UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

 

For the quarterly period ended June 30, 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 August 6, 2015 was 18,867,216.

 

 

---

 

RIGHTSIDE GROUP, LTD.

QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2015

TABLE OF CONTENTS

 

 

 

 

---

 

PART I.  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.

---

 

Rightside Group, Ltd.

Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

 

 

 

 

 

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

---

 

Rightside Group, Ltd.

Statements of Comprehensive Loss

(In thousands)

(Unaudited)

 

 

 

 

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

---

 

Rightside Group, Ltd.

Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

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

---

 

 

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 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

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 the Separation, holders of Demand Media common stock on the record date received one share of Rightside common stock for every five shares of Demand Media common stock.  Rightside became an independent, publicly-traded company on the NASDAQ Global Select Market using the symbol: “NAME.”

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 loss, equity and cash flows as a separate company and have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”).

---

 

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 9—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 and six months ended June 30, 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 and New Accounting Guidance

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 May 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-08, “Business Combinations (Topic 805): Pushdown Accounting - Amendments to SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 115.” The amendments update various SEC paragraphs included in the Accounting Standards Codification (“ASC”) to reflect the issuance of Staff Accounting Bulletin (“SAB”) No. 115. SAB

---

 

No. 115 rescinds portions of the interpretive guidance included in the SEC’s Staff Accounting Bulletins series and brings existing guidance into conformity with ASU No. 2014-17, “Business Combinations (Topic 805): Pushdown Accounting,” which provides an acquired entity with an option to apply pushdown accounting in its separate financial statements upon occurrence of an event in which an acquirer obtains control of the acquired entity. We have adopted the amendments in ASU 2015-08, effective May 8, 2015, as the amendments in the update are effective upon issuance. The adoption of this standard did not have an impact on our financial statements.

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 June 30, 2015, and December 31, 2014, we had $2.2 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 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. In July 2015, the FASB approved a one year deferral of the effective date. In accordance with the deferral, the new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early adoption is permitted but not before annual periods beginning after the original effective date of December 15, 2016. 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.

Reclassifications and Revisions

Certain amounts previously presented for prior periods have been reclassified to conform to current presentation as described further below.

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.

As we discussed in our Annual Report on Form 10-K for the year ended December 31, 2014, subsequent to the filing of our Form 10-Q for the third quarter of 2014, we determined that certain transactions were misclassified in the Statements of Cash Flows for the six months ended June 30, 2014.  The misclassifications primarily related to the repayment of an acquisition holdback liability for our 2012 Name.com acquisition and the timing of cash received related to gains on gTLD auctions.  For the six months ended June 30, 2014, these classification errors resulted in an

---

 

overstatement of cash outflows from operations by a total of $1.6 million; an understatement of cash outflows from investing activities of $0.5 million; and an understatement of cash outflows from financing of $1.1 million.  We assessed the materiality of the error on our previously issued quarterly financial statements in accordance with SAB No. 99, “Materiality,”  and concluded that the error was not material to the financial statements taken as a whole. We revised our Statement of Cash Flows for the six months ended June 30, 2014 to correct this error.

3.  Intangible Assets

Intangible assets consisted of the following (in thousands):

 

 

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

 

 

 

 

 

Estimated future amortization expense related to intangible assets held as of June  30, 2015 (in thousands):

 

 

 

4.  gTLD Deposits

gTLD deposits consisted of the following (in thousands):

 

 

 

 

 

We paid $10.0 million during the six months ended June 30, 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. Gains on the sale of our interest in gTLDs applications are recognized when realized, while losses are recognized when deemed probable.

 

The settlement of our interest in certain gTLD applications resulted in a net loss of $0.3 million and the withdrawal of our interest in certain gTLD applications resulted in a net gain of $0.9 million for the three months ended June 30, 2015 and 2014. The withdrawal of our interest in certain gTLD applications resulted in a net gain of $7.0 million and $5.7 million for the six months ended June 30, 2015 and 2014. We recorded these gains and losses in loss (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 six months ended June 30, 2015, Namecheap made two principal payments totaling $1.5 million, reducing the outstanding balance of the Note receivable to $1.0 million. Refer to Note 13—Subsequent Events for further information

 

6. Debt

Silicon Valley Bank Credit Facility

In June 2015, we amended our Credit Agreement (“Amendment”) with Silicon Valley Bank. The Amendment revises the terms of our existing Credit Agreement (“SVB Credit Facility”). The Amendment, among other changes, amends the consolidated fixed charge coverage ratio in the SVB Credit Facility, to require that we maintain a consolidated fixed charge coverage ratio on a scale depending on the available revolving commitment under the SVB Credit Facility plus unrestricted cash. As of June 30, 2015, we were in compliance with the covenants under the SVB Credit Facility.

7.  Income Taxes

Our effective tax rate differs from the statutory rate primarily as a result of state taxes, non-deductible stock option expenses and international operations. The effective tax rate was 11.4% and 30.6% for the three months and six months ended June 30, 2015, compared to 28.7% and 0.6% for the three and six months ended June 30, 2014.

---

 

We recorded an income tax benefit of $0.7 million during the three months ended June 30, 2015, compared to an income tax benefit of $1.4 million during the same period in 2014. The decreased benefit was primarily due to an increase in non-deductible stock warrant amortization and an increase in our state effective tax rate.

We recorded an income tax benefit of $1.7 million during the six months ended June 30, 2015, compared to an income tax benefit of $42,000 during the same period in 2014. The increased benefit was primarily due to a one-time tax expense in 2014 upon the reversal of deferred tax assets as a result of cancelled stock options.

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 and six months ended June 30, 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 tax return 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.

8.  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 offerings are as follows (in thousands):

 

 

Beginning January 1, 2015, we started presenting our Registrar services 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.

---

 

9.  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 $0.2 million and $3.0 million for the three months and six months ended June 30, 2014, for the employees of Demand Media whose cost of services was partially allocated to us.

 

 

10.  Fair Value of Financial Instruments

Our financial assets and liabilities are measured at fair value. We estimated the fair value of our term loan credit facility with Tennenbaum Capital Partners LLC (the “Tennenbaum Credit Facility”) using a discounted cash flow model with Level 3 inputs. Under this approach, we estimated the fair value to approximate its carrying value of $24.9 million as of June 30, 2015, and $25.1 million as of December 31, 2014.

 

---

 

11. 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.

For the three and six months ended June 30, 2015, we excluded 79,300 and 36,600 shares of restricted stock units and stock options from the calculation of diluted weighted average shares outstanding as their inclusion would have been antidilutive.  The $15.05 exercise price per share on the stock warrants related to the Tennenbaum Credit Facility did not have a dilutive effect for any period presented.  

12. Commitments and Contingencies

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 proceedings to which we are a  party that, in our belief, is likely to have a material adverse effect on our future financial results.

13. Subsequent Events

On July 31, 2015, we entered into a Master Agreement (the “Master Agreement”) with Namecheap that amends and replaces the Amended and Restated Letter Agreement dated April 1, 2011, as amended. The term of the Master Agreement is through December 31, 2018, and will automatically renew for an additional three year term unless terminated by either party. 

In addition, we and Namecheap entered into Amendment No. 3 of Senior Unsecured Promissory Note (“Note Amendment”) effective on August 1, 2015.  The Note Amendment extends the maturity date of the Senior Unsecured Promissory Note dated October 17, 2014, as amended, from July 31, 2015, to December 31, 2015.

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 Quarterly Report on Form 10-Q 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 Quarterly Report on Form 10-Q, 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 Securities and Exchange Commission (“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 of 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 and six months ended June 30, 2015, compared to the same periods in 2014, we refer to the prior periods 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 June 30, 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.

We are a leading domain name registry with a portfolio of 39 gTLDs acquired from ICANN’s expansion of gTLDs (the “New gTLD Program”). We began releasing our gTLDs into general availability in the marketplace beginning May 2014 and to date, we have launched 36 of our gTLDs into the market, including .NINJA, .ROCKS and .NEWS. By establishing our registry services business, we have built a distribution network of over 100 ICANN accredited registrars, including GoDaddy, eNom and Name.com, that offers our gTLD domain names to businesses and consumers. In addition to operating our own gTLD registries, we provide technical back‑end infrastructure services for new gTLD operator rights acquired by Donuts Inc. (“Donuts”), a third‑party new gTLD applicant (collectively with the New gTLD Program, 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. 

For the three months ended June 30, 2015, we had revenue of $52.2 million, net loss of $5.7 million and adjusted earnings before interest, income taxes, depreciation and amortization (“Adjusted EBITDA”) of $0.8 million; compared to revenue of $46.7 million, net loss of $3.5 million and Adjusted EBITDA of $(0.8) million for the three months ended June 30, 2014.

For the six months ended June 30, 2015, we had revenue of $102.7 million, net loss of $3.8 million and Adjusted EBITDA of $1.3 million; compared to revenue of $91.2 million, net loss of $7.4 million and Adjusted EBITDA of $(3.1) million for the six months ended June 30, 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.

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 on the record date received one share of Rightside common stock for every five shares of Demand Media common stock. 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 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 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 29% and 27% of our revenue for the three and six months ended June 30, 2015, and 24% for each of the three and 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.

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 and six months ended June 30, 2015, our revenue from our registry services was $1.9 million and $3.6 million, compared to $0.2 million and $0.3 million for the same periods in 2014.

For the six months ended June 30, 2015 and 2014, we made payments and deposits of $10.0 million and $12.0 million for gTLD applications under the New gTLD Program. These payments 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, 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.

Registrar Operating 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:

---

 

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):

 

 

 

 

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 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. Customer care expenses primarily consist of personnel-related costs

---

 

(including stock-based compensation expense) and are expensed as incurred. 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.

Sales and Marketing

Sales and marketing consists primarily of sales and marketing personnel-related 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 personnel-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-related 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 charges relating to 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.

Loss (Gain) on Other Assets, Net

Loss (gain) on other assets, net consists of gains and losses on withdrawals or settlement of costs related to 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. Interest expense includes amortization of deferred financing costs and debt discount.

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.

Income Tax Benefit

We are subject to income taxes principally in the United States, and certain other countries where we have a legal presence, including Ireland, Canada, Australia and Cayman Islands. 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 “Item 1. Financial Statements,” Note 1—Company Background, Separation from Demand Media and Basis of Presentation 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 U.S. generally accepted accounting principles (“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 and six months ended June 30, 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.

 

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):