and losses will vary depending upon potential gains or losses resulting from our resolution of gTLD applications for which there were multiple bidders.

Interest Expense

Interest expense consists primarily of interest expense on our credit facilities.

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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.

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 basis 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.

Basis of Presentation

Please refer to Part 1, Item 1, Note 1 of the Notes to Financial Statements for information on our basis of presentation.

Critical Accounting Policies and Estimates

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of these financial statements requires us to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions.

During the three months ended March 31, 2015, there were no significant changes to our critical accounting policies and estimates. Please refer to the critical accounting policies and estimates as described in the financial statements contained in the Annual Report on Form 10-K for the year ended December 31, 2014, filed with the SEC on March 23, 2015.  

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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The following table presents our stock‑based compensation expense included in the above line items (in thousands):

 

 

The following table presents our depreciation and amortization by expense classification (in thousands):

 

Revenue

Revenue by service line was as follows (in thousands, except percentage data):

 

Beginning January 1, 2015, we started presenting our Registrar and Registry services revenue separately. These amounts were previously presented on a combined basis as Domain Name Services revenue. Amounts in the prior

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periods have been updated to reflect this presentation. The amounts in the eliminations line reflect the elimination of intercompany transactions between our registry and registrar businesses.

Registrar Services

Registrar services revenue for the three months ended March 31, 2015, increased by $4.5 million, or 12%, to $42.0 million compared to $37.5 million in 2014.  This growth was primarily due to an increase in domain name registrations associated with the continued onboarding of eNom wholesale partners as well as revenue generated from registrations of new gTLD domain names.  

Registry Services

 

Registry services revenue for the three months ended March 31, 2015, increased to $1.6 million from $42,000 in 2014. The growth was primarily driven by new gTLD registrations which have an average selling price of more than three times that of legacy TLDs.  The remaining growth was driven by the improved performance of the existing wholesale partners as well as the continued onboarding of eNom wholesale partners.

Aftermarket and Other

Aftermarket and other revenue for the three months ended March 31, 2015, increased by $0.3 million, or 4%, to $7.3 million compared to $7.0 million in 2014.  

Cost and Expenses

Costs and expenses were as follows (in thousands, except percentage data):

 

Cost of Revenue

Cost of revenue for the three months ended March 31, 2015, increased by $4.3 million, or 12%, to $39.0 million compared to $34.6 million in 2014. The increase was primarily due to an increase of  $3.4 million in domain name registration fees associated with our growth in registered domain names and related revenue and $0.9 million in revenue sharing costs paid to our domain name monetization customers.

Sales and Marketing

Sales and marketing expenses for the three months ended March 31, 2015, decreased by $0.3 million, or 9%, to $2.5 million compared to $2.8 million in 2014. The decrease was primarily due to a decline of $0.5 million in stock-based compensation expense and $0.1 million in personnel costs due to the elimination of allocated costs from Demand Media, which was offset by an increase of $0.3 million for new marketing campaigns.

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Technology and Development

Technology and development expenses for the three months ended March 31, 2015, decreased by $0.6 million, or 10%, to $5.1 million compared to $5.7 million in 2014. The decrease was primarily due to $0.6 million in personnel costs due to the elimination of allocated costs from Demand Media and $0.2 million in one-time costs in 2014, partially offset by an increase of $0.2 million in infrastructure and technology costs to support our service platforms and our operations as a standalone company.

General and Administrative

General and administrative expenses for the three months ended March 31, 2015, decreased by $1.0 million, or 17%, to $5.0 million compared to $6.0 million in 2014. The decrease was primarily due to a decrease of $0.7 million in personnel costs due to the elimination of allocated costs from Demand Media and a $0.3 million reduction for consulting, legal and infrastructure costs.

Depreciation and Amortization

Depreciation and amortization expense for the three months ended March 31, 2015, decreased by $0.2 million, or 6%, to $4.0 million compared to $4.2 million in 2014.

Gain on Other Assets, Net

Gain on other assets, net for the three months ended March 31, 2015 and 2014, was $7.2 million and $4.9 million due to payments received in exchange for the withdrawals of our interest in certain gTLD applications.

Interest Expense

Interest expense for the three months ended March 31, 2015, was $1.2 million consisting of interest expense on our credit facilities. We did not have any interest expense in 2014.

Other (Income) Expense, Net

Other (income) expense, net for the three months ended March 31, 2014, included $1.4 million of gain on the sale of marketable securities.

Income Tax Benefit

Income tax benefit for the three months ended March 31, 2015, was $0.9 million, compared to tax expense of $1.4 million in 2014. The increase in tax benefit was primarily due to increased book losses and decreased expired stock options during the period.   

Non-GAAP Financial Measures

 

To supplement our financial results presented in GAAP, we use Adjusted EBITDA, a non-GAAP financial measure, to evaluate our business. We define Adjusted EBITDA as net income (loss) adjusted for interest, income taxes, gain on sale of marketable securities, gain on other assets, net, depreciation and amortization, stock-based compensation expense, as well as the financial impact of acquisition and realignment costs. Acquisition and realignment costs include legal, accounting and other professional fees directly attributable to acquisition activity as well as employee severance and other payments in connection with corporate realignment activities.

 

We believe that Adjusted EBITDA is helpful in understanding our financial performance and potential future results. These are not meant to be considered in isolation or as a substitute for comparable GAAP measures and should be read in conjunction with the financial statements prepared in accordance with GAAP.  Adjusted EBITDA may differ from non-GAAP financial measures with the same or similar captions that are used by other companies and do not

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reflect a comprehensive system of accounting.  We use Adjusted EBITDA internally to understand, manage, and evaluate our business and make operating decisions. In addition, we believe that the presentation of Adjusted EBITDA is useful to investors because they enhance the ability of investors to compare our results from period to period and allows for greater transparency with respect to key financial metrics we use in making operating decisions.

 

The following is a reconciliation of Net income (loss) to Adjusted EBITDA (in thousands):

 

Adjusted EBITDA for the three months ended March 31, 2015, increased $2.9 million, to income of $0.6 million, compared to a loss of $2.3 million in 2014. The increase was primarily due to an increase in revenue of $6.0 million, and a decrease of $1.4 million in personnel costs from the elimination of allocated costs from Demand Media, offset by an increase in cost of revenue of $4.3 million and $0.3 million for other operating expenses. The increase in cost of revenue consists primarily of direct costs we incur with selling an incremental product to our customers.

Liquidity and Capital Resources

Historically, we have principally financed our operations from net cash provided by our operating activities. Our cash flows from operating activities are significantly affected by our cash based investments in operations, including working capital, and corporate infrastructure to support our ability to generate revenue and conduct operations through cost of services, product development, sales and marketing and general and administrative activities. Cash used in investing activities has historically been, and is expected to be, significantly impacted by our ongoing investments in our platform, company infrastructure, equipment and, more recently, our investments in gTLD applications. Our capital expenditures and investments in gTLDs have to date been funded by both cash flow from operations and investment from our former parent, Demand Media, as well as proceeds from our credit facilities.

As of March 31, 2015, our principal sources of liquidity were our cash and cash equivalents in the amount of $45.9 million. For more information, see the section entitled “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Credit Facilities” in our Annual Report on Form 10-K which was filed with the SEC on March 23, 2015.

We believe our capital structure is appropriate for this stage of the Company and is sufficient to grow the business while pursuing our strategic objectives. However, we are participating in a dynamic and emerging environment, and will continuously evaluate our position relative to the opportunities available in the marketplace. We believe that our future cash from operations, together with our ability to access sources of financing, including debt and equity, will provide sufficient resources to fund both short term and long term operating requirements, capital expenditures, acquisitions and new business development activities for at least the next 12 months.

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Historical Cash Flow Trends

The following table sets forth our major sources and (uses) of cash for each period as set forth below (in thousands):

 

Cash Flows from Operating Activities

Net cash used in operating activities was $1.1 million and $2.1 million for the three months ended March 31, 2015 and 2014.

Our net income for the three months ended March 31, 2015, was $1.9 million, which included a gain on the withdrawal of gTLD applications of $7.2 million and non-cash charges of $5.0 million such as depreciation, amortization, stock-based compensation expense, and deferred taxes.  In addition, changes in our working capital resulted in a $0.7 million reduction in cash.

Our net loss for the three months ended March 31, 2014, was $3.9 million, which included a gain on the withdrawal of gTLD applications of $4.9 million, gain on the sale of marketable securities of $1.4 million, and non-cash charges of $7.5 million such as depreciation, amortization, stock-based compensation expense, and deferred taxes. In addition, changes in our working capital generated $0.6 million of cash.

Cash Flows from Investing Activities

Net cash used in investing activities was $2.2 million for the three months ended March 31, 2015, compared to cash provided by investing activities of $2.4 million in 2014.

The $4.6 million increase of cash used in investing activities was primarily due to an increase of $7.7 million of payments and deposits for investments in gTLD applications in pursuit of our ownership of certain gTLD operator rights, offset by a decrease of $1.9 million from purchases of property and equipment, and offset by an increase of $0.6 million in proceeds from gTLD withdrawals and a net increase of $0.6 million from other transactions (proceeds from the repayment of note receivable, change in restricted cash and proceeds from sale of marketable securities).  

Cash Flows from Financing Activities

Net cash used in financing activities for the three months ended March 31, 2015, includes $0.4 million in principal payments on debt and $0.2 million minimum tax withholding on restricted stock awards. Net cash provided by financing activities for the three months ended March 31, 2014, includes $11.3 million cash inflow from parent company investment by Demand Media.

Off‑Balance Sheet Arrangements

As of March 31, 2015, we were not a party to any off‑balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our financial condition, revenue or expenses, results of operations, liquidity or capital resources.

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Contractual Obligations

There have been no material changes outside of the ordinary course of business in our outstanding contractual obligations from those disclosed within “Management's Discussion and Analysis of Financial Condition and Results of Operations,” as contained in our Annual Report on Form 10-K filed with the SEC on March 6, 2015.

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

We are exposed to market risks in the ordinary course of our business. These risks primarily include foreign exchange and concentration of credit risk. To reduce and manage these risks, we assess the financial condition of our large registrar resellers and other large customers when we enter into or amend agreements with them and we limit credit risk by collecting in advance when possible and setting and adjusting credit limits where we deem appropriate. In addition, our recent investment strategy has been to invest in high credit quality financial instruments, which are highly liquid, are readily convertible into cash and that mature within three months from the date of purchase.

Interest Rate Risk

We are subject to interest rate risk in connection with the term loan drawn on our term loan credit facility with Tennenbaum Capital Partners LLC (the “Tennenbaum Credit Facility”), which accrues interest at variable rates. As of March 31, 2015, our borrowings under the Tennenbaum Credit Facility had an effective interest rate of 14.8%. Assuming the Tennenbaum Credit Facility is fully drawn and holding other variables constant, a 1% increase in interest rates, occurring April 1, 2015, and sustained would result in an increase in our annual interest expense and a decrease in our cash flows and income before taxes of approximately $0.3 million per year.

Foreign Currency Exchange Risk

While relatively small, we have operations outside of the United States. We have foreign currency risks related to a relatively small percentage of our expenses being denominated in currencies other than the U.S. dollar, principally in the Euro. We do not believe movements in the foreign currencies in which we transact will significantly affect future net earnings or losses. However, as our international operations grow, our risks associated with fluctuation in currency rates will become greater, and we intend to continue to assess our approach to managing this risk.

Concentrations of Credit Risk

As of March 31, 2015, our cash and cash equivalents were maintained primarily with one major U.S. financial institution and one foreign bank. We also maintained cash balances with three Internet payment processors. Deposits with these institutions at times exceed the federally insured limits, which potentially subject us to concentration of credit risk. Historically, we have not experienced any losses related to these balances and believe that there is minimal risk of expected future losses. However, there can be no assurance that there will not be losses on these deposits.

Item 4.    Controls and Procedures

(a)  Evaluation of disclosure controls and procedures. Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, have evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) prior to the filing of this quarterly report. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that, as of the end of the period covered by this quarterly report, our disclosure controls and procedures were, in design and operation, effective at a reasonable level of assurance.   

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PART II.  OTHER INFORMATION

Item 1.    Legal Proceedings

There is no pending or threatened legal proceeding to which we are a party that, in our belief, is reasonably likely to have a material adverse effect on our business, financial results and existing or future operations.

Item 1A.  Risk Factors

You should carefully consider the following risk factors, in addition to the other information contained in this report, including the section of this report captioned “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and related notes. If any of the events described in the following risk factors and the risks described elsewhere in this report occurs, our business, operating results and financial condition could be seriously harmed. This report also contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of factors that are described below and elsewhere in this report. 

Risks Relating to Our Businesses

If we are unsuccessful in marketing and selling our gTLDs or there is insufficient consumer demand for our gTLDs, our future business and results of operations would be materially adversely affected.

Our registry services business, which derives most of its revenue from registration fees for domain names, is expected to generate a significant portion of our revenue and margin in the future. The new gTLDs that we offer to the market are primarily untested and it is unclear what the ultimate market size or demand is or will be for these new offerings. There can be no guarantees that consumers will demand or accept new gTLDs in general or our new gTLDs in particular.

We face significant competition to our registry services business and we may not be able to develop or maintain significant market share.

Prior to the launch of the New gTLD Program, there were over 20 gTLD registries and over 290 ccTLD registries. We face competition in the registry services space from other established and more experienced operators in these service offerings, including other gTLD and ccTLD registries, as well as new entrants into the domain name services industry, some of which have greater financial, marketing and other resources. In particular, we face direct competition with other new gTLD registries offering gTLDs in similar verticals to our offerings. For example, we may offer the ability to register .DENTIST domain names, while a competitor may offer the ability to register .DENTAL domain names.

Other registries with more experience or with greater resources may launch marketing campaigns for new or existing TLDs, which result in registrars or their resellers giving other TLDs greater prominence on their websites, advertising or marketing materials. In addition, such registries could offer aggressive price discounts on the gTLDs they offer or bundle gTLDs as a loss leader with other services. If we are unable to match or beat such marketing and pricing initiatives, or are otherwise unable to successfully compete with other registries, we may not be able to develop, maintain and grow significant market share for our new gTLD offerings, and our business, financial condition and results of operation would be adversely affected.

Our registry services business is substantially dependent upon third‑parties to market and distribute our gTLDs, and we would be adversely affected if these relationships are terminated or diminished.

A large portion of our gTLD sales are made through third‑party channels, including resellers currently on our platform and third‑party registrars. Our distribution partners also offer our competitors’ gTLDs. The extent to which our third‑party distribution partners sell our gTLDs is partly a function of pricing, terms and special marketing promotions offered by us and our competitors. Our agreements with our third‑party distribution partners are generally nonexclusive

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and may be terminated by them or by us without cause. Our business would be adversely affected if such distribution partners chose not to offer our gTLDs in the future or chose to sell or offer greater amounts of competitive gTLDs relative to the amount of our gTLDs they sell or offer.

As a new gTLD registry, we are subject to ICANN’s registry operator agreement and governing policies, which may change to our detriment.

We are required to enter into a registry operator agreement with ICANN (each, a “New gTLD Registry Agreement”) for each new gTLD registry that we operate. To date, we have 39 New gTLD Registry Agreements. Of the 39 new gTLDs for which we are the registry operator, 36 have been delegated to us and inserted into the Root Zone.

We face risks arising from our New gTLD Registry Agreements with ICANN, including the following:

We may not be successful in acquiring the right to operate some of the new gTLDs for which we have applied, and therefore may not be able to grow our business as rapidly as we have planned and may lose some of our investments made in connection with the New gTLD Program.

We applied and were granted the right, through ICANN’s New gTLD Program, to operate registries for a number of new gTLDs on a stand‑alone basis. We have also acquired rights to certain gTLDs and intend to acquire rights in additional gTLDs, either directly or through strategic relationships, including with Donuts, a third‑party new gTLD applicant. We invested or made refundable deposits in the amount of $8.1 million associated with gTLD applications during the three months ended March 31, 2015, and from 2012 through March 31, 2015, we have invested or made refundable deposits in the amount of $62.3 million associated with certain gTLD applications under the New gTLD Program. We may choose to invest significant additional funds in this complex process.

We are in competition with other third‑party applicants for certain of the remaining new gTLDs for which we have applied or in which we have rights through our agreement with Donuts. There are multiple steps in the ICANN approval process. When more than one party applies for a gTLD, the parties are typically required to enter into negotiations or participate in an auction to win the registry rights. We may be outbid or otherwise be unsuccessful in acquiring gTLDs in these negotiations or auctions. We could also face lawsuits or other opposition to our gTLD applications or any award of gTLD operator rights.

If we are unsuccessful in operating a gTLD registry or providing back‑end infrastructure services, our business, future growth, financial condition and results of operations would be adversely affected.

We have limited experience as an operator of domain name registries for new gTLDs and limited experience providing technical back‑end infrastructure services to registries. If we are unsuccessful in fully implementing our gTLD Initiative, we may lose some of our current and future investment in our gTLD Initiative and the return on investment in our gTLD Initiative may not meet our current expectations justifying such investment. The loss of some of our investment or lower than expected return on investment in our gTLD Initiative could adversely affect our future growth, financial condition and results of operations.

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ICANN’s New gTLD Program may be modified  in unforeseen ways that could adversely affect our business.

ICANN is subject to many influences, both internally and externally, including registries, new gTLD applicants, registrars, governmental authorities, law enforcement agencies and trade associations. ICANN may be exposed to potential legal challenges from new gTLD applicants as well as entities opposed to the introduction of new gTLDs, which could cause unforeseen modifications to the process. In addition, the introduction of a large number of new gTLDs poses technical challenges for ICANN; ICANN’s management of such technical challenges could also create opposition to new gTLDs. Any changes to the New gTLD Program may impact the timing of revenue associated with our gTLD registry initiative, and therefore adversely affect our margins and results of operations.

If our registrar customers do not renew their domain name registrations or if they transfer their existing registrations to our competitors and we fail to replace their business, our business would be adversely affected.

Our success depends in large part on our registrar customers’ renewals of their domain name registrations. Our customer renewal rate for expiring domain name registrations was approximately 77.4% and 75.1% for the three months ended March 31, 2015 and 2014, respectively, and 72.9% and 69.9% for the years ended December 31, 2014 and 2013, respectively. If we are unable to maintain our overall renewal rates for domain name registrations or if any decrease in our renewal rates, including due to transfers, is not offset by increases in new customer growth rates, our customer base and our revenue would likely decrease. This would also reduce the number of domain name registration customers to whom we could market our other higher margin services, which could further harm our revenue and profitability, drive up our customer acquisition costs and negatively impact our operating results. Any significant decline in renewals of domain name registrations not offset by new domain name registrations would likely have an adverse effect on our business, financial condition and results of operations.

Our registrar services business is dependent on third‑party resellers, including a small number of resellers that account for a significant portion of our domain names under management. Our failure to maintain or strengthen our relationships with resellers, particularly those servicing a large percentage of our domain name registration customers, would have a material adverse effect on our business.

As a registrar with a wholesale component, we provide domain name registration services and offer value‑added services through a network of approximately 28,000 active resellers, comprised of small businesses, large e‑commerce websites, Internet service providers and web‑hosting companies, as well as through companies using our hosted back‑end registrar platform. These resellers, in turn, contract directly with domain name registrants to deliver these services. Maintaining and deepening relationships with our resellers is an important part of our growth strategy, as strong third‑party distribution arrangements enhance our ability to market our products and to increase our domain names under management, revenue and profitability.

Total revenue earned from resellers was $30.9 million, or 61% of total revenue, for the three months ended March 31, 2015, and was 28.1 million, or 63% of total revenue, for the comparable prior year period. As of March 31, 2015, our three largest resellers accounted for approximately 36% of our total domain names under management, and our largest reseller, Namecheap, Inc., represented approximately 26% of total domain names under management. In addition, Namecheap accounted for approximately 18% and 16% of our total revenue for the three months ended March 31, 2015 and the comparable prior year period, respectively. The term of our current reseller agreement with Namecheap expires in June 2015, but will automatically renew for an additional one‑year period unless terminated by either party. In addition, in October 2014, Namecheap issued a promissory note to us in the principal amount of $2.5 million in connection with our reseller agreement.  During the three months ended March 31, 2015, Namecheap made principal payments of $1.5 million on the promissory note.  As of March 31, 2015, the outstanding balance on the promissory note was $1.0 million. If Namecheap defaults on the promissory note, such default could adversely affect our reseller relationship with Namecheap and our covenants under our credit facilities. There can be no assurance that our established reseller distribution relationships will continue, as our resellers may cease to operate or otherwise terminate their relationship with us. Any reduction in access to third‑party reseller distributors, particularly those servicing a large percentage of our domain name registration customers, would have a material adverse effect on our ability to market our products and to generate revenue.

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Governmental and regulatory policies or claims concerning the domain name registration system, and industry reactions to those policies or claims, may cause instability in the industry and negatively impact our business.

ICANN is a private sector, not‑for‑profit corporation formed in 1998 for the express purpose of managing a number of Internet infrastructure related tasks previously performed directly by the U.S. Department of Commerce, including managing the domain name registration system (“DNS”). ICANN has been the subject of scrutiny by the public and by the United States and oth